Sep 23, 2005

Renminbi: Less Currency Basket More Dollar Peg

From Bloomberg:

China's central bank said today it will allow the yuan to strengthen by as much as 3 percent from a daily fixed rate against the euro, from 1.5 percent previously. It kept the range against the dollar unchanged. The 12-nation currency is also being hurt by expectations the interest-rate advantage of U.S. government debt over European bonds will widen.
Macroblog has more on the news but Brad Setser had something a few weeks back that telegraphed this pretty well. To me this news means China is not giving up on the dollar peg anytime soon. More important than my interpretation is what the U.S. congress makes of it. A lot on their plates now but protectionism was certainly more popular before China announced its currency basket. Probably bad for stocks if that sentiment returns.

Sep 14, 2005

UK Property Derivatives Market

From the FT:
Major players in the financial services industry are to partake in a trading game in property derivatives starting next month in a drive to accelerate the development of the market in the UK.

The initiative, which is being spearheaded by Hermes, the investment fund, is intended to give investors, property companies and investment banks the chance to gain practical experience in trading derivatives in a realistic environment – but on a virtual basis. The exercise is also aimed at gauging the level of potential demand.

Derivatives are financial instruments that effectively allow investors to bet on the direction of a particular market. A property derivative would give investors and companies exposure to the sector without having to own bricks and mortar. Buying derivatives is also often quicker and easier than physical property transactions.

Now that is interesting. I have believed for a very long time that with the massive amounts of wealth tied up in real estate and the normal concentration of risk by geography that a derivatives market was overdue in the sector. I am not familiar with the particulars of the contracts but it will be interesting to see how increased derivatives trading will impact the underlying market.

Sep 9, 2005

The Refinery Side of the Equation

From the FT:

Assessing the impact of the storm that closed refineries in the US's most important oil producing region, Europe's second largest oil group said it expected production in the region to reach only 60 per cent of the pre-hurricane levels by the end of the year.

It added that refineries at some sites including Mars, one of the gulf's largest deep water platforms capable of producing 220,000 barrels a day, were unlikely to resume activities this year.

The region, which produced an average 450,000 barrels of oil equivalent per day or about 15 per cent of group production in the first half of the year, is now only producing 160,00 boe/d following the damage caused by the storms.

This is the flipside of the story from last night.

Update: I may have confused some details and I kind of wonder if the author of the story did as well. Despite all the references to refineries and refining capacity near the top, the story closes with this:

In addition, Shell said a third of its refining capacity in the US had been knocked out by Hurricane Katrina. Before the storm Shell refined a million barrels of oil a day at its seven refineries in the US. Two of these sites - Motiva Convent and Motiva Norco had been affected but were expected to return to pre-hurricane levels by the middle of next week.

At this point I am guessing this last section is the only portion dealing with refining and that the deep water platform, Mars, is mistakenly referred to as a refinery.

Watching Oil vs. Gasoline Spread

From the FT:
The US and Europe are releasing more emergency crude oil than refineries in the Gulf of Mexico can handle, reinforcing suspicions that governments are using the crisis triggered by Hurricane Katrina to cap record oil prices.
Data from US oil inventories released on Thursday showed that crude oil stocks had fallen by 6.45m barrels, well below the 13.6m barrels of oil production that by Wednesday had been lost as a result of the hurricane.
This has been pretty well telegraphed with most people being very aware that the hurricane had a bigger impact on refining capacity than oil production. Prior to the hurricane refineries were already being talked about as a bottleneck.

It could still make an interesting situation though as a trader could have been very right and foreseen an inflation spike but still end up being positioned exactly wrong as oil (which has been leading the commodity charge) goes the other way. I don't know the commodity market as well as the credit market but the situation is a bit similar to the wishbone in the automotive sector when the credit downgrade came on the heels of Kerkorian's GM tender.

I haven't been blogging much lately as my views haven't changed very much since early Summer. The continued strength in the equity markets has been at odds with the problems I see so I have done very little. Prior to Katrina I thought the housing market was finally losing steam and leaving little cause for inflation. That is no longer the case as the refining and general transport issues caused by the storm are unknowable at this point.

Got to be one of the more interesting Fed meetings approaching. I lean towards a hike at this meeting.

Jul 21, 2005

Currency Story Continued

From Reuters:

The Singapore dollar, widely used with the yen to bet on a yuan move, shot higher to a two-month high of 1.6503 per U.S. dollar, up 2 percent on the day compared with 1.6843 on Wednesday, before dealers reported the intervention.
Singapore said it will maintain its policy of gradual and modest strengthening of the Singapre dollar and said fundamentals of the city-state's economy had not changed.
Hong Kong said it would not consider changing its currency peg to the dollar even if the yuan keep appreciating and said the Hong Kong dollar will remain very stable.
The Indian rupee rose to a six-year peak against the dollar around 43.20, up more than half a percent.
"The move is clearly positive for Asian currencies first, and to some extent the euro. It is pretty clear that the basket will involve a reasonable chunk of Asian currencies," said Emanuele Ravano, European strategist at PIMCO in London.
The Korean won's non-deliverable forward prices, used by offshore investors to trade the won, showed investors are factoring in a 2.2 percent rise in the won/dollar rate in one-month's time.

Following the yen's rise of more than two percent, Japan's top financial diplomat Hiroshi Watanabe said he is watching the market carefully and would take action if needed.
Japan has been urging China to reform the rigid FX regime but it had repeatedly said the yuan revaluation doesn't mean a higher yen and it has hinted it would intervene if necessar

Update 2:51 PM: This quote from Nouriel Roubini sums up what I am watching for:

And this could really be the beginning of the end of the Bretton Woods 2 regime of fixed pegs to the U.S. dollar in Asia. Malaysia already decided today to drop its peg relative to the U.S. dollar. This China move may also force Hong Kong to phase out its long term currency board and U.S. dollar peg. And other Asian currencies will soon sharply appreciate, following the yen's lead today. Even currencies at the periphery of this Bretton Woods regime (such as those in Latin America) may sharply appreciate. The systemic consequences of this currency realignment throughout Asia and the world could be radical and have significant impacts on U.S. long-term interest rates, on U.S. financial markets and on the U.S housing bubble.

Asian Currency Revaluations

China and Malaysia both moved their currency pegs last night. The move in the Renminbi was 2% which is smaller than the 5-10% most analysts had been mentioning but the impact could be quite large if other countries follow suit.

From the FT:
The effect of China’s move was expected to spread to other Asian currencies as other countries in the region were set to decouple their currencies from similar pegs to the dollar to make them more competitive.
Shortly after China’s announcement, Malaysia said it would alter its peg and allow the ringgit to fluctuate freely and Singapore, whose currency is tied to a trade-weighted basket of currencies, was also due to make an announcement.
Makes me wonder if the story won't continue to unravel for the next couple of weeks as other government reaffirm or change policy. That is a different story than the smaller than expected Chinese move in the headlines and it is what I will be watching for.

Jul 15, 2005

Snow Knows when China will Revalue

From the FT:
The Bush administration has told key senators that it expects China to revalue its currency in August ahead of a planned visit to Washington by President Hu Jintao in September, according to people familiar with the matter.
Senators Charles Schumer and Lindsey Graham, co-sponsors of a bill that would impose a 27.5 per cent tariff on Chinese imports, agreed to delay a vote on their bill after receiving what they regarded as an assurance that China will move on its currency next month.
In a June meeting attended by Alan Greenspan, Federal Reserve chairman, John Snow, Treasury secretary, told the senators that he believed China would allow the value of the renminbi to increase against the dollar in August, the people familiar with the discussion said.
Though I agree with the timing I am surprised they would tell Snow and surprised it would leak. The yen is trading 112.15 so I guess the market is yawning it off. Not sure that will continue.

The dollar seems like it is in a prime spot for a reversal (DXY is sitting below some long-term resistance in the 90-92 range). Also this fits with the current interest rate environment as the Fed has primed traders for more rate hikes while the yield curve threatens to invert. Seems like a bit of a disconnect between the carry traders in currencies and the "conundrumless" bond market.

Jul 7, 2005

London Bombings and the Markets

I don't think the markets have ever seen a 15 pt gap in the S&P index with an 11 handle on the VIX. That will probably lead to a gap in volatility prices when option markets open. The heads on CNBC are reminding people of the fast recovery the markets had after 9/11 and the Madrid bombings but the 11 VIX makes today completely different. There is a much higher risk that the vol increases from such a low level will lead to a very deep and sharp pullback that accelerates over the next few days.

Jun 22, 2005

More Peer-to-Peer Dreaming

From Marketwatch:

A Forrester Research Inc. analyst thinks Google's plan to facilitate payments on the Internet may go much further than helping people sell stuff at virtual yard sales.

Charlene Li wrote on her Web log that since Google Inc.'s AdSense service already puts links on Web pages, why not add micropayment processing?

"Google (GOOG: news, chart, profile) could offer a subscription 'pass' that grants users access to premium content on multiple sites, with each site getting a share of the payment based on usage," she wrote. Such an idea for bundled Web subscriptions was suggested several weeks ago by Martin Nisenholtz, senior vice president for Digital Operations at The New York Times.

The Forrester (FORR: news, chart, profile) principal analyst reasons that with millions of producers of Web logs and podcasts wondering how to make some money, Google's payment services venture might be a solution.

In remarks Tuesday, Google's CEO, Eric Schmidt, confirmed the company is working on payment services which are "a natural evolution of Google's existing online products and advertising programs," according to a report by the Los Angeles Times.

A service like this could provide serious competition for the current standard of "free" content paid for by advertising revenues. It is not clear to me how many people see this coming but I am guessing it is not too many yet.

Jun 21, 2005

Ford Cuts Guidance

From Marketwatch:

Ford Motor late Tuesday slashed its full-year profit target and said it would terminate about 1,750 of its North American salaried workforce to cut costs in the face of slumping sales.

Ford's stock (F: news, chart, profile) added 6 cents to close at $11.17 before slipping 5% to $10.60 in extended trading.

The No. 2 U.S. automaker now expects to report a full-year profit in a range of $1 to $1.25 a share, down from prior estimates of $1.25 to $1.50 a share.

Strange they didn't mention this before they sold debt. I wonder if "but a lot can change in two weeks" is a valid courtroom defense?

GM's bonds have already been trading a bit heavy the last week so I think the auto debt market could make it back to the headlines tomorrow.

*Update 6 AM 6/22 - According to the FT, "General Motors has stepped up the pressure on Ford in recent weeks with an “Employee Discount for Everyone” incentive programme. JD Power Associates estimated last week that GM’s discounts boosted its market share by eight percentage points in the first 12 days of June, while pushing down Ford’s share by more than a point.

Ford has responded by offering cash rewards of up to $1,000 to employees and pensioners who line up buyers of Ford vehicles."

Steel: Oh, How the Mighty have Fallen

From the FT:
The world's biggest steelmaker tried to calm markets on Tuesday as falling prices and profit warnings fuelled fears that the steel cycle had taken a turn for the worse.

Lakshmi Mittal, chief executive of Mittal Steel, blamed recent industry weakness on short-term factors such as the persistence of excess stocks that built up last year when customers were worried about shortages. "It's all about sentiment and an overhang of inventory," he told industry leaders in New York. "The long-term prospects remain strong."

His comments came as figures on global production suggest excess capacity may play a bigger part dragging the industry back to its old pattern of boom and bust.

Data on Tuesday from the International Iron and Steel Institute confirmed signs of a rise in Chinese production, in spite of attempts to control new investment. China was again the largest crude-steel producer, with output of 29.7m tonnes in May, up 37.5 per cent over this time last year.

Andy Mohinta, a commodities analyst with JP Morgan in London, said: "I don't think you can ignore the supply side. There now seems a real danger that increased Chinese production will slow their demand for imports and they may even start exporting back to Europe."

Steel is definitely weighing in on the bearish side of the market/economy lately. Particularly when - like this morning - it appears to be leading a general rout in both industrial and precious metals. The precious metals did alright (probably reacting to the yen) by the close but despite some attempts the industrials couldn't manage the same trick.

Yen Strength

From Bloomberg:
The yen rose the most in seven weeks against the dollar and appreciated against all major currencies on speculation China is closer to a decision to allow its currency to trade more freely.
The rise in the yen followed an announcement that U.S. Treasury Secretary John Snow and Federal Reserve Chairman Alan Greenspan will testify to Congress on June 23 about U.S.-Chinese economic relations. Both men have called for China to let the yuan float, freeing it to appreciate against the dollar. A stronger yuan boosts the yen by improving Japan's export competitiveness against China.
``The revaluation news spread like wildfire,'' said Enrico Caruso, chief trader at currency hedge fund Tempest Asset Management in Newport, California. ``That's the biggest driver of the dollar-yen right now.''
The latest round of speculation that the yuan would be revalued was tied to the announcement earlier today that Chinese President Hu Jintao will attend the Group of Eight industrialized countries' annual summit in the U.K. on July 7, according to Patrick Brodie, chief currency dealer in New York at Sumitomo Mitsui Banking Corp.
I am pretty sure this is a case of trying to fit the news to the market. Not that I disagree with the move but I don't think the G8 attendence in itself means anything. I mentioned last week that sentiment had swung about as far as I thought possible from the "its coming tonight" view of two months back.

Leading Indicators

From the NYT:
The Conference Board reported yesterday that only one of the 10 components of the leading index, stock prices, increased in May. The other components that dragged down the index included building permits, vendors' performances, the index of consumer expectations, manufacturers' new orders for nonmilitary capital goods, consumer goods and materials and average weekly initial claims for unemployment insurance.
I am not sure if the stock market's contrary move represents vision or the lack of it.

Jun 19, 2005

Bogle on the Fund Industry

From Marketwatch:
"The mutual fund croupiers rake huge sums off the stock market table," says Bogle. He estimates that management fees average 0.9%. Other expenses are 0.6%. So the average expense ratio is 1.5%, five to seven times the take for index funds.
Next deduct "hidden portfolio transaction costs of at least 0.8%" from managed funds says Bogle. Then deduct the long-term costs of "sales commissions on load funds, another 0.7%." So the total cost in an actively managed fund can run as high as 3%, leaving investors with just 4% on a 7% return.
But it's even worse on an after-tax basis: "Because of the shocking tax inefficiency" of funds' average turnover, which is greater than 100% for an actively managed stock portfolio, you deduct another 2.2%, says Bogle.
Bogle goes further and compares the results of compounding the two alternatives over a 20-year period: "The cumulative profit of each $1 initially invested in the managed fund came to just $1.55 in real terms, after taxes and costs, only 34% of the real profit of $4.50 in the index fund." In short, indexing is almost three times more profitable.

Jun 16, 2005

Philly Red Index

From Marketwatch:

Manufacturing in the Philadelphia region weakened unexpectedly in June, the Federal Reserve Bank of Philadelphia reported Thursday.

The Philly Fed's activity index fell to -2.2 in June from 7.3 in May.

This is the first negative reading since May 2003.

The drop was unexpected. Economists were expecting a slight increase to 9.4, according to a survey conducted by MarketWatch. See Economic Calendar.

Treasury prices reversed direction and moved higher after the report was released. Treasurys improve on weak Philly Fed data.

The index has been positive for two straight years. Readings over zero indicate expansion in the sector

In May, the index fell to 7.3 from 25.3, the largest one-month decline since January 2001.

The decline in the Philly Fed index contrasted with a rebound in the Empire State index in June and a strong gain in industrial production in May. See full story.

This is the kind of trend I was envisioning when I first thought the Fed might be done soon. As the story says this report is not consistent with May's production numbers.

Smart Money Walks Away

From Marketwatch:
Marin Capital Partners, a hedge fund that once oversaw about $2 billion in assets, is shutting down because the firm sees few opportunities in the convertible arbitrage and credit arbitrage strategies it follows.

Marin, which has moved most of its investments into cash, will stop trading at the end of June and return money to investors in early July, according to a letter the firm sent to investors this week.

"Due to a lack of suitable investment opportunities in the current market environment, and in our view an unfavorable risk/ reward situation in the relative value strategies we trade, Marin has moved the fund's portfolio largely into cash," Marin said in its letter, a copy of which was obtained by MarketWatch.
Marin, founded in 1999 by John Hull and J.T. Hansen, said it was proud of its record, citing the performance of its flagship Tiburon Fund which had returned more than 98% with relatively low volatility since inception, according to the firm's letter.

Morning thought

I think that higher open in Newmont (NEM) completes both a head and shoulders break, and an island reversal (updated 2PM - on further inspection the gap open did not clear the high of 39 from 4/27). It also looks a lot like the pattern in Phelps Dodge (PD).

Contrahour runs down the bull and bear views this AM. For bear support he also looks to transports but he sees the banks as central to the bull case. I would add to the bull side that with the yen joining in dollar weakness this AM, last week's bond weakness, and renewed commodity strength we are basically seeing a resumption of the trends from Spring '03.

Not quite convinced it will happen but yesterday's reversal to the upside certainly keeps it on the table.

Chinese Factory Worker...

can't believe the shit he makes for Americans.

FENGHUA, CHINA -- Chen Hsien, an employee of Fenghua Ningbo Plastic Works Ltd., a plastics factory that manufactures lightweight household items for Western markets, expressed his disbelief Monday over the "sheer amount of shit Americans will buy."

Chen makes yet more stupid crap for consumers overseas.
Above: Chen makes yet more stupid crap for consumers overseas.

"Often, when we're assigned a new order for, say, 'salad shooters,' I will say to myself, 'There's no way that anyone will ever buy these,'" Chen said during his lunch break in an open-air courtyard. "One month later, we will receive an order for the same product, but three times the quantity. How can anyone have a need for such useless shit?" - continued at the Onion

Hat tip to Mark in the comments at Brad Setser's Web Log.

S. Korea Follows through with Asset Diversification

From the Korea Herald:
The government yesterday unveiled measures to induce overseas investment by local firms and individuals, a major shift in its foreign exchange policy that once strictly restricted capital outflow.

The plan drafted by the Ministry of Finance and Economy is aimed at removing regulations on Koreans buying foreign real estate and other overseas assets.
The finance ministry expects the new measures to create outflows of between $1 billion and $1.5 billion per year. Korea has had a net inflow of foreign currencies worth about $25 billion on average every year since the 1997-1998 Asian financial crisis, according to the finance ministry. The central bank expects the net inflow to reach about $20 billion this year. In a separate move, the Bank of Korea yesterday was supposed to unveil a plan that would allow part of its foreign exchange reserves to be lent to overseas investors.

Jun 15, 2005

Shipping Rates vs. Mortgage Lending

Barry Ritholtz points out the weakness in the Baltic Dry Good Index, which is off by 50% since December. This fits in pretty well with my thoughts on transport stocks this AM.

Also check out Calculated Risk's summary of today's MBA report.

What happens when an unstoppable force meets an immovable object?

Commodity Spotlight

Prudent Investor explores the recent gold rally while Econbrowser takes apart Saudi Arabia's production rhetoric.

Bad Reaction

I wrote last week that I thought we were headed for a decision point and today looks like it. I am not doing a lot but am positioned for April's downtrend in equities to resume. My reaction to yesterday's economic releases is best captured in David Altig's quote from Reuters:
U.S. retail sales staged their sharpest drop in nearly a year in May while producer prices showed the biggest decline in nearly two, according to government data on Tuesday that may ease inflation fears but show consumers may be faltering.
I have been thinking a consumer slowdown or at least the fear of one was on the horizon so maybe I am just fitting the data to my view but it does not seem unreasonable. The CPI number this AM is also consitent with the idea that the worry going forward will be slack demand.

While commodities and their producers have managed a bounce the transports don't seem to be tagging along like they did last year. Norfolk Southern (NSC) and FedEx (FDX) stand out for their weak patterns. Last year the transports stormed higher through 9 months of market weakness and I repeatedly heard the reassurance that the sector was a leading indicator. I think this belief is rooted in Dow Theory and I am no expert there but I always try to note when once important "relationships" suddenly stop being discussed. That sector is giving the best support to the bear case in my view. Weakness in transports is also consistent with a continued weak production numbers.*

The bull case is still strongest in housing. Whether it is the all clear or just evidence of too many shorts remains to be seen. Also on the bull side was Walmart's (WMT) positive response to yesterday's data. Continued strong action in these sectors is pretty inconsistent with a thesis based on a weakening consumer.

*The airlines did not really play in last year's rally but the S&P downgrade of Northwest (and the insider sales) probably has some future relevance to the transport sector and possibly credit markets.

Jun 14, 2005

European Interest Rates

From the FT:
Hints by Jean-Claude Trichet, ECB president, and Otmar Issing, the bank's chief economist, that the possibility had increased of borrowing costs falling have contrasted with comments by several national central bank governors on the committee.
The differences highlight the dilemma faced by the ECB. Economic growth, lacklustre for the past four years, has slowed again, and politicians are increasing the pressure for a further cut in borrowing costs. But excess liquidity and oil price increases are sounding inflationary alarm bells.
The confusion puts pressure on the ECB to clarify its stance at its next rate setting meeting on July 7.
I wrote last week that I doubt U.S. interest rates will plunge like Japanese rates did in the 90's. I am much less convinced that the same can be said for Europe. The U.S. is in a much more attractive position to prevent deflation because lowering U.S. interest rates mostly punishes foreign lenders. Europe's higher savings rates make the ECB's decision tougher. In the end I think they will cut rates (maybe this fall) and I am guessing it will happen while the euro is rising rather than falling. I would also expect the ECB to follow any rate cuts by the U.S. Fed this time around too.
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CDOs and Market Failures

From the FT:
When Bank of America and Banca Popolare di Intra declared a truce in their long-running dispute over alleged derivatives mis-selling last week, they chose an odd time to release the news.
But, discreet or not, the news of this settlement is likely to provoke considerable debate among lawyers and investment bankers in coming days. Over the last five years, the CDO market has expanded rapidly and also moved to a new level of product complexity. Consequently, the question that worries some industry observers - particularly since credit conditions have become more volatile - is whether the BPI/BoA deal could be the precursor to a host of similar lawsuits.
I had not heard of this lawsuit before today. CDO's seem to be in danger of losing their status as a modern financial miracle.

This story of market failure (relating to GM/Ford downgrade) was also news to me. It seemed like pretty standard action for bonds as they jump across the great divide between credit grade and junk. A big dislocation and about 2 weeks to sort out forced sellers and new buyers. The Kerkorian bid spiced it up a bit but as he was buying in size it seems he would have done an aweful lot to relieve any panic. I am not active in corporate markets so maybe I am clueless about the horrors that transpired. With the SPX above 1200 I guess I have lots of company.

Jun 13, 2005

Facts Emerge About Spring Hedge Fund Losses

From the FT:
GLG Partners, Europe's largest hedge fund manager, has admitted that flaws in its trading models were partly to blame for a 14.5 per cent drop last month in the value of its Credit Fund.

In particular, it has acknowledged that the mathematical model it used to price complex credit derivative products failed to foresee market swings after last month's ratings downgrades of General Motors and Ford.

In a private letter to investors, a copy of which has been obtained by the Financial Times, the hedge fund argues that it has now rejigged these trading models. The admission is significant because other banks and hedge funds appear to have been using similar trading models, meaning that they may also have suffered big derivatives losses.

GLG warns that conditions in the credit market could remain difficult for some time because banks and hedge funds are trying to get out of loss-making derivatives positions at the same time.

"Segments of the hedge fund community and a substantial number of investment banks are nursing material losses in structured credit trades as a result of recent market conditions," the letter says.

I recommend this as some background reading on the current state of hedge fund risk models. The comments about Mandelbrot and Eckhardt seem most relevant.

The FT goes on to say that while the GLG's models considered a move like last month's (May?) an 8 sigma event that could be "ignored". This quote in particular seems like the root of problems: "GLG blamed the model's shortcoming on the fact that this CDO market had only traded since last year...". Personally I bet the model did exactly what it was built to. Generally they do that.

Maybe the CDO market is small enough and has had its time in the sun but with the VIX still tripping along sub 15% I find this kind of explanation troubling.

Jun 12, 2005

A Peer-to-Peer Future

From the FT:
Shawn Fanning's new company, dubbed Snocap, was poised to announce on Monday that it would start allowing all artists and record labels to register their music in a database designed to serve as a global clearing house that can identify digital tracks shared across the net and collect royalties on behalf of copyright owners.
"This registry is key to creating a world of authorised peer-to-peer networks that will attract music fans en masse - enabling consumers to share and discover new artists in much the same fashion as they did with old P2P - but done in a way that respects the rights holder," Mr Fanning, who serves as Snocap's chief strategy officer, said.
Finally. I imagine this kind of system will eventually replace the current advertising model that exists on blogs as well. I have not seen it yet but whether it is this product or something else the value added through distribution, filtering or promotion is falling to zero so I don't understand how money doesn't end up flowing directly from consumers to producers.

Jun 10, 2005

Google's Rally in Perspective

From CNET:
Google's stock has amazed investors and the public, but the returns still lag those experienced by New River Pharmaceuticals, a 19-employee company that has designed an attention deficit disorder drug.

The two companies went public two weeks apart in 2004. New River went public at $8.00 and is now sells at above $33, giving it a 317% return, according to statistics on IPO Home. Google went out at $85 and sells for $286, a 236 percent return. Google also trails China's Shanda Interactive, which has seen its stock rise from $11 to $38, in terms of return.

It's an improvement for the search giant, however. In April, it also trailed WPT Enterprises, which organizes the world poker tournament, and Syneron Medical, an Israeli company specializing in laser hair removal technology.

China's Peg Planning

From the NYT:
China's political leadership is actively considering breaking the 11-year link between the dollar and China's currency, the yuan, and tying its value instead to a group of currencies, current and former senior Chinese officials said in interviews. The proposal being weighed at almost daily meetings of the Standing Committee of the Chinese Communist Party's Politburo would use a so-called basket of currencies to set the yuan's value. The yuan would move up and down in currency markets in relation to the average values of the dollar, yen, euro and possibly other currencies like the British pound.

But the initial value of the yuan under the new system could, in dollar terms, be very close to its current value of 8.277 to the dollar.
The Politburo's Standing Committee - which includes President Hu Jintao, Prime Minister Wen Jiabao and seven other top officials - has made no decision yet on when or whether to act, and may decide soon or wait as long as next year, the officials said. But the deliberations have taken on a pressing quality, with the Standing Committee meeting almost every day last week to review currency policy. Senior economic officials have been told to be on hand for consultations at any moment.
In a telling instance, Yang Weizhe, the mother of Zhou Xiaochuan, the governor of the Chinese central bank, died at 6:30 a.m. on May 31, but Mr. Zhou was still required to attend a Standing Committee meeting on the currency an hour and a half later.


Victor Fung, a Hong Kong tycoon who is chairman of one of the world's largest garment companies and heads the territory's airport authority, said, "They recognize the need to go away from a peg and move toward a basket."
Mr. Fung said each currency's percentage in the basket should match the percentage of China's trade conducted in that currency, an approach favored by many economists. He also said that China should reveal the relative weightings of the currencies in the basket.
But other advisers said Chinese officials were leaning strongly toward switching to a basket without disclosing the currency weightings. Singapore has long done this with its dollar.
A few weeks ago speculative pressures were the reason for not moving. The current sentiment (knowing it is coming but it will be small and hard to time) is probably the best Chinese politicians can hope for.

They sure seem to be focusing on the finer details right now. In currencies I have quite a few yen longs on and most recently shorted AUD/JPY near here (stop at 83.5). That chart is bouncing along just on top of a long uptrend and looks set to have a big reaction to any yen strength. Other than oil, the commodity stocks have not put in much of a recovery so I am also watching the AUD to see if it is pointing out continued weakness there.

Jun 9, 2005

Two Roads for the Market

This series of charts maps the technical landscape pretty well. Personally I am expecting a bounce from near here that revisits recent highs. That will be decision time for the markets in my view, rather than holding the uptrend from April now.

Whether we spike to new highs or not after that is really dependent on consumers maintaining their confidence and spending habits in light of growing debt loads and a 'soft' wage market. That has been the same story really since 2002. Eventually consumers will balk though and the longer it lasts the easier it is to envision that happening.

So if low long-term interest rates can create another binge it is liquidity enema part III (I - Spring 03, II - Aug 04) I guess. Otherwise we see debt payments crowding out consumption which leaves little support for asset prices. I lean towards the latter but doing my best to stay open to signs pointing the other way.

Jun 8, 2005

Rehnquist will Step Down Soon

From the FT:
Chief Justice William Rehnquist, the ailing octogenarian who has presided over the US Supreme Court for 18 years, is expected to step down in about a fortnight. And immediately afterwards the body politic will be consumed with internecine combat over abortion.
Something to keep in mind I guess.

Kerkorian Done Buying

It is hard not to view this news as related to the Ford bond issue yesterday. Also, I am also surprised Kerkorian's tender didn't reach its intended size. When a bid comes in multiple points above the market I lean towards filling it.

I guess Kirk will be thanking Merrill for correctly recognizing the strong inherent demand while the stock was in free fall. That advice is all the more impressive as it was able to anticipate and look past the looming credit downgrade to the current nirvana.

While I am ranting I may as well discuss some other recurring thoughts that I have on GM and the auto sector. That Chicago number last week was nasty to say the least. Just one number but it is not too hard to imagine lots of bankruptcy headlines slowing purchase and hiring decisions at all levels. Those headlines could also have a very negative effect on the consumption of employees in the sector. Maybe that is not what is happening but I think it is too early to say for sure.

On another note it strikes me as a very large contrarian flag, that GM's salvation is being seen in ditching its manufacturing business so that it can focus on financing. If the long-term problem facing the US is an excess of borrowing and a lack of manufacture for export, there certainly appears to be some short-term forces going the other way.

These two thoughts contradict a bit but it comes down to timing. At this point demand for US exports is not sufficient to shift production patterns but at some point in the future it should be. In the mean time the manufacturers are dependent on US consumption which could be heading for a rough patch.

Japanese Yield Comparison - Part Deux

Barry Ritholtz added a comment to my JGB post yesterday so I thought I would elaborate on my view a bit. My main point is that when I look at the graph of 10-yr JGB and UST yields it is not obvious to me that they are related in some lagged fashion that centers around respective stock market tops in the two countries. Below is a straight comparison of the two data series from Oct 85 to April 2005 (JGB data source, UST data source).

Barry, in his post Monday, chose to shift the UST data to the left for comparison. I reproduce this below using my data. The chart extends further to the left including the data leading up to the Japanese stock market top.

It matches up pretty good, but both series have been in downtrends for the last 15 years so several sideways shifts will appear highly correlated over a 5 year period.

The argument I attempted yesterday was that the two series are already a good fit without any lag. I represent my view below by offsetting UST yields lower by 3%. This vertical shift lays the two data series on top of each other for visual effect.

It looks like a pretty good fit for the last 20 years. Lots of peaks and troughs line up. Notice that the last two years line up in uptrends similar to Barry's graph. The need for a 3% shift might be explained by the savings differential between the US and Japan. Probably an oversimplification but not entirely unreasonable.

The two shifted charts lead to different implications for the future. If the downtrend in JGB yields has reversed I would not expect US rates to continue lower. I would not even expect US yields to be weighed down by some sort of structural damage left over from the 1999 stock market top. I would instead expect them to continue tracking JGB yields and head higher.

Ford Drive By

From the FT:

However, the market has improved significantly from its worst levels in mid-May. Ford Motor Credit on Tuesday sold $1.5bn of three-year paper at 330 basis points over Treasury rates. It increased the size from the original $1bn as a result of demand.

The deal was a "drive-by", meaning it was announced and priced on the same day. This usually implies an issuer is taking advantage of market conditions. In the secondary market on Tuesday, Ford 2008 notes were trading at about 320bp over Treasuries, down from a peak of 514bp in mid-May, according to MarketAxess.

The article also mentions the Qwest $1.25 bn junk offering being placed tomorrow. It is the biggest junk issue since the auto downgrades.

Jun 7, 2005

VXO and SPX Divergence

The VXO already took out its Feb low last week and looks like it will manage the same trick again today. The SPX still needs to take out 1229 to keep pace so the market's forward view of risk is leading the actual price action.

Between this and my estimate of where sentiment is at I am going to buy some puts for the Fall. I am looking at the 1140 and 1100 strikes because I like to have the gamma around inflection points.

I probably won't short anything in cash unless TOL slips back below 85. Looking at other things too for that judgement but the breakout in homebuilders in the face of a lot of bearish commentary sums up my defensiveness best.

A divergence the other way occurred on May 13th just for some perspective.

Japan's Impact on the U.S.

There is interesting comparison of of JGB and UST rate paths at the Big Picture and the Skeptical Speculator throws in a look at how the Nikkei performed. While it is an interesting coincidence I have a hard time getting over the idea that it is Japan's current economic troubles that are helping to pull U.S. rates down and not an inevitable reaction to the popping of a stock market bubble.

Also, the most unique part of Japan's history is the 1994-1999 segment where rates fell from a 4 handle to a 1 handle. The policy mistakes (failure to clear out bad loans and banks mostly) in that period led to the long bottoming process we are seeing in that economy. The U.S. rate cuts of 2001-2003 were done specifically to avoid the deflationary trap that Japan fell into and so far it has worked. This comparison of bond yields also ignores the very different saving and fiscal situation of the two countries. Japan's high saving rates bias its policies towards deflation (defending the purchasing power of savers) while the U.S. will lean towards inflating its debts away.

I think JGB yields bottomed in March of '03 which not coincidentally is when U.S. deflation fears peaked. I would rather bet on U.S. interest rates following Japanese rates in the present than in the mid 90's.

Jun 4, 2005

AIG Downgraded Again

From the FT ($$):
Standard & Poor's on Friday cut its rating on American International Group's debt by another notch to AA, citing concerns about the scale of accounting problems the world's biggest insurer reported when it filed its annual report this week.

The downgrade represents another setback for AIG, which has seen its borrowing costs rise since it lost its prized AAA rating following the investigation by US regulators into its accounting standards.

Jun 3, 2005

Renminbi NDF Growth

From Cynic's Delight:
Second, there is a growing market for non-deliverable forward contracts for Chinese renminbi. NDF contracts are traded offshore and are used to hedge against exchange rate movements in non-convertible currencies. In this case they are agreements to buy or sell renminbi at a specific future date at a specific exchange rate. At maturity, the contracts are settled using only the hard currency, usually dollars, and no renminbi are deliverable. Dollar payments are made or due based on the difference between the prevailing spot rate and the NDF rate. If, at maturity, the renminbi has appreciated against the dollar, the holder of the NDF will be paid a certain dollar amount. If the renminbi has depreciated, the holder will owe a certain dollar amount.

The BIS report suggests that the growth of these renminbi NDF markets presents one of the few real price signals from the markets as to future expectations of the renminbi exchange rate. Billion dollar daily turnovers are now common, and most of the activity seems to be hedging against a renminbi revaluation. Moreover, the report has uncovered evidence of a movement away from strictly dollar oriented exchange rates among Asian currencies towards an "effective exchange rate orientation." In other words, Asian exchange rates are seeing higher volatility against the dollar as compared to between Asian currencies.

This is important, as it is evidence of market signals that the renminbi will play an increasingly important role in determining exchange rates across East Asia. Considering the rising trade flows between China and the other Asian economies, this only makes sense. It is becoming increasingly likely that a renminbi revaluation could allow other Asian currencies to rise against the dollar while maintaining (or at least limiting the rise in) their renminbi exchange rates.

Still, so long as the Chinese prevent current account convertibility, they will be free to determine exchange rate and monetary policy as they see fit, without bowing to pressure from the financial markets or foreign governments. But as China's share of international trade grows, renminbi turnover will inexorably rise along with it. Importers and exporters will find increasingly sophisticated ways to manage their foreign exchange needs, and capital flows should prove harder and harder to manage. In the long run, international financial markets will provide the real challenge to Chinese efforts to maintain control over their exchange rate and monetary policies, and not foreign governments.

Jun 2, 2005

Too Funny

From CNN:

Greenspan as Yoda
Conundrum, hmmm? Boost interest rates, I must.

Personally I think Greenspan gets a little too much abuse but this is still funny.

Jun 1, 2005

Corporate Spreads Still a Problem

From the FT:
The supply of new European corporate bond issues more than halved in May compared with the same period last year as borrowers were pushed to the sidelines amid the sharp volatility in the secondary market.
The supply of new bonds with investment-grade credit ratings reached just EUR6.875bn in May, down 52.5 per cent from the same month in 2004. The supply in the year to date is running 26 per cent below last year's levels, which ended up being 40 per cent weaker than 2003.
But the reason behind the low issuance in May and late April differed from that of the preceding months, in that it was the market that turned away from borrowers and not the other way round.
The article continues by discussing the return of investor demand in later May. Even so I think the trend of spread widening that started in March has a ways to go. Because of that I am leaning towards shorting stocks here but am patient to see where this rally goes. Seems like we could hang out around these levels for a few weeks.

Of course I am still watching TOL as a main tell. It seems like sentiment could keep squeezing it higher but it will be interesting to see how housing stocks can do if the market has a bad week.

Also watching silver and the yen to see if the dollar rally will run out of steam.

All in all not much to do.

May 31, 2005

Are Hedge Funds a Good Deal?

Seeking Alpha has a nice post looking at hedge fund returns. If you are interested in the sector or curious about how to think about returns across asset classes I recommend it.

May 26, 2005

Rising Japanese Bond Yields

From Bloomberg:

Japan's 10-year government bonds fell as yields near a 14-month low deterred investors from buying amid signs the world's second-largest economy is growing.

A government report on May 30 will probably show Japan's industrial production gained in April, according to a Bloomberg News survey. The economy in the first quarter expanded at more than twice the rate forecast by economists.

Hard to see why this trend wouldn't continue. To change it I think you would need to see a hard landing in China.

May 24, 2005

Marc Faber on Currencies, Commodities

From the Bloomberg:

Once the US economy deteriorates, the Fed "will go back to the old medicine, which is essentially to print money and the dollar will weaken again," Faber said in an interview with Bloomberg News yesterday. "Compared with the euro, the Asian currencies are very, very inexpensive."
``The foreign exchange market will anticipate this easing beforehand'' resulting in a drop in the dollar, said Faber, adding that he was a ``reluctant'' holder of dollars.

Some investors and traders disagree. Fifty-nine percent of the 54 strategists, investors and traders surveyed globally on May 20 said the dollar is poised for its longest winning streak against the euro since 2000 on expectations the U.S. currency's three-year bear market has ended.
Faber is also betting on gold because it has become cheaper compared with commodities such as crude oil.

Today, one ounce of gold, trading at $417.60, is worth about eight barrels of oil, according to Faber. In 1998, when oil fell to less than $11 per barrel, gold was trading at about $285 an ounce. That's equal to about 26 barrels of oil per ounce of gold.

``You should be long gold and short oil,'' Faber said. Commodity markets ``aren't particularly attractive.''

Hard to disagree with any of that. I would not hold dollars right now - even "reluctantly".

The EUR/JPY chart I put up just before the strong U.S. retail sales numbers still seems very relevant.

May 19, 2005

Reading the Market Bounce

From the FT:
Are investors risk-seeking or becoming more risk-averse? The recent rally in equity markets suggests the former; the fall in Treasury bond yields and the widening of credit spreads suggests the latter.
I am not sure I would read too much into the equity bounce. Stocks got held underwater for several weeks before staging this rally. Markets never move in a straight line and it is really the new highs and lows that have meaning.

Certainly with the mixed economic data it doesn't hurt to keep an open mind but I am not sure a rally reflects risk-seeking so much as relief.

If Toll Brothers can make new highs I would take it as a sign that any bear bets have to wait.

South Korea Intervenes

Yes, they did say yesterday that they were done.

Details from the FT:
The Bank of Korea on Thursday backtracked on its comments that it did not plan to intervene further in the foreign exchange markets, after precipitating a sharp fall in the US dollar overnight.

Currency traders said it appeared that the central bank in fact bought dollar-denominated assets on Thursday morning, less than 24 hours after Park Seung, the governor, told the Financial Times that he did not "anticipate" doing so.

Baffled about how this would happen. It is not that difficult to give an interview and repeat stock phrases. Probably doesn't mean much over the short-run as traders will just be left ignoring all comments. In the long-run the loss of credibility could really limit the bank's options.

I've got to wonder if it is not some sort of bureaucratic foul-up, either on the intervention or the statement. Seems like somebody needs to lose a job over it.

* Update 10:20 - Brad Setser's thoughts:

What is going on? It sure seems like the Bank of Korea (the central bank) and the Ministry of Finance (if not the entire government) are in somewhat different places. The Finance Ministry is worried about any slowdown in growth, and Korea's export growth seems to be slowing. This policy dispute just played out in a very public way.

An Inflation Hawk

Capital Spectator sounds more hawkish than I am:
Nonetheless, the preference for seeing as inflation as yesterday's worry suddenly finds new popularity. It must be stated too that this optimism is built in no small degree on the house of energy and the expectation that the price rally in oil is now behind us.

Definitely good for a read. I am more of a slowing-growth-due-to-rising-risk-premiums dove but even if that proves correct oil prices can still cause inflation problems this fall or next year based on increased emerging market demand.

May 18, 2005

Tim Duy Weighs In

From Economist's View:
Why do I keep harping on the necessity for a significant slowing in growth before the Fed changes course? Just look at yesterday's comments by Fed Governor Donald Kohn, speaking to the Australian Business Economists: "... if growth is sustained and inflation remains contained, we are likely to raise rates further at a measured pace." And "The federal funds rate appears still to be below the level that we would expect to be consistent with the maintenance of stable inflation and full employment over the medium run." And, if that wasn't clear enough, "[W]e have not yet finished this task." These are remarkably candid remarks, and imply a high degree of confidence in the continuance of existing policy. The recent bearish feelings on Wall Street are clearly not receiving much validation in the inner circles of the Fed.
In reading these thoughts, I can't help but think about the FOMC's policy shift in January of 2001. Following the flow of statements from Dec 19th, to January 3rd, to January 31st the commitee shifts from "everything is fine, there is nothing to see here" (my flippant summary) to a call "for a rapid and forceful response of monetary policy" (their words this time). I bring this up to show how quickly the Fed is willing to change its mind when the data hits them with a 2x4.

At this point signalling an end to the hikes could relaunch the commodity rally (dollar fall) and bring about inflation but if we arrive at the June meeting with oil in the low 40's it seems to me the risks are tipping towards slower growth. The Fed doesn't know any better than anyone else if April's market moves are just volatility or a trend change so they lean towards maintaining the status quo. No harm no foul if they get it wrong in the statements leading up to the next meeting. Kohn can just change his mind.

Oil in the low 40's and credit spreads wider than today's levels, which seems very likely, and I expect the Fed will be done in June. A lot can happen in a month and a half though.

South Korea Says "No Mas!"

From the FT:
South Korea's central bank will not intervene any further in foreign exchange markets, the governor of the Bank of Korea said on Wednesday in comments likely to unsettle financial markets.

"I believe that we now have sufficient reserves to secure our sovereign credibility, so I do not anticipate increasing the amount of foreign reserves further," Park Seung told the Financial Times. South Korea's foreign currency reserves stand at $206bn the fourth largest in the world.

Mr Park said: "We now need to take more consideration of profitability, and I think we're at a stage where we need to manage our reserves in a more useful way."

This will be harder to shrug off than Norway's sales.

Greenspan Staying?

Calculated risk picks up the news that Greenspan may stay a few months longer than expected. Not sure I see the logic in that but I guess I should be used to that.

Equities, Bonds, and Inflation

I imagine we are making near term highs in the equity markets. Maybe slightly above here over the next 4 days and then a pullback. Maybe to 36.20 in the QQQQ. I am chucking out some of my longs with plans to kick the rest out tomorrow. Maybe we are into a topping process that leads to some good long term shorts but I would say it takes a couple of weeks and will be staying flat on equities and watching.

I am going to start building a long bond short in here. Going to go slow as it seems like the dollar might need to top out to create any real weakness.

I don't see this mornings inflation number as a problem and generally just see it lagging the PPI top. I don't see how that top can get taken out without a massive reversal in commodities. Those charts are disaster zones and probably need to base for 2 months. If I am wrong and that rally relaunches I would reconsider my view that inflation fears peaked in March and are headed lower.

Auto Supplier Bankruptcy

My brother works as an engineer at an autoparts supplier and he asked me if he should buy some shares in Collins & Aikman, which filed for chapter 11, yesterday while it trades around $0.10. I replied that he has plenty of risk on the books just by working in the industry and that the action will be in bonds once the stock price is below a buck.

The company has some 2011 bonds that are trading near $0.40 at a roughly 35% yield. It may have overshot in the short-run but at those levels there is not much hope for the stock. I mentioned as a source for corporate bond prices the other week and while it is not a very good market for individual investors the prices can give some insight into a company's prospects. Definitely worth checking out before playing in the equity.

May 16, 2005

Norway Sells Half its U.S. Treasury Bonds

From Reuters:
A surprisingly small flow of foreign money to the United States in March was due mainly to a halving of oil-rich Norway's U.S. Treasury bond holdings, raising questions about whether overseas governments are cutting huge holdings of U.S. assets.

A U.S. Treasury report on Monday showed the net flow of foreign investment to U.S. securities at $45.7 billion in March -- more than $20 billion below expectations and less than needed to cover the $55 billion U.S. trade deficit that month.

Foreign official institutions, consisting mainly of foreign central banks, were net sellers to the tune of $14.98 billion.

Close examination of the data shows these sales were dominated by Norway's more than halving its holdings of Treasury bonds to $16.9 billion from $33.8 billion.

Analysts said Norway's holdings are most likely those of the $160 billion Government Petroleum Fund, a fund of foreign stocks and bonds set up in 1996 aimed at saving oil and gas revenues for the future, when energy resources run out.
Norway's Treasuries holdings rose by more than $20 billion in the second half of 2004 to $35.1 billion in January, said Goldman Sachs economist Thomas Stolper. He added that March looked consistent with a very active investment stance.

This was an interesting take on some pretty widely covered news. As Brad Setser says, "...Norway is not likely to sell $17 billion of Treasuries every month." Even so I am surprised the euro didn't get a little more mojo back against the dollar.

Today's news continues the trend of taking some pretty surpising data in stride. In the last two weeks we have gotten over strong employment data (too construction heavy), a shrinking trade deficit (it was Chinese New Year), and strong retail sales (screwed up by Easter). My answer to all this is that the market is just not focused on the data. It probably doesn't help that there has been a pretty mixed picture.

I kind of feel the path of least resistance for the markets is higher (lower for UST bonds) as lots of people seem to be looking at long-term problems to drive current prices. This is most noticable in housing but so far there is little sign that market can't stay strong through the fall.

May 14, 2005

Hedge Funds vs. Day Traders

From The Guardian:
The herding instincts of investors are truly remarkable. Similar beasts stick together, chasing the same stocks at the same time and often risking great financial peril, but such instincts can also overwhelm very different investor species. In recent times the grandest of hedge fund managers have found themselves thundering shoulder to shoulder with the scruffiest day traders ... towards oblivion.
The article makes some interesting comparisons but its probably a little over the top. Entertaining reading though.

May 13, 2005

Volatily Spiking Again

The scariest part of today's action has to be the spike in the VIX back near 18. The VIX bounced its way down to the 12 level over the course of 2 years and this quick move up is going to cause a lot of pain for options sellers. Besides that the higher vol will require options hedgers to sell increasingly larger size into the market as it heads lower. Implied and actual vols are also used pretty heavily to measure the risk on trading books so this move really has the potential to pull liquidity from the market.

As I mentioned all the talk of hedge fund trouble this week I was a bit skeptical. A rising VIX makes me a lot less skeptical.


The data and market reactions over the last couple of days have left me pretty confused. I am focused on the commodity weakness. In March the reason for Fed tightening was the inflation coming through the system and made obvious by the highs being hit in the CRB, oil, copper, steel and too a lesser extent houses. Now the commodity sector has backed off considerably. This could be viewed as evidence that growth is slowing in Asia. It should reduce the need for Fed tightening.

Ditto for the widening of corporate spreads. It was a sign of excess liquidity but now the rising risk premiums have taken that argument off of the table.

The dollar strength evident yesterday should also give the Fed more options.

Throw in a couple of good data points on the economy and the thought that securities markets could be distorted in here by hedge fund troubles and I am having a tough time knowing what to think.

May 12, 2005

Evaluating USD Strength

While the dollar is showing some strength on the smaller than expected trade deficit, I am not convinced it means a whole lot. I still tend to view Asia vs. Europe as the better risk trade but the U.S. is not fixing any of its longer term problems, so it will probably resume its downtrend eventually. The new budget (mentioned here via Brad Setser and here via Mark Thoma) is just adding to capital account needs and over time the trade numbers will reflect these policy mistakes.

Bill Cara explores the dollar's overnight strength and concludes with this:

I say that if the Bank of China does not revalue the Renminbi yuan this weekend, which is a longshot at best, there will be serious hedge fund failures next week. That's because traders like me are massively short the dollar and will have to close those positions.

Financial Armageddon just could be at hand, and we all were looking at the GM equity-bond trade issues as the biggest problem for some hedge funds when we should have been looking at the Dollar.

Traders cover losing bets all the time but hedge fund failures are a bit more infrequent. It is certainly in the air this week but with JPY below 136 to the EUR I am not sure people are that stressed. Below is a EUR/JPY chart with 4 hour bars.

Click on the chart to see a larger image!!
Posted by Hello

That seems like where the renminbi revaluation expectations have been most pronounced and probably where their is the most risk of a snapback. Greenspan's speech swung some weight behind the idea that China was facing internal pressures to revalue and that is a very persuasive argument for macro funds. The U.S. trade deficit doesn't seem like much of a catalyst in the trade. More of a distraction.

Explaining the Hedge Fund Rumors

From the FT ($$):

According to Mike Harris, credit derivative strategist at JP Morgan, hedge funds had been putting on a trade which involved buying the equity tranches (the most risky) and going short (gambling on a decline) in less risky mezzanine tranches. They leveraged up this trade by selling protection (options) against the equity portion. That trade gave investors a positive carry since the yields on the riskiest tranche were higher than the yields on lower tranches.

But the emergence of idiosyncratic risk in the form of the downgrades at General Motors and Ford has caused the spread on the equity tranches to widen, causing losses for the hedge funds putting on this trade. As they attempted to unwind their positions, the selling pressure pushed prices down even further.

There is a saying (mostly in currency markets) that goes "the road to hell is paved with positive carry." That people would have this kind of trade on and lose money doesn't really surprise me. That anyone would have it on in big enough size to risk their solvency would.

When considering trades like this it never hurts to just look at being naked long the riskiest portion in much smaller size (targeting an equal return). Usually when the trade goes bad the variance in the bid/offer spread has been grossly underestimated. Its possible that an unhedeged position might get the same yield with about 1/20th the notional value so if things go bad it's easier to dump it rather than hang on waiting for the bid/ask to tighten back to normal.

I have never traded the CDO market and am just assuming that like most derivatives the bid/offer is several times wider than on the underlying. When the underlying is a corporate bond that is a lot of hay just to break even on a spread trade.

May 11, 2005

Savings Glut or Investment Dearth?

I have been waiting patiently for Billmon at Whiskey Bar to post his 3rd entry on this issue. His first 2 pieces (Part I and Part II) were excellent and I highly recommend them to anyone who did not run across them already.

You'll probably want to read Nouriel Roubini's latest piece first as it is referred to at several points. It also provides context for the savings debate within a bigger economic picture.

Here is a taste of what Billmon says:

Instead, the problem appears to be a variation on the same theme Keynes explored 70 years ago: Private individuals with savings to lend are holding out for a higher price (interest rate) than borrowers are willing to pay - and in America's case, probably higher than it could afford to pay, given the quantity demanded.

By afford, I don't mean America is literally too poor to cover the vig, but rather that the interest rate required to finance the current account deficit solely from private sources would slow the U.S. economy and short circuit the current investment recovery - thus drastically reducing, if not eliminating, the demand for foreign savings.

This state of affairs has forced the ODIC governments to step into the breach and provide the financing that private lenders are no longer willing to offer. In effect, they are forcing the savings-investment market to clear - at an artificially low price. We can assume they are not doing this out of the goodness of their hearts or because of the kindness of strangers. They are propping up the market because they, too, are afraid of the deflationary wolf and so far haven't figured out another way to generate the kind of growth rates they need to stay one step ahead of it.

What makes all this such an interesting variation on the old Keynesian theme is that the recalcitrant lenders and the increasingly strapped borrowers happen to live in different countries with different currencies and different central banks - as well as different cultures, ideologies and geopolitical objectives, some of which may not be reconcilable.

I will probably be back when the series raps up with some thoughts. Until then I am keeping an open mind. This issue is extremely important though and perhaps even urgent. It seems like the next 6 months will see a short-term test of the "savings glut" thesis (a liquidity crisis). How that test works out just depends on where the long-term equilibrium actually is.

Hedge Fund Follow-up

These two articles show opposite side of yesterday's fears.

First from Bloomberg:
``It's more rumors than fact,'' said Brett Barth, a partner at BBR Partners LLC in New York, which invests in hedge funds for its clients. ``There are a handful of trades not working, so people are worried that there are hedge funds being forced to liquidate their holdings to meet redemptions.''
Next the NYT:

Another large hedge fund manager, GLG Partners, which is based in London and is 20 percent owned by Lehman Brothers, had losses ranging from 2.5 percent to more than 8 percent as of last month on some of the portfolios it manages, according to a person briefed on the results. Officials at GLG did not return e-mail messages sent to their offices yesterday afternoon. A spokeswoman for Lehman declined to comment.

Yesterday's sell-off began on European markets amid a rumor that Deutsche Bank stood to suffer losses because of its exposure to a hedge fund that was caught wrong-footed by the recent cut in the credit rating of G.M.'s debt. Shares of Deutsche Bank fell 3 percent.

I still have a hard time seeing the correlations between assets as high enough to prevent new money from flowing into disrupted areas. Not doing anything on the news but watching.

Yuan Revaluation Effects

Ezra Marbach summarizes a NYT article that lays out some possible effects of a renminbi revaluation.

May 10, 2005

GM Aftershocks

From the FT($$):

Many funds are believed to have bought GM bonds, which had fallen sharply in March following a profits warning, in the belief that the debt was oversold. Simultaneously, bets were placed short-selling the company's shares.

But last Wednesday, the stock leapt 18 per cent on news of billionaire Kirk Kerkorian's tender offer for shares in the struggling carmaker. On Thursday, Standard & Poor's caught the market off guard by finally downgrading the company to junk, pushing GM bonds sharply lower.

I did not think about this effect but it could be very powerful in the short-term. The risk is similar to the liquidity risk when LTCM went under. In the long-run either your bonds will pay off or the stock goes to zero but margin calls and marking-to-market are very real risks to levered players. Making it to see the long-term is the challenge.

It would need some pretty big knock-on effects into other issues to cause a real problem. Otherwise other funds who were uninvolved would be jumping into the bond stock spread or at least shorting GM stock against the $31 level.

Even easier for F with no looming bid.

*Update 4:00 PM - I having been looking at Merrill Lynch (MER) the last couple of nights and thinking it looked an aweful lot stronger than some other big financials (like Citigroup (C)). Since MER is involved in the GM bid I had kind of an "aha" moment thinking they would be prepositioned to pick up the pieces on a move like today. MER , however, is not holding up so well today so I guess I will just file my thought away for later.

Healthy 3-year Auction

From Reuters:
Treasury debt prices kept a grip on early gains on Tuesday as an auction of new U.S. government debt drew respectable demand, which may bode well for the rest of the week's $51 billion refunding.

The sale of $22 billion in three-year Treasury notes went at a high yield of 3.821 percent. It drew bids for 2.38 times the amount on offer, well above the 2.00 average of previous sales and the highest since the three-year was relaunched in May, 2003.

Indirect bidders, including customers of primary dealers and foreign central banks, picked up $8.66 billion, or 39 percent, of the issue. That was down slightly from February's 44 percent share, but in line with the average of 38 percent and a relief to traders worried that foreign demand could fall sharply. Primary dealers took $12.67 billion of the sale.

Still more auctions to come but this should be reassuring after last week's bond turbulence. I am a bit surprised the market has gotten over the strong jobs report so quickly. More strong data could cause a lot of pain.

Oil Futures Trade Contango

From the FT:
The crude oil futures market has produced plenty of hot news in the past 18 months. However, one of the more recent - and striking - developments has been the widening gap between nearby prices and the longer-dated prices, which has encouraged US refiners to buy oil and store it in the hope of selling it for a higher price later in the year.

This price pattern, known as "contango" - the industry term for when future delivery prices are higher than more immediate transactions - has reversed the normal price behaviour of crude futures markets. Usually nearby prices trade higher than longer-dated deliverable prices because oil markets have seen tight balance between supply and demand, which in turn pushes up nearby prices.
"Investors will have to hope that oil prices will have to rise strongly in absolute terms for them to hold on to their investments, because if the price were to remain flat and the steep contango persists, the losses will continue and their overall returns from crude futures will reduce," said Mr Lewis.

A while back I mentioned the spot market's focus on projected future shortages rather than current inventory levels. The market has now worked that out.

Tea Leaves

Looking through the charts today. The strength in housing looks impressive. Toll Brothers (TOL) is one of few charts that is still in position to challenge the March highs. It is especially impressive given that the bonds turned lower on the jobs report. I guess the market likes the construction jobs in spite of the higher rates. Same story in Fluor (FLR).

I also see strength in the Asian ETFs (EWY, EWS), semiconductors (INTC, SMH) and some of the retailers (SMRT, ANN).

Oil stocks look alright but other commodities sectors are still struggling near lows.

I am taking a wait an see approach to the charts. I would expect this rally to lead to some nice shorts in a bit but if home builders can break new highs it might postpone the markets demise by months.

May 9, 2005

Financial Risk Models

From the Mises Institute blog:

Although the mechanical philosophy is long dead and buried, our age is not without its own dogma regarding properly scientific explanations. Today, the prevailing belief is that any real science must be composed of mathematical models, models which yield quantitative predictions about some class of events based on particular, initial conditions, also specified numerically. Once again, the currently popular methodology has been imposed on diverse disciplines with little regard to whether it is suitable to their subject matter, but simply because it is thought to be the only respectable way to do science. The philosopher John Dupré calls this "scientific imperialism," meaning "the tendency for a successful scientific idea to be applied far beyond its original home, and generally with decreasing success the more its application is expanded" (2001, p. 16). Once again, we see a frantic effort to generate models fitting the accepted paradigm, with little regard for the realism of the assumptions and mechanisms from which they are constructed.
In my mind this relates prettly closely to this post from Brad Setser (be sure to read the comments which wade deeper into modelling and risk measurement). The basic problems in risk management seems to me that assets are assumed to have inherent properties like the physical bodies. Particles have mass, position and velocity while assets have price, varience, and correlation. I call it a basic problem because these aren't really the properties of the asset but are the properies of transactions.

Transactions necessarily have assets, counterparties, prices and times associated with them but assets need not be part of a transaction. A series of transactions in two identical assets need not have a realtionship at all if the counterparties have no contact. The existence of exchanges and the requirments of open-outcry and disclosure get around this basic problem, creating attachment between transactions but I am not sure this does much more than create the illusion that assets always have prices and those prices move in continuous fashion.

May 8, 2005

China's dilemma

This article provides some good food for thought about the timing of a yuan revaluation and the state of the Chinese economy. Some of the highlights.
Walker sees China hitting a wall, chiefly in the form of a labour shortage; not the much-publicised reluctance of inland Chinese recently to serve as factory fodder in the sweatshops of Guangdong, the industrial province bordering Hong Kong, but supply gaps in skilled workers and managers.
With about 1 million Taiwanese already employed on the mainland - about 10 per cent of the island's workforce and therefore probably close to the limit - newspapers in Hong Kong and South-East Asia are packed with ads for supervisory or technical jobs in China.


Nor was the diet of low-yield government paper doing much for profitability in the scandal-prone Chinese banks, whose non-performing loans Roubini and Setser put at somewhere between 46 and 56 per cent of China's GDP.
Also last week, the ratings agency Standard & Poor's said recapitalisation of two of the big four state banks - the Industrial and Commercial Bank of China, and the Agricultural Bank of China - would require injections of between $US110 billion and $US190 billion.

Indeed, the weak position of the Chinese banks and their huge requirements for capital are cited by Xie as one more reason against early revaluation. As well as adding to bad debts by raising domestic real estate and other prices in relative terms, a higher yuan would require more US dollar investment to achieve sound capital adequacy.
Although disposal of bad debts via asset management corporations is lagging badly, Chinese financial authorities are still hoping to bring two large banks - the China Construction Bank, whose assets are mainly infrastructure loans to governments, and the Bank of Communications, which already has a 19.9 per cent "strategic" holding by HSBC - to international share offerings in coming months.
A good general rule in economics is that flexibility and transparency lead to stability. Along those line I guess I can see why China's policies have left it with few good options.

May 7, 2005

Handy Bond Market Data

Brad Setser stuck in a comment that had me checking out bond data. I still have not found net long-term corporate issuance for 2004 but thought I would organize some of the resources I ran into.

Bond Market Association has a table of outstanding debt by sector from 1985-2004. Other BMA tables here.

Thomson Financial's capital market summary 4Q 2004 (U.S. total debt issuance by sector on page 13 shows long term issuance excluding MBS, ABS, and Munis down 2.5% from '03) and lots of other reports (mostly league tables) here .

The BMA also provides which is a good starting point for current bond prices and spreads. The corporate page will pop up the most active corporate issues and you can even watch a bond market ticker.

The U.S. treasure curve with swaps included is available at GovPx and there is a bond market outlook and news summary provided by Stone and McCarthy. You can also get economic headlines refreshed every 2 minutes if that is your pleasure.

NPR on Global FX Currency Traders

Five minute audio clip with the more interesting/entertaining stuff coming in the last 90 seconds. Quite a business model.

May 6, 2005

Summing Up the Week

We end the week weighing the auto downgrades and steepening yield curve (new 30-yr) against an unexpectedly positive jobs report and Kerkorian's bold bottom fishing maneuver in General Motors (GM).

On the auto downgrades it seems very likely that the bond market had already anticipated the downgrade. Its arrival shifts the focus off of the auto bonds and towards the wider bond market. I would not be surprised if GM and F bonds bottom here or shortly while junk spreads continue to widen. A best case would be junk widening while investment grade tightens but I would guess such a trend would be short lived. I am not really sure where Kerkorian's bid fits into this picture other than to muddy the waters. It is not clear what his motivations are and I am not sure that GM's equity is the best risk / reward trade in here.

I said any investment grade tightening might be short lived because the jobs report and new 30-yr created a lot of uncertainty in the long end of the yield curve. On Tuesday I thought the market would start to anticipate an end to the hiking cycle but this jobs report brings us back to considering 50 bp hikes. Easy to see why it was important for the Fed to reinsert a benign long-term inflation outlook. Anyway, the jobs report is just one data point and it needs confirmation in the rest of the data this month as well as next month's report. People were all about the "soft patch" at the beginning of the week so this report should cause a serious reexamination.

At some point between now and August the market will probably have serious doubts as to whether the 30-yr actually comes back. There are also supply constraints until the new bond is a sure thing so if the shorts get too heavy while it is only an idea that could set up quite a squeeze. A decision in August seems to put the new 30's issuance in Nov or Feb.

All this U.S. news has managed to crowd the yuan revaluation out of the news. Asian currencies are still trading strong though. Even though China does not want to reward speculators, the pressure internally are only going to get worse until they revalue. I thought they were coming to grips with that but maybe it takes another couple of months. They would need some help from Japan or Korea to scare the speculators at this point and I don't see much of a cause for that. The dollar also rallied nicely on the back of the jobs data but the theme to me is still European weakness. Gold and silver are focused on USD/EUR rather than JPY/USD. I am not sure why that is.