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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If over the past six months or so it has seemed as if you were partying like it was 1999 it might be time to reevaluate your stance.  One thing that we have been taking a closer look at lately is the pricing of risk.  Obviously when investors think that risks are low they will demonstrate risk seeking behavior.  We have seen this as the SP500 has climbed 56.6% from the March lows to the highs on 8/28/09.  With a rise like that you would think that 2008 never happened, of course if you believe that then you also believe  in a land of make believe with money trees, the fountain of youth, and SI models for all of us.

Of course some investors counter saying that while things could be better we are seeing the beginning of a recovery.  They then say that while the market will likely climb slower, that it will still climb higher.

While the above scenario is possible, anything is possible.  The more important question is to decide if the rewards outweigh the risk involved in being long equities right now.  Or even if at this point the better risk reward trade is to the downside.

Lets look at a few “risk gauges” or “fear indexes” as the press likes to call volatility indexes.  The first is of course the VIX.  After spiking to all time highs in October and November of 2008 we are already well on our way towards what was considered a “normal” level back in early 2008 before Bear Stearns.  The potential risks were obviously very mispriced at the beginning of 2008, are they mispriced again?  While likely not as off as they were at the beginning of 2008 we still think that there are a lot more real and potential risks then the market is currently pricing in. (Click on chart to enlarge)

SP500 VIX

What about foreign markets?  How do investors perceive the potential risks abroad?  Well if the VDAX is any gauge then investors see a rosy future in Europe as well.  Again maybe there are no big risks and maybe the EU is rock solid.  Then again maybe not.  With the complete lack of liquidity that businesses have had over the past several months in the EU it is really surprising that the VDAX is back to pre-crisis levels. (Click on chart to enlarge)

German DAX VIX

What about other asset classes?  What are investors saying about potential risks?  Using the MOVE Index which measures the range in which Treasury yields are expected to move over the next 12-months we can see that even here investors are becoming increasingly complacent.  What happened to the runaway inflation that we keep hearing is right around the corner?  Right now the market is saying that we will be in a 130 basis point range for the next 12-months. In The Macro Trader weekly newsletter we are long the TLT 20+ Year Treasury ETF and are expecting a bigger move then is currently implied via the MOVE index. (Click on chart to enlarge)

MOVE Index

Even in the currency markets we are seeing extreme complacency.  Apparently investors the world over are back to selling dollars in exchange for anything.  While the USD has its issues other currencies do to.  Right now the currency markets are not participating in the Keynes beauty pageant where you are trying to pick the girl that you think the judges will think is the beautiful.  No, with the current state of the global economy we are in the least ugly pig contest where we are only trying to find the least ugly.  That being said investors do not appear to see a lot of volatility any time soon. (Click on chart to enlarge)

JPM G-7 VIX

Even the emerging market currency volatility index is showing complacency. What happened to the banking issues in Eastern Europe? Apparently they vanished, or at least that is what it seems as though the market is telling us.  (Click on chart to enlarge)

JPM Emerging Market FX VIX

Even commodities markets are pricing in realtively low risk. While the price history of the Crude Oil and Gold volatility indexes does not go back as far as we would like, you can get a feel for what is happening as both indexes are dropping at a very steady rate.  Do investors really think that volatility will stay that low?  What happened to the oil spike if demand comes back?  And what happens if gold breaks $1000 on fears of hyper inflation?  (Click on charts to enlarge)

Crude Oil VIX

Gold VIX

Another excellent tool to evaluate the blind risk taking happening right now in the stock market is the JunkDEX invented by Bill Luby over at VIX and More.  By taking an equal weighting of junk stocks AIG, FNM, C, CIT, and BAC you can see how crazy or composed investors are acting. While we have seen, and actually use, an index of high momentum stocks we had never thought of making an index that tracks junk stocks to gauge investors risk appetite.

As you can see in the chart of the JunkDEX below the junk led the market off the bottom and then lagged until the last month when the index shot up +157.36% in a little over a month.  While it has pulled back over the last two days we are still in awe that investors are dumb enough to buy this junk at these prices. (Click on chart to enlarge)

VIX and More JunkDEX* vs SP500

After looking at all of this we need to ask ourselves if the rewards outweigh the risk to stay long?  Or if we should be flat or short.  In case you have not guessed we currently think that the risk reward is pointing to the downside.

Looking at the QQQQ we have a setup with a solid risk to reward situation. As you can see in the chart below the QQQQ has rallied back to its 50% retracement level, its 200-week moving average, and its downtrend line extending from October 2007.  While it could of course rally higher we like the risk reward enough to have put on a modest short position in our weekly Macro Trader newsletter. (Click on chart to enlarge)

QQQQ-NASDAQ 100 ETF

While not quite as nice of a setup as the NASDAQ 100, the SP500 also looks like a solid risk reward trade to the short side.  As you can see in the chart below of the SPY-SP500 ETF it has rallied up to the upper Bollinger Band and has already started to come back in.  We are looking for a move back to at least the $95-96 area. (Click on chart to enlarge)

SPY SP500 ETF

Obviously anything can happen.  The market could go up every day for the next year, or it could go down every day, but our job as traders is to look for the best risk to reward scenarios that we can find and place trades on probable scenarios and right now we think the most likely scenario is for the market to at least have a pullback if not a correction back towards its 200-day moving average.  Of course if this happens we will see the volatility indexes tick upwards to more realistic levels given our current economic environment.

*Our JunkDEX differs a bit from the one you can see at VIX and More.  After looking into it we found that  we built the index by simulating a $1000 investment in the index and in the SPY and Bill built it by normalizing the index starting value so we have slightly different values.  But don’t worry as the chart looks essentially the same and shows the same investor insanity.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In The Macro Trader newsletter as well as our accounts we are currently short some QQQQ-NASDAQ 100 ETF and long some TLT 20+ Year Treasury 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: Volatility Indexes, Risk Appetite, Mispriced Risk, And Where We Think We Are Headed
URL: http://www.themacrotrader.com/2009/09/02/mispriced-risk-macro-trader

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In our ETF based newsletter, the carry trade is one of the strategies that we employ.  For those unfamiliar with the carry trade, you are essentially trading the interest rate differentials of different countries.  You short a low-yielding currency and go  long a higher-yielding currency.

You can make money in two ways.  You earn the “carry” if the currencies remain very stable, and neither move.  You can also make money in this trade by being correct in the direction.  For instance if you are short the Japanese Yen and long the Australian dollar, then you can also make money if the Australian dollar goes up, and the Yen goes down.

As an example of how to earn the carry, lets look at the Japanese Yen versus the Australian Dollar.  The Yen has been the carry trade vehicle of choice for much of the past decade because Japan has consistently had extremely low interest rates.  Australia, on the other hand, has had relatively high rates over the last decade.

To construct the differential for this trade, take one rate and subtract the other rate. In the chart below, we plot the difference between the AUD and the Yen since the beginning of 2007.  As you can see, at one point the carry was as high as 7.34, but it has since declined to 2.69.  If you had been long the AUD and short the Yen, you would have earned this interest rate differential the whole time.

AUD-JPY Interest Rate Differential

Of course as we already mentioned, in order to make money on the carry trade, your long must outperform or stay flat relative to your short position in order to make money since a big directional move against you will wipe away any gains that you would be making solely off the carry.

There have been several academic studies as well as real world trading results that show that volatility is the biggest risk that the carry trade faces.  Over the years, most studies were stuck using the SP500 VIX as a proxy for global financial market volatility.  While it correlates quite well, there are now some far better options to help track and manage risk in the currency markets.  We at The Macro Trader use the JP Morgan G-7 VIX index for our carry trading model as it correlates extremely well to the volatility in the DBV-Currency Harvest Trust ETF.

What we first found in the academic literature, later confirmed by our own testing and used successfully in our trading, was that when volatility in the currency markets is flat or declining, the carry trade works very well.  On the other hand, when currency volatility is high, the carry trade typically is a money loser because the directional aspect of the trade overwhelms the carry, giving you a loss.

We look at the JP Morgan G-7 VIX using two different charts.  The first one is a reversion to the mean chart where plot the VIX data, the historic mean, then one and two standard deviations above and below the mean.  When volatility is high and then falls below one standard deviation, we start looking to enter the carry trade and when it get above the one standard deviation line we would sell if not already stopped out.  On the downside, we look to sell when volatility declines too much since it represents excessive complacency and usually is a sign of higher volatility ahead.

JP Morgan G-7 VIX

The other way that we like to look at the currency VIX is to invert it on a chart alongside the DBV. As you can see in the below chart, not only was equity volatility declining, but DBV managed to base for a few months before climbing higher and then consolidating at its 200-day moving average.  Finally today it was able to break out to the upside.

DBV and JPM G-7 VIX

Finally we have the DBV itself.  As you can see in the chart below, not only was equity volatility declining, but DBV managed to base for a few months before climbing higher and then consolidating at its 200-day moving average.  Finally today it broke out to the upside.

DBV-Carry Trade ETF

Hopefully you see how volatility is bad for a lazy trade like the carry trade where you trying to get paid for sitting.  If volatility climbs above 1 standard deviation above its mean we will look to tighten our stops as the odds of a downside move increase significantly.

DBV-G-10 Currency Harvest Fund is an ETF that goes long the three highest yielding currencies of the G-10 and shorts the three lowest yielding currencies on a 2x levered basis.  While investors can go into the spot and futures FX markets and put on the same trade the DBV is a very simple way to gain exposure to positive carry in the currency markets.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We currently hold positions in the DBV-G10 Currency Harvest Fund and FXA-Australian Dollar 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: The Carry Trade And Volatility
URL: http://www.themacrotrader.com/2009/06/01/the-carry-trade-and-volatility/

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One of our current positions is EWY the South Korean ETF. We went long a few weeks ago in our model portfolio based on the trend, valuation, and economic characteristics of South Korean stocks.

EWY-South Korea ETF

Another factor that got us into EWY was the increasing number of Asian countries that have been coming up in our global stock model.  Our global stock model looks at technical, economic, fundamental, and sentiment indicators to help find foreign stock indexes that meet our risk to reward criteria.

Apparently we are not the only ones to have found an opportunity in South Korea as the Oracle himself WarrenB apparently is getting long some South Korean stocks as well.

In order to catch our trades in foreign stocks as well as other asset classes like US stocks, bonds, currencies, and  commodities then sign up for a quarterly or annual subscription to The Macro Trader weekly newsletter with frequent intra-week updates.

Happy Trading,

Dave@TheMacroTrader.com

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We were long precious metals coming into 2009 as gold, silver, and even platinum were climbing higher.  Eventually we got stopped out as the group consolidated for the next three months.  The last two weeks gold and silver have been able to breakout of the consolidation and is once again in an uptrend.  We went long in out model portfolio last week and are currently looking to add to our position if the trend continues.

GLD Gold ETF

SLV Silver ETF

In order to catch our trades in precious metals as well as other asset classes like stocks, bonds, currencies, and other commodities then sign up for a quarterly or annual subscription to The Macro Trader weekly newsletter with frequent intra-week updates.

Happy Trading,

Dave@TheMacroTrader.com

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We track hundreds of different economic, fundamental, technical, sentiment, and cycle indicators.  Some are stand alone and only help us discern particular situations while others are full blown timing models that we use to get in and out of the market.  Some are very complex with ten and even twenty inputs ranging from jobless claims, to put call ratios, to nickel, to the advance decline line.  Essentially anything that we test that helps to give us an edge we use to some degree or other.  As global macro traders we of course have several models for every market that we trade, as well as models that only point us to markets showing abnormal movement.

As of a few days ago we had one of our longer term SP500 timing models trigger a buy signal.  This timing model is very simple and only uses the NYSE Advance Decline line and the SP500 closing price.  This models esge is not huge but it is solid and historically you are risking about 1:1 meaning that the historical return is almost the same as the worst historical drawdown.

In our macrotrader.com/subscribe/”title=”Macro Trader Newsletter” >newsletter and in our own trading we rarely use a model as an automatic buy or sell signal but we do use them to tell us which dorection to trade.  Right now this extremely simple model is showing that the advance delcine line has finally been able to have a sustained run and break above its long term trend, in this case the 150-day moving average.  Again we don’t, and don’t recommend, trading directly off of these signals as almost every model we track can be improved upon by selecting better entry and exit points but they do helo us tremendously in our trading.

SP500-NYSE Advance Decline Line

As you can guess we are becoming increasingly bullish after being bearish for the better part of two years.  Who knows if this rally will continue as there are a ton, and maybe a trillion tons, of harsh economic realities and hardships, but for now the trend is up and we are starting to lean to the long side.

Happy Trading,

Dave@TheMacroTrader.com

P.S. If you are getting value out of our posts, you can do us a favor by linking to us with your site or blog and mentioning The Macro Trader to any of your friends that trade.

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