Global Macro hedge funds hit with investor withdrawals

As discussed last month, the hedge fund industry continues to experience outflows. Net withdrawals that started in December 2011 continued through the first quarter of this year.

Given the increase in risk aversion since March, redemptions are likely to have accelerated recently. In particular Global Macro hedge funds are once again among the funds group that is struggling.

$MM by strategy

Throughout the second half of 2011, Europe became the bane of macro funds' existence, as managers got constantly whipsawed by the whims of Eurozone politicians and bureaucrats. Investing based on relative value became irrelevant. Market trends (in currencies, commodities, rates, equities, etc.) kept reversing direction (sometimes several times a month), often rendering fundamental economic analysis completely useless.

These funds continue to struggle with the same issues today, unable to recover even a third of their 2011 losses (see chart below). It looks increasingly unlikely that they will recover full losses ("high watermark") before the end of this year, which means most will not qualify to collect incentive fees in 2012. Even Brevan Howard's flagship fund which beat most of its competitors by returning 12% in 2011 is down year to date. Given its strong track record, Brevan Howard is going to be just fine, but its Global Macro competitors are likely to see further investor redemptions.

Global Macro hedge funds performance (source: DJ/CS Hedge Funds Index, 1/1/2011 = 100)

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Long US dollar increasingly looks like a crowded trade

Each week the CFTC publishes what they call Commitments of Traders. It basically shows the volumes of open futures positions by asset class. Even though the futures market represents only a fraction of the overall FX volume (most FX volume is OTC), it gives one a good window into what FX traders (particularly small- to medium-sized players as well as retail traders) are doing. The latest CFTC report shows an extraordinarily high net long US dollar open interest in the futures markets.

Source: CFTC via GS

As one would expect this resulted in a tremendous rally in USD against major currencies in May (some 5% run-up).

US dollar against currency basket (DXY)

But such a historically high long USD positioning in the futures markets is starting to increasingly look like a "crowded trade". That makes the dollar quite vulnerable to a downside correction. Any hint of incremental monetary easing by the Fed that involves balance sheet expansion could force a violent reversal (such action could be adding to the dollar supply). Ironically a material action by the ECB or even the PBoC could do the same by making "risk assets" more appealing.

Long the US dollar is clearly a good position to be in from a fundamental perspective given the global slowdown, but the technicals from the CFTC report tell us otherwise. Other technical indicators may be pointing to the US dollar being overbought as well. This is particularly true given a rapid increase recently of retail currency traders who are known to pile into the same trade (usually late in the game) and then panic.

WSJ: - Foreign-exchange brokers that handle the lion's share of retail trades—known in the industry as "retail aggregators"—accounted for 18% of volume in the $4-trillion-a-day currency market, compared with 10% in 2010, according to the latest annual survey by consultancy Greenwich Associates.

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A hidden surprise in the US employment report

Today's employment report brought with it all sorts of negative economic surprises, creating a sharp drop in the Citi Economic Surprise Index.

Citi Economic Surprise Index

Bloomberg: - The Citigroup Economic Surprise Index for the U.S., which measures how much data is missing or beating the median estimates in Bloomberg surveys, fell to minus 53.6, the lowest since September. It turned negative this year in April after remaining above zero since October. The Federal Reserve announced a program dubbed “Operation Twist” to boost growth on Sept. 21, 2011, four months after the index turned negative.

One of the worst surprises buried in the report however was the fact that all the job growth came from increases in part-time jobs. The number of full-time jobs actually declined significantly.

WSJ: - ... the job growth is coming entirely from workers getting part-time jobs. The number of Americans working full-time fell by 266,000 in May, erasing all the gains of the past three months. The total employment figure only rose because 618,000 more people got part-time jobs. Many of those people would rather be working full-time: The number of people classified as “part time for economic reasons” — meaning they’re working part-time because they can’t find a full-time job — rose by 245,000 to 8.1 million.

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Argument against Canadian property bubble

Guest post by Cliff Küle

Cliff argues that Canada's property market is in fact not a bubble as suggested in this post.

Why Canadian real estate is not in a bubble

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Inflation expectations collapse

There is some discussion in the blogosphere that this spike in gold reflects increased inflation expectations (possibly due to higher potential for Fed's QE3). That may be true, but that assumption is completely inconsistent with inflation expectations implied by TIPS. The 2x2 breakeven (2-year forward) inflation expectation came down hard today, dropping below 1%. This is an extraordinary correction from the peak - 1.36% drop in 80 days.

2x2 breakeven inflation expectation

The only explanation for the spike in gold is therefore "flight to quality", as other "safe assets" such as bunds trade near zero yields or even negative.

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The concept of "shadow demand" in the housing market

Guest post by Greg Trotter

Here is Greg's response to one of the comments received on his previous post on US housing. Thanks for everyone's feedback.

Comment: - I still don't get your housing argument. As long as there is excess inventory, there won't be any demand for new construction. The people that are delinquent on mortgages will move into an apartment, but the home they vacate adds to the excess inventory, so it's a wash at best.

The entire point is that people that are delinquent on mortgages don't disappear into thin air. Everyone seems to believe that they do. Only so many are going to move in with mom.

Based upon current build rates and population growth (see original post), there are not enough (or soon won't be enough) new or empty homes/apartments out there for all of the people looking to move out of mom's basement. If employment continues to grow (and it is growing), we're going to need more houses.

I'm not talking about the price of housing either. I'm just talking about construction supporting growth. Banks will take losses on defaulted mortgages, but no one goes to debtor's prison or goes in front of the firing squad. These people look for alternative housing at a different price. They re-enter the demand pool.

What doesn't make sense about that?

New one family homes for sale (completed)

Vacant housing units for sale

This could certainly look prettier. We have 450k more vacant homes for sale as of 3/31/12 than there were in 1998-2003. However, those 450k units only act as substitutes for new construction if they are in the right place. Also, we are “under building” by 50k units per month compared to history (to account for population growth and destroyed housing stock). Also, new household formations have been very depressed since the beginning of the recession, to the tune of 2+MM below historical rates since the start of the recession.

http://soberlook.com/2012/01/story-of-household-formation-is-about.html

http://www.businessinsider.com/harvest-capital-strategies-bullish-charts-on-household-formation-2011-10#-1

The next link is from a horrendously biased source….It references NY Fed President Dudley, though. Also, the NAHB data is not quite consistent with census links below. The NAHB study shows a lower level of households than the census report (per my reading) for 2010. Maybe we can trust Dudley. Here's a quote....

"This exercise suggests that a considerable portion of the excess housing supply (NY Fed president William Dudley recently estimated 3 million units) is due to a steep decline in demand related to economic conditions, rather than due purely to overbuilding. This insight has important implications for recovery in the housing market. "

http://www.nahb.org/generic.aspx?genericContentID=152243&channelID=311

This next one looks bad. It’s the total vacant units available for sale or rent. Vacant housing units are a lot higher than in 1990, but the number of households is up 24MM (>25%) since then—even with the lower household formation (according to 2010 census—link below). If you think that the number of vacant units should stay constant as a % of households, they subtract 3 million from current in order to compare to 1990. That would make an adjusted 15.5 million vacant units for 2012 compared to 12 million in 1990. However, you need to consider the 2-3 million “missing” households that didn’t form during the recession. Also, I was using the 2010 census, which would ignore any household formations since then. If you grant me all of that, we could be on par with or “over vacant” by at most 1 million units compared to potential demand (I’m being generous). Okay, counting the “missing” households might be a stretch, but we have also created 1.8 million jobs in the last year and 3.3 million over the last two—not so good, but positive. If/As that continues, people move out of mom’s basement. Note: if employment falls, I will be wrong.

My last request would be to think about which vacant houses aren’t on anyone’s bid list because of location or condition. Anyway, there’s enough potential demand for the current housing stock to be “balanced” or even under-supplied depending on how you round your millions of units and adjust for household formation, employment growth, etc. If you don’t like my adjusting and rounding, remember that ~1.3 million households are typically formed in a year (make it a little lower b/c of demographics) and we’re only building ~700k housing units on an annual basis. People that say there is 4+ years of excess supply are wrong.

http://www.census.gov/prod/1/pop/p25-1129.pdf

http://www.census.gov/prod/cen2010/briefs/c2010br-14.pdf

Vacant housing units for sale or rent in thousands

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Gold and copper decouple completely

Here is gold vs. copper futures intraday price action over the last couple of weeks. The decoupling, particularly after the horrible US employment numbers today, is striking (after being tightly correlated recently).

Gold futures vs. copper futures intaday

As the 2-year rates go negative in Germany, gold becomes a unique asset class for flight to safety.

2-year bund yield

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China's big customers will be doing less shopping

The pie chart below shows China's export markets. In the past when developed market nations slowed down, China relied on its emerging markets clients (EM) for growth. No such luck these days. Emerging markets across the board are slowing sharply, as we saw yesterday with India (China's big customer).

China export markets (source: DB)

Clearly the EU isn't going to do too much shopping, Japan is struggling, and now we have clear signs of the US slowing down. China's economy will be coming to a grinding halt unless the government kick-starts a massive stimulus program. Today's manufacturing PMI number is starting to reflect the situation (although this indicator has somewhat of a lag, and the current situation may be getting worse).

Source: HSBC

HSBC: - “May’s final reading confirmed that manufacturing growth slowed further on weakening demand from both global and domestic markets. This points to a continuous slowdown of the real economy in 2Q and should promote Beijing to step up easing efforts in the coming months. On top of monetary easing via additional RRR cuts and one 25bp rate cut, Beijing policy makers should allow fiscal measures and private investment to play a bigger role in supporting growth.”

At the same time China's government is facing a crisis of confidence within the Communist Party.

Bloomberg/BW: - After China’s economy grew at the slowest pace in almost three years last quarter, the government’s anxiety may extend beyond the Bo scandal. Premier Wen Jiabao said in a March speech that the regime could come to an end if it doesn’t address corruption.

Days before Wen spoke, Bo himself warned that China’s Gini coefficient, an index of the income gap, had exceeded the 0.4 mark that is used as a predictor by analysts for social disturbances.

Bo, once considered a candidate for the Politburo’s all- powerful Standing Committee, was stripped of his post as party secretary of the municipality of Chongqing later in March. A month after that, following accusations that his wife was involved in the murder of a British businessman, Bo was suspended from the Politburo.

“The party has control over millions of police, the secret police, the web police, the informers, so in a material sense its grip is very solid,” said Minxin Pei, a professor of politics and government at Claremont, California-based Claremont McKenna College. “In a psychological sense, the party’s grip is very tenuous. People say, ‘Wow, its own leaders are both corrupt and insecure, they have no confidence in the long-term survival of the regime itself.’”

This economic slowdown is likely to fuel more social unrest, particularly as the anniversary of Tiananmen crackdown approaches.

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Is Canada facing a housing bubble?

As discussed before, risk management, whether in banking or among regulators and consumers tends to "fight the last war". The "riskiest" asset class in people's minds is generally the one that got the most attention in the previous down cycle.

In the 2007 recession, the US residential property market was the hardest hit among the various asset classes. As a reaction to that event, lenders in the US are being fairly conservative in providing residential mortgages. Home buyers on the other hand are in no rush to buy properties. The risks associated with real estate markets are still on everyone's mind and will probably be for some time. That type of risk aversion keeps asset bubbles from forming.

Canada on the other hand did not experience the same level of housing bubble nor the correction that followed as did  the US (see chart below). Therefore housing in Canada does not tend to conjure up the same connotation of risk as it does in the US. At least not yet.

Canadian home prices have been growing quite rapidly, particularly as compared to the US. Some may argue that this is justified because Canada's unemployment rate is lower. 8.1% in the US vs. 7.4% in Canada. Is that enough to justify such a divergence in housing prices, particularly when the GDP growth rates in the two countries is fairly similar?

In addition, construction in Canada is booming. The chart below compares construction jobs as a percentage of total jobs for the US and for Canada. The divergence is quite striking.

Source: Bloomberg

Canadians have also been growing household debt levels. The chart below, though a bit dated, includes mortgage debt (total debt as percentage of net worth).

Canadian consumer credit plus mortgage debt as % of household net worth

Economists are becoming concerned.

Edmonton Journal: -  ...OECD economist Peter Jarrett ... described the housing market as the “biggest story in Canada.” Home prices, which corrected about 10% during the recession, have surged again, “making household balance sheets look increasingly fragile, he said.

Given the global economic backdrop, and in particular the sharp correction in energy prices to which Canada is highly exposed, the risks of a Canadian housing correction are rising. Watch the BBC video below to get a feel for the situation on the ground.

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India's GDP growth hits a wall

Concerns about India's growth that were reflected in the sharp decline of the rupee (see this post) turned out to be quite justified. India's GDP is in free-fall - with growth well below the levels of 2008-09 global recession. One could argue that 5% is still respectable when it comes to GDP growth. Not for India.

India's GDP growth

Reuters: - India's economic growth slumped to its lowest level in nine years in the first three months of 2012, marking a dramatic slide in the fortunes of a country whose economy was boasting nearly double-digit growth before the global recession.

"Urgent and bold steps are immediately needed to prevent the economy from descending into a full blown crisis. This must be averted at all costs," said Rajiv Kumar, secretary-general of the Federation of Indian Chambers of Commerce and Industry.

The economy grew 5.3 percent in the last quarter from a year earlier, a sharp slowdown from 9.2 percent growth in the last quarter of the previous year, government data showed. Finance Minister Pranab Mukherjee blamed the poor performance of the manufacturing sector, which shrank 0.3 percent from a year earlier, for the slowdown.

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More China stimulus coming

The ISI Group believes that more China stimulus is on the way, as the nation is facing a real slowdown. The measures taken so far have been relatively insignificant, particularly as a percentage of total GDP (chart below). The difference this time vs. 2009-10 is that the central government wants to control the stimulus process as opposed to allowing regional governments to run with it. And the central government’s approach has been far more measured.

Another reason further stimulus may be on the way is simply because the bank reserve ratio requirement (RRR) cuts – the most visible monetary action this year - have been ineffective due to low demand for loans.

Source: ISI Group

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US equities holding up well

US equities have been quite resilient in the face of this global retrenchment. Here are two comparisons that indicate that while the US market is not isolated from the global turmoil, it is certainly less vulnerable.

1. The S&P500 vs. the MSCI World index (US vs. global equities).

2. The S&P500 vs. the CRB Commodities Index. Commodities tend to reflect demand driven by global economic growth (recently dominated by emerging markets).

It remains to be seen whether this outperformance persists going forward. But for now large cap US stocks have been a de facto "safe-haven" in the global markets.

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Italy's recession is becoming severe

There is basically no good economic news coming out of Europe these days. And the news out of Italy has been particularly sad. A couple of nasty earthquakes that recently hit Italy have killed a number of people and damaged factories, adding to an already bleak economic picture. On top of that the government had to increase gasoline taxes to pay for the reconstruction.

FT: - Italy has started counting the cost of two devastating earthquakes in the northern industrial region of Emilia-Romagna.

The government has come under attack for responding by levying a tax of two euro cents on a litre of fuel to help finance reconstruction.
...
This latest blow to Italy’s economy in the midst of a double-dip recession follows estimates by Confindustria that industrial output in May has fallen by 0.6 per cent over April and is now 22.1 per cent down on the peak reached in early 2008.

The government’s decision to raise tariffs on petrol and diesel – already among the most expensive in Europe – was widely condemned by consumer associations and politicians on both left and right. They said the extra costs would hit spending and drive the economy deeper into recession.

Italy's double-dip recession is indeed becoming severe - even before the impact of these devastating events and the hike in gasoline taxes. Here are some of the latest economic trends.

1. Industrial orders have hit a wall as corporations cut back. Ultimately that is hurting jobs.

Italy's industrial orders YoY

2. Consumer confidence is now below the levels of 2008/2009 recession.

Italy consumer confidence

3. That is translating into a severe decline in retail sales (record year over year drop).

Italy Retail PMI(source: Markit Partners)

Markit: - The Italian retail sector remained in contraction during May, with sales again falling sharply in spite of widespread discounting. Cost pressures meanwhile grew from April’s recent low on the back of rising transport costs [remember this is before the gasoline tax hike], thereby adding more pressure to margins. Consequently, firms shed staff at a marked and accelerated rate that was the steepest since data were first compiled in January 2004.

And now the European Commission is telling Italy to "remedy" its weak growth (which is now more of a rapid contraction).

Europolitics: - Italy has been warned by the European Commission to remedy persistently low growth and address its high public debt in its upcoming budgets. In a 30 May report that forms part of the EU’s stepped-up screening system for national budgets, the Commission has urged Rome to crack down on tax evasion and free up the jobs market for younger people and women. “Italy is faced with the twin challenges of a very high public debt and persistently low growth,” the Commission’s report says. “These challenges long pre-date the global financial crisis and largely explain investors’ mounting concerns with the sustainability of Italy’s public debt in an environment characterised by high risk aversion.” Italy’s public debt of 120% of GDP is the second highest in the EU after Greece.

No matter how many reports the EC writes, there is nothing that can pull Italy out of this recession in the near term. The situation will get a great deal worse before it gets better. And the EU needs to come to terms with it sooner rather than later.

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Let's thank our friends in Spain for making this summer driving season cheaper

Spain's spreads once again hit new records today (10yr spread to Germany is now 5.37% - as the countdown continues). But the one positive outcome of the Eurozone crisis is a sharp decline in US gasoline prices. In fact the spike that started at the beginning of this year has pretty much been reversed.

NYMEX gasoline futures

So for those of us who have to do some serious driving this summer, let's not forget to thank our Spanish friends for making it that much cheaper.

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Gold is just another commodity, until it's not

Gold has been selling off recently with copper and other commodities on the back of the rapidly strengthening US dollar and demand uncertainties (particularly from emerging markets).

US dollar against currency basket (DXY)

But the tricky thing about gold is that it's just another commodity until it's not... We saw an example of that this morning as things started looking scary across financial markets.  The 2-year German bond traded at negative yield for the first time as flight of capital accelerated (someone was willing to pay the German government to hold on to their euros for 2 years!).

Current 2-year bund yield (3 days, intraday)

And as one would expect in such an environment, gold suddenly decoupled from copper. The sentiment quickly shifted from global demand uncertainty for commodities to urgent flight to safety. And gold became the beneficiary of this sentiment shift.

Gold futures vs. copper futures (3 days, intraday)

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