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April 14, 2015

The BOE forecasting model revealed

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

So the big news at the time of writing (9 pm NY time) is an FT story wherein a Greek official says that this time, they are serious about defaulting if the Eurozone doesn’t show them the money.

Yawn.

It’s been what, a good six weeks since the last farce in three acts featuring Greece and the Eurozone; Aristophanes would no doubt be proud.  While this apparently never-ending pas a deux is of course beyond tiresome, given the recent uber-surge in European assets, it’s probably worth taking at least some note.

Indeed, after a number of months of stumbling to get out of their own way, peripheral equities have finally joined the party that the Dax has been enjoying for some time now.   However, when they start handing out “forecaster of the year” awards to Buzz Lightyear when Greece starts to rear its ugly head, and May is just a few weeks away….well discretion would appear to be the better part of valour.

While the euro looks understandably putrid, Macro Man is actually getting more interested in sterling as a potential short candidate.   To be sure, cable has already collapsed from the heady heights of 1.70 in less than a year, and it’s difficult to see another 25 big figure decline over the next 12 months.

That having been said, monetary policy is nonexistent, and even commentary from Carney’s Bank of England seems to derive from a magic 8-ball.

At the same time, it seems rather more likely than not that Mr. Bean Ed Miliband will be the next prime minister, thanks to gerrymandering and a coalition with the SNP.  Things could still change, of course, but it looks to be a very close-run thing, and the uncertainty hardly looks bullish for the currency.   Macro Man isn’t pulling the trigger yet, but if we get a pop in cable back towards 1.50 over the next week or so, it will be hard not to.  Hey, even Mark Carney agrees!

February 27, 2015

A simple model

Filed under: Forex Strategies — Tags: , — admin @ 4:42 pm

So the US economy is not, in fact, falling off a cliff…just yet.  Although durable goods orders are notoriously noisy, yesterday’s solid print should assuage at least a few fears about the recent soft tone to some of the data.  That core CPI managed to beat expectations was icing on the cake, as the dollar and US yields both jumped smartly after the releases.   As Hannibal Smith used to say, “I love it when a plan comes together!”

Of course, it wasn’t all pony rides and lemonade.  Weekly claims were quite a bit higher than expected, albeit in the context of seemingly interminable snowy, nasty weather for much of the country.  Still, the decline in claims seems to have stalled a bit recently; although it’s probably too early to read too much into it, it nevertheless remains a development worth watching.

Every so often, Macro Man likes to take a step back and look at data in its unadulterated form- no rates of change, moving averages, or anything like that, just the level of the underlying data.  When looking at the level of durable goods orders, ex-transport, you can see the recent soft patch; put into context, it doesn’t yet look particularly abnormal or worrisome.  Certainly the loss of momentum is nowhere as severe as it was in 2012.

Perceptive readers will note that durables are basically at the peak level of the last cycle, whereas the SPX is comfortably above it.  How, then, do these orders figures compare with other data?   Macro Man assembled a chart showing nominal retail sales, the ex transport orders noted above, and industrial production, scaling each series to 100 as of February 1992.  As you can see, the relative fortunes of the 3 data sets vary starkly.

As the title of the chart suggests, these three series capture the changes in the economy quite well.  Consumers have continued to spend (note that retail sales are substantially above the level of the pre-crisis peak), but not, it would appear, on goods made in the US.  This is hardly a stunning revelation, of course, but it’s nice to see it demonstrated so sharply in a single chart.

This got Macro Man to thinking.   Retail sales, like the SPX, are very comfortably above pre-crisis highs, IP is marginally so, and orders are basically at the level.   What would happen if we regressed these 3 series against the SPX?  The results are set out in the chart below.

As you can see, the relationship is generally quite good, with an r-squared of .88.   Note that to some extent that should be expected, insofar as the entire time period was in-sample and your author regressed levels rather than changes.  Nevertheless, it’s interesting to note that the divergence between the current level of the SPX and that suggested by sales, orders, and IP is larger than  it has ever been over the past couple of decades.

To a large degree, of course, that is a function of QE/easy monetary policy/low bond yields/low discount rates.   One would naturally expect, ex ante, that stocks should look a touch rich to exclusively growth-based indicators given that global policymakers have begged investors to move out the risk curve for more than half a decade.

Naturally, equities also benefit (and suffer) from leverage, both on a corporate and investor level.  Indeed, generally speaking the amplitude of changes in stock prices dwarfs that of changes in the underlying data, so it may well be the case that a simple linear regression is a decidedly imperfect tool.

To mitigate the impact of leverage, Macro Man ran the same regression, but on the natural log of the SPX to smooth the swings in stocks relative to the economy.  Upon obtaining model output, it was a trivial matter to reconvert the data back into SPX terms.  The results of this study are below.

This model suggests a closer fit between the current level of stocks and that implied by growth data (and a closer overall fit, with an r-squared of 0.93), though it still views equities as nearly 10% too high (when using current stock prices.)  However, “mispricings” of this magnitude are fairly ordinary; indeed, the same model suggests that stocks were undervalued by a greater amount in the run-up to the crisis.  That very fact should tell you everything you need to know about relying exclusively on growth-based indicators that take no account of financial conditions.

So what have we learned?  A very simple growth-based model suggests that US stocks should indeed be at all time highs, albeit at levels lower than those currently prevailing.  Introducing a liquidity term would indubitably close that perceived valuation gap; indeed, in Macro Man’s own, more robust equity model, liquidity factors explain almost all of the ex ante expected return of the SPX.

As long as liquidity remains ample, growth doesn’t necessarily need to roar to justify current if not higher prices.   If and when the tap gets closed off, on the other hand, simple indicators like these can provide a rough and ready guide to how deep the correction might be if we were to revert to using growth rather than easy financial conditions as the primary valuation metric.

April 10, 2013

UK Model for Japanese Inflation.

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

If Japan is serious about wanting inflation then instead of flooding money into the global pool they should just turn to the UK and announce that they will soon - 

Have UK energy companies running their utilities. 
Have UK insurers insuring their cars. 
Have UK government price tobacco.
Have any UK train company running their public transport.
Have UK’s “PC World” fix their computers.
Have UK main dealers fix their cars.
Have UK local authorities run their car parks.
Have UK motorway service stations provide all fuel. 
Have their children educated at English private schools.
Have all online billing done by Ryanair. 
Have UK “payday loans” run their bank lending.
Have EasyJet supply all preprepared foods
Have UK Farmers’ Markets supply all fresh food.
And then make everything organic.

 That should scare the hell out of the population with respect to inflation expectations. It’s worked wonders in the UK. Just a shame about no growth.

If they do need to go further then perhaps-

Have USA run their fighter jet programs.
Have France run fiscal policy. 
Have Singapore tax their cars and price the beer.
Have Norway provide their holidays 
Have Switzerland run their McDonalds.
Have Courchevel run their ski resorts.

May 2, 2012

Behavioural Model.

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

What a difference a day makes. “Sell Aud? Australia? Where’s that?  We are back to selling Europe again”.

TMM’s Bloomberg IB chat bias-o-meter would have us believe that we are about to have a Euro panic similar to that of 10 days ago. If that is any indication of the size and commitment of short term positions then really the price moves so far aren’t that impressive. We will not get sucked in (though we may get spat out of existing positions).

But it doesn’t matter if we are right or wrong in our method, prices change because people decide levels at which they are willing to trade. So no matter how much we believe in our methodology, no matter how much it can mathemematically be proved correct, no matter how much our theory, or even what we thought was everyone else’s theory, tells us we are right; if everyone else is reacting for different reasons then our ultimate reward for rightness (profit on price movements) will remain elusive. Which is a long winded way of saying the market will remain irrational longer than we remain solvent.  This is of course why it is imperative to understand what drives other people to make decisions as much as understanding our own.

We often see the markets as a massive poker table around which sit thousands of players, all with their own different reasons to play and ways of playing. Understand all of them enough to pre-empt their actions and you can profit greatly. But that’s nigh on impossible so we tend to group the types. We have in the back of our minds ideas for a piece on all the different types they have encountered over the years but that is for another day.

Instead today we have knocked up a behavioural model of how the markets work, very much from our own perspective. It’s remarkable in its familiarity. No prizes for guessing which one we are.

July 21, 2011

Kim Kardashian sues Gap over look-alike model

Filed under: Business — Tags: , , , , — admin @ 12:19 am

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