By Oliver Biggadike Nov. 24 (Bloomberg) — James McCormick was home with his family in London on the evening of Sunday, Sept. 14, 2008, when he found out that Lehman Brothers Holdings Inc. , his employer of seven years, was filing for bankruptcy. The news, relayed on a conference call, derailed a two-year project building an analytical model that would predict currency movements based on economic data. “It was devastating,” McCormick, 41, says. “You lose all your intellectual property.” Eleven months after Lehman’s collapse and a stint at Citigroup Inc. , McCormick joined Nomura International Plc, whose Tokyo-based parent, Nomura Holdings Inc., bought Lehman’s European arm out of bankruptcy in 2008. McCormick, now head of European fixed-income research, is rebuilding the debt and currency analysis groups he lost, overseeing about 40 people, 80 percent of whom are from his old firm. McCormick’s focus on the economic reasons for currency moves is gaining more traction after years when traders and investors relied on mathematical models of quantitative analysis. These tools worked during times of global growth and declining volatility earlier this decade, yet failed to signal danger before the financial crisis sparked the biggest currency swings in more than 15 years. McCormick, using macroeconomic and quantitative analyses, detected growing stresses in the global economy before the meltdown. Best Predictor In Lehman’s 2007 outlook — published in December 2006, a year before the official start of the U.S. recession — he warned that U.S. growth would slow and push down the currencies of commodity-producing nations. “Macroeconomics was the best and earliest predictor that we had a problem,” he says. In mid-2008, McCormick recommended dollars - before the greenback’s rally — and correctly predicted that the yen and Swiss franc would gain because investors would seek safer alternatives after selling higher-yielding currencies such as the Australian dollar. Today, global economies are struggling to recover amid record government borrowing , shifting trade balances and near- zero interest-rates in Japan, the U.K. and the U.S. That makes understanding the economics behind currency moves more important than ever, says Paresh Upadhyaya , who helps manage $21 billion in currency assets as a senior vice president at Putnam Investments in Boston. “Foreign exchange is responding to and being driven by these big-picture, macro themes,” Upadhyaya says. “The economic data is going to be most important right now because it’s generally at these cyclical turning points in the interest- rate cycle where you typically see more impact in currencies.” Good, Bad Currencies McCormick views the world in terms of “good” and “bad” currencies, based on economic and fiscal conditions. The good currencies in Australia, Canada, Norway and Asia, excluding Japan, are benefiting from governments with less debt and healthy banks; the bad currencies such as the dollar and the pound are likely to suffer as governments borrow more, he says. “It’s been years from a currency perspective that we’ve had to think of fiscal policy and bond supply,” he says. McCormick’s approach was shaped by his background in mathematics. Born in Scranton, Pennsylvania, he graduated from Pennsylvania State University in 1990 with a degree in quantitative business analysis, which focuses on applying statistics to business-related data. First Job His first job out of college was at the Roseland, New Jersey, offices of the company now called Prudential Financial Inc. , where he was a software programmer preparing the insurer’s computers for the turn of the century in 2000. While there, he began a Master of Business Administration at New York University’s Stern School of Business , commuting to Manhattan two nights a week for classes in finance and economics. “I thrived at NYU,” he says. “I found I couldn’t get enough. My particular passions were anything to do with finance and economic history.” McCormick left Prudential in 1993 for J.P. Morgan & Co. in New York and earned his MBA two years later. At J.P. Morgan, now JPMorgan Chase & Co. , he worked in the global markets and U.S. economics departments before becoming a currency analyst in 1998 during the Asian financial crisis. The experience taught McCormick that “fundamentals matter,” he says. Barometers Ignored “Like the Asian crisis, today’s crisis was driven by a gross underpricing of risk that led to a massive misallocation of capital,” McCormick says. “Fundamental barometers, like bulging current account deficits, were ignored before the crisis hit.” Thailand’s current account, the broadest measure of trade, was negative from 1993 until 1997, when the crisis returned it to a surplus by pushing down the value of the baht and damping imports. In 2001, McCormick returned to his math roots by accepting a job at Lehman, where he ran the quantitative analysis section as deputy head of foreign-exchange research. He took over the department a year later and moved to London in January 2003, a time when quantitative modeling was winning adherents and displacing economic analysis. “By 2007, it was almost like people had forgotten about macro,” he says. “People made the mistake of thinking five years is a model.” Carry Trade Craze During that period, traders flocked to the carry trade, in which investors borrowed in one currency to fund purchases of higher-yielding assets in another, profiting from the difference — provided the funding currency didn’t strengthen and wipe out returns. That’s what happened in late 2008, when the yen rallied. From July 2006 through June 2008, a carry trade using borrowed yen to buy assets in Australian dollars earned 35 percent, according to data compiled by Bloomberg. Those profits were wiped out from July 2008 to December 2008, the data show. McCormick attributes the explosion of this and other quantitative models to analysts’ failure to consider the historical behavior of assets. “The best quant is the one who’s skeptical of the models,” he says. “Everything you can model, you do model; everything you can’t, you give to the guy with judgment. That’s the person who should have been in the room the entire time.” Not Satisfied Even when his team was working on quantitative strategies, McCormick remembered fundamentals. Unsatisfied with explanations that the yen rises and falls according to the ebb and flow of carry trades, he developed an alternative model using commodity price cycles and Japan’s terms of trade, a measure of how much the nation receives for exports relative to what it pays for imports. McCormick concluded in early 2008 that the yen couldn’t rally too far as long as raw materials costs kept going up, increasing the amount of yen importers needed to sell to get the same quantity of goods. “We avoided getting long the yen because the commodities side of it hadn’t changed at all,” he says. “People underappreciate how big an effect the commodity shock had on Japan. You could argue that the carry trade was just the mirror image of the terms of trade.” The yen began weakening in the second quarter, wiping out its gain, as oil rose to a record high of $147.27 on July 11. When crude started to fall, McCormick was ready to recommend yen and moved to his next idea: buy the dollar because investors were starting to invest in cheap U.S. assets. The U.S. Dollar Index rose 26 percent from July 15, 2008, to its three-year high of 89.624 on March 4, 2009. Borne Out For all of his success blending macroeconomics and quantitative modeling, McCormick missed the call that was perhaps most important to him: the collapse of Lehman. “It was a surreal time for me,” he says. “Think of it as not being able to see the trees through the forest. I got the macro part but not the micro one. “I just didn’t see Lehman being the catalyst for the crisis,” McCormick continues. “It felt like too much cruel irony: Not only was I part of the largest bankruptcy in history, but I had to watch from the sidelines as FX markets were doing precisely what we had expected them to do.” McCormick joined Citigroup in November 2008 to run the bank’s foreign-exchange and local-market strategy. His job was to integrate the research developed by the Group of 10 and emerging-market teams. He left Citigroup in August after Nomura offered him the chance to rejoin his Lehman colleagues. “This crisis has left a lot of gaps. Lehman doesn’t exist anymore,” McCormick says. “It’s a rare opportunity in the world we live in to try and do it again.” To contact the reporter on this story: Oliver Biggadike in New York at obiggadike@bloomberg.net
