Oversold Stocks Piling Up (Bespoke)

Thursday, May 10th, 2012

by Bespoke Invest­ment Group

May 9, 2012

Although the S&P 500 is down less than 5% from its bull mar­ket highs, the per­cent­age of stocks that are over­sold is really start­ing to pile up.  Using a bound­ary of one stan­dard devi­a­tion above or below the 50-day mov­ing aver­age as the thresh­old for being over­bought or over­sold, 49.4% of the stocks in the S&P 500 are now con­sid­ered over­sold, while just 19.0% of the stocks in the index are over­bought.  The chart below shows the daily per­cent­age of S&P 500 stocks that are over­bought and over­sold.  As shown in the chart, the cur­rent level of 49.4% is the high­est per­cent­age of over­sold stocks in the index since 10/3/11.

Tags: Amp, Bollinger Bands, Bounces, Bull Market, Commodity, Dead Cat, Downward Path, ETFs, European Elections, Futures Market, Hallmarks, Intermediate Term, Investment Group, Market Futures, Moving Average, Nbsp, Next Level, Oversold Stocks, Rebound, Relative Strength, Rubber Band, Selloffs, Standard Deviation, Sunday Evening, Swoons, Threshold, Trough
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BoJ Buys Record Amount Of ETFs And REITs To Prevent Crash

Monday, May 7th, 2012

One can call the BOJ inef­fi­cient, slow and for the most part utterly worth­less, but one can cer­tainly not accuse them of lying, and beat­ing around the bush. Because unlike all other cen­tral banks, with the BOJ at least it has been fully pub­lic knowl­edge that this par­tic­u­lar cen­tral bank unlike all oth­ers (wink wink), is actively engaged in buy­ing equity prod­ucts, among them REITs and broad equity ETFs (which pro­vide much explicit tail-wags-dog lever­age and explains why the FRBNY's red phone hot­line goes directly to Citadel's ETF trad­ing desk).

And buy stocks on full tilt and in record quan­ti­ties is pre­cisely what the BOJ just did, only as one can expect, with absolutely no impact on the broader stock mar­ket. Because once even the cen­tral bank is exposed as par­tic­i­pat­ing in the mar­ket, the ele­ment of sur­prise is gone, and the cen­tral bank becomes just one mark (if one with a lar­gish bal­ance sheet).

As Mar­ket­Watch reports, "The Bank of Japan stepped back into the stock mar­ket Mon­day, mak­ing its largest single-day pur­chase of exchange-traded funds to date... The Japan­ese cen­tral bank said it spent 39.7 bil­lion yen (about $500 mil­lion) buy­ing up stock ETFs as part of its ongo­ing asset-purchase pro­gram, break­ing a pre­vi­ous record of ¥28.5 bil­lion, set on April 16. In addi­tion to the ETF buys, the Bank of Japan also acquired ¥2.3 bil­lion in real-estate invest­ment trusts Monday."

Too bad that this lat­est out­right bull in a Japan store (sic) inter­ven­tion had zero impact: "the move failed to pre­vent a sharp fall for the Tokyo equity mar­ket." But at least they are hon­est. Imag­ine the shock and hor­ror (and com­plete lack of apolo­gies to all those who have pre­dicted just that) when the world finally gets a trade confirm-based proof that Brian Sack was indeed buy­ing (never sell­ing) SPYs and ES. Why every­one would be truly shocked, SHOCKED, that the Fed is noth­ing but another two-bit gam­bler in a rigged and bro­ken casino.

For those who are unaware of Japan's explicit but at least forth­right approach to asset price manip­u­la­tion, read on:

Japan’s mon­e­tary author­ity is almost unique among its peers in the major devel­oped economies, in its high-profile pur­chases of ETFs, which it began in Decem­ber 2010 as part of aggres­sive eas­ing measures.

Since then, the Bank of Japan has bought almost ¥1 tril­lion worth of ETFs — along with another ¥78.9 bil­lion in REITs — and has an addi­tional ¥642 bil­lion to spend on the stock funds after rais­ing the program’s size at it last pol­icy meet­ing in April.

The cen­tral bank empha­sizes that the pro­gram has only broad goals such as sup­port­ing inter­est rates and reduc­ing risk pre­mi­ums, rather than sup­port­ing finan­cial markets.

Jef­feries Japan’s head of Japan­ese strat­egy Naomi Fink says that while the ETF pur­chases are really part of the broad push to reflate asset prices in the deflation-plagued coun­try, they do “pro­vide a bit of a back­stop, when they think they can curb the down­side” for the market.

“Still, it’s a very small amount,” Fink said of the ETF pur­chases. “It’s more designed to bol­ster sen­ti­ment ... [and] it works best when sen­ti­ment is frag­ile.”

As a tan­gent here, do these "strate­gists" even lis­ten to what they sound like? "Very small amount"... "designed to bol­ster sen­ti­ment." Oh ok. That makes every­thing so much bet­ter. It is just too bad that a Mar­tin­gale strat­egy where one has an infi­nite bal­ance sheet is not all that avail­able to every­one in the world, except to 5 or 6 mar­ket par­tic­i­pants of course, all of whom are incen­tivized to destroy their cur­ren­cies and ramp their "inflation-sensitive" assets ever higher. Surely that accord­ing to Jef­feries is per­fectly acceptable.

Sen­ti­ment was cer­tainly frag­ile Mon­day, as investors returned from a four-day hol­i­day week­end to find the yen con­sid­er­ably stronger — a neg­a­tive fac­tor for Japan’s export-focused cor­po­ra­tions — U.S. employ­ment growth weaker than expected, and Euro­pean elec­tion results rais­ing more uncer­tainty for the euro zone.

And while investors don’t find out about the Bank of Japan’s mar­ket oper­a­tions until after the close of trad­ing, “there’s a mar­ket assump­tion that when the Topix falls more than 1%, that trig­gers ETFs,” accord­ing to Fink.

Still, Fink advised against try­ing to front-run the cen­tral bank by jump­ing into the mar­ket when­ever the Topix — Japan’s key broad-market index — drops 1%.

And what­ever you do kids, remem­ber: fron­trun­ning cen­tral banks is not to be tried at home...

“I wouldn’t exactly call that my favorite strat­egy,” she said, adding that since the ETF-buying pro­gram isn’t meant to be a “price-keeping oper­a­tion,” it offers lit­tle in the way of trad­ing opportunities.

... After all that's what Pri­mary Deal­ers are for: and since they make sure that no bond auc­tions can ever fail (cour­tesy of the $30 tril­lion cus­to­dial asset cloud, which des­per­ate econ­o­mists have pegged fancy post-modernist the­o­ries to explain how infi­nite sup­ply can gen­er­ate infinite+1 demand with­out hav­ing the faintest clue of how the shadow bank­ing sys­tem works) there nat­u­rally has to be some kick­back in it for them. Because oth­er­wise one of them might even speak up and tell the rest of the world just how much of a fraud the sys­tem truly is.

And yes, the BOJ IS com­pletely open about what they buy and how much:

Tags: Asset Purchase, Bank Of Japan, Beating Around The Bush, Buy Stocks, Central Banks, Element Of Surprise, Equity Products, ETFs, Exchange Traded Funds, Frbny, Full Tilt, Japan Store, Japanese Central Bank, Phone Hotline, Public Knowledge, Real Estate Investment, Real Estate Investment Trusts, Spys, Tail Wags, Wink Wink
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The High Yield Trade: Crowded, or Crowd Pleaser? (Tucker)

Monday, May 7th, 2012

by Matt Tucker, iShares

A fre­quent ques­tion that I’ve been get­ting from our clients is around the out­look for high yield bonds.  With record low rates cre­at­ing an income chal­lenge for investors, many are now will­ing to take on the extra risk involved in a high yield invest­ment in order to poten­tially add yield to their port­fo­lios – as evi­denced by the $29.0 bil­lion in flows into HY mutual funds and ETFs so far this year.  Com­pa­nies have responded to all this demand by issu­ing $115.1 bil­lion in new high yield bonds YTD, with most of the pro­ceeds going to refi­nanc­ing exist­ing debt or to fund gen­eral oper­a­tions.  But all this high yield hub­bub begs the ques­tion:  Is the high yield trade too crowded?

First, let’s review how much more room exists for pos­i­tive returns.  Almost half of high yield’s 4.55% year-to-date return can be attrib­uted to coupon pay­ments, while the remain­der was due to cap­i­tal appre­ci­a­tion from tight­en­ing HY credit spreads (cur­rently hov­er­ing around 5.5% over US Trea­suries, com­pared to their aver­age level of 6% over the past 10 years).  Today’s spreads are lower in part because the level of cor­po­rate bond default has been low, at around 2%.  In fact, spreads have typ­i­cally been 4–5% in sim­i­lar favor­able credit envi­ron­ments, so spreads are actu­ally wide rel­a­tive to the level of cor­po­rate defaults (see chart below).

So why are spreads higher than default rates would seem to sug­gest?  The answer is volatil­ity and uncer­tainty.  The for­ward path of the US econ­omy is still some­what murky.  Our view is that we will remain in a period of low but steady growth for a while, but there are risks that we could see another down­turn.  The Euro­pean debt cri­sis is the other major mar­ket dynamic weigh­ing on investors.  As the cri­sis con­tin­ues with­out a clear long term solu­tion, investors are nat­u­rally more skit­tish.  This skit­tish­ness, along with the con­cerns about the US eco­nomic out­look, results in investors demand­ing a higher level of yield for tak­ing on high yield cor­po­rate bond risk.  The extra risk pre­mium is what is keep­ing credit spreads higher than the default out­look would suggest.

Over­all, high yield spreads appear to be at a rea­son­able level, since investors are being paid both for the level of defaults as well as the level of global invest­ment uncer­tainty.  If you are an investor with a long-term time hori­zon and can han­dle some volatil­ity, then high yield could still be an attrac­tive place to invest.  If high yield spreads reach lev­els seen in 2004–2006, the bonds could have addi­tional cap­i­tal appre­ci­a­tion.  How­ever, investors have to be aware that neg­a­tive eco­nomic sur­prises, espe­cially in the US or Europe, could impact prices along the way.

With all this dis­cus­sion of high yield bonds, it’s impor­tant to think about the suit­abil­ity of these invest­ments in your port­fo­lio.  While HY expe­ri­ences about half the volatil­ity of equi­ties, the bonds are still more volatile than invest­ment grade bonds.  How­ever, with yield lev­els around 7%, yield-hungry investors may find them worth the risk.

Sources: Bar­clays Cap­i­tal, Moody’s, Morn­ingstar and Bloomberg as of 3/30/2012

Bonds and bond funds will decrease in value as inter­est rates rise. High yield secu­ri­ties may be more volatile, be sub­ject to greater lev­els of credit or default risk, and may be less liq­uid and more dif­fi­cult to sell at an advan­ta­geous time or price to value than higher-rated secu­ri­ties of sim­i­lar maturity.

Tags: Bond Default, Capital Appreciation, Corporate Bond, Corporate Defaults, Coupon Payments, Crowd Pleaser, Debt Crisis, Default Rates, Downturn, Economic Outlook, ETFs, Favorable Credit, Frequent Question, High Yield Bonds, High Yield Investment, Hubbub, Long Term Solution, Matt Tucker, Outlook Results, Treasuries
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The Curious Case of the Deviant Dividends

Sunday, April 22nd, 2012

Pull up any ETF ticker on your favorite finance page and a wealth of infor­ma­tion awaits you. Ever won­der about how accu­rate all of it is? If the answer is No, then today’s col­umn is for you.

Most of the infor­ma­tion is beyond dis­pute. The price is the price. But some val­ues such as price-to-earnings and espe­cially div­i­dend yields really need to be scru­ti­nized to avoid nasty surprises.

The other day on Bloomberg (the paid ver­sion), I came across sev­eral ETFs with incred­i­bly rich div­i­dends, with one – Guggenheim’s Solar ETF (TAN/NYSE) – out­shin­ing the others.

TAN holds about 30 solar energy com­pa­nies. Its div­i­dend yield is 9.2% accord­ing to Bloomberg and oth­ers. Indeed, its div­i­dend of $2.11 (adjusted for a 1:10 reverse split) divided by its price of $23.02 works out to 9.2%. But is that likely for what should be a high growth sector?

In fact, look­ing deeper, only seven of the com­pa­nies in the ETF, rep­re­sent­ing about 28% of the total allo­ca­tion, have ever paid a div­i­dend. Of those, two have post­poned div­i­dends for 2012 and another has cut its div­i­dend by more than half. The weighted aver­age yield on the seven is under 1%.

Since hold­ings can change every quar­ter I also checked hold­ings as of Feb­ru­ary 2011. The pic­ture was the same: seven dividend-payers with an aver­age yield of below 1%.

Where then did most of TAN’s div­i­dend come from? The answer, accord­ing to the fund’s prospec­tus, is secu­ri­ties lend­ing. Nearly 90% of TAN’s invest­ment income for the 12 months end­ing last August came from lend­ing about half its shares to short sellers.

You may recall that short sell­ers, expect­ing a stock to fall, sell shares that they have bor­rowed from other investors who are “long” (ie. They are invested in the shares). If the share price falls, short sell­ers buy it back at the lower price, return it to the lender and pocket a profit.

TAN, being an index ETF, is always long its shares. By lend­ing, it earns inter­est from the short sell­ers and pro­tects itself by demand­ing col­lat­eral, usu­ally worth more than the value of shares loaned.

Gen­er­ally, the ETFs with higher lev­els of lend­ing income tend to be sec­tor spe­cific or they hold secu­ri­ties that are thinly traded or harder to bor­row for other reasons.

Now you may say, a dol­lar is a dol­lar. How­ever, a dol­lar from secu­ri­ties lend­ing is not nearly as safe as a dol­lar from div­i­dends. Few ETFs can earn so much from secu­ri­ties lend­ing. It helps that TAN tar­gets a very spe­cific sec­tor of the mar­ket. That likely means its hold­ings are harder and more expen­sive to borrow.

It could also be that the man­ager is lend­ing to less credit-worthy short sell­ers or that the man­ager is accept­ing lower qual­ity col­lat­eral. Either way, it does open the fund up to more risk than if it pro­hib­ited or restricted secu­ri­ties lend­ing to a min­i­mal amount. If a short seller is not able to return the bor­rowed stock, the fund man­ager will have only the col­lat­eral. In the nor­mal course, that’s OK. But in a cri­sis, espe­cially if the man­ager is hold­ing poorer qual­ity assets, the fund will suffer.

The other con­cern, espe­cially for those seek­ing a steady stream of income, is that the income from lend­ing will be much more volatile. TAN has fallen by 70% over the last two years and val­u­a­tions on its hold­ings are begin­ning to look really cheap. At some point, that should see short sell­ers close their posi­tions. With­out that lend­ing income, TAN’s yield will likely be closer to 1% than to 9.2%.

One last thought: There is no argu­ment that secu­ri­ties lend­ing is a com­pletely legit­i­mate activ­ity within mod­ern cap­i­tal mar­kets. But con­sider the optics: a fund man­ager enabling short sell­ers to pum­mel the very stocks held in the fund. For investors, the extra lend­ing income helps fill the belly but taste like cardboard.

Besides div­i­dends, there are other fac­tors – price-to-earnings, use of deriv­a­tives and integrity to man­date being three – that must be exam­ined care­fully when select­ing an ETF. It takes time and effort but as the exam­ple of div­i­dends shows, this added scrutiny is a must for the seri­ous investor.

****

The archerETF Global Tac­ti­cal Portfolio

archerETF offers Global Tac­ti­cal Port­fo­lio Management.

Our out­look is Global: we invest across coun­tries, sec­tors, com­modi­ties and other asset classes to improve returns. Our man­age­ment is Tac­ti­cal: we strive to select the right oppor­tu­ni­ties at the right times in response to chang­ing mar­ket con­di­tions to man­age and min­i­mize port­fo­lio risk.

Please call us at TF 1–866-469‑7990 for more information.

Tags: 12 Months, Bloomberg, Curious Case, Dividend Payers, Dividend Yield, Dividend Yields, Earnings, ETFs, Growth Sector, Guggenheim, Investment Income, Investors, Nasty Surprises, Nyse, Prospectus, Reverse Split, Rich Dividends, Share Price, Short Sellers, Solar Energy Companies
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Rotation (Research Puzzle)

Thursday, April 5th, 2012

by Research Puz­zle

Those investors known as sec­tor rota­tors try to judge the most attrac­tive parts of the mar­ket and weight their port­fo­lios accord­ingly.  Often they do so based upon their assess­ment of where we are in the eco­nomic or mar­ket cycle, as a sim­ple Google search on the term will demonstrate.

The “how” of it varies from man­ager to man­ager, with some being index hug­gers and oth­ers will­ing to have more con­cen­trated bets.  Many of the man­agers have got­ten much more global in the last cou­ple of decades, so the amount of cur­rency risk is another fac­tor to consider.

Inter­est­ingly, the stan­dard reports of many data providers (and those of in-house sys­tems) use those same sec­tors, whether the man­ager is a sec­tor rota­tor or not, which sets up lines of cod­i­fi­ca­tion that affect deci­sion mak­ing that most peo­ple don’t think much about.

In any case, the chart above shows the rel­a­tive per­for­mance of three of the domes­tic sec­tors since the end of 2009, as rep­re­sented by their ETFs.  Energy (XLF) has been under pres­sure of late, while tech­nol­ogy (XLK) has done well (on the back of AAPL espe­cially).  The con­sumer sta­ples (XLP) have lagged the strong mar­ket so far this year.

It’s quite an inter­est­ing pic­ture, with all three close to where they began.  No one said this was easy.  (Chart:  Bloomberg terminal.)

Tags: Aapl, Bets, Codification, Consumer Staples, Currency Risk, Data Providers, Decades, Domestic Sectors, ETF, ETFs, Google, Google Search, Huggers, Investors, Nbsp, Portfolios, Puzzle, Relative Performance, Strong Market, Xlf, Xlk
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Shifting Focus: Behind Country Valuations Today

Thursday, April 5th, 2012

by Russ Koes­terich, iShares

As the Euro­pean finan­cial cri­sis raged last fall, investors were closely mon­i­tor­ing met­rics like credit default swaps and yields on Ital­ian bonds to deter­mine where to place their coun­try bets.

But 2012 has brought some sta­bil­ity to the euro­zone and with it we’ve noticed a shift in the types of indi­ca­tors that investors should be track­ing when it comes to deter­min­ing coun­try val­u­a­tions — met­rics that show eco­nomic growth.

Yes, investors have always kept an eye on eco­nomic growth by track­ing met­rics like lead­ing indi­ca­tors, retail sales and indus­trial pro­duc­tion. But what Nelli Oster, an invest­ment strate­gist on my team, has noticed is that over the last six months, the sen­si­tiv­ity of coun­try val­u­a­tions to eco­nomic growth expec­ta­tions has intensified.

Per­haps six months ago investors were too con­sumed by wor­ries over Euro­pean sol­vency to focus on eco­nomic growth. But today, that appears to have changed as those wor­ries have less­ened and as eco­nomic growth has become more var­ied and harder to find.

Nelli’s research shows that the coun­try val­u­a­tions have become more sen­si­tive to how the near-term growth prospects for a coun­try com­pare to past trends. Take China as an exam­ple. In early March, the Chi­nese gov­ern­ment mod­estly low­ered its annual growth tar­get to 7.5% from 8%. While that is still a very healthy pace com­pared to the devel­oped world, it left investors more wor­ried about a slow­down in China — and the MSCI China index fell 6.9% in US dol­lars in March.

Nelli has also found that the val­u­a­tions of devel­oped mar­ket coun­tries have become more sen­si­tive to absolute growth lev­els, or how the near-term growth pro­jec­tion for a devel­oped coun­try com­pares to those for other devel­oped mar­kets. The growth pro­jec­tions Nelli ana­lyzed were gar­nered from lead­ing indicators.

She also noted that there’s more vari­a­tion in growth rates. Coun­tries such as the United States, Mex­ico and Japan are expected to grow faster rel­a­tive to their past trends than six months ago, while prospects for coun­tries such as Italy and Bel­gium have dete­ri­o­rated. As growth is more dif­fi­cult to find, investors seem will­ing to pay a larger pre­mium to access it.

For investors, the inten­si­fied empha­sis on growth means that in com­ing months, faster grow­ing coun­tries will likely be rewarded with higher returns, and the dif­fer­ence in returns between faster grow­ing coun­tries and slower grow­ing ones will likely stay elevated.

Of coun­tries expected to fare well rel­a­tive to their past growth trends – also tak­ing into account val­u­a­tions, cor­po­rate sec­tor prof­itabil­ity and risk­i­ness – I hold over­weight views of Nor­way and Rus­sia. Of coun­tries expected to slow down fur­ther, I hold under­weight views of Italy and India (poten­tial iShares solu­tions: AMEX: ENOR, NYSEARCA: ERUS).

Sources: Bloomberg, Worldscope

Dis­clo­sure: Author is long ERUS

Inter­na­tional invest­ments may involve risk of cap­i­tal loss from unfa­vor­able fluc­tu­a­tion in cur­rency val­ues, from dif­fer­ences in gen­er­ally accepted account­ing prin­ci­ples or from eco­nomic or polit­i­cal insta­bil­ity in other nations. Emerg­ing mar­kets involve height­ened risks related to the same fac­tors as well as increased volatil­ity and lower trad­ing vol­ume. Secu­ri­ties focus­ing on a sin­gle coun­try may be sub­ject to higher volatility.

Tags: China, Chinese Government, Credit Default Swaps, Developed Country, Economic Growth, ETF, ETFs, Eurozone, Growth Expectations, Growth Projection, Growth Projections, Growth Prospects, Growth Target, India, Investment Strategist, Ishares, Leading Indicators, Market Countries, Metrics, Mining, Msci China Index, Russia, Shifting Focus, Slowdown, Solvency, Valuations
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Are Stocks Giffen Goods? (Tchir)

Tuesday, April 3rd, 2012

by Peter Tchir, TF Mar­ket Advisors

So when will retail investors start buy­ing stocks? One of the final legs prop­ping up this rally is the belief that retail investors will finally pile into stocks. There is hope that all this “money on the side­lines” will find its way into the stock mar­ket. The S&P at 1,350 was sup­posed to do the trick. Cer­tainly 1,400 on the S&P was going to be enough to chase retail investors into stocks. Basi­cally the argu­ment that retail will capit­u­late and finally invest in stocks is based on the assump­tion that higher prices increase demand – aka, a Gif­fen Good.

Is it real­is­tic to assume that investors will decide to pur­chase more of some­thing just because the price has gone up? They did it in 2000 with inter­net stocks, that infat­u­a­tion ended badly. They did it with hous­ing in the mid 2000′s, which ended even worse. If any­thing, Amer­i­cans have become more focused on buy­ing things on sale and get­ting things at a bar­gain. Why shouldn’t that apply to stocks as much as it applies to any­thing else?

We have hit multi year highs, yet most peo­ple seem to shrug it off. If the retail investor was about to increase their allo­ca­tion to stocks, do you not think there would be more hype in the media about how well stocks have done? Expect­ing “the masses” to buy just because some­thing is already up 20% seems a lit­tle silly, if not down­right arro­gant. The retail investors are not stu­pid. They can also see that the stock mar­ket has decou­pled from the econ­omy. While pro­fes­sional investors can eas­ily accept that, retail investors still have some level of con­vic­tion that the stock mar­ket should reflect eco­nomic activ­ity and not just cen­tral bank print­ing and gov­ern­ment spend­ing. Retail investors can see that the U.S. debt has con­tin­ued to grow and that in spite of lip ser­vice to deficit reduc­tion, we are cre­at­ing a big­ger deficit. They are ner­vous about what will hap­pen when finally the spend­ing gets pulled in. They are also very ner­vous (as are many pro­fes­sional investors) that they will be the last pur­chase of stocks before the cen­tral banks stop pump­ing fresh money into the sys­tem in their never end­ing attempt to inflate asset prices.

If there is one sec­tor where the upward price move­ment is suck­ing in more money it is amongst cor­po­ra­tions them­selves. The num­ber and size of buy­back announce­ments seems to be increas­ing. That makes sense, since if any group has shown an abil­ity to buy high and sell low, it is cor­po­ra­tions them­selves. In 2007 and the first half of 2008, com­pa­nies, includ­ing AIG, were buy­ing back their own stock aggres­sively. From the sec­ond half of 2008 and all of 2009, most com­pa­nies couldn’t afford to buy back shares and many had to issue. It is just wrong to expect indi­vid­u­als to be as friv­o­lous with their money as cor­po­ra­tions are.

I con­tinue to believe that retail is rea­son­ably allo­cated to equi­ties, under the new allo­ca­tion model. The new allo­ca­tion model takes into account debt before deter­min­ing what is investible. Then there is an actual allo­ca­tion to ultra-safe “rainy day” money. That “investible” money is then allo­cated at a much more real­is­tic per­cent­age to equi­ties and fixed income and “other invest­ments”. A myr­iad of new invest­ment vehi­cles have helped make it eas­ier for investors to par­tic­i­pate in the fixed income mar­ket and other asset classes, help­ing to ensure that the allo­ca­tion to those remains higher than it was through the 90′s and the first part of this century.

I do not believe stocks are a Gif­fen good, at least when it comes to retail, so expect­ing “dumb” money to come in and take out the “smart” money may be just as para­dox­i­cal as a Gif­fen good.

The mar­ket is a lit­tle weaker again this morn­ing, so I bet­ter type quickly, since the “Europe went home” rally now starts before Europe goes home.

Chi­nese ser­vice PMI came in strong, but no one really cares about China as a ser­vice econ­omy, so that news was largely shrugged off.

Euro­zone PPI came in slightly higher than expected and last month was revised slightly higher as well. Noth­ing too earth shat­ter­ing, but ris­ing infla­tion with falling employ­ment makes for a very bad combination.

Span­ish bond yields are once again under pres­sure – as they should be. Italy is also feel­ing weaker again. In 10 years Spain is back to 5.40% and Italy is at 5.15%, out by 5 and 7 bps respec­tively. We have seen sup­port, whether nor­mal mar­ket sup­port, or cen­tral bank pur­chase sup­port around the 5.20% and 5.45% lev­els in the past few days, so need to keep a close eye on these lev­els. Spain is under­per­form­ing more notice­ably in the 5 year sec­tor, but still trades at 4.19% com­pared to Italy at 4.32%. Yes, Spain yields more in 10 years than Italy, but less in 5 years. Span­ish 5 year CDS is at 436, but Ital­ian 5 year CDS is at 388. So the 5 year bond inver­sion is clearly an anom­aly and a func­tion of sup­ply and demand and an obvi­ous sign of how inef­fi­cient bond prices are. There are so many “tech­ni­cals” at work in the bond mar­ket that it is extremely hard to sep­a­rate what part of price is reflect­ing risk as per­ceived by the mar­ket and what part is influ­enced by other non mar­ket fac­tors. That is one rea­son CDS is so pop­u­lar – it is fun­gi­ble and not con­strained by who holds what issue.

CDS indices are all a lit­tle bit bet­ter today. Euro­pean ones were largely catch­ing up to the after­noon move tighter here. IG18 is trad­ing even richer to fair value. This shows a lack of con­vic­tion in the rally by the mar­ket as a whole since it looks like investors want to set their longs in the most liq­uid prod­uct giv­ing them the great­est abil­ity to exit if nec­es­sary. At 7 bps rich with a spread of 90, investors are over­pay­ing for that liq­uid­ity. Look for IG18 to con­tinue to lag.

Other anec­do­tal evi­dence of this ten­ta­tive con­vic­tion can be seen in the bond mar­kets, where once again, new issue trad­ing is dom­i­nat­ing daily flows. Investors have their core longs in bonds, add beta via the index, and look for alpha on new issue allo­ca­tions and flip­ping. While not bad in of itself, it is not a sign of a truly healthy mar­ket. The ETF’s con­tinue to get some inflows, but the pace has slowed dra­mat­i­cally and much of it can be accounted for by div­i­dend re-investment and “arb” activ­ity. While the ETF’s remain at a pre­mium, “arbs” are buy­ing the bonds that the ETF is will­ing to accept and exchang­ing them for new shares, which they then sell into the mar­ket. That form of share cre­ation is far less indica­tive of strength in the mar­ket, than when peo­ple are truly just buy­ing shares and leav­ing deal­ers and ETF man­agers scram­bling to find bonds. That is a sub­tle, but impor­tant difference.

Sources: Bloomberg, TFMA

 

Copy­right © TF Mar­ket Advisors

Tags: Amp, Assumption, Buying Stocks, China, Conviction, Deficit Reduction, Economic Activity, ETF, ETFs, Giffen Good, Giffen Goods, Hype, Infatuation, Internet Stocks, Invest Stocks, Lip Service, Mining, Professional Investors, Retail Investor, Retail Investors, Sidelines, Spite, Stock Market, Tf
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Proceed With Caution in the Hunt for High Yield

Tuesday, April 3rd, 2012

Given high yield credit’s recent rally and surge of inflows, I’m now get­ting a lot of ques­tions about whether or not the asset class still looks appealing.

While high yield pro­vides an attrac­tive pickup in yield and I’m main­tain­ing my neu­tral view of the sec­tor, I believe the easy money has prob­a­bly already been made and the asset class no longer looks cheap. As such, over high yield, I pre­fer invest­ment grade credit and munic­i­pals.

As high yield credit is highly cor­re­lated with equi­ties, it’s hardly sur­pris­ing that the asset class has ral­lied sharply since fall lows, tak­ing part in the strong rebound in stocks and other risky assets. The iShares iBoxx $ High Yield Cor­po­rate Bond Fund (NYSEARCA: HYG) is up more than 12% from its early Octo­ber clos­ing low. Past per­for­mance does not guar­an­tee future results. For stan­dard­ized per­for­mance, please click here. And of course, this surge in price has been accom­pa­nied by a surge in flows. Year to date, $6.5 bil­lion has flowed into high yield exchange traded funds, with half going to HYG.

Fol­low­ing this rally, the yield to matu­rity for high yield is roughly 7% or nearly a 500 basis point pre­mium to the 10-year Trea­sury. That’s close to fair value given the fol­low­ing analysis.

When you look at the his­tor­i­cal spread between high yield and the 10 year-Treasury, spreads typ­i­cally tighten as expec­ta­tions for the econ­omy improve. They widen when investors are wor­ried about a reces­sion and credit qual­ity.  In the past, eco­nomic indi­ca­tors have explained roughly 50% of the vari­a­tion in where high yield spreads rel­a­tive to Trea­suries, tes­ti­fy­ing that the eco­nomic sit­u­a­tion has been a key dri­ver of spreads LQDhistorically.

A com­par­i­son of high yield spreads with lead­ing indi­ca­tors today sug­gests that high yield should be yield­ing roughly 500 bps more than the yield on the 10-year Trea­sury, fairly close to cur­rent levels.

To be sure, I don’t believe investors should avoid high yield. Investors in high yield are still pick­ing up sig­nif­i­cant incre­men­tal yield, and given strong cor­po­rate bal­ance sheets, I don’t expect any sig­nif­i­cant pickup in default rates. But as the asset class no longer appears as inex­pen­sive as it was last fall, I wouldn’t advo­cate aggres­sively putting new money to work in high yield.

Instead, I pre­fer invest­ment grade and high qual­ity munic­i­pals. I hold over­weight views of both asset classes, which still appear rel­a­tively cheap ver­sus Trea­suries. Take invest­ment grade credit, which is a nice sub­sti­tute for those look­ing to lower their expo­sure to Trea­suries. While high yield spreads have con­tracted by 250 bps since last fall, spreads for invest­ment grade credit have not come in nearly as much.

Investors can access invest­ment grade credit through the iShares iBoxx $ Invest­ment Grade Cor­po­rate Bond Fund (NYSEARCA: LQD) and they can access munic­i­pals through the iShares S&P Short Term National AMT-Free Munic­i­pal Bond Fund (NYSEARCA: SUB) and the iShares S&P National AMT-Free Munic­i­pal Bond Fund (NYSEARCA: MUB).

Source: Bloomberg

The author is long LQD and MUB

The per­for­mance quoted rep­re­sents past per­for­mance and does not guar­an­tee future results. Invest­ment return and prin­ci­pal value of an invest­ment will fluc­tu­ate so that an investor’s shares, when sold or redeemed, may be worth more or less than the orig­i­nal cost. Cur­rent per­for­mance may be lower or higher than the per­for­mance quoted. Per­for­mance data cur­rent to the most recent month end may be obtained by call­ing toll-free 1–800-iShares (1–800-474‑2737) or by vis­it­ing www.iShares.com.

Bonds and bond funds will decrease in value as inter­est rates rise. High yield secu­ri­ties may be more volatile, be sub­ject to greater lev­els of credit or default risk, and may be less liq­uid and more dif­fi­cult to sell at an advan­ta­geous time or price to value than higher-rated secu­ri­ties of sim­i­lar matu­rity. A por­tion of a munic­i­pal bond fund’s income may be sub­ject to fed­eral or state income taxes or the alter­na­tive min­i­mum tax. Cap­i­tal gains, if any, are sub­ject to cap­i­tal gains tax.

Tags: 10 Year Treasury, asset class, Basis Point, Bond Fund, Bps, Corporate Bond, Credit Quality, Easy Money, Economic Indicators, Economic Situation, ETF, ETFs, Exchange Traded Funds, high yield, Hyg, Ishares, Leading Indicators, Municipals, Neutral View, Risky Assets, Treasuries, Yield To Maturity
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Stocks: Still A Bargain (Koesterich)

Friday, March 30th, 2012

With global stocks up approx­i­mately 25% from their fall low and many mar­ket watch­ers endors­ing equi­ties in recent weeks, it’s hardly sur­pris­ing that investors are won­der­ing if stocks are still a good bargain.

While some mea­sures of sen­ti­ment – notably abnor­mally low volatil­ity lev­els – could be inter­preted as flash­ing yel­low cau­tion signs, val­u­a­tions and fun­da­men­tals still favor global stocks over the long term.

Cur­rently, equi­ties look rea­son­ably priced on an absolute basis. Devel­oped mar­ket equi­ties are trad­ing at around 14.5x trail­ing earn­ings, while large emerg­ing mar­kets are trad­ing at roughly 12x earnings. These val­u­a­tions are sig­nif­i­cantly above those touched dur­ing last year’s trough, but both emerg­ing and devel­oped mar­ket stocks are now trad­ing at a sig­nif­i­cant dis­count to their long-term aver­ages.

The rel­a­tive case for stocks, how­ever, is even more com­pelling as equi­ties look very cheap com­pared to bonds. While equity val­u­a­tions are mod­estly below their long-term aver­age, bond val­u­a­tions are sig­nif­i­cantly above theirs when mea­sured by vir­tu­ally any metric.

Nowhere is this more evi­dent than in the US Trea­sury mar­ket. Late last year, the yield on the 10-year Trea­sury note dipped below the level of core infla­tion for the first time since 1980. Rather than pay­ing investors the typ­i­cal long-term aver­age real yield of 2.5% to 3%, the US gov­ern­ment is now pay­ing a neg­a­tive real yield to bor­row.  As a result, unless the US is slid­ing toward Japan­ese style defla­tion – and so far there is lit­tle evi­dence of this –US Trea­suries look extremely expen­sive and investors in 10-year notes are accept­ing a loss in pur­chas­ing power and no real income. In addi­tion, because coupons are so low, the dura­tion or inter­est rate risk of Trea­suries is at or near a his­toric high.

Some investors have weighed the volatil­ity of stocks against the low yield on bonds and opted for choice C: Cash. A tac­ti­cal move into cash is cer­tainly rea­son­able for brief peri­ods of time. But if you’re wor­ried about long-term pur­chas­ing power, hav­ing a sig­nif­i­cant, long-term allo­ca­tion to an asset pay­ing zero return makes lit­tle sense. Stocks are a more rea­son­able option to consider.

To be sure, invest­ing in equi­ties has its risks. Some have argued that equity val­u­a­tions are flat­tered by his­tor­i­cally high mar­gins. But in the United States at least, a com­bi­na­tion of just enough gross domes­tic prod­uct growth, ane­mic wage growth and low rates should sup­port mar­gins over the near term.

Among other risks, while US defla­tion looks unlikely, it’s pos­si­ble and it’s a sce­nario that would clearly favor bonds. Under the oppo­site sce­nario – higher US infla­tion – equi­ties would surely suf­fer thanks to lower mul­ti­ples. How­ever, in an infla­tion sce­nario, equi­ties would likely hold up bet­ter than bonds or cash.

In short, equi­ties may not offer the stel­lar prospects of the 1980s or 1990s, but absent a bout of defla­tion, stocks are likely to out­per­form the alter­na­tives over the long term. Pos­si­ble iShares solu­tions include the iShares S&P Global 100 Index Fund (NYSEARCA: IOO), the iShares MSCI ACWI Index Fund (NASDAQGM: ACWI) and the iShares MSCI All Coun­try World Min­i­mum Volatil­ity Index Fund (NYSEARCA: ACWV).

Source: Bloomberg

The author is long IOO.

In addi­tion to the nor­mal risks asso­ci­ated with invest­ing, inter­na­tional invest­ments may involve risk of cap­i­tal loss from unfa­vor­able fluc­tu­a­tion in cur­rency val­ues, from dif­fer­ences in gen­er­ally accepted account­ing prin­ci­ples or from eco­nomic or polit­i­cal insta­bil­ity in other nations. An invest­ment in stocks, bonds or ETFs is not equiv­a­lent to and involves risks not asso­ci­ated with an invest­ment in cash.

Tags: 10 Year Treasury, Absolute Basis, Average Bond, Caution Signs, Choice C, Core Inflation, Deflation, ETF, ETFs, Global Stocks, Gold, Good Bargain, Interest Rate Risk, Japanese Style, Perio, Purchasing Power, Tactical Move, Term Averages, Treasuries, Treasury Market, Us Treasury, Volatility Levels, Year Treasury Note
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Defence That Pays: Dividend Equities as a Long Term Strategy

Thursday, March 29th, 2012

Defence That Pays
Div­i­dend Equi­ties as a Long-term Strategy

by Alfred Lee, CFA, CMT, DMS
Vice Pres­i­dent & Invest­ment Strate­gist
BMO ETFs & Global Struc­tured Invest­ments
BMO Asset Man­age­ment Inc.
alfred.lee@bmo.com

March 29, 2012
Recent Developments:

• Despite the global macro-economic con­cerns that remain, year to date, investors have clearly favoured risk-assets as improv­ing sen­ti­ment has led global equity mar­kets to rally with sig­nif­i­cant breadth. Although, investors should not put too much focus on day-to-day head­lines, last Thursday’s read­ing of Europe and China’s weak Pur­chas­ing Man­agers Index (PMI), shows how the global eco­nomic recov­ery remains vul­ner­a­ble. While we have become more opti­mistic over the mid-term, we still remain con­cerned on the struc­tural issues remain­ing over the long-term, and is why we con­tinue to rec­om­mend that investors do not throw cau­tion to the wind.
• News of Greece’s debt restruc­tur­ing sev­eral weeks ago, has put con­cerns on the back­burner; although we believe Greece’s sol­vency issues remain over the long-term. On a short-term out­look, this has lifted a major over­hang on the equity mar­kets. Investors should note, how­ever, that credit default swap (CDS) prices of Por­tu­gal still remain ele­vated (Chart A). More­over, China’s poten­tial hous­ing bub­ble and infla­tion hand­cuffs the nation’s abil­ity to imple­ment a whole­sale mon­e­tary eas­ing pol­icy. Thus, unlike 2009, China will not be able to shoul­der the global economy.
• The year-to-date rally in risk-assets hinges on whether U.S. eco­nomic data can sus­tain or con­tinue to build pos­i­tive momen­tum. Although we have increased our rec­om­mended allo­ca­tion to Cana­dian equi­ties, we still remain defen­sive in our com­po­si­tion. Con­cerns on China should weigh on some commodity-based equi­ties over the short-term, so we rec­om­mend that investors look at non-cyclical areas such as div­i­dend pay­ing equi­ties in Canada.
• In addi­tion to being more defen­sive in nature, lower bond yields should lead investors to look to div­i­dend pay­ing equi­ties to source yield. Cur­rently, the 10-year gov­ern­ment bond yield is less than the div­i­dend yield of the S&P/TSX Com­pos­ite Index (TSX) (Chart B). An aging demo­graphic search­ing for income dis­tri­b­u­tions should pro­vide a fur­ther tail­wind for div­i­dend pay­ing equi­ties over the long-run.
• Improv­ing eco­nomic data has also recently led the yield curve to shift upwards (Chart C), which has neg­a­tively impacted bonds, espe­cially those of longer matu­rity. As we have become more bull­ish on equi­ties over the short– and mid-term, investors may want to con­sider real­lo­cat­ing some bond expo­sure to div­i­dend pay­ing equi­ties as a way of main­tain­ing over­all port­fo­lio yield while decreas­ing dura­tion risk. Investors should keep in mind that equi­ties and fixed income do react to risk in dif­fer­ent man­ners and there­fore should keep in mind their over­all port­fo­lio risk composition.

Invest­ment Idea:

• Investors may want to con­sider the BMO Cana­dian Div­i­dend Equity ETF (ZDV) as an effi­cient way to gain expo­sure to a bas­ket of 50 large and some mid-cap Cana­dian div­i­dend pay­ing stocks. Cur­rently, the under­ly­ing port­fo­lio yields 4.5%, diver­si­fied across eight dif­fer­ent sec­tors and a man­age­ment fee of only 0.35%. In addi­tion to being eli­gi­ble for a div­i­dend rein­vest­ment plan (DRIP) like our other BMO ETFs, ZDV pays a monthly dis­tri­b­u­tion. We con­tinue to rec­om­mend defen­sive hold­ings such as ZDV as core posi­tions and more cycli­cal ori­ented themes around the periph­eral as more tac­ti­cally ori­ented themes.

Chart A: CDS Prices on Por­tu­gal Remain Elevated

Source: BMO Asset Man­age­ment Inc., StockCharts.com

Chart B: Cana­dian Bonds Yield­ing Less than Cana­dian Equities

Source: BMO Asset Man­age­ment Inc., Bloomberg,

Chart C: Yield Curve Shift­ing Upwards Will Impact Fixed Income

Source: BMO Asset Man­age­ment Inc., Bloomberg

*All prices as of mar­ket close March 27, 2012 unless oth­er­wise indicated.

Dis­claimer:
Infor­ma­tion, opin­ions and sta­tis­ti­cal data con­tained in this report were obtained or derived from sources deemed to be reli­able, but BMO Asset Man­age­ment Inc. does not rep­re­sent that any such infor­ma­tion, opin­ion or sta­tis­ti­cal data is accu­rate or com­plete and they should not be relied upon as such. Par­tic­u­lar invest­ments and/or trad­ing strate­gies should be eval­u­ated rel­a­tive to each individual’s cir­cum­stances. Indi­vid­u­als should seek the advice of pro­fes­sion­als, as appro­pri­ate, regard­ing any par­tic­u­lar investment.

BMO ETFs are man­aged and admin­is­tered by BMO Asset Man­age­ment Inc, an invest­ment fund man­ager and port­fo­lio man­ager and sep­a­rate legal entity from the Bank of Mon­tréal. Com­mis­sions, man­age­ment fees and expenses all may be asso­ci­ated with invest­ments in exchange-traded funds. Please read the prospec­tus before invest­ing. The indi­cated rates of return are the his­tor­i­cal annual com­pound total returns includ­ing changes in prices and rein­vest­ment of all dis­tri­b­u­tions and do not take into account com­mis­sion charges or income taxes payable by any unit holder that would have reduced returns. The funds are not guar­an­teed, their value changes fre­quently and past per­for­mance may not be repeated.

Tags: Alfred Lee, Asset Management Inc, Backburner, BMO, Canadian, Canadian Equities, Canadian Market, Caution To The Wind, Cmt, Credit Default Swap, Debt Restructuring, Economic Concerns, ETF, ETFs, Global Economy, Global Equity Markets, Global Macro, Housing Bubble, Investment Strategist, Purchasing Managers Index, Structured Investments, Swap Cds, Term Outlook, Wind News
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Bernanke's Problem with the Gold Standard

Wednesday, March 28th, 2012

by Axel Merk, Merk Funds

In his new lec­ture series, Fed­eral Reserve (Fed) Chair­man Ben Bernanke is going out of his way to dis­cuss the "prob­lems with the gold stan­dard." To a cen­tral banker, the gold stan­dard may be con­sid­ered "com­pe­ti­tion," as their power would likely be greatly dimin­ished if the U.S. were on a gold stan­dard. The Fed, Bernanke argues, is the answer to the prob­lems of the gold stan­dard. We respect­fully dis­agree. We dis­agree because the Fed ought to look at a dif­fer­ent problem.

Bernanke lists price sta­bil­ity and finan­cial sta­bil­ity as key objec­tives of the Fed. Focus­ing on the lat­ter one first, the Fed was estab­lished to reduce the risk of finan­cial pan­ics. Bernanke points out:

"A finan­cial panic is pos­si­ble in any sit­u­a­tion where longer-term, illiq­uid assets are financed by short-term, liq­uid lia­bil­i­ties; and in which short-term lenders or depos­i­tors may lose con­fi­dence in the institution(s) they are financ­ing or become wor­ried that oth­ers may lose confidence."

Bernanke goes on to blame the gold stan­dard for the pan­ics. While he is cer­tainly not alone in his view – indeed, his very lec­ture to stu­dents at George Wash­ing­ton Uni­ver­sity is pro­mot­ing that view to a new gen­er­a­tion of econ­o­mists -, we beg to differ.

Banks — by def­i­n­i­tion — have a matu­rity mis­match, mak­ing long-term loans, tak­ing short-term deposits. As such, banks are prone to finan­cial pan­ics as described by Bernanke. To mit­i­gate the risk of finan­cial pan­ics, cen­tral banks can do what the Fed is doing, namely to be a lender of last resort. Alter­na­tively, cen­tral banks can focus on the core issue, the struc­tural "prob­lem of bank­ing." Fol­low­ing the Fed's approach, there are inher­ent moral haz­ard issues – incen­tives for finan­cial insti­tu­tions to increase lever­age, to become too-big-to-fail. To address a panic that might hap­pen any­way, the Fed would dou­ble down (pro­vide more liq­uid­ity), poten­tially exac­er­bat­ing future bank­ing pan­ics. After yet another cri­sis, new rules are intro­duced to reg­u­late banks. The result­ing finan­cial sys­tem may not be safer, but it will increase bar­ri­ers to entry, fur­ther bol­ster­ing the lead­er­ship posi­tion of exist­ing, too-big-to-fail banks. With all the gov­ern­ment guar­an­tees and too-big-to-fail con­cerns, banks might then be reg­u­lated in an attempt to have them act more like util­i­ties. Ulti­mately, that might make the finan­cial sys­tem more sta­ble, but will sti­fle eco­nomic growth. Finan­cial insti­tu­tions, as much as we have mixed feel­ings about their con­duct, are vital to finance eco­nomic growth, as they facil­i­tate risk tak­ing and investment.

The prob­lem of all finan­cial pan­ics is not the gold stan­dard — oth­er­wise, the panic of 2008 would not have hap­pened. The prob­lem of finan­cial pan­ics is — again — that "longer-term, illiq­uid assets are financed by short-term, liq­uid lia­bil­i­ties." Miss­ing from Bernanke's def­i­n­i­tion is a key addi­tional attribute, lever­age. A matu­rity mis­match with­out lever­age might cause a lender to go bust, but — in our inter­pre­ta­tion — does not qual­ify as a panic when a lim­ited num­ber of depos­i­tors are affected. The "panic" and the "con­ta­gion" may occur when lever­age is employed, as it cre­ates a dis­pro­por­tion­ate num­ber of cred­i­tors (includ­ing con­sumers with cash deposits).

There's a bet­ter way. To avoid hav­ing finan­cial insti­tu­tions serve as “panic” incu­ba­tors, reg­u­la­tion should address the core of the issue. Bernanke shouldn’t use gold, as a scape­goat for all that was wrong with the U.S. econ­omy pre­vi­ously, to jus­tify a license to print money. First, fail­ure must be an option; indi­vid­u­als and busi­nesses must be allowed to make mis­takes and suf­fer the con­se­quences. The role of the reg­u­la­tor, in our opin­ion, is to avoid an event where someone's mis­take wrecks the entire system.

The eas­i­est way to achieve a more sta­ble finan­cial sys­tem is to reduce incen­tives for lever­age. A straight­for­ward method is through mark-to-market account­ing and a require­ment to post col­lat­eral for lever­aged trans­ac­tions. The finan­cial indus­try lob­bies against this, argu­ing that hold­ing a posi­tion to matu­rity ren­ders mark-to-market account­ing redun­dant. Con­sider the fol­low­ing exam­ple, which high­lights the impli­ca­tion: assume a spec­u­la­tor before the finan­cial cri­sis took a lever­aged bet that oil prices — at the time trad­ing at $80 a bar­rel — would go down to $40 a bar­rel. In the “ideal world” accord­ing to the banks, this spec­u­la­tor would not have been required to post col­lat­eral and would have been proven right when oil (briefly) dropped to $40 a bar­rel after the finan­cial cri­sis. In real­ity how­ever, as oil prices soared to $140 a bar­rel before declin­ing, the typ­i­cal spec­u­la­tor would have been forced to post an ever larger amount of col­lat­eral; likely, the speculator's bro­ker­age firm would have closed out the posi­tion, as the spec­u­la­tor ran out of money. The spec­u­la­tor lost money because he was unable to meet a mar­gin call; impor­tantly, though, the sys­tem remained intact. The spec­u­la­tor might com­plain: the price ulti­mately fell to $40! But such whin­ing is futile because the rules of engage­ment were known ahead of time. As such, the spec­u­la­tor had an incen­tive to use less (or no) lever­age. The bank's atti­tude, in con­trast, incu­bates pan­ics. In this exam­ple, reg­u­lated exchanges exist. But even with­out reg­u­lated exchanges or eas­ily priced secu­ri­ties, sim­i­lar con­cepts can be developed.

Another way to make finan­cial firms more panic prone is to require them to issue stag­gered sub­or­di­nated debt. Rather than rely­ing heav­ily on short-term fund­ing (retail deposits or inter-bank fund­ing mar­kets), banks should be required to stag­ger the matu­ri­ties of their own fund­ing over years. If, say, each year 10% of their loan port­fo­lio needs to be refi­nanced, then — in times of finan­cial tur­moil — it might become exor­bi­tantly expen­sive for a bank to finance that 10% of their loan port­fo­lio. A bank should be able to shrink its loan port­fo­lio by 10% in a year in an orderly fash­ion, with­out jeop­ar­diz­ing the sur­vival of the firm or spread­ing exces­sive risks through­out the finan­cial sys­tem. Note that this is a market-based mech­a­nism to police the finan­cial system.

These con­cepts reduce lever­age in the sys­tem. And that's the point, as lever­age is the mother of all pan­ics. The con­cepts pre­sented above will not solve all the chal­lenges of bank­ing, but blam­ing "the prob­lem of the gold stan­dard" for finan­cial pan­ics is — in our analy­sis — premature.

Mod­ern cen­tral bank­ing is not the answer to mit­i­gate the risk of finan­cial pan­ics because the cost for this per­ceived safety is enor­mous. As a result of respond­ing to each poten­tial panic with ever more "liq­uid­ity", entire gov­ern­ments are now put at risk when a cri­sis flares up.

Beyond that, cen­tral banks have done a hor­ri­ble job in con­tain­ing infla­tion. The wis­dom of cen­tral bank­ing is that 2% infla­tion is con­sid­ered an envi­ron­ment of sta­ble prices. At 2%, a level often touted as a “price sta­ble envi­ron­ment”, the pur­chas­ing power of $100 is reduced to $55 over a 30-year period. It's a cruel tax on the pub­lic. What’s more, in prac­tice, coun­tries with a fiat cur­rency sys­tem have gen­er­ally been unable to keep long-term infla­tion below 2%.

Bernanke warns of defla­tion. To the saver, defla­tion is a gift. Not to the debtor. In a debt dri­ven world, defla­tion stran­gles the econ­omy. Gov­ern­ments don't like defla­tion as income taxes and cap­i­tal gains taxes are eroded. In a defla­tion­ary world, gov­ern­ments would need to rely more on sales taxes (or value added taxes): grad­u­ally reduced rev­enue in a defla­tion­ary envi­ron­ment would be okay as the pur­chas­ing power of those tax rev­enues would increase. That assumes, of course, that the gov­ern­ment car­ries a low debt bur­den — defla­tion would be a good incen­tive to limit spend­ing. Get the pic­ture why gov­ern­ments don't like deflation?

Read John Butler's new book
The Golden Rev­o­lu­tion: How to Pre­pare for the Com­ing Global Gold Standard

With infla­tion, peo­ple have an "incen­tive" to work harder, to take on risks, just to retain their pur­chas­ing power, the sta­tus quo. What about the pur­suit of hap­pi­ness? The idea that if you earn money and save, you can retire and live off your sav­ings? We con­sider it quite an impo­si­tion that unelected offi­cials have such sway over our stan­dard of living.

Bernanke also attacks the gold stan­dard for caus­ing havoc in the cur­rency mar­kets. Please sub­scribe to our newslet­ter to be informed as we pro­vide food for thought about the rela­tion­ship between gold and cur­ren­cies. We will also dis­cuss what investors may want to do in a world that has moved fur­ther and fur­ther away from the gold stan­dard. Sub­scribe to Merk Insights by click­ing here. Also, please click here to reg­is­ter for the Merk Webi­nar: Quar­ter 1 Update on the Econ­omy and Cur­ren­cies which will take place on Thurs­day, April 19th at 4:15pm EF / 1:15pm PT. We man­age the Merk Funds, includ­ing the Merk Hard Cur­rency Fund. To learn more about the Funds, please visit www.merkfunds.com.

Axel Merk

Man­ager of the Merk Hard Cur­rency Fund, Asian Cur­rency Fund, Absolute Return Cur­rency Fund, and Cur­rency Enhanced U.S. Equity Fund, www.merkfunds.com

Axel Merk, Pres­i­dent & CIO of Merk Invest­ments, LLC, is an expert on hard money, macro trends and inter­na­tional invest­ing. He is con­sid­ered an author­ity on currencies.

The Merk Hard Cur­rency Fund (MERKX) seeks to profit from a rise in hard cur­ren­cies ver­sus the U.S. dol­lar. Hard cur­ren­cies are cur­ren­cies backed by sound mon­e­tary pol­icy; sound mon­e­tary pol­icy focuses on price stability.

The Merk Asian Cur­rency Fund (MEAFX) seeks to profit from a rise in Asian cur­ren­cies ver­sus the U.S. dol­lar. The Fund typ­i­cally invests in a bas­ket of Asian cur­ren­cies that may include, but are not lim­ited to, the cur­ren­cies of China, Hong Kong, Japan, India, Indone­sia, Malaysia, the Philip­pines, Sin­ga­pore, South Korea, Tai­wan and Thailand.

The Merk Absolute Return Cur­rency Fund (MABFX) seeks to gen­er­ate pos­i­tive absolute returns by invest­ing in cur­ren­cies. The Fund is a pure-play on cur­ren­cies, aim­ing to profit regard­less of the direc­tion of the U.S. dol­lar or tra­di­tional asset classes.

The Merk Cur­rency Enhanced U.S. Equity Fund (MUSFX) seeks to gen­er­ate total returns that exceed that of the S&P 500 Index. By employ­ing a cur­rency over­lay, the Merk Cur­rency Enhanced U.S. Equity Fund actively man­ages U.S. dol­lar and other cur­rency risk while con­cur­rently pro­vid­ing invest­ment expo­sure to the S&P 500.

The Funds may be appro­pri­ate for you if you are pur­su­ing a long-term goal with a cur­rency com­po­nent to your port­fo­lio; are will­ing to tol­er­ate the risks asso­ci­ated with invest­ments in for­eign cur­ren­cies; or are look­ing for a way to poten­tially mit­i­gate down­side risk in or profit from a sec­u­lar bear mar­ket. For more infor­ma­tion on the Funds and to down­load a prospec­tus, please visit www.merkfunds.com.

Investors should con­sider the invest­ment objec­tives, risks and charges and expenses of the Merk Funds care­fully before invest­ing. This and other infor­ma­tion is in the prospec­tus, a copy of which may be obtained by vis­it­ing the Funds' web­site at www.merkfunds.com or call­ing 866-MERK FUND. Please read the prospec­tus care­fully before you invest.

Since the Funds pri­mar­ily invest in for­eign cur­ren­cies, changes in cur­rency exchange rates affect the value of what the Funds own and the price of the Funds' shares. Invest­ing in for­eign instru­ments bears a greater risk than invest­ing in domes­tic instru­ments for rea­sons such as volatil­ity of cur­rency exchange rates and, in some cases, lim­ited geo­graphic focus, polit­i­cal and eco­nomic insta­bil­ity, emerg­ing mar­ket risk, and rel­a­tively illiq­uid mar­kets. The Funds are sub­ject to inter­est rate risk, which is the risk that debt secu­ri­ties in the Funds' port­fo­lio will decline in value because of increases in mar­ket inter­est rates. The Funds may also invest in deriv­a­tive secu­ri­ties, such as for– ward con­tracts, which can be volatile and involve var­i­ous types and degrees of risk. If the U.S. dol­lar fluc­tu­ates in value against cur­ren­cies the Funds are exposed to, your invest­ment may also fluc­tu­ate in value. The Merk Cur­rency Enhanced U.S. Equity Fund may invest in exchange traded funds ("ETFs"). Like stocks, ETFs are sub­ject to fluc­tu­a­tions in mar­ket value, may trade at prices above or below net asset value and are sub­ject to direct, as well as indi­rect fees and expenses. As a non-diversified fund, the Merk Hard Cur­rency Fund will be sub­ject to more invest­ment risk and poten­tial for volatil­ity than a diver­si­fied fund because its port­fo­lio may, at times, focus on a lim­ited num­ber of issuers. For a more com­plete dis­cus­sion of these and other Fund risks please refer to the Funds' prospectuses.

This report was pre­pared by Merk Invest­ments LLC, and reflects the cur­rent opin­ion of the authors. It is based upon sources and data believed to be accu­rate and reli­able. Opin­ions and forward-looking state­ments expressed are sub­ject to change with­out notice. This infor­ma­tion does not con­sti­tute invest­ment advice. Fore­side Fund Ser­vices, LLC, distributor.

Copy­right © Merk Funds

Tags: Ben Bernanke, Central Banks, Core Issue, Depositors, ETF, ETFs, Fed Chairman, Financial Institutions, Financial Panic, Financial Panics, Financial Stability, George Washington University, Gold Standard, Hazard Issues, Illiquid Assets, India, Key Objectives, Lecture Series, Lender Of Last Resort, Long Term Loans, Moral Hazard, Price Stability, Short Term Deposits, Term Lenders
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Buy Commodities, Sell Brands (Smead)

Wednesday, March 28th, 2012

by William Smead, Smead Cap­i­tal Management

We saw War­ren Buf­fett quoted the other day say­ing, “We like com­pa­nies which buy a com­mod­ity and sell a brand”. We thought it would be very help­ful to unpack his thought and put it into the con­text of today’s cir­cum­stances. We at Smead Cap­i­tal Man­age­ment believe these cur­rent cir­cum­stances are framed by the his­tor­i­cal over-pricing of com­modi­ties, the com­ing eco­nomic con­trac­tion of China, the suc­cess­ful cleans­ing of the income state­ments of US house­holds and the inevitable rebound in hous­ing in the US. We will look at the makeup of our port­fo­lio com­pa­nies which buy a com­mod­ity and sell a brand to con­sider their upside poten­tial in this inter­est­ing environment.

When non-economic investors load up on invest­ments in any­thing which has had a big run up, please cir­cle the wag­ons. When com­modi­ties were at their low point in 1999, it was hard to find any insti­tu­tional investor or finan­cial advi­sor rec­om­mend­ing expo­sure in com­modi­ties for investors. As of the end of 2010, insti­tu­tions are ded­i­cat­ing as much as 52% of their port­fo­lio to alter­na­tive invest­ments. This includes com­modi­ties, gold and energy. These invest­ments are made today for diver­si­fi­ca­tion pur­poses and are sim­ply bets on ris­ing prices. These bets look good in a rearview mir­ror as we’ve had a once in a gen­er­a­tion move into this asset class. We believe that com­modi­ties have never been more over-priced in the US and are enter­ing a decade-long bear market.

We believe the rea­son com­modi­ties have been in a bull mar­ket for so long is the unin­ter­rupted eco­nomic boom in China. When a coun­try with 1.3 bil­lion peo­ple grows at over 10% for a num­ber of years with­out an occa­sional reces­sion, it ends up rely­ing on fixed asset invest­ments for growth. When fixed asset invest­ments dom­i­nate your GDP num­bers, bor­rowed money pre­pares to turn sour and ulti­mately lead to a recession/depression. This is some­thing that “get­ting rid of cable” can’t cure.

The Fed­eral Reserve came out with their house­hold debt ser­vice ratio (HDSR) last week. It shows that by the end of 2011, Amer­i­can house­holds had brought the ratio down below 11% to 10.88%. This matches up with the lev­els seen in the early 1980’s reces­sion and the “ane­mic” eco­nomic recov­ery of 1990–93. These ear­lier read­ings pre­ceded two of the best mod­ern eco­nomic growth peri­ods since World War II. While the doom­say­ers moan about absolute debt lev­els, we feel they are miss­ing the story on the health of the income state­ment of the aver­age house­hold. This has boded well for the econ­omy his­tor­i­cally. Also, if we con­tinue to be slow to buy houses and cars, this HDSR could put dis­cre­tionary spend­ing into its most favor­able posi­tion in decades.

Lastly, this cur­rent “ane­mic” eco­nomic recov­ery has been severely retarded by the boom com­mod­ity prices of the last two years, in our opin­ion. We’ve had to work off a huge num­ber of fore­closed and short-sale hous­ing inven­to­ries, while the deep reces­sion tem­porar­ily crip­pled house­hold for­ma­tion (Jeff, Who lives at Home). It is rebound­ing as 20-somethings get sick of liv­ing with the par­ents and the par­ents get sick of liv­ing with Jeff. As Mr. Buf­fett said recently, “even­tu­ally hor­mones take over” and as Brett Arends pointed out in Smart Money,” rent­ing is more expen­sive than buy­ing in about 75% of Amer­i­can cities.” You add high lum­ber, cop­per, iron ore and oil prices to this mix and you get the worst depres­sion in hous­ing and blue-collar employ­ment since the depres­sion. All these head­winds are about to become tail­winds, in our vision, over the next five years.

There­fore, bet­ting on the US econ­omy and the US con­sumer looks very favor­able to us, espe­cially where the rebounds in employ­ment and con­sumer con­fi­dence have an impact. In fairy tales, peo­ple are asked to spin straw into gold. We like to own com­pa­nies which spin milk and cof­fee (SBUX), cot­ton (JWN and CAB), inter­net access (EBAY and ACN), tax returns (HRB) and chem­i­cals (MRK, AMGN, BMY, ABT, PFE and MYL) into gold. Profit mar­gins on commodity-related com­pa­nies and com­pa­nies reliant on emerg­ing mar­ket growth could plum­met in the near future. Just ask the folks at BHP Bil­li­ton. They announced March 20th, 2012 that they are see­ing in a big drop off in demand from China. In turn, we believe mar­gins could go up for any­one who is pos­i­tively impacted by lower energy prices and/or com­mod­ity prices in gen­eral. This is espe­cially true if you “buy com­modi­ties and sell brands”.

Best Wishes,

William Smead

The infor­ma­tion con­tained in this mis­sive rep­re­sents SCM’s opin­ions, and should not be con­strued as per­son­al­ized or indi­vid­u­al­ized invest­ment advice. Past per­for­mance is no guar­an­tee of future results. Some of the secu­ri­ties iden­ti­fied and described in this mis­sive are a sam­ple of issuers being cur­rently rec­om­mended for suit­able clients as of the date of this mis­sive and do not rep­re­sent all of the secu­ri­ties pur­chased or rec­om­mended for our clients. It should not be assumed that invest­ing in these secu­ri­ties was or will be prof­itable. A list of all rec­om­men­da­tions made by Smead Cap­i­tal Man­age­ment with in the past twelve month period is avail­able upon request.

Tags: Alternative Investments, asset class, Asset Investments, Bear Market, Bets, Capital Management, Circle The Wagons, Commodities, Commodity, Diversification, Economic Boom, Economic Contraction, ETF, ETFs, Generation Move, Income Statements, Institutional Investor, Portfolio Companies, Rearview Mirror, Rebound, Recession, Warren Buffett
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Corporate Bond Intrigue (Video)

Monday, March 26th, 2012

  
Despite the slug­gish econ­omy, US cor­po­ra­tions have a few good things going for them right now.   Does this trans­late to their abil­ity to repay debt?  Spend a minute with Matt Tucker as he explores the cur­rent case for cor­po­rate bonds.

Tags: Corporate Bond, Corporate Bonds, Corporate Video, Corporations, Current, ETF, ETFs, Intrigue, Matt Tucker, Nbsp, Sluggish Economy
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Alfred Lee: Investment Outlook (March-April 2012)

Sunday, March 25th, 2012

Invest­ment Out­look, March 2012

Silent Waters Run Deep

by Alfred Lee, CFA, CMT, DMS, Vice Pres­i­dent & Invest­ment Strate­gist
BMO ETFs & Global Struc­tured Invest­ments, BMO Asset Man­age­ment
alfred.lee[@]bmo.com

As we artic­u­lated in last month’s report, equity mar­ket volatil­ity remains eerily quiet given the num­ber of macro-economic issues that remain largely unre­solved. With the news of Greece agree­ing to a debt restruc­tur­ing deal, the con­cern of a Euro­pean sov­er­eign debt cri­sis has been put on the back burner and the mar­ket has shifted its focus to U.S. eco­nomic data, which con­tin­ues to come in bet­ter than expected. The deci­sion by the Inter­na­tional Swaps and Deriv­a­tives Asso­ci­a­tion Inc. (ISDA) to deem the Greek bond deal a default, also restores faith in credit default swaps (CDS)1 as a viable insur­ance pol­icy for debt issuances, which will help Euro­pean sov­er­eigns keep their yields lower over the short-term. Although, U.S. eco­nomic data con­tin­ues to impress, con­cerns of the other, and larger, PIIGS2 nations, are being overlooked.

The con­tin­u­a­tion of the cur­rent rally does hinge to a degree on U.S. eco­nomic data and its abil­ity to con­tinue gath­er­ing pos­i­tive momen­tum. Most notably, unem­ploy­ment is down to 8.7% in its Decem­ber read­ing, from 9.1% in Sep­tem­ber. In addi­tion, there is a grow­ing, albeit small, trend of “on-shoring” where man­u­fac­tur­ing jobs are com­ing back state­side, due to ris­ing labour costs in cer­tain emerg­ing mar­kets. Recent opti­mism of the U.S. econ­omy has led the mar­ket to quell their expec­ta­tions for an addi­tional round of quan­ti­ta­tive eas­ing, or fur­ther stim­u­lus from the U.S. Fed­eral Reserve (Fed). As a result, our short-term momen­tum indi­ca­tors show that gold prices have stalled, and is the rea­son we remain neu­tral on pre­cious metals.

Despite the re-pricing of asset mar­kets to reflect improv­ing U.S. eco­nomic fun­da­men­tals and a lower per­cep­tion of tail-risk3, the CBOE/S&P Implied Volatil­ity Index (“VIX”)4 remains abnor­mally sup­pressed. In mid-March, the VIX had an intra­day print of 13.99, which would be con­sid­ered low dur­ing a sec­u­lar bull-market and well below its long-term aver­age of 20. As volatil­ity has a ten­dency to quickly revert to its aver­age, we remain cau­tiously opti­mistic on risk assets. While we have moved over­weight to equi­ties, we remain defen­sively posi­tioned in our equity expo­sure, in order to bet­ter dis­trib­ute risk across our strat­egy. Although we have become more pos­i­tive on equi­ties over the mid-term, we believe there are unre­solved struc­tural issues which will weigh on equi­ties in the long-term.

Notable Changes to the Mix

• Global equi­ties have ral­lied sig­nif­i­cantly over the course of the last five months with the MSCI All Coun­try World Index (ACWI) gain­ing 23.9% from its Octo­ber lows. More encour­ag­ing has been the breadth of the rally, with all sec­tors con­tribut­ing to the strength of its ascent. As the over­hangs on the mar­ket have been more macro-economically related, a ris­ing tide lifts all boats as the mar­kets have re-priced a lower prob­a­bil­ity of an imme­di­ate tail-risk event.

• We have decreased our allo­ca­tion to fixed income and increased our weight in equi­ties and cash. Though attrac­tive from a fun­da­men­tal per­spec­tive, the equity mar­ket con­tin­ues to look over­bought in the short-term based on tech­ni­cal and quantitative-based momen­tum indi­ca­tors. Con­se­quently, we antic­i­pate some short-term con­sol­i­da­tion. By increas­ing our cash posi­tion, it allows us to be more nim­ble and take advan­tage of any upcom­ing oppor­tu­ni­ties and slowly increase our weight towards tac­ti­cal oppor­tu­ni­ties in equi­ties. In addi­tion, the ongo­ing equity rally could put upward pres­sure on inter­est rate expec­ta­tions, which is why we have over-weighted the short-and mid-part of the yield curve to lower our dura­tion risk.

• Com­ing into the new year, we were bear­ish on Cana­dian equi­ties. Though we have raised our posi­tion­ing to neu­tral, we believe that weaker gold prices and con­cerns over China tar­get­ing lower growth expec­ta­tions will weigh on the S&P/TSX Com­pos­ite Index (TSX). We do how­ever remain bull­ish toward cer­tain areas within Cana­dian equi­ties such as lower volatil­ity equi­ties and div­i­dend pay­ing equi­ties, and we are rec­om­mend­ing the BMO Low Volatil­ity Cana­dian Equity ETF (ZLB) and BMO Cana­dian Div­i­dend ETF (ZDV), respec­tively, to access these areas.

New Additions/Deletions to Strategy:

• One of the areas where we have been bull­ish over the last six­teen months has been U.S. equi­ties. More specif­i­cally, we were bull­ish on the large-cap blue chip com­pa­nies, the rea­son why we have been rec­om­mend­ing the BMO Dow Jones Indus­tri­als Aver­age Hedged to CAD Index ETF (ZDJ). Though we still favour the stocks in the Dow Jones Indus­trial Aver­age (Dow), higher oil prices and a buoy­ant U.S. dol­lar, will weigh on the multi­na­tion­als in the Dow. More­over, improv­ing eco­nomic con­di­tions and on-shoring will likely lead to an improv­ing busi­ness envi­ron­ment for some of the smaller, more locally based U.S. com­pa­nies. We are there­fore par­ing back some of our expo­sure to ZDJ in favour of the BMO U.S. Equity Hedged to CAD Index ETF (ZUE) in our strat­egy mix.

• Last week, the Fed released the results of the U.S. bank stress test, which came in over­whelm­ingly pos­i­tive. Of the 19 banks, 15 were given pass­ing grades. Fur­ther­more a num­ber of the banks were given approval by the Fed to raise its div­i­dends. This news added a fur­ther tail­wind to the U.S. bank­ing sec­tor, as it con­tin­ues to show lead­er­ship amongst the U.S. equity sec­tors. Cur­rently, the BMO Equal Weight U.S. Banks Hedged to CAD Index ETF (ZUB), which tracks the Dow Jones U.S. Large-Cap Banks Equal Weight Total Stock Mar­ket Index CAD Hedged Index, trades at a for­ward price-to-earnings (P/E) ratio of 11.9x, a dis­count to the 13.5x for­ward P/E of the S&P 500 Com­pos­ite Index. Our tech­ni­cal indi­ca­tors sug­gests that pos­i­tive momen­tum in ZUB has returned, some­thing we like to see in assets trad­ing at attrac­tive val­u­a­tions as we want to avoid value traps. Given the sec­tor remains vul­ner­a­ble we rec­om­mend investors con­sider uti­liz­ing a trail­ing stop loss order of no more than 10% and limit their allo­ca­tion to mit­i­gate risk.

Things to Keep and Eye On

Last month, we men­tioned that most broad equity mar­ket indices, includ­ing the TSX, were trad­ing at a dis­count to their respec­tive 10-year aver­ages. This month we wanted to take a closer look at the TSX to deter­mine which of the sec­tors look more attrac­tive from a val­u­a­tion stand­point. We used the cur­rent price-to-earnings (P/E) ratios of the sec­tor index rel­a­tive to its own 10-year aver­age using his­tor­i­cal daily data. It should be noted that 10-years may not be a long enough period to demon­strate the sec­u­lar trend in equi­ties; how­ever, the 2008 finan­cial cri­sis should also com­press a 10-year aver­age P/E ratio, mak­ing a more strin­gent bench­mark for deter­min­ing which sec­tors are attrac­tive on a his­tor­i­cal basis. In addi­tion, investors should also note that since the TSX lacks depth in a num­ber of its sec­tors, the val­u­a­tion of those sec­tors can be heav­ily impacted by indi­vid­ual com­pa­nies. Infor­ma­tion tech­nol­ogy and health care are prime exam­ples of sec­tors lack­ing depth.

Rec­om­men­da­tion: A num­ber of the sec­tors trad­ing at a dis­count to their 10-year aver­age in terms of P/E are well rep­re­sented in the BMO Low Volatil­ity Cana­dian Equity ETF (ZLB). Although the mar­ket has rotated into more cycli­cal ori­ented areas, we con­tinue to favour lower volatil­ity areas in the equity mar­ket as a long-term core hold­ing. As men­tioned, in our recent BMO Trade Oppor­tu­nity report, a com­bi­na­tion of ZLB with the BMO S&P/TSX Equal Weight Global Base Met­als Index ETF (ZMT) pro­vides investors with a solid long-term hold­ing com­bined with a more tac­ti­cal ori­ented opportunity.

Since the 2008 finan­cial cri­sis, there has been an increas­ing con­cern of run­away infla­tion due to the stim­u­la­tive mea­sures and accom­moda­tive mon­e­tary poli­cies of cen­tral banks around the world. Although it can be argued that the Con­sumer Price Index (CPI) is not a good rep­re­sen­ta­tion of true infla­tion, espe­cially given the ele­vated prices of hard assets over the decade, CPI for the U.S. remains at 2.9%, well below its long-term aver­age of 3.4%. One of the key rea­sons why an increase in money sup­ply has not trans­lated to infla­tion is due to a slower money velocity7, which has decreased sub­stan­tially since the 2008 finan­cial cri­sis as a result of greater uncer­tainty with the busi­ness envi­ron­ment. Should the recent improve­ment in U.S. eco­nomic data and unem­ploy­ment prove to be a sus­tained trend, the rate at which money changes hands could increase, even­tu­ally mak­ing infla­tion a concern.

Rec­om­men­da­tion: As U.S. mon­e­tary pol­icy indi­rectly affects the actions of other cen­tral banks and par­tic­u­larly the Bank of Canada, investors should keep an eye on the actions of the Fed. Although not an imme­di­ate con­cern, an uptick in money veloc­ity could poten­tially make infla­tion a prob­lem sev­eral years down the road. As a result, we con­tinue to favour short– and mid-term bonds as a means of decreas­ing interest-rate risk (See Cross-Asset Allo­ca­tion Mix Table for our rec­om­mended exposures).

In recent weeks, there has been much dis­cus­sion about the diverg­ing trends between the VIX and the Credit Suisse Fear Barom­e­ter Index (CSFB)5. Both indices are used as a gauge of mar­ket sen­ti­ment with higher read­ings indi­cat­ing increased ner­vous­ness with investors. In recent months, the VIX has dropped sig­nif­i­cantly whereas the CSFB has steadily risen. The VIX is reflec­tive of the market’s cur­rent antic­i­pa­tion of volatil­ity over the next 30-days, annu­al­ized. The CSFB, on the other hand, is cal­cu­lated as a zero-cost collar6, using three-month options. As such, there are a num­ber of dif­fer­ences in the two indices, includ­ing dif­fer­ent matu­rity terms of the under­ly­ing options, mak­ing a diver­gence pos­si­ble depend­ing on the term struc­ture in volatil­ity. Also worth men­tion­ing, is that the VIX cal­cu­lates volatil­ity using options on indi­vid­ual com­pa­nies whereas the CSFB uses index options.

Rec­om­men­da­tion: As we noted at the onset of the year, the term struc­ture in the VIX futures curve is cur­rently upward slop­ing and rel­a­tively steep in the first three con­tracts, which has made a diver­gence between the two “fear indices” pos­si­ble. The term struc­ture for VIX can be inter­preted as the market’s cur­rent expec­ta­tion for volatil­ity in the future. Although the term struc­ture for the VIX futures changes over time, and it is pos­si­ble that the term struc­ture could flat­ten, the VIX is well below its long-term aver­age and can­not get much lower. We con­tinue to advise investors that short– and mid-term bonds should not be neglected as a risk mit­i­ga­tion tool and that investors should con­tinue to main­tain expo­sure to defen­sive ori­ented areas in the equity mar­ket.

Oil prices have seen a steady rise since early Octo­ber reflect­ing an increase in opti­mism of a global eco­nomic recov­ery. Though polit­i­cal tur­moil has had more of a direct impact on the prices of Brent crude (Brent), West Texas Inter­me­di­ate (WTI) which is more reflec­tive of North Amer­i­can oil prices has seen an indi­rect impact due to a chang­ing demand and sup­ply equi­lib­rium. Last year on Sep­tem­ber 26, we rec­om­mended investors invest in energy through our BMO S&P/TSX Equal Weight Oil & Gas Index ETF (ZEO), which has gained 13.7% on a total return basis since. Energy com­pa­nies remain our top invest­ment idea within the com­mod­ity sec­tor based on global macro-economic and polit­i­cal forces. More­over, both Brent and WTI prices tend to strengthen the first seven months of the year, which could pro­vide an addi­tional tail-wind for oil prices.

Rec­om­men­da­tion: Although we would never make an invest­ment rec­om­men­da­tion based on sea­son­al­ity alone, the ten­dency for oil to gain in the first half of the year does pro­vide us with an addi­tional rea­son to be pos­i­tive on energy com­pa­nies. How­ever, as we men­tioned last month, since oil does have a ten­dency to be very reac­tive to macro-economic risk, we con­tinue to rec­om­mend a trail­ing stop-loss order of 10% on BMO S&P/TSX Equal Weight Oil & Gas Index ETF (ZEO). Investors that acted on the trade in Octo­ber may also want to con­sider par­ing back their expo­sure to their orig­i­nal allocation.

Cross-Asset Asset Allo­ca­tion Mix using BMO ETFs (click to enlarge)

Foot­notes

1 Credit Default Swaps (CDS): A swap agree­ment where the seller of the CDS will com­pen­sate the buyer in the event of a loan default or other credit event. The buyer of a credit default swap receives credit pro­tec­tion, whereas the seller of the swap guar­an­tees the credit wor­thi­ness of the debt secu­rity. In doing so, the risk of default is trans­ferred from the holder of the fixed income secu­rity to the seller of the swap. As such, a ris­ing CDS price indi­cates an increas­ing prob­a­bil­ity of a default on a fixed income issue, while a declin­ing price indi­cates a lower prob­a­bil­ity.
2 PIIGS: An acronym used to refer to the five euro­zone nations, which were con­sid­ered weaker eco­nom­i­cally fol­low­ing the finan­cial cri­sis: Por­tu­gal, Italy, Ire­land, Greece and Spain.
3 Tail-risk: The risk of an out­lier or improb­a­ble event occur­ring. Sta­tis­ti­cally, the event is said to be three stan­dard devi­a­tions or more away from the mean, under a nor­mally dis­trib­uted curve.
4 CBOE/S&P 500 Implied Volatil­ity Index (VIX): shows the market’s expec­ta­tion of 30-day volatil­ity. It is con­structed using the implied
volatil­i­ties of a wide range of S&P 500 index options. This volatil­ity is
meant to be for­ward look­ing and is cal­cu­lated from both calls and puts.
The VIX is a widely used mea­sure of mar­ket risk and is often referred to
as the “investor fear gauge”.
5 Credit Suisse Fear Barom­e­ter (CSFB): mea­sures investor sen­ti­ment for 3-month invest­ment hori­zons by pric­ing a zero-cost col­lar. The col­lar is imple­mented by sell­ing of a 10% out-of-the-money call (OTM) option on
the S&P 500 Com­pos­ite (SPX) and using the pro­ceeds to buy an OTM put.
The CSFB level rep­re­sents how far OTM that SPX put is.
6 Zero-cost col­lar: con­sists of the simul­ta­ne­ous sale of one option and using
the pro­ceeds towards the pur­chase of another option at dif­fer­ent strikes.
7 Money veloc­ity: aver­age fre­quency with which a unit of money is spent on new goods and ser­vices pro­duced domes­ti­cally in a spe­cific period of time.

Tags: Alfred Lee, Asset Markets, BMO, Canadian, Canadian Market, Cboe, Cmt, Credit Default Swaps, Debt Crisis, Debt Restructuring, Economic Fundamentals, ETF, ETFs, European Sovereigns, Gold Prices, Investment Outlook, Investment Strategist, Labour Costs, Market Volatility, Mining, Momentum Indicators, precious metals, Silent Waters, Structured Investments, Volatility Index, Volatility Index Vix
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Gold Market Radar (March 26, 2012)

Sunday, March 25th, 2012

Gold Mar­ket Radar (March 26, 2012)

For the week, spot gold closed at $1,661.90 up $1.90 per ounce, or 0.1 per­cent. Gold stocks, as mea­sured by the NYSE Arca Gold Min­ers Index, fell 0.4 per­cent. The U.S. Trade-Weighted Dol­lar Index slid 0.6 per­cent for the week.

Strengths

• U.S. Mint gold and sil­ver bul­lion coin sales rebounded from dis­ap­point­ing lows in Feb­ru­ary. As of Sun­day, March 18, gold bul­lion sales totaled 30,000 ounces, while over­all gold bul­lion coin sales in all sizes were reported at 31,500 ounces. In Feb­ru­ary, these sales were 20,000 ounces and 21,000 ounces, respec­tively. Sales of one-ounce sil­ver bul­lion coins were 1,647,000 ounces, a sub­stan­tial increase over the 1,490,000 ounces reported for the entire month of February.
• Accord­ing to an indus­try source and a Finan­cial Times report, the fall in gold prices has prompted one or more cen­tral banks to buy as much as four tons of bul­lion in recent weeks. The pur­chases, worth about $250 mil­lion at cur­rent prices, were report­edly made through the Bank for Inter­na­tional Set­tle­ments (BIS). The FT said banks have bought between four and six tons in the over-the-counter phys­i­cal mar­ket last week.
• Zambia’s Finance Min­is­ter said that the coun­try will not bring back the 25 per­cent min­ing wind­fall tax it scrapped in 2009 because it may force mine clo­sures. This is the first that we have heard in some time of a coun­try real­iz­ing the neg­a­tive impli­ca­tions for demand­ing an increased share in the min­ing com­pa­nies’ profits.

Weak­nesses

• After clos­ing up shop for five days over the intro­duc­tion of an addi­tional tax on gold imports, bul­lion traders across India decided to open their shops on Thurs­day, fol­low­ing late-night devel­op­ments with gov­ern­ment offi­cials to end the impasse. More than one hun­dred thou­sand bul­lion deal­ers across the coun­try had shut their shops as a form of protest, and traders esti­mate they could have suf­fered a rev­enue loss of over $700 mil­lion in sales.
• Bernanke’s speeches haven’t been falling on deaf ears, with Turk­ish, Indian and Viet­namese gov­ern­ments wary of gold. The gov­ern­ments of the three coun­tries are fac­ing weak­en­ing cur­ren­cies, widen­ing trade deficits, and a pop­u­la­tion buy­ing more and more gold. In line with Bernanke, all believe gold should bear much of the blame.
• Thurs­day morn­ing, news quickly spread of a mil­i­tary coup in Mali, as reports emerged that sol­diers had over­thrown Pres­i­dent Amadou Toumani Toure’s gov­ern­ment and seized power. The stated objec­tive from the Malian army has been to end an “incom­pe­tent régime,” con­demn­ing the gov­ern­ment of its inabil­ity to fight ter­ror­ism. Rand­gold Resources, which owns three mines in Mali, plunged as much as 17 per­cent in Lon­don on the news before rebound­ing to about 12 per­cent off. The CEOs of IAMGOLD, Rand­gold and Angl­o­Gold Ashanti all have main­tained that pro­duc­tion has yet to be affected.

Oppor­tu­ni­ties

• The Finan­cial Times reported this week that Deutsche Bank has plans to open a new pre­cious met­als vault in Lon­don next year, seek­ing to cash in on boom­ing investor demand for phys­i­cal gold and sil­ver. In Lon­don, which is the cen­ter of the global bul­lion mar­ket, vault space is run­ning low even as the growth in exchange-traded funds (ETFs) backed by pre­cious met­als has led to a steep rise in demand for vaults.
• Although India may have increased taxes for gold, the move could present an oppor­tu­nity for sil­ver, the poor man’s gold, to shine. After escap­ing India’s bud­get reforms, investors have shown a keen inter­est in buy­ing one kilo sil­ver bars. On Fri­day, India’s Finance Min­is­ter exempted branded sil­ver jew­elry from excise duty. Sil­ver coins of purity 99.9 per­cent and above were also exempted from excise duty. How­ever, the excise duty on refined gold was dou­bled from 1.5 to 3 per­cent. “Sil­ver has clearly been exempted for a rea­son,” said Prithvi­raj Kothari, pres­i­dent of the Bom­bay Bul­lion Asso­ci­a­tion. “Out of $50 bil­lion worth of imports of pre­cious met­als into India, sil­ver imports were just $4 bil­lion, while that for gold was the other $46 bil­lion,” he said.
• Accord­ing to a sur­vey of fund man­agers, the era of quan­ti­ta­tive eas­ing, a process by which cen­tral banks buy assets such as gov­ern­ment bonds to inject funds into the mar­kets, may be com­ing to an end. Accord­ing to a March sur­vey by Bank of Amer­ica Mer­rill Lynch, investors are “more upbeat about the future and the prospects for growth and they no longer expect fur­ther quan­ti­ta­tive eas­ing mea­sures to be taken by the Fed­eral Reserve or the Euro­pean Cen­tral Bank.” The report, how­ever, did find that fund man­agers still see sov­er­eign debt as the biggest tail risk to the global recov­ery. Investors fore­see higher infla­tion, with a net 13 per­cent expect­ing it to rise in the com­ing year. All in all, the uncer­tainty could con­tinue to bode well for gold prices con­tin­u­ing to rise.

Threats

• In another move to con­trol min­ing com­pa­nies’ finan­cials, Zim­babwe ordered min­ing firms to bank locally this past week, deposit­ing their export earn­ings with local banks. This comes as the government’s lat­est move to exert pres­sure on min­ers as it tries to address the dol­lar crunch afflict­ing its econ­omy. Last week, Impala Plat­inum, the world’s second-biggest plat­inum pro­ducer, bowed to pres­sure and said it would sur­ren­der a 51 per­cent stake in its Zim­plats unit to local black investors.
• The impli­ca­tions of a sil­i­co­sis class action suit for the South African min­ing sec­tor are very seri­ous, but no one yet knows how it will all play out. On Tues­day, a South African lawyer said that he was prepar­ing a class action law­suit against lead­ing gold min­ing firms on behalf of thou­sands of for­mer min­ers who say they con­tracted sil­i­co­sis, a debil­i­tat­ing lung dis­ease, through neg­li­gent health and safety prac­tices. The prin­ci­pal tar­gets of the suit would be Angl­o­Gold Ashanti, Gold Fields and Har­mony Gold—South Africa’s three biggest gold miners—and minor pro­ducer DRDGOLD. The impli­ca­tions for the gold min­ing indus­try and for its rela­tions with the government—already strained by past talk of nationalization—could be huge.

Tags: Bank For International Settlements, Bank For International Settlements Bis, Bullion Dealers, Bullion Traders, Central Banks, Coin Sales, Dollar Index, ETF, ETFs, Gold Bullion Coin, Gold Bullion Sales, Gold Imports, Gold Market, Gold Miners, Gold Prices, gold stocks, Market Radar, Nyse Arca, Silver Bullion Coins, Spot Gold, U S Mint, Windfall Tax
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Horizons ETFS Announces March 2012 Distributions

Friday, March 23rd, 2012

HORIZONS ETFS ANNOUNCES MARCH 2012 DISTRIBUTIONS

TORONTO, March 22, 2012 — Hori­zons Exchange Traded Funds Inc. (“Hori­zons ETFs”) and its affil­i­ate AlphaPro Man­age­ment Inc. are pleased to announce the dis­tri­b­u­tion amounts per unit (the “Dis­tri­b­u­tions”) for cer­tain of the Hori­zons ETFs fam­ily of exchange traded funds (the “ETFs”), for the period end­ing March 31, 2012, as indi­cated in the table below.

The ex-dividend date for the Dis­tri­b­u­tions is antic­i­pated to be March 28, 2012, for all unithold­ers of record on March 30, 2012. The Dis­tri­b­u­tions will be paid in cash or, if the unitholder has enrolled in the respec­tive ETF’s div­i­dend rein­vest­ment plan (DRIP), rein­vested in addi­tional units of the applic­a­ble ETF, on or about April 12, 2012.

Read Com­plete Press Release [PDF] - HORIZONS ETFS ANNOUNCES MARCH 2012 DISTRIBUTIONS

****

HORIZONS ENHANCED U.S. EQUITY INCOME FUND ANNOUNCES MONTHLY DISTRIBUTION

TORONTO, March 22, 2012 — Hori­zons Exchange Traded Funds Inc. (“Hori­zons ETFs”) and its affil­i­ate AlphaPro Man­age­ment Inc. are pleased to announce the monthly dis­tri­b­u­tion of the Hori­zons Enhanced U.S. Equity Income Fund (the “Fund”) for March 2012 in the amount of $0.06667 per Class A unit of the Fund. The Class A units of the Fund are listed for trad­ing on the Toronto Stock Exchange (“TSX”) under the sym­bol HES.UN.

The dis­tri­b­u­tion rep­re­sents an 8.00% annu­al­ized yield on the Fund’s ini­tial pub­lic offer­ing price of $10.00 per Class A unit. The March dis­tri­b­u­tion ex-dividend date is antic­i­pated to be March 28, 2012, for all Class A unithold­ers of record on March 30, 2012. The dis­tri­b­u­tion is payable on April 12, 2012.

Read Com­plete Press Release [PDF] — HORIZONS ENHANCED U.S. EQUITY INCOME FUND ANNOUNCES MONTHLY DISTRIBUTION

For fur­ther infor­ma­tion:
Mar­tin Fab­re­gas, Investor Rela­tions, (416) 601‑2508 or 1–866-641‑5739.

Tags: Complete Press, Distribution Amounts, Distributions, Dividend Reinvestment Plan, Drip, Equity Income Fund, ETF, ETFs, Ex Dividend Date, Exchange Traded Funds, Fabregas, Horizons, Initial Public Offering, Investor Relations, Management Inc, Offering Price, Press Release, Toronto March, Toronto Stock Exchange, Tsx
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Catching the "Silver Crusher" Algorithm in the Act

Thursday, March 22nd, 2012

There was a time when catch­ing the sil­ver "whack-a-mole" algo, or process, or inter­ven­tion, or manip­u­la­tion, or what­ever one wants to call it, in action was a myth: an urban leg­end, per­pet­u­ated by sil­ver con­spir­acy the­o­rists. Until today that is. Cour­tesy of Nanex we now have direct evi­dence of just what the reflex­ive mar­ket (in which deriv­a­tive prod­ucts such as ETFs influ­ence under­ly­ing assets) goes to town by tak­ing sil­ver to the wood­shed at a whop­ping 75,000 times per sec­ond! From the bro­ken mar­ket sleuths at Nanex:  "On March 20, 2012 at 13:22:33, the quote rate in the ETF sym­bol SLV sus­tained a rate exceed­ing 75,000/sec (75/ms) for 25 mil­lisec­onds. Nas­daq quotes lagged other exchanges by about 50 mil­lisec­onds. Nas­daq quotes even lagged their own trades – a con­di­tion we have jok­ingly referred to as fan­tasec­onds." Trans­la­tion: so des­per­ate was the desire to crush sil­ver at pre­cisely 13:22;33, that the Nas­daq order flow direc­tive ended up mov­ing faster than light. Frankly, we don't know about you, but when some­one is will­ing to bend the laws of rel­a­tiv­ity, just to get a cheaper price in sil­ver, to per­pet­u­ate a fail­ing mon­e­tary sys­tem or for any other rea­son, we qui­etly step aside...

From Nanex:

SLV 1 sec­ond inter­val chart show­ing trades col­ored by report­ing exchange.

SLV 1 sec­ond inter­val chart show­ing the NBBO
Shaded black if nor­mal, yel­low if locked (bid = ask) or red if crossed (bid > ask).

SLV 1 mil­lisec­ond inter­val chart show­ing trades col­ored by report­ing exchange.
Chart shows about 200 mil­lisec­onds of time.

SLV 1 mil­lisec­ond inter­val chart show­ing the NBBO
Shaded black if nor­mal, yel­low if locked (bid = ask) or red if crossed (bid > ask). Note the insanely high quote rate in the bot­tom panel. Chart shows about 200 mil­lisec­onds of time.

SLV 1 mil­lisec­ond inter­val chart show­ing the quotes and trades from ARCA (red) and Nas­daq (black).
You can clearly see the delay in Nas­daq quotes, yet their trades aren't delayed at all. Chart shows about 200 mil­lisec­onds of time.

SLV 1 mil­lisec­ond inter­val chart show­ing the quotes and trades from BATS (pur­ple) and Nas­daq (black).
You can clearly see the delay in Nas­daq quotes, yet their trades aren't delayed at all. Chart shows about 200 mil­lisec­onds of time.

SLV 1 mil­lisec­ond inter­val chart show­ing trades col­ored by report­ing exchange.
This chart shows approx­i­mately 150 mil­lisec­onds of time.

SLV 1 mil­lisec­ond inter­val chart show­ing the NBBO.
This chart shows approx­i­mately 150 mil­lisec­onds of time.

Tags: 1 Millisecond, Algorithm, Arca, bottom panel, Conspiracy Theorists, Crusher, Derivative Products, Direct Evidence, ETF, ETFs, Faster Than Light, Interval, Laws Of Relativity, Manipulation, Milliseconds, Monetary System, Nasdaq Quotes, Nbbo, Sleuths, Urban Legend, Whack A Mole, Woodshed
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Falling Treasuries: A Currency Perspective (Merk)

Wednesday, March 21st, 2012

Axel Merk, Merk Funds

March 20, 2012

What are the impli­ca­tions for the U.S. dol­lar and investors’ port­fo­lios if bond prices con­tinue to fall, as they have of late? Within that con­text, should investors care whether the U.S. retains its sta­tus as a “reserve cur­rency”? Should it effect the way investors think about their own cash reserves?

Until the end of last year, China had been a net seller of U.S. Trea­suries for six con­sec­u­tive months, spook­ing some investors that China might start to diver­sify its reserves in earnest. That trend was reversed in Jan­u­ary, when its Trea­sury hold­ings grew by 0.7% in one month to $1.159 tril­lion; year-on-year, China’s hold­ings increased a mere $4.8 bil­lion. China’s year-on-year increase in Trea­sury hold­ings is suf­fi­cient to finance the U.S. cur­rent account deficit for about 3 busi­ness days; that’s a good rea­son why investors should care, as the cur­rent account deficit reflects the amount of U.S. dol­lar denom­i­nated assets for­eign­ers need to buy just to keep the green­back from falling.

Whereas China has taken a breather with regard to pil­ing on U.S. debt, Japan has increased its pur­chases of Trea­suries, pos­si­bly because it is eager to weaken its own cur­rency. Japan’s Trea­sury hold­ings now stand at $1.1 tril­lion. Together, total for­eign hold­ings of U.S. Trea­suries rose 0.9% to a record $5.05 tril­lion in January.

Unfor­tu­nately, for­eign­ers might be attracted to the U.S. dol­lar more for liq­uid­ity and less so for qual­ity con­sid­er­a­tions. Cen­tral banks with bil­lions to deploy are able to do so in U.S. Trea­sury mar­kets with­out influ­enc­ing mar­ket prices too much. Think of it as the upside of issu­ing a huge amount of debt: there’s lots of it one can buy and sell. Liq­uid­ity, how­ever, doesn’t guar­an­tee suc­cess, as the Ital­ian bond mar­ket has clearly shown; when weaker Euro­zone coun­tries are engulfed in a cri­sis of con­fi­dence, Ital­ian bonds have often been sold as a proxy due to the size and depth of the mar­ket. Japan rep­re­sents another large bond mar­ket. Still, the U.S. bond mar­ket dwarfs all of these. When it comes to per­ceived safe havens, Swiss gov­ern­ment bonds may be hard to come by at times; given the erratic actions of the Swiss National Bank in recent months and years, we have to cau­tion that even Switzer­land may not be the safe haven some per­ceive it to be. Mov­ing to Ger­many – con­sid­ered to be a large, mature mar­ket by many – note that even Ger­man Trea­sury bills have been extremely dif­fi­cult to obtain dur­ing stretches of the finan­cial cri­sis, even at neg­a­tive yields.

Indeed, one of the most pos­i­tive global devel­op­ments would be if emerg­ing mar­ket coun­tries develop their domes­tic fixed income mar­kets. If gov­ern­ments, par­tic­u­larly in Asia, were to issue more debt in their domes­tic cur­ren­cies, they would be less depen­dent on U.S. dol­lar fund­ing, reduc­ing the so-called con­ta­gion risk in a finan­cial cri­sis. Ide­ally, emerg­ing mar­kets would fur­ther develop both long-term bond mar­kets, as well as short-term Trea­sury mar­kets. The fol­low­ing exam­ple illus­trates how global mar­kets are so inter­re­lated, and why such a devel­op­ment is so impor­tant: cur­rently, a great deal of emerg­ing mar­ket financ­ing is U.S. dol­lar denom­i­nated, but orig­i­nates from Euro­pean banks. Those Euro­pean banks, with trou­ble at home, are cut­ting their credit lines, to both shrink their loan port­fo­lios, but also as their cost of bor­row­ing U.S. dol­lars soared. That’s because Euro­pean banks his­tor­i­cally obtain much of their U.S. dol­lar financ­ing through U.S. money mar­ket funds. On aver­age, U.S. prime money mar­ket funds held about 50% of their assets in U.S. dol­lar denom­i­nated com­mer­cial paper issued by Euro­pean banks. After lots of pub­lic scrutiny, includ­ing from us (see: Mak­ing the U.S. Dol­lar Safer: Return OF Your Money), those hold­ings fell to about 1/3rd of money mar­ket fund assets in late 2011. As U.S. money mar­ket funds reduced their appetite for debt issued by Euro­pean banks, the Fed­eral Reserve (Fed), in con­junc­tion with other major cen­tral banks, put in place “cen­tral bank liq­uid­ity swaps”, a fancy way of describ­ing U.S. dol­lar loans extended by the Fed to the Euro­pean bank­ing sys­tem via the Euro­pean Cen­tral Bank (ECB) to alle­vi­ate U.S. dol­lar financ­ing con­cerns and ulti­mately, con­ta­gion risks to the global economy.

A key attribute of liq­uid­ity is the abil­ity to take money out of a coun­try. An investor will be more will­ing to invest in a coun­try when there are no cap­i­tal con­trols, when there’s con­fi­dence in the rule of law, con­fi­dence that investors’ rights are pro­tected. And while emerg­ing mar­kets are gen­er­ally on the right path, it’s a path that takes a long time to build, as investors’ trust must be earned over many years.

As such, odds are the reserve cur­rency sta­tus of the U.S. is likely to erode over time rather than overnight, if for no other rea­son than the lack of suit­able alter­na­tives. In our view, how­ever, U.S. pol­icy mak­ers would be well served if they attempted to make the U.S. dol­lar as attrac­tive as pos­si­ble, rather than rely­ing on the fact that for­eign­ers have lim­ited alter­na­tives. As recent years have shown, the Chi­nese, for exam­ple, have gained oper­a­tional expe­ri­ence in deploy­ing their reserves into assets out­side of U.S. Trea­suries, in real assets, through­out the world: notably by invest­ing in nat­ural resources in Aus­tralia, Africa, Latin Amer­ica and Canada.

For many years, until a month ago, the ECB, in its monthly com­mu­niqué, warned of a “poten­tial for a dis­or­derly cor­rec­tion of global imbal­ances.” That was cen­tral bank par­lance for a dol­lar crash. For what it’s worth, the warn­ing was miss­ing for the first time in years in this month’s state­ment.¹ Like the boy who cried wolf, when some­one warns about some­thing repeat­edly, few may take that risk seri­ously any­more. Is it com­pla­cency when one drops the warning?

What many don’t real­ize is that we don’t need a low prob­a­bil­ity / high-risk event – a “black swan” event – to be con­cerned. Take the recent tur­moil in the Trea­sury mar­ket: from the high on Feb­ru­ary 28, 2012 until the close on March 15, 2012, the U.S. 30 year bond had fallen about 8.5% in value (with declines con­tin­u­ing as of this writ­ing). Many have pre­vi­ously been chas­ing yields: a lot of money had moved into longer dated secu­ri­ties, the so-called long end of the yield curve. In that process, volatil­ity in that mar­ket had come down, pro­vid­ing the illu­sion of safety. We don’t need a crash, we need a return to a more nor­mal envi­ron­ment to have what may be a rude awak­en­ing for investors. The plunge in the 30-year bond in just over 2 weeks should serve as a wake-up call. It turns out that for­eign­ers appear to have piled into longer-dated Trea­suries just before the recent cor­rec­tion (net long-term TIC flows of $101 bil­lion in Jan­u­ary vs. $38.5 bil­lion expected), pos­si­bly mak­ing for a few very unhappy, but very impor­tant investors.

What is the rel­e­vance for the dol­lar? For­eign investors tend to own a large amount of Trea­suries. When Trea­suries fall in value, their invest­ments may go down, unless the dol­lar increases by the same amount. While some pun­dits – in an effort to com­ment on short-term cur­rency moves on any one day — point out that falling bond prices make the dol­lar more attrac­tive as yields are higher, that’s lit­tle con­sol­i­da­tion to those already hold­ing Trea­suries. Indeed, his­tor­i­cally speak­ing, our analy­sis indi­cates that the U.S. dol­lar tends to weaken dur­ing early and mid phases of an increas­ing inter­est rate cycle. That’s pre­cisely because the bond mar­ket turns into a bear mar­ket in such an envi­ron­ment. It’s in the late phases of a tight­en­ing cycle that for­eign­ers come back to the bond mar­ket, in antic­i­pa­tion that the next bull mar­ket for bonds is around the cor­ner; in that phase, the dol­lar may get a reprieve.

How­ever, when rates are ris­ing, investors may want to con­sider reduc­ing their inter­est risk, mov­ing from longer dated bond funds to shorter dated ones. Look­ing at it from an inter­na­tional per­spec­tive, the same rela­tion­ship applies; it should not be a sur­prise that the volatil­ity in shorter dated fixed income secu­ri­ties is less than that of longer dated ones:

Per­for­mance data in the chart above rep­re­sents past per­for­mance and is no guar­an­tee of future results.

For investors con­cerned about plung­ing bond prices, the obvi­ous move may be to trim inter­est risk. Some may appre­ci­ate the per­ceived safety of U.S. dol­lar cash, although, as our dis­cus­sion of U.S. money mar­ket funds above has shown, not all cash is equal. Investors con­cerned about the pur­chas­ing power of the U.S. dol­lar may want to con­sider mit­i­gat­ing the poten­tial risk of a declin­ing dol­lar by diver­si­fy­ing to other cur­ren­cies. Be warned, though, that cur­rency risk is then intro­duced. A money mar­ket fund will thrive to hold a sta­ble net asset value in U.S. dol­lar terms; a cur­rency fund will not. Indeed, much of invest­ing is about try­ing to pre­serve pur­chas­ing power. By mov­ing to cash in other cur­ren­cies, one does avoid equity risk, and pos­si­bly mit­i­gates inter­est and credit risk. But risk-free it is not. Indeed, we have argued for a long time that cen­tral banks may be erod­ing the pur­chas­ing power of cur­ren­cies around the world – risk free assets can no longer be thought of as such. It was in 2006 when I first said “there is no such thing any­more as a safe asset: investors may want to con­sider a diver­si­fied approach to some­thing as mun­dane as cash.”

Notes:

Please sign up for our newslet­ter to be informed as we dis­cuss global dynam­ics and their impact on currencies.We man­age the Merk Funds, includ­ing the Merk Hard Cur­rency Fund. To learn more about the Funds, please visit www.merkfunds.com.

¹For­mer ECB Pres­i­dent Willem Duisen­berg men­tioned "risks per­tain­ing to exter­nal imbal­ances" in the first time in March 1999. But he didn't ref­er­ence it again until 2002. (Instead, he men­tioned "there are no major imbal­ances in the euro area which would require a longer-term adjust­ment process" in 2001.) In May 2002, Duisen­berg brought up this topic again at the press con­fer­ence, say­ing "there are still a num­ber of uncer­tain­ties such as those related to ... and to the impact of exist­ing imbal­ances else­where on the world econ­omy". He used the sim­i­lar phras­ing in June, Octo­ber and Decem­ber 2002 but not every meeting.

It was Jan­u­ary 2003 that for the first time Duisen­berg ref­er­enced "a dis­or­derly adjust­ment of global imbal­ances" by say­ing "there are still risks relat­ing to a dis­or­derly adjust­ment of the past accu­mu­la­tion of macro­eco­nomic imbal­ances, espe­cially out­side the euro area." Then he reit­er­ated it a cou­ple of times dur­ing his remain­ing term as ECB pres­i­dent ended in Octo­ber 2003. A note here, cur­rent Greek PM and then ECB vice-president Lucas Papademos hosted the Sep­tem­ber con­fer­ence in 2003, where he also ref­er­enced "macro­eco­nomic imbal­ances in some regions of the world persist."

Since Trichet took office in Novem­ber 2003, it became almost a rou­tine to ref­er­ence "external/global imbal­ances" at the press con­fer­ences, though his word­ing changed over time. Dur­ing Novem­ber 2003 and June 2006, Trichet often used the word "per­sis­tent global imbal­ances" when talk­ing about con­cerns and risks to growth. Then he ref­er­enced "a dis­or­derly unwind­ing of global imbal­ances" for the first time in August 2006. He fre­quently used "pos­si­ble dis­or­derly devel­op­ments owing to global imbal­ances" dur­ing 2007–2008 and "adverse devel­op­ments in the world econ­omy stem­ming from a dis­or­derly cor­rec­tion of global imbal­ances" in 2009, and started to reg­u­larly ref­er­ence "con­cerns remain relat­ing to … and the pos­si­bil­ity of a dis­or­derly cor­rec­tion of global imbal­ances" since Sep­tem­ber 2009, through his last press con­fer­ence in Octo­ber 2011. Dur­ing his eight years in office, the only times he didn't men­tion "global imbal­ance" at all were August 2007, April 2005, and from Octo­ber 2004 to Jan­u­ary 2005.

Draghi con­tin­ued the tra­di­tion of ref­er­enc­ing "the pos­si­bil­ity of a dis­or­derly cor­rec­tion of global imbal­ances" in all of his press con­fer­ences from Novem­ber 2011 to Feb­ru­ary this year. The past meet­ing in March was the first time he didn't ref­er­ence it.

Axel Merk

Man­ager of the Merk Hard Cur­rency Fund, Asian Cur­rency Fund, Absolute Return Cur­rency Fund, and Cur­rency Enhanced U.S. Equity Fund, www.merkfunds.com

Axel Merk, Pres­i­dent & CIO of Merk Invest­ments, LLC, is an expert on hard money, macro trends and inter­na­tional invest­ing. He is con­sid­ered an author­ity on currencies.

The Merk Hard Cur­rency Fund (MERKX) seeks to profit from a rise in hard cur­ren­cies ver­sus the U.S. dol­lar. Hard cur­ren­cies are cur­ren­cies backed by sound mon­e­tary pol­icy; sound mon­e­tary pol­icy focuses on price stability.

The Merk Asian Cur­rency Fund (MEAFX) seeks to profit from a rise in Asian cur­ren­cies ver­sus the U.S. dol­lar. The Fund typ­i­cally invests in a bas­ket of Asian cur­ren­cies that may include, but are not lim­ited to, the cur­ren­cies of China, Hong Kong, Japan, India, Indone­sia, Malaysia, the Philip­pines, Sin­ga­pore, South Korea, Tai­wan and Thailand.

The Merk Absolute Return Cur­rency Fund (MABFX) seeks to gen­er­ate pos­i­tive absolute returns by invest­ing in cur­ren­cies. The Fund is a pure-play on cur­ren­cies, aim­ing to profit regard­less of the direc­tion of the U.S. dol­lar or tra­di­tional asset classes.

The Merk Cur­rency Enhanced U.S. Equity Fund (MUSFX) seeks to gen­er­ate total returns that exceed that of the S&P 500 Index. By employ­ing a cur­rency over­lay, the Merk Cur­rency Enhanced U.S. Equity Fund actively man­ages U.S. dol­lar and other cur­rency risk while con­cur­rently pro­vid­ing invest­ment expo­sure to the S&P 500.

The Funds may be appro­pri­ate for you if you are pur­su­ing a long-term goal with a cur­rency com­po­nent to your port­fo­lio; are will­ing to tol­er­ate the risks asso­ci­ated with invest­ments in for­eign cur­ren­cies; or are look­ing for a way to poten­tially mit­i­gate down­side risk in or profit from a sec­u­lar bear mar­ket. For more infor­ma­tion on the Funds and to down­load a prospec­tus, please visit www.merkfunds.com.

Investors should con­sider the invest­ment objec­tives, risks and charges and expenses of the Merk Funds care­fully before invest­ing. This and other infor­ma­tion is in the prospec­tus, a copy of which may be obtained by vis­it­ing the Funds' web­site at www.merkfunds.com or call­ing 866-MERK FUND. Please read the prospec­tus care­fully before you invest.

Since the Funds pri­mar­ily invest in for­eign cur­ren­cies, changes in cur­rency exchange rates affect the value of what the Funds own and the price of the Funds' shares. Invest­ing in for­eign instru­ments bears a greater risk than invest­ing in domes­tic instru­ments for rea­sons such as volatil­ity of cur­rency exchange rates and, in some cases, lim­ited geo­graphic focus, polit­i­cal and eco­nomic insta­bil­ity, emerg­ing mar­ket risk, and rel­a­tively illiq­uid mar­kets. The Funds are sub­ject to inter­est rate risk, which is the risk that debt secu­ri­ties in the Funds' port­fo­lio will decline in value because of increases in mar­ket inter­est rates. The Funds may also invest in deriv­a­tive secu­ri­ties, such as for– ward con­tracts, which can be volatile and involve var­i­ous types and degrees of risk. If the U.S. dol­lar fluc­tu­ates in value against cur­ren­cies the Funds are exposed to, your invest­ment may also fluc­tu­ate in value. The Merk Cur­rency Enhanced U.S. Equity Fund may invest in exchange traded funds ("ETFs"). Like stocks, ETFs are sub­ject to fluc­tu­a­tions in mar­ket value, may trade at prices above or below net asset value and are sub­ject to direct, as well as indi­rect fees and expenses. As a non-diversified fund, the Merk Hard Cur­rency Fund will be sub­ject to more invest­ment risk and poten­tial for volatil­ity than a diver­si­fied fund because its port­fo­lio may, at times, focus on a lim­ited num­ber of issuers. For a more com­plete dis­cus­sion of these and other Fund risks please refer to the Funds' prospectuses.

This report was pre­pared by Merk Invest­ments LLC, and reflects the cur­rent opin­ion of the authors. It is based upon sources and data believed to be accu­rate and reli­able. Opin­ions and forward-looking state­ments expressed are sub­ject to change with­out notice. This infor­ma­tion does not con­sti­tute invest­ment advice. Fore­side Fund Ser­vices, LLC, distributor.

Tags: Axel, Billions, Bond Market, Bond Prices, Business Days, Canadian Market, Cash Reserves, Central Banks, Current Account Deficit, ETF, ETFs, Eurozone Countries, Foreigners, Good Reason, Greenback, Guarantee Success, liquidity, Portfolios, Quality Considerations, Reserve Currency, Treasuries, Treasury Markets, Trillion, U S Treasury
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Is Popularity Ruining Indexing?

Tuesday, March 20th, 2012

by William Smead, Smead Cap­i­tal Management

We have been trav­el­ing around the world deliv­er­ing a talk to CFA Soci­eties on why pas­sive indexes beat most active equity funds. We start the talk with the fol­low­ing William Sharpe quote from 2002:

“Should every­one index every­thing? The answer is resound­ingly no. In fact, if every­one indexed, cap­i­tal mar­kets would cease to pro­vide the rel­a­tively effi­cient secu­rity prices that make index­ing an attrac­tive strat­egy for some investors. All the research under­taken by active man­agers keeps prices closer to val­ues,
enabling indexed investors to catch a free ride with­out pay­ing the costs. Thus there is a frag­ile equi­lib­rium in which some investors choose to index some or all of their money, while the rest con­tinue to search for mis­priced securities.

Should you index at least some of your port­fo­lio? This is up to you. I only sug­gest that you con­sider the option. In the long run this bor­ing approach can give you more time for more inter­est­ing activ­i­ties such as music, art, lit­er­a­ture, sports, and so on.”

Jason Zweig of the Wall Street Jour­nal wrote a blog last week titled, “Sim­ple Index Funds May Be Com­pli­cat­ing the Stock Mar­ket”. In it he explained how pas­sive invest­ments have risen to 33% of the money in equity mutual funds. He the­o­rizes that all these agnos­tic invest­ments might be adding to the volatil­ity and the high cor­re­la­tions in the marketplace:

“Recently, lead­ing invest­ing experts—including Rod­ney Sul­li­van, edi­tor of the Finan­cial Ana­lysts Jour­nal, con­sul­tant James Xiong of Morn­ingstar Invest­ment Man­age­ment and Jef­frey Wur­gler, a finance pro­fes­sor at New York University—have been warn­ing that index funds could desta­bi­lize the finan­cial markets.

The rise of trad­ing in index funds, these researchers say, is caus­ing stocks to move more tightly together than ever before—as if they “have joined a new school of fish,” as Prof. Wur­gler puts it. That is reduc­ing the power of diver­si­fi­ca­tion and could make booms and busts more likely and more extreme.

Unlike con­ven­tional funds run by highly paid stock-pickers who seek to buy the best secu­ri­ties and avoid the worst, index funds—including most exchange-traded funds, or ETFs—effectively buy and hold all the secu­ri­ties in a mar­ket bench­mark such as the Stan­dard & Poor’s 500-stock index.”

Let us unpack Sharpe’s the­ory, Zweig’s hypoth­e­sis and our man­i­festo on “Long Dura­tion Com­mon Stock Invest­ing”, to see if we can make sense out of today’s stock mar­ket environment.

William Sharpe was an effi­cient mar­ket believer in 2002. His beliefs are pred­i­cated on two ideas. First, “All the research under­taken by active man­agers keeps prices closer to val­ues, enabling indexed investors to catch a free ride with­out pay­ing the costs.” In his research on intrin­sic val­ues in Feb­ru­ary of 2009, Ben Inker at Grantham, Mayo and Van Otter­Loo (GMO) con­cluded that 75% of the intrin­sic value of a com­pany comes from cash flows start­ing 11 years from now and that 50% of the intrin­sic value is from cash flows that come more than 25 years from today. Since there is almost no long dura­tion equity research analy­sis done on Wall Street, the mar­ket can’t pos­si­bly be effi­cient. The stock mar­ket and its par­tic­i­pants have been com­pact­ing the dura­tion of their equity invest­ments con­stantly since the stock mar­ket topped in early 2000. Hold­ing peri­ods are down to his­tor­i­cally low lev­els on the NYSE, insti­tu­tions are heav­ily com­mit­ted to hedge funds with very high turnover and active equity fund man­agers have aver­age turnover around 100%. A man­ager with 50% turnover is con­sid­ered a low turnover manager!

Sec­ond, Sharpe was expect­ing that those who get paid to asset allo­cate would never get so heav­ily involved in index­ing as to ruin the goose that laid the inex­pen­sive and con­sis­tent “golden eggs”. Index­ing suc­cess is pred­i­cated on being a small minor­ity of the mar­ket­place. In effect, its pop­u­lar­ity is doom­ing the strat­egy and mak­ing the mar­ket even more inef­fi­cient than it was before! Between short-sighted active investors and agnos­tic index­ers dom­i­nat­ing the mar­ket, Zweig explains that you get very high cor­re­la­tions and extreme volatil­ity. The volatil­ity dri­ves poten­tial long dura­tion investors away from the marketplace.

“Con­sid­er­ing that index funds charge annual fees about one-10th of those levied by actively man­aged funds, it isn’t any won­der index­ing has become a money mag­net. A decade ago, 278 index mutual funds and 119 exchange-traded funds held $347 bil­lion, or about 16% of all assets in U.S. stock funds. Today, accord­ing to Morn­ingstar, 336 index funds and 1,148 ETFs hold $1.24 tril­lion, or fully one-third of all the money in U.S. stock funds.

That wor­ries some ana­lysts. “Mar­kets work best when peo­ple think and act inde­pen­dently, not all together,” Mr. Sul­li­van says. When investors add money to an index fund, it gen­er­ally will buy every secu­rity in the mar­ket that it tracks—hundreds, some­times thou­sands at a time, regard­less of price. When investors pull money out, the index fund has to sell across the board.”

We believe the solu­tion to these times is at the heart of our man­i­festo. You need to ana­lyze com­pa­nies with a spe­cial focus on char­ac­ter­is­tics which con­tribute to long dura­tion. We like wide moats, sus­tain­able high prof­itabil­ity, high free cash flow and strong bal­ance sheets. GMO likes low beta, low lever­age, high sus­tain­able prof­itabil­ity and low earn­ings volatil­ity. These are all fac­tors which con­tribute alpha over long stretches of time.

In our opin­ion, you either need to be a low turnover stock selec­tor or hire one to be your equity rep­re­sen­ta­tive. War­ren Buf­fett is quoted as say­ing, “The stock mar­ket serves as a relo­ca­tion cen­ter at which money is moved from the active to the patient.” The main attrac­tion to the S&P 500 Index is it has low man­age­ment fees in a mutual fund or ETF form and very low trad­ing costs due to turnover that aver­ages below 5% per year. Boston College’s Cen­ter for Retire­ment Research found that the aver­age US equity fund spent 1.44% per year on trad­ing costs. Add this to man­age­ment fees and oper­at­ing expenses in the mutual fund world and you need the equity man­ager to beat the S&P 500 Index by at least 2.5% per year just to keep up. We strive for turnover in the 15–25% range and seek minis­cule trad­ing costs.

Scarcity cre­ates value in eco­nom­ics. In our view, what is scarce today is an equity man­ager doing long-term/long dura­tion equity analy­sis and institutions/individual investors will­ing to employ them. Since 33% of the stock mar­ket is indexed and most of the other 67% works in very short ana­lytic time frames, we believe the mar­ket must be as inef­fi­cient as it has ever been. Time is the ally of the long-duration com­mon stock investor and we believe more so now, because index­ing is get­ting too pop­u­lar and invest­ing in short dura­tions is at epi­demic lev­els. We won­der what William Sharpe would say today.

***

The infor­ma­tion con­tained in this mis­sive rep­re­sents SCM’s opin­ions, and should not be con­strued as per­son­al­ized or indi­vid­u­al­ized invest­ment advice. Past per­for­mance is no guar­an­tee of future results. Some of the secu­ri­ties iden­ti­fied and described in this mis­sive are a sam­ple of issuers being cur­rently rec­om­mended for suit­able clients as of the date of this mis­sive and do not rep­re­sent all of the secu­ri­ties pur­chased or rec­om­mended for our clients. It should not be assumed that invest­ing in these secu­ri­ties was or will be prof­itable. A list of all rec­om­men­da­tions made by Smead Cap­i­tal Man­age­ment with in the past twelve month period is avail­able upon request.

Copy­right © Smead Cap­i­tal Management

Tags: Art Literature, Coul, Equity Funds, ETF, ETFs, Finance Professor, Financial Analysts Journal, Index Funds, Jason Zweig, Jeffrey Wurgler, Journal Consultant, Morningstar, Music Art, New York University, Passive Investments, School Of Fish, Security Prices, Smead, Traveling Around The World, Wall Street Journal, William Sharpe, Xiong
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Middle Age For The Middle Kingdom

Monday, March 19th, 2012

Fea­tured: GUGGENHEIM CHINA SMALL CAP ETF — Ticker: HAO / NYSE

China is aging and as it leaves its youth­ful days of high-energy growth behind, the mid­dle king­dom will set­tle into a more gen­teel, more com­fort­able middle-aged exis­tence. The impli­ca­tions for investors are many and require a re-think of your invest­ment strategy.

Middle-age has been a few years com­ing but the joint pains were espe­cially sharp this week. Speak­ing at the annual National People’s Con­gress meet­ing, Pre­mier Wen Jiabao low­ered China’s tar­get growth rate and said it would grad­u­ally reduce its depen­dence on capital-intensive growth in favor of strength­en­ing domes­tic con­sumer demand.

Mar­kets reacted instantly. The Shang­hai Shen­zen 300 Index fell nearly 3% and the iShares FTSE China 25 Index ETF (FXI/NYSE) fell more than 6% on the announce­ment. But beyond the instant, is this pol­icy shift really a bad thing? We don’t think so.

My vision of China, shaped by trav­els and by Edward Burtynsky’s hor­ri­fy­ing pho­tog­ra­phy, is one of dirty, heavy indus­try con­sum­ing moun­tains of resources – peo­ple, steel, oil – to pro­duce cheap baubles for export to the world. To have this present give way to a kinder future would be wonderful.

Nor is the present model sus­tain­able. The last decade of lop­sided trade rela­tions between China and the rest of the world were doomed to fail, espe­cially with demand from China’s biggest cus­tomers, Europe and the United States, falling in recent times and aus­ter­ity cuts as far as the horizon.

Then there are China’s inter­nal pres­sures: Eth­nic hatreds spark hin­ter­land riots that are fed by idle poverty; Urban hous­ing is in cri­sis, with a mod­est apart­ment in south China priced at about 45 times the aver­age salary (they joke that a peas­ant would need to have worked from the end of the Tang Dynasty in 907 AD to afford a Bei­jing apart­ment today); iPad and Dell PC assem­blers at Fox­conn rou­tinely use sui­cide as a bar­gain­ing chip. If China did noth­ing, how long would this pres­sure cooker remain intact?

Pre­mier Wen con­fronted these ten­sions. He announced higher min­i­mum wages in the big cities, a 20% increase in edu­ca­tion, health and wel­fare spend­ing, and allow­ing more rural folk to migrate to the cities. The boost in con­sumer spend­ing from these changes will help off­set the loss in demand else­where. He also com­mit­ted to keep­ing a tight rein on prop­erty prices by con­trol­ling spec­u­la­tion and by build­ing more pub­lic, sub­sidised housing.

The evo­lu­tion under­way in China is not unique. Early indus­trial Eng­land with its hell­ish fac­to­ries and impov­er­ished masses even­tu­ally emerged as a more diver­si­fied econ­omy pro­duc­ing more wealth for more of its peo­ple. Could China achieve the same over the next decade? DDB, the ad agency behind Volkswagen’s cute-kid-as-Darth-Vader ad, thinks so. It is mov­ing its cre­ative office to China.

What about for investors? China will still have heavy indus­tries but demand for their out­puts will fall over sev­eral years. And the export-oriented fac­to­ries churn­ing out every­thing from tele­phones to teddy bears will need to tar­get domes­tic con­sumers. Consumer-oriented sec­tors will ben­e­fit: Retail­ers; mak­ers of refrig­er­a­tors, cars and other durables; health-care and pharmaceuticals.

There are sev­eral China ETFs avail­able but few reflect this future China. The biggest ETF is the iShares FXI, with about $7 bil­lion in assets, hold­ing 26 large cap stocks with mar­ket caps of near $100 bil­lion. More than half the ETF by weight is in finan­cials and real estate – two areas of the Chi­nese mar­ket that are best avoided right now. Another 30% is in other large energy, min­ing and indus­trial firms.

For a more Chi­nese consumer-oriented ETF, con­sider instead the Guggen­heim China Small Cap ETF (HAO/NYSE). It holds 230 com­pa­nies and a quar­ter of its allo­ca­tion is to firms like retail­ers, hotels, and food and beer mak­ers. Another quar­ter is in indus­trial firms mak­ing trains, planes and auto­mo­biles. Its expo­sure to banks and real estate is a tol­er­a­ble 16%. Over­all, HAO offers a more diverse slice of the Chi­nese econ­omy and espe­cially the parts that will ben­e­fit from a stronger con­sumer. Other met­rics – div­i­dend yield, price-to-earnings and returns – are also pos­i­tive com­pared to FXI and others.

Aging is rarely pleas­ant but with an ETF like HAO, it can at least be some­what profitable.

The archerETF Global Tac­ti­cal Portfolio

archerETF offers Global Tac­ti­cal Port­fo­lio Management.

Our out­look is Global: we invest across coun­tries, sec­tors, com­modi­ties and other asset classes to improve returns. Our man­age­ment is Tac­ti­cal: we strive to select the right oppor­tu­ni­ties at the right times in response to chang­ing mar­ket con­di­tions to man­age and min­i­mize port­fo­lio risk.

Please call us at TF 1–866-469‑7990 for more information.

Tags: Average Salary, Bargaining Chip, Dell Pc, Edward Burtynsky, ETF, ETFs, Fxi, Internal Pressures, Ipad, Ishares, Joint Pains, Kinder Future, Last Decade, Pc Assemblers, Policy Shift, Premier Wen Jiabao, Shenzen, South China, Steel Oil, Tang Dynasty, Target, Youthful Days
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