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Oil….Have we missed the bottom… ?

Ok a lot of analysts are calling for lower oil prices, possibly to pre-2000 levels….does it mean  that we are close to the bottom …or possibly that have missed it ?

Whatever the market being traded, there always will be a a question being asked at one moment: How far can this thing go ? Clearly not an easy question to answer as this will invariably depends on factors that are partly unknown or difficult to estimate, such as fundamentals, market positioning or market risk amongst others. The first part is obviously to assess how atypical the move experienced in the given instrument is. This report aims to contribute to this. The below chart shows the Reference Price for the OPEC Crude Oil Basket over the period of January 2003 to February 2015 . at Close of business 16 February 2015 it was trading at 56.43. plot of chunk chartdata In the below I used an R script written by The Sytematic Investor to plot the previous 250 days against other similar historical periods that would have closely matched the recent history. The data has been normalised so as to be on the same scale. The chart shows the latest 250 days in black, and overlay similar historical patterns in grey. It Also shows what has been the price path for the following 250 days as well as the observed quartiles. plot of chunk pattern Finally I plot the last 250 days and a trend forecast derived from an ARIMA(1,1,0) model as well as the 95% confidence intervals. The ARIMA model is fitted to the past 750 historical values whilst ignoring the last 250 days, therefore we can look at the recent price path against the trend forecast and its confidence intervals to gauge how (a)typical the recent move has been. plot of chunk arimaplot

Quick Update on Market Risk……

Ok we have had our fair share of event risk  so far this year. Ukraine, Israel, Portugal  to name but a few….and  we now have Yellen telling us that the Fed may hike the rates earlier than forecast. And guess what ? The Vix is still trading in the low bottom quartile.vix

Though my shock Index  (ratio of  VIX volga and Vix over  21 days) did venture above its long term median value on the back of the Portugal  news, all  of my risk indicators remain  well entrenched in risk seeking  territory….


My  2-state Markov model continue to sell volatility…I am not sure I would but I can t fault the outcome of the model so far.


Bearing in mind the above I am  still  a bit quizzical  as of why risk is  trading so low. We are getting  indeed very little reaction from events that  once would have sent the VIX flying into the 20 to  25% range . The only rationale I have is that Investors are now accepting that  growth is significantly  taking hold and therefore investment flows are  logically channelling  into risky assets and carry trades. Also there  is  now a strong understanding  that central banks   are determined in doing  whatever is necessary to support growth and rid of systemic risk. This clearly  has a strong dampening effect  on any risk spikes, but lets not get too complacent about it…

Is The Fed Changing Its View About Inflation ?

Yesterday in her  Semi-annual Monetary Policy Report to the Congress,  Chairman  Janet Yellen  stated the following: “If the labor market continues to improve more quickly than anticipated by the Committee… then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned.”  However Treasury yields  have barely moved and the dollar appreciation  again the Greenback remained muted . The Euro depreciated only by 0.6% against the US Dollar since her speech.  As shown from the chart below though the dollar against a broad basket of currencies is fairly well priced this is not the case for 10-year yields. US 10 year yierld traded weighted Against all odds, Yellen  seems to have managed to contain market expectations yet again. This is quite outstanding when one looks at the hard data. Unemployment is clearly below the 6.5%  Fed target level. Also the rise in industrial production is quite telling of  an even lower unemployment rate in the months to come. unemployement USINDPRO

It is true that we have not yet seen much wage inflation in the us. The annual rate of increase in the average hourly earnings remains below 2% as shown below.  Wages remain dampened by the spare labour capacity. average earnings Clearly the Fed has accepted to remain behind the curve for quite a while  so  as not  to compromise any renewed  growth  in the US. The current low level of the Fed fund rate is a good illustration of  this. Fed Fund Contributing to a generally  dim view on the US economy by Fed members  could be that many forecasting models use 2×10 spreads as an input to forecast GDP. The abnormally ultra-low fed fund and therefore current steepness of the curve  could contribute to why  the Fed  growth forecasts may not be as accurate as should be.  After all even the IMF got it wrong with its growth forecast for the UK. 2x10It is now noticeable that over the last few months,  Inflation has crept  above the 2% target of the fed as indicated by the below chart. This is not surprising as trend in consumerism and aptitude of  price increase  is somehow function of  employments and wages earned. Though arguably not yet at an alarming level it will be interesting to watch out how the Fed react to further developments. US CPI So is the Fed starting to worry about inflation ? Plotting a Word Cloud of Yellen’s  speech it is indeed quite clear that Inflation is the central issue …..   yellen speechBearing in mind the above  it will be interesting to watch out for changes in the pattern of the inflows/outflows in US mutual funds. My thought is that we could see a resuming of the exit of bond products which was compromised by the ultra dovish tone adopted by Yellen when she took office. As mentioned in my previous post , the relative inflow/outflow in US versus foreign equities  could also have a perverse effect on the valuation of the US Dollar. High rates are not necessarily a long term driver of currency , capital flows are more important.  As a remainder of the current trends in US mutual funds  below are  couple of charts of my previous post. They show the distribution of the inflows/outflows in US mutual funds by asset class since the beginning of the year and the cumulative   flows in domestic versus foreign equities products since 2007. distribution inflows 2014cumulative flows I’ ll stick to my Long global equities and short dollar view…..

Business as Usual… Buy Equities !

The latest batch of US mutual funds inflow/outflow data  has been released by the Investment Company Institute in the US today and guess what  ? It is business as usual for US investors….Buy international equities and sell bonds…guess no one has been paying scant attention to the equity market wobbles we have seen aside the wannabe Roubini and other scaremongers of this world. anyhow the usual charts are below….

risk   versus flows cumul


Rplot Rplot01

No doubt the international equities buying trend remain strong and  this despite the recent comments by Yellen and weaker than expected ( but not weak) US economic data as well as the recent jitters in the equity and emerging markets. Clearly this may have provided  a short term respite for bond holders but my thoughts are that all this will be short lived and that we will soon see the 10-year US trading above 3%. Also the continual purchase of international securities by US investor is likely to bring headwind for the US$. This is possibly highlighted by the high resilience of the EUR-USD bearing in mind the differences in yield and economic growth of both the US and Europe…..Bearing in mind the rumoured long US$ position of the market it may be tempting to become contrarian. Even at 1.3600 the Euro could still provide some good profit opportunities…..


Update on US Mutual Fund Flows and Market Risk

Another batch of data has came out from the Investment Company Institute and though  for the first time  in a long time we are seeing  modest inflows into taxable bonds  funds, the theme is still about buying International equities for US investors. as the below charts indicate (click on them if you want to see larger versions).

inflowoutflow Rplot01

The appetite for equities clearly affects market risk and as can be seen  through our  Markov regime switching analysis the market is still in risk on mode.


The world  appetite for risk and returns seems to pick up and economies are doing better (even Europe does…). So if the Chinese GDP does not come much worse than expected or surprise us on the upside it could be an interesting few weeks ahead for us Equity Bulls…..If it is worse I guess it will provide laggard with a better level to enter the market.



It is Risk On Again !

Seems like the markets have rallied top the  idea that the budget ceiling limit is sorted out…so it is business as usual…buy equities ! and probably a little bit of dollar as the relief trigger some short term enthusiasm….but you know my view on that one. The ICI US mutual fund flow data definitely point out  to some significant flows going into international equities, so the dollar weakness will come back….Anyhow I re-run my  Regime Switching Markov model and there is definitely statistical agreement….Risk On  sell the VIX !

markov 15102013

Smell of Armageddon on Capitol Hill ?

Ok what is happening in the not so great US of A ? Markets were clearly coming to a lull and Capitol hill  has decided to spoil the party by throwing us a curve ball with this on-going wrangling over the budget and debt extension ceiling. Can you imagine the US going into default ? No one has any real idea of the full impact of such an event  and because of this we see the Roubini of this world crawling out of the woodworks. Even Buffet mention the event has being potentially “Nuclear”. Clearly the US has already partially defaulted in 1979 on some of its treasury bills, this moved the yields by about 60bps in one day which by European standards does not seem much. Anyhow Forbes has published a good column on this…So this time is it different ?  Well from what we can observe in the equity markets the reaction has been somehow muted. We have seen some retracement over the last five days but it still leaves us with a very healthy performance since the beginning of the year (assuming you invested globally in equities).

macromap5days macromap9month-09102013

Fig. 1: 5-day return of Stock Markets              Fig. 2: 9-month return of stocks markets

Bearing in mind the nearing of the 17th of October which is when the US could potentially find themselves in default if the extension of the debt ceiling is not agreed upon I thought I would look at my risk indicators. The left hand chart shows that the VIX is still trading near its long term median, that the volatility of the VIX (Volga) is also close its median and that the ratio of the Volga and the VIX which is a good indicator of financial system shocks has remained close to its median also. In other words by these metrics we are still in a happy, long risk world.

riskmetrics-09102013 regime09102013

However the chart on the right hand side shows the probabilities of being in a high risk or a low risk environment  derived from a 2-state Markov regime switching model applied to the VIX. In simple terms the Markov model aims to split the sample under review into two distributions (low risk, high risk) and to establish the probability of moving from of distribution to another. Clearly it seems that something has changed (in fact it started  to change on the 29th of September). The model does seem to indicate that a bit of caution may be a good idea……Let ‘s hope those guys on Capitol Hill get to some convincing  agreement …..I ll keep my tin hat at close range, just in case….