John Butters John Butters John Butters John Butters Macro Analysis - - PowerPoint PPT Presentation

John Butters John Butters John Butters John Butters Macro Analysis

johnbutters.org

Two Types of Macro Analysis

Macro Analysis Macro Investing Page 3 Special Situations Page 15

2

Macro Investing

Macro Investing

• What do I mean by ”macro investing”?
• Major markets: equity indices, interest rates, currencies, commodities.
• Based on fundamental analysis.
• Infrequent trading; analogous to tactical asset allocation.
• Philosophy
• Equity investors rely on stories; they have standard valuation models to guide
• them. In contrast, macro investors have no standard models and are always at

risk of believing a bad story.

• My approach is to focus on rational forecasting: that is, on the use of a model

to make any forecast, and on the careful selection of the right model for the

• circumstances. Models may be quantitative or conceptual, but should be

sufficiently well-defined to provide a clear answer to a given question.

4

Investment Process

• Research
• Daily reading and noting of a range of news and commentary.
• Daily following of different markets and a range of indicators.
• Creation of structured data feeds that automatically put economic releases into

context.

• Analysis
• New information organised by theme market actor.
• Constant conversation, with oneself and others (notebooks, daily note).
• Work structured by maintaining separate databases of questions considered,

models used to answer them and arguments for action.

• Preparation of working papers to lay out important analyses.
• No forecast without an explicit model.

5

• Example 1: Short EUR USD July 2011
• Model summary
• Of interest rates: Two-year rates mainly reflect expected short-term rates.
• Of
• EUR USD: Driven by the two-year real interest rate differential. There had

been a strong empirical relationship since mid-2010.

• Of the Eurozone crisis: Fundamentally a balance-of-payments crisis. The

reluctance of the private sector in the surplus countries to lend to the deficit countries implied a net capital outflow. In a single currency, the natural mechanism of adjustment was a deep recession in the deficit countries, unless private-sector net outflows were offset by official sector inflows.

• Of austerity policy: A simple Keynesian IS-MP model, although I also relied

implicitly on the models of Keynesian commentators.

• Of the ECB: asymmetric inflation targeter with a pain threshold.

6

• Example 1: Short EUR USD July 2011
• Model implications
• Actual ECB rate hikes and further hikes were priced in to EUR USD.
• Crisis measures did not address the fundamental problem.
• Fiscal contraction would be contractionary: economies were likely to suffer.
• Continued crisis and economic weakness would breach the ECB’s threshold.
• Therefore rates would be cut, and EUR USD would fall.
• Execution
• Entered the trade at the date indicated on the next page, with a stop at two 10-

day average true ranges but was stopped out. Re-entered later in the month and held the trade until December 2012.

• Exited after the ECB announced the LTROs. I had not fully grasped their

implications when I exited the trade, but saw them as a danger.

7

• Example 1: Short EUR USD July 2011

8

• EUR USD (arrow shows date of investment call)

Source: TradeStation

Example 2: Long Gold December 2011

• Model summary
• Of gold: Closely related to the ten-year real interest rate. There was a very

strong empirical relationship from June 2009, my rule-of-thumb date for the normalisation of markets following the global financial crisis. I was reluctant to trade this without a theoretical basis, but found it in the form of Hotelling

• pricing. A paper that suggested a similar explanation for the behaviour of

prices under the gold standard also increased my confidence.

• Model implications
• Gold had fallen quite far from the level that a regression on real rates would

have suggested; it had also fallen to the edge of a scatter plot of the relationship.

9

Example 2: Long Gold December 2011

• Execution
• The gold price had been dropping through December, which was a good

reason to be wary of going long.

• However, on 29 December the price hit a new low, in the morning, on unusually

high volume for that time of day and in thin Christmas markets. There was a good chance that this would give at least a good short-term entry.

• Held the position until the end of January, when the market had had a good run.

The price was not obviously too low, according to the model, and I felt I had made enough.

10

Example 2: Long Gold December 2011

11

Gold Continuous Future (arrow shows date of investment call) Source: TradeStation

Example 3: Long S&P 500 January 2012

• Model summary
• Of equities: driven by changes in trailing earnings and credit spreads. I used a

volatility-weighted composite index of these two factors; it had a relatively strong relationship with the S&P 500.

• Of the ECB: asymmetric inflation targeter with a pain threshold.
• Of the Eurozone
• crisis (same as EUR USD example): Fundamentally a balance-
• f-payments crisis. The reluctance of the private sector in the surplus countries

to lend to the deficit countries implied a net capital outflow. In a single currency, the natural mechanism of adjustment was a deep recession in the deficit countries, unless private-sector net outflows were offset by official sector inflows.

12

Example 3: Long S&P 500 January 2012

• Model implications
• The S&P 500 had failed to rally because credit spreads were wide; credit

spreads were wide because of the risk posed by the Eurozone.

• Political defeat of the Bundesbank on the ECB committee lowered the ECB’s
• threshold. The ECB therefore instituted the LTROs.
• ECB LTRO lending to banks could offset balance-of-payments deficits. The

Eurozone crisis should abate and the S&P 500 should rise.

• Execution
• Execution of this trade was poor. Failed to enter on the date the call was made

to colleagues (indicated on the next page), waiting for a larger short-term

• pullback. Then traded the view in copper, which failed to rise further. Finally

entered the S&P 500 after a decent pullback, but the rally had already ended.

13

Example 3: Long S&P 500 January 2012

14

S&P 500 (arrow shows date of investment call) Source: TradeStation

Macro Special Situations

Macro Special Situations

• What do I mean by ”special situations”?
• Often in esoteric markets.
• Possibility of valuation.
• Low valuation provides downside protection.
• Strong upside potential.
• Philosophy
• Come up with a solid valuation method.
• Downside stresses to fundamental value or future cash flows are my favourite

methods.

16

Example 1: Argentine GDP Warrants

• An investment call on Argentina’s GDP warrants in November 2011.
• Valuation methods
• Downside stress: bad recession – GDP growth as from 1998.
• Downside stress: repeat of inflationary history – GDP growth and inflation as

from 1980.

• Downside stress: continued growth but peso declines at 30% per annum.
• Upside potential: coupons are paid and future prospects remain the same.
• Conclusions
• The three downside stresses implied IRRs to expiry in 2035 of, respectively,

18%, 15% and 32%.

• Coupons due within 13 months represented approximately 60% of the current
• price. This provided both downside protection and upside potential if the

market priced in further coupons.

17

Example 1: Argentine GDP Warrants

18

Argentine GDP Warrant, Coupons Added Back (arrow shows date of investment call)

Source: Bloomberg, John Butters

13 14 15 16 17 18 19 20

Example 2: European Dividend Futures

• An investment call on Euro Stoxx 50 2014 dividend futures in September 2011.
• Valuation methods
• Downside stress: dividends return to a ten-year low.
• Downside stress: dividends fall as much as they did in the global financial crisis.
• Downside stress: all index members simultaneously pay dividends at their

lowest levels of the past five years.

• Upside potential: investment-bank dividend forecasts.
• Conclusions
• All three downside stresses implied a value in the mid-80s.
• Investment-bank dividend forecast was 154 for 2014.
• The 2014 future was trading below 80.

19

Example 2: European Dividend Futures

20

Euro Stoxx 50 Dividend Future 2014 (arrow shows date of investment call) Source: TradeStation

Contact

johnbutters.org

• jdbutters

btinternet.com 07814 025457

21