With Christmas only hours away we thought it appropriate to give Santa something to mull over as he flies around the world giving all the good kids presents.  Here is our Christmas list and to hoping that we were good enough this year to get any of them.

-European leaders to realize that this is more than a liquidity problem.  Alternatively for European leaders to lead instead of the ridiculous statements that have been coming out of that continent for over  year now.

-Democrats and Republicans to find some competence.  Currently they seem to be trying to make stupid seem smart.  We realize that this is a tall order for Santa but if we got this present we would be content for years.

-Correlations to drop.  This past year everything has been trading with a correlation of either 1 or -1, neither of which is conducive to directional trading.  We like buying good industry groups, shorting bad ones, buying certain commodities, and selling others.  This past year has had us either buying “risk” assets or buying USD and Treasuries.  Santa please fix it as this is getting old.

-For the hyper inflationistas to STFU.  Yeah we said it.  I am completely sick of people like Peter Schiff coming on my TV and radio to tell me that hyper inflation is hiding right around the corner.  You have been yelling for four years and so far we have had mild inflation at best.  Please Santa if you would like to shut these people up it would be a great Christmas and New Year.

-Teach financial writers how to write headlines.  ”Market is down .01% on housing numbers.”  If the market barely moved then why do you have to apply a reason for it?  Just say that the market is up x% today and then list off what happened that day.  We don’t need a made up reason that only annoys us.

-An Energy Policy.  We realize that this present is as hard to deliver.  After all since WW2 every single president has said that we will be energy independent in X amount of years and yet after they are in office they do nothing, absolutely nothing.  Even though we realize that this present can’t fit under the tree it would be amazing to finally get it.

That’s it.  We already have our Red Ryder BB gun, our Radio Flyer wagon, a snuggy, etc.  This Christmas we would love for some of these problems to at least be addressed if not solved.  World Peace would also be awesome but we would be more than happy to settle for any and/or all of the above.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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  Not only did China stall out in mid-2009 but it has now surpassed the lows set in mid-2010.

Shanghai Index

 One of many indicators pointing to more troubles ahead, the port data out of LA and Long Beach is showing that trade has been slowing down for some time.  Usually traffic peaks in August-October but this year we hit a high in May that we were not able to break.

LA and Long Beach Port Traffic

The bottom line is that Europe may be getting all of the headlines but China has been slowing, is still slowing, and looks as if it will continue to slow.  With Europe and China basically in recession how much longer can the United States hold out?

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Right now we think it highly likely that going forward we see an increase in the rate of economic deterioration.  Europe is already in a mess but the economy in the United States is now showing signs of its last gasp of growth.  One indicator that we track is the Citi Economic Surprise Index.  In the chart below you can see that economic numbers have been coming in very strong for the past few months.  Based upon previous history it is safe to say that we have peaked or are very near peaking and that economic numbers going forward should start to turn lower.

Citi Economic Surprise Index USD and G-10

Not only are economic numbers expected to turn lower but we are also seeing several signs that inflation is dropping.  One relationship that we follow closely is that of the CRB Raw Industrials Index against the SP500.  As you can see in the chart below the two are usually very correlated.  When the industrials are moving higher stocks usually follow and when they turn down stocks tend to do the same.  Right now there is a disconnect, one that we expect to be resolved with the SP500 moving lower.

CRB Raw Industrials Index and SP500

This relationship matters because if inflation moves lower the stock market will as well.  We can see this very clearly in the next chart where we have overlaid the weekly SP500 with the 10-Yr TIPS breakeven rate.  As you can see these have a very tight relationship.  What you can’t see is that this relationship goes back long before the crisis.  When inflation expectations rise the stock market rises and when they fall the market falls.

SP500 and 10-Yr Breakeven Rate

Other signs that inflation is not upon are that government bond yields are hovering around historic lows.  As you can see in the next chart the 2-Year Treasury yield has been low and headed lower.  Despite all the hype regarding hyperinflation we have not seen any of it, and based upon the messages from the bond market we are not seeing it anytime soon.  In case you are wondering we are seeing the same thing farther out on the curve with 10 and 30 year yields also near their lows.

2-Yr US Treasury Yield

Another sign that we have been following is this chart of the Shanghai composite and the CRB index.  As you can see the two indexes peaked within two weeks of each other and have been steadily working their way lower for the past eight months.  As the nation of commodity stockpiling has slowed down so have their stockpiles.  As this huge underlying commodity bid has vanished it has allowed industrial commodities to drop.

Shanghai Composite and CRB Index

Whether it becomes an all out crash, ala 2008, or not is not known but we are confident that the global slowdown will continue.  So what have we done with this view?  In our model portfolio we are short the AUD/USD as we expect the Australian Dollar to move lower as commodity prices and Asian demand continues to falter.  We are short the EUR/USD via options in a trade we placed back in August.  Recently we bought the USD/CHF as we expect the Swiss Franc to weaken considerably from here.  We are also short the SP500 via options and long the Lehman/Barclays Aggregate index which is highly weighted with US Treasuries and investment grade credits.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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While the crisis in Europe and the slowdown in the United States seems to get all of the attention lately, the other big story is of course China.  China has been a leading indicator for global markets for some time now and as you can see in the chart, and hopefully have noticed for some time now, they peaked over a year ago.  We are seeing the same signs in raw materials such as copper and oil just as we are seeing them in everything but US Dollars and US Treasuries.  Until we see a firming up in either the US, Europe, or emerging markets most notably China we won’t be seeing a lasting rebound in global equity markets.

Shanghai Stock Exchange and SP500

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Many new traders spend a lot of time looking for the holy grail of trading.  The secret Gann angle, the right wave count, the perfect valuation model, etc.  What we have found is that while a lot of new and even old traders spend countless hours searching for the holy grail very few, if any, successful traders have found it.  Instead they figure out at some time or another that instead of a magical tool they should spend their time looking for useful tools that do a reasonable job of either lowering risk, increasing return, or increasing their hit rate.

One tool that we have found useful in looking out towards the future is that of the ECRI Weekly Leading Index.  While by no means a holy grail it has historically done a fairly good job at forecasting stock market returns.  As you can see in the chart below it has been very accurate over the past few years as it has led the SP500 by several months at important turning points.  (Click on chart to enlarge)

SP500 Year Over Year % Change and ECRI WLI Growth Rate

So what is the WLI saying right now?  Going along with our long held deflation thesis the WLI is now pointing towards slower growth in both the economy and particularly in the so-called “risk markets”.  This of course matches what we are seeing in several other indicators and relationships that we follow.  We have covered a few indicators in previous posts such as how junk spreads point to higher unemployment claims and how the PMI is pointing towards slower growth.  In addition to these we are seeing many other signs such as the drop in commodities, take a look at the CRB Raw Materials Index, and in the rise of the US Dollar.  Of course none of these are holy grails, just signposts in the fog.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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We saw this headline-

August is another cruel month for hedge funds-(Reuters) – Most hedge funds lost money again in August as hundreds of managers, including some of the industry’s best-known names, stumbled when stock markets swooned anew.

-and then we laughed.

Hedge Funds are no more an asset class than mutual funds are.  There are several “general” classes of funds investing in anything from stocks to bonds to art.  Long, short, long and short, arbitrage, levered, etc.  There are a gazillion different strategies that are employed so headlines like the above are not helpful for much more then a useless sound bite.  But onto the part that we actually liked.

One line mentioned how Global Macro was up 2.16% for the month of August which would indicate something less then cruelty for hedge funds, including some of the industry’s best-known names, but hey that’s just us.  Anyways how is Global Macro actually doing?  Well depending upon which macro index you use the numbers will be a bit different but for the most part this specific corner of the market is flat give or take a percent or so.  While we, we being our newsletter The Macro Trader, do not try and hug our benchmark it would appear as though this year we have.  In the table and chart below we show how our newsletter had done against the HFRXM and SP500 indexes.  The table has the raw numbers and the chart has the performance of $1,000 year to date. (Click on charts and tables to enlarge)

Performance

$1,000 Invested Year To Date

How do we explain our relatively high correlation to the HFRXM Macro Index?  Well we think that the next chart probably does a good job of answering this question.  But in case the chart is not clear enough the answer is risk management.  Global macro as an asset class has long held up well in any market with a penchant for bad markets.  In other words we tend to outperform in bad markets and do decent in good markets.  In the chart below you can see how our drawdowns compare to the SP500. (Click on chart to enlarge)

Drawdowns Year To Date

A few other observations that may or may not have anything at all to do with the initial subject of this post-

-We have seen few opportunities this year that have warranted an oversize allocation

-The SP500 is way to risky for the returns that it generates

-If markets are efficient how was the SP500 above 1250 for almost a year and then at 1100 a few weeks later

-There is no reason that you need to do what everyone else is doing

-Bill Gross is smart but he too can be wrong

-Warren B is also smart and can also be wrong

-95% of news is noise but we read it all in hopes of recognizing the 5%

-Anyone with the nickname Helicopter Ben is just looking for reasons to drop money from the sky

-If you aren’t at least semi-comfortable in Excel there is a high likelihood that you do not even know what due diligence is

-It is clean looking but so far Google+ is not Facebook

-More Money Than God is a great book

-The New Market Wizard interview of Stanley Druckenmiller is read by this author at least once every month or two

-Major bottoms and tops take more then a few days to form

-Yellowstone is awesome and everyone in America should go at least once every five years

Have a great Labor Day Weekend!!!!!!!!!!!!!!

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long Friday both the day and the excellent song by Rebecca Black .

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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One group of indicators that we follow quite closely are yield spreads.  They work as great risk indicators as well as  economic indicators. In the case of junk spreads they tend to lead rather than coincide or lag the overall economy.  One area where they really shine is at the darker end of the economy.  As you can see in the chart below junk spreads tend to lead the initial unemployment claims by anywhere from two-five months.  For the past four months junk spreads have been inching higher and higher as the economy has noticeably weakened.  What does this mean?  Well if the correlation holds up then we would expect initial claims to move higher.  This would go along well with most of the indicators that we are seeing such as the various manufacturing indexes pointing lower, with the exception of the Chicago PMI, as most indicators whether economic or market are pointing to a weaker economy. (Click on chart to enlarge)

Junk Spreads and Initial Unemployment Claims

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries and Gold.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Remember the anti-drug commercials with the frying pan and the egg?  As of late it would appear as though investors have forgotten that you are supposed to say NO to drugs, especially during market hours.  In the chart below we have a rolling 21-Day Standard Deviation for the SP500 as well as the 50-Day moving average of that number.  On a one month basis we are at the second highest reading in over 10 years, second only to the crash of 2008.  Looking at the smoothed 50-day moving average we are actually at a new high. The close to close movement is running at an average of 2.34%. (Click on chart to enlarge)

SP500 Rolling 21-Day Standard Deviation

How can you use this information?  There are a few trading strategies you can investigate from this such as selling options or putting on some arbitrage positions betting the spreads will come back in.  For most investors however the more important thing to see here is that risk management is not only paramount to your investing/trading but it is a moving target.  As a general rule when volatility is high, or extremely high as the case may be, you would want to look at using relatively loose stops, scaling down your position sizes, lowering your leverage, raising cash, etc.  While most, maybe all, long time traders already use good risk management we have found that far to many new traders don’t adjust their trading when the market gets stoned.   Consequently they lose far more money then they have too.  Following tools like this can help you to smooth out your returns and stay in the game.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We always use risk management and own the domain name riskfreak.com.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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We follow several different types of indicators to include economic, valuation, sentiment, technical, etc. but one of the most important and powerful family of indicators would be monetary indicators.  Monetary indicators allow us to measure liquidity which of course affects all markets.  Historically some of the best gauges of liquidity have been interest rate trends, interest rates, margin debt, public offerings, money supply, etc.  One of the most powerful indicators is Fed policy and the tools it uses to put their policy into effect.  We have all heard the saying “dont fight the Fed” and while many market sayings are cliche this one carries weight.

During this cycle the Fed, in addition to its zero interest rate policy ZIRP, has been using quantitative easing to inject money into the economy in an effort to “prime the pump” and get people spending.  Unfortunately there is little if any evidence that any of this money has been finding its way to main street. Instead it has been going into financial markets and in the process has helped fuel some bubbles.  While the term bubble has been overused as of late we are using it in the sense that without QE1 and QE2 most financial markets would be a lot lower then they are today or a few weeks ago.

All of this brings us to the current situation.  As you can see in the chart below whenever the Fed is actively buying or selling securities the market goes up or down.  From mid 2005-2007 the Fed was buying small quantities and the market, already in an uptrend, continued higher with muted volatility.  Later during the early stages of the crisis, and after the Bear Stearns breakdown, the Fed decided in all its wisdom to sell some of its securities taking liquidity out of the market at the exact time that they should have been adding it.  While not the cause of the crash it did further enable it.  In early 2009 the Fed began QE1 at the same time that the government passed TARP.  Between these two massive stimuli the market was able to shoot higher.  While the argument can be made that the pump was primed and brought investors back into the market it is hard not to notice what happened once the Fed stopped buying.  As you can see the correction in mid 2010 coincided with the end of QE1.  As this correction got going and with the backdrop of high unemployment and a still sluggish economy the Fed embarked on QE2.  As you can see the market once again started to move higher.  Well guess what?  Since the Fed stopped buying the market has consolidated and as you have likely noticed over the past few weeks has started to crash moving down 18% in just two weeks.  (Click on chart to enlarge)

POMO and SP500

While it is true that there are other factors at work it is obvious to everyone except maybe the Fed that they have been the buyer and until the economy really does improve the risk markets will fall anytime that they back away.  With the statement earlier this week that the Fed is going to maintain a ZIRP until at least 2013 we are also led to expect an eventual announcement of QE3.  While we don’t think that it will help the economy and might actually hurt it, we do think that in the framework of Helicopter Ben’s mind this is the only course of action.  If we break lower by 5-10% expect the Fed to come out and announce another round of purchasing.  Oh and one more thing, don’t fight the Fed.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT  and gold via GLD.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Despite the countless hours spent by the media talking up the debt ceiling debates and its effects on financial markets the real concern amongst actual investors has been the prospects of actual economic growth.  As we have stated in the newsletter as well as in previous posts on the blog we do not think, and bond yields have agreed, that anyone is actually scared of a default.  So despite the misguided hand of the media bonds and other financial markets are moving based upon future growth potential or the lack thereof.

On Monday we got a PMI number that came in not just low but drastically lower than expected and very near the negative growth line.  The PMI index is a diffusion index meaning that if it is above 50 then the manufacturing sector is growing and if it is below 50 then the manufacturing sector is contracting.  So how bad was the number?  Well last month PMI came in at 55.3 and this month it came in at 50.9 which means that manufacturing is barely above the zero line.  You can see the drop more clearly by looking at the chart below. (Click on chart to enlarge)

ISM PMI

As you can see the drop from the February peak reading of 61.4 has been fairly steady and swift as the manufacturing sector has been slowing down despite many economists expecting strength in the economy and a continued recovery.  Of course as long time readers know we have been less than impressed with the economy ever since the bottom back in March 2009.  The market rebound was impressive but the real economy has been very mediocre.   All this has weighed heavily on the markets as of late and since February bonds have been moving higher.  At the same time and with the help of he sideshow in Washington the stock market has taken a hard and swift hit as of late and is starting to get more in line with the actual economy.

One chart that we like to follow is that of the SP500 year over year growth rate overlaid with the PMI data.  As you can see the PMI is a good rough business cycle indicator.  While not perfect by any means it does a great job of tracking what the market is expecting in the medium term.  As you can see right now the PMI is pointing lower and it seems as though stocks are following its lead. (Click on chart to enlarge)

PMI and SP500 YoY % Change

Right now many of our economic indicators are saying to lighten up if not exit equities all together.  While this has been the case for a while the market via trend, breadth, and sentiment is coming around to the same conclusion, and that is that the economy is weak and prospects are not good for a favorable risk to reward environment.  Do you really want to sit in a market hoping to eek out meager gains of maybe 5% over the next year but with potential and relatively likely downside of 15-20%?  We don’t and instead have been going into assets that do well in times of slow economic growth.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT and also hold some small long positions in US equities.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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