The Investing Implications of Price Creep (Koesterich)

Friday, May 18th, 2012

Tuesday’s April Con­sumer Price Index (CPI) report was gen­er­ally received as pro­vid­ing more evi­dence that infla­tion is under con­trol. What many mar­ket watch­ers missed, how­ever, was that core infla­tion, infla­tion exclud­ing volatile food and energy prices, is dis­play­ing a wor­ri­some trend for both con­sumers and investors — price creep, or a grad­ual and almost imper­cep­ti­ble increase in prices.

Here are just a few of the con­cern­ing core infla­tion data points:

1.)    At 2.31%, April’s core infla­tion fig­ure was the high­est since Sep­tem­ber 2008.

2.)    April was the sev­enth month in a row in which core infla­tion was above the Fed’s stated tar­get of 2%.

3.)    April’s core infla­tion read­ing was nom­i­nally above the 20-year average.

To be clear, this doesn’t sug­gest that alarmist pre­dic­tions for Weimar-style infla­tion are about to come true. As I’ve men­tioned before, it’s hard to argue that infla­tion in the United States is about to accel­er­ate in any mean­ing­ful way this year. Wage growth is slow, most of the US man­u­fac­tur­ing sec­tor is still strug­gling with excess capac­ity and up until late last year, the dearth of bank lend­ing pre­vented any accel­er­a­tion in the money supply.

That said, while double-digit infla­tion still looks fan­ci­ful, the rise in core infla­tion shows that prices are slowly creep­ing up and US con­sumers and investors are likely accept­ing, and becom­ing accus­tomed to, higher prices and higher val­u­a­tions with­out even notic­ing. In other words, US con­sumers and investors may be the prover­bial frog in the pot of slowly heat­ing cold water and this is only likely to continue.

High unem­ploy­ment will prob­a­bly pre­vent any mean­ing­ful accel­er­a­tion in wages, though the skills mis­match between employ­ees and poten­tial employ­ers may still result in some wage accel­er­a­tion. In addi­tion, mon­e­tary con­di­tions are no longer quite so innocu­ous when it comes to infla­tion. Bank lend­ing to busi­nesses – mea­sured by com­mer­cial and indus­trial loan demand – is now ris­ing 13% year over year and is close to a 3 ½-year high. Mean­while, M2 has been grow­ing at about 10% year over year since last sum­mer. Though it still takes time for growth in the money sup­ply to trans­late into infla­tion, the mon­e­tary envi­ron­ment is slowly turning.

For investors, there are a cou­ple of implications:

1.)    Rec­og­nize pur­chas­ing power ero­sion: Even if infla­tion sta­bi­lizes at cur­rent lev­els, over the long term 2.3% infla­tion would still cause prices to rise by 50% in less than two decades time. In other words, infla­tion of this mag­ni­tude would cause a one-third ero­sion in pur­chas­ing power over the next 18 years. This is an impor­tant con­sid­er­a­tion for investors with large cash posi­tions. And for bond investors – par­tic­u­larly those with large Trea­sury posi­tions – this is one more rea­son to ques­tion the wis­dom of accept­ing sub-2% yields for the next decade.

2.)    Con­sider equi­ties and com­modi­ties: While uncer­tainty over Europe and Chi­nese growth are likely to keep volatil­ity high this sum­mer, investors should con­sider using near-term mar­ket weak­ness to add to long-term equity and com­mod­ity posi­tions. To be sure, nei­ther asset class is likely to offer double-digit returns over the long term. How­ever, both may help investors keep their pur­chas­ing power from being slowly heated away.

Source: Bloomberg

Russ Koes­terich is the iShares Chief Invest­ment Strate­gist and a reg­u­lar con­trib­u­tor to the iShares Blog.  You can find more of his posts here.

Tags: 3 April, Acceleration, Cold Water, Consumer Price Index, Core Inflation, Cpi Report, Dearth, Energy Prices, Excess Capacity, Index Cpi, Inflation Data, Inflation Figure, Manufacturing Sector, Mismatch, Monetary Conditions, Money Supply, Target, Valuations, Volatile Food, Worrisome Trend
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Berkshire 2012: The Times They Are A-Changing and Other Observations (Matthews)

Tuesday, May 15th, 2012

 
Berk­shire 2012: The Times They Are A-Changing and Other Observations<

by Jeff Matthews

Editor’s Note—

This year we’re uti­liz­ing a shorter, snap­pier way to sum­ma­rize the Berk­shire Hath­away annual meet­ing as a way to spare read­ers the redun­dan­cies in Buf­fett and Munger’s question-and-answer session.

After all, the com­men­tary over­lap with past meet­ings is prob­a­bly 75% nowadays—we’ve even devel­oped a sort of Berk­shire short­hand for our note-taking, writ­ing sim­ply “Gra­ham story” when Buf­fett launches into his dis­ser­ta­tion on the impor­tance of cer­tain chap­ters in Ben Graham’s “The Intel­li­gent Investor,” for exam­ple; “MBA joke” when­ever Buf­fett or Munger make fun of the mean­ing­less (and dan­ger­ous) risk-evaluating mod­els of the aca­d­e­mic world; and “IBK joke” when they go after invest­ment bankers, another favorite target.

Nev­er­the­less, the meet­ing was, as always, interesting.

For one thing, atten­dance was down, notice­ably, even if Buf­fett wouldn’t say so—probably a side-effect of his high, and highly con­tro­ver­sial, polit­i­cal pro­file these days. Also, there was the added (and, we thought, wel­come) pres­ence of insur­ance ana­lysts ask­ing ques­tions for the first time since the very old days when a few pro­fes­sion­als would show up at the Berk­shire cafe­te­ria and fire away.

Over­all, there was a detectable “thrill is gone” sense hang­ing over the week­end. Buf­fett him­self did not show up at some of the side-parties that many of his most loyal share­hold­ers rou­tinely sched­ule, as he did in the past, and even the press com­plained about the tight restric­tions on their cameras.

But Char­lie Munger, push­ing 90, was in great form, and Bono was spot­ted in the crowd, a step up from last year when George Lucas made it.

So there.

—JM, May 2012

Berk­shire Hath­away 2012

Biggest Change: Tighter secu­rity and more of Buf­fett The Ana­lyst than Buf­fett The New-Age Spir­i­tual Guru.
Gone, unfor­tu­nately, was Buffett’s pre-meeting stroll to a seat in the mid­dle of the floor of the arena to watch the kick-off movie (instead he was kept inside the Board of Director’s gated pen, up front near the stage, where beefy guards with ear­pieces and zero smiles stood watch).
Gone, for­tu­nately, were ques­tions like “What should I do with my life?” and “Do you believe in Jesus Christ and do you have a per­sonal rela­tion­ship with God?” (That was actu­ally asked—and answered by Buffett—a few years ago: you can read the answer in our book.)

Best Change: Three insur­ance ana­lysts ask­ing geeky busi­ness ques­tions about Berkshire’s operations—the first time in years Buf­fett has been ques­tioned in depth about the guts of Berk­shire Hath­away.
And while there was grum­bling from the sightseeing-types in the crowd about the tech­ni­cal dis­cus­sion (as well as from ace finan­cial analyst/money man­ager John Hemp­ton, who thought it was not tech­ni­cal enough and wrote about it here, although I knew what John thought before he wrote that because I sat with him), the fact is Buf­fett has got­ten away with very few hard ques­tions about Berkshire’s oper­a­tions in the years since he became a CNBC sta­ple.
Expect fewer atten­dees next year, and the year after, and the year after…but bet­ter questions.

Most Fun: Get­ting to see and hear War­ren Buf­fett dis­cuss the insur­ance busi­nesses in detail thanks to those geeky ques­tions. He didn’t cre­ate the track record of a life­time by luck.

Least Fun: Two rants, both by peo­ple from Boston (where else?)—one about the Lib­erty Mutual scan­dal and the other about Fan­nie Mae/Freddie Mac, both of which Buf­fett and Munger han­dled far more patiently than the crowd.
Also, way too many ques­tions about Berkshire’s lag­ging stock price (it’s a con­glom­er­ate with a bunch of low P/E busi­ness for gosh sakes, not a closet mutual fund run by War­ren Buf­fett any more.) Speak­ing of which...

Most Deli­cious Moment: Char­lie Munger blow­ing off a well-known hedge fund man­ager who used the micro­phone to talk up Berkshire’s stock before lob­bing a soft­ball, “what-am-I-missing” type of ques­tion about the lag­ging stock price.
Rather than respond in Typ­i­cal Pub­lic Com­pany CEO Fash­ion about how Berk­shire was “exe­cut­ing its strate­gic objec­tives” or com­plain­ing the stock was “not reflect­ing the under­ly­ing val­ues of the busi­ness” or reas­sur­ing us that man­age­ment would “pur­sue all means to enhance share­holder value,” as most CEOs would do, Munger sim­ply said: “I wouldn’t worry too much. I think you aren’t really wel­come in this room if that sort of short-term ori­en­ta­tion turns you on.”
And that ended the dis­cus­sion about Berkshire’s stock price.

Least Appre­ci­ated Line: “If you make your buy and sell deci­sions based on what a busi­ness is worth, you’ll make money.”—Warren Buffett.

Most Appre­ci­ated Line: (In response to a ques­tion about suc­ces­sion at Berk­shire after Buffett’s death.) “The good for­tune is not going to go away just because War­ren hap­pens to die. It won’t help him, but...”—Charlie Munger.

Weird­est Moment in the Open­ing Movie: The car­toon, in which the Uni­ver­sity of Nebraska foot­ball team (Buffett’s favorite) plays a Uni­ver­sity of Wash­ing­ton team made up of robots coached by failed/disgraced pres­i­den­tial can­di­date Her­man Cain. (I am not mak­ing this up.)
Worse, dur­ing his half-time pep-talk, Coach Cain made a bunch of 9–9-9 jokes and then urged his men to hit hard, yelling “Take that, sucka!” like a, well, like a stereo­typ­i­cal African-American.
Who thought that would be funny?

Best Com­ment on the Open­ing Movie: “Are they that corny every year?”—John Hempton.

Oh Puh-leeze Moment: When War­ren Buf­fett defended “the Buf­fett Rule” with talk of “shared sac­ri­fice” and the curi­ous claim that his rule applied only to “a very few” peo­ple, mean­ing those with “the 400 largest incomes in the U.S.” which of course is no longer the case, as every­one in the place knew.

You-Could-Hear-A-Pin-Drop Moment: When Buf­fett casu­ally said Todd Combs and Ted Weschler, the recently hired money man­agers at Berk­shire, are being paid “one mil­lion dol­lars a year,” plus incen­tive fees. Buffet’s no fan of “shared sac­ri­fice” when it comes to incen­tiviz­ing his own moneymakers…

A Les­son For Every Money Man­ager Depart­ment: Buffett’s rev­e­la­tion that in all of his and Munger’s years of man­ag­ing Berk­shire together (47 and count­ing), “We’ve never talked about macro stuff.”

Most Sur­pris­ing Applause Line: Becky Quick’s ques­tion on behalf of a man who first noted that his 84 year old father wouldn’t buy Berk­shire stock because of Buffett’s con­stant yap­ping about a Buf­fett tax, and then asked what impact Buffett’s high pro­file might be hav­ing on the stock price. (This got spon­ta­neous, fairly loud applause despite the Buffett-friendly crowd.)

Least Sur­pris­ing Applause Line: Buffett’s response to the young man, which was “I don’t think any­one should have their cit­i­zen­ship restricted” sim­ply because they run a pub­lic com­pany, plus this zinger about the young man’s 84 year old father: “Maybe he oughta own Fox.” (This got louder applause than the ques­tion, naturally.)

Feel-Good Ques­tion, Lit­er­ally and Fig­u­ra­tively: From Andrew Ross Sorkin, on behalf of “many” in the crowd who had urged him via email to ask, “War­ren, how’re you feeling?”

Feel-Good Answer, Lit­er­ally and Fig­u­ra­tively: Buffett’s response to Sorkin, “I feel great.”

Best Munger Retort: (To Sorkin after Buf­fett said “I feel great.”) “I’m jeal­ous. I prob­a­bly have more prostate can­cer than he does.”

Least Inter­est­ing Ques­tion: About gold. ‘Nuf said.

Most Inter­est­ing Ques­tion: “How do the large sov­er­eign debts get bal­anced, and do they con­cern you?”
Buffett’s answer was, “I don’t know how it plays out in Europe…I would totally avoid buy­ing medium or long term gov­ern­ment bonds.” Munger added, “He’s ask­ing the really intel­li­gent ques­tion of the day and we’re hav­ing a hard time answer­ing it.”
For the record, this “really intel­li­gent ques­tion” actu­ally drew applause from the crowd when it was asked, which tells you what’s on people’s minds regard­less of which party they’re vot­ing for in Novem­ber.
Also, for the record, the fel­low who asked it was from Boston, which just goes to show not every­one in that Com­mon­wealth is certifiable.

Least Con­vinc­ing Answer: Buf­fett, asked by the fear­less (and good friend of Buf­fett) Carol Loomis whether buy­ing the Omaha World-Herald news­pa­per was “some self-indulgence?”
The Ora­cle spent a good five min­utes explain­ing how the paper “still tells me some things I can’t find out about else­where,” such as—and I am not mak­ing this up—the obit­u­ar­ies and the wed­ding notices. Nobody was buy­ing it.

Most Con­vinc­ing Answer: Buf­fett and Munger, when asked by one of those geeky insur­ance ana­lysts whether Berk­shire would ever be sub­ject to the Invest­ment Com­pany Act of 1940.
Buf­fett said he’s read the Act “20 times” (and when Buf­fett says he’s read some­thing 20 times, he’s not kid­ding), and “I see no way Berk­shire comes close to that.” Munger said flatly, “We are NOT just an invest­ment company.”

Some­thing Every Investor Should Always Keep in Mind: Asked about why Berk­shire keeps such a large cash reserve, Buf­fett said, “We don’t ever want to go back to ‘Go.’”

Worst Answer: Buf­fett, when asked how Amazon.com will affect Berkshire’s var­i­ous busi­nesses, said, among other things, “It won’t affect Nebraska Fur­ni­ture Mart.”

Best Answer: Munger, to the same ques­tion, “I think it’s ter­ri­ble for most retailers—not slightly ter­ri­ble, really terrible.”

Most Con­cise Answer: Munger, when asked how a busi­ness can “build bar­ri­ers” around itself: “It’s tough. We sort of buy bar­ri­ers, we don’t build them.”

The Sin­gle Most Reveal­ing Com­ment About What Made Berk­shire A Growth Stock And Why It Is No Longer One: “There were times when Ajit [the genius who runs Berkshire’s rein­sur­ance busi­ness] would gen­er­ate bil­lions of float and War­ren would gen­er­ate 20% returns on that float, and that would hap­pen over and over and over…and that was fun.” —Char­lie Munger

One More Mun­gerism Before We Go: “I rejoiced the day I got rid of a stock quot­ing machine. I like this idea of own­ing busi­nesses forever.”

And War­ren Buffett’s Suc­ces­sor as CEO of Berk­shire Hath­away Is Who? The answer is clear. Read all about it in the forth­com­ing 99c mini-eBook on Amazon.com, “Buffett’s Suc­ces­sor: Who it Will Be, Why it Mat­ters.” To be pub­lished by eBooks on Invest­ing this summer.

Jeff Matthews

Author “Secrets in Plain Sight: Busi­ness and Invest­ing Secrets of War­ren Buffett”

(eBooks on Invest­ing, 2012) Avail­able now at Amazon.com

© 2012 Not­Mak­ingTh­isUp, LLC

Tags: Academic World, Answer Session, Berkshire Hathaway, Berkshire Hathaway Annual Meeting, Buffett, Charlie Munger, Dangerous Risk, Insurance Analysts, Intelligent Investor, Investment Bankers, Jeff Matthews, Loyal Shareholders, Political Profile, Redundancies, Shorthand, Spare Readers, Spiritual Guru, Target, Tight Restrictions, Tighter Security
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Emerging Markets Radar (May 14, 2012)

Sunday, May 13th, 2012

Emerg­ing Mar­kets Radar (May 14, 2012)

Strengths

• China’s April Con­sumer Price Index (CPI) was 3.4 per­cent, 0.2 per­cent lower than March but equal to mar­ket con­sen­sus. This is below the gov­ern­ment tar­get of 5 per­cent, leav­ing room for fur­ther mon­e­tary eas­ing if needed.
• Pas­sen­ger vehi­cle sales in April were up 13 per­cent to 1.28 mil­lion units, the China Asso­ci­a­tion of Auto­mo­bile Man­u­fac­tur­ers said Wednes­day. Sales were fore­cast to increase 11.3 percent.
• Indonesia’s real GPD rose 6.3 per­cent for the first quar­ter, in-line with mar­ket expec­ta­tions. In spite of a slow­down from the pre­vi­ous quarter’s GDP growth of 6.5 per­cent, the mar­ket was sat­is­fied with the out­come con­sid­er­ing the head­winds faced by the economies elsewhere.
• Stan­dard & Poor’s sta­ble out­look on Turkey’s long term rat­ing is sup­ported by the agency’s view of the country’s gen­er­ally effec­tive pol­i­cy­mak­ing and insti­tu­tions, its mod­er­ate and declin­ing pub­lic debt bur­den, and its mon­e­tary pol­icy flex­i­bil­ity, said S&P ana­lyst Eileen Zhang.
• Sep­a­rately, Sam Zell spoke at the annual CFA con­fer­ence in Chicago.  He men­tioned that one of his key the­ses in emerg­ing mar­kets is to invest in a coun­try 3 to 4 years before it attains invest­ment grade, because the process keeps pol­icy mak­ers hon­est in the run up to the upgrade.

Weak­nesses

• Russ­ian elec­tric­ity dis­tri­b­u­tion com­pa­nies were denied tran­si­tion to Reg­u­lated Asset Base (RAB) pric­ing by the Fed­eral Tar­iff Ser­vice, throw­ing util­ity sec­tor reform into dis­ar­ray.  The East­ern Euro­pean Fund has no expo­sure to Russ­ian utilities.
• Tai­wan exports dis­ap­pointed again in April, falling at a faster pace of 6.4 per­cent vs. 3.2 per­cent in March, partly due to hol­i­days in China. China’s April trade num­ber was also weak. China’s exports were up 4.9 per­cent vs. the esti­mate of 8.5 per­cent, while imports were up 0.3 per­cent vs. the esti­mate of 10.9 percent.
• China just released April eco­nomic data. April indus­trial pro­duc­tion was up 9.3 per­cent year-over-year, vs. the esti­mate of 12.2 per­cent; retail sales were up 14.1 per­cent, vs. the esti­mated 15.1 per­cent; new loans were RMB681.8 bil­lion, vs. the esti­mate of 780 bil­lion; M2 money sup­ply grew 12.8 per­cent vs. the esti­mate of 13.3 per­cent; and fixed asset invest­ment was up 20.2 per­cent year-to-date, vs. the esti­mated 20.5 per­cent. Due to the weak eco­nomic num­bers, the mar­ket spec­u­la­tion this morn­ing was that the People’s Bank of China (PBOC) will cut the bank reserve ratio tonight.
• The bank of Korea main­tained its bench­mark rate at 3.25 per­cent for the 11th suc­ces­sive month as expected, while Indone­sia also kept its bench­mark rate at 5.75 per­cent, but raised the cen­tral bank rate and term deposits to absorb exces­sive liquidity.
• Else­where in Asia, Malaysia’s indus­trial pro­duc­tion gained only 0.6 per­cent in March, vs. the esti­mated 3.3 per­cent; Philip­pine export unex­pect­edly dropped 1.2 per­cent in March.
• China’s home sales trans­ac­tion value fell 16 per­cent in April from the pre­vi­ous month as the gov­ern­ment reit­er­ated it will keep curbs on the prop­erty market.

Oppor­tu­ni­ties

• A sig­nif­i­cant por­tion of global equity returns comes from the local mar­ket cur­ren­cies effect.  The chart below from BCA Research plots coun­try equity val­u­a­tion along the hor­i­zon­tal axis and pro­pri­etary “cur­rency val­u­a­tion” along the ver­ti­cal axis.  From that per­spec­tive, China, Tai­wan, and Emerg­ing Europe mar­kets look under­val­ued, while Indone­sia, South Korea, and Latin Amer­ica look overvalued.

• In April, China’s power pro­duc­tion growth was less than 1 per­cent, one of the low­est monthly num­bers. If the past is any guid­ance, the Chi­nese equity mar­ket will rally fol­low­ing a dis­mal monthly power generation.

Threats

• One of Russ­ian Pres­i­dent Vladimir Putin’s first acts in his new/old job was to sign a direc­tive for the gov­ern­ment to imple­ment afford­able and com­fort­able hous­ing. Among the tasks set to be achieved by 2018, the gov­ern­ment must bring down the spread between aver­age mort­gage rates and infla­tion to a max­i­mum of 2.2 per­cent.  If imple­mented as such, net inter­est mar­gins at the banks would come under pressure.
• Weaker-than-expected April eco­nomic num­bers strongly sug­gest the People’s Bank of China needs to cut rates or bank reserve ratio to pro­vide liq­uid­ity to the economy.

Tags: Asset Base, Automobile Manufacturers, China Association, China China, Consumer Price Index, Debt Burden, Electricity Distribution Companies, GDP Growth, Gpd, Headwinds, Holidays In China, Index Cpi, Investment Grade, Market Consensus, Market Expectations, Sam Zell, Sector Reform, Stable Outlook, Target, Utility Sector
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Emerging Markets Radar (May 7, 2012)

Monday, May 7th, 2012

Emerg­ing Mar­kets Radar (May 7, 2012)

Strengths

• China’s April PMI went up 20 basis points from the pre­vi­ous month to 53.3 per­cent, a fifth month-over-month increase. In spite of improved read­ing, the PMI is below mar­ket expec­ta­tion for 53.6 per­cent, which caused investors to expect a bank reserve ratio cut to help eco­nomic growth. China HSBC April final flash PMI was 49.3 ver­sus the pre­vi­ous 48.3, indi­cat­ing small busi­ness activ­i­ties are improv­ing, but still in con­tract­ing mode. (PMI below 50 indi­cates man­u­fac­tur­ing activ­i­ties are contracting.)
• The Philippine’s Gov­ern­ment Eco­nomic Plan­ning Sec­re­tary opined that first quar­ter indi­ca­tors are good, and growth could reach the upper range of their 5 to 5 per­cent tar­get for 2012.
• China’s Secu­ri­ties Reg­u­la­tory Com­mis­sion cut trad­ing trans­ac­tion fees by 25 per­cent, which is ben­e­fi­cial to equity mar­ket liquidity.
• Korea’s Con­sumer Price Index (CPI) rose 2.5 per­cent in April, declin­ing to a 21-month low.
• The Russ­ian man­u­fac­tur­ing sec­tor reg­is­tered a pos­i­tive start to the sec­ond quar­ter.  April PMI rose to 52.9 from 50.8 in March, sig­nal­ing the best over­all per­for­mance of the sec­tor in twelve months.
• Turk­ish PMI also rose in April, reg­is­ter­ing 52.3, above the 50 no-change thresh­old for the first time since Jan­u­ary.  Out­put, new busi­ness and buy­ing activ­ity all returned to growth.

Weak­nesses

• China’s April home prices fell to a 14-month low as the gov­ern­ment pledged prop­erty curbs, accord­ing to SouFUN.
• The Philippine’s CPI rose 3 per­cent in April, rebounded from March’s 2.6 per­cent advance which was a 30-month low. April’s appre­ci­a­tion was still lower than 4.0 per­cent in Jan­u­ary, due to higher util­ity, fuel and food costs. Indonesia’s CPI accel­er­ated to a seven-month high in April, increas­ing 4.5 per­cent, in line with mar­ket expec­ta­tion. Thailand’s CPI rose 2.47 per­cent in April, the low­est increase in more than two years due to state sub­si­dies and eas­ing food prices.
• Temasek raised $2.48 bil­lion sell­ing stakes in Bank of China and China Con­struc­tion Bank, a sell­ing trend by early for­eign insti­tu­tional investors that is pos­si­bly approach­ing an end.
• Korea’s exports fell 4.7 per­cent in April, declin­ing for a sec­ond month and exceed­ing esti­mates of a 1.1 per­cent drop.
• Man­u­fac­tur­ing data in Cen­tral Europe fol­lowed the eurozone’s into con­trac­tion ter­ri­tory in April. Pol­ish PMI fell from 50.1 in March to 49.2 in April; Czech PMI fell from 52.1 in March to 48.7 in April, reflect­ing lower new orders, employ­ment, and stocks of purchases.

Oppor­tu­ni­ties

• Turkey’s hopes for invest­ment grade were dashed this week by S&P down­grad­ing its out­look from pos­i­tive to sta­ble.  Still, a tighter bias to cen­tral bank pol­icy should help the lira strengthen from here, accord­ing to the HSBC for­eign exchange strat­egy team.
• The chart below by Bloomberg shows increas­ing trad­ing vol­ume in the Philip­pine stock exchange, explain­ing why the Philip­pine mar­ket has out­per­formed Asian peer’s year-to date and the last year. Mor­gan Stan­ley research shows $829 mil­lion new money has flowed into the Philip­pine stock mar­ket so far this year, encour­aged by bet­ter macro eco­nomic indi­ca­tors and strong cor­po­rate growth prospects.

Threats

• Devel­op­ers in China may need to raise money to improve liq­uid­ity and con­tinue projects under con­struc­tion due to tight­en­ing pol­icy by the government.
• Pol­i­cy­mak­ers in coun­tries such as Brazil and India have been pur­su­ing stim­u­la­tive mea­sures to boost their eco­nomic growth rates.  How­ever, their equity mar­kets in gen­eral and bank stocks in par­tic­u­lar have de-rated sig­nif­i­cantly as a result of such activism. Indone­sia will likely be the next one affected, accord­ing to BCA research.

Tags: Basis Points, Consumer Price Index, Curbs, Economic Growth China, Economic Planning, Emerging Markets, Food Costs, Food prices, Hsbc, Improved Reading, Index Cpi, Manufacturing Sector, Market Liquidity, Pmi, Reserve Ratio, Securities Regulatory Commission, State Subsidies, Target, Transaction Fees, Utility Fuel
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Annualized Rebalancing Premium (Nairne)

Tuesday, April 10th, 2012

by Michael Nairne, Tacita Cap­i­tal

“Buy and hold” is not an effec­tive strat­egy for risk con­scious investors. Any portfolio’s asset mix will drift from its strate­gic tar­get as asset prices move dif­fer­en­tially in response to chang­ing eco­nomic and mar­ket forces. Over time, the higher return assets will com­prise a larger pro­por­tion of the port­fo­lio and dis­tort its return and risk dimen­sions from those orig­i­nally constructed.

Sound port­fo­lio man­age­ment is founded on “buy and rebal­ance”. Rebal­anc­ing involves sell­ing the asset classes that have done rel­a­tively well to buy those assets that have lagged in order to restore the portfolio’s tar­get mix. Rebal­anc­ing is vital in risk man­age­ment since it ensures that a portfolio’s risk dimen­sions stay within an investor’s defined tol­er­ance lim­its. This is illus­trated in the fol­low­ing graph which com­pares the return and risk of a port­fo­lio  com­prised of 40% US bonds and 60% US stocks which was rebal­anced annu­ally (in red) to those of the same port­fo­lio that was never rebal­anced (in orange).

The rebal­anced port­fo­lio expe­ri­enced much lower risk while the never rebal­anced port­fo­lio drifted into a much riskier asset weight­ing dom­i­nated by stocks. Its return was lower but that is because it avoided the esca­lat­ing risk of the never rebal­anced port­fo­lio. Crit­i­cally, the rebal­anced port­fo­lio had bet­ter risk-adjusted performance .

Rebal­anc­ing has a sec­ond vital role in a port­fo­lio. Rebal­anc­ing is a source of diver­si­fi­ca­tion return  that arises from the con­trar­ian act of sell­ing assets that have appre­ci­ated on a rel­a­tive basis and buy­ing the lag­ging assets in order to restore the weights of the tar­get asset mix of a par­tic­u­lar invest­ment strategy.

A return pre­mium is cre­ated by the dis­ci­plined act of reg­u­larly “sell­ing high and buy­ing low” while main­tain­ing the risk pro­file of the port­fo­lio. It can be cal­cu­lated by com­par­ing the return of a rebal­anced port­fo­lio to the weighted aver­age geo­met­ric return of the assets which com­prise the port­fo­lio . An exam­ple of the rebal­anc­ing pre­mium is illus­trated in the fol­low­ing table which sets out the returns of the indi­vid­ual assets in the 40% bond/60% stock port­fo­lio, the weighted aver­age return of the two assets, the return of the rebal­anced port­fo­lio and the rebal­anc­ing premium.

The rebal­anced port­fo­lio had an annu­al­ized return of 8.60% com­pared to the weighted aver­age return of 8.06% for the two assets that com­prise the port­fo­lio.  Rebal­anc­ing resulted in an annu­al­ized return pre­mium of 0.54%.

The rebal­anc­ing pre­mium can be increased by adding more assets when they exhibit the right blend of volatil­ity and covari­ance (i.e. ten­dency to move in tan­dem) with the over­all port­fo­lio — the more volatile the assets added and the lower their covari­ance, the higher the rebal­anc­ing pre­mium. This is illus­trated in the fol­low­ing graph which por­trays the annu­al­ized rebal­anc­ing pre­mium for the period Jan­u­ary 1972 to Jan­u­ary 2012 that resulted from sequen­tially adding asset classes to a two asset port­fo­lio com­prised ini­tially of 40% US bonds and 60% US stocks. The assets added in order are: inter­na­tional stocks, US small value stocks, Cana­dian stocks, US REITs, and finally gold .

The rebal­anc­ing pre­mium more than dou­bled — from 0.44% to 0.99% — as assets were added. It increased ini­tially as inter­na­tional stocks increased rebal­anc­ing oppor­tu­ni­ties. Then, the addi­tion of volatile small cap value stocks had a large pre­mium as its wide return swings cre­ated an even greater rebal­anc­ing effect. Adding real estate and commodity-biased Cana­dian stocks also increased the pre­mium. Finally, adding gold which is very volatile and has a low covari­ance to other assets had a par­tic­u­larly large pre­mium as there were fre­quent oppor­tu­ni­ties for sub­stan­tive rebalancing.

Earn­ing the rebal­anc­ing pre­mium is eas­ier in the­ory than in prac­tice. Sell­ing win­ners to buy losers seems to go against human nature. In fact, the vast major­ity of investors either don’t rebal­ance or don’t rebal­ance as fre­quently as they should .

That’s too bad. Rebal­anc­ing earns a return pre­mium while main­tain­ing the risk pro­file of a port­fo­lio – to para­phrase Scott Wil­len­brock, rebal­anc­ing adds a “free dessert” to the “free lunch” served by diver­si­fi­ca­tion.  Seri­ous investors need to stay seated long enough at the invest­ing table to enjoy both.

Foot­notes:
1. Bond and stock returns are from Ibbotson’s intermediate-term gov­ern­ment bond and large com­pany stock series. Rebal­anc­ing is under­taken on an annual basis.
2. Although not shown, the rebal­anced port­fo­lio had a higher Sharpe Ratio, Sortino Ratio and M-Squared Ratio.
3. Booth, D.G., Fama, E.F., Diver­si­fi­ca­tion Returns and Asset Con­tri­bu­tions, Finan­cial Ana­lysts Jour­nal, Vol. 48, No.3, p. 26–32, May/June 1992.  Booth and Fama define the incre­men­tal return from a rebal­anced port­fo­lio com­pared to the weighted aver­age asset com­pound return as the “diver­si­fi­ca­tion return”.
4. Wil­len­brock, Scott, Diver­si­fi­ca­tion Return, Port­fo­lio Rebal­anc­ing, and the Com­mod­ity Return Puz­zle, Finan­cial Ana­lysts Jour­nal, Vol. 67, No. 4, pp. 42–49, July/August 2011. Wil­len­brock states that “the diver­si­fi­ca­tion return is the dif­fer­ence between the geo­met­ric aver­age returns of both a rebal­anced port­fo­lio of volatile assets and a bal­anced port­fo­lio of hypo­thet­i­cal assets with the same weights and geo­met­ric aver­age returns as the true assets but zero volatil­ity.” Prac­ti­cally, the lat­ter term is the weighted aver­age geo­met­ric return of the assets com­pris­ing the port­fo­lio.
5. All return data is from Morn­ingstar Encorr.  The asset classes are based on the fol­low­ing indices: inter­na­tional stocks — MSCI EAFE; US small value stocks — Fama-French Small Value; Cana­dian stocks — S&P/TSX Capped Com­pos­ite in US$;  US REITs — FTSE NAREIT All Equity REIT; and gold — Lon­don Fix Gold PM US$. Pro­por­tions added vary but are based on prac­ti­cal weight­ing con­sid­er­a­tions. Rebal­anc­ing is under­taken on an annual basis.
6. Alliance­Bern­stein Invest­ment Research and Man­age­ment Asset Allo­ca­tion Research 2005.  Find­ings of a nation­wide tele­phone sur­vey of 1000 investors.

www.tacitacapital.com

Tacita Cap­i­tal Inc. (“Tacita”) is a pri­vate, inde­pen­dent fam­ily office and invest­ment coun­selling firm that spe­cial­izes in pro­vid­ing inte­grated wealth advi­sory and port­fo­lio man­age­ment ser­vices to fam­i­lies of afflu­ence. We under­stand the chal­lenges of afflu­ence and apply the lead­ing research and best prac­tices of top finan­cial aca­d­e­mics and indus­try prac­ti­tion­ers in assist­ing our clients reach their goals.

Tacita research has been pre­pared with­out regard to the indi­vid­ual finan­cial cir­cum­stances and objec­tives of per­sons who receive it and is not intended to replace indi­vid­u­ally tai­lored invest­ment advice. The asset classes/securities/instruments/strategies dis­cussed may not be suit­able for all investors and cer­tain investors may not be eli­gi­ble to pur­chase or par­tic­i­pate in some or all of them. The appro­pri­ate­ness of a par­tic­u­lar invest­ment or strat­egy will depend on an investor's indi­vid­ual cir­cum­stances and objectives.

Tacita rec­om­mends that investors inde­pen­dently eval­u­ate par­tic­u­lar invest­ments and strate­gies, and encour­ages investors to seek the advice of a finan­cial advisor.

Tacita research is pre­pared for infor­ma­tional pur­poses. Nei­ther the infor­ma­tion nor any opin­ion expressed con­sti­tutes a solic­i­ta­tion by Tacita for the pur­chase or sale of any secu­ri­ties or finan­cial prod­ucts. This research is not intended to pro­vide tax, legal, or account­ing advice and read­ers are advised to seek out qual­i­fied pro­fes­sion­als that pro­vide advice on these issues for their indi­vid­ual circumstances.

Tacita research is based on pub­lic infor­ma­tion. Tacita makes every effort to use reli­able, com­pre­hen­sive infor­ma­tion, but we make no rep­re­sen­ta­tion that it is accu­rate or com­plete.  We have no oblig­a­tion to inform any par­ties when opin­ions, esti­mates or infor­ma­tion in Tacita research changes.

All invest­ments involve risk includ­ing loss of prin­ci­pal. The value of and income from invest­ments may vary because of changes in inter­est rates or for­eign exchange rates, secu­ri­ties prices or mar­ket indexes, oper­a­tional or finan­cial con­di­tions of com­pa­nies or other fac­tors. There may be time lim­i­ta­tions on the exer­cise of options or other rights in secu­ri­ties trans­ac­tions.  Past per­for­mance is not nec­es­sar­ily a guide to future per­for­mance.  Esti­mates of future per­for­mance are based on assump­tions that may not be real­ized. Man­age­ment fees and expenses are asso­ci­ated with investing.

Tags: Asset Classes, Asset Mix, Asset Prices, Assets, Buy And Hold, Diversification, Graph, Investment Strategy, Portfolio Management, Portfolio Rebalancing, Proportion, Relative Basis, Retu, Risk Management, Risk Profile, Sound Portfolio, Tacita, Target, Tolerance Limits, Weights
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Tampering with Canadian Pacific risks Canada’s National Dream, in Ackman's Proxy Fight

Thursday, March 29th, 2012

by Jay Nor­den­strom, TalkRail.ca

Is it worth risk­ing an irre­place­able national trans­porta­tion sys­tem for a ques­tion­able promise of a cou­ple of extra pieces of silver?

That’s what Cana­dian Pacific share­hold­ers need to pon­der before vot­ing at the railway’s annual meet­ing in Cal­gary on May 17. Their dilemma results from a messy proxy bat­tle launched by Per­sh­ing Square Cap­i­tal Man­age­ment, a New York hedge fund with own­er­ship stakes in retail­ers J.C. Pen­ney and Tar­get, as well as McDonald’s and Wendy’s.Pershing Square’s CEO, Bill Ack­man, wants share­hold­ers to give him the power to dras­ti­cally revise CP’s board of direc­tors, its man­age­ment and their way of run­ning what is already a prof­itable transcon­ti­nen­tal rail­way. He wants to replace cur­rent CP pres­i­dent Fred Green with for­mer CN pres­i­dent Hunter Har­ri­son, who would return from retire­ment in the U.S. CP prof­its and div­i­dends would allegedly increase rapidly thanks to a new cor­po­rate cul­ture that would include large reduc­tions in loco­mo­tives, freight cars and employees.

On the other side of this dust-up is the cur­rent CP board. It is headed by for­mer Royal Bank of Canada chair­man and CEO John Cleghorn and includes two bright lights recently brought aboard from the U.S. rail indus­try, one of whom was Harrison’s oper­a­tions chief at CN. These heavy­weights and an out­side rail ana­lyst hired by the CP board endorse the cur­rent multi-year growth plan, which was pre­sented to investors in Toronto on March 27. The plan hinges on steady increases in traf­fic, rev­enues and prof­its, as well as cost control.

Per­sh­ing Square’s argu­ment rests on its view that CP has not been per­form­ing as well as CN of late. There is some truth in this, but there are also exten­u­at­ing fac­tors that are being addressed by CP now. A new man­age­ment team totally unfa­mil­iar with CP is unlikely to fix these glitches and mirac­u­lously unlock hid­den value in some­thing as com­plex, cap­i­tal inten­sive and phys­i­cally chal­leng­ing as a 23,700-kilometre, continent-wide rail­way. It’s like expect­ing a super­sized steamship to pull a 90-degree turn mid-ocean.

The real­ity of rail­road­ing is that no two rail­roads are alike. Nor should they be expected to per­form iden­ti­cally. CP and CN han­dle dif­fer­ent mixes of freight traf­fic, take dif­fer­ent routes (even between the same cities) and grap­ple with dif­fer­ent topo­graph­i­cal and cli­matic con­di­tions. These fac­tors can severely affect per­for­mance year-to-year.

The two rail­ways also have widely vari­ant fund­ing his­to­ries. From 1919 to 1995, CN was a Crown cor­po­ra­tion that enjoyed exten­sive pub­lic sup­port. This left a plush infra­struc­ture legacy that con­tin­ues to have a pos­i­tive effect on its per­for­mance as a pri­va­tized railway.

As an investor-owned com­pany through­out its 131-year his­tory, CP has always had to run hard to meet the chal­lenges posed by CN, some large U.S. rail­ways that cross the bor­der and other forms of indi­rectly sub­si­dized trans­porta­tion, such as truck­ing. These chal­lenges have been met and div­i­dends have been paid consistently.

If this CP approach is so flawed, why has CN’s cur­rent pres­i­dent been adopt­ing some of the tech­nolo­gies and customer-friendly ser­vice tech­niques CP has pio­neered and employed for many years?

CP share­hold­ers also need to con­sider the views of major freight ship­pers, who have a huge stake in the future of a nation-spanning rail­way that helps sup­port Canada’s econ­omy, its global com­pet­i­tive­ness and thou­sands of jobs on and beyond its rails. Among those in favour of the CP team’s growth plan are the senior exec­u­tives of min­ing giant Teck Resources, Pater­son Global Foods, Con­sol­i­dated Fast­Frate and Mosaic, the world’s lead­ing pro­ducer of potash and con­cen­trated phosphate.

It’s worth recall­ing the track record of oth­ers who promised untold riches if investors just put cer­tain rail­ways in their hands. As the fourth gen­er­a­tion of my fam­ily to work in and around the rail indus­try, I had a ring­side seat for the fall­out from mis­guided deci­sions to install these prophets of profit at the helm of sev­eral U.S. rail­ways. The result was asset strip­ping, ser­vice cuts, line aban­don­ments, employee lay­offs, insol­vency and gov­ern­ment intervention.

Do unsub­stan­ti­ated claims of ever-increasing CP div­i­dends make Per­sh­ing Square’s bid a risk worth tak­ing? Tam­per­ing with the rail­way long known as our national dream could be dan­ger­ous for investors, ship­pers, employ­ees and the pub­lic. It risks turn­ing CP into a national night­mare. That’s no way to run a railway.

Copy­right © TalkRail.ca

Tags: Bank Of Canada, Bill Ackman, Canadian, Canadian Market, Ceo John, Cp Board, Cp Rail, Freight Cars, Hunter Harrison, J C Penney, John Cleghorn, Mining, National Dream, National Transportation System, New Management Team, Pershing Square, Pershing Square Capital, Pershing Square Capital Management, President Fred, Proxy Battle, Proxy Fight, Royal Bank Of Canada, Steady Increases, Target, Transcontinental Railway
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There is No Such Thing as Harmless Price Inflation

Monday, March 19th, 2012

This arti­cle orig­i­nally appeared in the Daily Cap­i­tal­ist.

A "lit­tle" infla­tion will destroy cap­i­tal, rob you of your sav­ings, dis­rupt all of your long-term finan­cial plan­ning, cre­ate mar­ket insta­bil­ity, and leave you unpre­pared for retire­ment. You can pro­tect your­self and you must.

Price Infla­tion

The Bureau of Labor Sta­tis­tics released their offi­cial Con­sumer Price Index for Feb­ru­ary on Fri­day (up 0.4% MoM; up 2.9% YoY):

We also have the BLS sea­son­ally the so-called "core" mea­sure of prices ex. food and energy (up 0.1% MoM; up 2.2% YoY):

Accord­ing to most econ­o­mists includ­ing the Fed, this "infla­tion" is mod­est and accept­able, if not desir­able. The 2.9% annual rate is more or less within the Fed's tar­get for "inflation."

There is much crit­i­cism about the CPI indi­ca­tors. But, you can pick other mea­sures. In fact infla­tion can be what­ever you want it to be.

For exam­ple, if you are wary of the BLS mea­sures, then there is John Williams of Shad­ow­stats who has two mea­sures. One is based on the same method­ol­ogy that the BLS used in 1990 (up 6.2% YoY):

Or, if you pre­fer, there is his ver­sion of the BLS's 1980 base year method­ol­ogy (up 10.2% YoY):

Or you can use the MIT Bil­lion Price Project annual index which is up 2.8% as of Feb­ru­ary 1:

Another way to look at it is this way, the deval­u­a­tion of the dol­lar since the cre­ation of the Fed:

Today the value of the dol­lar is about 3¢ as mea­sure from1913 when the Fed became our cen­tral bank.

Under­stand that there is a lot of crit­i­cism of each of these mea­sures of prices. What each one is try­ing to tell us is how much our dol­lars have depre­ci­ated from month-to-month and year-to-year.

I don't know which of the above is the cor­rect mea­sure. In fact I don't think there is a cor­rect mea­sure because it is a very com­plex prob­lem to mea­sure prices over time and every­one spends dif­fer­ently. I think the bet­ter mea­sure is more related to money sup­ply, but that is a dif­fer­ent topic. In gen­eral I per­son­ally believe that prices are higher than what the BLS reports, but I'm not a statistician.

I think the most impor­tant thing for us to know is (1) whether or not prices are con­stantly increas­ing at whichever method you choose, and (2) how fast the monthly and annual rates change. Steady price infla­tion will kill you over the longer term. Rapid changes in the rates of change can wipe you out.

I don't mean to state the obvi­ous here, but we all need to pro­tect our­selves from the dollar's deval­u­a­tion or we will become poorer and poorer over time. I bring this up because I don't think most peo­ple under­stand what a "lit­tle infla­tion" can do to one's long-term finan­cial plans. If prices rise a steady 3% per year, for exam­ple, I know my $1,000 sav­ings is going to have to be $1,344 in ten years just to stay even (i.e., it's worth 34% less).

And if you think assets and wages always keep up with prices, the past two reces­sions should dis­suade you from that thought. Right now we have a sit­u­a­tion where the dol­lar is con­tin­u­ing to devalue and work­ers wages are actu­ally going down. Here is Friday's report on real (i.e., infla­tion adjusted) earn­ings (down 0.3%):

If the Fed keeps on cre­at­ing these booms and busts which first lead peo­ple down a path of wealth destruc­tion (what's your house worth now?) and then they devalue the dol­lar (i.e., "print" money) in order to try to stim­u­late a recov­ery but which fur­ther destroys cap­i­tal, how can one get ahead? From the data, it seems that most peo­ple aren't get­ting ahead. In fact the sys­tem is now geared more toward the One Per­centers who thrive on the finan­cial­iza­tion of the economy.

The Fed knows exactly what it is doing. While the offi­cial line is that the U.S. wants a "strong" dol­lar, the Fed and the fed­eral gov­ern­ment are doing every­thing they can to devalue it. Chair­man Bernanke believes that a lit­tle bit of infla­tion is an accept­able trade-off because it spurs eco­nomic growth. Why he thinks the destruc­tion of wealth is the road to wealth is not a mys­tery: it is the foun­da­tion of con­tem­po­rary eco­nom­ics of which he is an advo­cate. He under­stands that print­ing money causes prices to go up, and thus he is con­sciously devalu­ing the dollar.

If print­ing money were the elixir of pros­per­ity, bankers would have made us all rich long ago. It is too bad that Chair­man Bernanke does not under­stand that Fed­eral Notes are not wealth, but eco­nomic nanobots that con­sume and destroy that scarce resource, sav­ings. Only the sav­ings from the prof­its of pro­duc­tion can cre­ate wealth.

What Do I Do?

"What do I do?" is the ques­tion I am asked most often. It depends on your level of wealth, but ... It is likely that the longer-term will see higher price infla­tion than what we are now expe­ri­enc­ing so this is a seri­ous question.

I'm not try­ing to avoid the issue on how to pro­tect your wealth, but we don't give invest­ment advice here. Doc­toRx who fol­lows mar­kets at the Daily Cap­i­tal­ist has an excel­lent track record on invest­ments, so I urge you to pay atten­tion to him.

I will give you some cat­e­gories of invest­ment that any­one seek­ing to pro­tect them­selves from price infla­tion should consider:

Gold. You can buy phys­i­cal gold or shares in com­pa­nies that hold gold. The Doc has rec­om­mended PHYS in the past. The point is that gold is money, and is a refuge against instability.

Oil and Gas. This prod­uct will be in demand until cold fusion or the per­fect sun-powered bat­tery is invented. I like the idea of actu­ally own­ing pro­duc­tion and there are rep­utable drilling pro­grams one can invest in.

Agri­cul­tural production. Food will always be in demand in an unsta­ble world. This usu­ally means invest­ing in ag land, but there are farm­ing part­ner­ships one can invest in if one isn't a farmer.

Stocks and bonds. I'm not a big believer in buy and hold, so you've got to know what you are doing, or you've got to invest in some­one who does. I per­son­ally fol­low Doc­toRx. There are many oth­ers, but you've got to do the research. Be wary of "track records." There are still more Mad­offs out there. The irony is that any­one with a fab­u­lous track record (hedge funds and invest­ment advis­ers) can require mil­lions to hun­dreds of mil­lions to get in. Most of the rest who invite you in even­tu­ally go to the mean (at best) or blow up (worst case).

Off­shore assets. This is a bit of a snake pit, but invest­ing in fast grow­ing com­pa­nies in friendly economies is a way to diver­sify out of the U.S. You can't hide assets from your Uncle Sam, but ... you can get good returns.

These sug­ges­tions aren't new and many advis­ers who fol­low the Daily Cap­i­tal­ist or sites like it (are there any?) say the same things. So I am not telling you any­thing new.

This is a seri­ous game. It is no secret that most Boomers don't have enough assets to allow them­selves to retire. I fear that most retirees will be reliant on the gov­ern­ment to take care of them (Social Secu­rity and Medicare). If you have saved, but stuck the assets in a CD, you are get­ting poorer and poorer as those nanobots destroy your savings. It's not an easy task and you can thank the Fed and the fed­eral gov­ern­ment for that.

Here are my basic rules:

1. You've got to have a plan and you must save. You must not spend all of your income. This seems so sim­ple, yet few peo­ple really do it. There are many books on the topic of plan­ning for retire­ment and how much you need to save. There are retire­ment coun­selors who can help you devise a plan. Just be care­ful of what they are selling.
2. You've got to do your own research and do not accept any­thing on the basis of a word or promise.
3. You must check advis­ers out. Don't accept a demon­stra­tion port­fo­lio, rather ask to talk to other clients and see their real-time results. If they can't pro­vide the infor­ma­tion, go elsewhere.
4. Don't give any­one your money to invest with­out keep­ing it in a seg­re­gated account. I under­stand that there are part­ner­ship deals and mutual funds where this isn't pos­si­ble. Invest­ment advis­ers can have dis­cre­tionary author­ity, but the money should remain in your name.
5. Does the per­son or firm giv­ing advice have deep pock­ets? Are they audited by a promi­nent company?
6. Don't pay atten­tion to those who sell fear. We've all seen the ads on the Web about the cer­tainty of immi­nent col­lapse. I'm not exactly an opti­mist about the econ­omy, but fear as a sales tool has a false ring.
7. Gen­er­ally those who have been around a long time have some cred­i­bil­ity and stay­ing power. Of course Mad­off was a Wall Street fix­ture, but there is a good exam­ple of accept­ing his word on faith.
8. Stock bro­kers sell what their com­pany tells them to sell. If they were really good, they would be run­ning their own invest­ment firm. As we have seen even the "great" com­pa­nies such as Gold­man Sachs can fail to serve their clients' interests.
9. Pay atten­tion to the busi­ness cycle. This is one of the things we try to ana­lyze here at the Daily Cap­i­tal­ist. Where you are in the cycle is one of the most impor­tant thing an investor can know. Buy­ing a home in 2008 would have been a bad move. Buy­ing groceries.com before the Dot­com crash would have been a bad move.
10. If it's too good to be true, it isn't. Of course this is the Ponzi scheme hook. My the­ory is that boom-bust busi­ness cycles have cre­ated a meme of con­stant spec­u­la­tion in our soci­ety. Peo­ple think that "the Big Guys" always have the inside scoop and that's why they get rich (but see Lehman Bros.). They lose out on one cycle and when the next one starts and mak­ing money seems easy, they want in. This leads to sus­cep­ti­bil­ity to Ponzi artists and advis­ers who con­fuse their boom phase suc­cess with intel­li­gence (they quickly blow up in the bust).

This is hard work. But remem­ber that we are all in the same boat.

Good luck.

Copy­right © Daily Cap­i­tal­ist

Tags: agricultural, Annual Index, Bls, Bureau Of Labor, Bureau Of Labor Statistics, Capitalist, Consumer Price Index, Core Measure, Correct Measure, CPI, Devaluation Of The Dollar, Economists, Financial Planning, John Williams, Market Instability, Measures, Methodology, Money Supply, Price Inflation, Shadowstats, Target
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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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12-Mo. Target “Street” Consensus: S&P 500 Up 7.41% to 1509

Monday, March 19th, 2012

Based on apply­ing Street Con­sen­sus for each indi­vid­ual S&P 500 stock to the market-cap weight of the stock in the index, to arrive at the over­all consensus.

Tags: Amp, Consensus, Market Cap, Stock Market, Target
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Albert Edwards: JPY Devaluation Exacerbates Risk of China Hard Landing, Drags them into Currency war

Thursday, March 8th, 2012

by Daily Colat­eral

"What do peo­ple think will hap­pen if another reces­sion strides into sight any time soon? We are a hair's breadth or, more exactly, one reces­sion away from a mar­ket panic on out­right defla­tion — a panic that will send the cen­tral banks into a print­ing frenzy that will make their bal­ance sheet expan­sion so far seem like a warm-up act for the main show." Albert Edwards in his lat­est note, tak­ing a look at wage infla­tion (or lack thereof) in the United States:

Edwards calls the cur­rent envi­ron­ment the "Ice Age real­ity of ever lower nom­i­nal quan­ti­ties" and ref­er­ences Lak­sh­man Achuthan of ECRI's recent inter­view in which he reaf­firmed his call for a reces­sion in the U.S. as well as John Hussman's lat­est com­ment, which dis­cusses the same.

Albert Edwards' Soc Gen col­league Dylan Grice in his most recent note described the deci­sion behind the Bank of Japan's lat­est move to ease fur­ther, weak­en­ing the yen. Fur­ther, cur­rent infla­tion expec­ta­tions remain below tar­get in many DM economies, pro­vid­ing cen­tral banks fur­ther jus­ti­fi­ca­tion to con­tinue printing.

Edwards notes that Asian cur­ren­cies like the Korean won haven't been taken down by the BoJ move yet due to the risk rally that's played out so far this year, but sees that chang­ing if mar­kets reverse. Then, Edwards points out that "if the yen's decline takes other Asian cur­ren­cies lower, it would leave the ren­minbi as the anom­alously strong cur­rency in the region — much to the annoy­ance of the Chi­nese author­i­ties," like so:

This, of course, will not sit well with Chi­nese author­i­ties, who are cur­rently deal­ing with a ren­minbi at all-time highs in real terms, which is nec­es­sar­ily fore­bod­ing for the Chi­nese export situation:

Edwards on the inevitable consequences:

We have long stated that if the Chi­nese econ­omy looks to be hard land­ing, as we believe it will, the author­i­ties there will actively con­sider ren­minbi deval­u­a­tion, despite the polit­i­cal con­se­quences of such action. The ren­minbi deval­u­a­tion option is widely ignored by the mar­kets in the same way they ignore the like­li­hood that the Chi­nese econ­omy is hard land­ing. The deval­u­a­tion option should be seen as "in play" how­ever unthink­able it is believed to be at present.

Tags: All Time Highs, Asian Currencies, Bank Of Japan, Central Banks, Chinese Authorities, Chinese Economy, Chinese Export, Colateral, Currency War, Devaluation, Ecri, Grice, Inevitable Consequences, Inflation Expectations, John Hussman, Lakshman, Market Panic, Renminbi, Target, Wage Inflation
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Sharpen the Mower: Spain Needs Triple the Budget Cuts and Tax Hikes to Meet EMU Imposed Budget Targets

Thursday, March 1st, 2012

Con­di­tions in Spain have dete­ri­o­rated at a rapid pace. As lit­tle as a few months ago the Span­ish econ­omy was fool­ishly pro­jected to grow at .7%. Now it expected to con­tract 1%.

Like­wise, Spain's bud­get deficit was sup­posed to shrink to 6% in 2011 and 4.4% in 2012. Instead it rose to 8.51 per­cent in 2011, up from a revised esti­mate of 8.2% which was up from a revised esti­mate of 6.5%.

I think you can see a clear pat­tern here and as a result, the EU Com­mis­sion Pres­sures Spain for Expla­na­tions.

Spain must explain soon to the Euro­pean Com­mis­sion why its 2011 bud­get deficit was sub­stan­tially higher than expected and deliver clear future bud­get plans, the Com­mis­sion said on Tuesday.

Spain's 2011 bud­get deficit came to 8.51 per­cent of GDP, the finance min­is­ter said on Mon­day, up from early esti­mates of 8.2 per­cent and far above fore­casts from the Com­mis­sion for some­thing nearer 6.5 percent.

"We need to under­stand the causes of this sig­nif­i­cant slip­page," Com­mis­sion spokesman Olivier Bailly told a reg­u­lar brief­ing in Brussels.

Spain will have to come up with more than 40 bil­lion euros in sav­ings to meet that tar­get, imply­ing spend­ing cuts that most econ­o­mists see as impos­si­ble given that the econ­omy is already slip­ping into reces­sion and the job­less rate is the high­est in the Euro­pean Union at 23 percent.

Bailly said Spain also needed to deliver its 2012 bud­get esti­mates in the com­ing weeks, not at the end of March, say­ing the task in hand was so great it could not be delayed.

Sharpen the Mower

My friend Bran notes that Spain now needs to come up with another 30 bil­lion Euros in bud­get cuts on top of the 15 bil­lion promised. More­over, those cuts need to be spread out over 9 months, not 12.

This set of facts prompted the Span­ish Gurus Blog to write Sharpen the mower. Spain's deficit exceeds 90 bil­lion euros.

Specif­i­cally, Spain's bud­get deficit is 91.3 bil­lion euros, 8.51% of GDP. So it should not take a wiz­ard to real­ize the sim­ple math­e­mat­i­cal fact that team Rajoy has not yet begun with bud­get cuts and tax increases, if by 2012 Spain is to meet the 4.4% of GDP deficit tar­get set by creditors.

The mea­sures announced in Decem­ber were only an appe­tizer. Instead of sharp­en­ing the blades, I think a good lawn mower would be more practical.

The announced cuts and tax increases of last Decem­ber (income tax, cap­i­tal gains), are expected to gen­er­ate about 14,900 million.

To meet the objec­tive of a 4.4% deficit, in 2012 the gov­ern­ment deficit should not exceed 46,500 mil­lion euros.

To do so requires a nearly 30 bil­lion euros hole to be filled, with the aggra­vat­ing cir­cum­stance that it's now March and those 30 bil­lion euros need to come in the next 9 months.

This fig­ure is dou­ble the cuts and tax increases approved last Decem­ber. So Rajoy has quite imag­i­na­tion if he expects this to happen.

I mod­i­fied that trans­la­tion sub­stan­tially, but I am pretty sure I have it accu­rate. Spain's unem­ploy­ment is already 22.9%. What pray tell would another 30 bil­lion in cuts or tax hikes do to that number?

By the way, to go from 15 to 45 is tripling (not dou­bling) the tax hikes and cuts.

Many struc­tural reforms per­tain­ing to jobs and work rules are quite nec­es­sary. The accom­pa­ny­ing tax hikes are not and the Span­ish econ­omy is poised to implode as a result.

Not to worry, EU com­mis­sioner Jean-Claude Juncker promises to "exam­ine the sit­u­a­tion with calm and seren­ity".

Mike "Mish" Shed­lock
http://globaleconomicanalysis.blogspot.com

Tags: 9 Months, Bailly, Bran, Budget Cuts, Budget Deficit, Budget Estimates, Budget Targets, Commission Spokesman, Economists, Eu Commission, European Commission, Finance Minister, Gurus, Imposed Budget, Jobless Rate, Rapid Pace, Recession, Slippage, Spanish Economy, Target
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Confused By The Market? Here Is What The Smart Money Is Doing

Sunday, February 26th, 2012

Want to get into the head of a hedge fund man­ager, and see how they view the mar­ket: why just buy Apple of course, how­ever good luck explain­ing to your LPs why you deserve 2 and 20 for "active asset man­age­ment" aka just fol­low­ing the herd into the biggest hedge fund hotel in his­tory (for at least 216 hedge funds it may be a tough sell). So for every­one else, Goldman's David Kostin (who still has a 1250 year end S&P tar­get — the defin­i­tive indi­ca­tor to sell every­thing will be when he too gives up) has com­piled the data in all the just released 13Fs and has sum­ma­rized the results as follows...

From Gold­man

Our most recent Hedge Fund Trend Mon­i­tor report ana­lyzed 674 hedge funds with $1.1 tril­lion of gross equity posi­tions con­sist­ing of $715 bil­lion of long single-stock and ETF equity assets and an esti­mated $383 bil­lion of short single-stock and ETF posi­tions. We have pub­lished our Hedge Fund Trend Mon­i­tor quar­terly for the past six years and ana­lyzed constituent-level port­fo­lio hold­ings of US hedge funds since 2001. The cur­rent report focuses on hedge fund posi­tions at the start of 1Q 2012 and is based on 13-F fil­ings as of Feb­ru­ary 15, 2012. We high­light 7 conclusions:

1. The typ­i­cal hedge fund oper­ates 46% net long ver­sus 36% in 3Q 2011. Aggre­gate net expo­sure equals $332 bil­lion. We esti­mate 17% of short posi­tion­ing is con­ducted via ETFs with 13% occur­ring at the index level.

2. Com­bin­ing long and short posi­tion data, hedge funds have the great­est net port­fo­lio expo­sure to Infor­ma­tion Tech­nol­ogy (21%), Con­sumer Dis­cre­tionary (20%), and Energy (14%). Hedge funds are not bench­marked but rel­a­tive to the Rus­sell 3000 uni­verse they are 800 bp over­weight Con­sumer Dis­cre­tionary (20% vs. 12%) and 750 bp under­weight Con­sumer Sta­ples (3.5% vs. 11.0%). Net expo­sure rose in every sec­tor in 4Q.

3. Turnover of all hedge fund hold­ings aver­aged just 28% dur­ing 4Q 2011, an all time low. The top quar­tile of posi­tions (largest hold­ings)  turned over just 14% while the bottom-quartile (small­est posi­tions) turned over 41%. Since 2001, quar­terly turnover of fund posi­tions aver­aged 35%, peak­ing in 4Q 2008 at 45% but falling steadily since. Turnover fell in 4Q in all sectors.

4. Hedge fund returns are highly depen­dent on the per­for­mance of a few key stocks. The typ­i­cal hedge fund has an aver­age of 64% of its long equity assets invested in its 10 largest posi­tions com­pared with 34% for the typ­i­cal large-cap mutual fund, 18% for a small-cap mutual fund, 20% for the S&P 500 and just 2% for the Rus­sell 2000 index.

5. Apple (AAPL) mat­ters. One out of five long/short hedge funds has AAPL among its ten largest long posi­tions and approx­i­mately 30% of  hedge funds own at least one share of AAPL. When it ranks among the top ten hold­ings, AAPL rep­re­sents an aver­age of 8% of single-stock long equity expo­sure. In aggre­gate, hedge funds own only 4% of AAPL equity cap. The aver­age hedge fund AAPL posi­tion equals 1.6%, given 70% of funds own no AAPL.

6. Five stocks have been in our VIP bas­ket since incep­tion in 2007 (18 quar­ters). AAPL, GOOG, MSFT, QCOM, and CVS have ranked among fundamentally-driven hedge funds’ top 10 hold­ings for more than 5 years. AAPL (+195%), QCOM (63%) and CVS (12%) out­per­formed the S&P 500 return of 4% dur­ing the same period. MSFT (-4%) and GOOG (-8%) lagged.

7. Turnover for the VIP bas­ket in 4Q 2011 was below the his­tor­i­cal aver­age. 12 new con­stituents entered the VIP bas­ket in 4Q 2011 com­pared with an aver­age quar­terly turnover of 17 stocks since 2001. New con­stituents include the fol­low­ing: BAC, DLPH, ESRX, HAL, HPQ, LMCA, MCD, PXD, PCLN, STX, TYC, and VIAB. The fol­low­ing stocks are no longer in the bas­ket: AMT, ABX, CHK, CMCSA, CCI, EMC, EXPE, HES, M, ORCL, PG, and WLP. Exhibit 50 on page 17 con­tains a list of all 50 cur­rent con­stituents in our VIP basket.

Tags: 3q, Consumer Staples, Current Report, Definitive Indicator, Equity Assets, Equity Positions, Fund Positions, Hedge Fund Manager, Hedge Funds, Index Level, Kostin, Portfolio Holdings, Position Data, Quartile, Russell 3000, S David, Short Position, Smart Money, Target, Tough Sell
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Many Questions Around the Second Greek Bailout Remain Unanswered

Tuesday, February 21st, 2012

Think this time around finally the Greek deal is done? Think again. OpenEu­rope lists the "many" ques­tions still sur­round­ing the sec­ond Greek bailout that remain unan­swered. We would add that this is hardly an exhaus­tive list, and believe the key ques­tion, to put it sim­ply, is a CAC is a MAC? Because if the answer is yes, the deal is off.

From OpenEu­rope

Many ques­tions around the sec­ond Greek bailout remain unan­swered

We finally have an agree­ment on the sec­ond Greek bailout…in prin­ci­ple. It only took eight months. If you’re of the belief that a dis­or­derly Greek default would have trig­gered Armaged­don, the deal that was agreed (as ever ‘agreed’ is used loosely) by Euro finance min­is­ters in the early hours of this morn­ing is broadly good news.

Unfor­tu­nately, it is once again hope­lessly opti­mistic and con­tains numer­ous gaps and unan­swered ques­tions which could still bring down the whole deal. This is nowhere out­lined bet­ter than the damn­ing leaked debt sus­tain­abil­ity analy­sis (see here for full doc).

Below we out­line a few key issues (not exhaus­tive by any means, there are many more) and give our take on how they could play out.

Greater losses for pri­vate sec­tor bond­hold­ers: Reports sug­gest the Greek gov­ern­ment was sent back to the nego­ti­at­ing table with bond­hold­ers at least four times dur­ing last night’s meet­ing. Nom­i­nal write downs for bond hold­ers now top 53.5% (or around 74% net present value). The leaked Greek debt sus­tain­abil­ity analy­sis (DSA) assumes a par­tic­i­pa­tion rate of 95%.

Open Europe take: 95%, really? We weren’t con­vinced the pre­vi­ous thresh­old of 90% with a lower write down would be reached and that was while poten­tial ECB par­tic­i­pa­tion was still on the table. Although this tar­get may have been agreed with the lead nego­tia­tors for the pri­vate sec­tor, it is far from a cohe­sive group, dimin­ish­ing the value of the agree­ment. It will be inter­est­ing to see how bond­hold­ers respond to the plan but we think that hold outs could well be more than 5%.

Greek ‘prior actions’: The deal includes a list of require­ments which Greece must meet in the next week to get final approval for the bailout. These include: pass­ing a sup­ple­men­tary bud­get with €3.3bn in cuts this year, cuts to min­i­mum wage, increase labour mar­ket flex­i­bil­ity and reforms open­ing up numer­ous pro­fes­sions to greater competition.

Open Europe take: The now infa­mous €325m in cuts still needs to be spec­i­fied. The huge adjust­ments to labour mar­kets and pro­tected pro­fes­sions mark a cul­tural shift in Greece – push­ing these through will not be pain­less and could result in fur­ther riots.

Fun­da­men­tal ten­sions in objec­tives of the pro­gramme: The DSA notes that the prospect achiev­ing a return to com­pet­i­tive­ness while also reduc­ing debt is very small – the mas­sive aus­ter­ity could induce a fur­ther recession.

Open Europe take: As we have noted all along the assump­tion that Greece can impose mas­sive lev­els of aus­ter­ity and then return to growth in the next two years is a big leap and almost inher­ently con­tra­dic­tory. We’d also note that the cuts in expen­di­ture in Greece are larger than have been attempted any­where in recent mem­ory (suc­cess­ful or failed). Likely to be sub­stan­tial slip­pages in the aus­ter­ity pro­gramme while the growth pro­gramme remains almost non-existent, essen­tially clos­ing the book on Greek debt sustainability.

Fur­ther favourable treat­ment for the ECB: ECB and national cen­tral banks avoid tak­ing losses on their hold­ings of Greek bonds but promise to redis­trib­ute ‘prof­its’ from these hold­ings so that they can be used in Greece.

Open Europe take: See our pre­vi­ous post for a full dis­cus­sion of this issue. Mar­kets still don’t seem too wor­ried by sud­denly being sub­or­di­nated by cen­tral banks in Europe – they should be. This raises ques­tions of the basic premise that all bonds are treated the same, based on who issued them not who holds them. As we’ve noted before, the whole con­cept of ‘prof­its’ is mis­lead­ing, while any dis­tri­b­u­tion would hap­pen any­way – this is not a com­mit­ment from cen­tral banks but a fur­ther fis­cal com­mit­ment by the euro­zone (should really be included in total bailout funding).

Greece may not be able to return to the mar­ket even after three years: The DSA points out that any new debt issue will essen­tially be junior to exist­ing debt, ham­per­ing the chances of Greece issu­ing new debt in 2014/2015.

Open Europe take: This point isn’t too clear but given that the euro­zone, IMF and ECB will own such a larger per­cent­age of Greek debt in 2014 any new pri­vate sec­tor debt will be mas­sively sub­or­di­nated and at risk of tak­ing losses if any­thing goes wrong with the Greek pro­gramme. Addi­tion­ally after the restruc­tur­ing the remain­ing pri­vate sec­tor debt will be gov­erned under Eng­lish law and will have the EFSF sweet­ener – fur­ther sub­or­di­nat­ing any new debt issued to the mar­ket. Why would any­one want to pur­chase Greek debt in this sit­u­a­tion (espe­cially given the other con­cerns above)?

EFSF fund­ing require­ments: The EFSF will have to raise €70.5bn ahead of the bond swap – €30bn in sweet­en­ers for the pri­vate sec­tor, €5.5bn to pay off inter­est and €35bn to pro­vide Greek banks with assets to use to gain liq­uid­ity from the ECB.

Open Europe take: We’ve already ques­tioned whether rais­ing these funds so quickly can be done and whether the approval from national par­lia­ments will be forth­com­ing. Even if it is the €35bn is said to fall out­side of the €130bn mean­ing it is expected to be returned swiftly – given the uncer­tainty over how long banks will need these assets (as long as Greece as declared as in selec­tive default by the rat­ing agen­cies) this may be a gen­er­ous assumption.

There is also no talk of the money to recap­i­talise banks. This is a risky strat­egy given that Greek banks’ main source of cap­i­tal (gov­ern­ment bonds) will have just been wiped out sig­nif­i­cantly. The needs were pre­vi­ously spec­i­fied at €23bn, although reports now sug­gest they could top €50bn. It’s not clear where this money will come from or when it will be raised. The bond restruc­tur­ing will be like danc­ing through a mine­field for Greek banks.

We’re still trawl­ing through the responses, analy­sis and doc­u­ments to come out of the meet­ing – mean­ing there are likely to be plenty more ques­tions and uncer­tain­ties to come.

The one thing that is clear is that even if this bailout is ‘suc­cess­ful’, it will set Greece up for a decade of painful aus­ter­ity and low growth lead­ing to social unrest, while the euro­zone will have to pro­vide on-going trans­fers to help it keep its head above water.

Sorry to be killjoys but as Dutch Finance Min­is­ter Jan Kees de Jäger put it, the deal isn’t “some­thing to cheer about”.

Tags: Armageddon, Bailout, Bond Holders, Bondholders, Cac, Cohesive Group, Debt Sustainability Analysis, Dsa, Eight Months, Finance Ministers, Gaps, Greek Government, Least Four Times, Negotiators, Net Present Value, Open Europe, Participation Rate, Private Sector, Target, Unanswered Questions
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Do They Or Don't They? Will They Or Won't They?

Friday, February 17th, 2012

Sub­mit­ted by Peter Tchir of TF Mar­ket Advisors

It’s hard to believe that here we are again try­ing to fig­ure out what Europe will do over the week­end.  In our case a long weekend.

In spite of the fact that the Greek story has been out there for almost 2 years now, it still dri­ves the mar­ket.  Vir­tu­ally all of the big moves this week came on the back of Greek head­lines so it is impos­si­ble to argue that it is “priced in”.  My best guess is that a res­o­lu­tion (which the mar­ket believes is most likely) sparks a 2%-4% rally.  A default (which I think is most likely) sparks a 5%-10% decline.  So at these lev­els I will be short as I think the most likely move is lower, and the move lower is likely to be big­ger.  With the mar­ket being choppy, being nim­ble remains a key.

Yes­ter­day was one of the big­ger swings we’ve had.  The S&P moved almost 2% and is start­ing to feel like it did last fall – either extremely well bid with no sell­ers, or feel­ing ugly with no buy­ers and almost no mid­dle ground.  Be care­ful about high yield.  Every­one is still talk­ing about the “flows” but although JNK has been able to attract some new money, HYG has not added a sin­gle share this week. HY may be cheap, but if the new flows dry up, it will strug­gle from here.

The CPI data is also impor­tant.  The fed has set a 2% “tar­get” and talks and acts like we are run­ning below that rate, when in real­ity, infla­tion is above their tar­get. An upside sur­prise here would be bad for the mar­kets as it would be yet another argu­ment against QE.  The eco­nomic data has been good (though I believe influ­enced by unsea­son­ably good weather), but the mar­ket is impacted by the hopes of QE, so asides from Greece, that is the other big story to watch.

The mar­ket has a ten­dency to do well after the credit guys leave on hol­i­day short­ened trad­ing days.  So with the desire to believe that Europe will not let Greece default (in spite of evi­dence to the con­trary) the mar­kets may remain in rally mode for the day because no one wants to miss the immi­nent res­o­lu­tion of the cri­sis.  I am far more con­vinced that we will get some very dis­ap­point­ing head­lines because the sit­u­a­tion really doesn’t work, and the tone of Europe has switched from “No Default” to “No Dis­or­derly Default”.

Tags: Amp, Best Guess, Cpi Data, Decline, Economic Data, Evidence To The Contrary, Good Weather, Greece, Greek Story, Hy, Hyg, inflation, New Money, Qe, Rally, Spite, Swings, Target, Tendency, Upside Surprise
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Has PIMCO Become Too Big To Fail?

Saturday, February 11th, 2012

While I knew PIMCO was mas­sively influ­en­tial dur­ing the finan­cial cri­sis, I did not real­ize a mutual fund shop could poten­tially be thrown in with banks as "sys­tem­at­i­cally impor­tant" insti­tu­tions.  But con­sid­er­ing just how many bonds they own, I guess it makes sense.  Obvi­ously, Mr. Gross is not happy with this poten­tial sit­u­a­tion, as it would come with more cost and oversight.

But if push comes to shove and there is some sort of bond dis­as­ter down the road, I am sure the Fed would just do QE8 and tar­get all PIMCO's portfolio.

Lengthy story but some snip­pets below via Reuters:

• He is the man who made bond invest­ing sort of sexy – and now he may pay the price.   Over more than three decades, Bill Gross, co-founder of asset-management giant PIMCO, has made so much money for clients that he has become the barom­e­ter by which other bond traders are judged. His West Coast perch, pre­scient calls on the U.S. econ­omy and devo­tion to yoga only added to the mystique.
• But the very recipe that enabled Gross to dom­i­nate his indus­try may now be con­spir­ing against him.  He's com­ing off his worst year in the busi­ness after mak­ing a huge bet against U.S. Trea­suries that back­fired. Last year, for the first time in nearly two decades, investors pulled more money out of PIMCO's flag­ship fund than they put in.
• More trou­bling, U.S. reg­u­la­tors are now con­sid­er­ing whether PIMCO should be deemed a "sys­tem­i­cally impor­tant finan­cial insti­tu­tion" – that is, too big to fail, and thus sub­ject to tighter reg­u­la­tory over­sight. The con­cern: The jug­ger­naut man­ages so much money for pen­sion funds that it could ham­mer the econ­omy if it ever went under. The firm has dou­bled in size to $1.36 tril­lion in assets since the col­lapse of Lehman Broth­ers in 2008.
• The firm is lob­by­ing hard to fend off the "sys­tem­i­cally impor­tant" des­ig­na­tion, accord­ing to reg­u­la­tory dis­clo­sures. Like other finan­cial firms, it also objects to impend­ing rules that could make some of its deriv­a­tives trad­ing more costly.
• Indus­try ana­lysts also won­der whether PIMCO's $250 bil­lion Total Return Fund, the world's largest bond fund, is such a behe­moth that Gross some­times has to swing for the fences to gen­er­ate the kind of returns investors have come to expect. Because PIMCO's flag­ship fund relies heav­ily on deriv­a­tives to bet on bonds, some ana­lysts say it's unnec­es­sar­ily com­plex and poten­tially at risk should one of its trad­ing par­ties fail.
• Gross dis­misses con­cerns about PIMCO's girth. He says the firm isn't "lev­ered," or mak­ing bets with bor­rowed money, in the way that failed play­ers like Bear Stearns or Lehman Broth­ers did. The asset man­ager is using only client money to trade.  "It's not like we are a deposit insti­tu­tion and there'd nec­es­sar­ily be a run on the bank because they thought the bank was going to fail," Gross said in an inter­view. "'Too big to fail' is depen­dent upon tens of thou­sands of clients" aban­don­ing ship at once, and it's "hard to believe they'd want out at the same time."
• The debate over PIMCO's cen­tral­ity to the finan­cial estab­lish­ment is a turn­about: Up until the finan­cial cri­sis, the 67-year-old Gross was largely seen on Wall Street as a West Coast out­sider and a bit of a loner.  But dur­ing the cri­sis, scared investors piled into his funds. Pol­i­cy­mak­ers from the Fed­eral Reserve and Trea­sury Depart­ment turned to PIMCO to help with a raft of pro­grams meant to res­cue the finan­cial sys­tem. That helped forge closer ties between the firm and the gov­ern­ment and raised PIMCO's pro­file even more with investors.
• "The con­cen­tra­tion of bond-market assets in a few firms, which some could argue to be sys­tem­at­i­cally risky, is not of those firms' design, but rather stems from their suc­cess," says Joshua Ros­ner, man­ag­ing direc­tor of Gra­ham Fisher & Co., an adviser to insti­tu­tional investors.

Dis­clo­sure Notice

Any secu­ri­ties men­tioned on this page are not held by the author in his per­sonal port­fo­lio. Secu­ri­ties men­tioned may or may not be held by the author in the mutual fund he man­ages, the Pal­adin Long Short Fund (PALFX). For a list of the afore­men­tioned fund's hold­ings at the end of the prior quar­ter, visit the Pal­adin Funds web­site at http://www.paladinfunds.com/holdings/blog

Tags: Barometer, Bill Gross, Bond Traders, Co Founder, Financial Crisis, Financial Institution, Flagship, Gross Co, Juggernaut, Lehman Brothers, Lengthy Story, More Than Three Decades, Mutual Fund, Mystique, Pension Funds, Regulatory Oversight, Reuters, Snippets, Target, Treasuries
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PIMCO's El Erian: "Too Early to Declare Victory"

Wednesday, February 8th, 2012

PIMCO's Mohamed El-Erian vis­ited with CNBC this morn­ing, and offered his usu­ally inter­est­ing thoughts on the macro econ­omy and invest­ment themes. Inter­est­ingly, he touted pre­cious met­als in this inter­view (rel­a­tive to equi­ties) which is the first time I've really heard him tout them.

8 minute video – email read­ers will need to come to site to view:

• This year's mar­ket gains will need more than an improv­ing eco­nomic pic­ture and investor will­ing­ness to shrug off the Euro­pean debt cri­sis, Pimco's Mohamed El-Erian said. "It's too early to declare vic­tory," the co-CEO for the world's largest bond fund told CNBC in an inter­view Tuesday.
• He out­lined three issues that must be addressed if the 2012 rally is to continue:

1) Geopo­lit­i­cal risk that remains both in Europe and the Mid­dle East.

2) A "hand­off to more sus­tain­able poli­cies" beyond the mon­e­tary eas­ing from the world's cen­tral banks.

3) Get­ting "long-term investors" off the side­lines and putting their money to work in riskier assets than bonds.

• As those head­winds remain, El-Erian advises investors to ded­i­cate a smaller por­tion of their port­fo­lios to stocks and a larger allo­ca­tion toward pre­cious met­als. On bonds, he advo­cates shorter dura­tion, with a tar­get of seven years or less, which is where the Fed­eral Reserve has focused its debt-buying efforts.
• "They're both will­ing and able," El-Erian said of the Fed and other cen­tral banks and aggres­sive mon­e­tary poli­cies. "The issue is the effec­tive­ness. Even the cen­tral bankers are begin­ning to announce that it is not just about the ben­e­fits, it's also about the costs and risks."
• "The cen­tral banks are absolutely com­mit­ted, but we must not extrap­o­late that they will remain highly effec­tive," he con­tin­ued. "They need help. They are a bridge and they have to be a bridge to some­where. So far the other gov­ern­ment agen­cies are on the sidelines."
• "There's more to do," El-Erian said. "It's crit­i­cal that noth­ing be done to inter­rupt this won­der­ful cycli­cal bounce. We want the cycli­cal bounce to trans­late into a sec­u­lar bounce, because that's what the mar­kets need to sus­tain the won­der­ful returns so far this year."
• El-Erian con­trasted the sit­u­a­tion in Europe from the Lehman Broth­ers col­lapse in 2008, and said that while cen­tral banks "have become much more proac­tive" with refi­nanc­ing oper­a­tions, the cur­rent econ­omy may not be as pre­pared for eco­nomic shock. Regard­ing the "Lehman moment," El-Erian said, "If you define it as the econ­omy being able to take the shock, that's in fact a higher risk because we are in a worse place than we were in '08."

Dis­clo­sure Notice

Any secu­ri­ties men­tioned on this page are not held by the author in his per­sonal port­fo­lio. Secu­ri­ties men­tioned may or may not be held by the author in the mutual fund he man­ages, the Pal­adin Long Short Fund (PALFX). For a list of the afore­men­tioned fund's hold­ings at the end of the prior quar­ter, visit the Pal­adin Funds web­site at http://www.paladinfunds.com/holdings/blog

Tags: Bond Fund, Central Banks, Cnbc, Debt Crisis, Handoff, Headwinds, Improving Economic Picture, Investment Themes, Macro Economy, Mohamed El Erian, Monetary Policies, Other Government Agencies, PIMCO, precious metals, S Central, S Market, Sidelines, Sustainable Policies, Target, Term Investors
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Energy and Natural Resources Radar (January 30, 2012)

Sunday, January 29th, 2012

Energy and Nat­ural Resources Mar­ket Radar (Jan­u­ary 30, 2012)

Strengths

• Indus­trial met­als ral­lied strongly this week bol­stered by pos­i­tive eco­nomic data in the U.S., dovish lan­guage from the Fed­eral Reserve and likely short-covering. Cop­per fin­ished up almost 4 per­cent at $3.89 per pound, mak­ing this the third con­sec­u­tive week of gains.
• J.P. Mor­gan reported that China has now sur­passed Japan as the world’s largest coal importer after import­ing 183.2 mil­lion tons in 2011, up 10 per­cent on a year-over-year (yoy) basis. Com­par­a­tively, Japan’s total imports for 2011 came in at 175.2 mil­lion tons, down 5 per­cent (yoy). The drop in Japan­ese imports could par­tially be attrib­ut­able to the earth­quake and tsunami in the first half of 2011.
• Deutsche Bank high­lighted that com­modi­ties ral­lied across the board after the Fed­eral Reserve sig­naled that a rate hike was nowhere in sight. The Fed­eral Reserve’s state­ment that con­di­tions are likely to war­rant excep­tion­ally low lev­els for the funds rate “at least through late 2014” is on the sur­face a major dif­fer­ence from the “at least mid-2013” date given in the last statement.
• U.S. nat­ural gas prices have also ral­lied off a bot­tom near $2.32 mil­lion British ther­mal units (mmbtu) to break through a tech­ni­cal ceil­ing. Traders drove a sharp move higher on Wednesday.
• Grain prices recov­ered this week on sup­ply con­cerns due to dry con­di­tions in Argentina. Corn gained 5 per­cent and wheat gained 6 per­cent this week.

Weak­nesses

• Aus­tralian oil pro­duc­ers shut­tered as much as one-quarter of the country’s out­put as Trop­i­cal Cyclone Iggy was fore­cast to strengthen.
• India Coal Mar­ket Watch said that India’s coal pro­duc­tion fell 2.7 per­cent since April 1, 2011. The group said that out­put was 359.8 mil­lion tons from April to Decem­ber com­pared with 369.8 mil­lion tons the pre­vi­ous year. Pro­duc­tion was 8 per­cent less than the government’s tar­get of 391.48 mil­lion tons. India’s coal pro­duc­tion was 533 mil­lion tons in the year ended March 2011, below the gov­ern­ment tar­get of 573 mil­lion tons.
• South Africa has become sig­nif­i­cantly less attrac­tive as a min­ing invest­ment des­ti­na­tion since 2006, the South African Insti­tute of Race Rela­tions (SAIRR) said this week. "Uncer­tainty over nation­al­iza­tion and mine own­er­ship, and increas­ing work dis­rup­tions are affect­ing investors' will­ing­ness to get involved in min­ing ven­tures in South Africa," SAIRR researcher Jonathan Sny­man said in a statement.

Oppor­tu­ni­ties

• Cop­per stock­piles at the Lon­don Metal Exchange fell for the 16th week, declin­ing 2.3 per­cent to 348,750 tons. This is the low­est level since Decem­ber 2012 and could be another dri­ver for stronger cop­per prices as stock­piles get replenished.
• Bar­clays Cap­i­tal reported that global man­u­fac­tur­ing data and busi­ness con­fi­dence seem to sug­gest that indus­trial pro­duc­tion and sen­ti­ment have started to sta­bi­lize. On a monthly basis the Bar­clays aggre­gate global man­u­fac­tur­ing PMI data recorded its strongest improve­ment since Jan­u­ary 2011, advanc­ing from –0.71 in Novem­ber to 0.5. Fur­ther, that improve­ment was wide­spread, span­ning the U.S., U.K., Brazil, Asia and even in the Europe. In fact, Flash PMI for the euro­zone moved above 50 for the first time since August 2011.
• Bar­clays cited a news report that the cur­rent size of the cat­tle herd in the U.S. may be the small­est since Dwight Eisen­hower was Pres­i­dent in 1958. A Bloomberg News sur­vey said ranch­ers held 91.24 mil­lion head of cat­tle as of Jan­u­ary 1, down 1.5 per­cent from a year ear­lier. A record drought in Texas last year and ris­ing feed costs prompted ranch­ers to cull herds, even as beef exports from the U.S. surged. Cat­tle futures are up 15 per­cent since the end of June. After reach­ing an all-time high on an annual basis in 2011, the Live­stock Mar­ket­ing Infor­ma­tion Cen­ter says retail-beef prices will keep ris­ing through next year.

Threats

• GMP reported that an oil pipeline in United Arab Emi­rates that would strate­gi­cally bypass the Strait of Hor­muz to the tune of 1.5 mil­lion bar­rels per day could face more delays due to dif­fer­ences with a Chi­nese con­struc­tion company.
• Gains that made nat­ural gas the best-performing com­mod­ity this week may soon be evap­o­rat­ing as traders bet U.S. pro­duc­tion cuts won’t be enough to reduce the biggest sup­ply sur­plus since 2009. Resource Daily com­mented that futures soared as much as 20 per­cent from a 10-year low in New York after Chesa­peake Energy Corp. and Cono­coPhillips said they’ll reduce out­put. Energy pro­duc­ers are shift­ing spend­ing to basins that yield more lucra­tive oil and gas liq­uids, in addi­tion to pro­duc­ing nat­ural gas. Gas has tum­bled 14 per­cent this year as a boom in U.S. shale out­put pushes inven­to­ries toward record lev­els. Stock­piles were 21.4 per­cent above the five-year aver­age last week, the most since June 19, 2009. Data from the U.S. Depart­ment of Energy shows pro­duc­tion grew by an all-time high of 4.5 bil­lion cubic feet a day in 2011, while demand rose 920 mil­lion cubic feet.

Tags: Australian Oil, Coal Market, Coal Production, Deutsche Bank, Dovish, Economic Data, Federal Reserve, Grain prices, Industrial Metals, J P Morgan, Japanese Imports, Market Radar, Market Watch, Milli, Natural Gas Prices, Oil Producers, Rate Hike, Supply Concerns, Target, Tropical Cyclone
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Gold Reacts as Quantitative Easing Becomes Fait Accompli

Friday, January 27th, 2012

I had pro­posed at the begin­ning of QE2, we are now in a QEn envi­ron­ment.  My work­ing assump­tion is when QE2 ended last spring we'd have about a 6–8 month win­dow before the des­per­ate Fed­eral Reserve began QE3.  I was thrown a curve­ball with Oper­a­tion Twist instead – although my time frame was accu­rate; it was just a pro­gram of a dif­fer­ent fla­vor.  But no wor­ries, yes­ter­day Bernanke kicked the door open and whis­pered songs of addi­tional mea­sures at every oppor­tu­nity pos­si­ble dur­ing his news con­fer­ence.   This fits with my work­ing the­ory that aside from LTRO this incred­i­ble strength in the mar­ket was sim­i­lar to the "pre game" we saw ahead of the offi­cial QE2 announce­ment.  This is the "David Tep­per" effect we saw fall 2010 where "if the econ­omy improves, it is good for the mar­ket – buy stocks.  If the econ­omy fal­ters, it is good for the mar­kets as the Fed will QE – buy everything."

Hence, go for­ward we have to change our work­ing assump­tion to one that includes another mas­sive pro­gram of asset pur­chases (many believe these will be con­cen­trated on mort­gage backed secu­ri­ties to get mort­gage rates even lower than their cur­rent record rates).  What­ever the case, gold (and sil­ver) reacted accordingly….

……and we are in another round of global stim­u­lus – this time with the ECB join­ing forces.  I'd also point out the UK printed a poor GDP fig­ure yes­ter­day and we cer­tainly should expect a new round of quan­ti­ta­tive eas­ing out of the Bank of Eng­land shortly as well.   Of course, in the very short term this is now all "known" news, so we'll see how long the mar­ket can con­tinue the non stop 'teflon' rally with­out nary a rest­ing point.

Via Reuters:

• Bernanke on Wednes­day opened the door a bit wider for the Fed to return to buy­ing secu­ri­ties in the months ahead to but­tress a weak recov­ery and keep infla­tion from slip­ping too far below its newly adopted 2-percent target.
• "It sounds like the fin­ger is on the trig­ger," said Thomas Simons, a money mar­ket econ­o­mist at Jef­feries & Co.
• "Prob­a­bly the main take-away from the press con­fer­ence is the sense con­veyed by Bernanke that it would not take much of a dis­ap­point­ment in growth or infla­tion to get the Fed to start another round of QE," said Michael Fer­oli, chief U.S. econ­o­mist at J.P. Mor­gan. "In fact, from his answers it's not even clear any dis­ap­point­ment would be nec­es­sary to see more QE," Fer­oli wrote in a note, adding he was not fore­cast­ing another round of asset pur­chases even if the bar for action was low.
• "I think it could hap­pen any time now, based on the lan­guage that we saw today," said Eric Stein, a port­fo­lio man­ager at Eaton Vance in Boston.
• Econ­o­mists at 12 of 18 pri­mary deal­ers, the large finan­cial insti­tu­tions that do busi­ness directly with the Fed, believe the cen­tral bank will under­take fur­ther quan­ti­ta­tive eas­ing, accord­ing to a Reuters poll after Bernanke's news conference.
• The Fed has trained its sights on the stalled hous­ing mar­ket in recent months, so any move to QE3 is most widely expected to involve buy­ing mort­gage secu­ri­ties to help bring down fur­ther already record-low mort­gage inter­est rates.

Dis­clo­sure Notice

Any secu­ri­ties men­tioned on this page are not held by the author in his per­sonal port­fo­lio. Secu­ri­ties men­tioned may or may not be held by the author in the mutual fund he man­ages, the Pal­adin Long Short Fund (PALFX). For a list of the afore­men­tioned fund's hold­ings at the end of the prior quar­ter, visit the Pal­adin Funds web­site at http://www.paladinfunds.com/holdings/blog

Tags: Asset Purchases, Bank Of England, Buy Stocks, Curveball, David Tepper, ECB, Fait Accompli, Gold And Silver, Known News, Last Spring, Massive Program, Mortgage Backed Securities, Mortgage Rates, News Conference, Qe, Qe2, Resting Point, Reuters, Stimulus, Target
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The Impact of Low Rates Through 2014

Thursday, January 26th, 2012

Bloomberg details the lat­est from the Fed:

Chair­man Ben S. Bernanke said the Fed­eral Reserve is con­sid­er­ing addi­tional asset pur­chases to boost growth after extend­ing its pledge to keep inter­est rates low through at least late 2014.

Pol­icy mak­ers are “pre­pared to pro­vide fur­ther mon­e­tary accom­mo­da­tion if employ­ment is not mak­ing suf­fi­cient progress towards our assess­ment of its max­i­mum level, or if infla­tion shows signs of mov­ing fur­ther below its mandate-consistent rate."

The imme­di­ate mar­ket reac­tion was a risk asset rally, a huge rally in gold (per Cal­cu­lated Risk: Bernanke made it clear that even if infla­tion moved above the tar­get — and unem­ploy­ment was still very high — the Fed would only slowly pur­sue poli­cies to reduce the infla­tion rate), and a rally at the belly of the yield curve (the yield curve flat­tened out to five years... shorter rates couldn't fall as they are already at or near zero). Why? The "late 2014" date is much later than the June 2013 date pre­vi­ously pro­jected by Bernanke last sum­mer.
The impact of this announce­ment (and the pre­vi­ous pro­jected rates) can be seen in the chart below that shows the Fed Funds rate curve (implied by EuroDol­lar futures) for March 2013 through Decem­ber 2014, as of var­i­ous dates over the past year.

What do we see? We see an ini­tial drop between March and June of last year as Bernanke indi­cated low yields for the fore­see­able future, then a huge drop (mid-summer) after Bernanke stated rates would remain zero through June 2013. Today's announce­ment really did noth­ing through June 2013 (that was already pro­jected), but was felt fur­ther out along the curve.
The key ques­tion is what is the Fed try­ing to accom­plish?
In "nor­mal" times, low yields = cheap financ­ing = increased con­sump­tion (it cre­ates an incen­tive for indi­vid­u­als to bor­row and banks to lend), but in today's zero-bound world the impact is min­i­mal. Increased con­sump­tion is lim­ited as indi­vid­u­als are try­ing to rebuild their own bal­ance sheets and those that might ben­e­fit most from bor­row­ing, don't nec­es­sar­ily have the credit to qual­ify for a loan. In terms of impact on unem­ploy­ment, GYSC (of Eco­nomic Dis­con­nect fame) states:

Unem­ploy­ment is a struc­tural prob­lem, not a cycli­cal one, but the FED is still stuck in the past.

In addi­tion, there are some the­o­ries that con­sump­tion may actu­ally be neg­a­tively impacted by zero bound rates. As I out­lined over the sum­mer, I think it is pos­si­ble that neg­a­tive real inter­est rates may actu­ally cause indi­vid­u­als to save more, while Kid Dyna­mite out­lined yes­ter­day that low rates fore­casted may cause indi­vid­u­als to hold off from mak­ing a loan fueled purchase:

Let me explain: right now, one appeal­ing fac­tor of home buying/selling deci­sions is that inter­est rates are very low – you can afford to buy more house. If I think that inter­est rates are going to remain low for a long period of time, I will be in no hurry to lock in this low rate on the debt I’m bor­row­ing – I will be in no hurry to go out and buy a house.

So what is it then? Cor­po­ra­tions!
There is one sec­tor that I think will be pos­i­tively impacted by the lat­est announce­ment.... cor­po­ra­tions. Don't let their record prof­its as a per­cent of GDP (while per­sonal income is at record lows) fool you into think­ing they don't need help at the pop­u­la­tions expense. Seri­ously though... my ini­tial reac­tion upon hear­ing that rates would be held down near zero through 2014... buy credit... WITH dura­tion out to around ten years (the sec­ondary impact is pos­i­tive for equi­ties, as explained below).
While Trea­sury yields are at all-time lows, cor­po­rate spreads remain at ele­vated lev­els (when yields fell dur­ing the sum­mer when we had to deal with the US down­grade and Europe, spreads widened sig­nif­i­cantly).

In "nor­mal" times, when mar­kets calm these spreads would be expected to nar­row, which I still believe is the case. One would also "nor­mally" expect Trea­sury yields to rise as investors shift out of Trea­suries, caus­ing the hard inter­est rate com­po­nent of cor­po­rate yields (rate + spread = yield) to rise, but this risk has been removed for the fore­see­able future out to around ten years. The result is that cor­po­rate bonds seem like a very safe invest­ment. This decreased risk should mean even cheaper financ­ing for longer dated matu­rity cor­po­rate bond issuance.
So will this finally set off a round of cor­po­rate fueled expan­sion? If they don't see aggre­gate demand improv­ing, then I don't see how this will impact the under­ly­ing econ­omy. But, with the cost of equity high (i.e. what I per­ceive as fair to cheap equity val­u­a­tions) and cost of debt low (i.e. these lower yield­ing cor­po­rate bonds), we may see sig­nif­i­cant change in cap­i­tal struc­tures (per­haps via pri­vate equity).
Source: Bar­clays Capital

Tags: Asset Purchases, Balance Sheets, Bernanke, Bloomberg, Consistent Rate, Consumption, Eurodollar Futures, Fed Chairman, Fed Funds Rate, Federal Reserve, Foreseeable Future, Inflation Rate, Initial Drop, Mandate, Maximum Level, Mid Summer, Pledge, Rally, Target, Yield Curve
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Goldman Tells Clients to Short 10-yr Treasurys

Monday, January 23rd, 2012

As of a few hours ago, Goldman's Francesco Garzarelli has offi­cially told the firm's clients to go ahead and short 10 Year Trea­surys via March 2012 futures, with a 126–00 tar­get. While Garzarelli is hardly Stolper (and we will have more on the lat­est Stolper­ing out in a sec­ond), the fact that Gold­man is now openly buy­ing Trea­surys two days ahead of this week's FOMC state­ment makes us won­der just how much of a rates pos­i­tive state­ment will the Fed make on Wednes­day at 2:15 pm. From Gold­man: "Since the end of last August, we have argued that 10-yr US Trea­sury yields would not be able to sus­tain lev­els much below 2% in this cycle. Yields have traded in a tight range around an aver­age 2% since Sep­tem­ber, includ­ing so far into 2012. We are now of the view that a break to the upside, to 2.25–2.50%, is likely and rec­om­mend going tac­ti­cally short. Using Mar-12 futures con­tracts, which closed on Fri­day at 130–08, we would aim for a tar­get of 126–00 and stops on a close above 132–00." As a reminder, don't do what Gold­man says, do what it does, espe­cially when one looks the firm's Top 6 trades for 2012, of which 5 are los­ing money, and 2 have been stopped out less than a month into the year.

What is Goldman's ratio­nale for short­ing 10 Years?

At this stage of the cycle, growth expec­ta­tions are in the driver’s seat: The value of inter­me­di­ate matu­rity gov­ern­ment bonds can be related to expec­ta­tions of future pol­icy rates, activ­ity growth and infla­tion, and a ‘risk fac­tor’ highly cor­re­lated across the main coun­tries. These sim­ple rela­tion­ships are cap­tured by our Sudoku econo­met­ric frame­work for 10-yr matu­rity yields. In com­ing months, we expect effec­tive overnight rates to remain close to zero in the main cur­rency blocs (US, Japan, Euroland, and UK) and retail price infla­tion to hover around 1.5–2.0% – con­sis­tent with the for­wards and cen­tral banks’ objec­tives. With pol­icy rates and infla­tion ‘dor­mant’ at this stage of the busi­ness cycle, bond yields (and the 2–10-yr slope of the yield curve) will likely react mostly to shifts in growth expectations.

Bond val­u­a­tions are already stretched rel­a­tive to con­sen­sus growth expec­ta­tions: Around the turn of the year, the out­look on eco­nomic activ­ity was buf­feted by cross-currents reflect­ing the adverse credit con­di­tions in the Euro area on the one hand, and the upward revi­sions to US GDP growth on the other. Our Sudoku model, which helps us trade-off these shifts, indi­cates that 10-yr gov­ern­ment bond yields are cur­rently trad­ing too low (to the tune of 50-75bp) when mapped against pre­vail­ing macro expec­ta­tions. Tak­ing into account the cumu­la­tive impact of the Fed’s secu­rity pur­chases, the degree of mis-valuation of 10-yr bonds is roughly the same across the main regions.

Bond yields are lag­ging the improve­ment in indus­trial activ­ity seen since late 2011: The momen­tum of our Global Lead­ing Indi­ca­tor (GLI) for the indus­trial cycle bot­tomed out in the fourth quar­ter of 2011, although the revised series after the lat­est data show it steadily improv­ing through the sec­ond half of last year. The sequen­tial improve­ment has extended into this year. We observe that, since pol­icy rates have been floored in early 2010, inter­me­di­ate matu­rity yields have tended to lag improve­ments in the GLI by around 2–3 months. With cen­tral banks on hold pro­vid­ing ‘carry’, fixed income investors may have been wary to trade on early cycli­cal sig­nals until these received val­i­da­tion in the early ‘hard’ data.

Real rates (and the 2–10 curve) could play catch-up with cycli­cal stocks: We have iden­ti­fied a rel­a­tively tight pos­i­tive rela­tion­ship between the rel­a­tive per­for­mance of US cycli­cal stocks vs. defen­sives (as cap­tured, for exam­ple, by our US Wave­front Growth equity bas­ket), and the 2–10-yr slope of the Trea­sury curve. The depar­ture from this rela­tion­ship since the turn of the year is now eye-catching. Cycli­cal stocks have strongly out­per­formed the broader mar­ket, a move prob­a­bly ampli­fied by posi­tion­ing, while bond yields have barely moved, under­pinned by US domes­tic investors’ con­tin­ued attrac­tion for ‘carry’ strate­gies. At a closer inspec­tion, yields out to the 5-yr matu­rity have con­tin­ued to decline in real terms, and are now in deeply neg­a­tive ter­ri­tory (-150bp in 2-yr and –100bp in 5-yr, near the early Novem­ber lows), while 5-yr 5-yr for­ward rates are barely above zero. Our esti­mates sug­gest that for­ward rates (5-yr 5-yr for­ward) are now too low. Inci­den­tally, the fact that a poten­tial rise in yields would come from a depressed base and mostly in response to an improve­ment in growth prospects (which should also influ­ence earn­ings growth expec­ta­tions) means that a fixed income sell-off should not pose a threat to the equity market.

The FOMC state­ment could pro­vide a near-term cat­a­lyst: Accord­ing to a client sur­vey by our US trad­ing desk, around half of those polled expect the Fed announce­ment to ease finan­cial con­di­tions fur­ther, with only 12% expect­ing a tight­en­ing. Around two-thirds of par­tic­i­pants believe the mid-point of the ‘cen­tral ten­dency’ range for the Fed funds rate at the end of 2014 will be 75bp (the for­wards) or below. Finally, 72% of respon­dents expect the FOMC will announce a long-run neu­tral pol­icy rate of less than 4%. These results are con­sis­tent with our impres­sion that Wednesday’s announce­ment is now largely dis­counted to rep­re­sent an ‘eas­ing event’. With the data improv­ing, trea­sury yields below ‘equi­lib­rium’, cur­rent coupon 30-yr mort­gage yields at all-time lows, and dis­cus­sions on pol­icy eas­ing shift­ing to ways to sup­port the improve­ment in the hous­ing mar­ket more directly, such expec­ta­tions may be dis­ap­pointed, in our view.

Tags: Business Cycle, Central Banks, Euroland, Fomc Statement, Forwards, Futures Contracts, Garzarelli, Goldman, Government Bonds, Growth Expectations, Maturity, Overnight Rates, Price Inflation, Rationale, Risk Factor, S Francesco, Target, Tight Range, Treasurys, Us Treasury Yields
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