Tanned, rested, and ready

So, did I miss anything?

Unbelievable as it may seem to those who have sat through the carnage of the past couple of weeks, two of the bellwether asset prices in global finance would suggest 'not really.'

The S&P 500 closed last Friday at 1445.94, a smidge higher than the 1433 closing price on August 3, Macro Man's last day in the office.

Likewise, the current yield on the benchmark 10 year US Treasury bond is 4.69%, identical to the closing yield on August 3.

So nothing's really changed, right?

Clearly, that's not the case. There has been an enormous amount of financial, reputational, and psychological damage wrought over the past couple of weeks. Those suffering know who they are, and in many cases, so do the rest of us. Yet the lack of net change amongst the two most important financial asset prices in the US, the epicenter of the recent market earthquake, is telling. Macro Man is now tanned, rested and ready to step back into the fray, happily in considerably better financial and emotional shape than many other market participants.

Here are his first impressions of the recent carnage and where we stand today:

1) While more equity volatility is to be expected, there's a good chance we've seen the low in the S&P 500.

This conclusion, it must be said, has nothing to do with sifting through the trade blotters and performance details of suffering hedge funds, a projection of consumer spending over the next six months, or a firmly held belief that the Fed will cut rates 0.50% in September. Rather, it is based on his reading of the chart, which is his only tool for objectively assessing the price action while he was gone.

The S&P 500 has sketched out a pretty textbook A-B-C correction, albeit a deeper one than originally anticipated. The A wave, from the highs down to 1427, represented an 8.2% decline. The B wave, back to 1503, retracement almost exactly 61.8% of the A wave. And Wave C, that most painful of waves, has had a peak to trough decline of 8.9%.

That Wave A and Wave C are roughly equal in magnitude is a good sign that the correction has fulfilled its objective. Moreover, the bottom was marked by a bullish candlestick, with a long downward wick and a small positive daily return. That is generally a reversal signal. That the bounce from Wave C has eclipsed the Wave A low also suggests that the pattern will not morph into a more bearish type structure.

From here, Macro Man would expect a bit more upside, culminating in failure, and then a noisy downmove that fails somewhere around 1400, give or take. That will likely be the dip to buy.
2) The Fed has changed its tune, but that doesn't guarantee a rate cut

Jim Cramer's rants remain misplaced, in Macro Man's view. Natural selection mandates that a normalization of volatility conditions will weed out some traders and portfolio managers who are ill-equipped to deal with the new reality, just as natural selection has dictated that US autoworkers have seen job losses because of Detroit's inability to manufacture high-quality automobiles at a competitive price. Cutting rates because some hedge funds are closing would be a grave, grave error, and merely propagate the next financial asset bubble.

However, it is also the case that a permanent increase in borrowing costs, lower household equity wealth (on top of continued reductions in household housing wealth) , and the recent inability of the money markets to clear does represent new information. The move in the discount rate looked largely symbolic to Macro Man, and it is possible and perhaps even likely that it will eventually be seen as such.

More important was the change in bias, reflecting the potentially pernicious impact of higher borrowing costs (which seems likely to be a feature of the landscape for some time) and lower household equity wealth (which, if equities remain weak, would no longer offset housing) on economic growth and employment.

However, it doesn't seem quite right to assume that a September cut is a done deal, as some investors mistakenly did immediately after the August meeting. In a sense, the surest way to a rate cut is to experience more pain; the more pleasure that markets feel over the next four weeks, the less likely a rate cut (which is presumably the whole rationale for the risk asset rebound) is to pan out.

All the more reason, then, to expect more volatility over the next few weeks.

3) As noted previously, a lower Sharpe ratio for risk trades does not necessarily mean a negative return for risk trades

Macro Man has debated internally this morning whether we have seen the 'death of the carry trade' and/or the 'death of the equity dip buyers.' His answer to both of those questions was 'no.'

Liquidity has, in his view, been the primary explanatory variable in the superb performance of most risk asset markets over the past several years. And while it seems quite clear that liquidity conditions are less easy now than they have been in some time, it does not necessarily follow that they are restrictive.

Yes, cash markets have seized up, but Macro Man would suggest that that was down extreme risk aversion in the wake of the credit crunch, not necessarily because of insufficient liquidity. To put it another way, just because liquidity was the solution does not necessarily mean that it was the problem.

Global liquidity conditions remain moderately easy, in Macro Man's assessment, because of the EM central banks- i.e. the BRICS. That China was rumoured to be the buyer of last resort for Bear Stears tells you much of what you need to now. VIG has plenty of cash and no internal risk manager that shrieks every 20 minutes or 2% (whichever comes first.) As such, they and other SWFs are sitting in the catbird seat; private sector investors have been selling assets almost regardless of price, which naturally sets up some nice bargains.

Should equity and other risk asset weakness continue, Macro Man would expect these guys (and others, such as Warren Buffett) to step in and starting buying up quality assets on the cheap. And, that, ulimately, should help drive decent if not spectacular risk asset returns moving forwards.

So what if the Bernanke put is struck lower than the Greenspan put; Gentle Ben is also long the Voldemort put.

There was some portfolio activity during Macro Man's absence, per the post from August 3:

* He bought 120,000 shares of XHB at 25.50

* He sold 70,000 shares of SPY at 150 (whew!)

* He bought $15 million USD/JPY at 117 spot basis

* The DAX puts expired

* The XHB puts expired

Also note that the comments section now requires word verification due to the sad recent emergence of spam posts from online purveyors of pharmaceuticals.

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Click here for comments
August 20, 2007 at 2:37 PM ×

“ The move in the discount rate looked largely symbolic to Macro Man, and it is possible and perhaps even likely that it will eventually be seen as such.”

Certainly agree. It’s a promise of cheaper last resort bank funding if things get a lot worse – contingency funding of sorts, but not particularly impacting in an operational sense. The amount of window borrowing is typically miniscule relative to the size of the banking system. It’s more importantly a way for the Fed to buy more time to see if credit stress shows signs of stabilizing or deteriorating further. In that sense, the Fed has duped the market in the short term. Once the market fully comprehends the symbolism, I’m not sure the Fed will get away with just another discount rate cut without a fed funds rate cut at the same time.

August 20, 2007 at 3:38 PM ×

What did you miss? Just a whole bunch of weeping and wailing and gnashing of teeth and the reaction. Ideal time for a holiday, which maybe gives you a clearer. Some may wish the Fedheads had taken one.

August 20, 2007 at 5:47 PM ×

Welcome back. Yes, MM appears to have relaxed somewhat. If it's of any interest, though, we here are probably willing to book his version of outcome. The past few weeks is being sold as an event, but it may, in fact, be an environment.

August 20, 2007 at 8:47 PM ×


Do you have any color on the move in Nymex natural gas today? The mainstream press is blaming it completely on Hurricane Dean missing the production facilities in the gulf. However, there are speculations that a big player that was hoping to liquidate money losing positions into a hurricane induced bounce finally gave up and could be in some serious trouble. The price action certainly suggests some serious dumping.

Macro Man
August 20, 2007 at 9:59 PM ×

To be honest, I don't have any particular insight there. That Dean was originally feared to plow through the Gulf but veered south would have been my guess, and I suppose it's entirely possible that a big spec is liquidating as a result. But your guess is as good as mine there.

August 21, 2007 at 12:24 AM ×

Not sure about your comment regarding the S&P low. We may see a rally to 1465 (maybe 1520) followed by another sharp sell-off which will take out the bottom of 1380.

Market may have a much more decline in its future and we may not see a bottom till Q1 2008.