We are sick of talking about QE2.  Instead lets look at the EU.   European Credit Default Swaps are blowing out, and really it is the consistently weak countries known as the PIIGS.  Italy is actually doing alright although it too is ticking higher but Ireland, Portugal, Greece, and Spain are once again on the races to see who can suck the worst…again.  If this continues, and it probably will, we will have to revisit  shorting the Euro.  For now we will just sit back and watch.

Ireland 5-Yr CDS

Portugal 5-Yr CDS

Greece 5-Yr CDS

Spain 5-Yr CDS

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-Right now we are riding out Ben “The Bubble” Bernanke’s bubble (long a slug of “risky” assets) but are looking to short the Euro soon.

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Ever since the David Tepper interview last week on CNBC we have heard a lot about how money supply is finally expanding.  Yes, M2 has been rising the last several weeks, but before the hyper inflation crowd gets out of control we thought it would be a good idea to look at the actual numbers.

Looking at a plain chart of M2 you can see that yes it has broken to new highs but it really only declined for about six weeks back in March and April of 2010.  During this time and since then we have seen bond yields drop lower and lower indicating that inflation is essentially non-existent.  So this rising M2 is really nothing new.

M2

To get a better picture of the money supply we can look at M3 data.  In the chart below we have M3 with the 12-month ROC overlaid.  As you can see not only has M3 been headed slowly but continually lower but the 12-month ROC has not exactly rocketed higher.  Yes, it has improved but marginally at best.

M3 and M3 Annual ROC

Finally lets look at a chart that we showed a few months back when we discussed money supply being quite tight.  If we look at real M3 adjusted for inflation minus industrial production we get a good view of how loose or tight money supply is relative to growth in the economy.  As you can see in the chart below things have improved a bit but they are still extremely low from a historical perspective.

Real Money Supply (M3) minus Industrial Production (Year-to-Year Changes)

So while M2 has been improving a bit and overall money supply is a bit improved we are not exactly awash in liquidity.  No, despite the best if a bit misguided efforts by the Fed to flood the planet with US Dollars, the massive deleveraging has managed to cancel most of it out.  So before you run out and short the hell out of the bond market, load the boat with stocks, and go all in on commodities stop and think about the likely scenario.  Do you really think that hyper inflation is right around the corner?  We obviously don’t.  We continue to be of the thought that the Fed will do what it thinks it should and while it will help financial assets go higher it will not really go into the real economy and consequently we will see little real inflation for the next year or two or maybe even longer.  Yes, we are long stocks but we are not long in size and we continue to trade commodities cautiously.  So while the Fed put might be, the  minor up-tick in M2 is not , at least for now, a major game changer.

Happy Trading,

Dave@TheMacroTrader.com

P.S.-Since M3 has been discontinued by the Fed we are now using the M3 data from NowandFutureswhich has reproduced it with a correlation of .99999 to the old M3 data.

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As of late we have heard a lot about how sentiment was too bearish and that this justified the market rally.  While we no doubt got a rally, we have to question the idea that sentiment is overdone to the downside.  In the world of sentiment indicators there are more then a few ways to look at things.  You can look at polls like Investors Intelligence or the AAII numbers, you can look at anecdotal indicators like covers at the magazine rack or listening to your shoeshine boy, and finally you can look at market derived indicators.

Looking at poll data alone would have you thinking that either the world is coming to an end or that we are due for a large counter sentiment trade.  The first chart here is of the Investors Intelligence Bulls to Bears ratio popularized by Marty Zweig.  As you can see in the chart it is hitting lows not seen since 2008.

Investors Intelligence Bulls Bears Ratio

If you want an equally extreme way to look at it below is a chart of the Investors Intelligence percent bears.  As you can see we are spiking to new highs not seen since the dark days of 2008.

Investors Intelligence Percent Bears

Looking at just these two charts makes the trend followers short and happy, and the contrarian leveraged long.  Of course we have a lot more tools at our disposal then just the Investors Intelligence poll data.  We like to check the poll based data against the market based data to see if it is inline with what investors are actually doing.  Usually it is, but sometimes it gets out of line.  As you can probably guess now is one of those times.  In the chart below we have taken the VIX and overlaid the percent bears.  As you can see both indicators usually move roughly to the same beat but lately the poll data has been getting more and more negative while the market derived data, data that actually shows where people are putting their money, has been getting more positive.

VIX and Investors Intelligence % Bears

Because of this disconnect we think that sentiment is not overdone to the bear side and that there is still some room to the downside.  In fact one of our short term sentiment indicators is showing exactly that as the 5-day equity only put call ratio hit .55 yesterday.  This level is significant as it has done an excellent job of showing when things are in fact too optimistic and has a good record calling tops in the equity market.  So while we aren’t calling for some Dow 1,000 crash, our analysis which includes sentiment data, does show room for more downside.

5-Day Equity Only Put Call Ratio

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In our model portfolio we are long some SPY puts.

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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

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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

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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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