Relative Value Trading

The other shoe is dropping? but will pad the hurt by printing money...

2010-05-10T07:26:00.001-07:00

The other shoe (from my column a while ago), seems to be dropping.....

Usually central banks have three options available to repay debt for which they don't have money- print, default, restructure. So when these banks owe debt denominated in their own currency- say a 100 Euros and they only have 50 Euros, then either they can just print another 50 Euros, or they can refuse to pay, or they can say how about we pay you 50 today and 10 in the future and let's call it even.
Now, if both banks choose to "print" (print in quotation marks since they are buying bad bonds but effectively they are printing money to buy those bonds.)

I haven't gathered much data, I am just trying to simply think through the options facing OTHER central banks (debt and assets)/Sovereign funds ( assets)- who need to hold these "stronger" currencies and cannot simply trade them nimbly.
Earlier in the week, when we all were digging a grave for EUR (political confusion means economic death and EUR definitely has more political confusion than USD). It seemed that we will be left with only ONE panic currency to hold- USD. As these central banks and sovereign funds get out of the Euro or just stop buying it , it would be bad for the Euro. Rescuing Greece, Portugal, Italy, Spain etc. (high debt) countries would place a burden on German taxpayers who won't like handing Greeks their money.
Now the ECB has announced a Trillion dollar rescue package and the Euro has bounced back from 1.25 levels back to 1.30 very quickly.
So now we might see ECB seek guidance from the Fed on how to go about buying up every single asset. A few things emerge

1) The EM banks/Sovereign funds have two currencies following quant easing. We will see commodities becoming more expensive since we buy commodities in a currency and that currency is being printed and hence losing value
2) Naturally this is the same as saying higher inflation
3) Mediocre/Low growth. With quant easing I fear that the "weaker" companies won' learn they are weak quickly enough and they will continue to live in a zombie state (see Japan).
3) Higher levels of govt. regulation and control over the markets
4) Lower levels of shadow lending may be the desire (and the high levels of govt regulation will do that) but the banks will continue to be the whipping boys. So lower trading profits from banks
5) Consumers, esp US, are still saving too little and spending too much. I think that will change somewhat as we see lower number of credit cards and home equity loans in their pockets. Thus there may be some enforced savings. Lower student loans.
6) The houses that they bought and are underwater will continue to be so and these consumers won't be as mobile since they don't want to write off their houses. Lower labor mobility, high debt burden - worse labor markets.
7) There will be repeated small panics as some situation or the other (unforeseen as usual) emerges.
8) Haven't thought through the stock market situation. For now I remain bearish for medium term, with choppiness and intermittent panics and rallies - many banks will now NOT want to be short gamma, so expect gamma to be bid up. Vega goes bid too. The reason to not be bearish is high inflation. I do think (see above) high inflation is coming and expected inflation may be a common driver up of commodities stocks as whole. However, UNexpected inflation will obviously drive up commodities but I am not sure about stocks- there may be an interesting trade of long and short baskets of commodity owning and consuming stocks.

Funds withdrawn from long dollar and US equity positions

2010-01-20T13:22:00.000-08:00

Reading the headlines below it seems investors want to be short USD and short USD equities while investing in other foreign equities and US Bonds. The thinking must be that a second shot of Fed stimulus awaits! If so, corporate bonds (Fed made a killing on AIG bonds as the risk aversion dies) will do well AND the dollar will continue to go south.

If you want to send your money to India and ride the carry train (long INRUSD) not a bad idea.

I also find it interesting that ETFs continue to become more popular. Wonder if small hedge funds are using them more (since banks are tightening and the easy money to hedge funds may be drying up) or individual investors are.

Fund Flow News Below

Bond funds (+$24.6 billion) padded their coffers in December, while stock and mixed-equity funds (-$2.1 billion) and money market funds (-$7.7 billion) were in the red for the conventional funds business.
- However, ETFs experienced inflows for both major macro groups: bond ETFs garnered $3.4 billion while stock and mixed-equity ETFs attracted $21.3 billion.
- Investors continued to shun USDE Funds in December, redeeming a net $10.3 billion from the group. However, the other equity macro-groups caught investors' attention, drawing in a combined $8.2 billion.
- Mixed-Equity Funds (+$3.8 billion) attracted the largest net inflows of Lipper's four equity macro-classifications for the first month in four.
- A strengthening dollar and minor concerns over the extended run-up in world markets weighed marginally on World Equity Funds' flows, but the macro-group still attracted net inflows ($2.8 billion) for the ninth consecutive month.

Roubini(Gloom) vs. The Street (Great fundamentals for this rally)

2009-11-04T06:56:00.000-08:00

Dr. Doom (Roubini) expresses fears of excess liquidity on the "dollar carry trade" i.e. such low dollar interest rates are propelling this boom- the low interest rates and the high liquidity are leading to another bubble.

"So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions"

Street says No rather emphatically and focuses on the fundamentals and says go long stocks since corporates will spend now as they overreacted last time they set budget.

Key defining characteristics of the 7-month and 62% rally have been:
(i) Its “prove it” nature: up on earnings surprises, flat-lining otherwise ;
(ii) Textbook relative sector performance. Financials and Consumer Discretionary up the
most, Energy and the defensives lagged ;
(iii) Lower quality higher beta stocks outperformed ;
(iv) Equity investor underweight positions have unwound but there have been little or no new
inflows into equities

Is this a bear market liquidity-driven rally? We don’t think so.
A positioning unwind can entail a significant rally even in the absence of a perceived change in fundamentals. This in our view would qualify as a bear market rally. In our view, the large unwind of equity investors underweight position was a key driver of the rally, and so on this measure the recent rally qualifies.
But it fails the fundamentals test in that it took place in response to repeatedly better-than-expected earnings. As to being liquidity driven, liquidity can drive equities two
ways—directly through inflows into equities or by liquidity-induced improvements in the
fundamentals or earnings. On the first count, inflows into equities have been limited so it is not as if the liquidity found its way into equities. On the second count, earnings improvement on cost cuts can hardly be attributed to liquidity.
Our take remains that the rally reflected excessively pessimistic expectations of corporate earnings causing investors to cover short
and underweight positions on much better than expected earnings delivery.
What’s priced in: Yesterday’s earnings; not a cyclical recovery yet. On a trailing multiple of
20, equities look expensive. But given that earnings snapped back in H1 2009 from off the
cliff levels of Q4 2008, a better gauge of where we are is provided by more recent earnings.
S&P 500 Q2 EPS came in at $16 or an annualized $64. Our fair value multiple of 16.4 implies
1050 on the S&P 500, around where we are today. So the market has nearly priced in last
quarter’s earnings. Q3 earnings are up sequentially by 6% and seasonally adjusted by 11%.
Thus, Q3 earnings are not yet priced in, let alone a cyclical recovery in earnings going forward

The key drivers and themes for equities the street sees are:
(i) Production to catch up with sales. The large gap between final sales and production
creates strong pressure for a cyclical recovery.
Buy Industrials (Capital Goods, Transportation), Consumer
Discretionary (Autos, Consumer Durables & Apparel), Materials and Tech (Semiconductors,
Hardware)

(ii) Corporate (not consumer) spending the key. Corporate budgets were last set at end-2008, when expectations for the economic outlook were very low. On an imminent increase in enterprise spending, buy Tech (Software and Hardware), the Industrials (Capital Goods), and advertising (Media in Consumer Discretionary).

(iii) Unemployment to peak. Policy uncertainty in a variety of spheres will likely keep the labor market recovery slow, but a peak in unemployment seems near. Buy the Financials (Universal Banks and quality Regional Banks) as a peak in unemployment should be a catalyst for marking a turning point in write-downs. Buy the Temp staffing agencies, which typically
benefit at this point in the cycle, but should do particularly well this time around .
(iv) Equities are cheap on normalized earnings. In a baseline of gradual recovery, equities are
very cheap. Buy the sectors which are cheapest on normalized earnings: Financials (-20%);
Industrials (-10%); Materials (-5%) .

next time : My view!

View from the street: Long high beta sectors but within sectors long better (lower beta/blue chip) stocks

2009-09-25T10:19:00.001-07:00

Spot view:The view below is from one of the respected researchers on the street. So far we have seen a grind up in the S&P from 700 levels in March and we are still below last year September's levels around 1150. Personally, I am more concerned about either a grind up or a grind down. I think the Fed has propped up the economy so far but the data being released is mixed- negative (Housing/Durable goods) vs. some positive (consumer sentiment). So we are far from being out of the woods and I wouldn't be surprised if there were another slew of not so good data and a fall back to the 900s.
Vol view:Options traders might like selling short dated far out of the money calls although with VIX at 26-28 range. With the realized vol at 14%-15% and the implied vol at 26% -28% it seems smart to be short vol... However, I would only sell short dated vol- since I am still bearish and there may be a jump up in vol. Worth noting that if I sell short dated vol, I benefit from both the implied vol and the realized vol going down....depending on the instrument used

A persistent question since the March low and the large out-performance of higher beta stocks has been whether the beta trade has further to run? Is it time to rotate to quality stocks (lower beta)?We examine the relative performance of high versus low beta (quality) stocks historically. We do this first for the S&P 500 stocks unconstrained by sector membership, and then explicitly taking it into account. In the first exercise, we compare the performance of baskets of the 100 highest and lowest beta stocks in the index that are rebalanced monthly. In the second exercise, we constrain the baskets to include only the top and bottom quintiles for beta within each sector. History suggests the beta trade has further to run. In previous recoveries, the duration and magnitude of relative outperformance were longer and larger. Over the last two economic and equity market recoveries, from trough to peak the duration of high beta outperformance, was around 16m after both the 1991 and 2002 equity bottoms, compared with the current 7m run. As to magnitude, since 1992 relative performance of high versus low beta stocks has tended to converge to a fixed level. The long and severe underperformance from mid-2007 to early 2009 has meant that despite the substantial recent recovery, relative performance is still well short of this level But within sectors, the beta trade has run too far. When sector membership is explicitly accounted for, the same exercise indicates the beta trade has run too far. To be clear, we note that the recent trend has been for high beta out-performance within sectors but, in our reading, the magnitude of relative outperformance is overdone and thus argues for being cautious Strategy: The beta trade has further to run but look for beta outperformance from sectors not stocks. Stay overweight higher beta sectors, but higher quality names within sectors. On the view of a slow but continued economic recovery (DB economics forecast) that delivers significant earnings growth (our view), with forward equity multiples slightly below fair value, we see further upside for equity markets over the course of next year and maintain our 2010 S&P 500 target of 1260 set in May. A continued trend of beta outperformance but reflecting sector rather than stock beta argues for being overweight the high beta sectors. Who has the beta: by far the Financials; next are Materials, Consumer Discretionary, Industrials and Energy with similar levels; Tech has recently moved to low beta; Consumer Staples and Health Care remain the lowest. Our sector allocation remains in particular overweight the Financials and Consumer Discretionary sectors

Why trading strategies are important? a tale of market index fund vs. momentum

2009-09-14T07:18:00.000-07:00

Since 1994 a simple strategy of going long the market yielded not very much- $100 invested in the S&p 500 index fund in Jan 1994 would give you $145 today. Adjusted for inflation that is a remarkably poor return.

A strategy called momentum- long the past month winner and short the past month loser would give you $372 today.... Naturally, these don't include transactions costs that can be big but it is an interesting observation....At this time there are no REALLY well known risk based explanations for momentum in academia...

I will discuss this more soon

Hedge Funds did well in August. Should we worry about EM?

2009-09-09T08:48:00.000-07:00

This year has been terrible for funds short the stock market and a great year for those who bought bargain price bonds. It seems that the central bank money is helping out the fixed income funds- convertible arb has had an amazing year with 35% returns YTD.

Below is a summary of the action so far, expect more analysis later.

Credit Suisse/Tremont Hedge Fund Index (“Broad Index”) will finish up +1.68% in August
This is the sixth straight month of positive performance.

Wide dispersion in returns across global equity markets last month- EM in trouble?
Shanghai equity markets closed down over 20% , US and European markets peaked mid-month, reaching their highest levels since October 2008.
-This is concerning. I am going to look at more EM markets and see if we have an EM crisis coming up.... The EM central banks are weaker and cannot print money to support their debts... As the G-10 countries start saving more will the export oriented EM countries have a much harder time?

Small caps in Japan do better after elections
In Japan, markets rose modestly following the country’s national election and Japan-focused Long/Short Equity hedge funds were up approximately +1% for the month on average, benefiting primarily from stock selection and outperformance by the small-cap sector of the equity markets.

As a whole, Long/Short Equity managers had a generally positive month, finishing up an estimated 1.42%, while Emerging Markets returned an estimated 2.18%.

Event driven reaping benefits of special situations area
Event Driven managers returned approximately +2.46% for the month as managers continued to take advantage of tailwinds in equity and credit markets in the distressed environment. The majority of investment opportunities in the space currently appear to coming from the special situations area.

Global Macro, Futures etc. continue to do well
Managed Futures posted returns of 0.79%, representing their second positive month of performance so far this year (the sector was up +0.85% in May). Many managers in the strategy have struggled for most of this year, although trend followers appear to be beginning to show profits as models gain more traction. The Global Macro sector also experienced positive returns in August, posting a +0.94% gain as commodities-focused managers capitalized on rallies in metals, sugar and certain other softs.

Convertible Arb is back over this year after a horrible last year (up 35% over the year)
Convertible Arbitrage extended its run of positive performance to eight consecutive months, finishing up 3.37% in August, as opportunities in the space remained strong. Performance was muted, however, in comparison to returns of the past four months, when the strategy posted consecutive monthly returns of greater than 4%.

Fed helps Fixed Income funds do better
The US Federal Reserve and US Treasury announced an extension of its $200 billion term asset-backed securities loan facility (TALF) program, adding an additional three to six months from its original end-of-year expiration date. This was welcome news to many fixed income investors and relative value managers who had an overall positive month. Fixed Income Arbitrage managers are now up 2.39% year to date.

I will be back! with lower risk premia do we say hurrah?

2009-06-09T20:54:00.000-07:00

So I am... passed my generals for the Ph.D. Loads of academic papers read.. few retained :) I am now going to think through this "rally" that has failed to cross 1000. Views on FX where the dollar has gone down against the Euro. Commodities etc. also included.

Interestingly funds have been having a good time..quite a bit of which comes from lower risk aversion- notice how the risk premia has narrowed and closed end fund discount- another measure of risk premium is narrowed down. In fact various risk premia narrowing is the key point/theme in all the "news" below.

- For the third consecutive month both equity (+10.28%) and fixed income (+4.58%) closed-end funds (CEFs) posted plus-side returns. Both macro-groups posted eye-popping returns for the three-month period ended May 31, 2009.
- On the stock side Mixed Equity Funds (+13.81%)-catapulted by Income & Preferred Stock Funds-and World Equity Funds (+13.39%) outpaced the Domestic Equity Funds (+7.76%) macro-classification.
- For the month 99% of all CEFs were able to post plus-side returns, with 100% of bond CEFs and 99% of equity CEFs chalking up returns in the black.
- Bond investors continued to be less risk averse and yield seeking in May, pushing Loan Participation Funds (+7.74%) and Global Income Funds (+7.29%) to the head of the class.
- In May the median discount of all CEFs narrowed 73 basis points (bps) to 7.96%. The largest narrowing of discounts (454
bps) was seen in the World Income Funds macro-group.

Bond Funds getting money and large cap stocks are facing redemptions

2009-04-02T14:39:00.000-07:00

- The bond funds macro-group (+$13.8 billion) was the only macro-classification attracting net flows in February, while stock and mixed-equity funds handed back $24.9 billion and money market funds witnessed $6.7 billion of net redemptions.
- Large-cap funds (-$6.4 billion) continued to be the pariah of the U.S. Diversified Equity (USDE) funds group, while small-cap funds (-$1.2 billion) mitigated outflows better than the other capitalization groups.
- In February the Mixed-Equity Funds macro-group (-$3.9
billion) suffered its fifth monthly redemption in eight. The mixed-asset target horizon funds group's inflows (+$2.7
billion) were swamped by the net redemptions witnessed in the mixed-asset target allocation funds group (-$6.4 billion).
- For the year-to-date period World Equity Funds, shedding some $8.9 billion to net redemptions, handed back the largest amount of the four equity macro-classification breakouts.

Em Hedge Funds

2009-03-27T08:29:00.000-07:00

Just checking that I can upload graphs now! Yaay...

This is the graph of factor loadings of Emerging Markets Hedge Funds... interesting how much of their returns can be explained by BRIC MSCI, Put Call ratio, Istanbul Index, Fama French Size Factors, and U.S. GDP growth...
We did know that there is little diversification in EM funds, but we didn't know that the EM funds were quite dependent on the U.S. GDP to this extent...

Credit Card Defaults

2009-03-18T05:41:00.000-07:00

The S&P is rallying back and we are full of confidence... I am still bearish and think that credit card defaults are a big reason to be so...

U.S. Credit Card Delinquencies At Record Highs: Same Dynamics As Mortgages?
• U.S. credit card defaults rise to 20-year high. Analysts estimate credit card charge-offs could climb to between 9 and 10% in 2009 from 6 to 7% at the end of 2008. In that scenario, such losses could total $70bn to $75bn in 2009. The $5 trillion in outstanding credit card lines (of which $800bn is currently drawn upon) are being trimmed even for credit worthy borrowers with Meredith Whitney estimating that over $2 trillion of credit-card lines will be cut in 2009 and $2.7 trillion by the end of 2010
• Losses are particularly severe at American Express and Citigroup amid a deepening recession. AmEx, the largest U.S. charge card operator by sales volume, says net charge-off rate rose in February 2009 to 8.7% from 8.3% in January 2009 as job losses accelerated and the economy deteriorated. For Citigroup, one of the largest issuers of MasterCard cards, default rate soared to 9.33% in February 2009 from 6.95% in January 2009

What's going on?

2009-02-24T05:40:00.000-08:00

The S&P has slipped below 800 to 750 levels with such ease that I fear we are indeed going to 600 as I thought earlier.

Here are the main views:
Real Economy

* Pain in the real side of the economy. Look for S&P to keep going lower

* The stimulus package will be moderately ineffective, inefficient and quite small. I think the market is falling in part because the REALIZATION of Obama's plan was far lower than the EXPECTATION!. We were hopeful but are disappointed that he, the smart new prez, has no magic bullet

- Currency views:

* EUR is under severe danger over the medium term- all the differences in various countries' political economies will come to fore... the interest rates will have to be drastically cut for a longer term than is currently priced in AND the stability of EUR currency itself is threatened.
* The short EURUSD trade has made a lot of money so far. Also long USDJPY may be the trade to get into... with Japan's horrible GDP numbers.

Below is something I read in a publication that shows how badly the small countries are doing...

Dubai Receives Capital Injection To Ease Debt Burden
• As concerns about the emirate of Dubai's financing needs mount, it launched a bond issue, the first tranche ($10b) of which was fully subscribed by the Central bank of the UAE. Dubai is estimated to have $14b in interest and principal payments due in 2009 (EFG-Hermes via WSJ) and it is slated to run a fiscal deficit in 2009
• Central bank of the UAE had $44.5 billion in fx reserves in September (most recent data) but has since provided liquidity to several of the country's banks. Instruments are five-year bonds that carry an annual interest rate of 4 percent
• The loan, the first major step of a long-anticipated support from oil-rich Abu Dhabi via the federal government, should ease the cost of insuring against a default, which in recent weeks saw five-year credit default swaps on Dubai debt rising to levels similar to Iceland (FT) Doing so might also lower risk premia on Dubai banks

JPY view from I Banks

2009-02-02T06:16:00.000-08:00

Below is the view of one of the investment banking analysts that is quite respected in the industry-

Essentially the analyst is saying that the yen is done rallying. It may definitely seem that way looking at the fact that USDJPY hasn't moved from the 88- 90 range. My view is that USDJPY will move in that range 85- 92 for a while. ...

Cyclical and Structural Drivers of the Yen

Since the credit crisis broke in the summer of 2007, the Japanese yen has
been by far the best performing major currency. Since its lows in July
2007, the yen has risen by 43% in trade-weighted terms, 37% against the
dollar, 40% against the euro and it doubled against sterling and the New
Zealand dollar. Over this period, the yen outperformed the other risk
aversion currency, the Swiss franc, the second best performer, by a hefty
30%.

This strong performance reflected the confluence of a set of supportive
factors: cheap initial valuation, narrowing yield differentials, rising
risk aversion and, in the initial stages, a strengthening basic balance.
Just prior to the onset of the credit crisis in July 2007, the yen had
cheapened against the dollar to 20% below fair value, which we view as the
boundary in our valuation lines-in-the-sand framework. The yield
disadvantage of the yen narrowed as first the US and then other countries
cut policy rates. The appreciation reflected the risk aversion role of the
yen, outperforming during periods of heightened volatility. The initial
phase of the appreciation also reflected improvements in the Japanese
basic balance, which we view as the medium-term or structural driver of
the currency, as the current account surplus continued to grow and there
were limited FDI outflows from Japan.

Is the yen done? We take stock of valuation and prospects for the cyclical
and structural drivers of the yen.
(i) The yen is no longer cheap against the dollar but it is not unduly
expensive either, while it is near fair value against the euro and
approaching very expensive levels against sterling.
(ii) The policy rate differential has already narrowed (completely)
against the dollar though it has further to go against the euro, sterling
and commodity currencies.
(iii) Equity volatility has fallen from its peaks, but it remains high and
has further to fall over the next two quarters. We expect FX vol to
follow.
(iv) The Japanese basic balance has deteriorated dramatically on the back
of continued FDI outflows, while the trade surplus has given way to a
deficit. While we expect the basic balance to improve as capital outflows
diminish, with the trade deficit persisting through the global recession,
we expect the basic balance to remain well below recent peaks, arguing for
a weaker yen.

Long the dollar/short EUR?

2009-01-18T22:50:00.000-08:00

I think it may be time to short the EUR against the USD again...

-I think Europe will sink into recession more than the US and the authorities there have not officially recommended a Zero interest rate policy... So any moves towards that will "surprise" the markets.

- Also, with news like Ireland, Greece etc. being more likely to default the status of Euro as a single currency may be a bit more under siege....

News Below....

The Irish IMF Rumor: Is A Payment Default Or A EMU Break-Up More Conceivable?

Ireland was at pains to deny rumours that the IMF is about to walk in. Investors are getting increasingly nervous about the prospect of payment default in the euro area, and this is reflected by an increase in spreads and a weakening euro. The Irish spread has now widened to 184bp, and five-year credit default swaps for Ireland yesterday shot up from 193 to 207bp. Greek CDS are now at 250bp. The notion of a payment default among euro members spooks global investors, and the euro duly fell to $1.31 (Eurointelligence)

Hedge Fund Performance Dec 2008

2009-01-18T12:34:00.001-08:00

Index / Sub Strategies	8-Dec	YTD	1 Year
Convertible Arbitrage	-1%	-32%	-3%
Dedicated Short Bias	-2%	15%	15%
Emerging Markets	0%	-30%	-30%
Equity Market Neutral	0%	-40%	-40%
Event Driven	-1%	-18%	-18%
Distressed	-3%	-20%	-20%
Multi-Strategy	0%	-16%	-16%
Risk Arbitrage	2%	-3%	-3%
Fixed Income Arbitrage	-1%	-29%	-29%
Global Macro	1%	-5%	-5%
Long/Short Equity	1%	-20%	-20%
Managed Futures	2%	18%	18%
Multi-Strategy	-2%	-24%	-24%

Risk Aversion still rules money markets funds still getting money!

2009-01-18T12:17:00.000-08:00

It seems hedge funds are not the only industry having money outflow problems... ( $150 billion was withdrawn from hedge funds in December alone). We see money coming out of mutual funds as well.
The fact that world equity funds are suffering outflows could be bad news for the EM countries- risk aversion means that people continue to withdraw money and are afraid to invest.

The fresh round of banking troubles can only worsen the situation for small and emerging countries in the short term- lower liquidity means fund withdrawal from their stock and bond markets leaves those emerging markets more subject to shocks and jumps.

- The money market funds macro-group (+$127.4 billion) was the only macro-group attracting net flows in December, while stock and mixed-equity funds handed back $27.3 billion and bond fundswitnessed $6.7 billion of net redemptions.

- Large-cap funds (-$5.2 billion) continued to be the flows outcast of the U.S. Diversified Equity (USDE) funds group, while small-cap funds (-$1.0 billion) mitigated outflows better than the other capitalization groups during the month.

- In December the Mixed-Equity Funds macro-group (-$0.4

billion) suffered its fourth consecutive monthly redemption.

The mixed-asset target horizon funds group (+$2.6 billion) just managed to make up for the net redemptions witnessed by the mixed-asset target allocation funds group (-$2.1 billion).

- For the second month in a row the World Equity Funds macro-classification experienced the largest net outflows of Lipper's major equity groups, handing back $15.5 billion.

Happy New Year

2009-01-04T20:33:00.001-08:00

Last Year:
So some of my banker friends have become stand up comedians... no really... they have... AND knowingly... as in, these guys intend the world to laugh when they talk ...( the first 6 months of the year when they were saying things and the market was crying...)
That pretty much sums up the year that was... on another note I am very proud of these friends for being creativity and having the desire to pursue other dreams than to structure complicated stuff.

Next Year...

I am a contrarian trader this year as well... still a buyer of gamma/volatility... especially on the 3 month, 6 month front and especially one touch options /wings etc. however, the key idea is to SELL your options when they are worth a lot instead of waiting till expiration date.

Mean Reversion with some downward drift is the theme of the market:
I see that the market has a lot of movement... the last active trading day was a more than 3% movement day.... or an yearly vol of 50% ish...which is a lot. That vol means that roughly an at the money option would cost 12.5% of the notional. However, if you notice, we have been moving in the 750- 950 ish range for a while now; since October 6th we have moved from below 1000 to almost back to 930 now. We have still generated a lot of volatility... how could this be? this can only occur if the market does a lot of mean reversion.... So if you want to trade somewhat contrarian this is the time to do it...

How to trade contrarian?
My view is contrarian with a short bias (i.e. I still do believe that the market is going down overall just not on the same trajectory as most people)... In other words, I buy options when I think they are too cheap, I wait until the market moves in my direction and then I sell the option without trying to exercise it. Interestingly, if I had tried to exercise the options, I would have made $0.00 this year....
A concrete example: I bought Jan 20 expiration 950 strike calls ( on the S&P) when the market had tanked to 815 levels. Then when the market rallied back to 930, I sold my calls. In between, I waited patiently.
Caveats: The waiting can be painful. If the market remains at 815 then I make no money, If the market tanks even more, then I make no money and if the market rises to 930 on Jan 19th , I will still make no money... so select your strikes wisely...
Decay: Naturally, I have to pay the cost of those calls when the market does nothing... that is the decay- the optionality decreases everyday so it can definitely be the case that the market doesn't move and your option decays like a dead horse.

But why might this strategy work? high intraday vol and lots of mean reversion, which you can take advantage of by placing LIMIT orders. Don't run into buy at the market price. In other words, have a view BEFORE hand... put in a price you will be happy to own something at

I think going long the dollar in the next few months may be a smart trade. if wrong , get out of it and wait on the sidelines.

Don't risk more than 5% of your capital on any one trade... especially involving options...Be conservative in these highly volatile times...

Enjoy and Happy New Year!

short the dollar? a bit late but sure if you have to!

2008-12-17T09:38:00.000-08:00

The train has left the station a bit but it would be interesting to see what other countries do.
USDJPY has sold off by 2 to 3% over the last few days. The EURUSD has also rallied similar amounts.

I would perhaps go long the momentum for a bit but not too crazily....
Will think about it more and post.

I am more worried about the long term inflation...

Money market funds are getting the money

2008-12-17T09:37:00.000-08:00

The money market funds macro-group (+$121.6 billion) was the only macro-group attracting net flows in November, while stock and mixed-equity funds handed back $26.4 billion and bond funds
witnessed $16.7 billion of net redemptions.

- Large-cap funds (-$4.7 billion) continued to be the flows pariah of the U.S. Diversified Equity (USDE) funds group, despite posting better returns than the other capitalization groups during the month.

- In November the Mixed-Equity Funds macro-group (-$4.6
billion) suffered only its fourth monthly redemption since July 2002. The mixed-asset target horizon funds group (+$1.9
billion) could not make up for the net redemptions witnessed by the mixed-asset target allocation funds group (-$5.5 billion).

- In November the World Equity Funds macro-classification recaptured the claim to shame of having the largest net outflows of Lipper's major equity macro-classifications, handing back $11.2 billion.

Auto Companies

2008-12-12T10:31:00.000-08:00

My thoughts are these wranglings are going on because all the parties concerned feel that the companies WILL be rescued any way....
However, investors didn't fall into as much of a panic so far today...VIX has mostly fallen today from 59 levels to 55...
Let's wait and watch...

Short BRL?

2008-12-12T07:40:00.000-08:00

One of my friends from Brazil sent me this note on the Brazilian Real... This short BRL trade may be worth doing simply as a hedge against your long stock positions...
Capital Flows out of BRL
1. the process of portfolio realignment is not over... capital is fleeing and this process is correlated with bad news there (investors taking money out to cover theirs obligations abroad or just to buy safer assets in other places)
Commodity Prices
2. Price of commodities (main Brazilian exports) is going down, which is also reflecting on balance of commerce (this effect tends to be greater than benefits to increase the volume of goods exported - given that the world is not buying so much). This means that the adjustment on the balance of commerce will be slow, and for the next year, the balance tends to be negative...Also, the balance of commerce is sensitive to Embraer exports (aviation company), which, under the current scenario, has not received many requests.

Central Bank
3. The Brazilian Central bank has signed that it will not increase interest rates (which attract foreign investors) since inflation is under control . Although the rate is high - 13.75% - this is not historically very high (we had long periods recently with the basic rate in 17-20%). In the last meeting of the monetary policy committe the rate was mantained and the head of the Central Bank indicated that changes in the near future, if any, will be downward (also, there is a lot of political pressure from politicians afraid that we go through a recession...)
My comments: The investors may still flock to the Real for the high interest rates if they don't cut too aggressively and it seems that they will survive the crisis. My view on short Real etc. is predicated upon the slowing down of growth for the short term.

Trade: I would go short the BRL preferably thorough some sort of a barrier option which will be a cheap punt. One can also go short via regular options but that will be quite expensive with the volatility. Now is the time to go on Oanda online and bet on barriers

BAD BAD Day ahead

2008-12-12T05:55:00.000-08:00

Today is going to be a BAD day in the financial markets…. Bail out rejected and a massive securities fraud by ex NASDAQ Chairman up to 50 Billion dollars it seems…..

Note on Market Movements

USDJPY is close to breaking 90. USDBRL has climbed to 2.39 as opposed to 1.6 levels in September 08! ( Meaning Brazilian Real has fallen…)
NZDJPY – the most popular carry trade has fallen from 90 this Jan to below 50… I wonder how it will do today..
S&P futures are showing a 4% fall today… VIX is at 55.98 and I think it will go above 60 again. Expect Bond prices to rise like crazy again. Wonder where we go from 0% yields on T Bills….
I couldn't get short financials in time... BLAH but it is a good trade if you are short!

Trading Performance

2008-12-10T04:43:00.000-08:00

I will be a bit coy about the numbers. However, my portfolio is small and I have done quite well with my investments in the short market positions. The issue many people will raise is that it is not a "REAL PORTFOLIO" since I may be excessively risk taking in a bragging rights portfolio. So I won't release the exact numbers until I am able to make this portfolio into a "real one" by graduate student standards :)...
Personally, I am just trying to trade it professionally and my views are my views.

- Current views/Positions I want to have:

I am trying to buy some puts on all financials (yes, again)

I am trying to buy "cheap" Jan 20th putts and Feb 09 puts on the S&P 500 since I think this is a trending down market with nice tradable "range" it pays to enter low bids and when you get filled to trade them.

I am especially interested in buying puts on Capital One Financial, Discover and most other credit card companies- If I really believed in the position, I would sell calls on them to fund the puts but I don't want to be short vol in this market

I want to buy Walmart as I think the recovery is a long way off and all the cheap stores will do quite well.

Maybe time to look at infrastructure etc.

in 6 months time, we start buying financials and Gold...

in 6 months/12 months, I start going long India massively...as I have said before, great exchange rate and great prices. When the world economy recovers, India and China will be ahead....

Bailing out Detroit SUCKS - Welcome USSA

2008-12-10T04:35:00.001-08:00

USSA?
I understand the political need to get reelected. However, Hayek, the famous political economist would turn in his grave to watch the USA get back to pre Thatcher Britain. The Govt. will manage car companies, banks, decide the products, decide the pay and so on and so forth. These actions, are even more quickly marking the "top" of the American supremacy.... What has made us great is fostering competition and innovation. The United States of Socialist America is a terrible idea- it has almost never worked.

Bailing out financial institutions, I understand- else the rest of the economy grinds to a halt as financial intermediation is stopped and the risk premium really shoots up. If all the mortgage, credit card and other financial companies fail then innovation is stifled. However, TAKING our money and putting it in a place not known for innovation is quite counterproductive. Interestingly, we are not treating the other car companies (BMW, Toyota etc.) as the "same"- something we punish Japan for.
Managing Detriot's "bankruptcy" such that none of the bond holders would be hurt, in my mind would have been wort considering. Let the equity holders decide who runs the company- stop the CDS market from freezing if you want by protecting the bonds (if we are being consistent with let's protect financial intermediaries....).
Now there will be unusable DEMOCRATIC cars....

Blah....

Hedge Fund Performance- Managed Futures is doing well

2008-12-08T09:55:00.000-08:00

Early estimates indicate the Credit Suisse/Tremont Hedge Fund Index (“Broad Index”) will finish down approximately 0.71% in November (based on 69% of returns received).

The overall hedge fund industry is expected to post modest losses in November, which is welcome news after two of the lowest months of performance on record. Continuing downward trends in US Treasury yields, commodity and currency markets led to positive performance for the Global Macro and Managed Futures sectors and helped mitigate the losses from other sectors. While several sectors capitalized on the month-end equities rally in which the S&P saw its largest weekly gain since 1974, the move does not appear to have been a main driver of performance due to its short duration.

Managed Futures was the best performing sector in the Broad Index, finishing the month up an estimated 3.21% (with 90% of funds reporting). In addition, three other sectors appear to be ending the month in positive territory, including Dedicated Short Bias, Equity Market Neutral and Global Macro.

Commodity and Interest Rates Head Lower

The continued commodities bear market benefited the Global Macro and Managed Futures sectors as short positions in the commodities sector led to gains for the month. Oil prices dropped below $50 a barrel from October highs, and were down almost $100 a barrel from previous levels this summer.

Yields on 10-Year Treasury Bonds dropped to record lows, falling below 3% in November. Some analysts currently forecast a further decline in yields if the U.S. Federal Reserve lowers interest rates in December as expected. If Federal Reserve efforts to improve market conditions by providing liquidity for asset-backed securities through the Term Asset-Backed Securities Loan Facility (TALF) are successful, a possible investment shift from treasuries to other securities could begin to create opportunities in the Relative Value sectors as well.

Next 6 months view- still short

2008-12-02T04:40:00.000-08:00

Recently my view on the S&P had been that it
would bounce around between 800 to 1000 with some downside drift. I still hold on to that view except I am a bit more bearish now. The other shoe consisting of the real side of the economy hasn't dropped.

More gloomy views

I expect anybody competing with Home Equity Loans lines of credit, student loans, credit cards, Installment loans to post much bigger defaults numbers since credit was so cheap over the last few year and the lenders must have lent to the same group of customers with the same reckless abandon.... 0 % financing etc.

Credit Cards: I expect more credit card firms to go bankrupt. When I scan the credit card firm numbers it seems there are "trading losses" that are quite large in magnitude... for example it seems Capital One Financial had losses on the order of 3 Billion this quarter from trading but overall made 1 Billion dollars... this is worrying...

Commercial Real Estate: Dennis Gartman, in his letter, talks about how he expects bad times to come for commercial real estate... malls etc. and I agree. With many stores closing a lot of the malls will become unprofitable and commercial real estate will suffer tremendously.

Private Equity: A lot of private equity funds will have problems raising money, or closing, or even GETTING the money they have been promised. Additionally, the portfolios they had with high leverages and high multiples on these land deals- hotels, entertainment, restaurants etc. are all rapidly becoming worthless. These are the "shadow lenders" in the economy. When the cheap credit goes away they will suffer a lot and it will take time before the extent of suffering is made public and known.

So I expect some sort of a meltdown from the real recession on the above mentioned parts of the
economy...

However, let's hope I am totally wrong....
My trading Performance:
I am toying with putting up my trading performance for this year on the web. My positions are small but I run them seriously. If anyone's interested or has a view on if I should put up my trading numbers please let me know via the comments section

cheers

Waiting for "Black Friday" numbers

2008-11-28T10:55:00.000-08:00

I don't have a clue about what the "Black Friday" numbers will look like. Sure the consumers want to buy less, but the stores, who know the consumers' reluctance to open the purse strings, are constrained for liquidity. These stores have to get rid of inventories and also face liquidations. Thus it is possible that the sales numbers may paint a falsely positive picture of the economy. It is also possible that the numbers are terrible.....

Anyway, below are Mr. Dennis Gartman's Rules of Trading. It is interesting to see how many are "momentum" related. Also, there are some self contradictory ones here :) .... I will wait for the astute readers to point that out. Overall, these rules are still worth a read..

Trading Rules (by Dennis Gartman)

1. Never, Ever, Ever, Under Any Circumstance, Add To A Losing
Position... Ever! Adding to losing positions will lead to ruin. You can count
on it. Ask the Nobel Laureates in Economics at Long Term Capital! (Disposition Effect)

2. Trade Like A Mercenary Soldier: As Jesse Livermore said, it is not
ours to be bullish or bearish, but to be right.

3. Mental Capital Trumps Real Capital: Capital comes in two types;
mental and real. Holding losing positions costs measurable real capital, but
immeasurable mental capital. (Very very true)

4. We Are Not A Business Of Buying Low And Selling High; We are,
however, a business of buying high and selling higher. Strength begets
strength, and weakness further weakness almost always. (Momentum)

5. In Bull Markets One Can Only Be Long or Neutral, and in bear
markets, one can only be short or neutral. This may seem self-evident, but
very few understand it, and fewer still embrace it. (Don't try to catch a falling knife as they say. Interestingly Mr. Gartman himself has been trying to catch the proverbial knife in the recent equity market..... He has declared the bear market to be over several times.)

6. "Markets Can Remain Illogical Far Longer Than You Or I Can
Remain Solvent." J.M. Keynes. Illogic does often reign, and it is our duty
to learn to handle it as best we might.

7. Buy Markets That Show The Greatest Strength; Sell Markets
That Show The Greatest Weakness: Metaphorically, when bearish we
need to throw rocks into the wettest paper sacks, for they break most
easily. When bullish we need to sail the strongest winds, for they carry
the farthest.

8. Think Like A Fundamentalist; Trade Like A Chartist: The
fundamentals may drive a market and need to be understood, but if the
chart is not bullish, why be bullish? Trade when the technicals and
fundamentals, as you understand them, run in concert, one with the other.
(This is what separates theoretical economists from traders)

9. Trading Runs in Cycles; Some Good; Most Bad: In "good times,"
even errors turn to profits; in "bad times," the most well researched trade
will go awry. This is the nature of trading; accept it and move on.
(Interesting idea- Most traders have a style that can be linked to a mechanical trading strategy and sometimes those strategies do badly and sometimes well...)

10. Keep Your Technical Systems Simple: Complicated systems breed
confusion; simplicity breeds elegance. The great traders we've known
have the simplest methods of trading. There is a correlation here!
(definitely agree. Yet paradoxically you must seek complex markets to play in since there is a definite complexity premium)

11: In Trading/Investing, An Understanding Of Mass Psychology is
Often More Important Than An Understanding of Economics: Simply
put, "When they are cryin', you should be buyin'! and when they are yellin',
you should be sellin'!" This is psychology at work and its most elegant.
(Elegance is questionable but the risk premium story is intact. More amusingly, this contradicts the first few rules about momentum)

12. It Takes Buying And Lots Of It To Put A Market Up; It Takes
Only A Lack Of Buying To Put Any Market Down: Gravity is an amazing
force of nature; it is even more amazing in the world of investing.

13. There Is Never Just One Cockroach: The lesson of most markets
is that bad news follows bad... usually hard upon and always with
detrimental effect upon price, until such time as panic prevails and the
weakest hands finally exit their positions.
(fair enough as seen now)
14. Be Patient With Winning Trades; Be Enormously Impatient with
Losing Trades: The older we get, the more small losses we take each
year... and our profits grow accordingly.

15. Fear Turns To Greed At Break Even... And Vice Versa: Know
this; understand this; accept this and deal with it.
(Again very true... controlling emotions while trading is about 80% of it)

16. Do More Of That Which Is Working and Less Of That Which Is
Not: This works in life as well as trading. Do the things that have been
proven of merit. Add to winning trades; Cut or eliminate losing ones. If
there is a "secret" to trading (and of life), this is it.

17. All Rules Are Meant To Be Broken.... but only very, very
infrequently. Genius comes in knowing how truly infrequently one can do so
and still prosper, but when one must, one must!

Hedge Fund Performance Oct 08

2008-11-20T09:48:00.004-08:00

Fund Type	Oct. 2008	Sep. 2008	YTD
Hedge Fund Index	-6.30%	-6.55%	-15.54%
Convertible Arbitrage	-12.59%	-12.26%	-29.59%
Dedicated Short Bias	9.66%	-6.08%	13.38%
Emerging Markets	-13.63%	-8.93%	-29.24%
Equity Market Neutral	-1.83%	-1.41%	-0.19%
Event Driven	-5.09%	-5.75%	-13.92%
Distressed	-5.66%	-5.18%	-14.11%
Multi-Strategy	-4.77%	-6.17%	-13.97%
Risk Arbitrage	-3.06%	-3.49%	-4.77%
Fixed Income Arbitrage	-14.04%	-6.80%	-23.99%
Global Macro	-5.13%	-6.63%	-7.10%
Long/Short Equity	-7.13%	-7.81%	-19.46%
Managed Futures	4.96%	-0.57%	11.99%
Multi-Strategy	-6.94%	-7.35%	-18.68%

Investors Seek Refuge in Money Market Funds in October, Adding a Net $38.4 Billion to the Funds Business

2008-11-20T09:46:00.001-08:00

- The money market funds macro-group (+$169.1 billion) was the only macro-group attracting net flows in October, while stock and mixed-equity funds handed back $86.3 billion and bond funds
witnessed $44.4 billion of net redemptions.
- Large-cap funds (-$16.2 billion) continued to be the outcasts of the U.S. Diversified Equity (USDE) funds group, while small-cap funds (-$3.5 billion) managed to avoid the large losses witnessed by the other capitalization groups.
- In October the Mixed-Equity Funds macro-group (-$19.4
billion) suffered only its third monthly redemptions since July 2002. The mixed-asset target horizon funds group (+$0.9
billion) could not make up for the unprecedented net redemptions witnessed by the mixed-asset target allocation funds group (-$18.4 billion).
- In October the World Equity Funds macro-classification
(-$24.1 billion) suffered its worst monthly drawdown in over ten years, surpassing the previous month's record decline of
$20.8 billion.

What is the "right level" for equities?

2008-11-20T04:41:00.000-08:00

What can the academics say besides - we don't know what the price should be. The MARKET decides that.

Short Answer: S&P around 600 won't be surprising and around 700 is fair value.

I thought about our most sacred academic cow of equity market ratios and wondered what it would tell me. The D/P ratio. Here D means the Dividend Yield and P is naturally the price. So this ratio measures the "yield" if you will of investing in equities. Obviously if prices increases the yield falls and vice versa.

Where is this D/P ratio these days? Has it come back to the historical average of around 4% or is it still low? If we want to come up with a target for the S&P I think we could do worse than saying this is the level of S&P that gets us a D/P ratio of 4%. That number has a pretty long history.... Roughly speaking it seems the level on stocks should be from 700 to 800 ( for a ratio of 4.5% to 4%). Naturally, in a scenario like the current one, the pendulum swings too far to the other side to give it a reason to rally! so say D/P swings to 5% - 6% not unnatural after such a risk inducing event. then we see the levels of around 580.
So my fellow student Manuel's idea of going in at 600 is not bad.

My highly complex quantitative rule of what price to offer for assets in distressed times: After many regressions and highly complicated maths, I have come up with my wonderfully quantitative rule of what price to offer when there is SERIOUS trouble around. The rule is 1/3rd. Just offer 1/3rd of what the value was. You will offer more for finance firms :) but overall for the S&P you would be doing fine.... Remember you are making a bid and letting the market COME to you. No rush to spend your valuable money in times like this.... I think you should use the strategy on cars, houses as well... If you are in a developing country then it the rule is 1/4th :)

D/P chart
http://www.newyorkfed.org/research/directors_charts/ipage20.pdf

Interesting how commentators that I read are remarking on how the yield on equities has exceded the yields on the 10 year bonds after many years. However, no one is thinking of what the historically HIGH D/P ratios are... We are thinking of average D/P and then will act surprised when it is broken. No one cried wolf when the D/P ratio was 2.5 earlier...

My idea: It would be better to invest in India/China than the U.S. once this crisis is over
I thought about investments a little bit and it occurred to me that when the market starts recovering in the next 3-6 months or so ( if it does!) then I should invest in India or China. The exchange rate is quite favorable ( drop of 25-30% vs. the dollar from 39 to 51, and if the market recovers India's stock market that has gone down about 62% to 63% of what it was- from 21000 to 8000! these emerging markets have HIGHER betas and will recover more quickly. I believe their economic story anyway...Maybe I can figure out their D/P ratios...

If I could buy BRIC notes in the next 6 months I would. No need to rush in. Decide the price you want to OWN the thing at and leave a bid and let the market come to you.

My own trading:
I sold out of my S&P puts way too early- made a profit still but could have made more.... This is what happens when you don't have a crystal ball AND not enough contracts to average :).

Are we on track to becoming Japan? Please post some comments

2008-11-16T13:21:00.000-08:00

Low nominal rates of interest

Want to "rescue" firms that have all become too big or too important to fail

Likely to have an interventionist government

Stock market over the last 10 years is flat/lost money in NOMINAL terms (In real terms i.e. when you take the time value of money or the interest rate into account, it has lost a lot of money)

These are some of the concerns I have. I need to think about this more deeply and figure out what the right things to look at are. I do think we have better corporate governance than Japan does,are quite risk taking as a country and our culture are quite different. However, the possibility of a long and gradual road to recovery cannot be ruled out.

If any of the visitors or readers has any comments/views/suggestions on whether we are in danger of becoming Japan and what are the key metrics to examine, please post some comments.

thanks

Soros makes sense

2008-11-13T10:31:00.000-08:00

Below are some of Mr. Soros's views and I have to say I find myself in considerable agreement with almost all of the points he makes.

My explanation for why there will be recession:
Time to delever: The basic idea behind this is that it took 3-5 years for various financial institutions in the LOW volatility cycle to lever up (as volatility decreases, financial institutions lever up to make higher returns since lower volatility typically means lower spreads on illiquid and hard to value assets which is how most people make money. Also the "risk" seems lower so institutions can gamble more)So it will take time to UNlever.

Consumers delever too when they are losing jobs AND can;t get credit card lines Just as banks levered up, consumers levered up to with the savings rate dipping to 1% or so from 7%. Thus there will be considerable "systematic" and systemic pain. Systematic pain/risk means ALL people suffer together. Hence we will have a recession.

I continue to hold my short position that I put on when the S&P reached a 1000 and Mr. Obama got elected.

Mr. Soros's comments text from yahoo

Reuters
Soros says deep recession inevitable, depression possible
Thursday November 13, 11:01 am ET

WASHINGTON (Reuters) - George Soros, chairman of Soros Fund Management, testified at a House Oversight and Government Reform Committee hearing on Thursday. Highlights:

* Said "a deep recession is now inevitable and the possibility of a depression cannot be ruled out."

* Said hedge funds were an integral part of the financial market bubble which now has burst.

* Said hedge funds will be "decimated" by the current financial crisis and forced to shrink their portfolios by 50-75 percent.

* Said Fed, Treasury Department and the SEC must accept responsibility to prevent market bubbles from growing too big in future.

Said impossible to prevent market bubbles from forming, but they can be kept within "tolerable bounds."

* Said financial engineering should be regulated and new products approved by regulators, and that such regulation should be a high priority of the new Obama administration.

* Said a recent IMF credit facility not large enough to stabilize markets.

Closed End Funds get hammered - worst since 1987

2008-11-08T13:43:00.001-08:00

The credit crisis and thoughts of a global recession hammered closed-end funds (CEF) in October, leading to their worst one-month decline since 1987, with the average equity CEF declining 21.47% and fixed income CEFs handing back 9.66% of their value for the month.
- On the stock side Mixed-Equity Funds (-17.66%) mitigated
losses better than its Domestic Equity Funds (-21.83%) and
World Equity Funds (-23.15%) counterparts.
- For the month only 13 funds were able to post plus-side returns, leaving 666 funds underwater and one at the breakeven mark.
- The Real Estate Funds (-38.07%) classification posted the worst return in the CEF universe.
- In October the median discount for all CEFs narrowed 445 basis points (bps) to 11.61%, still well above the 12-month average of 8.70%.

Jobless rate at 6.5%

2008-11-07T07:26:00.000-08:00

The non-farm payrolls number was bad: 240,000 job losses and the unemployment rate up from 6.1% to 6.5% (from last month). Ford lost about $1.50 per share while the analysts expected about $0.90- $1.0 However, we see a jump up in the stock market this morning that I am inclined to say is a "technical correction." I think everyone and their mom had a short trade on the non-farm payrolls, especially after the ADP report that guesstimates the non-farm payroll numbers. Overall, there is no doubt, we are in for a big recession - worldwide. I will be watching to see if the market closes above 960 levels today.... If not, I will continue to assume it is a technical correction and remain convinced about my short view

Watch Out for Non Farm Payrolls

2008-11-06T12:26:00.001-08:00

The non-farm payrolls number that indicates how many jobs were lost/created is something the Fed looks at quite seriously. Tomorrow at 8.30 am EST, we will know what that number is via Bloomberg or yahoo news. If the number is "bad" i.e. more jobs than expected are lost then naturally the stocks will fall figuring a recession. I have been short of the S&P via the 750 strike Dec 08 contracts and look to sell into the heightened feelings of gloom if any. If the NFP number is "good" then I will happily thank the Gods for sparing this economy and wait for the next time the general population panics. Also, Friday is a bit of a nasty day for these releases since no one wants to go home with naked short positions in a falling market people panic a lot if the number is bad.

Owning Gamma (or abusing terminology short dated volatility) is paying these days. The level of volatility we see right now is high and persistently so- FX volatility has tripled from mid 2007 levels and so has equity vol. I think commodity volatility has also doubled/tripled- look at oil falling from $120/$130 levels to $60/$70 levels.

Good Luck tomorrow

Why the Fed can't prevent a recession and why I am still short

2008-10-30T06:33:00.001-07:00

The gap between what the Fed provides the banks and how the banks provide money to the consumer is becoming bigger and bigger. The Fed rates are cut but they are overnight lending rates and hence the banks are borrowing more cheap money AND hoarding the liquidity provided from other sources the Fed.
In other words, banks which are supposed to lend CONSUMERS money to grease the flow of goods and services are NOT doing that since they are afraid they will go out of existence. It is perfectly rational for banks to do so. Additionally, the banks are concerned that people who have lost their jobs, have seen the value of their houses drop a lot, have no health insurance, and have to send kids to college will not be the best parties to lend to....
So the bank has to charge such people a higher rate of interest AND lend them less money....

All this above is the reason why the real economy will suffer quite badly. Also, there are many illiquid assets, the effect on which is not felt quickly. The losses are NOT all fully realized. So I think there will be more pain to come.

How to Trade this?
I like buying puts - Dec 08 750 strikes. May consider selling 1150 calls to fund it ( same maturity). The way I like to do it is to put in a limit order and wait for the market to reach my price. If I don't get it at the price I wanted I don't trade since I don't have enough time to monitor...

Mr. Kipling

2008-10-28T06:55:00.000-07:00

This seems oddly fitting ....

If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you
But make allowance for their doubting too,
If you can wait and not be tired by waiting,
Or being lied about, don't deal in lies,
Or being hated, don't give way to hating,
And yet don't look too good, nor talk too wise:

If you can dream--and not make dreams your master,
If you can think--and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two impostors just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
And stoop and build 'em up with worn-out tools:

If you can make one heap of all your winnings
And risk it all on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: "Hold on!"

If you can talk with crowds and keep your virtue,
Or walk with kings--nor lose the common touch,
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much,
If you can fill the unforgiving minute
With sixty seconds' worth of distance run,
Yours is the Earth and everything that's in it,
And--which is more--you'll be a Man, my son!

the worst 81% return in a day of my life

2008-10-09T14:40:00.000-07:00

So I have been short the S&P for a while betting on the fact that volatility will shoot up massively and increase the values of highly leveraged puts. ...This is indeed what has happened... VIX, the volatility index has jumped to levels unheard of ( at 63 as compared to sub 10 in 2007 and levels of mid 20s most times) and I made a big return. However, my HUMAN CAPITAL is tied to the market and I am REALLY worried about a recession now... 7% index drops in U.S. markets on successive days are jumps no one had really modeled before.
This is the environment when GAMMA pays even though it is expensive i.e. better to be LONG options than short....

volatility, jump risk, inflation and fear premia are back

All the King's men...

2008-10-08T16:29:00.000-07:00

Couldn't put the economy back together again.

The Fed has thrown everything at the crisis and still the s&P closes below 1000. These are BAD times...

I still like the short EUR And GBP trade but more against the Yen (JPY) than against the dollar... simply because the Fed will cut more than the ECB AT the moment. Thus I expect a temporary bounce in EURUSD but later on for EURUSD to tank again as Europe's problems come to the fore...

Close End Funds get hammered!- That's Illiquidity and info. asymmmetry for you

2008-10-07T05:32:00.000-07:00

In September, the median discount for all closed-end funds

(CEFs) widened an amazing 687 basis points (bps) to 16.05% (the largest overall end-of-month discount in over ten years), almost doubling the 12-month average of 8.46%.

- The global credit crisis and recent failure of supportive legislation led to dramatic declines in equity CEFs (-13.22%) and fixed income CEFs (-8.31%) returns for the month of September, and the lot cumulatively posting a minus 10.14% return on a NAV basis.

- On the stock side Domestic Equity Funds (-10.89%) and World Equity Funds (-14.35%) mitigated losses better than their Mixed-Equity Funds (-19.15%) counterpart.

- For the month only 13 funds were able to post plus-side returns, leaving 668 funds underwater and one at the breakeven mark.

- The Income & Preferred Stock Funds (-21.12%) classification posted the worst return in the CEF universe

USDJPY has screamed down to 100, Dow down to 9612 and S&p to 1015

2008-10-06T11:41:00.000-07:00

The world looks quite bleak...There is REAL panic now and I fully expect a global recession over the next two years

I was somewhat wrong about USDJPY not trading outside of 101/109 levels.... This is a massive vote of no confidence by the markets... I think this is Europe and Britain having crises that is being priced in....I still hope USDJPY bounces back and it is impressive that USDJPY didn't break 100 even with VIX above 52, however it doesn't mean it wouldn't

I still like the following trade

Short EUR, GBP ( against USD and JPY)....

Long USD vs. short GBP and EUR

2008-10-05T16:15:00.001-07:00

The current crisis is quite interesting- both academically as well as personally, although I suspect most people would change the order of my adjectives.
First of all, the trades

I have been long the dollar for a while against the EUR and GBP and I continue to like the trade- Euroland will face its first recession and two things will weigh upon it: first, the survival of Euroland as an entity is doubtful, the second the extent of the problem is not being realized fully and Trichet and co. always lag the US in monetary policy. While the first reason doesn't apply to GBP, the second does. British banks will have a pretty rough time in the coming few months in my view.

I think USDJPY doesn't move too much from here. I would say it remains rangebound between 101- 109 over the next month. Obvioulsy you can buy leveraged Double Knockout etc. Or you can range trade with spot- say USDJPY goes to 108, then go short and if USDJPY goes to 102, go long.

S&P has broken 1100 levels and it is interesting that this is AFTER the bailout package was passed! VIX- the measure of 1m implied volatility for the S&P (roughly speaking) has been at 45 levels for a week. Normally, VIX is used as a gauge of fear over the next month. I think the correct way to look at VIX is fear + expectation of movement. ( In acacdemic jargon, the expected realized volatility + volatility risk premium). The reason VIX is at 45 -levels rarely seen and ones close to Aug 1998 crash is because now, like then, we are uncertain about the direction of indices as well as afraid.... Believe it or not it is possible for
VIX to remain at 45 levels for a while.
I think VIX at these levels shows that investors are afraid of what will happen and there is doubt about the Fed's ability to control the outcome at this point and that is what makes us afraid. If the biggest Central Bank cannot control this, then we are screwed... buy GOLD and hide money in your mattresses scenario comes to mind.
I don't think that we should be so pessimistic but the Fed IS doing some strange things so it is hard to blame the market. The market just reflects what the people participating in the market believe.

Good Luck!

What the crisis has to teach traders AND my view on the bailout

2008-10-01T07:14:00.000-07:00

This crisis is teaching a very valuable lesson to traders; you can't rule anything out! For instance many people assumed that the "bailout bill" would be passed... and it wasn't. I was totally shocked and I think most of the market participents were also.

Why do such extreme movements mostly destroy capital
It would seem that in a "zero sum game" of day trading capital should be preserved- i.e. if someone bet on the bill not being passed out then they should have made boatloads of money, equal in amount to the money that other people who were depending on the bill being passed lost.
Sometimes it does work the way people think. Other times, when the movements are too extreme - first one way and then the other way, BOTH parties can end up bankrupt! Say the market starts at 100 - goes to 50 and then comes back to 150. The person who was "long" i.e. had bought the market should make 50 units (150-100) however if that person cannot meet the margin call at 50 he will get liquidated and will have nothing to trade when the market does rise. Thus trading becomes PATH DEPENDENT. There are almost no path independent securities! Path dependent means that the overall profits realized don't depend only on the final and initial values but also on the path taken.

My view on the bailout plan:
I like the bail out plan in its current form a bit better. One of the issues is how exactly do we propose to value the complex securities. The second one is moral hazard that the banks who rolled the dice will do it again...

I think destroying equity value and preserving the bond value will be a decent answer to the moral hazard. In other words if the banks who rolled the dice are told- ooops bad outcome it means you go bankrupt (slowly), or are acquired AND your CEO gets fired... other bank won't do this in the future. However, by insuring that money market accounts ( who buy the bonds) don't go under , the "Main street" will be safe as people's deposits won't be taken away from them and the credit crunch won't be as bad. Just imagine the consequences of no one accepting credit cards anymore...... or bank checks or whatever> we are back to barter and cash :)...
Valuing complex securities... perhaps we have an auction where banks can bid on it.. the market is always a better determinant of prices than individuals (even the Fed!)

Please bail me out I went to Vegas and lost- on Why my office mates want to punch the bank rescuers in the face

2008-09-19T07:37:00.001-07:00

The govt. bailout plan to help the banks who fully knew the risks they were taking by buying off the said banks' bad mortgages using the taxpayer's ( i.e. my money) stinks

What's worse is that this is being done in the guise of helping the "little people"- no you are helping the RICH people who took risks . If the risks turned out well- they got their huge paychecks and if they turn out badly, don't worry their buddies in the government ( who coincidentally worked at Goldman before) will bail them out.

AAHHH

The Fed wants to bailout everyone and their dog

2008-09-18T19:56:00.000-07:00

Just read the NYTimes article
http://www.nytimes.com/2008/09/19/business/19fed.html?hp
"While details remain to be worked out, the plan is likely to authorize the government to buy distressed mortgages at deep discounts from banks and other institutions. The proposal could result in the most direct commitment of taxpayer funds so far in the financial crisis that Fed and Treasury officials say is the worst they have ever seen."

This is quite the most awful way to stem the crisis I feel.

a) The issue is not liquidity... it is the LIBOR that is so high and the fed funds that have a lower yield! ( The TED spread has spiked... meaning banks are afraid to lend to each other - banks lend to each other USD in the London Interbank market at the LIBOR rate. Since the banks don't want to lend to each other the LIBOR is quite high. While the "safe assets" i.e. the T Bills have very low interest rates since everyone wants them. The difference is roughly speaking the "Ted spread" which is high since the LIBOR is high (Ted Spread = the three-month LIBOR rate
-three-month U.S. Treasury yields)

b) The issue is ASYMMETRIC INFORMATION: - Nobody knows which bank has what toxic stuff on the balance sheet. Any banning short selling, extra lending won't take away the fact that you HAVE CRAP ON YOUR BALANCE SHEET!

c) To reduce the asymmetric information, the Fed might be better off creating a stamp of approval that banks can voluntarily get by showing the Fed their books ( or publicly declaring their assets). Qualified people can go through the banks' balance sheets and assess their risk. I am sure someone else can come up with a better plan to reduce the asymmetric information but I just wanted to put it out there.

Most Hedge Funds lost money in Aug 08?

2008-09-16T04:41:00.001-07:00

Category	Aug 2008 Return	7/1/2008 Return	YTD 08 Return
Convertible Arbitrage	-0.66%	-2.14%	-8.20%
Dedicated Short Bias	-4.50%	2.98%	10.09%
Emerging Markets	-4.00%	-2.84%	-10.03%
Equity Market Neutral	-0.59%	-0.06%	3.12%
Event Driven	-0.16%	-2.53%	-3.78%
Distressed	-0.07%	-2.59%	-3.99%
Multi-Strategy	-0.20%	-2.53%	-3.72%
Risk Arbitrage	-1.16%	-0.39%	1.78%
Fixed Income Arbitrage	-0.70%	-0.37%	-5.13%
Global Macro	-1.37%	-2.64%	4.89%
Long/Short Equity	-2.11%	-3.43%	-5.92%
Managed Futures	-2.48%	-4.20%	7.30%
Multi-Strategy	-1.26%	-2.47%	-5.69%

S&P did finally break 1200 and USDJPY is below 105

2008-09-15T17:58:00.000-07:00

Finally the chickens are coming home to roost...

But still not as bad as one might have thought. The end of the week would be the test for Bernanke, Paulson and co. If the markets go through with limited panic (by limited, I mean S&P doesn't fall below 1100 and USDJPY doesn't fall below 100 for more than a day)

Let's see what happens

So far the market is doing pretty well!

2008-09-15T08:39:00.001-07:00

Perhaps the panic was so high and expected that the S&P hasn't broken 1200, USDJPY actually rallied above 105 levels to 106 levels. VIX is indeed at 27. Does this mean there are already a lot of short positions in the market... quite possible. Let's see what happens in this week. If S&P doesn't break 1200 this week, I will have to reassess my 6-9 month gloomy view of the market

Waiting for the OTHER shoe to drop : RIP Lehman

2008-09-14T19:15:00.000-07:00

So I caught the cheap bug and bought Lehman stock at $8.00 as a Fed put :) I ignored the main rule in trading that says wait until something stops falling to buy it :). Oh well... such acts of catching a falling knife work about 20% of the time when you look like a genius and other 80% you look like an idiot.

The "second wave" of banking crises is due to hit. The signs are here

- BRL has finally shot back up to 1.80 levels against USD from 1.70 levels
- Financial stocks are falling again
- VIX higher than 25 again
- JPY is rallying again

he 1200 levels for the S&P continue to hold but I think the Lehman crises as it unfolds on Monday has potential to break the 1200 levels. It will be an interesting test for the Fed. For the economy this "second wave" is the other shoe that had been waiting to fall...

What I expect will happen
- EM currencies will go down even more- BRL ( I expect 1.90 from 1.80) , INR(46.50 from 46.00 levels. INR was only 43 a month ago!) , Ruble ( from 25.50 to 26.00 levels) , TRY(Turkish Lira from 1.2650 to 1.3000 levels) etc.
- VIX around 30
- S&P may break 1200 to the downside.
- USDJPY to fall. I am a buyer of USDJPY call options around 99/100 levels right nowHowever, if USDJPY drops very quickly then I will rethink my trade idea.But given that if the US melts, the whole world will suffer a lot, I do believe it is an opportunity to buy the dollar depending on how fast it falls.

To watch-
-Goldman and Morgan Stanley to come under fire as well (maybe more so)> Perhaps these banks will face takeover rumors as well. It should be interesting to watch what happens to the two remaining pure I banks

Good luck!

Real Economy feeling impact?

2008-09-05T06:18:00.000-07:00

S&P 500 seems to go back and forth between 1230-1290- some days of cheer and then some gloomy economic statistic that seems to "surprise" economists (and the market). In this case, the statistic if the 6.1% jobless rate (today was Non-Farm Payrolls Friday)the forecast was -75,000 and the number was -84,000. This is hardly a catastrophic drop. However, the jump of unemployment rate to 6.1% from 5.7%, the last month is what is causing the angst of sending the S&P down to 1230 levels from 1280 a few days ago.

If you are a short term trader, you may want to buy and get out of the position quickly via S&P futures.

However, overall this unemployment number is exactly the effect on the REAL economy that I was talking about earlier. Such effects on the consumption ( the non financial/saving) side of the economy mean lesser consumers in a slowing economy which in turn like the money multiplier effect propagates through the economy, lowering the growth rate.

I continue to be bearish over the next 6-9 months but expect a lot of range trading with a downward trend. Apparently, the economy doesn't realize the extent of the recession until it is all done- so a "good" economic number makes people hopeful and a bad one makes them not so hopeful... there is a LOT Of information updating going on...

Hedge Fund Performance Aug 08

2008-09-04T10:56:00.000-07:00

It seems that August 2008 was a month of good old fashioned flight to quality - read the details of hedge fund performance below. Note how badly the Emerging Markets Funds have done. This also highlights the case that many hedge funds are highly paid "mutual funds that use asset classes in addition to stocks!". EM funds do badly when VIX jumps up, Put call variable from CBOE is significant and when yield spreads widen.....
I also sense a long dollar story here....

For the first month in three fixed income CEFs (+0.60%) managed to move into the black during the month of August, while equity funds continued to struggle (-1.13%), cumulatively posting a minus 0.05% return on a NAV basis.

On the stock side Domestic Equity Funds (+0.04%) and Mixed-Equity Funds (+0.06%) outpaced their World Equity Funds(-4.40%) counterparts.

- Six of Lipper's 12 equity CEF classifications were able to post a plus-side NAV-based return in August, with Value Funds (+0.65%), Options Arbitrage/Options Strategies Funds (+0.64%), and Growth Funds (+0.56%) leading the way.

- The Emerging Markets Funds (-6.44%) group posted the worst return in the CEF universe.

- For the third consecutive month the median discount of all CEFs widened--by 80 basis points (bps) to 9.18%. The High Current Yield Funds macro-group witnessed the largest widening of discounts (146 bps to 12.22%).

what's going on? Good quants an oxymoron?

2008-09-01T19:28:00.000-07:00

Haven't had time to write much....

- fannie and freddie continue to go between 3- 12
- USDJPY has fallen back to 108 levels
- VIX at 21
- interestingly the stock market has risen back to 1285 levels

I notice that volume is higher when stocks are falling and volume is lower when they are rising... in other words stock returns and volume increases have a negative correlation of about -30%. Similar to the 2001 and onwards downturn for the stock market. This phenomenon indicates that market is more moved by "bad news" and the investor on the margin wants to jump off at the slightest shock.
Given the fact that the "real economy" in my opinion, has not yet felt the effects of the credit crunch, I am still bearish the stock market. However, after the next 6- 9 months, I feel it may be time to buy. Bottom picking is hard but after the next 6 months, I feel the risk reward looks favorable to buy.

Good/Bad Quants are not the problem
A friend forwarded me Paul wilmott's blog entry relating to the current credit crunch about how mostly finance PhDs and "rigid ideas" about modeling correlations were all wrong. I agree with wilmott on quite a few things (rants) but when Wilmott talks about "good quants" in a plug for his own magazine :) ...I feel the term "good quant" is a bit of an oxymoron- not due to a lack of intellignece or good intentions of quants but becausemost times quants donot have CONTROL over what gets traded and how risk gets marked. Incentives and power my friend and incomplete contracts are the answer. In other words, regardless of how GOOD a model is made by however GOOD a quant, ( the quant will doubtless be certified by a Wilmott signature on his forehead) , traders, salespeople and managing directors will ALWAYS act in THEIR interest and all these people's interest is mostly SHORT term. The short term interest results in quick riches and quick meltdowns when the gravy train stops.
COMPLEX MODELS HELP SELL CRAP! MODELS MAKE THINGS HARD TO UNDERSTAND. MODELS MAKE THINGS SEEM BETTER THAN THEY ARE. ....

Birmingham , Alabama bankrupt? Who else will follow?

2008-08-19T13:44:00.000-07:00

Muni Bond Spreads were wide for a reason
The word is that Mr. Paul Maco, formerly of SEC said that "I don’t think there’s anyone who has been involved in the swaps and derivatives market to the extent that the Jefferson County (Birmingham, Alabama) sewer system was.”
Apparently these positions means possible bankruptcy for Birmingham, Alabama. This is serious and does indeed prove the point about credit crunch being only "half done." This lends credibility to the reports of municipal bonds having spreads one could drive a truck through. Basically, wall street knew that many of these municipalities were exposed to toxic credit derivatives, and the fact that due to the current recession -that no one saw coming in the boom times when the bonds were being issued, these cities/boroughs will have lower revenue in the coming years than imagined/planned.

I am just wondering which other city/respectable organization will follow and yield the next round of text book business cases ?

Lehman and the financial stocks are in trouble again :).... Goldman shorts continue to rake it in. I would stop out around 150. GS was trading at 180 when I suggested the short...

Trading Strategy: I feel that in this environment of "bad news" followed by recovery the best method is to "range trade" with low amounts and stops of 1310 on the topside for the S&P and around 1200 on the downside.
Similar trading ranges may be established for currencies/favorite stocks. My only suggestion is to trade using small amounts unless you have a very strong view....
you are likely to get whipsawed and if you are not used to it, get emotional and tense...

Hedge Fund Performance this year and what it tells us

2008-08-15T18:35:00.001-07:00

Foreign Exchange, Commodities and shorting the equity markets is where the money is this year :)

I am enclosing the hedge fund performance year to date in various categories

* Naturally funds shorting the market have made money.
**What's more interesting is that Global Macro has come back in a big way (it had been dying slowly through the last 10 years).. I take that to mean that commodities and FX have been making money. Even in I Banks those two are among the top money makers in this terrible year....
Also worth observing is that Equity neutral has made money. Stock pickers have had a field day... Contrarian trading strategies have also made money.

Strategy	Last Month	Year to date Return	Last Year
Hedge Fund Index	-3%	-2%	1%
Convertible Arbitrage	-2%	-8%	-7%
Dedicated Short Bias	3%	15%	17%
Emerging Markets	-3%	-6%	1%
Equity Market Neutral	0%	4%	7%
Event Driven	-3%	-4%	-2%
Distressed	-3%	-4%	-4%
Multi-Strategy	-3%	-4%	-2%
Risk Arbitrage	0%	3%	6%
Fixed Income Arbitrage	0%	-4%	-2%
Global Macro	-3%	6%	15%
Long/Short Equity	-3%	-4%	0%
Managed Futures	-4%	10%	14%
Multi-Strategy	-2%	-4%	-3%

Inflation rises - a positive for the dollar?

2008-08-14T06:00:00.000-07:00

Inflation is high
The Labor Department reported Thursday that consumer prices rose by 0.8 percent last month, twice the 0.4 percent gain that economists had been expecting.

Bullish dollar, bearish stocks
I see this as bullish for the dollar as the market will price in Fed Rate Hikes sooner rather than later and combined with the bad news in the financial sector (yet again!) bad for the stock market. I think that euroland will have lower inflation as will other countries who havent cut rates as aggressively as the US. Hence the dollar will climb.....

The volatility numbers on currencies-my trading view
The 1 week implied volatility i.e. the options market's estimate of the expected movement in the next coming week for EURUSD has risen to 11.50 % while the realized volatility was 14.63% last week. Interestingly, implied volatility has been paying for itself for the last 20 days- the pnl of selling1 week straddles has been negative. While the gamma sellers will jump into the market and probably the realized gamma will go down, I think there is a trade here that combines the dollar view and the gamma view- a risk reversal. i.e. I think the EURUSD upside volatility is worth selling and downside is worth buying. Volatility will die if the Euro climbs back up so the EUR call you are short won't be worth very much and volatility will rally if the dollar gains in which case your option will be worth something....

Overall market
I still think credit card companies and other luxury goods that may be affected by low credit are vulnerable.

US market M&A recovering- word on the street

2008-08-10T22:19:00.001-07:00

Companies are voting that dollar is cheap and euro is overvalued and the financial sector is coming back to life

The Financial sector seems to be coming back to life. The word on the street is that
here has been a notable revival in announced M&A deals over the last two months. The value of announced M&A deals has been recovering notably in recent weeks.

Cross-border M&A flows have surged, with US companies the largest target across regions, while the euro area has been the largest source of inflows into the US.

Expect US to recover more quickly than Europe and the dollar is cheap right now...

Data Summary
Dollar finally stops falling (and in my opinion it is time to get long)
Oil slides and Breakeven inflation rates falling hard
Liquidity and credit spreads: Both Ted and corporate spreads widen
Corporate Issuance: Slowdown in debt issuance continues
M&A and Buybacks: Cross-Border M&A at new high

So there is still a possibility of a liquidity crisis since the Ted Spread and the Corporate Spread is still wide, either the corporations think that the interest rates are likely to fall even more or they think the risk premia is too high at the moment or they just don't have great ideas to invest in! My guess is that it is the last two reasons. Probably a lot of companies will go through cost cutting projects and eventually find good projects to invest in.... Naturally this doesn't apply to all sectors.

Time to go long the dollar here?

2008-08-06T06:53:00.001-07:00

Dollar Rising
I think the time to go long the dollar is approaching/here. USDJPY usually falls when the stock market falls, today the market opened a little lower on Freddie Mac news but USDJPY gained from 108 levels to 109 levels. This tells me that there are a lot of shorts out there who will be feeling the pain. Also, the dollar has gained against the Euro...
The market is betting on the European Central Bank and other banks wanting to cut rates in the future and the Fed holding them steady or to raise them...
the last days have seen the dollar rally a lot.

Currency Volatility is Lower which means low priced options
Also front end currency volatilities across the board are low again... EURUSD volatility is nearing 7-9% levels from double digits.

Trades: Long spot with 3- 4% stops won't be a bad idea. An out of the money European Option, if you think that volatility will increase as dollar rallies. The European option strategy will make a positive return since spot will go in the favor of the trade and volatility may increase on surprise announcements of macro figures in Europe/Japan.

Second Strategy: Another strategy could be to just buy spot and then use barrier options as an add on to increase your leverage substantially. The tricky thing with barrier option is that if your barrier is touched even once the option becomes worthless. However, this knockou characteristics is what makes them cheap in the first place! Additionally if your barrier is in the same direction that you make a profit, i.e. imagine you get long USDJPY spot at 109 levels and your barrier option becomes worthless in a month at 115.10 spot level. If the option touches 115.10 you will have made a lot of money from your spot position! If spot stops at 112 then you will still make a lot of money from the barrier and from the spot. If USDJPY falls then you will have lost less money than you would have paid otherwise for a European Option. I am not suggesting that a barrier option is "cheaper" - it is usually fairly priced but that the barrier may be the appropriate option to express your view.

IF YOU HAVE QUESTIONS PLEASE POST THEM HERE

Central Bank Actions

2008-08-02T21:10:00.001-07:00

These days Central Banks are in the spotlight and they are driving the markets. Below is a little table showing the eventful weeks ahead. The FX, Equity and Bond markets will all be hanging on to each word of the Central Bankers!

Central Bank	Next Meeting	Last Change	Current Interest Rate
Bank of Canada	Sep 03 2008	Apr 22 2008	3%
Bank of England	Aug 07 2008	Apr 10 2008	5%
Bank of Japan	Aug 19 2008	Feb 21 2007	0.50%
European Central Bank	Aug 07 2008	Jul 03 2008	4.25%
Federal Reserve	Aug 05 2008	Apr 30 2008	2%
Swiss National Bank	Sep 18 2008	Sep 13 2007	2.75%
The Reserve Bank of Australia	Aug 05 2008	Mar 04 2008	7.25%

My Fav. Economic Indicator Series: Today is VIX

2008-08-02T19:39:00.000-07:00

Thanks for the feedback folks. Your comments have helped me decide the direction for the blog. I am going to have some daily updates about what's going on and at least on a weekly basis I will have some trade ideas. Also, I will answer questions whenever I don't have too much to write about or when a situation lends itself to a particular question.

My Favorite Economic Indicators:
I am researching links between macroeconomic variables and hedge fund returns. Naturally, the examination resulted i me revisiting my old friends ( the indicators) and some new ones. I will cover economic indicators for a few days. Today, I talk about VIX

VIX: Approximates the expectation of the volatility i.e. how much movement (going up or down both count for movement!) in the S&P 500 stock market index is expected. Naturally, there is more movement expected in more volatile times. Some people call it the "fear" index. If there is a lot of movement; the market is up one day and we think the worst is over; the market tanks the next day with news of yet more writedowns by banks and we get nervous. This uncertainty makes people unlikely to want to buy stocks. Also, when such "shocks" (in the form of bad news) occur people naturally get less optimistic about the future growth of companies. The stock market is forward looking and less optimism about future growth lowers the prices! Thus typically there is a negative correlation between an increase in VIX and the stock market levels ( and returns).
Range: When VIX jumps above 30 really bad times are here. If you are brave enough you can take a long position and make money. However, remember the market could continue to go south and bottom picking/catching knives can be dangerous!
Yahoo Finance Symbol: ^ VIX
Why I like it? : VIX tells me what the options traders think about the stock market. Currently, the U.S. stock markets are moving the world and VIX is a good predictor of what will happen to the FTSE, BSE, Nikkei, CAC40 etc.
VIX and Currencies: When VIX increases, typically the high interest rate currencies ( example NZD, the New Zealand dollar with interest rates around 8% , will drop in value and the low interest rate currencies (JPY- the Japanese Yen with rates 0.5% ) will increase in value. There are a number of reasons for this phenomenon.
a) Many hedge funds like to borrow in the low interest rate currencies and "invest" in the high interest rate ones and it is called the "Carry Trade". When there is panic and fear in the financial markets then speculative positions are unwound quickly.
b) Fundamentals: There is many times a reason for the panic! When economic fundamentals are weak ( our economy now is a good example) then investors may not want to invest in that particular country anymore. Investors may conclude that there could be runaway inflation and the possibility of a currency crisis is increased.

The Blue line = S&P 500 and the Red line = VIX levels. So you can see the negative relationship.

more to come....

Please submit your " I never understood what this means.." question here

2008-07-25T09:02:00.000-07:00

Dear readers

It has struck me that many of the terms I use are complete jargon ( blah blah) to a lot of people. In addition to market commentary, I am going to answer questions about any financial term/finance questions that you have. I will also suggest books/other resources for further reading.

PLEASE SUBMIT ANY QUESTION THAT YOU HAVE IN THE COMMENTS SECTION.

Here are a couple I will address:

1) What is an option and when and why should I use it?

2) What is the benefit of buying a stock vs. a bond and in which economic climate should I do what?.....

3) What does a "risk reversal" mean?

4) Your questions...

The stampede

2008-07-15T07:04:00.000-07:00

Panic Abounds
1) USDJPY falls from 106 levels to 104 levels
2) VIX climbs to 29 from 26-27 and
3) S&P 500 is poised to break 1200 to the downside just before the financial report their earnings.
Should be interesting to see what happens now since this seems to be a market moving down with no news just expectations of bad things to come. If expectations continue to change like this, we may even have a positive bounce when earnings are actually released
So far anyone who had gotten short financials based on my recommendations Friday, is probably doing well. ...

USDZAR: I was asked my views on the South African Rand. Here is what I know

a) The spot trader on my desk used to hate trading the rand :)... it has jumps. For instance notice the rand vol is 20% in chart 2 while most currency vols are 10-15%.
b) It used to follow the EURUSD and is now diverged a bit as you can see in chart 1. this may seem like an opportunity to get long ZAR, esp. with the gold production
c) I think some cheap punt like a 1m Reverse Knock Out on top of a short USDZAR position may work.
d) For this trade (short USDZAR) I would set my stops quite conservatively like around 8.25 or something around those levels. If it hits that get out of the trade....and make sure you have an automated stop since with a jump it may get to much worse levels before you can stop

chart1 red line = USDEUR and blue line = ZARUSD

chart 2 blue line = USDZAR annualized volatility

SORRY ABOUT THE CRAPPY PICTURES. I WILL FIGURE OUT HOW TO DO THEM BETTER NEXT TIME.... BUT YOU CAN CLICK ON THEM TO GET BETTER RESOLUTION

Hope vs. Reason - get long skew and tails

2008-07-14T07:34:00.000-07:00

Was just pondering the question of why most macroeconomists employed by investment banks continue to give positive news during downturns and how most forecasts of recessions' extent and time of ending are flawed.
Since the beginning of this mortgage mess, most analysts continue to say things like financial stock has bottomed out etc. or the worst is behind us...Interestingly, the earnings expectations for , say, S&P 500 continue to decline. For instance:

*Q2 2008 estimates have been marked down significantly- around 12-15%
*Q3 2008 and Q4 2008 earning estimates have only been lowered by 2-4%

I won't be shocked if Q3 and Q4 turn out to be worse than expected and stock prices fall! In my mind there are two reasons for such behavior

1) People are unable to see an "unexpected negative shock"- tautological but that's the point! I think this is the climate of unexpected NEGATIVE shocks and they will continue to occur

2) People talk their book- most investors are long and want this to end. Thus they talk about what they HOPE rather than what will happen..

View and Trade Ideas (horizon is 3 months unless specified otherwise)
1) Stocks:Short financial sectors and Short US, UK stock markets in general. Long Bonds for now.
2) skew, tails and vol: I like being long vol, skew and tails. When VIX < 25 great opportunity to buy 3m/6m vol.
Trade: I like being long vega and long gamma via 3m 10/25 delta puts and short the 10 delta/25 delta calls. i.e. buy the downside risk reversals. Exposed to skew and wings. They shall be valuable.
Why:In a range bound but drifting downwards market the risk reversal is not a bad way to get long stuff. you can sell out your position in times of panic and make decent money.
3) International: Long Brazil and Australian stock market and short China and India markets.
Trade:AUDUSD. That has been a steady train! Expect resistance around parity. So I like 3m call spread 0.97/1.0 strikes
4) Hurricane payoffs: Long Gold and Long Oil (hope for a hurricane payoff). Again, Risk Reversals are a decent way to do this.
5) Watching short GBP and EUR vs. USD. Not convinced time is now but time is coming to get long the dollar

Market Panic July 11th

2008-07-13T22:17:00.000-07:00

Below is a post I sent as an email to various friends in the middle of the day on Friday, the 11th of July 2008. I am posting it here for fun and completeness.
I stand by my predictions.. this time I will beat my chest a bit more since I had talked about these on my blog

1) S&P going to 1100 and Dow going to 10K before 3 months are up. I think it will bounce back though in the short term- i.e. the next week. This is a classic case of everybody collectively putting their heads in sand and then realizing it was a bad strategy as they get hit. I think overall we are going DOWN... Right now everyone is panicking but Bernanke and Co. will resuce us again the market will bounce back a bit and then go down slowly again.

2) It is interesting that today is Friday which is BAD for a market meltdown starting early in the day since there is enough time to panic and NO one wants to go home long ! As yahoo finance says- Investors have little reason to shop for bargains Friday because many financial companies are reporting results next week and are expected to announce another round of big write-downs. I say- Thus today could be a full fledged panic and this time I am talking REAL panic. FNM and FRE are central to America. This is not an I Bank failing ....

3) I expect home prices to fall severely actually across the global markets.

4) SHORT TERM: Govt. is caught on the wrong foot I think. They have to come out and say they will save fannie and freddie but they don't want to totally SAVE it either! There is a limit to what they can save. I think though that the two days weekend will give the govt a chance to say something reassuring on MONDAY or over the weekend most likely. I also expect politicians to say something and put pressure to save FNM and FRE. This is Mr. Bernanke's worst case scenario or approaching that anyway...So far he has done well I think but he must stay up at night thinking INFLATION....

5) Long Term This is going to severely dent any confidence the average investor has left. I won't be shocked to see people buying bonds and pension funds getting out of the stock market in larger quantities. I expect HFs to get long vol quickly. So Vol will spike, esp. as everyone and their mom will buy puts.

6) Beginning of the bigger recession coming...Many credit card companies, Home Equity companies are going to have a very hard time.

7) Indicators- VIX is at 29. I expect VIX to go to 35-40. You can check the bid/ask spreads on FNM and FRE on Etrade or whatever. It is awesome... the bid/ask is wider than the price!!!

the Awesome thing is that USDBRL- brazilian real is APPRECIATING against the dollar. I still like being long BRL! Right now USDBRL is at 1.6-1.7 levels. Typically in times of crises it goes to 2.5. Turkish Lira is going to hell in a handbasket.

Cheap PuntTrade Ideas:
1) I am trying to buy FNM and FRE at 3.1 and 2.1 dollars. DO NOT pay more than 5 at any rate. it is a cheap punt for s**ts and giggles.

2) Short Goldman stock - too high at current levels. Buy some puts on it.

3) 5) Inflation will be the BIG deal- in the US, UK, China, India. Buy some Gold calls but the train has left the station a bit so wait for the bounce back in the stock market and fall in Gold. Inflation is coming. You can sell some puts on Gold or buy call spreads - but the bid/ask will kill you...still worth a shot if you think inflation is going to be as bad as I think it will be.
4) Oil is going to $175 before the year is over. Esp. if a hurricane comes. No speculators are not at fault... :)
5) Would short the dollar againt NZD and AUD and JPY
6) Long AUD, CAD and Oil producers all commodity producers for the next 1 year. After that short....
7) Short Indian and Chinese stock market- long Brazilian and Russian stock markets.
8) short credit card companies ( yes STILL bearish them. Their losses will come to head in about 4-6 more months and their defaults will climb. Until then they will hide it.)

Enjoy the mayhem... it is sad but educational