WealthTrack: Romick’s Contrarian Views

Sunday, February 28th, 2010

This week on Wealthtrack, Consuelo Mack sits down with Steven Romick, the founder and portfolio manager of the five star FPA Crescent Fund. Romick’s contrarian views and go anywhere, invest in anything style have put him in the top one percent of all money managers over the last decade and earned him a finalist slot for Morningstar’s new “Fund Manager of the Decade Award”.

Note: The transcript of this interview is not available yet, but will be posted here as soon as it arrives.

Source: Wealthtrack, February 25, 2010.

Tags: Consuelo Mack, Contrarian Views, Crescent, Decade Award, Five Star, Last Decade, Money Managers, Morningstar, Portfolio Manager, Wealthtrack
Posted in Bonds, Markets | No Comments »

Ian Ainsworth - The Case For High Technology

Thursday, February 11th, 2010

Ian Ainsworth, 25-year veteran fund manager, and two time Canadian Investment Awards winner, discusses the case for high technology with Dan Richards, of Client Insights.

Source: ClientInsights.ca, February 10, 2010

This video interview is just one of many produced recently by Dan Richards, in an effort to bring the industry and market closer to the people who manage money. Find this and many other fund manager interviews at http://www.ClientInsights.ca.

Tags: Ainsworth, Awards Winner, Canada, Canadian Investment Awards, High Technology, Insights, Money, People, Veteran, Video Interview
Posted in Bonds, Markets | No Comments »

Whither Deflation?

Thursday, February 4th, 2010

This article a guest contribution by Leo Kolivakis, of Pension Pulse.

Last week, I warned my readers to get ready for more upward growth revisions. I believe that US growth in Q1 2010 will surprise even the most optimistic forecasters.

Why am I so confident? After all, my last call before the December employment report was way off. The bond market didn’t go ‘boo’ back then and more jobs were lost. Today, Bloomberg published a sobering article stating that 824,000 jobs will disappear on February 5th.

No doubt, when all is said and done, and the government bean counters finish tallying up the wreckage, job losses from this recession will be far worse than what was initially thought. And this recession hasn’t been gender neutral. By far, men have suffered a lot more than women as cyclical industries got hit harder.

But all that is about to start changing in Q1 2010. Consider the following very carefully:

• The Conference Board Leading Economic Index™ (LEI) for the U.S. increased 1.1 percent in December, following a 1.0 percent gain in November, and a 0.3 percent rise in October.
• The January 2010 ISM Manufacturing report showed widespread growth. Importantly, the manufacturing sector grew for a sixth straight month, and both the New Orders and Production Indexes are above 60 percent, indicating strong current and future performance for manufacturing.
• US real GDP surged 5.7% in the fourth quarter 2009, confirming that the recession is over and the recovery is gaining traction. While the acceleration in real GDP growth in the fourth quarter primarily reflected an acceleration in private inventory investment, there was a pick-up in non-residential investment, exports and investment in equipment & software, a harbinger of future job growth.

In the near term, it is highly likely that US growth will continue to surprise to the upside. Interestingly, Tom Braithwaite of the FT reports that US deflation no longer seen as a risk:

The US has escaped the danger of a Japanese-style deflationary trap, according to James Bullard, a voting member of the Federal Reserve’s key policy-setting committee.

Mr Bullard, president of the Federal Reserve Bank of St Louis, told the Financial Times in an interview that his preoccupation throughout 2009 had been deflation, but the risk had “passed”.

Last week’s Fed meeting produced a dissenting vote for the first time in a year when Thomas Hoenig, president of the Kansas City Fed and a rate hawk, argued that financial conditions no longer warranted a policy of holding rates at “exceptionally low levels . . . for an extended period”.

Other members of the Federal Open Markets Committee voted to preserve the “extended period” phrase, generally taken to mean near-zero interest rates will continue for at least six months. But they are also working on an exit strategy from the exceptionally loose policy used to fight the financial crisis.

Mr Bullard, who is considered a centrist member of the FOMC, said he was happy to continue with the current guidance, but he did have some sympathy for Mr Hoenig’s argument that “if you come off zero and you move up a little bit, it’s still a very easy policy. You’ve still got a very large balance sheet and you’re still at very low interest rates.”

He added that, although it was not time to tighten policy, members of the committee would weigh in their decisions factors other than inflation and unemployment. Factors to consider would include asset bubbles.

“I think they’re gaining weight with many people because of the bad experience we had in the aftermath of the last recession, the housing bubble and how that really has blown up and caused so many problems,” he said.

When the Fed does come to raise rates it may have to switch from its traditional benchmark of targeting the federal funds rate to targeting a repurchase rate because of the upheaval in the two markets over the last two years.

“I think what the operating regime will really look like going forward is an open question and one that the committee is working on,” said Mr Bullard, who said the Fed could consider using interest it paid on reserves as the main rate but that it might prefer a market measure such as the repo rate.

The broader post-crisis economy was “on track” with its recovery, he said. “It’s not a real strong recovery but that’s what we had predicted anyway. But it will be above-average growth for the first half of 2010 and we’ll probably see some positive jobs growth in the first part of 2010 here.”

He “hoped” that improvement in the labour market would come in the first quarter.

Following harsh criticism of Ben Bernanke in the Senate ahead of his reconfirmation as Fed chairman last week, Mr Bullard warned that political interference with the Fed would be dangerous and he strongly opposed plans to strip banking supervision from the central bank’s roster of duties.

“I think it’s dangerous for America and dangerous for a global economy to try to divorce this central bank from true understanding of financial markets, and I think that that’s the direction we’ll be going in if we separated out the central bank from regulation,” he said.

“What this crisis has shown is that our understanding of financial mediation and how it can impact on macro economy was not good enough. So what you want is to force the central bank to get better understanding and more information about financial markets as they’re making monetary policy decisions.”

Not good enough? I’d say the Fed’s understanding of how financial mediation impacts the macro economy was downright pathetic pre-crisis and has only marginally improved post-crisis. Who is tracking flows into hedge funds, commodity funds, private equity funds, and flows coming from sovereign wealth and global pension funds?

More importantly, who is tracking leverage being built into the bond market? There too, pension funds are playing an increasingly important role as they leverage up their fixed income holdings to deliver on their required actuarial rates of return.

I urge you to carefully read Niel Jensen’s February 2010 letter from Absolute Return Partners, aptly titled If PIIGS Could Fly. Mr. Jensen’s conclusion is a stark reminder of the challenges that lie ahead:

As far as the bond market is concerned, as often pointed out by Martin Barnes at BCA Research, if you want to know where the next crisis will be, then look at where the leverage is being created today. And nowhere is there more leverage being created at the moment than on sovereign balance sheets. What is happening is an experiment never undertaken before. As John Mauldin puts it, we are operating on the patient without anaesthesia.

The big challenge will be to get the timing right. These situations can run for longer than most people imagine. Japan’s crisis has been widely predicted for almost a decade now, and the ship appears to be as steady as ever. As I suggested earlier, the key to predicting the timing of Japan’s demise – because there will be one – may very well be embedded in the savings rate, which could quite possibly turn negative in the next few years.

The Dubai crisis taught us that markets are in a forgiving mode at the moment and, before long, Greece could very well find some respite from its current problems. But then again, ultimately, governments will find – just like millions of households have found over the years – that you cannot spend more then you earn in perpetuity. The enormous debt levels being created at the moment will haunt us for many years to come and we may have to wait a long time to see PIIGS fly again.

While I agree with many of the arguments Mr. Jensen puts forward, I am not convinced that the bond market will be the next crisis. You will likely see the short end of the curve getting hit hard in Q1 2010 as the market adjusts its expectations on the Fed’s next move, but not a full-fledged crisis in bonds.

Neither am I convinced that deflation is dead. The risks of deflation have subsided but the bigger test will come in the following few years, especially if stimulus programs do not translate into a sustained improvement in US and global labor markets. And that still remains the overarching concern of policymakers across the planet. If they fail to achieve this, a nasty deflationary spiral will ensue, in which case high quality government bonds will look very attractive, even at historic low yields.

Tags: Bean Counters, Bond Market, Commodities, Cyclical Industries, Economic Index, Employment Report, Fourth Quarter, GDP Growth, Harbinger, Inventory Investment, Ism Manufacturing, Manufacturing Sector, No Doubt, Optimistic Forecasters, Private Inventory, Q1, Real Gdp, Recession, Residential Investment, Upward Growth, Wreckage
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India’s Growing Appetite for Energy

Friday, January 29th, 2010

India’s appetite for energy continues to grow, pushing Indians to consume coal in ever great quantities. Whole cities, like Jharia, in eastern India, are disappearing. At a time when Global Warming is at the top of world’s agenda, FRANCE 24 takes you to a town sacrificed to the pursuit of energy. Click the image for the video.

Tags: Agenda, Appetite, Coal, Eastern India, Emerging Markets, France 24, Global Warming, India, India India, Indians, Quantities
Posted in Bonds, Gold, Markets | No Comments »

Oil Market Outlook: When Contango Trade Unwinds

Sunday, January 17th, 2010

The West Texas Intermediate (WTI) crude oil market went into contango back in June 2008 and reached an apex super contango in late December. (Fig. 1) Since then, investment firms, investors as well as producers have been stockpiling oil and booked a record number of vessels for storage seeking to profit from the contango effect in the oil market.

In fact, the WTI futures curve serves as a good indicator of the U.S. oil inventory levels since a contango typically coincides with higher inventory levels and vice versa. The latest inventory data certainly can attest to this relationship.

Bursting U.S. Inventory

In its most recent weekly assessment, U.S. Energy Information Administration (EIA) data show a surprising rise in petroleum stocks of 3.7 million barrels from the previous week despite freezing temperatures across Europe and the U.S. in recent weeks (Fig. 2).

At 331.0 million barrels, U.S. crude oil inventories are above the upper limit of the average range for this time of year. The aggregate inventory rise of 8.9 million barrels is also amongst the largest weekly aggregate increase ever.

In addition, FT.com reported that the U.S. strategic petroleum reserve is now full as of Dec. 27, 2009 adding to the already bearish tone in the market.

Costs & Profits

Contango trade is profitable if the spread is wide enough to cover the costs of holding crude stocks, namely storage and working capital. Such stocks are discretionary stocks built or drawn in response to prices, and particularly in response to forward price curve.

Discretionary stock building occurs “disproportionately” in the U.S. Northeast, particularly around New York, and in Northwest Europe, especially in the Antwerp-Rotterdam-Amsterdam (ARA) area where the world’s two active product futures exchanges, the NYMEX and the International Petroleum Exchange are based.

Storage costs money, but how much? The U.S. EIA estimated holding crude oil would cost a company about $1.50 and $4.00 per barrel per year depending if it owns or rents storage. For gasoline, the costs would be $2 and $6 per barrel per year, or $0.01 per gallon per month:

A 26-Mile Long Oil Contango Trade

With on-land tank farms getting full, the discretionary stocks turn to oil tankers for floating storage. According to research by Gibson Shipbrokers, one in twelve of the world’s largest crude oil tankers are being used to store oil rather than transporting it.

Bloomberg gave a good visualization of this massive convoy:

“Those storage tankers, if lined up end to end, they would stretch for about 26 miles, enough to blockade the English Channel.”

More than half of the ships are in European waters, with the rest spread out across Asia, the U.S. and West Africa. Royal Dutch Shell Plc (RDS.A), BP Plc (BP); Goldman Sachs Inc. (GS), JPMorgan Chase & Co. (JPM); and Morgan Stanley were among those that sought vessels for storage.

145 Tankers & 127 Million Barrels at Sea

By one estimate, the crude stored at sea is enough to supply the 27- nation European Union for more than three days.

Shipbroker SSY estimated offshore worldwide, there are a total of about 145 vessels holding roughly 127 million barrels of crude oil and oil products at the end of December 2009. That is down from 161 ships with 141 million barrels in November.

Oil Crash by Contango Trade Unwind?

Attractive contango spread tends to incentivize traders buy up spot and nearby futures which inadvertently narrows the spread (Fig. 3). (Read more on what a flatting oil contango means here.)

The spread between the first and sixth Brent crude-oil contracts on ICE Futures has declined around 4% from 23% a year ago, and the spread to January 2011 is only around $7. The spread for heating oil also shrank to a low of around $2 from about $18 a ton in December.

Since oil storage trade is no longer as profitable, these tankers are expected to start offloading oil en masse. Based on the median estimate in a Bloomberg News survey of 15 analysts, traders and shipbrokers, about 26%, or 39 million barrels of the stored crude and oil products could be unloaded from offshore alone in the next six months.

One could only speculate at least some offloading from tank farms as well.

This is when some analysts predicted that the eventual storage trade unwinding could lead to a $10-oil scenario. Lower demand forecasts for oil by various agencies and analysts only add strength to the prediction.

Is the crude market destined for a crash by the contango trade unwinding?

In order to answer that, we need to first take a look at the current crude price dynamics.

Where Are Oil Prices Going?

After spiking to a 15-mnth high of above $83 per barrel from freezing temperatures across Europe and the U.S., crude oil for February delivery settled at $78 a barrel on the NYMEX last Friday, the lowest settlement since Dec. 23. Futures fell 5.7% in one week, the first weekly decline in five weeks.

Now, one of the biggest questions of the market is “Where are oil prices heading?” as no other commodity impacts the global economy in as far reaching as the price of oil.

Crude was weighed down by forecasts for weak demand by the International Energy Agency (IEA) and some disappointing U.S. earnings and economic data. Stronger dollar, forecasts of milder temperatures, and moves by China to stem the expansion of the world’s fast-growing economy also affected crude futures.

A Crude Technical Correction

Still, by looking at the current crude oil price levels, one would think there is a shortage of supplies. But nearly all market indications and forecasts are quite to the contrary.

So, technically as well as fundamentally, oil prices are set for a correction as the cold weather abates and the reality of weak demand and high inventory set in. .

Oil volume in electronic trading on the volume totaled 645,000 contracts last Thursday, 14% above the average of the past three months. Open interest was 1.35 million contracts, the most since July 11 2008; the day crude oil reached a record $147.27 a barrel.

Meanwhile, the inverse correlation between oil and the dollar, which had eased briefly, seems to have resumed in recent sessions.

Currently, most of technical indicators are pointing downwards (Fig. 4). We could see crude trading with high volatility, inversely with the Dollar, testing the $77/b level with strong technical indicators point to around $74 and then we could see $73 tested.

Long Live the Contango Trade

A narrowing contango is typically perceived as a bullish sign for the oil market. The market correction along with continued optimism about global economic recovery could mean market participants will take it as a signal to go back into the oil storage trade.

There are other factors also underpinning the contango trade:

• The Federal Reserve will likely keep interest rates low, curbing financing costs for those storing cargoes.
• The much worried CFTC position limits proposal does not seem as bad as the market had feared.
• Weak dollar and inflation hedge should continue to encourage investment in commodities such as crude oil.

“Storage Interest Is Still There”

In addition, a portion of the discretionary stockpile is long term and strategic in nature, and thus tend not to respond to the futures curve as some may expect.

Based on a report by Platts dated Nov. 24, 2009, traders indicated storage interest, though not as strong as before, is still there. Morgan Stanley has chartered a newly built supertanker to possibly store up to 2 million barrels of diesel/gasoil to be delivered by the end of last November.

In the same report, Platts also noted broker reports showed 16 Very Large Crude Carries (VLCCs) have been taken by charterers such as Royal Dutch Shell (RDS.A), Barclays Capital (BCS), Vitol, and JPMorgan Chase (JPM) to store diesel/gasoil off European and Asian coasts.

Boon for Tank Farms

Oil inventories in the most industrialized countries remain well above average as global demand declines for the first time in a quarter of a century. And based on the latest EIA forecast, global oil stocks are expected to remain in the upper range of the five-year average through 2011. (Fig. 5)

According to FT.com, with high demand for storage space, owners have gained pricing power. In some cases storage operators are even turning away clients.

Most land storage capacity is held by oil majors and state-owned producers or in strategic government reserves. But a quarter is run by independent storage companies that rent out tanks to outside parties.

Some storage operators even have joined the futures trade themselves. Plains All American Pipeline (PPA) uses its 57 million barrels of storage for both lease and “contango market storage activities”, according to its quarterly report.

Storage demand has also been boosted by new environmental rules that require blending of oil products with biofuels, multiplying the number of separate tanks necessary to serve consumers.

Tanker Sector Hit By Glut

The floating storage demand helped prop up tanker rates in 2009, but analysts estimate that the unwinding of oil storage trade would add to vessel supply and pushing rates for supertankers down more than 25% to an average of $30,000 a day in 2010. That would be below the break- even point of some ship operators such as Frontline Ltd. (FRO), who said its supertankers need $32,900 a day to break even.

So far, current prices for forward freight agreements, or FFAs, suggest that the average tanker rate for 2010 will come to $36,000 a day, down from $40,212 at the end of 2009, but still higher than the average $23,130 last year.

Meanwhile, the global tanker fleet is estimated to expand about 12% next year, of which 5% will come from ships released from storage.

Crude Long Term Intact

The IEA forecast for 2010 global crude demand to increase an anemic 1.6% or 86.3 million barrels a day from the group’s 2009 estimate.

For now, most analysts are holding the 2010 forecast between JP Morgan’s $72 to $90 by Goldman Sachs (GS), while Bank of America (BAC) expects oil to average $85/b through 2010.

Furthermore, BofA sees growing risk of a spike above $100/b by 2011 from a combination of loose monetary policy and dollar depreciation. Tightening physical oil supply and demand fundamentals in 2010 could also prop prices.

ExxonMobil (XOM) also indicated in its latest long-term energy outlook released last month that global energy demand will be around 35% higher in 2030 than it was in 2005. The forecast suggested:

“Oil remains the largest energy source through 2030, but natural gas will move into second place ahead of coal. In 2030, these three fuels will meet approximately 80% of global energy needs.”

Longer term, consistent positive reports in the U.S. and China will form a base for oil to appreciate. Of course, any geopolitical upset could easily send crude all the way up to the North Pole, then all bets will be off.

Investment Strategy

Contrarian & Long-term – The bearish outlook for the vessel sector could be a buying opportunity of operators like Frontline Ltd. (FRO) and Nordic American Tanker (NAT) as a recovery and emerging market play.

Short Term – Depending on investment horizon and portfolio composition, the other side of the contrarian/long-term vessel sector play would be to buy puts in the sector in anticipation of lower earnings this year.

Medium Term: Storage operators such as Kinder Morgan Energy Partners (KMP) and NuStar Energy (NS) should stand to benefit from the expected high oil stocks through 2011.

Long Term: The long term oil market outlook would make integrated oil companies like Exxon Mobil (XOM), Chevron Corp. (CVX), and BP Plc (BP) with strong international presence and both E&P and refining/marketing operations worthy of investors consideration.

A combination of all or some of the aforementioned strategies could provide some interesting diversification and hedge as well.

Tags: China, Commodities, Crude Oil Inventories, Crude Oil Market, Crude Stocks, Eia Data, Emerging Markets, Energy Information Administration, Forward Price, Futures Exchanges, Gold, International Petroleum Exchange, Inventory Data, Inventory Levels, Northwest Europe, Nymex, oil, Oil Market Outlook, Petroleum Stocks, Price Curve, Storage Costs, Strategic Petroleum Reserve, U S Energy, West Texas Intermediate, Wti Crude Oil
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Roundup: The Economy and Bond Market

Sunday, January 17th, 2010

The Economy and Bond Market Treasury yields rallied as this week’s 10 and 30-year auctions received a good response and concerns of global stimulus removal have highlighted risks in the global recovery story. Economic data was mixed this week as December retail sales were surprisingly weak and seemed to contradict earlier data. On the other hand, industrial production rose for the sixth straight month and is giving a classic sign of economic recovery. The chart below graphs industrial production on a year-over-year basis and makes clear the change in direction of activity. Strengths

• Industrial production rose 0.6 percent in December and has now risen for six months in a row.
• Chinese imports and exports moved sharply higher in December, which implies continued improvement in not only China’s economy but the global economy.
• Consumer prices in December remained muted, rising only 0.1 percent and giving the Fed plenty of room for monetary policy flexibility.

Weaknesses

• Retail sales for December disappointed and appeared to contradict earlier data. One positive caveat was November data was revised higher making the numbers a little more palatable.
• The Obama administration is proposing a tax on big banks as a way to recoup the government’s support. The concern is that this appears somewhat punitive and more taxes and/or regulation are not an effective way to stimulate the economy.
• The Fed’s beige book reported only a modest improvement in the economy around year end, and cited weakness in real estate and labor markets.

Opportunities

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4-5 percent. The global economic recovery appears to be taking hold.

Threats

• The U.S. is facing a long-term risk as Fitch cited the budget deficit as a threat to the U.S. AAA debt rating.

Tags: Beige Book, Bond Market, Budget Deficit, Caveat, Change In Direction, China, China Economy, China S Economy, Chinese Imports, Economic Data, Economic Recovery, Emerging Markets, Global Economy, Global Recovery, Imports And Exports, Labor Markets, Monetary Policy, Plenty Of Room, Retail Sales, Stimulus, Treasury Yields, Year End
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Roundup: Economy and Bond Market

Monday, January 4th, 2010

The Economy and Bond Market

The Treasury yield curve flattened this week as yields rose on the short end of the curve while the 30-year bond experienced a modest decline in yields. The Treasury issued $118 million in 2-, 5- and 7-year maturities, pressuring the short end of the market. In addition, economic data continues to show improvement and that also weighed on investor sentiment.

One of the strongest signs that the economy continues to progress is the improvement in employment indicators such as the weekly initial jobless claims data, shown below. While there is still plenty of room for improvement, we are at the lowest levels since mid-2008.

Strengths

• All indications are the holiday shopping season was a relative success and consumers were willing to open their pocketbooks for a little holiday cheer.
   
• The Consumer Confidence Index bounced back this month and expectations are improving.
   
• South Korean president Lee Myung-bak expressed confidence that the South Korean economy will grow faster in 2010 than the official government forecast of 5 percent. Historically, South Korea has been a good barometer for global growth and this news is very supportive of strong global GDP growth in 2010.

Weaknesses

• The Federal Reserve is considering options for withdrawing the emergency monetary stimulus that was put in place to combat the global financial crisis. This week’s proposal included potentially selling term deposits to banks to reduce excess reserves. The market is concerned that the termination or reversal of these programs could put upward pressure on bond yields.
   
• Money supply in the Euro zone fell slightly on a year-over-year basis in November for the first time since records began in 1991 and indicates potential headwind for future growth.
   
• China is also targeting a slowdown in money supply to about 17 percent in 2010, versus roughly 30 percent in 2009.

Opportunities

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4-5 percent. The global economic recovery appears to be taking hold.

Threats

• The Fed reiterated their monetary policy stance at the December 16 Federal Open Market Committee (FOMC) meeting and on the surface nothing really changed. However, they are incrementally moving to reduce the policy accommodation and often these changes move more quickly than many expect.

Tags: Advertisement Opportunities, Bond Yields, China, Consumer Confidence Index, Emerging Markets, Employment Indicators, Euro Zone, Excess Reserves, GDP Growth, Global Financial Crisis, Global Gdp, Headwind, Holiday Cheer, Initial Jobless Claims, Investor Sentiment, Money Supply, President Lee, Relative Success, South Korean Economy, South Korean President, Term Deposits, Treasury Yield Curve, Upward Pressure
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Good Things Come in Small Packages

Thursday, December 17th, 2009

One of the most important findings of modern finance is that small companies, on average, have higher returns than large companies. This size premium is evident from the following graph which illustrates the growth of $1.00 U.S. invested in small company stocks (in red) compared to large company stocks (in green) from January 1926 to November 2009.

The investment in small company stocks grew to $11,253 - more than four times the $2,537 of the large company stocks.

The size premium is not restricted to the United States. A number of researchers have confirmed its presence in most other countries around the world. In a study spanning seventeen countries, Hawawini and Keim found that small company stocks outperformed large company stocks in every country except Korea.

The size premium is unique in a number of respects. First, the relationship between return and size applies across the complete spectrum of firm sizes. Returns become progressively higher as one moves from large to medium to small to micro companies (see Table I at the end of the Commentary). Risk also grows commensurately since the smallest stocks are more than twice as volatile as the largest stocks.

Second, the size premium is a highly streaky phenomenon. The following graph, which depicts the cumulative size premium (i.e. small company returns – large company returns) since 1926, shows that outperformance by small company stocks was concentrated in the mid-1930’s, the early to mid-1940’s, the late 1960’s, the mid-1970’s to early 1980’s, the early 1990’s and the earlier part of this decade.

As can be seen, the periods of outperformance by small company stocks have frequently been punctuated by lengthy spans of underperformance. Accessing the size premium therefore requires patience.

One of the more remarkable elements of this firm size effect is that it seasonal. Virtually the entire size premium occurs in January, an outsized month for small company returns. This excess performance is evidenced in the following bar graph which depicts the average monthly return of U.S. small company stocks from 1926-2008.

Source: Tacita Capital, based on Ibbotson Associates SBBI Small Company Stocks

40% of the average annual return of small company stocks has occurred in January. Two theories have been advanced for this “January effect”. The first attributes the effect to tax-loss selling where losers that were disposed of in the prior year are re-acquired bidding up prices in January. The second attributes the effect year-end “window-dressing” by fund managers who rid their portfolios of losing stocks before year-end thereby depressing prices which bounce back in January.

One of the enduring myths about small company stocks is that they represent a spectrum of the market where, on average, active managers add value by outperforming small company indexes. The evidence refutes this belief. In a comprehensive study

of U.S. mutual funds from 1965-1998, Davis found no evidence of positive, abnormal returns in actively managed small stock funds. More recently, Standard & Poor’s found that small stock funds as a group underperformed their benchmarks in both of the past five-year market cycles including the bear markets (see Table II at the end of the Commentary).

Small company stocks offer patient investors an opportunity to enhance performance. Their “streakiness”, however, means that a strategic, long-term commitment is essential to realizing on this opportunity. Also, given the volatility of this asset class, portfolio allocations must be consistent with the risk profile of the individual investor. This isn’t a free lunch – extra helpings bring extra risk.

December 17, 2009

www.tacitacapital.com

Source: Ibbotson SBBI 2009 Classic Yearbook

Source: SPIVA Scorecard: Active Management Myths;

http://www2.standardandpoors.com/spf/pdf/index/SPIVA_2009_UPDATE.pdf

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

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

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

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

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

Tags: 1940, Company Stocks, Countries Around The World, Cumulative Size, Decade, Good Things Come In Small Packages, Graph, Investment Stocks, Keim, Korea, Micro Companies, Outperformance, Patience, Periods, Phenomenon, Presence, Remarkable Elements, Respects, Spans, Spectrum, Volatile Stocks
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SWOT: Index Summary and Markets

Sunday, December 13th, 2009

Index Summary

• The major market indices were mixed this week. The Dow Jones Industrial Index rose 0.80 percent. The S&P 500 Stock Index gained 0.04 percent, while the Nasdaq Composite finished 0.18 percent lower.
   
• Barra Growth underperformed Barra Value as Barra Value finished 0.08 percent higher while Barra Growth was unchanged. The Russell 2000 closed the week with a loss of 0.40 percent.
   
• The Hang Seng Composite finished lower by 2.51 percent, Taiwan gained 1.88 percent, and the Kospi rose 1.98 percent.

   

• The 10-year Treasury bond yield closed at 3.55 percent, up 7 basis points for the week.
   

Domestic Equity Market

For the five trading days through Thursday, the figure above shows the performance of each sector in the S&P 500 index. The best-performing sector was telecom services, up 1.7 percent. The other better-performing sectors were consumer discretion and utilities. The worst-performing sectors were energy, materials, and financials.

Within the telecom services sector, the best-performing stock was Sprint Nextel Corp, up 9.8 percent. Other outperforming stocks in the sector were Qwest Communications International Inc, Metropcs Communications Inc, and Verizon Communications Inc.

Strengths

• The aluminum group was the best-performing group for the week, up 12.5 percent, led by its single member, Alcoa Inc. The price of aluminum has risen for each of the last two weeks. A major brokerage firm analyst raised his profit estimate for the company, along with a host of other metal and mining companies, based on expectations that metal, iron ore, and coal prices will increase significantly in 2010.
   
• The publishing & printing index was the second-best performer, rising 10.2 percent. The CEO of McGraw-Hill Cos Inc., the largest member of the group, said that the firm expects a better year for all of its businesses in 2010, helped by higher school enrollment, increased spending on textbooks, and a recovery in its credit rating business.
   
• The managed healthcare group was the third-best performer, gaining 8.1 percent. The health insurance companies rose after the “public option” appeared to be excluded from the Senate healthcare legislation.

Weaknesses

• The food retail group underperformed, down 6.6 percent, led by its largest member, Kroger Co. The grocery firm reported third quarter earnings below the consensus estimate, and it lowered guidance for full year 2009 earnings. The firm’s CEO said that financial results are being pressured by factors including persistent deflation, unusually intense competition, and the cautious mindset of customers.
   
• The healthcare technology group was among the underperformers, losing 6.0 percent. The group’s single member IMS Health Inc. declined after an amendment to the Senate health care bill would effectively ban pharmaceutical data mining, the drug company practice of buying prescription records to target sales presentations to doctors.

   

• Two banking groups (diversified banks and other diversified financial services) underperformed, down 4.6 percent and 3.1 percent, respectively. This was probably due to investor concern over financial reform legislation being crafted in Congress, as well as dilution and potential dilution due to sale of bank stock in order to repay Troubled Asset Relief Program (TARP) funds.

Opportunities

• There may be an opportunity for gain in M&A (merger & acquisition) transactions in 2009 and 2010.
   
• The strength in the market since March could be an opportunity to eliminate weaker companies in the portfolio and upgrade to companies with better fundamental outlooks.

Threat

• Should investors’ expectations for an improving economy not come to fruition on a reasonable time frame, it could be a threat to stock prices.

Tags: 10 Year Treasury Bond, Alcoa Inc, Alert Index, Aluminum Group, Brokerage Firm, Coal Prices, Dow Jones Industrial, Dow Jones Industrial Index, Index Summary, Major Market Indices, Mcgraw Hill Cos, Mcgraw Hill Cos Inc, Nasdaq Composite, Printing Index, Qwest Communications, Qwest Communications International, Qwest Communications International Inc, Sprint Nextel, Treasury Bond Yield, Verizon Communications, Verizon Communications Inc
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China as a Nuclear Power Play

Sunday, December 13th, 2009

China as a Nuclear Power Play

By Romeo Dator
Co-manager, China Region Fund (USCOX)

Like all major economies, China is preparing for its energy future to accommodate rapid growth and the movement of more and more Chinese to cities. The foundation of the nation’s electricity generation plan is coal, but with loud calls coming from around the world for China to cut its output of greenhouse gases, a significant portion of new power will be nuclear.

From an investment perspective, this shows massive potential opportunity both in terms of infrastructure and natural resources, including uranium. Some analysts say the price of uranium, while soft now, could double over the next couple of years in recognition of future market tightness.

China’s nuclear capacity is now less than 9,000 megawatts, but the country has more than a dozen more plants either under construction or in the planning stages – according to figures from the brokerage CLSA, the capacity could grow fivefold by 2015. The official target is 40,000 megawatts by 2020.

Such an ambitious program raises the question of how to fuel all of the new plants that China wants to bring online in the next decade. Where will all of the uranium come from to handle this new demand?

China is not alone in its nuclear plans. Two decades of languishing interest in nuclear power after the Three Mile Island and Chernobyl incidents has reversed, and now too many nuclear energy is viewed as a relatively “green” energy with greater cost-benefit potential than solar, wind and other alternatives. Of course, the long-term storage of radioactive waste remains a stubborn obstacle to fuller acceptance of nuclear power.

Earlier this year, the International Atomic Energy Agency (IAEA) projected that global nuclear capacity would grow from about 370,000 megawatts (14 percent of world energy consumption) now to as much as 540,000 megawatts by 2020 and 810,000 megawatts by 2030. In dollar terms, capital expenditure on nuclear plants could total more than $500 billion over the next 20 years.

Roughly 40,000 megawatts of nuclear capacity are now being built on four continents, with China accounting for a quarter of that total, well ahead of #2 Russia and #3 South Korea. The chart above shows the global breakdown – even the United States is in expansion mode – and the chart below shows that China will be second only to the U.S. in terms of future capacity when projects at all phases are considered.

China has uranium reserves within its borders and it is aggressively lining up supplies in Central Asia, Africa and Australia to make up any shortfall. Government officials in Beijing say that more uranium mines are badly needed to satisfy future global demand for the resource – in China’s case, a Reuters story says the country can supply only a third of the 10,000 metric tons annually required to meet its 2020 nuclear capacity target.

The World Nuclear Association says the world’s measured uranium resources are sufficient to last 80 years at current usage rates, with the largest untapped deposits found in Australia, Kazakhstan, Russia and Canada. But just looking at China makes it clear that usage rates are soon to see a sizable increase. Like other resources, more uranium deposits may be economically viable at higher prices.

Uranium prices shot up to more than $135 per pound in 2007, after the first nuclear power projects began emerging, and are now around $45 per pound after a brisk supply response.

Some analysts see the price falling below $40 as new supplies from Asia and decommissioned Russia weapons come onto the market, but by 2011, price forecasts go up to $80 per pound as demand takes hold as the key price driver.

Romeo Dator is the co-manager of the U.S. Global Investors China Region Fund (USCOX). For more insights and investment research from U.S. Global Investors, visit www.usfunds.com.

Tags: Ambitious Program, Atomic Energy Agency, Canada, China, China Region, Dollar Terms, Electricity Generation, Emerging Markets, Energy Future, Future Market, Green Energy, Greenhouse Gases, International Atomic Energy, International Atomic Energy Agency, International Atomic Energy Agency Iaea, Investment Perspective, Long Term Storage, Manager China, Megawatts, Nuclear Capacity, Target, Uscox, World Energy Consumption
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