Two things that provide comfort...and one thing that causes worry

There's a faint whiff of panic in the air this morning, as equities look horrible, bonds remain bid, and FX carry is getting carted out. The weekend G7 meeting was predictably lame, and the call for China to allow faster RMB appreciation has fallen on deaf ears. Indeed, over the past month USD/RMB is actually a bit higher....and that's before you add in the horribly negative carry available to foreign investors.

Macro Man's weekend post, wherein he articulated a broadly constructive medium-term outlook for equities, generated a fair amount of pushback. True, last week's earnings reports out of the US were rubbish, with the bulk of the weakness coming from domestic earnings. But Macro Man's large cap/small cap trade should help capture that dynamic.

It's also the case that oil is at stratosphereic levels. Yet the hit to consumers may be less than you think. Here in the UK (where, incidentally, Macro Man this morning had to scrape his windshield for the first time this autumn), petrol prices have yet to reach last year's highs....and that's with the Government's fuel duty escalators. In the US, meanwhile, a very notable divergence has occurred between the price of crude and the price of gasoline. The steady moves in gas prices offer some comfort that the world is not, in fact, coming to an end. Readers with an expertise in crack spreads should feel free to chime in with any insights they may have on the issue.
Another bedrock of the constructive risk-asset view is the ongoing glut of liquidity in financial markets. While last week's TIC data received mammoth amounts of attention, a less remarked-on development is that Fed custody holdings of Treasuries and Agencies have made a new all-time high. The CB buyers' strike in August is looking like a temporary phenomenon, and a continued CB demand-inspired decline in risk-free rates should enourage equity multiple expansions.
On the flip side, fundamentals do at the end of the day matter, and so does sentiment. And what seems clear is that the credit environment is deteriorating once again. The latest tranche of BBB- asset-backed turds, as shown below in the Markit chart, has plumbed new depths. As July and August showed, a significant weakening of credit conditions can lead to babies being chucked out with bathwater as people sell first and ask questions later.

So the market merits attention. In this environment it may be a delicate thing to filter out the noise and still capture signal. Short term pain is and may remain a reality. Macro Man's judgement is that it is too late to buy equity puts or yen calls-he has some of both already- but he could of course be wrong. The holy grail is a cheap hedge on something that has yet to perform.

An obvious candidate is gold, where Macro Man will sell his Dec 750 calls and replace them with 200 740 puts when the maket opens.

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October 22, 2007 at 1:46 PM ×

I spent the weekend pouring over charts, timeframes, seasonality, etc., and a few simple things stuck out when the US market goes down in a big way (sometimes for no apparent reason): 1) the yen vs. USD goes up & then goes way up if the Fed cuts, 2) the CAD vs. USD goes down, until the equities market stops going down, & 3) gold succumbs to steep, yet short-lived sell-offs until it decides on its own when to rally (i.e. not market dependent after the initial drop).

Coming into today, I was flat gold per my post last Monday morning when I thought gold would have a hard time breaking $770-$780 (Dec) without a correction - that still stands and now I see gold to $720 and maybe $700 in the next few weeks if not sooner. This will provide a tremendous buying opportunity when everyone will be talking about the death of gold and probably crude too. I can chart gold moving from $720 to $920-$1,000 between November - February 2008.

For my other two trades, per last Monday I'm long yen and was short the RUT where I'm now flat. As I like to be long instruments when the Fed is in cutting mode (or don't like being caught short I guess), my favorite trade is to be long Yen until 9400 (Dec basis).

I agree with Macro man on the current low interest rates being highly supportive of equities at some point, but I would tend to favor commodity equities when that time comes. If the interest rate dynamic changes somehow, i.e. Voldemort goes on strike, then that environment could produce a huge gold move that only the crazy gold bugs envision: $2,000-$3,000.

October 22, 2007 at 3:05 PM ×


I was wondering what source are you using to create your charts. Are you pulling in rough data and creating them yourself, or is there a provider? If you are pulling straight stats, are they from bloomberg?


Macro Man
October 22, 2007 at 9:46 PM ×

Appreciate the update, Corey. My take is that I don't really understand the price action I see, so it makes sense to trim a bit of risk. A Halloween "treat" from the Fed should prove sufficient to revive the reflation bandwagon, if only temporarily.

Andrei, unless noted otherwise, e.g. the Markit chart today, all graphs are of my own devising. Data generally comes from Bloomberg, but also on occasion Thomson Datastream. The TIC data I get from the Treasury.

October 24, 2007 at 6:06 AM ×

In re crack spreads, the simple and unenlightening answer is supply and demand. Viz and

*Why* supply is finally outpacing demand is another issue. My guess is that gasoline is showing the effects of demand erosion from normal seasonality with just a hint of pressure on working-class wallets, while distillates are being pressed ever-so-slightly by warm weather.