The Risk Manager

The Risk Manager - asset allocation011209

“The magic lies in orchestrating the extremes…”
-Mick Malisic, 2008
 
Mick is our Chief of everything Creative Design here at Research Edge, and when he said that to me last year... I paused… and looked at him and said, “Mick, you would be a great risk trader.”
 
Make no mistake folks, this is a global market of interconnected macro factors that needs to be risk managed with both precision and a process. The “extremes” of October- November 2008 have burned imprints into most trader’s heads. Those days are behind us, and the volatility (VIX) associated with them has been cut in half as a result. There is a huge difference between a global risk manager and a securities trader. Don’t mistake one for the other.
 
SP500 futures traders who got bulled up at the 941 peak of last week and freaked out 72 hours later on Friday’s closing low of 890 (-5.4% lower) are not risk managers – they are the people we to wake up and manage tail risk for. Not unlike most of the “prop desk traders” that are no longer part of the core “Investment Banking Inc.” business model of the 25 year bull market past, most of them come and they go.
 
Most of the received wisdom in this business would have told you 18 months ago that the likes of Dick Fuld and John Mack were “great traders” – I have no quibble with that. Bull market traders they were, indeed. No one in this business who ever worked with Vikram the Pandit “Bandit” will ever tell you he could trade anything. Some of the guys on the floor at Morgan Stanley used to make fun of him calling him “Trader Vic” (you don’t want to be that guy).
 
Pandit is good at trading his credibility however. After telling his team he wouldn’t sell Smith Barney, it looks like he is going to hope the You Tubers don’t call him on the mat again, after he turns around and sells it to Morgan Stanley. The US Financials (XLF) etf is the worst looking sector exchange traded fund in our 9 Sector S&P Model for a reason – there remains a “Crisis in Credibility” in the leadership at these horse and buggy whip investment banks. Our models had the critical breakdown line of $12.23 broken in the XLF on Friday. The math doesn’t lie, people do.
 
In stark contrast to the legacy US Financials that everyone and their brother wants to “buy because they’re cheap”, 7 out of the 9 SP500 sectors look relatively healthy. This is also part of “The New Reality” associated with markets and sectors that continue to close at higher highs and higher lows. The SP500’s test of 941 was a new 3-month cycle high, and at 890 it is still a healthy +18.4% higher than its cycle low of 752.
 
So what is the risk trader to do? I started buying US Equities again more aggressively on Friday, taking our Asset Allocation Model’s position in US stocks up to 21% from 9% on Wednesday. I actually bought the SP500’s etf (SPY) outright, and that’s something I have done very infrequently over the course of the last 12 months – does that mean anything to most of the said masters of the hedge fund universe? I don’t know – I’m just a newsletter writer with a better than bad batting average.
 
All 3 of the following levels in the major US stock market indices would have to be overcome (we need to close below them, not trade below them) for me to move back to the dark side of trading my shorts more aggressively: SP500 887, Nasdaq 1550, and Russell 476. Yes, those are very close to where we closed trading on Friday. No, managing risk in a bear market is not for the faint of heart.
 
After the 2nd worse year for the US market since 1871, plenty of money managers and the manic media alike basically aren’t allowed to be bullish anymore – with the SP500 already down -1.4% for 2009 to date, the trigger fingers associated with chasing short term performance are already shaking. This is good - crisis in confidence creates opportunity.
 
What has people shaking is a view that I don’t share – that unemployment trends in this country will sequentially accelerate (on a 6-month basis) from here. This 7.2% unemployment rate, of course, is last year’s number. Markets move on expectations of tomorrow, and this past week’s -4.5% drop in the SP500 implies that the masses genuinely expect US unemployment to worsen – and I agree that it will – but NOT at an accelerating 6 month rate…
 
That’s why I am getting bullish for another “Trade” higher in both commodities and US stocks. Everything that matters in my macro model occurs on the margin. If the unemployment rate starts to go up at a decelerating rate, the US stock market is going to continue to make higher lows.
 
US jobless claims have improved materially in the last 2 weeks, and we are eight days away from Obama waking people up to the simpleton math that he has 3M jobs on his accountability card to get on the tape in short order (the USA lost 2.6M jobs last year).  Do we have a lot of economic problems in this country? You bet your Madoff we do! They are much larger than the spreads he stole. This, however, presents the Capitalist with one of the greatest opportunities that has ever presented itself – to rebuild the US Financials sector on our handshakes.
 
Yes, that will take time. No that wont equate to the current US Financial stocks that have inflated market caps to outperform – but together, stylistically at least, this rhymes with where the US stock market is flashing Sector Level divergences. The American consumer of financial services is taking back this country from the bankers. Be patient on price, and always pay attention to Mick’s “extremes” – that’s where we should continue to find the magic of risk management.
 
Have a great week.

The Risk Manager - etfs011209