Friday, July 18, 2014

Trade Ideas: USD vs GBP Short End/ Belly Convergence

Following up on my last post where I promised a closer look at the convergence trade of USD and GBP short term rates

Based on the latest data on both (We have the latest June prints for UK consumer prices, US prints are till May, the next US prints are due this Tuesday). The US CPI has recovered from last year's lows firing on all major component - food, housing and transportation (partly driven by energy prices). For UK, CPI prints have softened. The energy component seem yet to pass through and food has been weak as well. The stronger components have been housing, education and restaurant + hotel expenses. On pure price terms, if the trends remain, US will soon catch up a lot with the UK inflation, and inflation expectations should be priced upward accordingly as well.

Crucially, the one of the core drivers of forward looking inflation, the wage growth and personal income growth, have been much robust in the US (part of the productivity puzzle in UK employment, where presumably a large part of the employment gain has been at the expense of productivity and wage growth). Neither of them particularly impressive, nonetheless the US is doing better in forward looking terms. The counterpart of the productivity puzzle of the UK employment has been the dropping participation rate for the US. However, a large part of that has been attributed to changing demographics (retiring baby boomers) and the latest such study (opens PDF) is from the President's Council of Economic Advisers. If that is the cause, the overhang on the inflation should be less.

Also, the credit side of the story is much better for the US as well. The household credit growth and credit demand picture also support a stronger come back of inflation in the US compared to the UK.

Ignoring jitters about the compression of the term premiums and the asset price bubbles, or the recent round of Risk Offs, US inflation is poised for an outperforming compared to UK. And this means trades for short end convergence in USD and GBP. The price momentum was against this trade even a few weeks ago, and now the weekly moving average of the spread (on 5y swap rate) has cross the 50 day MA. 

Time is ripe for this trade!

UPDATE: Another study on the participation rate concludes similar

Saturday, July 12, 2014

Macro Views Series: 2014 H1 Quick Look-back

A quick re-look at the performances of the trades suggested at the start of the year (see here)

A mixed bag here, but overall, a really good performance given the rates rally that surprised most market participants. The 5s30s flattener in USD vs EUR is a huge winner, so is the short collar in EUR rates, and all carry trades in EUR. The AUD receivers outperformed as well. The losers are the long dollar trade and USD vs GBP convergence. These ideas are still valid. Especially the USD/GBP short end convergence. I will follow up with more on that

And totally irrelevant to the above, as you gear up for the World Cup 2014 final this Sunday, here is an excellent piece on why Lionel Messi is impossible!

Friday, July 11, 2014

NIFTY: Technicals - Choose Your Divination!

Now with the budget out of the line, we will be trading relatively event-less in near term more or less. So focus is less macro and more micro, stock-picking and timing the markets etc. In case you rely on technical indicators, here is a quick summary of what works and what does not among the weapons in the technical traders' arsenal for NIFTY. All data from Bloomberg.

The first chart shows the total performance of different strategies based on technical indicators, against simple buy and hold. The whiskers show the maximum and minimum annual returns, while the thicker bar s show the average annual returns in a trending market and in a range-bound markets (it is white if trending return < range bound return and black otherwise). The data spans 2004 to YTD 2014. The trending years are identified as 2004 to 2007 and then 2010 and 2014.

The second chart shows the relative rankings of strategies in a given year (1 is the best, 23 the worst). Again the whiskers show the best and worst ranks over the years and the thick bars show the average annual ranks in trending as well as range bound markets (again, it is white if the average trending rank is lower than, i.e. better than, average range bound rank)

So based on this if you believe we are in a trending market, NOTHING beats the simple strategy of buy and holds. And if you think we are in a range bound market, the best performing strategy is a variation of moving average (Triangular moving average - a three-point double-smoothed variation of the moving average method, with majority of weights in the middle point).

In general, you are better off following Ichimoku or different variations of moving average methods in a trending markets (if buy and hold is too simple for your taste!). And in range bound market also, the moving averages perform relatively better than other complicated indicators. But even then, they do not beat the simple buy and hold strategy by a large margin.

Of course, as we all know, past performance is not indicative of future returns.

Wednesday, July 2, 2014

Macro View Series: Cross Country Market Cap To GDP

Out of sheer lack of actions in the market (which I hope will change with the NFP and ECB tomorrow, the ADP came in great today), we take a look at cross country relative equity valuation. That is basically a vague sounding smartspeak for checking out the market capitalization of listed companies (as a % of GDP). Market cap to GDP is a quick and dirty way to compare fundamental valuations across countries, assuming fundamentals matters in your trade horizon (so we are talking long term here). Of course, this ratio will be influenced by, among others, share of unorganized sectors (inversely proportional) and proportions of productive companies listed (directly proportional), and claim on other countries' GDP (like Switzerland - a home of many multinationals, directly proportional)

We look at two aspects. First, the market cap to GDP vs real GDP growth rate - this kind of gives how the market prices in the expected growth in earning vs price. 

Also we look at the ratios with comparison to investment share of GDP. Note the countries are presented using internal country code (ISO 3166) here.

From the above we see a certain patterns. Most economies lie with reasonably narrow band no the 2nd chart. Look at the outliers - like on richer side Switzerland and Singapore. Both are financial hubs and home of many multinationals. So we naturally expect the market cap to GDP ratio to be higher. However, the South African and Malaysian markets are suspect of overvaluation. On the cheaper side you have Venezuela, Argentina and China. Venezuela and Argentina have their own pressing problems. And China is, well, China. So hop over them, and you see the suspects for cheap valuation: Kazakhstan and Czech Republic

Now the fun is to look in to more details of the specific economy and convince yourself. Happy hunting!

And here for the tail piece: the market cap to GDP ratio for India and US over the years (approximated from BSE 500 and S&P 500 market cap respectively)