3 Reasons to Consider Spanish Stocks

Wednesday, June 19th, 2013

by Russ Koesterich, iShares

Europe is far from out of the woods.

Bond yields in Italy and Spain are creeping higher.  The region also still faces record high unemployment, a lack of growth, a fragile banking system and political dysfunction.

But while I generally remain cautious on Europe, I am starting to see some modest improvement in some of the peripheral countries — particularly in Spain. In fact, as I write in my latest Investment Directions and weekly commentary pieces, I’ve recently upgraded my view of Spanish stocks to neutral from underweight. While Spain continues to face severe growth headwinds, there are three main reasons why I’m less concerned about the market now:

1.)   Improving Profitability. Following the completion of the Spanish government’s mandated cleanup of the country’s real estate sector and banks, Spanish corporate profits are expected to recover, albeit from a low base.

2.)   Attractive Valuations. While the Spanish economy will likely continue to struggle this year and into next, most of the bad economic news is now priced into current valuations. This is thanks to Spanish stocks’ massive underperformance in recent years. Since I initiated my underweight call on Spain at the end of 2011, Spanish stocks have underperformed other developed markets by around 20%.

3.)   Reduced Risks. Finally, the market’s risks have been reduced due to the European Central Bank’s (ECB) proposed asset purchase program, which is designed to fuel Europe’s growth.

However, Spanish stocks aren’t without their risks. One potential roadblock on the horizon for both Spanish and European stocks: An upcoming ruling from the German constitutional court on the legality of the ECB’s proposed asset purchase program.

In addition, until we see more aggressive measures from the ECB to boost lending to small- and medium-sized enterprises in Southern Europe, it’s hard to envision a quick turnaround for the region.

However, Europe has one distinct advantage to domestic equities: market watchers’ low expectations. In the current environment, even modest signs of good news can have a positive impact on European equities in general and on Spanish stocks. The latter can be accessed through the iShares MSCI Spain Index Fund (EWP).

Source: Bloomberg

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Securities focusing on a single country may be subject to higher volatility.

Copyright © iShares

  Latest AdvisorAnalyst Stories

Tags: Spain
Posted in Europe, Insight, Outlook, Stocks | Comments Off

Managing Equity Risk: Some Rules for the Road

Wednesday, June 19th, 2013

by Kurt Feuerman, AllianceBernstein

Under the surface of May’s strong equity returns were major shifts in sector leadership, notably a rotation from defensive to traditional cyclical sectors. Given the market’s tendency to change gears, it helps to be flexible in managing portfolio risk. In fact, it should be a daily exercise.

Here are a couple rules for the road that can help investors balance long-term conviction with the ability to respond to near-term challenges and changing environments.

Manage position sizes dynamically. Conviction is critical in equity investing—it’s impossible to outperform the market if you’re constantly second-guessing your research conclusions. But being confident that you’re on the right course with a specific stock doesn’t mean you can’t be adaptable in an unforgiving stretch.

Even if the long-term prospects for a company are bright, a challenging near-term environment can still hurt its stock. Adjusting expectations and the size of the position dynamically can lessen the pain of a temporary impairment without having to give up on the stock altogether. As long as the long-term thesis is intact, there’s nothing wrong with playing a little defense when needed.

Take IBM. A year or so back, the tech giant seemed to be on top of its game fundamentally, but there were signs that technology spending by IBM’s corporate customers could enter a weak patch, creating near-term headwinds. An IBM investor could hold on for the ride or get out—or manage the position size down to reduce exposure until things cleared up.

In the end, the latter option likely would have worked out pretty well. After limping through a disappointing earnings period, IBM steadied itself, and ended up a strong performer. The outlook for tech spending improved, too. Reducing exposure to IBM during that rough stretch could have reduced potential damage while retaining some exposure that could be ramped back up as the picture began to improve.

Adjust sector exposure to tailor portfolio beta. Portfolio adjustments can be made more broadly, too. Most portfolios have exposure to many sectors—each with a different sensitivity or responsiveness to the direction of the broader equity market. Sectors such as consumer cyclicals (think cars, retail stores and entertainment) tend to outperform when markets rally on economic strength and underperform in downturns.

In contrast, defensive sectors, such as utilities and consumer staples, tend to be less economically sensitive, because their products are largely everyday necessities for customers. Somewhat counterintuitively, growth-oriented stocks also tend to be less sensitive to general economic weakness—their stock values tend to be driven more by company-specific factors over time.

The mix of cyclical, growth and defensive stocks that makes up a portfolio influences its overall market sensitivity, or beta. By adjusting the sector mix, a portfolio’s beta can be dialed up to take advantage of a stronger market environment or toned down to operate with more restraint in a less favorable period.

Let’s say that a look at the macro and market environments suggested trouble ahead. In that case, a portfolio could be shifted to create a more defensive and secular-growth tilt that might weather a downturn more effectively. If the outlook were more positive, a shift toward cyclicals could better position a portfolio to take advantage of a strong market.

The name of the game with this approach is flexibility. Conviction in long-term stock ideas and equity potential are good things. But the market can change its mind on short notice—often daily. Constantly adapting in response can help a portfolio better navigate the twists and turns.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Kurt Feuerman is Chief Investment Officer of Select Equities at AllianceBernstein.

Copyright © AllianceBernstein

  Latest AdvisorAnalyst Stories

Tags: Alliancebernstein, Risk Management
Posted in ideas, Insight, Monetary Policy, Outlook, Sentiment, Stocks | Comments Off

The Art of Low Turnover (Smead)

Wednesday, June 19th, 2013

by William Smead, Smead Capital Management

We have argued vociferously that active managers have given up their preferred position in the investing marketplace to passive indexes because of high turnover. A recent Wall Street Journal article referenced 78% turnover as being the average among large-cap US equity funds. Studies have shown that as much as 144 basis points each year in return is chewed up by trading costs. Explaining turnover and its impact is one thing, but it is more important to ask a question. How do you practice low turnover while seeking maximal long-term performance?

We at Smead Capital Management practice low turnover in the following ways. First, we like to buy at what John Templeton called, “the point of maximum pessimism”. If you follow an admirable company long enough, either the stock market, industry wide difficulties or an inner-company stumble of their own making will cheapen their shares to the lowest P/E quintile in the S & P 500 index. Valuation matters dearly to low turnover, because the original depressed price leaves a wonderful company plenty of upside potential at historically normal P/E ratios. If a stock has gone up markedly since you bought it and is a superior company in many ways, then you are in position to make attractive returns at a fair price. Warren Buffett reminds us of why below: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

Second, owning high quality companies allows for long holding periods. In his 2005 study on quality aspects of a company which provide long-term alpha, Ben Inker of GMO, showed that low leverage, low earnings volatility, high and consistent profitability, and low stock price volatility (beta) contributed significant alpha over 24 years from 1980-2003. We use wide moats, long histories of high profitability, high and consistent free cash flow, and strong balance sheets as our qualitative aspects of stock selection. We believe that humans are unlikely to hold low quality securities through multiple cycles. We like to look at a company in their darkest hour and ask if we could have withstood the pressure to sell at that point before we buy it originally.

Third, we have what we consider a sensible sell discipline and appreciate the way your sell discipline can lead you to either high or low turnover. In our case, we sell for three reasons. 1) We sell if one of qualitative criteria get violated going forward. Did they lose their moat, permanently damage their balance sheet or cease to maintain historical profit margins? 2) We sell investments which we were wrong on. We sell a stock which declines 15-20% in the first three years we own it, if when re-analyzed, doesn’t motivate us to buy more. In other words, some companies are not meant for us to be a long-term holder (we have duds). 3) Sometimes the wonderful companies we are part owners of get maniacal pricing in the market place. This usually means a P/E ratio two times the norm for that company. Extremes of popularity must be avoided even for those of us who resist turnover.

Lastly, holding winners to a fault contributes to low turnover and maximal long-term portfolio performance. The math of common stock investing is very simple: generally stock performance tends to fall along a bell curve in the long run. Good stock picking and portfolio management seeks to find a few of the companies which make it to the best 5% of performance among all stocks on that bell curve. We argue that active managers have given up too much advantage to the index on the simple math. In the Bible, love covers a multitude of sins. In portfolio management, our theory is that a ten-fold increase or greater in a few stocks out of 20-30 covers a multitude of duds.

The S&P 500 holds its winners straight through without any effort to weed out maniacal securities. Therefore, they satisfy the bell curve. In our opinion, most active equity managers spend way too much time attempting to determine the top in a stock under the guise of price targets and intrinsic value calculations. We believe that the urge to smooth returns for short-term performance reasons and/or an effort to be smarter than anyone really expects them to be drives stock picking organizations that direction. When an equity manager research person asks us what our price target is for a certain company we cringe. The whole idea behind what we are doing is auditioning companies for use in our portfolio in hopes of finding multi-decade success stories! Other than maniacal pricing, we believe equity managers kill long-term performance by cutting off their best performers. The crime is the penalty to short-run performance coming from the trading costs associated with their impatience and attempts at perfection.

Think of it this way. If you were a producer of plays and movies, you would audition actors and actresses. If everything works well, you could find a Meryl Streep, George Clooney, Kevin Bacon, Reece Witherspoon, Bradley Cooper or Jack Nicholson. Think how depressed you’d be today if you had Meryl under contract in the 1970s and 1980s and let her go in the early 1990s because you thought she was “fully valued”. She is still cranking out hits in this decade, 20 years after a pretty actress like her is supposed to be left with supporting roles. I’m pretty sure that the “Devil Wears Prada” and a devil sits on the shoulder of active managers and begs them to sell out of their best performing securities.

In conclusion, we believe that low turnover is critical to outperforming the S&P 500 index. We also believe that every stock picking organization should consider establishing a discipline to promote low turnover to get at bell curve success and low trading costs. We believe that Michael Price, former manager of Mutual Shares said it best, “The fewer decisions I make, the smarter I am”.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

This Missive and others are available at smeadcap.com

Copyright © Smead Capital Management

  Latest AdvisorAnalyst Stories

Tags: Outlook, Smead, Value Investing
Posted in Insight, Opportunities, Outlook, Stocks, US Stocks, value investing | Comments Off

Kyle Bass: “The Next 18 Months Will Redefine Economic Orthodoxy For The West”

Tuesday, June 18th, 2013

Kyle Bass covers three critical topics in this excellent in-depth interview before turning to a very wide-ranging and interesting Q&A session. The topics he focuses on are Central bank expansion (with a mind-numbing array of awe-full numbers to explain just where the $10 trillion of freshly created money has gone), Japan’s near-term outlook (“the next 18 months in Japan will redefine the economic orthodoxy of the West”), and most importantly since, as he notes, “we are investing in things that are propped up and somewhat made up,” the psychology of negative outcomes. The latter, Bass explains, is one of the most frequently discussed topics at his firm, as he points out that “denial” is extremely popular in the financial markets.

Simply put, Bass explains, we do not want to admit that there is this serious (potentially perilous) outcome that disallows the world to continue on the way it has, and that is why so many people, whether self-preserving or self-dealing, miss all the warning signs and get this wrong – “it’s really important to understand that people do not want to come to the [quantitatively correct but potentially catastrophic] conclusion; and that’s why things are priced the way they are in the marketplace.”

2:40 Bass begins

3:15 Central Bank Expansion

“We’ve essentially printed $10 trillion in the last few years”
“The first $5 trillion replaced the lost equity in the leveraged financial system and the second $5 trillion is making its way into deposits and expanding the monetary base”
“This is unprecedented… and it’s not going to change.”

The numbers that Bass reels off are incredible…

“What we’ve seen is a massive credit-led boom (+11% CAGR) and that can’t last forever”

11:00 “The next 18 months in Japan will redefine the economic orthodoxy of the West”

“Japan is so far off the bell-curve that no one wants to talk about it”

“if you repeat things enough, everyone will believe them.”

There are three key myths about Japan that Bass shows are simply false but remain repeated for the comfort of the cognitively biased investment community:

1. The current account allows the country to self-finance its deficit
2. The Bank of Japan is not monetizing debt
3. Retail investors will always support the JGB marketplace

From the nation’s own largest institutions forced to sell assets to the crushing demographics, Bass explains – in greater clarity than the soundbite-idiocy we get each night from Abe/Kuroda/Aso etc…

The smartest money is leaving Japan in a hurry already – Q4 2012 was the largest M&A quarter ever for Japanese firms buying foreign entities – Western productive assets – (just as was seen in Mexico before their crisis) as they try to get out of JPY

25:00 The Psychology of negative outcomes

“as an investor and a fiduciary, I get paid not to be an optimist or a pessimist; I get paid to be a realist”

“Denial” is extremely popular in the financial markets.

Simply put, Bass explains, we do not want to admit that there is this serious (potentially perilous) outcome that disallows the world to continue on the way it has. and that is whay so many people, whether self-preserving or self-dealing, miss all the warning signs and get this wrong.

“no one is ever going to tell you something is wrong”

“we have blind faith in the people running our institutions…that they can figure things out. They are a mental crutch to insure and placate depositors and investors that everything is going to be ok”

“we are running a huge economic experiment,” and you can’t control it all since there are too many variables

Once you understand the psychology of the participants, the key is to understand their actions based on that.

“It is the qualitative shift in the market participants’ belief systems that literally flips a switch overnight”

Bass reminds us of Taleb’s work on central planning: “if you suppress volatility long enough, then when the ‘event’ happens it is greater than the sum total of all the suppressed vol over time.”

He warns – these shifts happen so fast that you will never get hedged or out of the way in time…

32:00 Q & A begins

First he discusses the naysayers on a Japanese bear thesis

“I would like to live in a world where it’s all rainbows and unicorns and we can make Krugman the President – but intellectually it’s simply dishonest”

“If you were advising Abe, what would you say?” – “Quit!”

41:00 General China discussion (in the context of the Japanese-China rhetoric)

43:30 Iceland – not as great as some would suggest

“China is building an embassy in Iceland that can fit 500 people in it. Iceland only has a population of 300,000!”

“You have a roach motel of a country; the New York Times and Krugman saying it’s “The Model”; but they still haven’t addressed the problem of their debt.”

46:35 Do you worry about the US?

“I quit worrying about them because it’s just a waste of time – I always leave DC demoralized”

“The central bank is the great enabler of congressional profligacy”

48:00 How does the small investor play the Japanese market – Bass responds that they can’t and shouldn’t. Shorting JGB futures means high carry costs and negative convexity

And our favorites question!!

49:00 Why can’t the Central Bank just buy all the JGBs and then forgive them?

A speechless Bass responds…

52:00 Bank VaR and under-capitalization

Well worth an hour of your time before the FOMC tomorrow…

  Latest AdvisorAnalyst Stories

Tags: kyle bass, Markets
Posted in Insight, Japan, Markets, Monetary Policy, Outlook | Comments Off

JPMorgan: “Fed Stimulus Inflated Prices Of Financial Assets…. Removal Could Create Tail Event”

Monday, June 17th, 2013

Then: Risk-On/Risk-Off. JPMorgan’s Marko Kolanovic head of Equity Derivatives Strategy explains:

Over the last 5 years, Treasuries and Equities had strong negative correlation. This was the risk-on / risk-off (RORO regime) in which Treasuries were the most broadly used ‘safe haven’ asset. In the RORO regime, investors would hold treasuries and sell them to buy risky assets (and vice versa) while being reassured that Fed will keep the price of Treasuries supported. While we are still on average in a RORO regime, the bond-equity correlation started significantly weakening due to increased risk of Fed tapering and a bond selloff. The effect of the Fed reducing the stimulus could result in lower bond prices as well as lower prices of stocks, commodities and other risky assets whose prices were inflated by the Fed’s stimulus.

Over the past month, in several instances bonds and stocks moved together as investors re-assessed the probability of early tapering. Figure 1 below shows equity-bond correlation (calculated from high frequency intraday data). Correlation turned positive on May 9, 22, and 31 and most recently over the past few days. May 9th and 31st brought better than expected macro data (jobless claims, consumer confidence and Chicago PMI). Ironically, positive data caused equities and bonds to trade lower on increased probability of tapering (good data were bad for stocks). Similarly, on May 22nd, bonds and stocks sold off as Bernanke indicated the possibility of tapering over the next few meetings.

And Now: the “Fed Regime“

A byproduct of these new bond-equity dynamics is that USD is losing its status as a ‘risk off’ currency. As expectations of more (less) stimulus pushes up (down) treasuries and US stocks (both USD denominated), resulting currency flows are weakening the historical negative USD-Equity correlation. Historically, USD had strong negative correlation to equities (i.e. EUR and EM currencies had a positive correlation to equities). This recent relationship is now undermined as treasuries are losing their appeal as a safety asset. This weakening of EM FX and EUR correlation to the S&P 500 (Figure 2) was also helped by investors putting money in US stocks, while avoiding European and Emerging markets in the last leg of market rally.

Fears of Fed tapering the massive QE program is now changing bond-equity correlation from a RORO regime towards a ‘Fed Model’ regime (coincidentally, the name ‘Fed Model’ was crafted in 90s long before invention of quantitative easing). We do not think equity-rate correlation will fully revert back to the ‘Fed Model’ regime, but the recent spikes in rate-equity correlation are worrying signs. Recent bouts of positive correlation of equities, bonds and commodities, suggest that the Fed’s stimulus inflated prices of a broad range of financial assets, and removal of the stimulus could create a tail event in which prices of all assets could go down. While it is expected that the Fed will try to avoid such a scenario by maintaining an appropriate level of stimulus, in the absence of more robust growth, this may turn out to be a difficult task (akin to driving a car without brakes). On this account, we expect more volatility in H2 as compared to the first part of the year. To reduce risk of a bond and equity tail event, investors could diversify ‘safe haven’ assets away from treasuries and into other assets that are at lower risk in case of tapering. For instance investors could increase allocations to cash or Equity Put options.

Helpful. It also appears that Marko and Tom Lee, who sees nothing but smooth sailing from here until S&P 2,000, don’t talk much.

And just so the message of JPM’s derivatives group is clear, they look at the unprecedented (and previously documented) surge in NYSE margin debt, which has risen at the fastest pace ever so far in 2013, and analyze the empirical evidence of what happens after such a radid move. The result is below:

Last month, NYSE published April data on aggregate debt balances in stock margin accounts. This measure shows how much funds were borrowed to purchase securities, and it reached all time high of $384bn. Net margin debt (calculated as a difference of debt in margin accounts and all credit balances) also reached a high level of $106bn, and the pace of net margin debt increase YTD ($87bn) was the highest on record. We have been asked whether this increase in leverage is a sign of an impending market selloff. To analyze the relationship between S&P 500 prices and margin debt we look at their historical levels over the last 15 years. Figure 7 shows a strong correlation between S&P 500 and NYSE net margin debit. Positive correlation between the S&P 500 and net margin debt indicates that clients tend to finance a fraction of their equity exposure with margin debt. We also note that peaks in margin debt are usually followed with a sharp market correction. However, this on its own does not imply that high margin debt leads to market correction (given the positive correlation of net margin debt and S&P 500, highs in margin debt coincide with highs in S&P 500).

To test for a causal relationship we looked at the changes in net margin debt against S&P 500 performance 3, 6 and 9 months afterwards. Figure 8 shows that large increases of net margin debt are indeed on average followed by weak equity returns. Note that the YTD increase of margin debt is the highest on record, as indicated by the arrow.

Another test we performed is to look at levels of margin debt normalized by the level of the S&P 500. Dividing margin debt by the level of the S&P 500 may give a more accurate measure of leverage (by remove the bias coming from correlation of S&P 500 and margin debt levels).

Figure 9 shows the ratio of margin debt to S&P 500 (red) as well as ratio of net margin debt to S&P 500 (blue). One can see that these normalized measures of leverage peaked prior to the tech bubble burst, in H2 2007 and H1 2008, and in H1 of 2011 – in all cases ahead of significant market corrections. While these are effectively only three data points and hence do not amount to a reliable statistical sample, we think that the quick increase of net margin debt, and high ratio of margin debt to S&P 500 do point to an increased probability of a market correction and volatility increase in the second half of the year.

But don’t worry. The Fed is on top of it. All of it.

  Latest AdvisorAnalyst Stories

Posted in Credit Markets, Economy, Interest Rates, Markets, Outlook | Comments Off

Jeffrey Saut: “The Game of Risk”

Monday, June 17th, 2013

The Game of Risk

by Jeffrey Saut, Chief Investment Strategist, Raymond James

June 17, 2013

“To be sure, there is no exact definition of what ‘calling’ a market top or bottom involves. In the case of the March 2009 bear market bottom, for example, does ‘calling’ it mean the adviser’s portfolio needs to have moved from being all cash to 100% invested in stocks on the exact day of the bottom? If my analysis had relied on a definition as demanding as this, then it wouldn’t be surprising that no timers called recent market turning points. But my analysis actually relied on a far more relaxed definition: Instead of moving 100% from cash to stocks in the case of a bottom, or 100% the other way in the case of a top, I allowed exposure changes of just ten percentage points to qualify. Furthermore, rather than requiring the change in exposure to occur on the exact day of the market’s top or bottom, I looked at a month-long trading window that began before the market’s juncture and extending a couple of weeks thereafter. Even with these relaxed criteria, however, none of the market timers that the Hulbert Financial Digest has tracked over the last decade were able to call the market tops and bottoms since March 2000. These results add up to perhaps the most important investment lesson of all that: predicting turns in the market is incredibly difficult to do consistently well.”

… Mark Hulbert, MarketWatch (3/10/10)

The above excerpt was penned by Mark Hulbert in an article titled “Fools R Us.” Appropriately, that article ran in a MarketWatch column on the 10-year anniversary of the NASDAQ Composite’s peak of March 10, 2000. Ten years ago the COMP was changing hands around 5132. It is now trading at 3423 for a 13-year loss of some 33.3%. Meanwhile, over that same timeframe, the earnings of the S&P 500 are up 83%, nominal GDP is better by some 57.6%, and interest rates are substantially below where they were back then. If you are a college professor such statistics do not “foot” with your teachings because professors tend to believe stock returns are all about earnings and interest rates. I concur, but would add the caveat, “That is if you live long enough.” As money manager Greg Evans, eponymous captain of Millstone Evans in Boulder Colorado, writes:

“Hey Jeff, I enjoyed your missive on Mr. Market. I use that Warren Buffet allegory quite a bit with clients. One interesting statistic on Berkshire is that its stock price was $38 in 1968 and 8 years later, after trading higher and lower, ended up (again) at $38. Most clients would look at that (performance) and say – it hasn’t done anything for 8 years so I am going to sell. But an astute investor, looking at the underlying growth in book value, would see an average annual growth rate of 14.6% over those 8 years and conclude they should buy more. As to your point that over the long-term stock prices are ultimately determined by their book value, earnings and cash flows, I have often run numbers on stocks over a 25-year time frame to show to clients. For example, Coca-Cola’s stock price in 1983 was $5.10 (midpoint); and, Coke earned $0.30 per share that year. The stock price today is ~$40, and they earned $1.97 last year. That’s about a 15% annualized growth rate on the stock price; and, a ~15% growth rate on earnings – QED.”

Surprisingly, however, if an investor bought Coke shares at their peak price in 1972, over the next 12 years the company compounded earnings at nearly double-digit rates (with only four down quarters), yet said shareholders actually lost money. The reason was “Mr. Market” was unwilling to capitalize that improvement in earnings anywhere near the P/E multiple of 1972. Regrettably, “Mr. Market” is indeed manic depressive, which is why the stock market is truly fear, hope and greed only loosely connected to the business cycle. And that, ladies and gentlemen, is why the successful investor needs to learn how to manage risk. As Benjamin Graham wrote, “The essence of investment management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept.”

Clearly, Warren Buffet understands this “management of risk” concept for he too has learned when to “play hard” and when not to “play.” Decidedly, his insight to hoard cash, and shun internet stocks, in the late 1990s was brilliant, yet it was greeted with catcalls that “the old man has lost his touch and just doesn’t understand the Internet age.” However, investors benefitted handsomely if they heeded his advice. Enter the aforementioned quote from Mark Hulbert espousing the old market axiom, “It’s TIME in the market, not TIMING the market.” Typically such comments are accompanied with the verbiage, “If you missed the 10 best stock market sessions of the year it kills your returns.” To be sure, over the 25-year period ending on 12/31/2011 the buy and hold investor saw returns of 6.81% per year. But, if you missed the 10 best sessions your annualized return falls to 3.67%. Miss the 20 best and you experienced only a 1.65% yearly gain, and missing the 40 best yields a negative 1.62% return. However, miss the 10 worst days and a prescient investor realized a 10.89% per annum gain, while missing the 40 worst shows annualized returns leaping to a 17.74% – according to a study from Hepburn Capital Management – thus proving the management of “risks” is more important than the management of “returns” (see chart on page 3).

That said, while I too don’t believe anyone can consistently “time” the stock market, I do believe in Dow Theory. Dow Theory is like a roadmap for the “primary trend” of the stock market. Recall, Dow Theory gave you a “sell signal” in September 1999 (albeit three quarters too soon), a “buy signal” in June 2003 (a few months too late), and again a “sell signal” in November 2007 (note, it is not Jeff Saut “calling” the stock market, but Dow Theory). More importantly, the Dow Theory “buy signal” of earlier this year remains in force. Nevertheless, I continue to think we are in a short/intermediate “topping” process. The timing models that have worked so well year to date targeted June 11/12th as the days that a feint to the downside would start. While I had thought the convening of the German Constitutional Court would be the causa proxima, it turned out to be Japan and its statement that it would not increase the monetary stimulus operations. Subsequently, in Friday morning’s verbal strategy comments, I said:

“I think we are going to limp around and then try for the reaction high of 1687. If we don’t make a higher high on that attempt, and turn down from there, then the mid-July swoon I have been targeting will arrive prematurely. However, if we do make a higher high it probably means we are still going up to make a new high into the first or second week of July and then start the swoon. Indeed, I have mixed signals into the end of this week (meaning last week), as well as mixed signals into the beginning of next week (meaning this week). So, it would not surprise me to see the upside action fizzle today (last Friday) and have the market limp around with attempts to sell off into early next week. However, there are much more positive timing point signals coming next week (aka, this week), so my hunch is that the SPX limps for a few sessions and then starts to push higher.”

And while Friday’s Fade (-106 points) wasn’t much of a “limp,” Thursday’s upside action surely fizzled.

The call for this week: Nassim Taleb (trader extraordinaire) has 10 rules. Rule number 8 reads: “Always protect the downside. As pointed out ad nauseum, Black Swans do occur. No matter how much you test, there will be a ‘this time is different’ moment forcing your bank account into oblivion. No matter how confident, always protect the downside.” I agree with Taleb’s comments and therefore always try to “look” down before looking up in an attempt to manage the risk. As for the here and now, as I said on Friday, “It would not surprise me to see the upside action fizzle today (last Friday) and have the market limp around with attempts to sell off into early next week. However, there are much more positive timing point signals coming next week (aka, this week), so my hunch is that the SPX limps for a few sessions and then starts to push higher.” And this morning “higher” is the watchword as last week’s “taper tantrum” is fading on rumors of a softer Fed at this week’s meeting, leaving the preopening S&P 500 futures up about 12 points.

Click here to enlarge

Click here to enlarge

Copyright © Raymond James

  Latest AdvisorAnalyst Stories

Tags: Saut
Posted in Bonds, Markets, Outlook, US Stocks | Comments Off

Changing Picture? (Sonders)

Monday, June 17th, 2013

June 14, 2013

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
and Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research
and Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research

Key Points

• Stocks have seen some selling pressure, while other assets have also reversed course. We believe this is the start of the next phase of investing, with an increase in volatility and more grinding action likely.
• The Federal Reserve continues to prepare the market for its “tapering” of Treasury and/or mortgage-backed securities associated with quantitative easing (QE). This process is likely to be met with continued elevated levels of volatility.
• Emerging markets have had a rough ride, with heightened volatility, and we think it’s likely to persist. Japan’s market and currency action has been stomach-churning recently but we remain optimistic and urge patience, while Europe’s economy may be turning the corner.

Since Chairman Bernanke’s testimony in front of Congress in late May, where “taper” entered the lexicon, we’ve seen a shift in market behavior.

Recent action may be a foreshadowing of action to come as we slowly transition to a more normal economic environment. Gold has retreated over $300, stocks have seen a roughly 3-5% pullback, and we’ve seen the yield on the 10-year Treasury move to its highest level in over a year. Equities are likely to remain more volatile in the near-term. But it is encouraging to note that many of the technical and sentiment conditions that were troubling at the recent market highs have corrected. The AAII bull/bear ratio has moved close to zero—which is a neutral reading; while the Ned Davis Research Daily Trading Sentiment Composite moved from excessive optimism to extreme pessimism. Both are contrarian indicators. Many of the indicators we watch reversed quite quickly, suggesting that further downside may be limited; albeit with heightened volatility.

We don’t believe we’re in store for a large spike higher in yields. Yield-hungry investors may be attracted to the higher yields, but the Federal Reserve doesn’t have much stomach for much higher yields. We continue to suggest caution with regard to certain segments of fixed income; with a focus on higher-quality credit and away from longer-term Treasuries.

Economy not hitting on all cylinders

The Fed will continue to telegraph its tapering plans consistent with incoming economic data. Although the data has been mixed, there are encouraging signs, and we believe improving growth is likely for the second half. The Chicago purchasing managers index (PMI) rose to 58.7 from 49.0; and the Institute for Supply Management (ISM) Non-Manufacturing Survey rose to 53.7 from 53.1, indicating improving conditions in the much larger service side of the economy. But there was softness in manufacturing as the ISM Manufacturing Survey dropped to 49.0, its lowest reading since June 2009. Additionally, within that report, we saw the employment component dip to 50.1 from 52.0.

Services diverging from manufacturing?

Source: FactSet, Institute for Supply Management. As of June 11, 2013.

On the jobs front, ADP reported a relatively soft 135,000 jobs added in the private sector. But the government’s labor report surprised on the upside by reporting a gain of 175,000 jobs. The unemployment rate did uptick to 7.6% from 7.5%—largely due to an increase in the participation rate, which is generally viewed as a positive development. Job growth is improving but likely not yet where the Fed would like to see it at this point in the recovery.

Finally, housing, one of the pillars of support for the economy, may be facing some minor headwinds as the recent rise in yields has also pushed mortgage rates higher by about 80 basis points. We don’t view this as overly concerning, and may in fact result in fence-sitters being spurred into action. In addition, the “real” mortgage rate remains negative thanks to double-digit increases in home prices; a very strong support for housing.

Mortgage rates creeping higher

Source: FactSet, Freddie Mac. As of June 11, 2013.

Does the Fed move sooner rather than later?

We agree with the consensus that September is likely the earliest meeting at which the Fed might announce a tapering of purchases associated with QE. Inflation continues to be quite low and is not yet forcing their hand; however some Fed members have expressed concerns about asset bubbles. Recent action has appeared to remove some of the air from those potential bubbles (such as REITs), giving them some more leeway.

It’s important to remember that tapering is initially likely to be quite modest. The Fed has been clear about its ability to reverse direction if the impact of tapering is detrimental to the economy, and specifically the job market. As long as taping is initiated because of an improving economy—and not rising inflation—it’s’ likely to have a limited negative impact on the stock market, beyond some near-term volatility.

Congress quiet…for now

With other things dominating attention on Capitol Hill, Congress has been less of a market needle-mover recently. We still have a debt ceiling debate to deal with this fall, while corporate and individual tax reform remains on the table. Additionally, the sequester remains in place, with impacts potentially growing as the year winds down. Finally, we are getting closer to the implementation of the Affordable Care Act, which may be at least a near-term drag on economic activity.

Great rotation – out of emerging markets

The discussion over US Fed tapering alerted investors that a reduction of QE could potentially occur in their near-term investment horizon. As a result, risk-based trades that benefitted from what was perceived to be a relatively free lunch from zero interest rate policies (ZIRP), have experienced pressure. Emerging markets (EM), on which we’ve had an underperform rating, have experienced a particularly big hit.

Emerging markets melting down

Source: FactSet, MSCI. As of June 11, 2013. Indexed to 100 as of June 11, 2010.
* A larger/smaller number above 1 denotes greater outperformance/underperformance of the MSCI EM Index relative to the MSCI EAFE Index.

While we have been expressing caution on EM stocks for several months due to slowing growth prospects, the new wrinkle since May 22 is notable weakness in EM currencies and bonds. The risk is that further emerging market currency weakness could create inflationary pressures and reduce the ability for some EM central banks to ease. Additionally, if the US dollar resumes its strength, this could reduce foreign investment flows into emerging market economies and further pressure growth. This is troubling for countries that are dependent on foreign investment due to current account deficits, such as in India, Brazil and Indonesia.

We are maintaining our preference for developed international stock markets over emerging markets due to the continued risks to EM growth. Our negative call on China remains a cornerstone of our view on EM, due to the outsized influence it has on the EM universe. We’ve been expressing our concern about the sustainability of China’s debt-fueled, construction-led growth, and economic data continues to disappoint. Interestingly, China’s Premier Li believes growth remains “relatively high and reasonable,” according to a June 8th statement; but investors view the growth rate differently, as consensus estimates continue to fall. We believe China-related investments will encounter difficulty until investors have confidence about where and how China’s economy stabilizes. Read more Avoid China—Subprime-Like Bubble Brewing, as well as related topics at www.schwab.com/oninternational.

Speed bump in Japan, but story still intact

In recent weeks, volatility has spiked in Japan’s stock and bond markets, as well as for the currency. This comes on the heels of a 76% gain in stocks, 21% fall in the yen, and 29-basis-point drop in Japanese government bond (JGB) 10-year yields from late November to mid-May for the Nikkei and yen; and to April 4 for the low in JGB yields. The volatility in the yen, combined with the Fed taper talk, resulted in some unwinding of the yen “carry trade,” where investors borrow money at low rates in Japan and invest in higher-yielding assets elsewhere. Investors have been forced to sell riskier assets to cover short positions in the yen. Adding to the negativity, early June brought disappointment in the lack of reform details in Prime Minister Abe’s anticipated speech; and little change to Bank of Japan (BoJ) monetary policy.

Despite the extreme volatility, we don’t believe it’s time to panic. The potential for revival in Japan is still in the early stages, with the BoJ’s targeted doubling of the monetary base just beginning. In our opinion, it’s too early to expect changes to monetary policy, and tackling reforms makes more sense after the July 11 parliamentary elections. However, structural reforms are needed for a sustained recovery and will be more difficult than fiscal and monetary stimulus, while remaining a risk for a longer-term move higher for Japanese stocks. Additionally, the Japanese government needs to provide fiscal consolidation plans to maintain the confidence of the bond market.

The economy and corporate profits have begun to improve, with Japan posting the highest gross domestic product (GDP) in the G7 in the first quarter, at 4.1% annualized. Consumer confidence is at a five-year high, wages are starting to rise and consumer spending has rebounded, as discussed in Japan: Land of the Rising Consumer. However, despite the rebound in earnings, business sentiment remains subdued; but continued demand and structural reforms could improve the picture.

We believe Japanese stocks could benefit over a multi-year period, but markets could remain volatile until there is more certainty about economic reforms, and because Japan’s economic data could moderate after a nice rebound.

Eurozone may be bottoming

While the narrative has been of a continued eurozone recession, we believe the eurozone may be in the process of bottoming. The region is receiving relief as policymakers are easing on fiscal austerity, and the fiscal drag in 2013 will likely be less severe than in 2012. Manufacturing PMIs in all nations covered by Markit rose in May for the first time since July 2009; and leading economic indicators in the major economies in the eurozone have been improving or stabilizing in recent months.

Eurozone may be bottoming

Source: FactSet, OECD. As of June 11, 2013.

Additionally, the slowdown in global growth has eased inflation pressures, allowing the European Central Bank (ECB) to cut the benchmark interest rate in May and consider other non-standard measures. As monetary policy works with a lag, changes by the ECB could add to our view that the eurozone could emerge out of recession later in 2013 and maintain recovery in 2014.

That said, there are still risks in the eurozone. In May, Spain’s central bank urged banks to further write down questionable loans by September, with corporate loans joining real estate loans as a concern, with risks most pressing for smaller banks. Yields for government debt globally have recently rebounded, in tandem with the unwind of yield-chasing trades globally on the Fed taper talk, which could pressure countries with more risky outlooks, and a potential bailout for Spain could come back into the discussion. However, a fair amount of bad news has likely already been priced into eurozone stocks, where earnings and valuations for eurozone stocks are depressed and could offer opportunity for investors.

So what?

We could be in the beginning stages of an adjustment toward a more “normal” monetary policy environment, with attendant volatility. This once again illustrates the importance of diversification and focusing on long-term goals when investing. We continue to believe the US equity markets are an attractive place for assets and recommend buying on pullbacks to the extent that you need to add to equity exposure. Additionally, continue to exercise caution around fixed income allocations and focus more on the developed markets vs. EM.

Important Disclosures

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

The Morgan Stanley Capital International (MSCI) Emerging Markets (EM) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

Real Gross Domestic Product (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced in a given year, expressed in base-year prices.

The Consumer Confidence Index is a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.

The Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.

The Institute for Supply Management (ISM) Non-manufacturing Index is an index based on surveys of more than 400 non-manufacturing firms by the Institute of Supply Management. The ISM Non-manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.

Manufacturing Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index includes the major indicators of: new orders, inventory levels, production, supplier deliveries and the employment environment.

Ned Davis Research (NDR) Daily Trading Sentiment Composite® shows perspective on a composite sentiment indicator designed to highlight short- to intermediate-term swings in investor psychology.

Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly.

Past performance is no guarantee of future results.

Investing in sectors may involve a greater degree of risk than investments with broader diversification.

International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.

  Latest AdvisorAnalyst Stories

Tags: sonders
Posted in Bonds, Economy, Inflation, Insight, Interest Rates, Outlook, US Stocks | Comments Off

Cyclical Stocks Appeal After Defensive-Led Rally (Zlotnikov)

Thursday, June 13th, 2013

by Vadim Zlotnikov, AllianceBernstein

This year’s equity market rally was initially led by defensive stocks, as macroeconomic concerns persisted despite improved risk appetite. With valuations in these sectors looking stretched and cyclically oriented stocks starting to rebound in May, is a bigger shift starting to unfold?

Defensive sectors—such as utilities, consumer staples and healthcare products—typically benefit from investor skepticism about the economic outlook. These sectors normally underperform in rising markets and have a beta of less than one, meaning they are less volatile than the broader market. Yet defensive sectors delivered well above expectations in the first four months of 2013 (display). Meanwhile, sectors more sensitive to economic cycles—such as commodities, autos and energy—underperformed the broader market. As Chinese economic growth disappointed, underperformance was particularly marked in sectors that are seen to be leveraged to emerging markets, such as commodities, energy and capital equipment.

Some people think this is a bad omen. Perhaps, they argue, an unusually strong run for defensive stocks might portend a collapse in market performance?

The problem is that there’s no evidence to support this argument. Our analysis of defensive-led stock rallies shows that they are no more or less likely to be followed by a broader market downturn than an upturn. However, it is true that after a defensive-led rally, the performance of defensive stocks themselves tends to be more muted.

Might defensives continue to retreat? Valuations offer some clues to answer this question. If we look at price/book valuations, we find that defensive stocks are still trading near record highs in relation to cyclical stocks—even after the rebound in cyclicals since May (display). Price/forward earnings metrics show the same thing. Although the data I’m showing here are for US large-caps, similar observations can be made for international stocks as well. This may be a signal to start taking cyclically sensitive stocks more seriously again.

Still, for cyclically sensitive stocks to continue to outperform, some of the skepticism about future growth and profitability needs to dissipate. Trends in earnings revisions help illuminate the earnings outlook for cyclical stocks.

In the year through April, earnings revisions improved modestly in developed markets and deteriorated slightly in emerging markets, because of disappointing growth in China and India. However, high-volatility stocks—which are typically much more cyclically sensitive—saw significant deteriorations in earnings revisions across Europe, North America and Latin America. Sales growth decelerated across all regions, with developed Asia further affected by the yen’s depreciation.

I think this might be about to change. Over the next couple of quarters, comparative sales figures from the corresponding periods last year will be much easier for cyclical companies to beat. This could provide a near-term tailwind for profitability—and for a continued recovery by cyclical stocks in the coming months.

Given attractive spreads, significant recent underperformance and downward revisions, I think there could be more to come, and selective opportunities can still be found in economically sensitive stocks across various regions. In particular, I have my eye on high-beta stocks in companies with functioning business models, and with reasonable profitability and growth prospects, that have significantly underperformed in recent months on substantial downward revisions.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Vadim Zlotnikov is Chief Market Strategist for AllianceBernstein.

  Latest AdvisorAnalyst Stories

Tags: zlotnikov
Posted in Energy & Natural Resources, Markets, Outlook, Stocks, US Stocks | Comments Off

Who is Your Daddy and What Does He Do?

Thursday, June 13th, 2013

by Cole Smead, CFA, Smead Capital Management

In the 1990 movie Kindergarten Cop, Arnold Schwarzenegger portrayed a police officer who goes undercover as John Kimble, a kindergarten teacher in Astoria, OR. Early in the movie, Mr. Kimble tells his class they are going to play a game called “Who is your daddy and what does he do?” After a myriad of answers, one of the children asks him if his ensuing headache is a tumor. Kimble replies “It’s not a tumor.” We at Smead Capital Management believe this was not only one of the more comical moments of Kindergarten Cop, but also a great question to ponder in today’s investment environment.

Our firm has been trying to help the investment community understand a misperception that has come under our purview. Most people believe the risk of a stock comes from the market it trades in; most people call this market risk or beta. The problem is that stocks like Microsoft, GE and Boeing don’t just trade on the US exchanges like the NYSE and the NASDAQ, but also EuroNext, the London Stock Exchange, the Hong Kong Exchange and Deutsche Bourse. Less important than where a business trades is where they take their company risk or put another way, their operating risk. This is where their cash flows come from. To us at Smead Capital Management, the value of a business is the present value of those future cash flows.

To illuminate our point, during a recent trip to London we came across a feature article in the Financial Times titled “P&G gambles on A.G. delivering the goods.” The article highlighted the return of A.G. Lafley to the helm of Proctor & Gamble. What caught our eye was the graphic to the left that was printed with the article. The numbers entailed in it get to the heart of our concern for quite a few US large cap companies that we believe will be problematic for index investors and can, in turn, create lots of alpha for stock pickers and asset allocators that take heed.

The graphic shows seven large consumer staples companies that have worldwide brands and the percentage of revenues that come from the emerging markets. Colgate-Palmolive derives 50% of its revenues from the emerging markets, followed by Proctor & Gamble with 40% of its revenues coming from emerging markets. It is our opinion that the last 10 years were a fairly poor economic period in the history of the US. We believe that in order for companies to report robust growth, they had to seek out growth away from US shores. This greatly benefited these companies, in our opinion, but that is in the rear-view mirror.

What we believe has been inherently lost on investors is that these are not what we would consider “US Equity Risk.” Yes, they are US-Listed stocks, but more than half of their business risk is coming from abroad. It may be more appropriate to call companies like Colgate-Palmolive and Proctor & Gamble “Foreign Equity Risk” or “Emerging Market Equity Risk”. No one in the US went without toilet paper, tooth brushes or ketchup in the last five years. What leverage do these businesses have in the comeback of the US economy?

This missive is not to pick on these individual companies, but to show why this has become an index problem. Bespoke Investment Group presented the chart below on their blog on April 19, 2013. The chart shows the S&P 500 Sectors with one-year performance on the Y-Axis and the percentage of revenues in the US for those sectors on the X-axis. You can quickly see what our problem is today with certain sectors in the market.

Source: Bespoke Investment Group

We believe the best investment opportunity in the world is domestically-oriented (US) companies. We want the leverage from US consumers and accelerating household formation. This will come from the largest age group in America, the 86 million people in the 18-37 age group. Consumer discretionary and financial stocks have a very high portion of their revenues in the United States. We see them benefitting greatly from the comeback in the US. Technology, materials, industrials and consumer staples have a higher percentage of their revenues coming from beyond our shores.

We own companies like Nordstrom (JWN), Bank of America (BAC) and Gannett (GCI), whose revenues are heavily weighted to the US comeback. The most non-US equity risk we are taking is in companies like Merck (MRK), Pfizer (PFE) and Walgreens (WAG) due to their operations in Europe. We like this risk, because of the need for healthcare. More importantly, these companies have very little revenue in the emerging markets, especially compared to companies like Colgate-Palmolive, Proctor & Gamble or the Technology sector broadly-speaking. We believe investors should be asking “Who is your daddy and what does he do?” Where do your companies take their risk and where will their business expansion come from? We are making the case to advisors, family offices and institutions that these companies with low levels of operating risk in the US could be a “tumor” in their investment portfolios. We can almost hear these investors with their Austrian accent brimming with confidence saying, “It’s not a tumor.”

All the Best,

Cole Smead, CFA

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

This Missive and others are available at smeadcap.com

  Latest AdvisorAnalyst Stories

Tags: Smead
Posted in Insight, Outlook, US Stocks | Comments Off

Sea of Red

Thursday, June 13th, 2013

In the brief but tempestuous fight between Abe and the “deflation monster”, the latter is now victoriously romping through an irradiated Tokyo, if last night’s epic (ongoing) collapse in the Nikkei is any indication: down 6.4%, crushing anyone who listened to Goldman’s “buy Nikkei” recommendation which has now been stopped out at a major loss in three days, and now well in bear-market territory, it would appear that a neurotic Mrs. Watanabe is finally with done with daytrading the Pennikkeistock market, and demands Shirakawa’s deflationary, triumphal return to finally clam the market. Only this time the Japan’s selling tsunami is finally starting to spill, if not to the US just yet (it will) then certainly to Asia, where the Shanghai Composite which was down 2.7%, and is once again well down for the year, and virtually all other Asian stock markets. Except for Pakistan – the Karachi Stock Exchange is an island of stability in the Asian sea of red.

… As is Italy.

RanSquawk summarizes it best: broad based risk off sentiment was observed in Europe this morning, after the Nikkei 225 index over in Japan officially moved into bear market territory and officials at the World Bank slashed global and China’s growth forecasts. As a result, the positive correlation between the Nikkei 225 index and USD/JPY saw the major pair decline over 200pips to trade at levels not seen since early April. However, even though the spot rate remained under pressure, the implied vols surged to 2y high which indicates that the sell-off may now be viewed as a buying opportunity. Technically, major support level is seen at 93.57 which is the 38.2% retracement of the September to May rally.

Looking elsewhere, Italian Treasury successfully tapped markets this morning and sold just shy of €5 billion planned in BTPs. Still, the risk off sentiment ensured that peripheral bond yield spreads with respect to the benchmark German Bund remained wider. Going forward, market participants will get to digest the release of the latest Retail Sales report, as well as the weekly jobs data.

SocGen’s macro update confirms more of the same:

Risk aversion is back today, as investors turn concerned about the Fed exit and the success of the Abenomics. JPY and CHF are the best performers on the FX, while USD and EM currencies are hardly hit.

Will US retail sales reassure today? Consensus is for a 0.4% increase. A positive economic surprise could revive selling pressure on 10Y Treasuries. However, 2.23% must be fully cleared to catch a glimpse of 2.40% and see dollar buying rekindle.

As far as EUR/USD is concerned, we continue to think that the EUR/USD’s current upside will not last. Should global risk aversion continue, the USD would have to benefit at the end of the day: the BoJ and the SNB will not accept that the JPY and the CHF recover their safe haven status.

Moreover turning to the EUR, the ECB’s surplus liquidity reserves have been falling on a regular basis for a while now, and European banks have continued to reimburse the two 3-year LTROs: to date, they have reimbursed 40% of the amounts borrowed. This may have contributed to the EUR’s current resilience of late. Indeed, the reduction in surplus liquidity has mechanically hardened monetary conditions.

Nevertheless, while this likely will hinder the ECB in its ultra-accommodative monetary policy, the ECB does have room for manoeuvre. Although President Draghi last week indicated that no urgent action was needed, which is also underpinning the EUR, but he stated that the bank has several instruments at its disposal and that they are easy to implement. In short, the ECB is still considering using them. SG economists project that the ECB will go ahead with new accommodative monetary measures by the end of 2013: they expect a further 25bp decline in the repo rate and do not exclude more non conventional measures.

* * *

All the bulletin points that’s fit to print, courtesy of Bloomberg’s DayBook:

• Treasuries gain as Nikkei slides into bear market territory, leading global stocks lower, as JPY strengthens past 94; Japanese investors were net sellers of foreign bonds for a fourth week.
• Emerging markets from Brazil to India took steps to stem an outflow of capital as concern mounts that developed nations are approaching the beginning of the end unprecedented liquidity
• More than $2.5t has been erased from the value of global equities since Bernanke said May 22 that the Fed could scale back QE should the job market show “sustainable improvement”; the BoJ left its stimulus unchanged at June 11 meeting
• Reserve Bank of New Zealand left its official cash rate at  2.5%, said kiwi remains overvalued; Bank of Korea left its benchmark rate unchanged at 2.5%
• BoJ’s Kuroda said Japan’s real economy is recovering steadily, signaled confidence markets would recover
• The World Bank cut its global growth forecast for this year after emerging markets from China to Brazil slowed more than projected, while budget cuts and slumping investor confidence deepened Europe’s contraction
• Canada and the U.K. are seeking to galvanize an austerity alliance within the G-8 amid mounting pressure to ease up on the spending-cut strategy
• Treasury 30Y bonds to be sold today yield 3.335% in WI trading; stopout yield at that level would be highest since March 2012; 10Y notes sold yesterday awarded at 2.209%, highest since Oct. 2011, tailing 1pm level by 0.1bps-0.2bps; 2.53 bid-to-cover lowest since Aug. while indirects surged
• Sovereign yields mostly lower. Asian and European stock markets, U.S. equity index futures slide, WTI crude, metals lower

Finally, DB’s Jim Reid with the usual recap of all other major and non-major overnight events:

A bleak month for Japanese equities has just become bleaker with large declines seen in the Nikkei and TOPIX overnight. The overnight declines have been broad based with all but one constituent in the Nikkei trading lower. By sector, declines have been led by Retail, Automakers and Consumer Finance stocks. At the same time, dollar yen has broken through the 95 level to a 2-month low of 94.5. Since hitting 103.2 in mid-May, the yen has strengthened by more than 8% against the USD. Overnight flow data from the Japanese Ministry of Finance showed continued selling of foreign assets by Japanese investors for a fourth straight week. Domestic money managers sold a net JPY387bn yen of foreign debt and a net JPY222bn of foreign equities for the week ended June 7th. On a slightly better note, JGBs are firmer across the curve with 10yr yields having their best day in more than two months (-8bp as we type). Having played down the recent volatility in Japanese markets, the BoJ said that Governor Kuroda will meet with PM Abe later today to discuss recent moves in the yen and stock markets. It is unknown at this stage if there will be an official statement following the meeting.

Elsewhere in Asia, the temporary respite in emerging markets has been rather short-lived. The Asian IG credit index is currently marked 12bp wider at 153bp and sovereign CDS such as China and Korea are marked about 8-9bp wider. Meanwhile in Asian equities, the Hang Seng (-2.6%) and KOSPI (-1.0%) are both nursing losses, partly in concert with the declines seen in Japanese equities. Mainland Chinese equities are down 2-3% in their first trading session since last Friday and are in part reacting to the weaker-than-expected trade numbers which were released last weekend. In currencies, the Indian Rupee is 0.7% weaker against the USD, despite news that the RBI had intervened in the FX market in recent days to support the currency after it record lows against the dollar on Tuesday.

Returning to yesterday, a strong start to the European trading session failed to carry through to the market close (Stoxx600 -0.36%). Some of yesterday’s late selloff was attributed to talk of a “no confidence” vote in Greece. Greece’s government came under some pressure from junior coalition members in the Pasok and Democratic Left parties following public anger over the sudden closure of the Hellenic Broadcasting Corporation (ERT) on Tuesday night. According to Reuters, ERT had a combined audience share of 13%. PM Samaras described the closure as a necessary process before a relaunch of the broadcaster in a slimmed-down form later this year. A number of Greek labour unions have planned a protest in the Greek capital today to voice out against the closure. Greece’s ASE Index fell 3.2% after the country became the first developed nation cut to emerging-market status by MSCI Inc. In other changes announced by MSCI, Qatar and the United Arab Emirates were raised to emerging markets, while Morocco was cut to a frontier market.

Across the Atlantic, we had an interesting day where we saw weakness in both equities and fixed income. Indeed, the S&P500 closed 0.8% weaker, while 10yr USTs added 4bp to close at 14mth highs. Some of the weakness in USTs came after soft demand at a 10yr treasury auction where the bid-to-cover of 2.53x was the lowest in 10 months. There was also data showing that outflows from US long-term mutual funds were $11.5bn for the week ending June 5th, of which US bond funds saw outflows of $10.93bn. The last time fund outflows reached a similar figure was in early October 2012. Indeed, bond fund flows remain highly topical given the recent move in rates and follows findings last week that investors had pulled a record $12.53bn from bond funds tracked by EPFR Global for the week ended Wednesday June 5th. In other markets, the dollar index (-0.3%) continued its decline from YTD peaks and credit markets finished weaker (CDX IG +2bp) amidst the move higher in rates.

Turning to the day ahead, US retail sales, business inventories and initial jobless claims are likely to be the main focus of a sparsely populated data docket. In terms of retail sales, DB is forecasting gains of +0.3% across both the headline and ex-auto sales. It’s also worth watching today’s 30yr UST auction following yesterday’s lacklustre 10yr sale.

  Latest AdvisorAnalyst Stories

Posted in Markets, Outlook, Sentiment, Stocks | Comments Off