tirsdag den 17. april 2007

It's so easy, it's almost not easy...

The market has become easy, almost to easy. Just sell low yielders and buy high yielder in foreign exchange. Stocks got positive drift "always".

Let's run the numbers: In Saxo Asset Management we believe in generic models and in them explaining where the money "flows": (Click on gif to get bigger view)

The different strategies pretty much explain themselves; Think about it; Rolling the lowest yield in G-10 vs the highest yield (and the difference is not 200 bps!!) has given 417 bps this year! Doing the same in Emerging currencies earned you 591 bps, and what makes it even worse for simple macro guy like me; the risk numbers are excellent. Sharp is high, volatility is decent, in other words; a non-thinking strategy is not only making more money than me it is also less volatile (almost)

On the other hand our "momentum" part of the model (think John Henry) is losing money faster than a Formula One car! Macro - Turle model with all instruments in it down 903 bps and Foreign Exchange turles is down 578. Clearly sitting and earning interest works and trading(trending) does not!

What to learn from this? Well having observed this way of trading for a long, long time there are some simple rules;

1. Excess return on pro anno basis in carry trading unleveraged is about 400 bps - Yes, 400 bps. Similar to equity there seems to be 'positive drift' in favour of taking on risk.

2. The return profile tends to mean revert, trending did really well end of Q4-2006 and was up more than 500 bps.... so......in the long run.... (we are all dead .... JM Keynes)

This leads me to think about catalyst's for unwinding of carry trades. I know even considering a reversal of carry is the equivalent of being a witch in the Middle Age, never the less I have made my few pennies on being contrarian at the top or bottom AGAINST the prevailing direction.

I noted, late as per usual, this story from International Herald Tribune:

TOKYO: Sumitomo Life Insurance, Japan's fourth-largest life insurer, said it will move funds from maturing bonds in Europe into yen-denominated debt on concern the euro is too strong.

The insurer will increase its holdings of Japanese bonds by "several hundred billion yen" in the year started April 1, after an increase of ¥650 billion, or $5.46 billion, the previous 12 months, said Hirofumi Miyahara, deputy general manager of investment planning in Tokyo. Sumitomo Life will keep reducing overseas debt holdings after cutting them by about ¥500 billion last year, he said.

"The euro is quite strong so it's difficult to buy the euro-denominated bonds at these levels," Miyahara said in an interview last week. The company will invest mainly in Japanese 10-year and 20-year bonds as well as residential mortgage-backed securities, shifting money from maturing euro bonds, he said.

Sumitomo Life is the second life insurer in Japan this month to say it will buy more domestic debt to reduce currency risk. Meiji Yasuda Life Insurance, the third-largest, on April 5 said it planned to raise Japanese bond holdings by ¥300 billion to ¥9.38 trillion this fiscal year.
Japanese investors sold more bonds abroad than they bought in nine of 13 weeks this year after the cost of protection against a drop in the euro climbed to the highest in three years. Life insurers were net sellers of overseas debt in 2006 for a second year, according to Ministry of Finance figures.

That's interesting, it is however countered by the massive demand by Japanese retail clients doing everything they can to secure yield, but the key phrase in the text above is; 'The euro is quite strong so it's difficult to buy the euro-denominated bonds at these levels'.... It's the fx relationship which prevent them from buying not the tactical allocation!

To me that's an early warning signal. Add to this that EURJPY and USDJPY seems to be topping out - if it doesnt make new highs today.......

April is the start of the new financial year in Japan (March 31st end of fiscal year)

The inflation numbers this week will be major movers, UK just out above expected, later today we got US CPI, which I expect to be closer to 0.3 than 0.1 in core-inflation.

Market tends to ignore that Asia is now EXPORTING inflation net net. This will show up as increase in import prices across the globe shortly, also in Japan. In other words I am betting on combination of;

Too cheap JPY for Japanese investors to invest in overseas markets (Non private), a rising inflation trend generated by higher export prices from Asia, positioning and finally some inidications of toppish behaviour in JPY crosses.


Equity: Well got stopped out on DAX for sure, options worth ZERO... but another day another play. Still short NASDAQ futures (stop v.v.v.v close)

Fixed Income: Doubled the 2-10 y. spread yesterday. Firmly believing in back-end will have to adjust and soon.

Foreign Exchange: Long EURUSD, bought JPY call USD put, one month today 15 dlt, short EURGBP, short EURCHF

Commodities: Long Wheat. Winter condition tough on the shorts in agricultures.

Looking at: Gold(long), short Credit, Cotton and Crude...longs...

Remember as always; at best my predictions are random, this is written to provoke thinking out of the box nothing else.

Steen Jakobsen, April 17th, 2007

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