Wednesday, July 30, 2014

Encore Une Fois

Yesterday's discussion of financial market versus real economy leverage prompted Macro Man to spend some time hanging out with FRED to do some digging.  What follows are the fruits of his labours.   Although he retains his caution not to expect daily updates henceforth, let's have a look at leverage encore une fois.

As a couple of commenters noted, overall leverage in the economy as measured by total liabilities as a multiple of GDP has steadily declined since the crisis, albeit while remaining at historically high levels:

The decline has been largely driven by two sectors.  The first of these is from households/nonprofits, which is unsurprising given the environment of tight credit conditions, uncertain employment prospects, and weak income growth that has prevailed since the crisis.

The second is equally unsurprising, given the nearly daily levy of fines and the 13,000-plus behemoth that is Dodd-Frank and its sundry legacy laws and regulations.   The authorities have stated that they don't want any financial sector institution to be too big too fail, an on an aggregate basis their plan is working.   Now about that credit creation to spur economic growth.....

Ah, but that doesn't tell the whole story now, does it?  As a number of commentators, including the Fed, has noted, nonfinancial corporate debt issuance has been "brisk."   How brisk?  Well, it's soared to all time highs as a percentage of GDP.  Last year alone, the stock of debt liabilities increased by $744 billion at the same time the sector was pushing through some $450 billion of stock buybacks.   Hmmm.....issuing debt to buy back stock.   If that isn't increasing leverage, Macro Man isn't sure what is.    On a macro basis, this is one of the reasons to be concerned about credit, even if there has yet to be a notable deterioration in credit quality.   Remember, folks, come the revolution someone is going to want to sell this stuff.....who's going to step up and buy?

The final sector worth highlighting is of course the Federal government, which has seen its liabilities grow by some 40% of GDP over the last six years.  Of course, the Fed and other central banks have taken down a decent slug of this issuance, and it is worth wondering what might happen if the improvement in the government's fiscal stance were to reverse.   Then again, such a reversal would probably come in the context of a weak economy, which itself would likely catalyze QE Googolplex or whatever the next round will be called.

While this little study isn't exactly rocket science, it is occasionally worthwhile to review slow-moving figures like this to ensure that they say what you think they should.   Specifically,  the expected deleveraging of households and banks is occurring apace (hence the Richard Koo 'balance sheet recession' concept), though corporate debt issuers continue to party like its 1999, if not 2006.  Again, this may not be particularly useful in timing an eventual crack-back in credit, but it does suggest that when such an episode occurs positioning will be just as important there as it is in many other markets these days.


Tuesday, July 29, 2014

Thoughts on leverage

Yesterday's post generated quite a bit of repartee in the comments section, including a good question from TMM alumnus Polemic about the level of leverage in the financial system.  While it certainly seems fair to suggest that leverage in the banking system is lower than it was pre-crisis, courtesy of various regulatory bogeys and the collapse in the velocity of collateral, this doesn't say much about the leverage taken by people who are buying and selling securities.

Although there is no perfect measure of leverage, a simple and widely-cited proxy is the level of margin debt on the NYSE, which has the benefit of a relatively long data history.   Macro Man hadn't really looked at this data in a while, since the last time he had it appeared to be relatively benign.  So he pulled it up, and lo and behold!  It has now reached all-time highs in nominal terms.

Of course, both the size of the economy and the size of the stock market's capitalization have changed as well, so looking at a nominal margin debt figure in isolation may not be particularly useful.   Macro Man could only source monthly stock market capitalization data going back to 2003 (if anyone has a longer dataset, feel free to share it!)  What we can observe is that while debt as a % of market cap is above the levels prevailing before the crisis, it is not at the threshold that precipitated financial meltdown.

Of course, it's not exactly an apples-to-apples comparison.  Referencing NYSE margin debt to total market cap could potentially miss shifts in the relative capitalization of NYSE stocks to those listed on other exchanges.  Moreover, it sure would be nice to see what the indicator looked like during the tech bubble in the late 90's.

(Edit:  Thanks to SP for sending an alternative datasource that goes back to 1980.   As you can see, margin seems to have continued its inexorable trend drift higher of the last two decades, though without the parabolic rise that has augured previous secular tops.)

One thing we can look at, however, is the ratio of margin debt to GDP.  Again, it's not a perfect indicator, but at least it has the benefit of history that predates even the 1980's bull market.   So what happens when we pull this data up?

Zowie!  The current 2.5% level represented the top of previous leverage cycles, peaking there in April 2000 (the month after the Nasdaq peak) and July 2007 (the month the Bear credit funds blew up, ushering in the financial crisis that still resonates today.)

Now, as some readers will no doubt point out, those previous peaks in market leverage were accompanied by peaks in real-economy leverage that exacerbated the impact of a market down-turn.   Point taken, but the aphorism that the "market is not the economy" cuts both ways.   If leverage and pricing can build up in the absence of brisk economic growth, presumably they can draw down without the necessity of a recession.

Now, while the third chart above would certainly suggest that a market top could be near, Macro Man is not going to stand on a soapbox fulminating that the End Is Nigh and that OMG! #Stocksovervaluedinnit.   He would, however, suggest that the data would appear to support his notion that despite all the warnings, markets may be ill-equipped to deal with an eventual liquidity withdrawal.   While such a view may be consensus, it would not appear to be positioned for in certain market segments. 

And if it's not positioned for, how consensus can it really be?

ED. NOTE:    Sadly, Macro Man has seen his Bloomberg transition account withdrawn this week.  While he can still of course get news and prices, data and charts will be somewhat harder to come by.   As such, it will be nigh-on impossible to provide quality insight on a daily basis.  (Some readers may wish to point out that that hurdle had already proven to be insurmountable for your author.)

As such, updates are likely to be a little more sporadic and long-form in nature, perhaps not unlike those from TMM when they were in their transition phase.  Macro Man already has one in mind that he hopes to finish by the end of the week.

Monday, July 28, 2014

A few thoughts on volatility

Market volatility is low, whether measured on an historical or option-implied basis.  Indeed, based on a measure of the normalized deviation of cross-asset implieds from long-term averages, it's the lowest since at least 2001 (the currency volatility index data only begins in that year).   Given the nature of asset markets in the 1970's-90's,  this essentially means that cross-market volatility is at its lowest level of the post-Bretton Woods era.

Now, you don't have to be a particularly discerning Fed-watcher to have realized that certain segments of the FOMC are getting a little antsy about the low levels of market volatility.  It's not quite at the level that they are shocked, SHOCKED to find that gambling is going on here....but it's not far off.

Indeed, the recent warnings from the Fed recall previous episodes of hand-wringing...notably Greenspan's (in)famous "irrational exuberance" speech in November 1996, as well as global monetary disquiet over the "complacency" and low levels of market vol a decade later.

Naturally, they would never admit to their own culpability, even though a cynic suffering macro punter anyone who sees better than Stevie Wonder realist might suggest that some of the culpability lays at their door.

Now, Macro Man will concede that it is somewhat tautological to use one measure of market volatility to explain other such measures.    However, the indicator that he likes to follow, the spread between the second and fourth eurodollar futures contracts, has historically been a pretty good proxy for Federal Reserve monetary policy expectations.  And as the nefarious Professor Woodford will tell you (or at least Ms. Yellen)...the FOMC can exert a great deal of power over market expectations of policy, and that these expectations themselves can have a substantial impact on markets (if not, as their voodoo might suggest, the real economy.)

In any case, if we look at the volatility of the 2/4 ED spread over the last quarter century, what do we find?  In late 1996, for example, the volatility of that spread was at its lowest point to date in the sample....just as Greenspan was moaning about irrational exuberance in the equity market.   Gee, Al, can you guess why equities were so perky?   

The last tightening cycle, of course, was incredibly well-telegraphed through the use of guidance-laden statements of the type we see still see today- "considerable period", "measured" withdrawal of accommodation, etc.   Greenspan, of course, famously credited the concurrent bond conundrum of low yields to his credibility and efficacious communications.   He must have been sleeping when those Asian central banks were buying hundreds of billions of dollars worth of Treasuries per year.....

In any event, the lack of volatility in expectations, which Greenspan triumphed in his self-fellating autobiography as a victory for transparent policy-making, naturally led to another massive misallocation capital and risk, most notably in the housing and volatility markets.  While the regulators have of course chosen to blame the cupidity of market participants (some of whom, it must be said, were truly loathsome), Macro Man cannot help but observe that they occurred simultaneously with a nadir in the volatility of Fed policy expectations.   The hangover, of course, required a little more than a few aspirin and a bacon sandwich to vanquish.

Fast forward to today, and we see that unsurprisingly, the measure of Fed expectations vol quite literally approached zero a couple of years ago, but has steadily risen since (though still remains at levels consistent with previous lows.)  Still, it's worth noting that the blow-ups generally seem to occur only after this measure eclipses 15 bps.    Russia/LTCM, the popping of the NASDAQ bubble, and the implosion of the Bear Stearns credit hedge funds in the summer of 2007 all occurred shortly after the 15 bps threshold was breached.

Perhaps it's a coincidence.  At the very least, there is no guarantee that the correlation implies causality- indeed, one could argue that some of the causality in the past may have worked in the opposite direction. reference to the top chart of the post, Macro Man may not know when the next 2 SD move in cross market vol is going to come....but he has a damned good idea of which direction it's going to be in.  

With the FOMC and payrolls this week, it may be tempting to think that the rise in vol will come sooner rather than later.   Perhaps it will.   On Macro Man's read, however, we probably need to get a little closer to the whites of the eyes of the tightening cycle before vol buyers get the all-clear.

Friday, July 25, 2014

One of these things

It's time to kick it old-school play a game of the perennial Sesame Street favourite, 'One of These Things is Not Like the Others.'  For those readers not familiar with the program and this game, here's a short video of the Cookie Monster that will instruct you in the nuances of the undertaking:

Got it?   Good.   See if you can spot which of these things doesn't belong as we head into the weekend.....

1) Initial jobless claims hit their lowest level since early 2006

2)  As a result, Dec 16 eurodollars have broken a host of moving averages, as well as the trendline from the early April low (which also pretty much hits the 'Summers low' from last September.)

3)  The DXY has surged to its highest level in a month, and looks set to threaten its highs of the year....

4)  The SPX, lifted for several years by a sea of over-abundant liquidity, closed within 0.03% of its all-time high yesterday, with cross asset implied volatilities at local or all-time lows.

Don't worry if you can't get the answer before Cookie finishes his'll probably have another few weeks to answer correctly.....

Wednesday, July 23, 2014

Same-o, Same-o

Last week's min-bout of volatility notwithstanding, one day just seems to run into another these days, doesn't it.  Consider the following, which makes yesterday indistinguishable from countless others recently:

* SPX makes a new high

* USD/JPY trades at 101 and change

* USD/MXN trades 13.00, +- 10 centavos

* EDZ5 trades 99.00 , +- a few ticks

* An equity guy who loves the sound of his own voice says Herbalife is a fraud

* Another one, who loves the sound of his own voice, says it isn't: nicky-nicky-nah-nah

* A US regulator alleges wrongdoing at a non-US bank

* Ex post facto standards are applied to foreign exchange fixing behaviour by people who haven't got a scooby how the FX market works

* Government and regulatory outrage over the scandalous sums of money thrown at Congress by the corporate sector and other vested interests remains strangely silent

* Allegations of currency manipulation by foreign sovereign institutions, who have had a net impact several orders of magnitude larger than any fixing business, remain absent from the public discourse on the subject

* No one has yet to read the Dodd-Frank act from cover to cover

Tuesday, July 22, 2014

A couple of thoughts on EM equities

At last, some peace and quiet.  After two days of searing, 1% move volatility, the S&P 500 finally allowed punters to take a breather yesterday, registering its smallest percentage move since all the way back Tuesday.

That having been said, tensions continue to intensify between the West and Russia, with each side accusing the other of culpability for the MH17 disaster.  Whatever the truth may be- and it certainly appears as if the balance of evidence points towards the pro-Russian rebels- we can unfortunately say that at the very least, the Russians have prior form on this sort of thing, right down to denying responsibility for the tragedy.

Whether the EU stands up forcefully to Putin's Russia remains to be seen, of course.   Realpolitik has a funny way of injecting itself into any moral crusade, and one wonders how willing certain EU nations will be to cut off a vital source of export demand and/or energy.

Russian assets have unsurprisingly taken a tumble, with the RTS $ index almost (but not quite) back to where it was when Jay Carney issued his investment advice to go short.

The chart of Gazprom is obviously quite similar.   Now, losses incurred during the Russian invasion of Georgia prompted your author to adopt the principle of never investing in the markets of a nation that invades another sovereign state, unless the invaders speak English.  For the past six years he has held to this precept without fail.  Given that Gazprom currently boasts a dividend yield of 5.4% and a P/E of 2.56, should the price fall back to the March lows, Macro Man will have to consider whether he can swallow his distaste for the Blofeld-like character of Putin and buy some. 

What's interesting is that this latest swoon has come at a time when EM equities generally are faring quite well, as reader abee crombie pointed out in yesterday's comments section.  Over the summer, Macro Man has been working on a little equity screen project for developed and emerging markets.  For reasons noted above, he does not include Russian stocks in the screen.  In the EM space, it is curious to note that the screen's 3 favourite individual markets are all China-related (Taiwan, China, and Hong Kong.)  A sign, perhaps, that the bad news there has been comfortably priced?  (Note that the table displays rankings within the universe- so a low number is better.)

Hmmm....perhaps Macro Man should focus his attention there.   Something tells him he'll sleep better at night owning the Taiwan ETF than Gazprom.....

Monday, July 21, 2014

Two for two

Volatile days are like late-night buses:  None for ages and then a bunch come all at once.   The SPX registered its second 1% day in a row on Friday, this time on the positive side of the ledger.  With the weather looking good on both sides of the Atlantic, it's not hard to see a scenario where normal service is resumed and the market grinds higher for another few weeks as punters head off to the beach.

Macro Man is lacking a bit of inspiration ce soir, so he will merely point out the interesting fact that the bellwether EDZ5 contract, widely watched to gauge the extent of expected Fed tightening next year, closed last Friday at 98.96.....a mere one tick higher than the contract closed on the equivalent Friday two years ago.   So much for rolldown, so much for volatility.....