Bill Black: JPM’s “Wild, Crazy Insane Gamble” Puts Economy at Risk [Video]

Thursday, May 24th, 2012

Tags: Bill Black, Economy, Insane, Jpm, risk
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Market Gut Check Time, Again (Boyle)

Thursday, May 24th, 2012

by Mike Boyle, Advisors Asset Management

From 4/2/12 through 5/18/12 the S&P 500 lost 8.73%. This marks the18th time since 3/9/09 (the beginning of the current bull market) that the S&P 500 has corrected by at least 3% and the eighth time that the S&P 500 has corrected by at least 7%. In addition, our research of the last 50 years shows 3% pullbacks occur on average four times a year. So, clearly pullbacks are commonplace during a normal bull market; however, every time they occur they still set investor emotions on edge and test their resolve. At times like this we like to try and decipher what drove the selloff and try to resolve if we think it is just a normal correction or the beginning of a longer trend down and possibly the start of a new bear market.

In late March, we highlighted that the equity markets appeared to be due for a correction and consolidation as the run from the 10/3/11 bottom seemed unsustainable and the equity markets appeared overbought. April then began with a mild selloff (-4.26%) but then it traded back towards its near-term high in late April and early May. However, as May progressed investor appetites soured and the equity markets turned south again driven by seasonality fears (Sell in May…), banking concerns (JP Morgan’s trading loss) and worries over the viability of the Eurozone due to the recent elections in France and Greece. On their own, any one of these factors was enough to push the market lower and together they drove a pretty strong selloff of 7.87% for the S&P 500 (5/1/12 – 5/18/12). Yet it wasn’t all bad news, but the good news on corporate earnings and U.S. economic strength was just that, good news, and the markets were in need of great news to help stem the short-term tide.

Some of this good news includes an earnings season that is, statistically, better than last quarter. In addition, EPS (Earnings Per Share) for the S&P 500 has risen over 10% year-over-year and is expected to grow about the same over the next year. On the value side the P/E (Price per Earnings) for the S&P 500 now sits at 13.29 well below its value of 15.32 from a year ago and its 60-year average of 16.4. Other good news includes reports of home inventories shrinking over 20% year-over-year, existing home sales rising and vehicle sales hitting levels last seen four years ago. This reinforces our thesis that the U.S. economy is continuing to mend (albeit slowly) and should continue to do so and should be helped along the way by the positive feedback cycles we are beginning to see from a number of industries including housing and autos.

Will there be more bumps in the road and more gut check moments? Absolutely! However, we still like the outlook for equities and are standing by our end-of-year target of 1430 for the S&P 500. We would continue to recommend investors take advantage of the dips as they come (disciplined dollar cost averaging if they can) and would favor our themes of investing in companies and strategies that offer quality dividends, quality balance sheets and quality (above trend) growth.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at ~/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com

Copyright © Advisors Asset Management

Tags: Appetites, Bad News, Bear Market, Corporate Earnings, Earnings Per Share, Earnings Season, Economic Strength, Eighth Time, Elections In France, Eurozone, Great News, Gut Check Time, Jp Morgan, Last Quarter, Mike Boyle, Pullbacks, S Trading, Seasonality, Selloff, Viability
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Is Quantitative Easing the Silver Bullet to Economic Recovery? (Giulotto)

Thursday, May 24th, 2012

 
By Joseph Giulitto, Trust Company of America

Some rise by sin and some by virtue fall.
– Shakespeare

I saw this quote recently while researching another topic. I found it to be appropriate to capture the challenge that professional money managers have in finding investments appropriate for the current domestic economic and geopolitical environment. The rules (that apply to what makes an investment good or bad) that have been established over the previous 40 years of investing are no longer relevant, and those investments that typically would struggle during a massive global recession have been successful in achieving a rising valuation. The Fed’s actions of late have certainly created buoyancy in a rather questionable market. But to what end? Are we slated now for yet another round of quantitative easing? QE3 to the rescue…

The Fed’s Answer to Recovery

Trying to find the right blend of investments during any normal market cycle can be trying. Throw into the equation the Fed’s involvement with quantitative easing, colloquially known as “QE,” and suddenly everything you may have thought you knew is no longer relevant. To add to the confusion, there are few historical references on which to base our future decisions – creating a recipe for complexity. The standard variables that an advisor may use to determine investment quality or the technical analysis that has worked over the previous decades may not apply in the same manner as before.

The term quantitative easing, as defined by Investopedia, describes a form of monetary policy used by central banks to increase the supply of money in an economy when the bank interest rate, discount rate, and/or interbank interest rate are either at, or close to, zero.

Quantitative easing is a phrase that has been added to the vocabulary of nearly every human in the developed world. Over the last four years, actions by the national banks across the globe have taken steps to stave off massive economic downturns by finding ways to inject liquidity into their respective economies. Historically, where government spends- a bubble develops. Only to be further followed by the eventual collapse of the bubble and the wake that is created.

The now infamous quantitative easing is the Fed’s answer to providing a potential recovery to the markets and economy. In past years, the Fed’s “go to philosophy” was to simply cut or raise interest rates to either cool or ignite the economy. While arguments exist in support of this methodology the question might be: why not stick with what works? Well, to answer my own question- because it wasn’t working.

When the Fed lowered rates to near zero it became a game of “what next.” What fiscal silver bullet existed that the Fed could use to create an up swell in the overall sentiment of the American and global investor? While the idea of QE seemed a fresh perspective on our shores for solving the financial crisis one didn’t need to look back too far to find an eerily similar event.

Japan: A QE Case Study

Japan is the only economy in the modern age to have tried a nationwide stimulus of QE for a significant period. The Bank of Japan lowered its rate aggressively with no effect on the economy. Once at zero the Bank of Japan (BOJ) instituted the first set of QE and ran the process for the following five years. Some economists would say that it appeared that the BOJ continued to have a hand in the economy by injecting liquidity from time to time even up to the current day. Like a defunct junkie, the economy of Japan is attempting to wean itself from the BOJ and its liquidity injections. Is this what the future holds for not only the US, but all economies that have participated in the game of QE (read – Euro zone)?

With today’s active methodology of QE the RIA would have to ask what this means to the current day investor. If we have this one example of the impact of QE on Japan’s monetary policy as our historical reference, we would ask what the impacts of QE were and how do we use this knowledge to our advantage? Looking at Japan as our case study, we find that the period that the BOJ was active in its QE philosophy corresponded to the largest expansion of Japan post WWII. In my readings many economists would not credit the QE with this expansion. I believe we would be remiss to think one did not impact the other.

QE and the Investor

With that said- should an investor throw caution to the wind and build an all equity exposure portfolio and let it ride? Hold on before you push that trade button. There is always another side to the market. What happened in the past will certainly happen again. Let us not forget to refer to our history lessons. Japan experienced significant volatility within the bond markets during the advent of QE. A bond bubble was created that had a significant impact on the economy of Japan. So much – that it nearly thrust them into another bought of stagnation, and ultimately a depression. This bond correction forced more action from the BOJ. This proverbial teeter totter of activity by the Japanese Fed has still yet to fully play out.

The consideration in this history lesson is asking the question how should one (country) use the power of QE? While most agree that QE is an effective measure to help stabilize short term liquidity issues, QE will never serve to provide the replacement for the truly hard decisions that need to be made by government to create a healthy and productive capitalist system.

We know that QE works, at least for a short term fix. The question is how long is this fix going to be used? We also know that from a historical precedent there are pitfalls, specifically in the bond market.

With the recent commentary coming out of the Fed identifying several downside risks. Is it time to reevaluate your current position?

Or to quote Shakespeare once again:

A fool thinks himself to be wise, but a wise man knows himself to be a fool.

Tags: Bank Interest Rate, Buoyancy, Central Banks, Complexity, Economic Recovery, Geopolitical Environment, Global Recession, Interbank Interest Rate, Interest Rate Discount, Investment Quality, Investopedia, Monetary Policy, National Banks, Professional Money Managers, Qe, Qe3, Silver Bullet, Trust Company Of America, Virtue, Vocabulary
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Chinese, European Data Continues to Weaken as Market Potentially Forming New Bear Flag

Thursday, May 24th, 2012

First we’ll go to the technicals.  Back in mid April I had opined a ‘bear flag’ formation was being created. [Apr 17, 2012: Potential Bear Flag Forming]  But the market being the difficult beast it is, head faked everyone and rather than a break down from said flag it first went UP and nearly touched yearly highs.  This caused everyone to think the bear flag had failed…. only to lead to a horrid May in the market.  Generally a bear flag will resolve relatively quickly but the longer that one lasted the more doubt it created and potentially transitioned into a market that was creating a new range before a new move up.  Hence, why it was so tricky.

I speak of this only because we potentially are forming a new bear flag.  After extreme oversold conditions the markets finally held a previous low Monday and rallied.  This had been expected for a few days but anyone trying to catch the knife last week had their fingers chopped off… repeatedly.   We had mentioned a potential bounce level to 1338 minimum [May 22, 2012: Market Bounce Arrives - How Durable?] but as of Tuesday mid day the rally only hit 1328 as it was rejected by the quickly falling 10 day moving average.  Then yesterday started horribly as news surfaced that discussions / preparations for a Greek exit from the EU are formally starting behind the scenes, and it really looked like the bears would take charge.  Instead it was a trap, as rumors out of Europe that (a) Merkel supports backstopping all EU bank deposits (b) Italy and France support Eurobonds [May 22, 2012: Are Eurobonds Coming?] and/or (c) pick your rumor, hit.

The larger picture is this environment is akin to summer 2010 and latter 2011 where headline rumors, European comments, intervention hopes dominate the landscape and the market is herked and jerked around while in a downward path.   The action is violent in sharp contrast to January and February of this year.   Stocks are moving en masse as correlations return, and individual stock picking is nearly useless again.  Meanwhile the safe havens – the U.S. dollar and Treasury bonds, surge.  Therefore, unless you know the rumor/intervention hope of the day ahead of time it’s really not a place anyone with intermediate term views is going to risk a lot of capital.

Speaking of the bear flag, yesterday’s sharp rally to take markets out of steep losses to very modest gains helps define a current potential bear flag range of about 50 points: S&P 1290 to 1340.  While we did not reach the 1338 in the S&P 500 I am still going to include that in the range as that is a multi month resistance/support level the market has been dealing with throughout the year.   So just as I said in mid April what happens WITHIN that range means nothing.  The market could be UP 25 S&P points or DOWN the same, but as long as it’s within that range it is only a basing activity and nothing but “white noise”.  And until further notice it is has the potential of a new bear flag forming.   Of course we sit almost smack dab in the middle of said range today.

If you turn this chart upside down you would call this very bullish…. we’d be saying after a large move up, the market is going sideways for a few days to digest the move.  Hence, it is only fair to lean bearish when we have the inverse situation.  The market can always differ and change things – technicals are only a roadmap and in a world of massive intervention they can quickly be obliterated as said roadmap.  So if we hear that to stop bank runs every single cent of bank deposit in the Eurozone will be backstopped by the ECB or “Germany” (with what money???) you will get a ‘face ripper’ type rally I am sure.  You can see that from yesterday where nothing but rumors got the Dow up 200 points from the low.  We repeat the same pattern year after year now, downfall, bad news, crisis, intervention, rally.  Rinse, wash, repeat.

As for economic news overnight – it continues bad.  China continues to weaken, but I think commodities have been telling us this for months.  Expect more easing in the future although they cut reserve requirements 50bps a week and a half ago.  And Europe data is also very weak, but this should come to no surprise to anyone.  I think some/much of this is ‘priced in’ the market but the mess that is the Eurozone remains the key issue.  Everyone awaits the authorities to swoop in and “fix it” (kick the can).  My thesis that QE3 is arriving has not changed since last fall, and is only being strengthened by the day.  In fact we might get coordinated global central bank action since the level of worries are global – we’ll see in a few weeks.

• The euro zone composite PMI, a combination of the services and manufacturing sectors and seen as a guide to growth, fell to 45.9 this month from April’s 46.7, its lowest reading since June 2009 and its ninth month below the 50-mark that divides growth from contraction.
• Markit, which complies the PMIs, or purchasing managers indexes, said the reading was consistent with gross domestic product, which stagnated in the first quarter, falling by at least 0.5 percent across the region in the current quarter.
• “The flash PMI figures for May look horrible and provide a clear warning that euro zone GDP will almost certainly show a contraction in Q2 after stagnating in Q1,” said Martin van Vliet at ING.
• Across the channel, official data showed Britain’s economy shrank more than first thought between January and March, after the deepest fall in construction output in three years, while government spending made the biggest contribution to growth.
• PMI data from Germany, Europe’s largest economy, showed its manufacturing sector contracted at a far greater pace than was expected, and its service sector saw minimal growth. In neighboring France, both sectors contracted faster than predicted by most economists.
• German business sentiment also dropped for the first time in seven months in May, the Ifo think tank said, missing even the most conservative forecasts, in a sign that Europe’s largest economy is vulnerable to euro zone turmoil despite holding up well until now.
• HSBC’s Flash China PMI, the earliest indicator of China’s industrial sector, retreated to 48.7 in May from a final reading of 49.3 in April. It marked the seventh straight month that the index has been below 50.  ”The series of highly disappointing April activity data – exports, imports, industrial production and retail sales indicators all fell short of even the most pessimistic forecasts – the first gauge for economic activity in the current month is a further signal that internal and external headwinds are still biting into economic momentum,” said Nikolaus Keis at UniCredit.

Tags: Bank Deposits, Bear Flag, Bears, Beast, Bounce, Doubt, Downward Path, Environment, Eurobonds, Europe, Few Days, Fingers, Italy And France, Landscape, Merkel, Mid Day, Moving Average, Rally, Sharp, Technicals
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Minimum Volatility: A New Approach to Equity Investing (Morillo)

Thursday, May 24th, 2012

by Daniel Morillo, PH. D., Head of Investment Research, iShares

As minimum volatility investments gain popularity, clients are asking me if investments that track minimum volatility indexes can be used as a tool to “time” exposure to the equity market during risk-off periods.  While it’s an interesting question, I think it overlooks the real benefit of this kind of exposure in an investment portfolio.

To me, the value of a relatively low-risk investment like a minimum volatility portfolio is not its low risk, but how its returns can compare with those of a capitalization-weighted equity portfolio, or a so-called market portfolio. I would argue that a minimum volatility portfolio of equities potentially offers a better way for long-term investors to invest in equities – even if they have no interest in the lower risk that these portfolios provide.

Yes, I know. To many readers, this might seem like a bold statement. After all, according to modern portfolio theory, the market portfolio (aka the cap-weighted equity portfolio) is generally considered to be theoretically “efficient” in that it should provide the best possible trade-off between risk and return.

Let’s look at the traditional “portfolio frontier” chart that can be found in almost every introductory finance textbook[1].

The chart shows that over the long run, equity markets are expected to reward riskier assets with higher returns. In this case, the market portfolio (the cap-weighted equity portfolio) is expected to provide the highest level of return for its level of risk, while the low risk minimum volatility portfolio should provide commensurately lower returns.

The problem with this picture is that a wide range of empirical studies have found that the market portfolio does not appear to deliver enough additional return to compensate an investor for the additional risk it takes compared with the minimum volatility portfolio[1].

Let’s look at this modified chart:

Tags: Bold Statement, Empirical Studies, Gain Popularity, Introductory Finance, Investment Portfolio, Investment Research, Investments, Ishares, Market Portfolio, Modern Portfolio Theory, Nbsp, New Approach, Portfolio Frontier, Portfolios, Risk Investment, Term Investors, Textbook, Time Exposure, Traditional Portfolio, Volatility Indexes
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Planning, Carry, and Intervention (Tchir)

Thursday, May 24th, 2012

by Peter Tchir, TF Market Advisors

The market continues to trade with extreme volatility. Yesterday’s decline was deep and painful, only to be followed by an equally vicious rally on rumors of a rumor. This morning has already seen Europe rally, fade, then rally again. The overall theme remains the same, with concerns about Europe being counterbalanced by hopes of central bank action and government policy. Maybe as a bank bull down here, I am reading too much into it, but the whale trade fiasco seems to finally be getting put into perspective. That is good for JPM and the financials and the market.

The fear that the EU is preparing a plan for Greece to exit seemed like the worst excuse to sell off that the market has used. There is a real chance Greece will exit. Without significant concessions from the ECB and Troika, it will be there only option. I would much rather that Greece planned for it rather than just gave it a shot. Any hope of a Grexit not being incredibly disruptive to itself and to the rest of Europe will depend on planning. Real planning, not the typical EU style that assumes the market will do what it would like, but one that puts some stresses on the potential outcomes and works hard to deal with them. Given how much money the ECB and Troika are on the hook for, the concerns of deposit flight in other countries if redenomination risk rises, the EU will have to be very careful what it does. I think that as the EU actually works on some plans (shocking that it hasn’t yet) their concern for their own safety and their ability to really manage the worst case scenario will come into doubt, and they will make some concessions with Greece to give everyone time.

And timing is everything. Lots of people are asking what changed from Friday, or from yesterday afternoon. The answer is very little. But what actually has occurred from 2 weeks ago when the S&P was 1,357. The answer there is also very little. Fears of an imminent Grexit have been overblown. That has been our message. Neither side will have the guts (nor stupidity) to rush this decision. It will take time. Time is key because it does give hope that enough can be done that the exit doesn’t turn into a full blown crisis in Europe and that risk of currency flight in Spain and Italy can be contained. Timing is key, because without imminent catalysts, the oversold conditions and “carry” can come into play. RSI, as simple as it is, remains one of my favorite indicators. So much bearishness has been stuffed into the market, that the ability to rally on next to nothing remains high. We even ignored some okay housing data, which only 2 months ago everyone agreed was the key to a successful recovery.

Shorting credit is expensive. Everyone seems to forget about that. Seeing IG18 blow out from 93 to 123 reminds everyone how cool it is when credit blows out. HYG down from 91 to 87.5 is another great example of how quickly credit moves. Spanish CDS at 540 and still near the record highs posted last week is another example where it blew out from a low of 355 in March, to 555 last week. The problem here with being short is how expensive it is. HYG is paying 7% per annum and the price is rising. The cost to sit short is high, and if you take away the noise around Greece (overdone) and JPM (overdone) the arguments for it to be higher than this are all still in place. Even with Spain, you pay 100 bps running and have a pull to par effect, so you slowly bleed money being short. Add to that, the fear that one of these mash it all together and throw government money (that the government doesn’t have) solutions is enough to get the markets excited and you have the making of a short squeeze. The true “trading float” of Spanish bonds in particular is very small. Most bonds are held in buy and hold accounts at banks and insurance companies. Neither of these groups, overexposed as it is, are buying, but they aren’t selling either, so any improvement in the situation can result in a move disproportionate to the improvement. This is also true, to a lesser extent, in the Italian bond market.

I remain constructive here under the assumption that

• Central banks continue to be extremely dovish and may even take some actions
• Grexit, while likely isn’t imminent and the EU will start trying to sound less arrogant and belligerent towards Greece
• The sell-off in financials, part in Greece, but at least in part due to the whale trade, is over and is reversing as people are able to understand that even at JPM the CIO’s entire book is okay, and that this was not a systematic trade affecting all banks
• Data will continue to be mediocre, but with enough bright spots that the bulls can latch on to something and try and push high
• Sell in May and go away may be a good investment strategy, but selling ahead of a long weekend typically isn’t

Copyright © TF Market Advisors

Tags: Amp, Concessions, Decline, ECB, Excuse, Extreme Volatility, Fears, Fiasco, Government Policy, Greece, Hook, Jpm, Nbsp, Rally, Stresses, Tf, Troika, Whale Trade, Worst Case Scenario, Yesterday Afternoon
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In Your Face … Book (Bradley)

Thursday, May 24th, 2012

By Tom Bradley

I find the kerfuffle about the Facebook initial public offering (IPO) interesting. I don’t know if anything nefarious went on behind the scenes, but it seems to me that what played out on this overhyped and highly priced IPO (the $38 issue price equates to over 20x revenue) fell within the range of possible outcomes.

Facebook is impossible to value at this point in its development. It’s already one of the most important web platforms (along with Google, Apple and Amazon) and it certainly has a shot at becoming a highly profitable company (as the others did), but it’s still a bit of a crap shoot. Ultimately the stock price will be determined by how well the company monetizes (makes profits from) its user base. In the meantime, because Facebook’s valuation is so far out of the normal range, the stock will ebb and flow with every new analyst report, privacy abuse and Zuckerberg sighting.

Clearly the company and large shareholders got greedy in pricing and sizing the issue. Employees and other early shareholders sold over $9 billion of stock to the public, while only $6.8 billion was put into the company’s coffers. But should the buyers of Facebook shares, on the IPO or in the market afterwards, be surprised that Wall Street is hyperventilating (it was before the issue, why not after) and media sentiment is swinging like a baby on a Jolly Jumper? Certainly the sophisticated institutional buyers shouldn’t be. They read every page of the prospectus and knew the risks. Individual investors bought through full service advisors, so presumably their Facebook shares were put in the ‘high growth / high risk’ bucket of their portfolios.

I’m not trying to make light of investors’ short-term paper losses, but the result here was well within the realm of possibility. New issues aren’t a one-way street. They don’t all go to massive premiums on the first day of trading. Indeed, the fact that some do, like LinkedIn and Groupon, just reinforces how imprecise the IPO process is.

Tags: Amazon, Analyst Report, Face Book, Google, Hyperventilating, Individual Investors, Initial Public Offering, Initial Public Offering Ipo, Institutional Buyers, Jolly Jumper, Kerfuffle, Linkedin, Media Sentiment, Nefarious, Paper Losses, Privacy Abuse, Profitable Company, Stock Price, Tom Bradley, Web Platforms
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Frontline On MF Global’s Six Billion Dollar Bet

Thursday, May 24th, 2012

While the sur-realities of just what Corzine and the rest of the MF Global ‘traders’ did has been extensively discussed here and elsewhere, PBS’ Frontline provides the most succinct (and relatively in-depth) documentary on just what occurred from how the corrupt CEO lobbied regulators who had the power to stop his risky bets to the endgame realization of the missing customer money. A narrative, not just of “a bet that went bad”, but “a Wall Street morality tale“. Must watch!

The story of Jon Corzine, the former head of Goldman Sachs and political power broker, who took over MF Global in the spring of 2010 with oversize ambition and a passion for risk. But after a massive bet on European debt turned sour, the firm lay in ruins, with more than a billion dollars of customer funds missing.

Chapter 1: Six Million Dollar Bet – The Power of Jon Corzine

Watch Six Billion Dollar Bet on PBS. See more from FRONTLINE.

Chapter 2: Six Million Dollar Bet – The Final Days Of MF Global

Watch Six Billion Dollar Bet on PBS. See more from FRONTLINE.

Tags: ambition, Bet, Bets, Billion Dollars, Customer Funds, Endgame, Global Traders, Global Watch, Goldman Sachs, Jon Corzine, Mf Global, Morality, Narrative, Pbs, Pbs Frontline, Power Broker, Realities, Realization, Regulators, Six Billion
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