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March 26, 2015

Running in place

Filed under: Forex Strategies — Tags: , — admin @ 4:43 pm

A 1.5% downday, and the SPX is basically unchanged on the year.   There’s a reason that Macro Man hasn’t written too much about equities recently, and that’s it in a nutshell.  For the first three months of the year, US equities have been a bloke on a treadmill, running at a brisk pace simply to stay in place.

Not that this has come as any great surprise.  In October, Macro Man noted that liquidity factors were the primary explanatory variable for the S&P’s stellar run of performance over the past few years, and with the tap being turned off (in the US at least) there was naturally some reason for concern over future returns.

Indeed, more than a year ago Macro Man performed an analysis of the SPX’s return and vol by Fed policy regime; he thought that he had published it here at some point over the summer, but he’s deuced if he can find it.  Regardless, the analysis suggested a very bullish outlook for US equities as long as the Fed was a net purchaser of assets, and a dim prognosis whilst the Fed did nothing.   He’s taken the liberty of updating the study for the full body of the Fed’s QE Era (Dec 2008- Oct 2014); a summary of the results are below.

As you can see, based on this study, the right question for US equities is not “why aren’t they going anywhere?”, but “why are they doing so well?”  Since the end of October, the SPX has generated an annualized price return of 5.4%, with a vol of just over 13%.  Of course, a number of ancillary factors have also impacted the price- ECB QE, the collapse in energy prices (bad for producers, good for energy consumers), and of course, the shifting sands of Fed policy expectations.

There are, of course, limits to this type of analysis, given the paucity of truly independent samples.  Even going back several decades delivers little more than a handful of policy cycles, which is really an insufficient number from which to draw strong statistical inferences.  For what it’s worth, a year ago Macro Man also performed a study on SPX performance by orthodox Fed policy regime, splitting the cohort into the first 6 months of tightening/easing, subsequent tightening/easing, and on hold (defined as no policy moves for the last 6 months.)  The results are set out below.

On the face of it, this might suggest that a rate hike might be the best thing to ever happen to the US equity market, but correlation does not of course imply causality.  One might posit, for example, that early-stage and subsequent tightening cycles are driven by robust economic activity, which would naturally prove supportive of stock prices.  The lower returns from on hold and easing, meanwhile, would reflect the weak underlying economic conditions justifying those policy stances.

In the current environment, the expansion is already somewhat long in the tooth when measured by the calendar (though not by the credit cycle), and earnings have had a lot of “unnatural” support baked into the cake thanks to uber-accommodative policy over the last six years.  This is unlike any of the scenarios captured in the data set above.

Current and future financial conditions in the US look set to be tighter than those of the past several years, so it seems natural to expect equity performance to be worse (and, cough cough, macro performance to be better.)  That being said, Macro Man’s model is still somewhat bullish of the SPX, which informs a moderately long strategic position even as he is agnostic tactically.  He is following developments in the model and the market from afar, however, and is ready to change his stance when and if circumstances warrant.

In the meantime, there’s always the DAX, though it certainly looks like at least a good chunk of the easy money’s been made in that one for the time being….

6 Comments »

  1. @Dan:
    Not sure what the inconsistency is – say taken to an extreme BoJ will ultimately own all equities and bonds issued in yen – in the process it will debase paper currency, thereby decreasing the nominal value of the debt and also increasing the value of japanese equities, keeping down the implied leverage and financing costs low both for itself and other entities. As long as Japan is a closed economic system this would be fine for a very long time – over time, living standards would go down as the percentage of domestic savings (or forced savings via consumption taxation) required to maintain this ponzi would keep increasing, but as long as there is no 'run on the bank' or a nasty rebellion it can be self sustaining. It can even end well provided the rate of technological innovation in japan goes higher.
    Basically if you have a docile population that is willing to believe in the cause of higher inflation for the sake of it, this can be done, and thats what their long game seems to be. There is nothing in this game that rewards the kyle basses or other japan doomsayers, just a long steady grind down to a non-market based system.

    Comment by washedup — March 26, 2015 @ 5:11 pm

  2. My two cents: terms go to the zero boundary and yields go to the zero boundary to reflect the likeness of currencies and their corresponding credits.

    As long as the political spheres adequately hold up, the CBs can, theoretically, hold the sovereign credits on their balance sheets and the treasuries can modulate taxes to manage inflation, interest rates and runoff the CB balance sheet over time.

    A major political dislocation is how we would get a real mess in the financial markets with wild interest rates, IMO.

    Comment by Dan — March 26, 2015 @ 5:59 pm

  3. Can one of the smarter folks explain to this lesser mind the accounting 101 mechanics of the BOJ buying all JGBs, canceling JGB debts, Ms. Watanabe (she's single, un-sexed now) buying japanese equities and then BOJ buying all equities until Japanese secular island of Eden manifests?

    I want to believe I am not the only person smart enough to see all of the basic logical impossibilities here. There are mutually exclusive events being assumed in the aforementioned scenario.

    I believe it is very critical to remember that the financial system is first and foremost a credit system based upon asset-based lending and classical double-entry bookkeeping. If you cancel a JGB, where is the corresponding currency now?

    JGBs are claims on yen currency, correct? If the repayment risk on a self-referencing currency is zero because the treasury can print currency to cover obligations and the currency is secured by like-denominated sovereign credits, what should the entire yield-curve yield? Theoretically speaking…it can't happen.

    😉

    The markets are all about currencies, politics and war now. It's not that they aren't always, but most of the time the skirmishes are between very unequal competitors.

    Comment by Dan — March 26, 2015 @ 6:30 pm

  4. it will come from you, silly, when you cover your shorts much quicker and more desperate than how you 'scaled; into them.

    Comment by Anonymous — March 26, 2015 @ 6:57 pm

  5. http://fat-pitch.blogspot.com/2015/03/can-money-flows-push-equity-prices-much.html

    "In summary, investors, large and small, have a high allocation to equities and those allocations seem to no longer be rising. Margin debt has flatlined. And whatever impact buybacks had in raising equities seems to be waning. We're not sounding an alarm but it takes increasing money flows to push equities higher and its not immediately clear from where the next huge source of additional demand for equities will come."

    Comment by Anonymous — March 26, 2015 @ 7:29 pm

  6. You said Deuced
    haha

    Comment by Anonymous — March 26, 2015 @ 7:54 pm

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