testing

The market has shown new strength on slightly better economic data, increasing oil prices, and continued increased monetary liquidity, but care should still be taken with taking on more equity risk.  First, the threat of a recession albeit low is much higher than what we have seen in years. I have taken the St Louis Fed recession probability model estimates and changed the values to logs. This will place more roughness in the low probability numbers. It is nice way to look at the marginal changes in probabilities. The readings are certainly not close to Jim Rogers "100%" recession comment this week, but the threat is real and certainly more than what we have seen since the last recession.  Second, I look at the financial stress indices produced by different Fed banks. Below we show the Cleveland Fed numbers. That number shows a heightened level of stress although it looks like we have reached a local maximum. Financial stress is subjective and not part of the Fed's policy...

If you are an allocator to global macro strategies, you have to make some assessments on the relative opportunities across asset classes. Choices have to be made. Someone asked about our view on which sectors have better opportunities, so we developed a simple table of opportunities by sectors.  In the post 2008 period, there was limited moves in foreign exchange, so even if you picked the best FX manager, you would not have done as well as just holding beta exposure in equities. Being long-biased in commodities was horrible in the post crisis period. Trying to trade short rates would have gained limited money. Fixed income generated gains.  One of the key determinants of where to put capital to traders is volatility. Not standard deviations but spreads from market moves. Although it may seem counter-intuitive, asset classes that are subject to large moves offer better opportunities for traders. Sectors which have little volatility make it harder to generate gains. There may b...

Instead of predictions of what will happen, it may be a good idea to talk about where there will be surprises. A surprise is an event that is contrary to the consensus of the market. There are five that will be the key focus of the year. We are not saying that any will occur, but argue that these are events or market reactions that will surprise the consensus. The dollar declines - The consensus is that the Fed is tightening and raising rates while the rest of the world is easing. This is all true, but if the Fed does not follow its path of increases, a dollar reversal will be the trade in foreign exchange. Is this dollar decline likely? The Fed has generally predicted a faster increase in rates over the last few years only to go slower than expected. History tells us four Fed increases per the SEP dot forecasts is aggressive.  A rate decline - With negative rates in the EU and the Fed expected to raise rates four times in 2016, the market bias is toward higher rates. This view is...

Computers are boring. They only give answers. - Pablo Picasso Predictions for the new year are about the same. They only give answers for what may be the wrong questions. I think there are only three questions for the year. I keep it three to ensure it is very simple. One policy, one environmental, and one behavioral. The policy question is the follow-through question from 2015. In 2015, the issue was when would the Fed raise rates. The 2016 question is how will they further raise rates. The behavioral question is also simple. The last few years was determining how investors would reach for yield in a zero rate environment. The 2016 question is determining how investors will react to a rising rate environment. The reach for yield may actually be more like the RORO (risk-on/risk-off) environment of 2010-2011. The third question is focused on the macro-environmental. How will the emerging market slowdown spill-over to developed markets? China trade is bigger than the US. EM economies are...

The oil price shock is affecting the oil patch. Companies are going under with most of the defaults in 2015 associated with commodity and energy names. Oil workers are getting cut with above average lay-offs relative to other economic sectors. However, the rest of the country is enjoying low oil and gasoline prices. Price decline shocks are always a trade-off between localized negative effects and positive macro effects. What will surprise markets are the secondary effects, the spill-over to other sectors which were not expected.  We think housing markets in Texas and other oil regions may be affected. Just look at the price indices for Dallas and Houston versus the other major markets of New York, LA, and Chicago. Texas housing has actually increased its momentum since the Financial Crisis. The other three major cities have not matched pre-crisis highs.  We know that Texas is a much more diversified economy than during the oil shocks of the 90's or the 80's, but on margin, a ...

There is economic reality and then there is the rhetoric of talking heads about the economy. Depending on the week, we can hear from Fed officials that the economy is ready for a rate increase or you can hear about how "data dependent" decisions require more information. So what will a simple look at the data tell us as we prepare for the holiday? The leading economic indicator (LEI) index has been available for a long-time but sometimes gets missed in all of the talk about the latest economic announcement. It is still a good base indicator that provides early warning about economic downturns. There is no question that if the index turns negative, there will be a recession or you are in a recession. Generally, if the index falls below 1%, there will be a recession. The US economy shows signs of slowing but we are still above the 1% threshold. There should be a concern about the decline, but the rate is still good.  Looking at the percentage change from a year ago will show th...