We run several different models that help us to determine what the market is favoring in regards to style-growth/value and size-market cap and right now they are pointing to a potential mean reversion trade going long Large Cap Value against Small Cap Growth.

Looking at the chart below you can see that over essentially the last decade the Russell 1000 Value and Russell 2000 Growth ratio has reached extremes around 1.00 and .82.  We are obviously nearing the lower end of the range where the Russell 1000 Value index typically takes over. (Click on chart to enlarge)

Russell 1000 Value/Russell 1000 Growth ETF Ratio

Since these types of mean reversion trades can last for a few years at a time it is important to look at as much data as possible.  Looking at monthly Russell data from 1979 to now you can see in the lower panel below that when normalized using a 36 month moving average that the ratio is more than one standard deviation away from the norm.  While it has been, and could definitely become more extended we are looking at this as a potential pairs trade using the ETF’s IWD for the Russell 1000 Value and IWO for the Russell 2000 Growth indexes. (Click on chart to enlarge)

R1KV/R2KG Ratio and Mean Reversion Charts

We also like the fundamentals of this trade.  If as we believe we are going to see what we are calling a slowth (slow growth) period for at least the next year or so and possibly for the next five plus years (what PIMCO calls the “new normal”) it would follow that the market would start to back out of small cap growth stocks and go to areas where there is more safety of principal as well as decent and reliable dividends.   This area typically is large cap value where most of the companies are diversified across the globe, across product lines, and have large cash positions.  In addition to the macro landscape, on a valuation/expected returns standpoint this area is also favored by some well known asset class return forecasts such as the GMO 7-Yr forecast seen in the chart below. (Click on chart to enlarge)

GMO 7-Yr Forecasts for US Stocks

Disclaimer-The Macro Trader currently does not hold any of these securities.

Happy Trading,

Dave@TheMacroTrader.com

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After a 72% move higher in the SP500 a lot of bears are saying that the market has gone far enough and that we are due for a new crash that will take us back to and in some cases past the lows of 2008.  While a crash is possible and probably justified we are instead looking for something along the lines of a modest pullback to maybe a 10% correction.

One of our favorite sentiment indicators is that of put/call ratios.  We use the 5-day equity only put call ratio to warn of high risk areas and to point our low risk areas.  As you can see in the chart below we are currently at a reading of .51 which is not only below out “high risk” threshold but is also the lowest reading in over a year.  While the signal could be wrong it is hard to argue that options traders are not overly one sided right now.

5-Day Equity Put/Call Ratio and SP500

In case you want to see more bearish sentiment look no further than the 10-day total put/call ratio.  Anything below .75 is typically considered very bearish and right now we have a reading of .68 which is the lowest reading in two years.  Needless to say this indicator is also showing that option traders are too bullish.

10-Day Total Put/Call Ratio and SP500

One price based indicator that we use at The Macro Trader fairly extensively is what we call a reversion to the mean chart.  Basically it takes a long term reading of the market, normalizes it, and then gives an overbought/oversold reading.  We then plot one and two standard deviation lines above and below the mean.  As you an see in the chart below we are about 1.5 standard deviations above the mean which is significantly higher than we saw for most of the 2002-2007 bull market suggesting that things are a bit overdone.

SP500 RTM Chart

Add to all of this a TD Sequential sell signal a few day ago and how near we are to a 50% retracement of the crash and things look less like a buying opportunity and more like a selling/shorting opportunity.  Again we are not calling for a new low, just a pullback/correction.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is short the SPY-Sp500 ETF

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We keep hearing that long term Treasury Bonds are going to tank and that we need to get short before they fall off a cliff.  While this may very well happen, we doubt that it occurs anytime soon.  We are not alone in this view as Bill Gross and the gang at PIMCO seem to agree.  While some argue with his view of a new slow growth period the market does not seem to have an issue with it.  Not only has Helicopter Ben said that the Fed is not raising rates anytime soon, but market indicators are saying the same thing.

One Treasury indicator that we use is the MOVE index which is a  “yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of volatilities on the CT2, CT5, CT10, and CT30.”  As you can see in the chart below it has been falling since July as the market has come to the realization that we are in for a slow growth period and that the Fed is not going to raise rates any time soon.

MOVE Index

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is currently long AGG

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Interest Rates and the MOVE Index
URL: http://www.themacrotrader.com/2009/11/18/interest-rates-move-index/

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One of the largest problems that seems to be getting little attention is that of the pension fund crisis.  While it has yet to hit in earnest it is definitely upon us.  The basic problem is that due to poor returns, both nominal and adjusted for inflation, pension funds are extremely underfunded.  While everyone in the investment world seems to know about the problem it does not seem as though anyone is talking about it.  So here are some charts that show the problem with the standard pension fund.

In the chart below we are looking at someone who started at the beginning of 1995 investing $1,000 a month, in a 70/30 stock bond mix, rebalanced monthly.  We are using real returns on the SP500 and on the Dow Jones Corporate Bond Index as our investment proxies.  Also in the chart is the same $1,000 a month invested solely in T-Bills.  As you can see T-Bills are actually slightly ahead and have had very little volatility and is at $184,120.  The 70/30 mix on the other hand has had a rocky path and is at $181,173.20.  Essentially the typical 70/30 stock bond mix in real terms has returned virtually nothing.  You could have saved the same $1,000 a month and put it in T-Bills and you would be ahead after nearly 15 years. (Click on chart twice to enlarge)

70/30 Stock Bond Real Return $1,000/Month Rebalanced Monthly

We could write about this topic for days and will in fact cover it more in future posts but the problem is obvious.  Pension funds are underfunded and there is no way in hell that without a major bailout from the government that they will be able to meet their liabilities.  So add this to the mix of current spending habits, unfunded liabilities of medicaid and social security, and the other retiree problem.

What is the “other” retiree problem?  The primary issue is that if you have a 401K, IRA, or other non-pension fund retirement plan you are likely under water.  Up until this year when investors, along with the Fed, have been flocking into bonds, most investors have been primarily invested in stocks.  How has that done?  Well in nominal terms it has been less than great.  If you were invested in an index fund over the last 10 years you would still be under water.  In real terms things get even worse.

In the two charts below you can see the SP500 from 1950 to now adjusted for inflation as well as the % drawdown.  As you can see we are still very much under water.  In fact as of the end of October the indexer is down -45.51% from the highs reached back in August of 2000. (Click chart twice to enlarge)

SP500 Real Returns and % DrawDown

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We wish there was a way to short Pension Funds.

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Real Returns, The Pension Fund Crisis, and Buy and Hold
URL: http://www.themacrotrader.com/2009/11/12/real-returns-and-the-pension-fund-crisis/

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Since the start of our newsletter we have been using a relative strength table that looked at Fidelity Select Sector Funds to show what industry groups are leading and which groups are lagging.  The relative strength calculation is similar to the style used by Bill Oneil and IBD but is slightly shorter term in nature. We used the Fido Funds due the their price history and breadth of different groups.  Now that there are not only enough different industry group ETF’s, but also the needed price history we have revamped the model to use ETF’s instead.

We publish one list for United States industry groups and one that is focused on global ETF’s with several country and a few sector specific ETF’s.  These tables are valuable in a few ways.  One is that we have developed a trading model based upon them that uses the rankings along with buy, sell, and money management rules.  Over time this model has beaten the market with far less risk.  The other way that these tables are useful is that they show you what is strong and what is weak.

While this concept is not rocket science we are consistently surprised how little attention it is given by other traders.  By using relative strength we can see what is really working and where investors are going.  Many times the supposed “hot sector” is not really that hot.  By looking at the tables we can see what is really working and what is not.  For instance looking at the Global RS Ranking table below you can see the leaders and the laggards.  While it is no surprise that Brazil is at the top when was the last time you saw someone on CNBC telling you to buy Indonesia or Turkey?  Yeah we missed that segment as well. (click on table twice to enlarge)

Global RS Rankings

Right now this table is confirming to us that for the most part developed nations are weak and should be sold and that emerging markets are strong and should be bought.  No, this is not the first or the only tool that told us this same thing but it is one way in which we can systematically be long the best areas of the world and short the worst areas of the world.  It also gives us a road map of where investors are putting their money and where they are withdrawing it.

Another point worth noting is that while we are starting to run this as a “standalone system,” the system represents only a part of our portfolio.  In our trading and our newsletter model portfolio we use several different methods in order to build a less correlated portfolio trading across asset classes.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are long EWZ-Brazil, EWT-Taiwan, and EWM-Malaysia

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Macro Trading Using Relative Stength
URL: http://www.themacrotrader.com/2009/11/10/macro-trading-relative-strength/

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After being the largest hedge fund strategy in 1990 representing 71% of the overall hedge fund assets global macro has shrunk and now only represents about 15% of total assets.  While most people assume that this dropoff in assets was due to poor performance the numbers actually show a totally different story.  In fact according to the Credit Suisse/Tremont Hedge Fund Indexes, global macro has been the number one investment strategy with a total return of 502% from 1994 through June 2009.  Compare that with a total return of 335% from long short equity or 321% from event driven funds.

Of course most investors also have a misguided perception that every trade is like the trade that “broke the Bank of England.”  That trade in 1992 made Soros and his Quantum Fund over $1 Billion in a few days and garnered a lot of publicity.  The funny thing is that in a study done later by the IMF it was shown that if anything hedge funds shorting the Pound actually dampened the effects.  And in interviews since it is obvious that while the position size was huge the realistic downside was not.  Yes, Soros had a $10 Billion position on that week but thats not the right way to look at it.  Instead he and his portfolio manager Stanley Druckenmiller figured that if they were wrong they would lose a few hundred million at worst and that if they were right they would earn a billion or more.  Anyone who has traded for any period of time will tell you that a trade that has a risk to reward ratio of 5:1 is a fantastic trade.  As you can see, not only did Soros and Druckenmiller not break a bank, but they also did not take a huge outsized risk.

So while most investors think that global macro is made up of a bunch of drunk cowboys that are always swinging for the fences the real stories, and the numbers behind them do not bear this out.  In fact if you look at what global macro has actually done you will see that macro traders are some of the best risk managers in the world.  In the chart below we have the Barclays Group Global Macro Index and the SP500.  Starting with $1000 from 1997 to the end of July 2009 the Global Macro Index delivered 219.77% with a worst case drawdown of 6.24%.  Contrast that with the SP500 which from 1997 tot he end of July 2009 only delivered 33.30% with a worst case drawdown of -52.56%. (click on chart to enlarge)

Barclays Group Global Macro Index Vs. SP500 Jan 1997-July 2009

The above chart shows how well that global macro has done in absolute terms since 1997 but what about the risk that they took to achive these results?  Well as you an see in the chart the dips in the macro index look a lot shallower and shorter then the dips in the SP500.  Looking at the actual drawdowns shows that this is in fact the case.

In the chart below we have the drawdowns of the SP500 and then the drawdowns of the Barclays Group Global Macro Index.  As you can see the SP500 has had two massive drawdowns in the last 12 years.  The SP500 dropped over -46% in 2002 and then dropped over -52% in 2008.  In fact as of the end of July 2009 the SP500 is still down over -36%.  Contrast this with the Barclays Global macro Index which has had a worst case drawdown of -6.42% and is currently only -3.22% away from new equity highs. (click on chart to enlarge)

Barclays Group Global Macro Index and SP500 drawdowns Jan 1997-July 2009

As you can see the perception of the global macro trader as a gunslinging cowboy is anything but the truth.  Instead they are some of the most consistent and risk adverse traders in the world.  In fact some of the hedge funds with the longest, and best, track records are global macro funds.  Three of the best and longest running global macro funds are Soros and his Quantum fund which have delivered north of 30% annually since 1967, Bruce Kovner and Caxton Associates have delivered over 25% annually since 1983, and Paul Tudor Jones and his BVI Global Fund has returned 23% annually since 1986.  Obviously these are some of the best of the best but can you name three other fund managers with returns like this, that also follow the same basic strategy?

So what enables global macro to do so well when everyone else is rapidly losing money?  Global macro does well because of the fact that it is entirely opportunistic.  Macro does not pigeonhole an investor into US equities or emerging market bonds, or European event arbitrage.  Instead macro enables investors to go wherever and whenever.  By trading all four major asset classes not only can macro traders generate uncorrelated returns but can also see dislocations that other investors miss, or in some cases are forced to miss.  For example if a long/short equity manager thinks that we are on the verge of hyperinflation and wants to be long gold he has two different options.  He can go long companies that should do well in the face of inflation and then go short stocks that should do poorly.  The macro trader on the other hand has far more flexibility and can go long commodities, go long and short currencies, go short regular bonds, long TIPS, and can still go long and short stocks.  The opportunity set is much larger for the global macro trader then it is for the long/short equity manager.

Going forward we see no reason to believe that global macro will not continue to outperform.  When we are in a bubble and everyone is making money, macro will perform inline or slightly underperform, and when things go crazy and everyone else is losing money global macro will be generating positive returns.

Happy Trading,

Dave@TheMacroTrader.com

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Global Macro Trading
URL: http://www.themacrotrader.com/2009/08/05/global-macro-trading/

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For the second week in a row our equity risk index ticked up again, this time to a reading of 31.25%. In this case it was due to one of the many breadth indicators that we use that comes up with a signal based on a mix of NASDAQ up and down volume. After months and months of horrible breadth we are finally starting to see some near signals in a few of our models. If the market can advance a bit more they will likely trigger, therefore causing the risk index to become more bullish.

Our models are made up of several different indicators. We look at trend, breadth, sentiment, liquidity, valuations, economic indicators, trend duration, and cycle analysis to put together the risk index for each of three different asset classes as well as for our individual trading models. While our trading involves a significant amount of discretion we have found that models are vital in ensuring consistent gains and even more importantly avoiding large losses.

If you are interested in learning more about what we do feel free to e-mail us at  Editor@TheMacroTrader.com with “Trial” in the subject line to receive a free 1-month trial of our bi-weekly newsletter with weekly updates.

Happy Trading,
The Macro Trader

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This week we had the first uptick in the equity risk index in a month. The primary reason that it moved up was due to some sentiment indicators such as the Investors Intelligence Bull Bear Ratio hitting levels that historically have provided good buying opportunities.

Of course if you look at the chart you can tell that it is still very low. A low level in the risk index signifies a market that is very unattractive, whereas a very high level is bullish. Right now there is a ton of bad data out there and only a few things that are bullish. While we have not ruled it out we do not feel like this is the second coming. Eventually US Equities will start to look attractive again and we will allocate accordingly. We gauge risk first and then look at return.

Happy Trading,
The Macro Trader

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Our US equity risk index has been at the same level for three weeks now.  Not too much has changed.  We have a few valuation and sentiment indicators that are bullish and everything else is bearish which does not bode well for the market.  As we have stated in our newsletter we are short term positive and long term bearish.

Again the higher the index level the more bullish we get and conversely the lower the level gets the more bearish we get.

macrotrader.com/wp-content/uploads/2008/11/stockriskindex.jpg” title=”Stock market risk index”>

We hope that you find the weekly equity risk index useful.  In our newsletter we also provide risk indexes for fixed income and precious metals.  These are but a few of our proprietary models that we use to help guide us in our trading.

Happy Trading,

The Macro Trader

P.S. We are currently running a 1-Month free trial offer.  Simply e-mail editor@themacrotrader.com with trial in the subject line.

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Macro Trading has several advantages to regular trading or investing.  Most people either are long only or they trade one asset class.  Instead of focusing on one area of the financial markets, Global Macro Traders focus on the best risk to reward opportunities they can find regardless of asset class or whether it is long or short.  By not tying ourselves to one source of returns we can better balance our risk profile with our return objectives.  Global Macro allows one the flexibility to not be dependent on any one thing or be held hostage by the downside of a particular asset.

Here we are comparing the returns of the Barclays Global Macro Index against the SP500.  As you can see the Macro Index has performed significantly better than the SP500 from 1997 through the end of October 2008.

While the Global Macro Index is currently in a drawdown it is far smaller than that of the SP500. The SP500 is down -37.47% while the Global Macro Index is only down -7.14%.

Anyone that is still tied to the notion that all you need to do is buy and hold has lost money over the last 10 years. While we hope that investors are finally coming around to the idea of absolute returns and risk management, we also realize that investors by nature are irrational and that they will continue to repeat the same mistakes.

We here at The Macro Trader try to generate absolute returns because a relative loss is still a loss. If you are interested in learning more please send us an e-mail.

Happy Trading,
The Macro Trader

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