My Diary 555 --- Volatility, Correlation and Position

Market Diary (April 23, 2009) --- Volatility, Correlation and Position

US stocks gained on Friday with BTE Mic.U. consumer confidence (61.9) and stabilization in GE and Citi’s (EPS =0.18 vs. 0.34 cons.) 1Q09 results, plus BTE Google Earnings. Looking back, it seems sth suddenly happened over the last few weeks and I observed some changes of risk indicators among asset markets and macro data. Asset correlations and volatility are also pointing to sth different as I saw gold lower, bonds lower and oil flat. Having said so, 1) S&P500 is up 29% since Mach low while VIX is down 32% to just under 34. The drop in volatility, including FX Vol has brought back carry trades; 2) Better risk sentiment has also compressed credit spreads across fixed income universe globally (NA HY narrow 640bp since 09 March, Asia HY down 450bp), helped also by a combination of very low and stable ‘benchmark’ rates. Yield hunting gains its traction; 3) Bank earnings, US and Chinese macro numbers painted the picture somewhat like that the worst risks of the global economy have past. The rate of pain has slowed sufficiently for many investors to consider value again; 4) 1yr forward inflation expectation rose 1ppt to 3.0%, the highest since Oct08 and 5yr expectation rose 0.1 ppt to 2.7%

Certainly, the broader doubt in the markets is the sustainability of this new status of happiness. Some famous professionals expressed their concerns based on – 1) US bank stress tests and the capital holes that will undoubtedly exist as consumer debts turn sour with unemployment; 2) Government and central bank induced liquidity is not growing more and Sovereign borrowing squeezes out private markets; 3) The quality of growth “recovery” remains weak and fragile, even considering China, not mentioning Japan and Europe; 4) ECB Trichet in Tokyo was talking down EUR and global devaluations is still a risk to stability. All in all, one could argue that maybe the foundation for sustainable recovery is not yet ready – but the momentum is there.

However, from the market positioning perspective, I think we are going to see a correction this week --- 1) Technical wise, S&P has rallied 6 weeks, which is typically indicative of a market overdue for some consolidation. The “dumb money” sentiment measures are back above the January high and suggesting an approaching top. 2) 1Q09 is the weakest quarter for US economy growth in almost 50 years. Thus putting the trading results of US banks aside, we are almost certainly due for some disappointment as there are 143 S&P 500 companies and 13 Dow components report this week; 3) On Friday, Citigroup (-9%) was a laggard even though it posted a BTE results and was a leader during the last weeks. Obviously, investors pushed back when the firm indicated a WTE outlook on 2Q09 charge offs and its credit costs.

Local markets, both HK and Shanghai are clearly overbought – 1) Hangseng Index has failed twice to break the resistance @16000; 2) The RSI of most Index component stock are top or near 70; 3) USD index is testing its top-end and if it breaks out, that would generally be negative for Asian equities and risk appetite. Moreover, it is interesting to keep an eye on A-shares as there are more warnings from regulators cautioning the risks of chasing the current rally and amid worries on the destination of a material section of the recent enormous loans. The weekend press re-hashes the same topics -- a long recession, a weak recovery and -ve earnings surprises.

Overseas Market Reviews

On Friday, equities moved up 1.7% in Japan, 1.6% in EU, and 0.6% in US. Globally, stocks climbed 2.1% last, up 9% in April and 25% from their low since 09 March. Rates wise, 2yr UST added 7bp to 0.96% and 10yr by 11bp to 2.95%. Treasury yields have steadily climbed in April and are now close (6bp) to their levels prior to the announcement that the Fed would start purchasing government debt. 1MWTI oil closed at $50.33/bbl. Oil has traded roughly sideways, ranging from $49.15 to $52.24, while in contrast, industrial metals have risen 9.4% during the past two weeks. USD has weakened 1.8% this month on TW basis. USD gained 1% wow to EUR1.304, but slipped 1% to YEN99.2.