Fallout From The Crash: Carry Trade and the AUD

An explanation for the crash that is gaining credence (according to Art Cashin) is a spike in the Yen before the crash caused a rapid unwinding of carry trade positions, an idea that may have first been noted by Trader's Narrative. The Yen has the most reliably low interest rate for the cary trade, and fear of a spike in the US rates could move money out of USD carry and back into Yen carry. As the bond market is an order of magnitude beyond the stock market in size, Forex dwarfs bonds. A little carry goes a long way to whipsaw stocks. 

We saw a bit of normalization of carry currencies Monday, but will this sustain? If the crash is the warning shot of a change across lots of bets that worked during the Hope Rally, a lot of positions need to be rotated, starting with the darling of the carry trade, the Australian Dollar (AUD). 

A quick comment about the AUD in a ZH post on the crash caught my eye about the AUD. The post noted how markets stopped at the same time worldwide across almost every type of market including futures, bonds, gold and forex. How could this be if it were merely a glitch in a few stocks? And how could this happen so swiftly unless a substantial majority of all trading is in the hands of a very small number of firms who made the decision to freeze over just a few minutes? The markets came back around the same time, but a few lagged, and this raises a red flag: 

Finally notice that the EURUSD and AUDUSD are slightly late to the game to recover. Although the auction resumes about the same time, they continue to print precipitously longer.  This is all the confirmation of Cluesix' AUD analysis I need.  No one is talking about it today, but after Asia tonight they will; Asia (and even China) are next.

I dug up the Cluesix Report: The Case Against the AUD. It observes that the AUD is the most overvalued currency in a developed market, too high by 30%. It is highly dependent on financials and commodities, and commodities may be in a huge bubble echo. The Lucky Country's real estate may be as much as 50% overvalued. Speculators and carry-traders are betting heavily on the AUD uptrend. 

The carry-trade may be rapidly unwinding in the wake of the crash. The AUD will suffer the most. 

Committing economic suicide won't help: a few days before the crash, the the Rudd government announced a 40% tax on profits from its mineral resources, to get a "fairer share" of the natural wealth of the country. Reaction was negative to shock at the utter foolhardiness of the blunder from down under. 

The Case Against the AUD

An Australian business man shared his thoughts on the Cluesix report with me (excerpted below the fold):

Currency: I think it is overvalued, but then I ask: against what – as does Cleusix.  The fundamentals of the European economy do not suggest that the AUD is over-valued against the Euro or the USD.  Even after 3 years Labour depredations, the Australian economy can be restored to strength relatively quickly and with less pain than Europe and the US.

China: I don’t trust official Chinese government figures, and I think they have a huge problems with loans to State owned companies, but anecdotal evidence suggests that the underlying strength of economy is undoubted. 

 

Real Estate: Cleusix is right about property being overstated, but probably overstates the over-valuation.  Land is more expensive in Australia for two reasons: 

1. people want to live in capital cities and/or near the water; and 
2. and is rationed by the government.    

If there was a proper free market in land, the price would rapidly establish itself at more economic levels, but that will not happen ever.

 

Banks: Cleusix is correct in identifying problems with the finance sector.  The major structural problem here is the “four pillars policy” which sees the four major banks as being protected from takeover by each other and by foreign banks. The result is a tight oligopoly where the banks move in lockstep.  Currently they are all concentrating lending on residential mortgages which are “safe" but they will not lend to developers; the net effect is to choke the supply of residential units at the same time that they are increasing lending to residences.  

Bubble: There is a housing bubble, the responsibility for which lies with the banks, the governments at all levels (Federal, state and local), and unfortunately the Reserve Bank, who through its rate setting orchestrates interest rate levels for residential mortgages – each bank simply adopts whatever increase in rates immediately, so there is no price competition amongst the banks.

 

If you allow for the basic cost of land, and over-hyping by the big four, I would put the over-valuation somewhere closer to 20%.  Since the GFC the Big Four now control 90% of residential mortgages, and the government will not allow any of the Big Four to fail, any failure will be at the S&L level (10% of loans) and will have limited impact on the economy. 

Comments

[Hockthefarm]

Looks like Prechter is going to win:

http://tinyurl.com/3657wqy

Definitely not a great day for the Irish.

Hock

[Midas]

Tomorrow we will have dinner in hell...

http://midasfinancialmarkets.blogspot.com/2010/05/tomorrow-we-will-dinner-in-hell.html

[Hockthefarm]

Like most parents I'm sure, I spend a lot of time instilling values in my children that more often than not I learned from my parents. When I read stuff like this I wonder if maybe I have it all wrong. Out, out damn spot!

A recent piece from Brendan O'Connor, published in the Irish Sunday Independent:

"The Greeks ruined it for the rest of us. You would have to imagine that that'll be the end of the bailouts. The Germans only barely gave it to the Greeks. And if they do ever consider a bailout again, we seem to be a few down the list anyway, so by the time they've finished with Spain and Portugal you can be sure there'll be no appetite to bail us out.

"In retrospect, we were probably too good, too eager to please. We should have run the place into the ground and been first on the list for a bailout. But no, we took the pain, because we're Irish and we're drawn to the pain, and we'd rather inflict it on ourselves than give anyone else the satisfaction of saying they inflicted it on us.

"And it gave us a kind of moral high-ground on the Greeks, which we love as well. And we try not to think about the fact that the Greeks, in turn, are looking down on us, that Ireland has become their catch cry for everything they don't want to be. As far as the Greeks are concerned, we're the country that beggared ourselves to bail out the rich. That couldn't be true, could it?

"Of course there is method to the Greek madness too. Many reports pointed out that the reason the Greeks are angry is because 'they do not have a culture of balancing the books in Greece.' Or, as one eminent economist put it: 'There's plenty of money in the world.' And the Greeks know this. We are the good sibling in the family, doing the right thing, while Greece does what it wants, secure in the knowledge that the family will always be there to sort them out.

"If there is plenty of money in the world, it has to make you wonder. It gradually became apparent during the week that any bailouts of countries are actually bailouts of banks, German banks more often than not. And, given that there is plenty of money in the world, and yet everybody is up to their neck in debt, there is something not adding up, and maybe it's time to start again. Maybe it's time for not just us to default, but for everyone to default. They (whoever 'they' are) will get over it soon enough and they'll give us more money to buy stuff from them. It would be a delinquent thing to do, yes. But if we've learnt anything from all this, and we haven't really, it's that being good gets you nowhere."

Maybe we should just wait until the race is over. But he sure makes a great point.
Hock

[yelnick]

Hock, the debt-trap article is a great dissection of the mistake they just made. When the world's income cannot cover the debt cost, it will break down badly for all of us

[Zendo]

I would expect AUD or CAD will crack not because of USD carry trade, but Chinese demand quickly dried up due to their tightening policy. Check the Shanghai Composite, it's going lower.

[nspolar]

On May 5th I received this from Neowave in my email:

"Ten days ago, NEoWave S&P Trading customers went fully Short at 1187.00 (in the Jun. futures). That is more than 100 S&P points above today's low! We were Short well before today's catastrophic decline, which means our position is doing very nicely.

The most recent S&P Trading update is attached so you can see what Mr. Neely was saying just yesterday, before today's meltdown. With the back of the 14 month "bear market rally" broken, trading will become much more active for months. You don't want to go this alone. Click the link below to access the information you need to deal with this kind of volatile environment."

A pdf chart accompanied the trumpeted short sale.

The pdf predicted the first low above 1150, and a final low for the projected wave of 1100.

In fact the first low was at 1062, and it is not yet known if this is the low. The pdf is completely out of sync with the 'sellers' press issuance. Thus the Neowave count is likely out of sync as well.

Neely (Neowave) is trying to sell me a subscription. Does the guy not care about quality anymore? If the pdf is completely out of sync with the what the market actually did, am I not to notice?

ns

[Chico]

nspolar,

As a NeoWave subscriber, I didn't get that e-mail. I guess he was careful who he sent it to. I like the way he conveniently forgets to mention his abysmal record before that trade. He finally gets one good trade, which was bound to happen, and he cranks up the marketing machine. I did get another e-mail though, as my subscription is about to expire. The marketing angle on this one was that the unpredictable phase of the market is about to end and the easy money will be coming back real soon. I'm sure he has a lot of subscribers dropping his service and he's trying to convince them that things are going to get better. I have to seriously wonder how much money he makes from trading his own account. A good trader shouldn't have to desperately market his services to make a good living. In fact, if you were really good, I don't even know why you would bother. You'd have more money than you would know what to do with and you wouldn't have to deal with any crap from the public.

[trailblazer]

Neely launched a fund recently does anyone know how it has performed??

[Neelytheguru]

"the unpredictable phase of the market is about to end and the easy money will be coming back real soon"

Isn't this a Joke? They make conclusions as if they discovered a scientific theory with no proof. How can they throw such claims of knowing when the market is predictable and when it is not. Had they known that, they should have anounced that right after the bottom in March 2009 but they did not. They were certain the markets will collapse to the abyss in June 2009 and they set themselves apart from the techncial crowd as the gurus. We did not hear then the market is entering unpredictable stage. NeOWave is a scam.

[anom]

kenny getting squeezed in this market... now he is squeezing more people for donations

[trendlines]

Looking for a reversal around 1180 for the SPX:

http://trendlines618.blogspot.com/2010/05/s-stop-sign-at-1180.html

[vipul garg]

ns: i hope you werent seriously short gold.

gold is one ignored commodity between all the panics and crashes of spx.
since it is closed to tgt1 of 1250 , caution is needed. it may have enough steam for next leg to 1400.

[bob m]

Gold is de-coupling from stock.

[Astro Trade]

Ra Merriman has a nice summary of some astrological cycles that caused the meltdown....

http://www.mmacycles.com/weekly-preview/mma-comments-for-the-week/mma-comments-for-the-week-beginning-may-10,-2010/

[Astro Trade]

Rogue astrological events alwaus have and will continue in the future to confound the so-called experts.

[DG]

I have to seriously wonder how much money he makes from trading his own account.

Rather than repeat my estimates, based on the information I've found in the public domain and which I've posted before, I will just say that if you really "seriously wonder" about it, the information you need is available online.

In fact, if you were really good, I don't even know why you would bother. You'd have more money than you would know what to do with and you wouldn't have to deal with any crap from the public.

When I look at a trading method's long-term results, I am looking for three things:

win-loss ratio
size of winners compared to losers
amount at-risk for each trade

because I try not to use any "qualitative" words when describing trading results, only "quantitative". If you were willing to take on enough risk and could apply enough leverage to your account, taking every one of Neely's Weekly trades and using the Kelly Criterion for determining position size (recalculating it after each trade), you could have taken a $50K account in August 2006 to $~550K today, even with his bad trades over the past year. The account will have peaked out at $2.5M in March of last year, so clearly the leverage on the downside would have been massive, too.

Is that a "really good" method? I don't know, you tell me. There could very well be other services that have done better over this time period, but, on an apples-to-apples comparison, using the 3 variables I mentioned above to get an objective comparison, I'd put 10X gains (50X at the peak) from NeoWave up against any other service.

To a certain extent, Neely sets his subscribers up for disappointment by not being more analytical about his results and what can be expected from trading his recommendations. If I were him, I would put the numbers I just showed you on my website and say, "If you did this using my trade recommendations, here would be your results. Scale the results up or down to fit your risk profile." Since, at the peak, Neely's Kelly Formula result recommended risking 45% of your portfolio on a single trade, MOST people aren't going to be comfortable doing that.

Anyway, I just don't think you can speak rationally about a trading method's quality or lack thereof without those statistics.

How can they throw such claims of knowing when the market is predictable and when it is not.

Neely has not done a good job discussing this idea, even though the "intuition" behind it is sound. It is possible to quantify the relative predictability of markets and to test current market conditions against that quantification to determine where in the predictable/unpredictable continuum the current market is.

That's not what Neely is doing, at least not in any rigorous way. What he is saying is based on an idea that was part of EWP, in which Prechter discussed "wave personality". Chapter 11 of MEW also hints at the different characteristics of each wave structure by Progress Label. What needed to be done, in my opinion, was to take those "subjective" analyses and turn them into something more "objective" by quantification. If Neely's "intuition" about predictability coming and going in phases correlated to Progress Labels was right, the mathematical analysis should back it up and it does. It's not a super-complicated analysis, but it does require that you understand linear regression modeling.

Now, the disclaimer to keep the haters off my back. None of this is specifically meant to defend Neely's recent track record, or, really NeoWave in general. It's simply a discussion about what would be required to make a valid critique of a trading method and various aspects of that trading, regardless of whose trading method it is.

[marketman]

"If Neely's "intuition" about predictability coming and going in phases correlated to Progress Labels was right, the mathematical analysis should back it up and it does." - DG

According to who???

[marketman]

"you could have taken a $50K account in August 2006 to $~550K today, even with his bad trades over the past year. The account will have peaked out at $2.5M in March of last year..." - DG

And how much of the $50,000 account was put at risk for each trading signal during this time frame?

[Ed]

I got the Neely email too basically saying that the hard part is over, from here on out the patterns and trades will be a whole lot easier. I'm going to be rolling in the dough soon I think.....I can't wait!

[DG]

And how much of the $50,000 account was put at risk for each trading signal during this time frame?

An average of 29.6%. I calculated the Kelly Formula result after each trade and then allocated the resulting percentage to the next trade. That's why I say it's more or less an impossibility (one could probably attain it using IMT options with a high delta to increase leverage) that anyone get that actual return, but it's a metric that can be used across methods to compare results.

According to who???

Uh, logic. If someone says something which, in its essence, can be shown to be true or untrue via quantitative methods, yet the person making the statement doesn't provide quantitative proof for that statement, a third party can then step in and do the quantitative analysis to say that the first person's claim was either true or untrue. What I am saying is that IF Neely's non-quantitatively-substantiated claim is correct even though he does not provide the quantitative analysis, THEN someone doing the quantitative analysis can state whether or not Neely's original claim was correct by comparing the results of the quantitative analysis to the original claim.

[DG]

And how much of the $50,000 account was put at risk for each trading signal during this time frame?

And, of course, gains were recycled into the account for the next trade.

[marketman]

What I am saying is that IF Neely's non-quantitatively-substantiated claim is correct even though he does not provide the quantitative analysis, THEN someone doing the quantitative analysis can state whether or not Neely's original claim was correct by comparing the results of the quantitative analysis to the original claim." - DG

Understood.

But my problem is . . . why MAKE THE CLAIM in the first place if Neely is not willing to do the quantitative analysis to support it?

It sounds lazy, sloppy, and amateurish to me.

[trendlines]

Chart of the Bombay SENSEX index:

http://trendlines618.blogspot.com/2010/05/sensex-trendline-watch.html

[JT]

"Isn't this a Joke?

They make conclusions as if they discovered a scientific theory with no proof. How can they throw such claims of knowing when the market is predictable and when it is not. Had they known that, they should have anounced that right after the bottom in March 2009 but they did not. They were certain the markets will collapse to the abyss in June 2009 and they set themselves apart from the techncial crowd as the gurus. We did not hear then the market is entering unpredictable stage. NeOWave is a scam." - NeelytheGuru

I agree with your post 100%.

And herein lies the crux of the issue between marketing yourself as a professional with quantitative analysis to back up your claims . . . or simply going the Snake Oil salesman route. It appears as though Neely has conveniently done the latter with his undocumented claims of "predictable vs unpredictable" market environment.

[DG]

But my problem is . . . why MAKE THE CLAIM in the first place if Neely is not willing to do the quantitative analysis to support it?

It sounds lazy, sloppy, and amateurish to me.

I could speculate on a motive, but I don't know for sure. There's definitely a CYA aspect to it. Although, in fairness, Neely has said many times that wave-Bs (and Corrective patterns in general) are unpredictable, so it's not as if this concept is something he never discussed before.

Neely definitely needs someone to do "quality control" on his public statements.

[DG]

And herein lies the crux of the issue between marketing yourself as a professional with quantitative analysis to back up your claims . . . or simply going the Snake Oil salesman route. It appears as though Neely has conveniently done the latter with his undocumented claims of "predictable vs unpredictable" market environment.

To a certain extent, he's relying on the chart he uses to make the point to be a compelling representation, in the "a picture is worth a 1,000 words" kind of way. I DON'T agree with that approach because it leaves too much open to question. I also would like to see an analysis of the "win-rate" by "predictable/unpredictable" market phase over the time period covered in the chart. My own data only goes back to 2006, but does provide support for Neely's statement that his method does better during the "predictable" phase. Now, one would have to do a full-blown analysis of whether or not EVERYONE does better in the "predictable" phase, etc.

If I had to speculate, I'd say that Neely might not know how to "prove" his point analytically, so he relies on the chart being convincing enough. For all of his quantification of wave theory, Neely's mathematical depth doesn't seem to go very far. Or, it does and he's just keeping it simple for "the masses". I'm more inclined to think it's the former than the latter.

[Wags]

"kenny getting squeezed in this market... now he is squeezing more people for donations." - Anonymous

I saw this too.
He says that he will not be doing any wave analysis for the rest of the week because his "followers" have not been donating. LOL!

[Wave Rust]

The same market that sent us the Flash Crash in the stock market is setting up nearly exactly the same way again.

Tomorrow may not be a time to be long stocks. I won't be.

wave rust

[yelnick]

trendlines, the SSEC has broken below the wedge - are you still hanging onto the bullish count?

[trendlines]

Hi Yelnick, I have abandoned the bullish triangle count since the break below 2700 for SSEC. Looking instead for a zig-zag correction, with one more high to come(short-term & long-term bearish, still bullish for the medium-term). I've posted the possible support levels here, and the reasons:

http://trendlines618.blogspot.com/2010/05/shanghai-composite-zig-zag-correction.html