While we have been long various risk assets over the past several months we have been very cautious and have had some short positions the entire time.  We have been very defensive due to the plethora of indicators pointing to an economy that at best was going nowhere for the majority of 2010.  The reality is that as time has gone on we have seen more and more indicators deteriorate showing that money for the real economy is tight, employment is worsening, risk assets are overpriced, demand is not there, etc.   This basic outlook has served us well as our newsletter model portfolio has generated positive returns with very low drawdowns so far this year.

Here are two indicators that show that their is a very high likelihood that we are headed for not just a slowdown but a recession.  The two indicators are the PMI and the ECRI WLI growth rate.  As much as the ECRI has been trying to say that they aren’t calling for a recession we and several other analysts find a lot of use in looking at it.  We think that the main reason for some of this controversy is that the folks at ECRI think that Hussman and Rosenberg are using it as a mechanical model and that if it does X then Y will happen.  Instead we are confident that most analysts look at it as another tool in the toolbox, albeit a very good one.  Like inflation, interest rates, industrial production, etc.  it is but a piece in the puzzle. At least that is how we use it.

Looking at the ECRI WLI growth rate and the PMI on the same chart you can see that the WLI tends to lead the PMI by roughly three months.  Not only does it tend to lead but with a few exceptions it does a pretty good job of showing the magnitude of the future move of the PMI.  Looking at the chart right now it appears as though the PMI is headed to a level below 50 and we would not be surprised to see it down to 40.  These levels tend to be not just slowdowns but recessionary.

ECRI WLI Growth and PMI

Happy Trading,

Dave@TheMacroTrader.com

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

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Some of the more useful liquidity indicators are the different money market spreads.  Typically when the financial system is feeling stress  we will see spreads rise as banks become hesitant to even lend to each other due to counter party risk and general uncertainty.  We saw this in the 1987 crash, in the 90-92 recession, in the bond market route of 94, in the .com crash, and then in the crash of 2008.  A rise in spreads does not guarantee a crisis or crash but we have seen higher spreads during each crisis.

Right now we are seeing what could be the beginnings of a new liquidity crisis or maybe just the second leg of the last crisis.  If spreads were rising just due to a weakening economy then we would not be overly concerned as these events take some time to really move lower.  Right now however we have a huge mess that goes by the name of the EU.  We are not necessarily saying that 2008 part 2 is upon us but we are saying that this is a real cause for concern, basically the rise in spreads is anything but bullish and as it reinforces our view that this is not just a normal correction but instead could be the start of something a lot worse.

Money Market Spreads

Happy Trading,

Dave@TheMacroTrader.com

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

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With the recent rise in LIBOR we have been reading a lot of concerns over what it all means.  The two main arguments that we have seen is that either it is due to liquidity concerns or it is due to the supposed recovery in the United States economy.  For many reasons we obviously fall on the side of this being led by fear and liquidity rather than due to a recovery and an expectation of the Fed raising rates anytime soon.

3-Month LIBOR

The first thing that would lead us to assume that this is due to panic and not recovery is the way in which LIBOR is rising.  What we mean is that if you compare it to T-Bills it usually trades very much in line except in times of fear.  Looking at the chart below you can see that the last three times that it has diverged was also when we had banking system fears.  The top in the summer of 2007 which kind of started off the whole mess, fall of 2008 when the world seemed to be falling apart in front of us, and then in late winter 2009 when we already had the ZIRP in place but it looked like things might be getting even worse.  Of course once things got back on track and the end of the world as we know it was at least postponed the relationship got back in line with LIBOR at a slight premium to T-Bills like regular times.  Another thing that we find odd is that if LIBOR is rising on a recovery then why aren’t T-Bill or  2-Year Treasury yields climbing?  Would bond investors not drive yields higher if they thought this recovery had legs?

3-Month LIBOR and T-Bills

Looking at other money market spreads shows much of the same thing.  Namely that spreads are going up, this by the way is usually not a good thing.  Looking at the TED spread, LIBOR-OIS spread, and 90-day commercial paper-T-Bill spread you can see that they have all been climbing since the Greece and EU problems really started to gain some attention.

Money Market Spreads

Now lets look at some spreads in other nations.  It should come as no surprise that they are also on the rise.  In the first chart we have the EURIBOR-OIS spread, after spiking higher it has continued to inch its way basis point by basis point wider and wider.

EURIBOR-OIS

Next up is the TIBOR-OIS spread.  As you can see it is also rising although a lot slower then in the US or in the EU.  As we will see in a few charts however that is how it always is.

TIBOR-OIS

Finally we have the UK LIBOR-OIS spread. Again it should not be much a surprise that it too has been climbing quite a bit.  The UK is weak and its nearest mega-economy the EU is weaker.  Banks are and should be scared.

UK LIBOR-OIS

Looking at the three spreads over the last few years you can see in the chart below that the global banking crisis affects them all.  Another thing worth noting is that Japans spread (the yellow line) may be rising slower but the swings have been far more muted the whole time.  Of course Japan has been dealing with a broken banking system for almost two decades now.

EURIBOR-OIS  TIBOR-OIS  UK LIBOR-OIS

We will end this post with one last indicator that we follow closely and that is the VIX.  This volatility index is simply an average of stock, bond, currency, and commodity volatility indexes.  If most asset classes are seeing an increase in volatility it rises and if most are declining it goes down.  As you can see in the chart below it has been going up the last few months as many market participants are once again focusing on risks.

Average VIX

In closing we have many concerns in our current situation.  Some pundits claim that markets are headed higher and that we are under estimating the recovery.  They say that everyone is too worried and that the fundamentals are strong.  We apparently are looking through an entirely different lens.  With the EU continuing to deteriorate we cant help but wonder how investors can look at the rise in LIBOR as anything but bad.  While Greece is indeed a small nation the Euro is what is at stake.  Yes, the same Euro which is probably the biggest economic experiment of the last 30+ years.  In addition to the EU we have “regular” geo-political concerns as well like Iran, the Korea’s, and our future energy supply.  So while we could of course go higher we definitely should be concerned.

Happy Trading,

Dave@TheMacroTrader.com

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

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Today in the Financial Times there was an article entitled “Macro Funds Miss Out On Crisis” where they show how many macro funds are currently lagging their expected performance so far for 2010.  While it is true that many funds are relatively flat e are surprised that the article had nothing good to say.  We being proponents of Global Macro as not only a strategy but as the best strategy across a full market cycle decided to take it upon ourselves to look at Global Macro against the SP500 from the beginning of the crisis October 2007 to now.

What we find is that while the SP500 is down -24.41% from the beginning of the crisis, the HFRXM Global Macro Index is basically flat at +1.04% for that same time.  In fact if you had invested $1000 in each of the HFRXM and the SP500 on October 1, 2007 your investment in the Global Macro Index would be ahead of the SP500 by 33%.  So while you wold not have huge absolute gains, you would also not have huge absolute losses.

$1,000 Invested In HFRXM and SP500

Of course such comparison offer little real value since the SP500 is a horrible benchmark for a macro trader.  Global macro encompasses stocks, bonds, commodities, and currencies so it should be relatively uncorrelated to any one asset class.  What sets global macro apart from other strategies is that it enables the trader to go wherever they see the best opportunities.  Of course just because they have the flexibility does not mean that they will catch every move, but it does allow them the flexibility needed to avoid large losses.

Happy Trading,

Dave@TheMacroTrader.com

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

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In the investment world it should be no surprise to anyone anymore that outlying events actually happen with a decent amount of regularity. Looking at the past 12 years we have had the Asian Contagion, Russian Default, LTCM, .Com crash, housing crash, and the subsequent crash of everything else. Most of these are one in a gazillion year type events and yet they all happened inside of 12 years. Statistics while useful, are not able to perfectly model the real world.

So mixing stats with history let us look at the MOVE Index. The MOVE Index, essentially the bond markets VIX, typically trades between 128 and 79. Anything outside of those two lines is at least one standard deviation from the mean. As you can see in the chart below we are currently more than one standard deviation below the mean and look to be headed lower. (Click on chart to enlarge)

MOVE Index

Of course the interesting thing about the MOVE Index is not what level it is at but what tends to happen when it reaches certain levels.  Essentially whenever the MOVE Index drops below one standard deviation something blows up. Apparently bond market investor complacency is a better gauge of “too complacent” than other volatility gauges.

Drops below the lower one standard deviation have preceded the following events

-First Gulf War

-Asian Contagion

-LTCM bailout/Russian Default

-.Com tech crash

-Housing/Credit crisis

While it is not a crystal ball, see the extended period below one standard deviation preceding the credit crisis, the MOVE index is still a good risk gauge with a solid track record of saying investors are too risk averse or that we are too complacent and therefore not really aware of the risks on the horizon.  Consider this the yellow light, its not saying stop but its not saying go either.

Happy Trading,

Dave@TheMacroTrader.com

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

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One indicator that we follow is that of the 5-Day Equity Put/Call Ratio.  In fact it was one of the indicators that helped lead us to call for a correction back on January 12th in our post “It’s Time For A Pullback In Stocks”.  A few days later the SP500 started its 9% pullback.

So what is it saying right now?  If you look at the chart below you can see that the reading on the 5-Day Equity Put/Call ratio is at its lowest (most bearish) level in over four years with a reading of .50. This of course coincides with a near new high in the SP500. (Click on chart to enlarge)

SP500 and 5-day Equity Put/Call Ratio

While we aren’t calling for a new correction, we do think that we are likely in for a pullback of sorts before moving higher.  We remain bullish in the medium term as breadth remains strong and many industry groups continue to break out.  While shorting is definitely an option, in light of our longer term outlook we have instead opted to hedge our long exposure with some slightly out of the money options.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We hold long positions in several industry group ETF’s and puts on the SP500.

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

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It has been a while since the last time we posted our global GDP weighted yield curve.  While it has been months it might as well have been a day as nothing has really changed.  After being inverted for all of 2007 and most of 2008 the yield curve flipped and became extremely positive as central banks worldwide lowered short term rates.  You can see this very clearly in the chart below of the G-10 nations short and long term rates. In spite of Australia raising theirs, short term interest rates remain extremely low everywhere else.

G-10 Short and Long Term Interest Rates

Another way to look at interest rates and in fact the title of this post is by using the global GDP weighted yield curve.  In the chart below you can see the global yield curve.  While it has fluctuated it has essentially gone nowhere for the last eight months.

Global GDP Weighted Yield Curve

So whats The Macro Traders outlook?  We think that things will remain more or less the same for most if not all of 2010.  On the deflationary side banks have not started to lend, real estate is not going up anytime soon, debt deleveraging is in overdrive, unemployment is as bad as ever, etc.  On the inflation side commodities are up, stocks are up, and bonds are up.  At best we would call this a standstill.  So while we could envision long term rates going higher on credit risk, yes we think that sovereign debt is full of credit risk, we think that short term rates will remain low for most if not all of 2010.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is long TLT

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Over the past year one of the biggest themes has been to short the US Dollar and go long anything that is considered risky.  If you bought stocks, any grade of corporate bond, commodities, even real estate stocks and you would have made money.  Many strategists, The Macro Trader included, used the falling US Dollar as a reason to go long stocks, bonds, commodities, etc.  The reason of course is that since the March bottom the USD and the SP500 have been almost perfectly inversely correlated.  Well that relationship appears to be breaking down right now as the US Dollar has been rallying and other risk assets have not been falling in sympathy.

In the chart below you can see how as the US Dollar has fallen, the SP500 has risen.  In fact when there is a wiggle in the USD there is an opposite move in the SP500.  As you can see in the bottom right hand corner the USD is rallying while in the top right hand corner the SP500 is still looking strong. (Click on chart twice to enlarge)

US Dollar vs SP500

Of course if this inverse correlation is falling apart the correlation between the SP500 and the Euro is also falling.  Apparently, at least for now, you are able to be short the EUR/USD and still be long stocks and make money.  Looking at the chart below you can see almost the exact opposite of what we see with the US Dollar.  As the SP500 has moved higher the Euro has climbed as well until the last few weeks as the Euro has tumbled and equity markets as well as other risk assets have managed to remain strong and in many cases hit new highs. (Click on chart twice to enlarge)

Euro vs SP500

What do we take from this?  One thing is that the carry trade using the US Dollar was not as heavy as many people feared.  Another thing is that the market is always changing and that many intermarket relationships work well in some periods and fall apart in others.  As always it is important that we have solid risk management principles and that we are open to change.  For now we are short the EUR/USD and long equities…but that could change tomorrow.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is long several equity index ETFs such as IWF, EWZ, and MOO and we are short the FXE-Euro ETF.

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: US Dollar Correlations Breaking Down
URL: http://www.themacrotrader.com/2009/12/16/us-dollar-correlations-breaking-down/

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We have heard about the so called economic recovery for months now and while it is true that markets are higher we have our doubts that any of this optimism is seeping into the real economy.  Because of this we tend to believe that we are headed for a double dip recession, assuming that we ever got out of the first one.

Lately we have started to see renewed signs of a downturn in some of the economic indicators that we follow.  All things employment have been bad with the unemployment rate, exhaustion rate, and unemployment 27 weeks or longer rates up.  Anyone that is seeing an upturn in employment must be on an acid trip as there are no signs of anything but more unemployment.  Just Wednesday we had housing starts come in lower than expected.  One indicator that we follow is the Citi Economic Surprise Index.  They have them for all of the G-10 nations and it does a good job of showing if economic numbers are doing better or worse than expected.  As you can see in the chart below the index is turning over in both the United States as well as the G-10 indexes. (Click on chart twice to enlarge)

Citi Economic Surprise Index

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is actually long various indexes but since he’s negative on the economy is looking to lighten up on the first signs of weakness.

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: Is The Recovery Slowing Down?
URL: http://www.themacrotrader.com/2009/11/19/slowing-economic-recovery/

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A lot is made of relative returns and how one strategy or fund does against the SP500.  While not the best benchmark for something like Global Macro it is nonetheless the benchmark that everyone is most familiar with and that is used the most on CNBC and in magazines.  So how does global macro stack up to the SP500?

The chart below shows how $1000 invested in the SP500 and the Barclays Global Macro Index would have done for YTD for 2009.  As you can see the SP500 while getting off to a rocky start is now leading the macro index by 9.68% so far.  While the performance of the SP500 has been impressive the other side of the story is that to get the 18.04% return in the SP500 you first had to go through a -19.56% drawdown in January and February to get it.  Contrast that to the Global Macro Index where you had a -2.06% drawdown and a 6.63% return YTD.  Yeah you are outperforming with the SP500 but the volatility has been huge. (click on chart to enlarge)

Barclays Global Macro Index vs SP500 2009 YTD

Of course nine months is not usually the best representation of a strategy.  Going from 1997 to the end of September 2009, how has the SP500 done in absolute and relative terms?  Since 1997 the SP500 has given a total return of 42.70% and a CAGR of 3.07%.  The Global Macro Index on the other hand has delivered a total return of 237.91% in the same time and a CAGR of 10.92%.  Looking at the chart below you can see that while the SP500 has periods of serious out performance, over time it has lagged in a big way. (click on chart to enlarge)

Barclays Global Macro Index vs SP500 1997-September 2009

Not only has the SP500 lagged in total return but when looking at the risk taken to achieve the anemic 42.7% you really have to step back and rethink a long only equity approach.  In fact if you have been in a SP500 index fund since 1997 we excuse you to go bang your head against the wall for a few minutes.  Once you are back look at the chart below of the drawdowns that you had to endure to get that awesome 42.7% total return.  Yes, you see two drawdowns over -45% each.  In 2002 we were down -46.28% and in early 2009 we were down -52.56%.  All this for a return that was not much better then sitting in T-Bills. (click on chart to enlarge)

SP500 Drawdown 1997-September 2009

Looking at the same chart for the Global Macro Index below we can see that the drawdowns are far lower and shorter in duration.  In fact the worst drawdown that we have seen so far is -6.42% in October 2008 and right now we are at new equity highs while the SP500 is still -31.78% below its highs.(click on chart to enlarge)

Barclays Global Macro Index Drawdown 1997-September 2009

Does this mean that everyone should go out and invest all their money in global macro and buy our weekly global macro newsletter?  No, on the first and yes on the latter.   All kidding aside what this does show is the fallacy of long only equity investing.  While being 100% invested in equities is great when they are moving higher you get absolutely crushed when things come crashing down.  In global macro you are not beholden to the possibility of equity risk premia but instead are able to look for the best risk to reward opportunities out there in any asset class.  This includes stocks, bonds, commodities, currencies, and more.  This flexibility to go where the best opportunities are enables the global macro investor to outperform not in any given year but in a full market cycle.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are a global macro research company and are therefore a bit biased in our investment views.

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 vs SP500 1997-September 2009
URL: http://www.themacrotrader.com/2009/10/07/macro-trading-vs-sp500-1997-september-2009

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