Archive for April, 2011
Friday, April 29th, 2011
Here are this weekend’s reading diversions for your personal enlightenment. Have a great weekend!
Judith Johnson: Overcoming Our Fear of Death
We know that we will all die, but we have yet to learn to accept this reality and to normalize the conversations needed to comfort ourselves and each other around the issues surrounding dying and death.
7 Ways To Protect Your Memory
Skipping carbs may harm your memory. A Tufts University study found that folks who eliminated carbohydrates from their diets performed worse on memory-based tasks than those who included them. Why? Your brain cells need carbs, which are converted in your body to glucose, to stay in peak form, says study co-author Robin Kanarek, Ph.D., professor of psychology at Tufts.
Easter Bunny Explained: How A Rabbit Got Associated With Easter
Well there clearly seems to be no correlation between the secular symbols and the Christian holiday. While the first known mentions of the bunny tradition appear in 15th century German literature according to Discovery, the bunny has its roots in pre-13th century pagan traditions
5 Things Every Happy Woman Does – Oprah.com
Illustration: R.O. Blechman
Sages going back to Socrates have offered advice on how to be happy, but only now are scientists beginning to address this question with systematic, controlled research. Although many of the new studies reaffirm time-honored wisdom (“Do what you love,” “To thine own self be true”), they also add a number of fresh twists and insights. We canvassed the leading experts on what happy people have in common—and why it’s worth trying to become one of them
Restless legs may be sign of heart risks – USATODAY.com
Restless legs syndrome is thought to afflict millions, though there’s argument about just how many. Some doctors think its seriousness has been exaggerated, possibly to help sell treatments.
Diet soda may be tied to heightened risk of stroke, study claims | Herald Sun
People who drink one can of soda a day are more likely to have several risk factors for diabetes and cardiovascular disease including high blood pressure, elevated triglycerides, and high fasting blood sugar levels
Foods That Make You Fat – Healthy Foods That Make You Gain Weight - Cosmopolitan
Chips, gooey desserts, anything that starts with fried — you know to fight off these calorie cows with a stick. What’s tricky is that some foods with famously healthy reputations are actually worse for your weight than the snacks in vending machines and drive-throughs. We fill you in on what they are and why they keep you from hitting that golden number on the scale.
The Dish: Pad Thai worse for your waist than four McBurgers – Healthzone.ca
The 1,131 calories is more than double the amount that should be consumed in one meal, especially considering this is an on-the-go lunch. A 1,000-calorie meal could be overlooked if it were a luscious, multi-course special occasion dinner. This is just a container of noodles.
Kate Middleton Wedding Dress Designed by Alexander McQueen’s Sarah Burton, Recalls Grace Kelly – ABC News
Looking both modern and traditional, Middleton recalled another commoner who became royalty, actress Grace Kelly, who married Rainier III, the Prince of Monaco, and became The Princess of Monaco.
*$%#@! Cursing Can Soothe Pain, Research Shows
The next time you let a string of expletives rip in front of a disapproving audience, try this excuse: Swearing, it seems, is actually a powerful painkiller.
Best And Worst Sleep Positions For Your Health
Your preferred p.m. pose could be giving you back and neck pain, tummy troubles, even premature wrinkles. Discover the best positions for your body–plus the one you may want to avoid.
8 Ways to Reuse Old T-Shirts | Care2 Healthy & Green Living
We all have them in our dressers: a couple of t-shirts that are past their prime, but we just can’t get rid of them. Whether it’s from an awesome concert or a really special family reunion, you can give an old t-shirt a new life with some crafty skills!
Can ginger ale help my child feel better when she has an upset stomach? – Sniffle Solutions
It’s common for children to experience stomach pains, and ginger ale can be beneficial in soothing an upset stomach in healthy children. Fluids help your child to maintain hydration, and evidence exists that the herb ginger — in its pure form — may ease a child’s symptoms of nausea and indigestion.
Leo Galland, M.D.: Olive Oil: A Natural Painkiller?
This robust, flavorful oil is an example of the food as medicine concept, that foods can have a powerful impact on health.
Teaching Kids About Money – Kids and Money – Parenting.com
You don’t have to be Warren Buffett to raise a financially savvy kid. You don’t even have to be good at math. The key? Establishing a conversation about dollars and cents — and keeping it going as your child grows. Parenting and the National PTA team up to get you started.
Despite connecting with new “friends” via online social networking (e.g., Facebook), despite living in cities with thousands of people, and despite working in large organizations, the incidence of people who say they are lonely keeps rising. Many people are connecting all the time–working two jobs, using Blackberries, iPhones, and other devices 24/7, engaging in numerous activities–yet they still feel they have no one with whom to talk about serious issues in their lives, no one to talk things out. It’s becoming a big issue in our society and postmodern world.
18 Common Phrases to Avoid in Conversation | Real Simple
Some things should never be said―like these phrases. Here, what to say instead.
Tags: Brain Cells, Christian Holiday, Controlled Research, Diet Soda, Diversions, Dying And Death, Easter Bunny, Fear Of Death, German Literature, Happy Woman, Heart Risks, Herald Sun, Judith Johnson, Kanarek, Pagan Traditions, Personal Enlightenment, Restless Legs, Restless Legs Syndrome, Stroke Study, Tufts University
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Friday, April 29th, 2011
CIBC World Markets’ Avery Shenfeld shares his views on the U.S. economy, oil prices, housing, and employment with Bloomberg’s Tom Keene and Ken Prewitt.
APRIL 19, 2011
TOM KEENE, HOST, BLOOMBERG SURVEILLANCE: Avery Shenfeld joins us, CIBC World Markets. Avery, good morning.
AVERY SHENFELD, MANAGING DIRECTOR, CIBC WORLD MARKETS: Good morning.
KEENE: Is there a housing recovery in sight?
SHENFELD: Not really. You have to look – I mean we did see a bounce in housing starts today. But if you saw the Homebuilders Index earlier, you could see that there is a lot of pessimism. There is still lots of inventory of newly built houses, and, of course, a huge inventory of existing homes waiting to be cleared out.
If you go back to 2008, the housing starts numbers are basically bouncing aimlessly in a range between 475,000 and 675,000. So these latest numbers are really just part of that very bouncy, but still sideways trend.
KEENE: Where is your first quarter GDP? Michael Moran and Daiwa sub- two percent. Have you gone sub-two percent?
SHENFELD: We haven’t gone quite so low. We’re sitting at about 2.5 percent. And the reason is that if you look at the industrial production numbers, they still looked quite strong for the first quarter, which is telling you that the good sector – at least in production – was fairly healthy.
Our suspicion is that a good deal of that must have ended up in inventories because we are seeing the demand side numbers, which is what others I think are reacting to pushing their forecasts so low, are, in fact, responding to.
So it looks to me like we are at 2.5 percent, but that’s still – you know, it’s still a pretty big disappointment. Remember this was the quarter we were supposed to get the big benefits of the tax cuts announced in December, and they basically got eaten up in part by high gasoline prices and some disappointments elsewhere.
KEN PREWITT, BLOOMBERG NEWS: Well, what happens – this is sort of a moratorium so to speak on foreclosures while banks try to get their paperwork straightened out. Where are we in that process?
SHENFELD: Well, there are still some details being ironed out. The way this story is talking about dealing with some of the foreclosures that had, in fact, taken place under procedures that are now being accused of being unfair. But eventually we’re going to get that whole process unstuck and going again.
In my mind, that is actually a bit of a healthy development. You know, while we need to get this cloud lifted, we need to get the houses into the hands of people who are paying their mortgages, in terms of sort of start the process of the righting the ship.
But in terms of actually getting a big pick up in construction, I think the only good news here is that we are at such low levels that even if in 2012, for example, we are running at 700,000 or 800,000 starts, that is still an abysmal level by historical standards. But it would represent a nice percentage increase. So the irony is it is hard to go lower, and that’s I guess the best news.
KEENE: Avery, your team has been way out in front on oil. You called for higher oil prices before anywhere else. Oil, okay, a little bit of a respite – Brent $119.85; NYMEX $105.97. Will this be a stochastic surge, a pointy surge up and then down in hydrocarbons and commodities in general? Or is there a new persistency here at higher prices?
SHENFELD: You know, I think there is a bit of both. There may well be a secular trend that we are in where troughs in commodity prices at the lows of cycles are not as low as they used to be and peaks are generally somewhat higher than they used to be, which really reflects the growth we are seeing in emerging markets, their heavy use of commodities as part of that, and, at least for awhile, some need to invest again, to rebuild supply. So I think we are in for some cycles where peaks are a little higher than they used to be.
That said, if we look at the current situation, in my mind there may be – the next move might be actually a bit lower. We have those emerging markets that I talked about raising interest rates, trying to deal with inflation by effectively slowing economic growth. And so we may lose a bit of the juice that we are now seeing in commodity markets over the next six months or so.
PREWITT: Well, given that prices are down so much, and mortgage rates are the lowest pretty much they’ve ever been, what are people waiting for? I mean is it just uncertainty over the labor market?
SHENFELD: I think that it is not that there aren’t buyers. I mean we do see people out kicking the tires at these very low prices. But if there was simply – you know, the scale of the shock wave that hit and the overhang of houses to be cleared out just means that even when buyers do return, even when they recognize that these are very low prices, even with mortgage rates that are quite low, it is simply going to take time to clear out all that inventory.
And that is somewhat true in the – in the new home market it is getting a little bit better because we are not building, we are not completing very many houses now. There are only about 500,000 houses being completed a month; that is half of what we would normally see at the bottom of a deep recession. So that is helping, but, you know, I think the existing home market also needs to be repaired before builders gain the confidence. So it is just simply a matter of time.
PREWITT: Well, have we seen kind of a shift in attitude on a national basis, that people were scared by the price decline in housing and decided – you know, just like people got turned off by the stock market?
SHENFELD: That may be part of it. And, of course, for awhile it was also – and for some still, it was difficult to get mortgage credit. Not just the buyers were scared, but the financiers were scared, too, about lending – you know, having been burned by lending too much to the household sector, the financial system doesn’t tend to make the same mistake twice.
So we suddenly became a market that was erring on the side of caution, the mortgage insurers were really the only game in town. So I think part of it was on the credit side as well. But it was a mutual feeling, the borrowers didn’t want to borrow and the lenders didn’t really want to lend.
So for awhile, the pace of clearing out this inventory was stalled. It also takes awhile before the sellers recognize what their house is really worth and agree to cut the price enough to really get the market moving, and that’s where we are now. But prices have still been edging lower and so we may well be still another five percent or so for the bottom of house prices.
KEENE: Avery, your colleague, Benjamin Tal, has just been brilliant on the self-employed in the United States. Give us an update. Are our self- employed recovering?
SHENFELD: You know, I think we are starting to see a bit of a recovery there. It is part of a general recovery in the overall business conditions.
You know, we do have the labor market recovering. If you really want to know the key to the housing market, it is that we need people without jobs to get jobs again.
But it, again, goes back to the scale of the original decline. We’ve never seen recession that wasn’t called a depression, where we lost six percent of total employment. And if you go back since the post-war period, we’ve never had that deep a recession that then didn’t have an equally quick rebound in job creation.
So until we make more progress on the labor market as a whole, I think both the self-employed and the people who have pay jobs are still going to feel a little bit cautious. Remember, we see that in the wage numbers, which are climbing at an extremely slow pace these days.
KEENE: Let’s leave it there. Avery Shenfeld, thank you so much for that update. CIBC World Markets, this as housing permits and starts bounce along, a little better statistic today.
***END OF TRANSCRIPT***
2011 Roll Call, Inc.
Provided by ProQuest Information and Learning Company. All rights Reserved
Tags: Avery, Bloomberg, CIBC World Markets, Daiwa, Disappointment, Disappointments, Economy Oil, First Quarter, Gasoline Prices, GDP, Homebuilders, Inventories, Managing Director, Michael Moran, Oil Prices, Pessimism, Prewitt, Production Numbers, Quarter Gdp, Tom Keene
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Friday, April 29th, 2011
by Trader Mark, Fund My Mutual Fund
For those of you who follow the hedge fund world, you will know of one of the younger breed of gurus Bill Ackman, who is a regular on the CNBC circuit. The New York Observer has a pretty in depth piece on him, touching on his major investments but also from a personal perspective – interesting to hear about where these success stories came from, and what they do in their free time (Ackman plays tennis with Andre Agassi and George Soros). Like many of the top dogs in the industry, Ackman is super competitive in every part of his life.
In this story in 2008 we learned that Ackman was one of those encouraging Goldman Sachs to restore confidence by getting a cash infusion from Warren Buffet. He also made one of the best investments of the past few decades, by investing into General Growth Properties.
- His most successful investment to date may be the purchase of General Growth Properties, the mall operator. Mr. Ackman bought at 34 cents a share and led it through bankruptcy, and now it trades in the mid-teens.
- Since launching Pershing Square, Mr. Ackman has turned a $54 million initial investment into a $9.3 billion behemoth, according to his March report—conveniently leaked, as it always does, on the rambunctious Wall Street gossip site Dealbreaker.
- “I want to have one of the great investment records of all time, why not?” Bill Ackman, founder of hedge fund Pershing Square Capital Management said nonchalantly over breakfast one Saturday in early April. “That’s why I have to be healthy,” Mr. Ackman continued. “It’s not just compounding a high rate; it’s living a long time. Buffett has a 55-year-old record. I’ve got a seven-and-a-half-year-old record. It’s going to be 90-I’ll be almost 90 by the time I’ve got a 50-year history.” He paused to refine the math. “I’ll be 87.” (He could shave a few more years off since Pershing is currently returning 24 percent annually compared to the 22 percent of Warren Buffet’s storied Berkshire Hathaway.)
- While he prefers to see his seven-year-old fund in the same positive light as many people view the work of Mr. Buffet, comparisons are more often made to Mr. Icahn. Both he and Mr. Ackman are known for their activist investing, taking huge stakes in the bluest of blue-chip companies and then agitating for changes they believe will improve the stock price. Mr. Ackman, who considers his work as benevolent and beneficial—not just to the companies but also to the entire country—hates the comparison to the notorious corporate raider.
- LIKE A HANDFUL of other hedge fund managers, Mr. Ackman’s profile exploded at a time when pretty much everything else around him was imploding. It all began in 2002, when he had made a now-notorious bet against gargantuan muni-bond insurer MBIA. Before that, there had been the occasional headline-grabbing deal, such as when he tried to separately team up with Donald Trump and Jerry Speyer to buy Rockefeller Center from the Japanese in the late 1990s, or when he led the first successful hostile takeover of a real estate investment trust, Cleveland’s First Union. But it was not until he got a tip that the federally backed agricultural insurer Farmer Mac was grossly overleveraged that he would hit upon the investment strategy that serves him to this day.
- Like its bigger siblings, Fannie and Freddie, Farmer Mac had hordes of unregulated, risky loans sitting on its books, just waiting to default. At the time, though, it had “buy” or “strong buy” recommendations from a number of major banks, another counterintuitive investment for the combative Mr. Ackman. Gotham Partners took a huge short position in the company, then released a report titled “Buying the Farm.” In the meantime, Mr. Ackman reached out to a reporter at The Times, Alison Leigh Cowan, whose brother was a business school classmate of his. When the gambit worked—some said thanks to Ms. Cowan’s reports—it made the fund $75 million and sent Mr. Ackman looking for another company to pursue.
Tags: Andre Agassi, Cash Infusion, Cnbc, Few More Years, General Growth Properties, George Soros, Gold, Goldman Sachs, Hedge Fund, Initial Investment, Investment Records, Mall Operator, Mid Teens, New York Observer, One Saturday, Pershing Square, Pershing Square Capital, Pershing Square Capital Management, Personal Perspective, Street Gossip, Top Dogs
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Thursday, April 28th, 2011
by Mark Mobius, Vice-Chairman, Franklin Templeton Investments
In my previous blog, I touched on some of the opportunities I saw in Africa. In this post, I will discuss what I think are the continent’s key challenges and my outlook for the region.
Corruption is a major problem in Africa. However, it takes two to tango, so accusations of corruption against African governments could also potentially be lodged against entities in the developed world that seek to buy the influence of these governments. One important development has been the Cardin-Lugar amendment to the Dodd-Frank finance reform bill in theU.S., requiring among other things, that oil, natural gas and mining companies registered on the New York Stock Exchange disclose any payment made to a foreign government for the purpose of the commercial development of oil, natural gas or minerals. Some believe that the Cardin-Lugar amendment is more important to Africa than the debt relief of the last decade.
The sentiments that arose in recent tensions in North African countries such as Tunisia, Egypt and Libya have spread not only to other African and Middle Eastern countries but also to Asia and other parts of the world. I believe regimes that do not have the support of the public and have not been elected democratically are likely to come under increased pressure going forward. Such a transition could lead to periods of volatility, as we continue to see in the Middle East and North Africa. While these events can be distressing and sometimes have a very high personal cost, it is important to consider how these developments can act as building blocks for the future, with increasing economic and political freedom being very positive for the welfare of individual countries as well as the overall region in the long term. Wherever we invest, we do consider these risks and factor them into our investment decisions.
Despite Africa’s problems, I believe the long-term outlook for the continent is bright. With its substantial wealth in natural resources such as gold, oil, platinum, iron ore, copper and large areas of arable land, Africa is well-placed to benefit from increased growth and higher demand in emerging markets such asChinaandIndia. In 2010, Anand Sharma, India’s Minister of Commerce and Industry, announced that the Indian government planned to invest US$1 trillion in Nigeria and other parts of Africa during the next decade. In countries such as Angola, Nigeria and Ethiopia, rapid economic growth has resulted in better living conditions, lower child mortality, higher primary school enrollment and greater access to clean water. As larger emerging markets increasingly invest in Africa, we are seeing a lot of money funneled toward infrastructure projects such as roads, bridges, schools and hospitals, all which are likely to benefit African economies over the years to come.
Tags: African Countries, African Governments, Cardin, Dodd, Finance Reform Bill, Franklin Templeton Investments, Gold, India, Infrastructure, Investment Decisions, Key Challenges, Last Decade, Mark Mobius, Middle Eastern Countries, mining companies, New York Stock, New York Stock Exchange, North Africa, Political Freedom, Term Outlook, Theu, Two To Tango, York Stock Exchange
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Thursday, April 28th, 2011
This post (with the exception of the two video clips at the end) is a guest contribution by Asha Bangalore, vice president and economist at The Northern Trust Company.
Today’s post-FOMC meeting analysis has two components: policy statement and Chairman Bernanke’s press conference. Starting with the policy statement, the Fed held the federal funds rate unchanged at the narrow band of 0 to ¼ percent. There were no dissents, although in recent speeches, Fed Presidents Plosser and Fisher (both voting members) had voiced their concern about imminent inflationary pressures.
The Fed’s views about the economy shows a minor difference from the March 15 policy statement. The first sentence of the today’s policy statement describes the economic recovery as “proceeding at a moderate pace.” The March statement upgraded the economic recovery to be on “firmer footing” from the January 2011 statement which simply noted that the “economic recovery is continuing.”
The Fed’s take on spending components of GDP was left intact, with housing sector continuing to be depicted as “depressed” and household expenditures and equipment and software outlays as expanding The Fed indicated that “inflation has picked up in recent months” but continues to view higher prices of energy and other commodities as “transitory.” Rhetoric about closely tracking inflation and inflation expectations was retained in today’s statement.
The policy statement settled the uncertainty about whether the Fed will complete the $600 billion purchase of Treasury securities, referred to as QE2, by noting that it “will complete” these planned purchases.
There was no change to the Fed’s near term outlook for monetary policy as the phrase “low levels for federal funds rate for an extended period” continues to be part of the policy statement.
The much awaited first press conference of Chairman Bernanke after an FOMC meeting revealed that the Fed plans to reinvest maturing securities and maintain the size of the balance sheet. Effectively, the amount of monetary policy easing will be unchanged after the completion of the $600 billion purchase. The Fed’s balance sheet as of April 20 stood at $2.67 trillion (see Chart 1). The Fed has purchased $548 billion of the $600 billion target so far.
The looming question at the present time is the course of monetary policy if oil prices continue to advance. Chairman indicated that the Fed expects oil prices to stabilize and trend down. In the event that this does not occur, Chairman Bernanke noted that the evolution of inflation expectations would be the Fed’s guide to monetary policy action. He went on to add that if inflation expectations fail to be stable and well anchored (which is the case at present) the Fed will have to take action. The five and 10-year break-evens obtained from Treasury inflation-protected securities are currently at levels seen prior to the onset of the financial crisis (see Chart 2). Markets will be tracking these levels closely in the days and months ahead.
Chairman Bernanke responded to a question about the meaning of the phrase “extended period” by noting that it would imply the Fed is unlikely to take any action for a “couple of meetings.” June 21-22, August 9 and September 20 are dates of the next three meetings of the FOMC .
There are many unanswered questions about the Fed’s exit strategy such as the actions it is likely to take to tighten monetary policy when economic conditions improve and inflation is a threat. Chairman Bernanke pointed out that the early step would be to stop reinvesting all or some part of maturing securities. In other words, if maturing securities are not replaced, the action would be akin to open market sale of securities, the action the Fed typically takes to tighten monetary policy.
The Fed also made available its latest forecast of real GDP growth, inflation, and unemployment rate today. The Fed has lowered projections of real GDP growth for 2011 and raised estimates of the unemployment rate, overall inflation, and core inflation for 2011 compared with the predictions published in January 2011.
In the two clips below, Fed Chairman Ben Bernanke takes questions on yesterday’s FOMC decision, the fate of QE2 and the Federal Reserve’s plan for dealing with creeping inflation.
Source: CNBC, April 27, 2011.
Source: CNBC, April 27, 2011.
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, April 27, 2011.
Tags: Asset Purchases, Commodities, Dissents, Economic Recovery, Economist, Federal Funds Rate, Fomc Meeting, Footing, Household Expenditures, Inflation Expectations, Inflationary Pressures, Moderate Pace, Monetary Policy, Northern Trust Company, Outlays, Qe2, Rhetoric, Term Outlook, Treasury Securities, Voting Members
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Thursday, April 28th, 2011
This week on Wealthtrack, Consuelo Mack talks to James Grant, editor of Grant’s Interest Rate Observer. He explains why he believes the Federal Reserve’s easy money policies will wreak havoc on the economy and markets. Grant discusses the dangers of inflation creep and how to protect portfolios against is. He also mentions Annaly (LY) at the end of the discussion, as a income paying stock he likes.
CONSUELO MACK: This week on WealthTrack, while Federal Reserve Chairman Ben Bernanke reassures us that “inflation is not a problem,” our Financial Thought Leader guest strenuously disagrees. Author, historian, columnist and contrary-minded editor of Grant’s Interest Rate Observer, Jim Grant, on why even a little inflation is a dangerous thing, next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Federal Reserve Bank Chairman Ben Bernanke has told us on numerous occasions that we need not worry about inflation and that he views recent increases in commodity prices as “transitory,” and predicts they will “eventually stabilize.” As far as most of us are concerned, stabilization, if not reversal can’t come soon enough. Just about everywhere you look, the cost of basics- food, energy, medical and rent- are going up. Those headlines about record highs being set in commodity prices including wheat, corn and cotton and accelerating prices of oil and gas are hitting home. Gasoline prices at the pump have surged more than a dollar a gallon over the past seven months.
Then there is the purchasing power of our currency. As you can see from this chart, provided to us by crack technical market analyst Louise Yamada, the dollar has been in a two year decline versus the currencies of its major trading partners. Yamada expects the value of the dollar to continue to weaken. But what about the broad measures of inflation? What are they showing? Depends upon which one you look at. The chart we are about to show you comes to us courtesy of this week’s Financial Thought Leader guest. He is James Grant, editor of Grant’s Interest Rate Observer, a self-described “independent, value oriented and contrary minded journal of the financial markets.” It also happens to be a must read among top professional investors. This chart, which Grant titles “Inflation Webcast” compares the government issued consumer price index, which as you can see has been rising gradually since early 2009, to what’s called the “Billion Prices Daily Online Price Index,” a real-time index created by two MIT professors. As Grant’s reported, web-monitored prices jumped by 3.2% over the 365 days ended April 4th, considerably higher than the government’s 2.1% rise in the CPI over the 12 months ended in February. And according to MIT, inflation has picked up considerably over the last six months.
But what really sticks in Grant’s craw is that the Federal Reserve feels that 2% inflation is not only acceptable, but desirable. Au contraire says Grant, who says what he calls inflation creep is downright dangerous. I asked him why.
JIM GRANT: Well, yesteryear, not so long ago, in the ‘50s and ’60s- that is 1950s and ‘60s- there was a little fashion for the idea of just a little bit of inflation, 2 or 3%, some of these theorists thought, would be just what we needed. It would impart a lilt to our economy; it would make everyone feel a little bit more prosperous. You get up the morning with a little spring in your step because everything was getting higher, and this was called “creeping inflation”, and some of the advocates were of most learned segment of the provisorial class.
So this idea gained wide circulation, and no little credence, but it was met tellingly by the most orthodox central bankers as rank heresy. As a fellow of the Atlanta Federal Reserve, in fact, the president of that regional Federal Reserve Bank named Malcolm Bryan, and Malcolm Bryan regarded the premeditated creation of inflation by the Fed as an act of moral affront. It was a sin in his view, and he spoke in terms of… he spoke it with almost an evangelical fervor against it. So fast forward to the present day, which is not so far forward in the scheme of time, and creeping inflation by another name has been instituted as official policy. We call it “inflation targeting”. Monetary masters seek 2% a year, which in their self-delusion, they think they can deliver.
CONSUELO MACK: So what is wrong with a little inflation, and especially given the fact that we’ve just gone through a period of financial crisis, as a matter of fact, where inflation– there were eight consecutive months at one point of declining prices, and if the Fed’s, one of the Fed’s primary mandates is price stability, if, in fact, prices are declining, don’t you want to goose the pump a little bit, or prime the pump, and actually get prices so they’re relatively stable?
JIM GRANT: Well, I think one thing to ask is what do we mean, or what should we mean by this phrase “price stability”, which is so often heard and glibly spoken? And let us suppose that the modern world has delivered a kind of cornucopia, that with the addition of 200 or so million willing new hands in one country in Asia, and another couple of hundred willing, new eager hands, another country that the world’s labor force expands, that digital technology further makes us productive, and that the world supply curve, as the economists say, shifts benignly, that is to say at a given level of prices, there is more stuff for sale. More things more cheaply priced is, in fact, what you find when you walk into Costco or Wal-Mart. I’m astounded at the sheer volume of merchandise and its accessibility. So that’s one observation.
So that’s every-day low prices, right? It’s every day low and lower prices. Explain again, Mr. Fed, what’s wrong with that, is what many Americans spend all weekend looking for, right? And we are meant to understand our Fed, experts tell us, that this is somehow dangerous. So I would ask us all to reconsider if stable prices in a time of rising productivity growth and of profound historic expansion of the world’s productive apparatus, if stable prices ought not to mean Wal-Mart kind of every-day low and lower prices. So I think the Fed I think does not believe that. So to give us stable prices, it would have to create more credit to compensate for the Wal-Mart effect in retail, right? So it’s creating the dollars with which to lift the price level from what it would otherwise be, and in so lifting, it affects a widespread distortion of prices and structures in the economy.
CONSUELO MACK: But Jim, the other side of that Walmartization of consumer prices, and I can see that is considered to be a good thing, the other side of that is the Walmartization of wages. Address the issue of wage deflation.
JIM GRANT: It’s hard to find good work at a good wage, and a lot of people in this country are hurting, and it will be of little or no comfort then to know that their lot has frequently been the lot of people in a time of great economic and technological upheaval. Late in the 19th century was a time much like ours in that it was a time of almost miraculous advances and productive technology. Just imagine how much more efficient the world suddenly became with the advent, for example, of electricity, telephone, and telegraph. It was a world of wonder, and in this world of wonder many people were displaced from work; fewer people were necessary to produce what had been produced before these advances in technique and technology, and the people who were displaced had to find something else. They found it, and society moved on, the country improved, got richer. We are phenomenally richer than we were then. Again, this is a little sermonette that will please no one who is looking for– you know, this is not to patronize anyone who is suffering by saying that before you, have others gone just like you, but that happens to be the fact.
CONSUELO MACK: Let’s talk about inflation, and the fact that you were talking about this inflation creep, which you believe is dangerous, and the fact is that the Federal Reserve, and Fed Chairman Ben Bernanke, has targeted, and quite openly said that he’s targeted 2% inflation, and that they, the Feds, seem to feel, and a lot of the financial community seems to feel as well, that 2% inflation, it’s benign, and that inflation really isn’t an issue, and they don’t see any signs of inflation. Man, woman on the street, I see lots of signs of inflation. Are the statistics wrong, is their interpretation wrong? I mean, what do you think the given inflation rate is right now?
JIM GRANT: Sometimes I think that our experts make an easy thing hard. I would define inflation not as too much money chasing too few goods, which is arbitrary, but too much money, and the thing that the redundant segment of money chases, varies from cycle to cycle. It could chase skirts during the inflation of the ‘70s when everything went up at the cash register, or it could chase stocks and bonds as in our own day when the form of inflation is called a bull market, a very pleasing form of inflation on Wall Street. But the process of creating more money than is demanded for productive enterprise is inflation by any other name, and the form that it takes, as I say, is variable. And today, we don’t have to look too far to see many forms this inflation takes. The shiniest skyscrapers in our most prosperous coastal cities are priced as they were at the peak of the real estate lunacy of 2006 and ’07 all over again.
CONSUELO MACK: Which was news to me, but that’s an astonishing fact.
JIM GRANT: Commodity prices we know about- new highs in gold, new highs in silver.
CONSUELO MACK: Farmland and …
JIM GRANT: … farmland in Iowa. Grundy County farmland is now, some of these transactions are taking place at $10,000 an acre, which translates into some of the lowest rental returns on record for lease 40 years. So the Fed, I think, is unconscionably complacent about the consequences of what it’s doing, and let us not blink at what it’s doing. It has imposed the lowest money market interest rates that anyone remembers, and indeed, they could hardly go much lower, they being at zero. It has expanded its balance sheet into something grotesque all in the space of a couple of years. You know, these are monetary events that have never before been seen, and indeed, never before imagined.
CONSUELO MACK: The Fed Chairman would say and has said, and what much of Wall Street has said as well, is that the Fed needed to take dramatic action in a dramatic time, and in order to basically, you know, bail us out of an unprecedented financial crisis, or something not as great as we’ve had since the Great Depression, that it needed to do all of these things; and isn’t it great, in fact, that we’ve recovered to the extent that stock and bond prices are going up, and commodity prices are going up, and that, in fact, you know, is a good thing for people who work in those industries, and the household wealth of…
JIM GRANT: Well, Consuelo, you’re right, they do say that, they do say that, and it is certainly great for one class of society. It’s great for the speculative classes. In private testimony before the financial crisis inquest, Ben Bernanke, the Fed Chairman, he said, “I, speaking as a scholar of the Great Depression, I’ll tell you, that the events of 2008 were, in fact, the worst financial crisis is in American history, period. Twelve out of the thirteen largest American financial institutions were on the brink.” Now, we ought to stop and ask why that was so, if it was so. Let’s say it was. Our GDP was down less than 4% top to bottom during our Great Recession. During the Great Depression, our GDP was down in nominal terms, that is to say dollar terms, was down not quite, but almost half, yet most banks did not fail during the Great Depression.
During our piddling Great Recession, by contrast, we hear from the regulator and chief that we’re at death’s door financially, so something has happened to our financial institutions and to our way of doing business, which I think speaks to the monetary arrangements we have elided into. We have socialized risk, we have privatized gain, much to the relief of Greenwich, Connecticut, where our zillionaires live, and the unconscionable and indefensible fallout of this is that savers get zero on their savings balances, and the speculative classes get to borrow in wholesale markets at zero, and make their zillions all over again in commodities, stocks, and bonds. So I think that the Chairman is whistling by the graveyard, and he’s whistling by the graveyard in this matter of a 2%inflation rate being harmless.
CONSUELO MACK: And let’s put some numbers to that harmlessness of the 2% inflation rate.
JIM GRANT: Let’s talk about the Federal finances for a second. In the past five years- I’m using round numbers- the Federal debt is gone from quote $5 trillion to almost $12 trillion, yet during that period, thanks to these little miniature interest rates the Fed has imposed, the interest bill on the public debt has risen hardly at all. The government is paying like 2% plus on these trillions of dollars of indebtedness, and as percentage of federal outlays, interest expenses, like 6 ½ %, it is the lowest it has been in decades.
So if interest rates were to go back to where they customarily were, where they have been for the past five decades, say between 4 and 6%, our interest expense on this debt is going to be enormous. So people who say, “Ah, thank goodness for our federales, thank goodness for our masters in Washington, they rescued us from ourselves.” Well, yes, in a way, but the consequences of this rescue are enormous morally; let us not forget, financially and fiscally, and we haven’t finished reckoning them yet. They’ve barely started reckoning them.
CONSUELO MACK: I was going to ask you, so what are your inflation expectations?
JIM GRANT: So my expectation about inflation is that there will be a lot of it suddenly, and by a lot of it, I mean something that people can’t explain away, that the authorities can’t explain. I say 4 or 5%, let us say. So think about what that would mean. So much of our speculative apparatus is powered on these 0 percent interest rates- hedge funds, and the professionals who borrow…
CONSUELO MACK: Because that’s what they can borrow at, right.
JIM GRANT: Yeah. Why wouldn’t you? I can’t blame them. So they’re borrowing at nothing. Banks are paying nothing on deposits, so banking margins are fat. You know, we are back to rates of return in banking capital we haven’t seen before. We are about on the verge of all-time highs and bank profits thanks in part to this uniquely, this unusually– I use “unique” a little too loosely. Nothing is unique in finance. This astoundingly twisted interest rate structure. So much of the structure of values and prices in financial markets are based upon an interest rate structure that is, you know, beyond strange, and it certainly can’t be supported forever.
CONSUELO MACK: Tell me what this means as far as our investment, investment strategy is concerned.
JIM GRANT: Nothing is going to be good. So think how hard it is to hold back a cash reserve in this time, when cash yields nothing, it yields a negative because the inflation we all see is something more than zero, right? Cash yields zero. That’s hard. It’s doubly hard because your stupid neighbor who doesn’t watch this program is making a lot of money in the stock market. How hard is that not to participate… you can’t not do it.
CONSUELO MACK: Just like the housing market a couple years ago.
JIM GRANT: Right. But stop and think what it would mean if there were 4%, a persistent and undeniable, you can’t explain away this 4% inflation rate. It would mean that the Fed would clear its throat and say in the marble mouth way it speaks, the party is over.
CONSUELO MACK: Right. And they do it pretty quickly.
JIM GRANT: So suddenly, you know, the commodity markets have been the great haven for inflation-fearful people. I don’t think they do very well in this moment of reconsideration of interest rates and leverage. So suddenly everything would fall out of bed, I think. I think gold would ride itself, silver would ride itself because their money, I think, would come into their own at the end of the cycle of disillusionment. But for a time, I think there would be terrific chaos in investment markets, meaning terrific opportunities. People would be selling stuff they shouldn’t sell, so people with liquidity, which again, pays nothing and is impossible to hold when your friends are getting rich without it. The liquidity would come into its own very suddenly.
CONSUELO MACK: So cash would no longer be trash…
JIM GRANT: Right.
CONSUELO MACK: …cash would be precious and valuable.
JIM GRANT: It would. Yeah, even dollar bills, which I’m in a habit of disparaging, because they’re paper.
CONSUELO MACK: So, Jim, the gold standard. You’ve been an advocate of a gold standard for a long time.
JIM GRANT: Yeah. I was an advocate of the gold standard when there actually was a gold standard, in 1914. It would take a terrific collective rethink, and it would take a great unfrocking of the authorities and the experts who now not only, who don’t even disagree with us. It’s worse. They don’t just say, “Grant, you’re wrong”, they say– it’s a smiling condescension one can’t stand.
CONSUELO MACK: Right. They dismiss it.
JIM GRANT: Right. Sorry, right. But I think, if I’m right, and I think I am, if I’m right about the dynamics of the Federal debt, if I’m right about the absence of a check on our continued running of the most profligate deficits, and if I’m right about the social and political immorality of monetary arrangements as they now exist- that is to say savers getting nothing, and the speculators getting most everything- it seems to me not only is the mathematics of a gold standard compelling, but also the politics are compelling.
CONSUELO MACK: So, Jim, you have in the past, when you’ve been on WealthTrack and in other places, have bemoaned the fact that you are viewed as a bear, because in Grant’s Interest Rate Observer, you always have a long idea, and usually have short ideas, as well. So what’s your long idea?
JIM GRANT: I’ll tell you what we’re looking at right now, we’re looking at commercial real estate. What is new and what is really interesting about the commercial real estate market these days is there is enormous spread in returns between what is popular and liquid, and shiny, that is so-called trophy properties in the big cities, that’s on the one hand, versus less liquid, more out-of-the-way properties outside–
CONSUELO MACK: Tarnished?
JIM GRANT: Some of them tarnished, but some of them are just plain fine, but they are not at the corner of Park Avenue and 54th Street. So an office property recently changed hands in Milwaukee, the first such sale in a year, such as the ill-liquidity of the commercial real estate market. It changed hands for a cash on cash return without financial leverage of 8%. This is fully leased, ten years, one tenant, sounds like a pretty substantial property, and 8% versus the 4 or 5%. Increasingly 4% you get on these core properties. So we intend to do a great deal more digging, and try to surface investments that offer good valuations now, and that offer some inflation protection because rents will escalate as the cost of living goes up. So that’s our new idea.
CONSUELO MACK: So what is an accessible investment for individuals, for instance, who can’t buy a building, a commercial building?
JIM GRANT: There was a great income famine in the world, right? You can’t get any return on your savings. You look around, even junk bonds have junky yields.
CONSUELO MACK: Right.
JIM GRANT: High yield isn’t high yield, high yield is low yield. So what to do? So I own this personally, for whatever it’s worth. I’ve been friends forever with the management, I think they’re solid people, something called Annaly, N, as in Nancy, LY is the ticker–
CONSUELO MACK: And we know, we’ve had Mike Farrell on the founding of the CEO–
JIM GRANT: It trades around book value, it yields something in the teens, it buys mortgages with borrowed money. The leverage is conservative as mortgage real estate investment trust. Leverage is reckoned. These people have been through the cyclical mill, they have seen what it’s like to have been on the wrong side of too much leverage, and I think they’ve had the fear of God instilled in them. So they yield in the teens.
So how to get income if you’re an individual. Well, you can go out and buy REITs, yield say 5 or 6 %.You can go out and buy dividend-paying stocks that yield 2 or 3 %, and the stocks are priced reasonably at 15 times earnings. You can go out and buy municipal bonds that yield 3 and 4%. Some of them aren’t so bad, some of them are, in fact, quite good. The municipal bond market is immense. You can get some comfort, a credit quality in municipal bonds. But to do all those things, you’re not talking about a great deal of income.
My idea is that perhaps one goes out and buys rather more of Annaly, and rather less of the other things, keeps a substantial cash reserve for that moment, which I think is coming, in which the realization of a new inflation cycle shakes up valuations and prices across the broad spectrum of financial assets, and you have the liquidity ready to take advantage, to buy things on the cheap.
CONSUELO MACK: Jim Grant, it is such a treat to have you on WealthTrack again.
JIM GRANT: Consuelo, thank you. I’m so delighted to be here.
CONSUELO MACK: It is not only a pleasure to talk to Jim Grant, it is also a treat to read him. He has a new book coming out next month called Mr. Speaker!: The Life and Times of Thomas B. Reed. As one reviewer put it: “No period in American history is more colorful or relevant to our own- for better and worse- than the Gilded Age. James Grant brings it all memorably to life.” As soon as I can get my hands on Mr. Speaker!, it is going on the WealthTrack bookshelf!
Next week we have a double header with an up and coming financial thought leader, Strategas Research’s Jason Trennert, and a highly rated global equity fund manager, PIMCO’s Chuck Lahr. To see this program again please go to our website, wealthtrack.com, and while you are there, check out WealthTrack Extra, where you can listen to a podcast of my recent interview with wealth advisor Chris Cordaro, who has some timely tax tips for this year and next. Thank you for taking the time to visit with us and make the week ahead a profitable and a productive one.
Source: Wealthtrack, April 15, 2011.
Tags: Commodity Prices, Consuelo Mack, Dangerous Thing, Easy Money, Federal Reserve Bank, Federal Reserve Chairman, Federal Reserve Chairman Ben Bernanke, Food Energy, Gasoline Prices, Gold, Hitting Home, Interest Rate Observer, James Grant, Jim Grant, Major Trading Partners, Market Analyst, Purchasing Power, Record Highs, Seven Months, Thought Leader, Wealthtrack
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Thursday, April 28th, 2011
Stock market movements since the start of the credit crisis have been characterised by relatively high volatility as uncertainty became paramount. And as new pieces of the economic recovery puzzle are added every day, investors are increasingly struggling to make sense of the most likely direction of stock prices.
It seems to be a case of so many pundits, so many views. Has the market started topping out and is a primary bear market about to resume, or will the secular bull market merely be correcting the strong rally that commenced in March 2009, before moving higher? Or is a “muddle-through” trading range in store?
It is one thing to trade the market’s rallies and corrections, but this is easier said than done, with not many people actually getting it right with any degree of consistency. Others are of the opinion that the recipe for creating wealth is simply to follow the patient approach, saying that “it’s time in the market, not timing the market” that counts.
This gives rise to the all-important question: does one’s entry level into the market, i.e. the valuation of the market at the time of investing, make a significant difference to subsequent investment returns?
In an attempt to cast light on this issue, my colleagues at Plexus Asset Management have updated a previous multi-year comparison of the price-earnings (PE) ratios of the S&P 500 Index (as a measure of stock valuations) and the forward real returns, as done by Jeremy Grantham’s GMO. Our study covered the period from 1871 to April 2011 and used the S&P 500 (and its predecessors prior to 1957). In essence, PEs based on rolling average ten-year earnings were calculated and used together with ten-year forward real returns.
In the first analysis the PEs and the corresponding ten-year forward real returns were grouped in five quintiles (i.e. 20% intervals) (Diagram A.1).
The cheapest quintile had an average PE of 8.9 with an average ten-year forward real return of 11.0% per annum, whereas the most expensive quintile had an average PE of 25.5 with an average ten-year forward real return of only 2.1% per annum.
This analysis clearly shows the strong long-term relationship between real returns and the level of valuation at which the investment was made.
The study was then repeated with the PEs divided into smaller groups, i.e. deciles or 10% intervals (see diagrams A.2 and A.3).
This analysis strongly confirms the downward trend of the average ten-year forward real returns from the cheapest grouping (PEs of less than six) to the most expensive grouping (PEs of more than 21). The second study also shows that any investment at PEs of less than 12 always had positive ten-year real returns, while investments at PE ratios of 12 and higher experienced negative real returns at some stage.
A third observation from this analysis is that the ten-year forward real returns on investments made at PEs between 12 and 19 had the biggest spread between minimum and maximum returns and were therefore more volatile and less predictable.
As a further refinement, holding periods of one, three, five and 20 years were also analysed. The research results (not reported in this article) for the one-year period showed a poor relationship with expected returns, but the findings for all the other periods were consistent with the findings for the ten-year periods.
Although the above analysis represents an update to and extension of an earlier study by GMO, it was also considered appropriate to replicate the study using dividend yields rather than PEs as valuation yardstick. The results are reported in diagrams B.1, B.2 and B.3 and, as can be expected, are very similar to those based on PEs.
Based on the above research findings, with the S&P 500 Index’s current ten-year normalised PE of 27.1% and dividend yield of 1.8%, investors should be aware of the fact that the market is by historical standards in “extreme overvaluation” territory. As far as the market in general is concerned, this argues for unexciting long-term returns, and possibly a “muddle-through” trading range for quite a number of years to come.
Although the research results offer no guidance as to calling market tops and bottoms, they do indicate that it would not be consistent with the findings to bank on above-average returns based on the current valuation levels. As a matter of fact, there is a distinct possibility of below-average returns.
Tags: Bear Market, Creating Wealth, Credit Crisis, Economic Recovery, Investment Returns, Jeremy Grantham, Muddle, Patient Approach, Pe Ratios, Predecessors, Price Earnings, Pundits, Quintile, Rallies, Secular Bull Market, Stock Market Returns, Stock Prices, Stock Valuations, Store Stock, Volatility
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Thursday, April 28th, 2011
by Mark Mobius, Vice Chairman, Franklin Templeton Investments
Those who are optimistic about Africa say that after many years of colonialism, it is beginning to demonstrate its potential. The continent does have its detractors, who say that while it may have been free of colonial rule for 60 years, the continent continues to battle poverty, corruption, AIDS and armed conflict. However, while Africa does have challenges, I am encouraged by another side of Africa that is gradually emerging with the development of capital markets, consumerism and technology.
(Mark Mobius visits a paper factory, in photo)
I believe the opportunities for the development of Africa’s markets are appealing primarily because of the strong growth numbers now emerging out of the continent. Africa is expected to grow more than 7% annually in the next 20 years, due to an improving investment environment, better economic management and China’s rising demand for Africa’s resources. More than 100 African companies have revenues in excess of $1 billion. Africa also has impressive stores of resources, not only in minerals but also in food — 60% of the world’s uncultivated arable land is found in Africa. As global demand for hard and soft commodities continues to grow, I believe Africa is in an enviable position with its vast natural resources. The potential for long-term growth in consumer-related areas is also very attractive, with around 1 billion inhabitants on the African continent. These are people, just like many others all over the world, with aspirations to own their own homes and buy possessions such as cars, refrigerators, washing machines and the like.
Within Africa, Nigeria is one of the frontier markets that I like. The country has a population of about 155 million people. It is rich in oil and gas reserves and raw materials such as iron ore, coal and bauxite. In addition, its climate and large areas of fertile land lend themselves favorably to agriculture. Nigeria’s economy has benefited from strong commodity prices; it is estimated to have grown 7.4% in 2010 and is forecasted to grow 7.4% again in 2011. The highly-anticipated Nigerian presidential election may be seen by many as a measure of the country’s progress and stability despite the clashes and unrest running up to the election. Our local sources remain confident about the elections overall and are not expecting any significant derailing event. We share this sentiment for the most part, given the current positive economic environment, fueled by high oil prices, as well as more tangible reforms in the country. Moreover, banks in Nigeria are particularly interesting. In our view, the government’s recent bailout of banks has made the nation’s bank stocks cheap, creating some very interesting investment opportunities.
I also see a lot of potential in markets such as Ghana and Kenya. Ghana was the first sub-Saharan country in colonial Africa to gain independence. Although it endured an extended period of military rule, a new constitution and multi-party politics were introduced in 1992. Currently, Ghana is seen by many as one of the most politically stable democracies in sub-Saharan Africa. We are excited about the prospects for consumer-related sectors in this market, given its relatively young and dynamic population of more than 20 million. The country is also rich in natural resources such as oil and gold. Oil production in the offshore Jubilee field commenced in December 2010 and is likely to make a significant contribution to the country’s economic growth going forward. Of course, related investment in infrastructure is also likely to require financing, so we are looking closely at the financial sector as well.
The Kenyan economy appears to be doing well at the moment. The post-election violence in late 2007 and early 2008 took many by surprise, but it culminated in the establishment of a coalition government and the adoption of a new constitution in 2010, creating a solid foundation for future stability and growth. Kenya’s position on the east coast of Africa allows it to act as a hub for trade and investment flows from the east into the rest of the continent. Exports, predominantly tea and horticultural products, have recovered strongly, and the tourism sector is also seeing a strong rebound in the form of incoming foreigners.
There are also many challenges to investing in Africa. In my next post, I will discuss these further as well as my overall outlook on the region.
 Source: The Super-Cycle Report, Standard Chartered Bank, as of November 15, 2010
 Source: McKinsey & Company, Asia should buy intoAfrica’s growth, as of August 12, 2010
 Source: World Bank, Feature Stories: Concessional Funding Key to Unlock Africa’s Agriculture, as of January 29, 2011
 Source: UN Statistics Division, Department of Economic and Social Affairs, World Population Prospects: The 2008 Revision
 Source: World Bank, as of 2009
 Source: IMF, WEO, as of October 2010
Tags: Africa Nigeria, African Continent, Arable Land, Armed Conflict, Bauxite, Colonial Rule, Colonialism, Detractors, Economic Management, Fertile Land, Franklin Templeton Investments, Frontier Markets, Gas Reserves, Global Demand, Gold, Growth Numbers, Infrastructure, Investment Environment, Iron Ore, Mark Mobius, Nigeria Ghana, Soft Commodities
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Thursday, April 28th, 2011
RBC Capital Markets’ Chief Institutional Strategist, Myles Zyblock, discusses his insights on how American companies are sustaining their profitability in the post-financial-crisis era.
Myles Zyblock, Chief Institutional Strategist at RBC Capital Markets, talks to Bloomberg’s Tom Keene and Ken Prewitt on Bloomberg Surveillance.
APRIL 19, 2011
SPEAKERS: TOM KEENE, HOST, BLOOMBERG SURVEILLANCE,
MYLES ZYBLOCK, CHIEF INSTITUTIONAL STRATEGIST, RBC CAPITAL MARKETS
KEN PREWITT, BLOOMBERG NEWS
TOM KEENE, HOST, BLOOMBERG SURVEILLANCE: Now joining us Myles Zyblock, RBC Capital Markets. He’s the 75th equity strategist for RBC. Good morning, sir.
MYLES ZYBLOCK, CHIEF INSTITUTIONAL STRATEGIST, RBC CAPITAL MARKETS: Good morning, Tom. How are you doing?
KEENE: Very good. In there and bouncing off of Alan Blinder’s Wall Street Journal article today, the secretary talked and alluded to a guilded age of income distribution. This equity market recovery we’ve seen, does it talk about markets that are separate of the haves and the have nots? Do we have another guilded age upon us?
ZYBLOCK: You know, my sense here is if you just look at the survey of consumer finances out of the Federal Reserve itself, the ownership of equities obviously concentrated in the hands of the upper income distribution. So as we know, a near 100 percent rally in the stock market over the past couple years has definitely benefited some of the upper income class more so than the rest.
KEN PREWITT, BLOOMBERG NEWS: Well, isn’t that pretty much always the case though?
ZYBLOCK: That is indeed. Well, it is always the case to a degree, but I guess, you know, what a labor economist might look at as you said that the income distribution has never been more skewed as it is today. So in relative terms, I guess the benefits at the margin are going to the upper income class. They have always been going there in level terms, but increasingly so.
KEENE: You have an incredibly powerful page, Myles, and it really goes again, not so much a gilded age, but let’s call it an industrial separation. You have the S&P 500 ex the financials. And you have a chart back 30 years of the net margin of the non-banks. I would just simply editorialize I’m observing a miracle here of profitability, aren’t I?
ZYBLOCK: A miracle – I’m not sure about a miracle, but I would say a lot of hard work and restructuring of corporate America through – Tom, I think the trend upwards, the 30 year trend upward the next financial net margins, is a function of a lot of things.
And a couple I could point to is labor cost savings efforts – some of that is good obviously and bad, like off-shoring and the declining unionization rates. And there is also a lot of innovative progress, like better inventory management systems. And I think these have all come together to push that long term trend higher.
PREWITT: Are we pretty much at the end of that cycle though?
ZYBLOCK: I think we are nearer to the end. I wouldn’t say the end, Ken. It’s – you know, can margins make some new highs over the next few quarters? I think so. You know, my sense here is obviously one of the big concerns that analysts are talking about are commodity price pressures or cost inflation through the commodity complex.
And I think that is going to be more a localized problem. What I mean by that is there are some industries or sectors within the market that are more susceptible to rising commodity prices than others. And some of those include the consumer related segments.
But, you know, talking about a broad-based margin compression, when we look back through time, what really drives margins – the primary driver of margins are still labor costs. And that is, you know, as we estimate, labor costs still account for something like 62 percent of the total cost of doing business.
So if you have an acceleration in wage growth on top of an acceleration in payrolls, that is where you usually see – within a quarter or two, that is where you usually see some more noticeable margin compression, not just the isolated stuff I’ve been hinting at. So in my opinion, I think the margin profile can make some modest gains here. But it will – in my sense, it will start to flatten out as we go into 2012.
KEENE: We’re going to come back with Myles Zyblock, RBC Capital Markets, after Secretary Geithner’s speech with our Peter Cook.
KEENE: We continue with Myles Zyblock, RCB Capital Markets, looking at equity investment, return of the fear trade. One little sentence here, Myles, really gets my attention. Main Street is massively under invested. What is it going to take besides healing to get Main Street back on Wall Street?
ZYBLOCK: Yes, I mean you make a great point, Tom. It is, you know, we have seen negative net flows into the equity market almost unabated. There has been some short periods of reprieve here, but almost unabated since 2008. And this is really – you know, obviously there has been a lot of psychological damage created as a result of too [two] big bear markets and the housing collapse in the last decade.
Tags: Alan Blinder, Bloomberg News, Federal Reserve, Financial Crisis, Good Morning Sir, Guilded Age, Income Distribution, Labor Economist, Myles Zyblock, Nots, Prewitt, Profitability, Rbc Capital Markets, Relative Terms, Stock Market, Strategist, Street Journal Article, Survey Of Consumer Finances, Tom Keene, Wall Street Journal
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Thursday, April 28th, 2011
by Leo Kolivalis, Pension Pulse
On Wednesday I had a nice chat with Jonathan Jacob of Forethought Risk, an independent risk advisory firm that educates and advises public and private pension funds, asset managers, an insurance companies to create a greater understanding an appreciation for the nature of risk and how to use it to the firm’s advantage. They also advise treasury management functions on risk, risk valuation, how to hedge risk and provide transaction oversight to ensure pricing fairness.
Jonathan traded interest rate swaps for many years at Bank of Montreal and even worked a year with the Fixed Income division at Ontario Teachers’ Pension Plan during the financial crisis. After speaking with him, I simply don’t understand how Teachers’ let a guy like this slip through the cracks (absolutely terrible decision and just goes to show you that really smart and honest people get the short end of the stick during tumultuous times).
If you want someone to help you hedge risk, this is the person you want to talk to. Stop paying consultants who provide you with cookie cutter “one size fits all” solutions and get a hold of Jonathan who will provide you with tailor made strategies that fits the maturity of your plan and the duration of your liabilities. We both agree that the state of pension consulting is simply atrocious, with too many consultants cutting corners, offering the same advice to all pension funds without taking into consideration their unique characteristics.
Jonathan and I talked a lot about leverage, specifically how pension funds are using or misusing leverage. In June 2010, he wrote a comment for Benefits Canada, The L Word:
The global financial crisis has acted as a catalyst for many things—perhaps most importantly for pension funds, a renewed focus on risk. No longer does a lack of obvious correlation between assets presume protection, and the startlingly simple mantra “don’t buy what you don’t understand” has taken renewed prescience.
However, the decision to increase efforts at risk management does not make the process any easier. There are many mathematical measures of risk, including:
- volatility: the magnitude of potential returns of a particular asset;
- leverage: the borrowing of funds to increase exposure to a particular asset; and
- correlation: how assets perform relative to one another.
Watch your liabilities
A pension fund may choose to measure the risk of its assets on a stand-alone basis or it may choose to measure it against the risk embedded in its liabilities. This second method of measuring risk often leads to liability-driven investing (LDI), which attempts to manage the risk of the assets in tandem with the risk of the liabilities. The implementation of LDI is subject to vast interpretation and may include the use of various tools, such as derivatives and hedge funds, not previously accessed by many pension funds.
One interpretation of liability-driven investing involves the hedging of all interest rate risk while maintaining current allocation to equities. Hedging is the attempt to minimize exposure to a particular risk (in this case interest rate risk), and it can be done through the use of a derivative called an interest rate swap, which does not require the use of cash, thus enabling the fund to maintain its cash in equities. It would seem that the use of swaps in this fashion reduces the financial risk of the pension fund as interest rate risk has now been hedged, while it retains upside exposure to equities. However, the fund has exchanged one form of risk for another.
The fund has undertaken a degree of leverage in that the notional value of the assets exceeds that of the liabilities. While this may be within acceptable risk parameters, it depends significantly on the expected correlation (how two securities move in relation to each other) of two asset classes. For example, the fund that layers interest rate hedging through derivatives on top of a cash equity mandate must consider the expected correlation of bonds and equities. Experience over the past 25 years shows that in times of stress Treasury prices are highly negatively correlated with (or opposite to) equity prices. Our pension fund manager can thus feel comfortable with the decision to layer on leverage since the interest rate hedge will outperform in an equity meltdown, while a rally in equities will likely improve funding ratios regardless of the underperformance of the interest rate hedge.
In the current environment, however, such analysis is fraught with potential pitfalls. The world economy is facing a tug-of-war between inflationary and deflationary forces. In the late 70s and early 80s when the world last faced significant inflation, equities and bonds were positively correlated as both sold off. A fund with leverage can lose much more than its allocated risk budget in such a scenario.
Another matter to consider is the “basis” risk between the interest rate hedge and the liabilities. There are many health ratios for pension plans, including the funding ratio and the solvency ratio. Depending on the ratio in question, the yields discounting the liabilities may be determined from the use of only Government of Canada bonds or it may also include corporate bonds. Interest rate swaps are highly correlated to both Government of Canada bonds and corporate bonds as the core interest rates are the same in each subclass of fixed income. However, both corporate bonds and swaps trade as a spread to Government of Canada bonds and these spreads can fluctuate significantly and in opposite directions. For example, at the outset of the credit crisis, corporate spreads widened significantly while swap spreads simultaneously tightened.
A final consideration for any pension plan considering leverage is the funding rate for the financed asset. The minimal benchmark for any asset should be the funding rate; otherwise, the leverage employed is a financial drag on performance. The asset being measured against this minimal benchmark depends on the outlook of the plan sponsor. If, in our example above, the benchmark asset allocation is a typical 60/40 equity to fixed income ratio then the additional 60% of assets used to hedge interest rate risk would be measured against this minimal return hurdle. On the other hand, if the pension fund’s benchmark asset allocation is a full interest rate hedge, then the equity allocation should be measured against this hurdle even though the interest rate swap is the financed asset.
Historically, strategic leverage of assets was not employed by pension funds because many did not use derivatives nor were they able to issue bonds. As funds have become more sophisticated, however, new avenues have opened up including the ability to use leverage. If employed with the proper understanding and risk limits, leverage can assist pension funds in reaching their funding goals.
Benefits Canada also had a recent summit notes on one plan’s use of leverage:
Calvin Jordan, CEO of the Nova Scotia Association of Health Organizations Pension Plan (NSAHO) in Bedford, N.S., discussed how this DB plan uses leverage to improve its asset liability matching at the Pension & Benefits Conference today in Toronto.
The $3.6-billion plan’s asset mix is 25% fixed income (65%, but 40% is leveraged), 40% equities and 35% alternatives. “That [alternatives] may be on the high side,” said Jordan, “but it’s not including hedge funds.”
Using leverage in its asset strategy causes an increase in risk to the assets but a decrease in risk to the balance sheet, he explained.
Strategy has nothing to do with past results, said Jordan, it’s whether your strategy glues everything together.
Watch for more to come on this topic.
Jonathan and I also discussed the increasing allocation to private markets in many of the large Canadian pension funds. He rightly notes that a lot of this is done for mark-to-market reasons because pension fund managers have more flexibility marking these assets up and down whereas they can’t do this in public markets.
I told him that when I started my blog, I started writing on the ABCPs of pension governance and blasted pension funds that were using bogus benchmarks in alternative investments. I strongly feel that it’s critical that we demystify pension fund benchmarks once and for all, and stop claiming that added value at pension fund A is the same as added value in pension fund B. Importantly, if they use different benchmarks for their individual investment portfolios and if one uses a lot more leverage than the other, then added value is not the same!
Go back to read my recent comments on apples and oranges, OTPP’s Neil Petroff on active management, and a look at the Caisse’s 2010 Annual Report. It’s worth noting that while Teachers’ is leveraging up, the Caisse is reducing leverage across the board. Does this mean Teachers’ is better at managing risk? Maybe or it just means they’ll get whacked harder during the next crisis as they did in 2008 when they crashed and burned.
I have discussed how public pension funds are increasingly leveraging up to make the returns they’re looking for. I have also discussed how public pension funds are increasingly allocating to private markets and hedge funds, another source of additional leverage (juice). The truth is private markets have been good to pension funds and senior pension fund managers. Guys like Claude Lamoureux, the former president and CEO of Ontario Teachers’ made millions by allocating to private markets. In fact, almost all of the added value among all the large Canadian pension plans in the last 10 years or more came from private equity and real estate (and more recently infrastructure). No wonder senior pension fund managers can’t get enough of private markets — they’ve become stinking rich allocating to these investments.
To be fair, if you look at how corrupt and manipulated public markets have become — with high frequency trading and naked short-selling — you have to ask yourself why would pension funds not move all their assets into private markets. I used to think funds like OMERS were nuts to set long-term strategic asset allocation of private markets at 60%. I still feel this is going to be difficult but I understand why pension funds want to have more control over their investments and not rely as much on volatile public markets.
Getting back to the use of leverage at public pension funds, Jonathan shared some additional comments with me:
Just to let you know, I believe that many pension funds employ some use of leverage either knowingly or unknowingly. Some of the large consulting firms are recommending use of interest rate derivatives to hedge interest rate risk even while maintaining exposure to equities.
As I mentioned in the Benefits Canada article I sent you, there is extreme danger in times like these where the potential for serious inflation is non-negligible, to take care as fixed income is not necessarily negatively correlated with equities. My research has shown that this negative correlation (equities & FI) was a Greenspan invention which he used to fix the market after the ’87 crash by lowering administered rates. If you go back to the ‘70s, equities and fixed income both sold off due to inflation. Therefore, I recommend funds using these strategies to employ stops on some form of the leverage – either the equity or fixed income portion.
You should also be aware that I am not fundamentally against leverage as I think good uncorrelated alpha product on top of interest rate derivatives used to hedge the interest rate risk in a pension fund is a relatively solid approach. The trick is to find those types of assets.
Funds that employ leverage but may not be aware of such will find it buried in some private market investments such as private equity or real estate, which may use borrowed money to lever funds.
Funds that use leverage knowingly include OTPP, which issued bonds to back its real estate portfolio (this is a continuation of the way Cadillac Fairview managed its real estate portfolio).
I want to emphasize again that not all leverage is bad, but it should be used with the proper level of risk management and portfolio expertise.
On the question of inflation, I told Jonathan I don’t see it without wage inflation. He agreed with me and sent me a recent comment of his on the wall of worry:
The stock market continues to climb a wall of worry, buoyed by “free money” – zero interest rates. But zero rates are really here to create inflation – real inflation, not the kind that increases prices of food, metals and energy. Real inflation is wage inflation and with high unemployment in the US, it is hard to see a way into real inflation. Meanwhile, the inflation generated by zero rates (higher prices of food, energy and metals) are simply taxes on the normal citizen. With greater funds set aside to drive, eat and build (shelter), there is less room for discretionary spending.While the demographics are not similar, we could be seeing a new iteration of Japan.
I thank Jonathan for providing me with his comments on the use of leverage in pension funds. We both agree that if used properly, leverage can add value to overall results. But we also fear that fiduciaries don’t understand all the risks of using leverage in both public and private markets and all too often rely on spurious “one size fits all” advice that pension consultants routinely peddle. Unfortunately, much more needs to be done to address this lack of knowledge among fiduciaries.
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