Macro Ain't Easy

If you’ve been befuddled by some of TMM’s missteps and confusion at the world well, apparently we are not alone per the WSJ. It has not been a particularly easy year for the industry thus far and looks to be getting no better. Some of this is no doubt due to there being way too much money in this space chasing far few trades but some of it invariably comes down to the set of opportunities available at the moment. Most investors require some kind of dispersion to make money or generate “alpha” in order to get paid. “Dispersion” is pretty broad but ultimately it comes down to how much of a spread there is between the stuff you trade. If things are all moving together all the time, there is only the business of when to be long and in what size rather than what to be long and short and in what size. Picking winners and doing research is irrelevant in a directional punters market and really, it is hard to have any distinctive edge.

Dispersion operates at a few levels: the typical macro stuff like different equity indices, FX, and rates but also within indices (sectors, subsectors, etc) as well as dispersion within those sectors. Different mandates and strategies require different types of dispersion to make money: market neutral guys can do great in range bound markets if there is a lot of change in the profitability within indices, opportunistic or thematic guys can do well out of long term industrial or technology trends and macro guys need to see some separation of indices and broader more liquid rates. A chart is below:

That sadly is what appears to be the case in big picture asset allocation land and most major indices. Dispersion is relatively short lived and there isn’t an awful lot that is consistently trending. As a result researching something that is durable and lasting is tricky. There are things, however, that do seem to work but they are increasingly looking like they are all the same trade – look at Eurobanks and EURCHF below.

The implication of which is that your positions are highly correlated, therefore you cannot be as leveraged and make less money on the trend.

This is not happening so much within sectors or themes. Take two examples close to TMM’s heart: the inevitability of Chinese clothing and footwear manufacturers getting squeezed as they cannot move up the quality chain to displace the likes of Nike and the wage pressure they get from a workforce with little slack left. TMM can say this has worked out pretty well and has been nice and low(-ish) volatility. Price performance of the basket:

Historical Vol:

And Bollinger bands to show how well it has trended:

Similar names would include a basket of large lithium producers / battery separator producers (PPO US, SQM US, FMC US, ROC US) or a basket of Chinese banks or Aussie banks, names associated with cloud computing… you get the drift. The baskets tend to be lower vol and as performance is pretty similar amongst the names, you get a better sharpe. If your mandate allows you to trade sectors and themes without having to slavishly stay market neutral then the pickings have been pretty rich this year though as always you have to go out and pick them.

With that in mind, what do TMM think is going to “work” in equities against what is regarded as a relatively tough longer term macro backdrop of rising input prices and higher funding costs if not in EM then generally? A few things seem to work to TMM:

1. Stuff with an inflation linked top line but relatively consistent unit costs. Railroads are one example, gas producers aren’t far off. These are often slow moving changes in margins but they tend to last. Pretty basket friendly, for the most part.
2. Picking the winner of a tournament where the winner gets monopoly rents. Who is the next Google / Microsoft? Facebook? Limit long – the incredible performance of Netflix and the fact that Google trades pretty rich despite being close to ex-growth says a lot about what people are willing to pay up for a “big moat”. Consumer brands in EM that establish supply chains and channels quickly would also fit in this bucket. The downside hurts if you lose a tournament though (ask Myspace) so this is definitely a situation where buying a basket of 10 gives you one 10 bagger and lots of disasters. This is single name territory.
3. Eat Somebody Else’s Lunch: Find an industry which is going to more or less inevitably replace something else because you can wait. The lithium names’ pricing relative to other mining names reflects this now but is indicative of what the market is willing to pay up for now. This is very basket friendly.

Aside from that, there is plenty to short so long as the data looks this awful. TMM look to earnings season with bated breath.