Cibeles Capital Euphoria/Alarm reversal indicator

·        The Cibeles Capital Euphoria/Alarm Index tries to identify when the market is over enthusiastic/pessimistic regarding equity markets, in an effort to predict S&P500 returns. It is important to read this index just as an indicator of positioning and sentiment, rather than to try to understand the drivers of the returns that we are forecasting fundamentally.

·        The index was constructed by using weekly data from August 2006 through December 2010.

·        The model tries to forecast 6-month forward returns on the S&P500 Index by using different positioning, risk and sentiment indicators, such as: total outstanding shares in emerging markets, open interest in Nasdaq and S&P500, Bull/Bear surveys, VIX, Put/Call ratio, spread in AAA corporates securities and Investors’ Confidence. All the variables were lagged 6 months.

·        In the out-of-sample period that goes from January 2011 through February 20102, the index presents a 73.4% correlation with the 6-month forward S&P500 returns (Figure 1).

Figure 1

Figure 2

·        On a rolling basis, the correlation is pretty stable between 65% and 80%, and way above the statistical significant value. This proves in some way the robustness of the model. (Figure 3)

·        Furthermore, 72.58% of the time, the model correctly predicts the direction of the market. (this was calculated using the number of times that the forecast lies in the same direction as the actual return of the S&P500)

·        Finally, the index suggests that the six-month forward return of the S&P will be around 15%, with an average gain of 5.4% (figure 1). This could be translated into a bullish signal, given that the mean return over our sample period is around 1.5%. Moreover, if we look to the individual indicators, three of them are one standard deviation above their 6-month moving z-score (Open interest, put/call and SSIC), and one indicator is 2 standard deviations away (bull-bear). (figure 4). 

Figure 3

Figure 4

Appendix

AAA – USD domestic corporate AAA yield less US 5 years treasury

BULL_BEAR – Percentage of bullish investors over the next 6 months less the percentage of bearish investors

CMDTY – Weekly Bloomberg survey

EEMSO – Total outstanding shares of MSCI emerging market ETF

PUT_CALL – Put/Call ratio of equity options traded on CBOE

SSIC – State Street Investor Confidence

VIX – Volatility Index

OI – Aggregation of open interest on Nasdaq 100 and S&P500

Implied Odds in the Mexican Presidential Election 2012

The next charts shows the risk-neutral implied probabilities according to intrade for the next presidential election in Mexico. The RHS axis, labeled as price, could be thought as the probability of the candidate to be elected according to market expectations (i.e. $1 = 10%). Due to the low liquidity of the market, this data should be read carefuly.

Rules of the contracts:

-This market will settle at $10.00 if the named individual is elected President of Mexico in the 2012 general election.

-This market will settle at $0.00 if the named individual is not elected President of Mexico in the 2012 general election.

-Settlement will be based on the outcome of the election, as reported by three independent and reliable media sources. 

EPN

 AMLO

 JVM

Source: Intrade

Why gasoline price in Mexico should be higher?

The price of the gasoline in Mexico has always been an important topic for the media, as it is now for political parties as we approach the presidential election. Some people argue that increasing the price of gasoline would hurt the already struggling households in the country. While this is true, the opportunity cost is higher, and the impact on low-income families is very small. As an international comparison, Mexico ranks 48 out of 57 in the ranking of prices of gasoline, according to Bloomberg (http://goo.gl/1epIJ), in which #1 is the most expensive. In the list, there are several countries that are poorer than Mexico (in GDP per capita terms), and that have higher gasoline prices, such as India, Brazil, Bulgaria and China, just to mention some examples.

Regarding the wealth effect argued by some people, Mexican families on average use only 5% of their total spending in electricity and fuel. Furthermore, while the poorest population deciles spend a bigger share than the richest (Figure 1), the VI-X income deciles spends twice more than the I-V deciles (Figure 2).

Another interesting fact is that, according to the World Bank, there were only 276 cars for every 1000 habitants in Mexico in 2009. This suggest that most of the spending of low-income families goes towards domestic use fuel. All of these, point to the well-known fact that this kind of subsidy is highly regressive, and that its existence in a poor country like Mexico is very difficult to support.

While it is true that there exist negative effects by an increase in the price of fuels in the economy, savings coming from a free-floating price of gasoline would over-compensate the costs. In 2011, Mexico spent around 170 billion MXN (Mexican pesos) subsidizing gasoline. This amount represents about 5 times the budget of the UNAM, 5/4 times the total household spending in public transportation, and 3/16 of the total spending of households in food, beverages and tobacco. What’s more, because of the price difference between US and Mexico, some of the subsidy goes to the US, as some drivers come to Mexico to fuel their tanks (http://goo.gl/Ujt5Y).

Last but not least, by subsidizing gasoline prices, the government incentivizes the use of non-eco-friendly fuels, when Mexico has a long history of pollution issues.

*This piece constitutes a short preview into the topic. We must not forget that there are multiple influencing factors that offer further insight and dimensions to the analysis. Comments are more than welcome.