Fundamental Trading Diary

Fundamental analysis of the capital markets

Top-Down Global Macro Analysis


As we near the end of March, the new year has brought stock returns of close to -20%.  We’ve seen the Dow touch 6,469.95.  This was almost inconceivable, and one of the few people who were calling this level while the Dow was hitting 14,000 was Bill Cara.

We’re in a very different political, social and economic climate than we were a year ago.  Central banks around the world have abandonded their coy monthly meetings, opting for bold statements and massive monetary actions that would have not been thought possible two years ago.  Major news outlets used to report if Ben was carrying his briefcase in his left or right hand!

Calculated Risk, excellent as usual, has the state of the present economy presented in graphs (link will open new window).  This is prerequisite viewing for the rest of this article.


Euro, Oil, Gold, Silver & Dow30 YTD

Euro, Oil, Gold, Silver & Dow30 YTD

Every valuation starts with the denominator on the other side of the trade.  Cash historically has had very simple relationships.  The USD moved with yields, and inversely to risk and inflation sensitive assets.  Since the beginning of the year, USD cash has outperformed euros, stocks, oil and yields while underperforming silver and gold.  Far more money is in each of assets than the total size of the gold market, so it’s clear that deflation is still the most significant risk.

Fed Funds Rate vs Target

Fed Funds Rate vs Target

Inflation and deflation are a big see-saw which largely reflects the net increase in borrowing.  Looking at the Fed Funds graph, it is clear that the prime broker/dealer appetite for borrowing money (and consequently taking risk to commit risk arbitrage) has certainly become far more stable than it has since the fireworks began.

The question is:  where is this borrowed money being relent? Examining the asset classes in the USA yields a clear answer.  We can assume that the dominant buying force on the market is this money since everything else in hard deflation.

In the past, I wrote about the curious relationship between different government borrowing and lending instruments.  I found a curious divergence in the 5 week t-note and all other treasury borrowing.  Instead, it seemed to follow the path of Federal Reserve lending through the discount window, but most especially through repurchase agreements.  The obvious reason is that money created and lent by the FRB was being used for risk-free arbitrage on higher yielding government securities.

I think it’s safe to say the same is happening here, except on a much larger scale.  The bubble in government securities is probably being directly funded by the government! The Fed lends cheaper money to big banks who will buy up higher yielding treasuries.

The conclusion I come to is that central banks now, more than ever, are the greatest influence on asset prices.  The balance sheet has become a giant juggling game of replacing maturing lending operations with new ones.  If they slip for even a minute, violent deflation will return, and probably more quickly than we’ve seen yet.  The New York Fed Open Market Operations should be monitored very closely for this.  In the absence of violent deflation from a flaming torch juggling error, I think we will see momentum carry over from the recent movement:  precious metals and bonds will increase in value while stocks decline.  General economic pressure — mostly stemming from declining home values — are putting far too much pressure on deflation for a different outcome to take effect.

Continued later..


March 23, 2009 Posted by | Uncategorized | 1 Comment

Late March Performance Analysis

It’s almost been a quarter since I last wrote, but the themes are very much the same.  Let’s examine some of the last predictions:

  • January 2nd/09:
    • Pair trade:  Long Oil & Short Exxon Mobil:  It’s taken some time, but this pair trade is in positive territory.  XOM is down close to 20%, and oil is down about 9%.  I think this is still a good bet.  I don’t think anything has really fundamentally changed with the supply/demand dynamics, or with XOM’s business model.  One of Exxon Mobil or Oil is priced incorrectly, and this trade will make money either way.  Currently +5.5%.
    • Pair trade:  Short BGZ (2x big caps), TNA (2x long small caps):  Statistics and the January effect did not play out.  This trade closed out at -4.35%.
  • November 30/08:
    • TBT (2x Long 10y Bond Yields):  This trade is essentially even so far.  The bubble in treasuries bottomed yields out at the end of December.  There was some queer behaviour in treasuries this week where yields dropped 50 basis points over 5 minutes on Wednesday.  The EUR/USD rocketed from 1.3036 to 1.3485 the same day.  The Fed printed a _lot_ of money to buy treasuries on Wednesday.
  • November 20/08:
    • Long XLV (Healthcare ETF):  Currently sitting at -0.01%.  This was a great call relative to stocks.  The S&P 500 is -15.51% in the same period.
    • Short XLE (Energy ETF):  Energy is down modestly for a profit of a +6.75%.
    • Short XLI (Industrials ETF):  Industrials are down mostly in sympathy to the rest of American stocks to yield a short profit of +15.38%.
    • Short XLY (Consumer Discretionary ETF):  This sector seems to be by far the most sensitive to positive sentiment.  In the recent rally, it’s put our short -6.92%.
  • November 3/08:
    • Long SLV (Silver ETF):  +41.48%.  Go team!

The markets haven’t been very efficient, have they?

March 21, 2009 Posted by | Uncategorized | Leave a comment