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The MOVE Index And Outlying Events

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

move-index2

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

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Favorable Risk to Reward in Treasuries

While many investors are calling for a large drop in long term Treasuries we are currently seeing a good risk reward trade to the long side in the long bond. In the chart below you can see our reversion to the mean chart on the 30-year Treasury yield. When it is stretched to the downside things are bearish and when it is stretched to the upside it is bullish. Right now it is stretched almost 1.5 standard deviations away from its historical mean which usually leads to a move lower in yields and a move higher in bond prices. (Click on chart twice to enlarge)

30-Year Yield Reversion to the Mean Chart

tyx-30-year-treasury-yield-rtm-chart

As you can see in the chart below of the 30-Year Treasury yield we are at the top of a long term downtrend in yield. Each time since the 1987 that yields have hit this line they have gone lower. Eventually this will stop and yields will breakout to the upside but if history is any guide and the trend continues than at least for now yields are once again headed lower. (Click on chart twice to enlarge)

30-Year Treasury Yield

tyx-30-year-treasury-bond-yield-long-term-chart

Finally lets look at the LT 20+ year Treasury bond ETF. As you can see below it has found support over the last seven months in the highlighted $86-89 range. On the upside we have resistance around $98. The risk to reward is quite favorable right now as we can risk $1-2 with an upside around $9. (Click on chart twice to enlarge)

TLT-20+ Year Treasury Bond ETF

tlt-one-year-chart

So while this may be the time that Treasuries tank and yields go screaming higher we doubt it and are modestly positioned to the long side. Eventually we will be shorting Treasuries but not until yields break out and end the trend that has been in place for over 20 years.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is currently long TLT

Volatility Indexes, Risk Appetite, Mispriced Risk, And Where We Think We Are Headed

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

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

dax-vix-volatility-index

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

move-index-merrill-option-volatility-index-treasuries

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

jpmvxyg7-g-7-volatility-index

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

jpmvxyem-emerging-market-volatility-index

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

ovx-oil-volatility-index

Gold VIX

gvz-gold-volatility-index

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

junkdex-vs-sp500-2009

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

qqqq-weekly-chart-short-setup

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

spy-sp500-etf-daily-chart

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

Global Macro Trading

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

barclays-group-global-macro-index-versus-sp500

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

sp500-and-barclays-group-global-macro-index-drawdowns

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/

Port Data, Green Shoot or a Weed?

If you have been following port data you no doubt saw the large spike in March of both inbound and outbound volume, and then a bit of continuation in April and May.  A lot of people, both mainstream media as well as bloggers, came out saying that this was a huge green shoot and a sign that things were improving for the global economy.  The Macro Trader came out with this post (click here) where we explained that there is a lot of seasonal influence in shipping and without looking at it you are missing a huge part of the picture.

Looking at the data below is the chart for the month of March from 1995-2009 (click to enlarge).  As you can see March is a historically strong month, in fact it is historically the strongest month of the year.  So while we had a strong rebound in month to month data that was to be expected in March.  What many commentators forgot to mention was the year over year numbers which were anything but impressive, being down -17.21% that same month, not exactly the definition of a green shoot.

March Data

march-port-shipping-data

So where are we now?  Well after March we had slight increases in both April and May.  Historically April is the second best month of the year, so again not very unexpected.  In June we had a decline of -6.02%, and a year over year decline of -19.31% in total loaded volume. Looking at the chart below (click to enlarge) you can see that seasonality is easily seen in the data and that we are a ways off from a new move higher.

Combined Port of Long Beach and Los Angeles Data

long-term-port-data-for-la-and-lb

We looked in the dictionary of overused terms and negative numbers were not under the term “Green Shoots”, however when we looked under weeds the exact definition was “negative numbers.”  OK, maybe that was a sad attempt at being funny but still the numbers are not pointing to a current increase in global shipping. To help smooth out the data and show the long term trend of shipping data here is a chart of total loaded along with a 12-month moving average (click to enlarge).  As you can see we are still in a downtrend and it will take more then a few months of increased activity to show real improvement.

Total Loaded with 12-Month SMA

total-loaded-chart-with-12-month-sma

Happy Trading,

Dave@TheMacroTrader.com

http://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: Port Data, Green Shoot or Weed?
URL: http://www.themacrotrader.com/2009/07/19/port-data-green-shoot-or-a-weed/