Declines in Transports, Dr. Copper, and Equity Volumes are Seasonal Weakness (Until October)

Monday, August 13th, 2012

by Don Vialoux, EquityClock.com

Upcoming US Events for Today:

• No Significant Events Scheduled

Upcoming International Events for Today:

1. The Bank of Japan releases the Minutes from its July meeting at 7:50pm EST.

The Markets
Markets in the US ended positive on Friday, despite concerning signs of economic contraction with China posting a disappointingly low trade surplus number for the month of July. Investors were expecting a surplus of $33.0B, up from the $31.7B reported previous, but the actual was a mere $25.2B. A shockingly low increase in exports at only 1.0%, off from the 8.8% analyst expectation, was the predominant factor behind the weak headline number, which is being pinched primarily by slowing demand from Europe. According to Econoday.com, “this was their worst performance for a non-holiday month since November 2009.” The impact of slowing exports from China is being picked up in the Baltic Dry Index (BDI), which tracks the price to ship freight over the world’s oceans. The BDI is once again pushing towards the lows of the year, signaling that economic fundamentals remain severely depressed. This is typically a leading indicator to equity market weakness.

The Baltic Dry Index is not the only shipping gauge that is under pressure. The Dow Transportation Index has been significantly underperforming the market for almost a month, hinting of weak demand for goods. The Dow Transports typically confirm broad market equity moves, leading markets higher when economic fundamentals are strong, and leading the markets lower when fundamentals are weak. The fact that this cyclical industry, Transportation, is not showing the same upside momentum as what the broad market showing is a significant concern. Higher oil prices are also pressuring transportation stocks, a situation which is seasonally typical into September and October.

Turning to the equity markets, last week saw the lowest equity market volumes for a non-Christmas holiday week in years. The S&P 500 ETF (SPY) was shown on Friday with a 4-day volume moving average. The fifth day, Friday, only weakened the average further. The Dow Jones Industrial Average is also showing a similar volume profile to SPY. Now take a look at the NYSE Primary Exchange Index, which showed the lowest 5-day volume average since the 1990’s. Low volume implies low conviction, often a precursor to market declines. Volumes are typically lower than average during the summer months, albeit not as low as present levels, picking up once again in September as traders return to their desks from summer vacation. As a result, September and October are known to be the most volatile months on the calendar as regular trading resumes.

Concerning activity remains evident in the price of Copper, often referred to as “Doctor Copper” due to its ability to predict broad market moves. Copper has maintained a long-term declining path over the past year, underperforming the market in the process. With expectations of further monetary stimulus overriding economic fundamentals, it would be expected that copper would react positively as well, producing positive results and outperforming the market before central bank officials confirm activity, similar to what occurred prior to the last two QE programs. Investors in the cyclical metal are showing signs of skepticism toward the prominent stimulus expectations, perhaps warning that fundamental concerns are still too serious to ignore. Copper seasonally declines between August and October due to economic factors, such as weak manufacturing demand.

Despite a number of warning signals that remain intact, bullish characteristics are prevailing within the price action of equity markets. The S&P 500 continues to maintain a trend of higher-highs and higher-lows following a June low. Significant moving averages (20, 50, and 200-day) are curling positive. Even bond prices are showing signs of coming under pressure, a positive for equity markets. Sell signals for broad market indices have yet to be confirmed, so although risks are increasing, maintaining appropriate allocations to equities appears prudent until technical indicators roll over. Seasonal tendencies for Presidential election years turn negative into September, so equities are within a window where a peak could be realized at any time. Be prepare to react accordingly.

Sentiment on Friday, as gauged by the put-call ratio, ended neutral at 0.99. The ratio broke out of a falling wedge pattern, which could be the precursor to elevated levels of volatility. The VIX has fallen back to levels where the market has been known to correct as complacency reaches extremes. Volatility remains seasonally positive through to October.

S&P 500 Index

Chart Courtesy of StockCharts.com

TSE Composite

Chart Courtesy of StockCharts.com

Horizons Seasonal Rotation ETF (TSX:HAC)

• Closing Market Value: $12.37 (unchanged)
• Closing NAV/Unit: $12.39 (unchanged)

Performance*

* performance calculated on Closing NAV/Unit as provided by custodian

Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.

Tags: Baltic Dry Index, Baltic Dry Index Bdi, Bank Of Japan, Broad Market, Christmas Holiday, Don Vialoux, Economic Contraction, Economic Fundamentals, ETF, ETFs, Exports From China, Headline Number, Leading Indicator, Lows, Market Equity, Market Weakness, Oil Prices, Predominant Factor, Seasonal Weakness, Significant Events, Trade Surplus, Transportation Index, Transportation Stocks
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David Rosenberg: “Despair Begets Hope”

Sunday, May 20th, 2012

Presenting the best weekly self-contrarian segment from everyone’s favorite Gluskin Sheff-based skeptic – David Rosenberg:

DESPAIR BEGETS HOPE

… Over half of the 2012 price advance has been reversed in barely over a month as the broad market drifts down to its lowest level since February 2nd. The Financial Times makes the point that the 10-day relative strength index at 29.2 is deeply into oversold territory. The Canadian TSX index is officially in bear market terrain, having declined 21% from its cycle high (posted in April last year) and is back to levels prevailing on October 2011.

Fading risk appetite is also underscored in the credit markets where BB-rated corporate spreads have widened to 450 basis points from the recent low of 420bps. Until we see some resolution to the latest round of euro area angst, one can reasonably expect spreads to widen further, but we would look at this as a nice buying opportunity as the link between the problems there and corporate default rates here is extremely loose. The fact that gold and other commodities are slipping while core government bond markets — gilts, bunds and Treasuries — are rallying strongly suggests that deflation risks are getting repriced into various asset classes. Greek bonds are trading at pennies right now and implicit probabilities in peripheral bond markets are highly discounting exits from the monetary union by year-end. Spanish bond yields have blown through 6% (Italy getting closer too) and 10-year spreads off Germany have hit a new record high of 485bps.

This is where the LTRO has proven to have actually been a dismal failure. Domestic banks used the program as a carry trade to play the yield curve and are now choking on losses on the sovereign government bonds they were enticed to buy. So thanks a lot, Mr. Draghi — ECB policies are at least partly responsible for why it is that euro area bank shares have sunk all the way back to March 2009 lows. Non-domestic investors have been dumping the peripheral government bonds just as the Italian and Spanish banks have been loading up — these foreign entities, we see in the FT, have been net sellers of Italian government bonds to the tune of 200 billion euros in the past nine months and 80 billion of Spanish debt over the same time frame. And guess what? They can unleash even more supply damage because they still own roughly 800 billion euros worth of combined bonds of both basket-case countries.

The most bizarre quote we have seen in quite a while came from a strategist in the FT. Get this:

We can take comfort from the fact that while the Greek electorate are against austerity, the support for staying within the eurozone is even stronger”.

I can replace that with this real-life comment:

We can take comfort from the fact that while my three sons are against doing their homework, the support for getting a passing grade is even stronger”.

How utterly lame.

If the Greeks want to stay in the eurozone, it’s probably because they know they can continue to suck at the teat of the Troika. More bailouts please and on easy terms since “austerity” is the new dirty nine-letter word globally.

The best lines actually came from the FT Lex column:

“All balled-out eurozone countries will ultimately have to decide whether they can make the fiscal adjustments and achieve economic growth more quickly in, or outside, the euro. That is where Greece now finds itself.”

Now that is a thoughtful comment.

There was another really good zinger in the Markets and Investing section. To wit:

“it’s naïve in the extreme to think you can limit the knock-on effect. As soon as Greece leaves or defaults, contagion will pass like a cannon going off in Spain”.

That was from an executive at a U.K. bank.

Arvind Subramanian penned a truly brilliant piece in the FT as well, titled Why Greece’s Exit Could Become the Eurozone’s Envy. In a nutshell, Greece’s challenge is that it is woefully uncompetitive and as such needs wages and prices to adjust sharply lower. You either do that organically or you devalue the currency — which then sharply boosts exports and fosters import substitution. Of course, the initial impact is recessionary and deflationary, but only for one to two years, if history is a guide, followed by a boom. This is exactly what happened to Asia a decade ago. As Arvind concludes, “the ongoing Greek tragedy could yet turn out not too badly for the Greeks. But tragedy it might well be for the eurozone and perhaps the European project”.

Indeed, the cost estimates I have seen published for the euro area would be in the neighbourhood of 400 billion euros — in terms of immediate direct financial losses. Second round impacts are far more difficult to assess, but would be enormous. While there are a myriad of legal complexities surrounding a Greek departure, it is not an impossible task. The bigger issue would be how the ECB would manage to ring-fence the banks in Portugal and Spain and prevent a contagion.

But let’s talk about what we do know with some certainty.

The Greeks voted against the status quo. It isn’t working for them. An election is likely around mid-June, and the party in the lead is dead-set against the initial bailout terms. The government, meanwhile, runs out of cash by early August when a bond payment comes due and that could well be the trigger for default and exit. It is tough to see this process being orderly — confusion, turmoil and volatility all come to mind. But if we do get a cathartic event, we will be able to buy assets for our client base at excellent prices. There always is a silver lining. You just have to find it.

We also know that Angela Merkel this far is not being swayed by her party’s recent electoral setbacks — at least that is the indication we are getting from her latest rhetoric.

Tags: Bond Yields, Broad Market, Bunds, Carry Trade, Credit Markets, David Rosenberg, Default Rates, Dismal Failure, Domestic Banks, Domestic Investors, Draghi, Financial Times, Gilts, Government Bond Markets, Government Bonds, Greek Bonds, Relative Strength Index, Risk Appetite, Sovereign Government, Yield Curve
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U.S. Equity Market Radar (May 7, 2012)

Monday, May 7th, 2012

U.S. Equity Market Radar (May 7, 2012)

The S&P 500 Index declined 2.44 percent this week. Telecommunication services and utilities outperformed as investors sought higher dividend yields in the wake of higher market volatility.  The S&P 500 suffered its worst weekly decline since December as the market digested a slew of economic releases, which on average came in slightly below expectations.

Strengths

• AT&T and Verizon led the telecommunication service sector for a second week, as investors sought the relative safety of market leading dividend yields.
• Utilities also performed well during this “risk off’ week, particularly as the 10-year U.S. Treasury yield sank to just 1.88 percent.
• The defensive consumer staples sector outperformed the broader market with relatively small decline of 0.52 percent.  Whole Foods Market and Archer-Daniels gained 7.8 percent and 3.8 percent, respectively, during a challenging trading week.

Weaknesses

• Notably, information technology trailed the S&P 500 Index this week by 131 basis points, and was the worst-performing sector within the broad market. Accordingly, Apple declined by 6.3 percent over the last five days.
• Energy and Materials lagged the market as the price of crude oil dropped below $100 a barrel and the Thompson Reuters/Jefferies Commodity Index fell by 2.7 percent this week on soft employment data and economic growth concerns.  Diamond Offshore Drilling fell 4.6 percent during the week.

Opportunity

• Despite downside volatility during the week, the homebuilding subsector continues to perform well, hitting a new 52-week high, and finishing the week relatively flat in a down market.

Threat

• The U.S. remains a bright spot in the global economy and external shocks from Europe or Asia can’t be ruled out.

Tags: Archer Daniels, Broad Market, Commodity Index, Consumer Staples, Diamond Offshore Drilling, Dividend Yields, Downside Volatility, Economic Releases, Employment Data, energy, External Shocks, Global Economy, Growth Concerns, Market Radar, Market Volatility, Price Of Crude Oil, Relative Safety, Telecommunication Service, Telecommunication Services, U S Treasury, Whole Foods Market
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Goldman Explains Why The Market Has Gotten Ahead Of Itself In Its European Optimism Again

Wednesday, February 8th, 2012

While hardly new to anyone who actually has been reading between the lines, and/or Zero Hedge, in the past few months, the Greek endspiel is here, and as a note by Goldman’s Themistoklis Fiotakis overnight, the Greek timeline, or what little is left of it, “allows little room for error.” Furthermore, “Due to the low NPV of the restructuring offer it is likely that part of this investor segment may be tempted to hold out (particularly owners of front-end bonds). How the holdouts are treated will be key. Paying them out in full would probably send a bullish signal to markets, yet it would be contradictory to prior policy statements about the desirability of high participation both in practical terms as well as in terms of signalling. On the other hand, forcing holdouts into the Greek PSI in an involuntary way would likely cause broad market volatility in the near term, but could be digested in the long run as long as it happens in a non-disruptive way (as we have written in the past, avoiding triggering CDS or giving the ECB’s holdings preferential treatment following an involuntary credit event could cause much deeper and longer-lived market damage).” Once again – nothing new, and merely proof that despite headlines from the IIF, the true news will come in 2-3 weeks when the exchange offer is formally closed, only for the world to find that 20-40% of bondholders have declined the deal and killed the transaction! But of course, by then the idiot market, which apparently has never opened a Restructuring 101 textbook will take the EURUSD to 1.5000, only for it to plunge to sub-parity after. More importantly, with Greek bonds set to define a 15 cent real cash recovery, one can see why absent the ECB’s buying, Portugese bonds would be trading in their 30s: “Portugal will be crucial in determining the market’s view on the probability of default outside Greece… Given the significance of such a decision, markets will likely reflect concerns about the relevant risks ahead of time.” Don’t for a second assume Europe is fixed. The fun is only just beginning…

From Goldman Sachs – Market Uncertainty Ahead from Euro Area Sources

Overview

News reports over potential progress in Greece’s PSI talks and the possible involvement of the ECB/EFSF in the restructuring deal have once again boosted the performance of risky assets, with S&P futures trading stronger and the dollar weaker. Peripheral Euro area bonds are trading flat-ish. Today is a quiet day in terms of data releases and markets are likely to start focusing on tomorrow’s ECB and BOE meetings…. In today’s note we discuss the reasons for managing our recommendations more cautiously, linked to Euro area sovereign uncertainties and the likely balance of risks around the ECB’s policy stance vs. market expectations.

A Tight Timeline For Greece Allows Little Room For Error

Greece remains an important source of risk to watch. As we have argued in the past, markets have interpreted the case of the Greek Private Sector Involvement as a precedent for restructuring within the Euro area. Over the last eight months of PSI discussions and preparations, the deterioration in Greek debt dynamics has been accompanied by a gradual deterioration in the terms of the deal for the existing bondholders (in an effort to achieve debt sustainability). In the end, the revealed preference of policymakers in the Greek case has been to pass a significant part of the cost of restructuring Greek debt to the private sector. Fundamentals in Greece may be much worse than in other countries, but the market has extrapolated the policymakers’ reaction function to the other peripheral countries with better fundamentals, thus pushing risk premia higher.

The next few weeks will be no exception. There are important issues to be resolved and further important precedents to be set thereby. To better grasp the complications at hand it is important to discuss the timeline of events ahead. The agreement between the Greek government and the creditors represented by the IIF is likely to be reached in parallel with an agreement between the IMF and the Greek government on the new austerity measures. Then the new austerity measures (including reductions in minimum wages and further reductions in pensions), which are likely to prove unpopular domestically, will need to be approved by the Greek parliament. All this needs to take place about 3-4 weeks ahead of the March 20th bond redemption, so that there is enough time for the IMF to sign off on the new loan package, for the offer to be extended across bondholders and for maximum participation to be pursued.

As we have discussed in previous pieces on the subject, outside official lenders, Greek bond holders and Euro-area banks, there are about EUR70bn of bonds scattered across different institutions. Due to the low NPV of the restructuring offer it is likely that part of this investor segment may be tempted to hold out (particularly owners of front-end bonds). How the holdouts are treated will be key. Paying them out in full would probably send a bullish signal to markets, yet it would be contradictory to prior policy statements about the desirability of high participation both in practical terms as well as in terms of signalling. On the other hand, forcing holdouts into the Greek PSI in an involuntary way would likely cause broad market volatility in the near term, but could be digested in the long run as long as it happens in a non-disruptive way (as we have written in the past, avoiding triggering CDS or giving the ECB’s holdings preferential treatment following an involuntary credit event could cause much deeper and longer-lived market damage). One way of staging such an involuntary restructuring operation for the holdouts would be the retroactive imposition of collective action clauses and their invocation following the conclusion of the voluntary restructuring operation. The introduction of such clauses would likely happen before the PSI exchange offer goes live – in order to further discourage investors from holding out.

The good news is that after a successful restructuring operation, Greece’s systemic importance as a source of risk declines meaningfully due to the limited refinancing needs, the meaningful reduction in debt servicing costs and the low levels of residual market exposure to Greek bonds post PSI.

Portugal’s Significance to Rise Post-Greece

Greece has created a market concern to do with low recovery rates in the event of a restructuring episode in the Euro area, which has been reflected across sovereign risk premia in peripheral Euro area bond markets. However, Portugal will be crucial in determining the market’s view on the probability of default outside Greece. This is because Euro area policymakers have gone out of their way to signal that Greece is a unique case, addressed with a one-off operation. Therefore it will be important that this commitment is maintained.

As Silvia Ardagna and Andrew Benito discussed in a recent Viewpoint, it is likely that Portugal may need an increase in assistance funds. The progress that Portugal has made in its adjustment programme and the reasonably limited resources that need to be put to work make it likely that a “top-up” of official funds to fully cover Portugal’s needs may ultimately be the preferred policy option.

But given the significance of such a decision, markets will likely reflect concerns about the relevant risks ahead of time.

Tags: Bondholders, Broad Market, Bullish Signal, ECB, Eurusd, Goldman, Greek Bonds, Greek Timeline, Holdouts, Market Volatility, Npv, Optimism, Parity, Policy Statements, Preferential Treatment, Probability, Psi, Reading Between The Lines, Restructuring, True News
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Wood Block ETFs for a Solid Portfolio

Thursday, January 12th, 2012

It’s just weeks since Christmas and crisis! Two little boys, buried under wrapping paper, flit frantically from Beyblades to Wii to Lego. They collapse, overcome not by plastic fumes but by too much choice.

This could just as easily describe the world of exchange-traded funds, circa 2012. Early investors were happy with the ETF equivalent of a few wood blocks. Now there are over 1,600 ETFs, in every shape and color, some with triple-zoom, some virtually real.

The basic premise of ETFs is powerful: An efficient, low-cost way to invest in a broad, diversified set of stocks or bonds. With many ETFs you can almost ignore company-specific risk and focus instead on the one thing that matters most to your portfolio: asset allocation. The decision to invest X% in bonds and Y% in stocks and adjusting that to reflect economic conditions affects your portfolio more than picking, say, TD over CIBC.

However, the overwhelming growth in exotic ETFs means investors risk losing themselves in arcane ETF details at the expense of ignoring the big asset allocation decision.

Instead, when building your portfolio, first think carefully about economic conditions, then make your asset allocation decision and after that, head to the back of the store. That is where you will find a good selection of solid wood blocks. I’ve chosen a few of these that are TSX-listed – though there are many other good ones – with which to begin building a basic balanced ETF portfolio.

BROAD MARKET EQUITIES

Canadian Large-Cap Equities
iShares S&P TSX 60 (XIU/TSX)
Fee: 0.17% Balanced Allocation: 10 to 15%

XIU holds the 60 biggest Canadian companies, with 26% in banks. Its 36% allocation to energy and mining firms connects it closely to global economic growth and commodity demand, especially from emerging markets. Generally, that is a good thing if you don’t mind high but volatile growth. In a balanced portfolio, consider allocating between 10 and 15% to XIU. More conservative investors could opt for higher dividend, lower volatility ETFs like Claymore S&P/TSX Canadian Dividend ETF (CDZ/TSX).

U.S. Large-Cap Equity
iShares S&P 500 Hedged to C$ (XSP/TSX)
Fee: 0.24% Balanced Allocation: 10 to 15%

XSP invests in the 500 biggest U.S. firms. Many people are thoroughly pessimistic about the United States. There are some good reasons for that. But the fact remains that it is the world’s largest economy by far and is showing signs of economic renewal. XSP is more diversified than XIU, with info tech, financials and energy holding the biggest weights.

International Developed Market Large-Cap Equity
MSCI EAFE Index Fund Hedged to C$ (XIN/TSX)
Fee: 0.50% Balanced Allocation: 10 to 15%

The XIN invests in large developed markets like Britain, Germany, Japan and Australia. It is well-balanced across a range of sectors, with financials and industrials being the largest. Europe’s troubles have hit XIN hard this year. But XIN represents the largest share of the global economy. Its holdings are multinationals like Nestle and Shell. Watch your timing on entry but do not ignore XIN. On XIN’s currency hedge, it is only on U.S. dollar exposure and not the other currencies.

Emerging Market Large-Cap Equities
Vanguard MSCI Emerging Markets Index ETF (VEE/TSX)
Fee: 0.49% Balanced Allocation: 4 to 8%

Emerging markets performed terribly in 2011. But new pro-growth policies in most emerging markets should see a rebound in 2012. Longer term, emerging markets are the drivers of global economic growth and investors would do well to have some exposure, even if it comes with higher volatility. Be sure to adjust exposure in response to global economic trends. Emerging market growth drives commodity prices but this will change as these economies develop. The VEE ETF has just been listed in Canada but it is based on Vanguard’s comparable U.S. product, which has offered bargain-priced emerging market exposure for years.

FIXED INCOME

iShares DEX Universe Bond Index (XBB/TSX)
Fee: 0.30% Balanced Allocation: 40 to 60%

Compared to individual bonds, bond ETFs are more liquid and have a constant time to maturity. They also benefit from better bid/ask spreads. XBB holds a mix of Canadian government and quality corporate bonds with a maturity of about 10 years. If you believe interest rates will rise soon, you would want an ETF with a shorter maturity like iShares XSB/TSX, or, if vice versa, iShares XLB/TSX. Alternatively, you might split your allocation across all three.

SECTOR-SPECIFIC EQUITIES

ETFs that focus on a specific sector have proliferated in recent years. Two issues with them: they are more micro than macro and they have more company-specific risk than the wood block ETFs. The better ones minimize these effects but still, they should be used judiciously and only as part of a diversified portfolio. A couple to consider are: the BMO Equal Weight REITs ETF (ZRE/TSX) with high dividends and lower volatility; the iShares S&P/TSX Capped Energy ETF (XEG/TSX) is more volatile but does well when commodities rally. For both of these, limit allocations to about 6%.

Tags: Asset Allocation, Balanced Portfolio, Beyblades, Broad Market, Cap Equities, CIBC, Conservative Investors, Economic Conditions, Emerging Markets, ETFs, Exchange Traded Funds, Global Economic Growth, Overwhelming Growth, Plastic Fumes, Solid Wood, TSX 60, Two Little Boys, Wii, Wood Blocks, Wrapping Paper
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On Tap for 2012: More Bond Market Transparency

Monday, January 9th, 2012

In my year-in-review blog, I noted that fixed income market conditions in 2011 turned out to be pretty much the opposite of what investors were expecting. With that in mind, I am well aware of how difficult it is to offer predictions for 2012. But I did want to provide a few insights into how I expect the fixed income ETF landscape to evolve this year.

One trend I definitely expect will continue is the launching of new fixed income ETFs.  2011 was a strong year for new products, with 102 new fixed income funds launching across exchanges in Europe, Canada, Asia and the United States. As of December 6, the total number of fixed income ETFs globally had grown to 467, according to data from BlackRock and Bloomberg.

Within the United States there have been a total of 39 new funds launched this year. One of the big trends has been the introduction of funds that offer exposure to bond markets outside the United States. For instance, this year we saw new funds launch that provide exposure to offshore Chinese Yuan denominated bonds. Broad local currency emerging market debt funds also launched that offered investors additional ways to access non-US dollar bond markets. In Europe, product launches focused on gaining access to non-Euro zone markets, like the United States or emerging markets.

With 115 new fixed income ETFs filed with the Securities and Exchange Commission as of December 6, this will be another busy year for fixed income ETF launches. The most popular sector for new filings is broad market, with 23 applications. This is followed by 16 filings for international developed ETFs and 14 filings for investment grade credit fixed income ETFs.

Based on the pipeline, more active mangers appear ready to get into the ETF game. The active managers that have filed for fixed income ETFs have chosen to start with broad market and active short duration funds.

Source: SEC EDGAR and BlackRock’s HEARSAY database

The continued growth of the fixed income ETF market should provide investors with even greater clarity into fixed income market movements. It is now possible to see and track investor behavior in fixed income by watching fixed income ETF trading volume and fund flows. For many investors this is providing them with real-time data on bond market movements for the first time. The expansion of the fixed income ETF market will allow all investors to see investor sentiment expressed on an even larger number of markets.

Bonds and bond funds will decrease in value as interest rates rise. 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. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Tags: Blackrock, Bloomberg, Bond Market, Bond Markets, Broad Market, Chinese Yuan, Debt Funds, Dollar Bond, Emerging Market, Emerging Markets, Euro Zone, Europe Canada, Europe Product, Fixed Income Market, Investment Grade, Investment Objective, Market Transparency, Securities And Exchange Commission, Year In Review, Year One
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A Test of Fortitude & Discipline: 2011 in Review

Friday, December 23rd, 2011

Monthly Strategy Report December 2011

by Alfred Lee, CFA, DMS, Vice President & Investment Strategist,
BMO ETFs & Global Structured Investments
BMO Asset Management Inc., alfred.lee(@)bmo.com

Just when you thought financial markets couldn’t get any more extreme, they suddenly prove otherwise. Such was the theme over the course of 2011, a year where market volatility caused constant changes in sentiment and significantly frustrated many investors. Global equities fell 6.5% on the year, as indicated by the MSCI World Index (Total Return), which should actually be viewed as a positive given the macro-economic backdrop.

As the year progressed, the market was hit with an increasing number of negative headlines including: the unfortunate Japanese earthquake/tsunami; the downgrade of U.S. Treasuries by Standard & Poor’s; deteriorating sovereign debt issues in Europe; and growing concerns of a hard landing in China. As a result, most of the gains experienced in broad market equity indices during the first quarter of the year rapidly reversed course as sentiment became increasingly bearish from these news items during the last six months of the year. Moreover, since August, both realized and implied volatility have remained elevated, providing a serious test of discipline for investors.

We started the year with a more bullish tone as markets continued to enjoy the effects of “QE2” (the second instalment of quantitative easing by the U.S. Federal Reserve). However, as the year progressed and market sentiment soured, our Global Inter-Market Model showed developing trends in defensive-oriented assets. Consequently, and also considering the worsening macro-economic data, we issued a report on August 15, titled “Navigating Market Volatility” where we recommended a more defensiveoriented portfolio strategy. Given the rapidly changing market environment, our recommendations in 2011 were significantly more tactical than the previous year. Below, we highlight some of the recommended themes throughout the year.

Asset Allocation Themes:

1) “Overweight Equities Relative to Bonds:”

This asset allocation decision fared extremely well during the first quarter with the S&P/TSX Composite Index to DEX Universe ratio expanding until April 8, as Canadian equities outperformed bonds. Though we remained optimistic on equities through June, as the summer progressed, both macro-economic data and technical indicators suggested a greater emphasis to fixed income. We therefore recommended an overweighting in bonds in our previously mentioned August 15 report. That tactical shift to fixed income has served us well as our BMO Aggregate Bond Index ETF (ZAG) has gained 3.5% on a total return basis since that report, while the S&P/TSX Composite Index returned -6.7% on a total return basis from the same period. That tactical shift led to a difference of 10.2% in performance.

2) “Be Prepared for Sudden Upside Volatility:”

At the beginning of the year and a theme highlighted throughout 2011 was to prepare for constant shocks in volatility or what we noted as “volatility-squared,” as markets were becoming more behaviourally driven and increasingly reactive to negative headlines.

Tags: Alfred Lee, Asset Management Inc, BMO, Broad Market, Debt Issues, Economic Backdrop, Global Equities, Investment Strategist, Japanese Earthquake, Market Environment, Market Equity, Market Model, Market Sentiment, Market Volatility, Msci World Index, Negative Headlines, Portfolio Strategy, Sovereign Debt, Strategy Report, Structured Investments
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Ugly Close As 30Y Treasury (TSY) Yield Drops Most Since March 2009

Tuesday, November 1st, 2011

While much was made of the MF Global news today, we suspect that the tipping point for risk assets was more likely driven by the plethora of reality-based analysis of the situation in Europe combined with the afternoon news that Greece is facing a referendum and a lack of demand for the EFSF issue today. Heavy volume arrived into the close to the downside, suggesting asset allocation rotation from equities to bonds, which helped propel TSYs even further down in yield. The entire complex flattened notably with 30Y outperforming -24.5bps, the largest single-day yield move since March 2009, as the much-watched 2s10s30s butterfly has retraced all of last week’s increase. ES closed at its lows (down over 2.5%) only to extend those losses in the evening session as we post.

At over 4 standard deviations, today’s drop in 30Y yields was the highest for a single-day since 3/18/09.The roundtrip in the entire TSY complex from last Wednesday is quite impressive and remains surprising as to how a broad market can interpret what was so clearly no-real-news in such a schizophrenic way without some ‘help’.

35bps sell-off in 30Y at its best early Friday – only to give it all back and some by the close of today – perhaps there is something to our perspective on MF Global and its TSY inventory last week. The drop in TSY yields was initially shrugged off by ES but very quickly it became clear that fears were gathering and ES accelerated to the downside – with IG and HY credit tracking wider also. VWAP acted as natural resistance at every small rally suggesting there was more of an institutional bias to selling today – which again fits with the rotation we would expect after such an aggressive month’s performance in stocks.

As the day wore on, all risk-drivers were reverting back to what is more realistic (as opposed to the intervention-dislocation from the overnight session). EURJPY has retraced almost the entire move and as we closed CONTEXT and ES were back in line – rather surprisingly given the amount of movement (and lack of recalibration) in asset classes today – though we did note earlier that risk-off in broad markets was dominating any correlation-drivers.

Under the surface, HY and HYG underperformed stocks (having not really seen the kind of risk-on moves to bring them back to fair even with last week’s ebullience) but IG was the worst relative-performer (as we suspect low-cost hedges /shorts were laid back out). Financials in the US were not pretty  (even though Materials and Energy underperformed broadly) as CDS widened and stocks tumbled in the majors (e.g. MS -9% and 35bps wider!!). We have to say it was rather quiet and slow to start with – which makes sense given last week’s violence – but by the close equities and credit were losing ground fast once again.

EURUSD lost 1.39 and DXY managed a 2% gain from Friday’s close (as JPY’s 3% loss contributed). PMs slid lower as the dollar rallied and aside from what appeared to be a liquidation (and unique to itself) rip-fest in WTI in the middle of the day, moves in commodities were all negative.

Volumes were in general light until the last hour or so. Whether this was MF related as traders were anxiously re-arranging clearing or a month-end wait to transact is unclear. It is clear, however, that firms are clearly derisking (as IG reaches back to fair-value and HY cheap once again and the European financials and sovereigns face renewed pressures).

Tags: Asset Allocation, Bonds, Broad Market, Commodities, Dislocation, Downside, Evening Session, Global News, Institutional Bias, Mf Global, Natural Resistance, News Today, Overnight Session, Plethora, Real News, Risk Drivers, Roundtrip, Selling Today, Single Day, Standard Deviations, Tipping Point, Tsy
Posted in Bonds, Brazil, Commodities, Markets | Comments Off

Diversification’s Dirty Secret

Tuesday, October 18th, 2011

This Week: iShares CDN S&P/TSX Cap REIT ( Ticker: XRE )

One of the pillars supporting modern portfolio management is diversification. However, with markets around the world suffering equally, you could be forgiven for thinking that the pillar has crumbled and brought your portfolio down with it.

But let’s not jump to such a hasty conclusion. It could be that what looked like diversification in good times turned into concentration in bad.

On the surface, many portfolios look diversified. Obeying the dictum, “Don’t put all your eggs in one basket”, many investors hold a good mix of Canadian, U.S. and international stocks. That helps improve returns in good times.

But global equity markets have a bad habit of moving in step with each other just when you would rather they marched to different beats. In the language of Bay Street, correlations increase in bear markets. This tendency undermines diversification’s protective role.

The last six months are proof. The S&P 500 is down 15%, the S&P TSX 60 is down 20%, the MSCI EAFE, which includes developed markets outside the United States, is down 23% and the MSCI Emerging Markets is down 30%.

It is clear that simply investing in broad market indices across many countries does little to protect against bad times. As all markets become more globalized and interconnected, as corporations become more multinational, this tendency will strengthen.

Then where does that leave diversification and more importantly, the future of your portfolio?

Ironically, it turns out that diversification may come from within. Rather than diversify across countries, it may be more effective to diversify across sectors, be they domestic or international. In fact, sectors within a market often have much lower correlation to each other than the broad market index does to its global counterparts.

The S&P TSX 60 has a correlation of +0.84 to the S&P 500, +0.80 to the MSCI EAFE and +0.85 to the MSCI Emerging, with perfect correlation being equal to +1.00.

However, its correlation to its parts is lower, excepting energy and financials – no surprise given their dominance of the TSX.  The Canadian Energy sector has a +0.90 correlation to the S&P TSX 60, Financials are +0.75, Materials are +0.68, REITs are +0.66, Utilities are +0.50 and Telecoms are +0.45.

Returns across sectors are just as varied. Over the last six months, Energy is down 25%, Banks down 15%, Materials down 17%, REITs down 1%, Utilities and Telecoms both up about 3%.

REITs, utilities and telecoms are also less volatile and pay higher dividends than sectors like energy, materials and financials. That makes them good candidates for troubled times.

Last December, we began reducing the riskiness or “beta” of our portfolios. We reduced our allocation to the iShares S&P TSX 60 ETF (XIU-TO) and cut the iShares S&P TSX Materials (XMA-TO).

We added the iShares S&P TSX REITs ETF (XRE-TO) and the Claymore S&P TSX Canadian Preferred Shares ETF (CPD-TO) for their lower volatility and high dividends. Since then, both XRE and CPD both have helped improve the total portfolio’s returns.

The current dividend yield on XRE is about 5.25% and about 4.90% on CPD and their total year-to-date return is 8.76% and 1.92%.We expect that with interest rates low and with little chance of an increase by the Bank of Canada in the near future, both ETFs will continue to perform well.

The other sector to consider is utilities. iShares recently added a S&P TSX Utilities ETF (XUT-TO). It has returned about 3% in gains and dividends since its launch in April. It may be another candidate for calming a portfolio, though its size is small at only $8 million in assets and it is concentrated with only 11 firms in total and 65% of the allocation in the top four companies.

Allocating by sector is not as simple as allocating by country. Nor are there as many good choices available in Canada, though the selection is better in the United States.

But as globalization causes equity markets to move more and more in tandem, the sector allocation decision will become more important. And the dictum may change to “Don’t put all eggs in your basket, add bread and potatoes too.”

Disclaimer: We may hold positions in any and all securities mentioned in this report.

The archerETF Global Tactical Portfolio

archerETF offers Global Tactical Portfolio Management.

Our outlook is Global: we invest across countries, sectors, commodities and other asset classes to improve returns. Our management is Tactical: we strive to select the right opportunities at the right times in response to changing market conditions to manage and minimize portfolio risk.

Please call us at TF 1-866-469-7990 for more information.

Tags: Bad Habit, Bear Markets, Broad Market, Canadian, Canadian Market, Cap Reit, Commodities, Correlations, Dictum, Dirty Secret, Eggs In One Basket, Global Equity Markets, Hasty Conclusion, International Stocks, Market Index, Market Indices, Modern Portfolio, Msci Eafe, Msci Emerging Markets, Outlook, Portfolio Diversification, Portfolio Management, Tsx, TSX 60
Posted in Canadian Market, Commodities, ETFs, Markets, Outlook | Comments Off

Energy and Natural Resources Market Cheat Sheet (September 26, 2011)

Saturday, September 24th, 2011

Energy and Natural Resources Market Cheat Sheet (September 26, 2011)

Strengths

• The latest South Korean oil demand numbers released this week show the second straight month of year-over-year growth, following a weak second quarter. In August, Korean inland deliveries totaled 2.172 million barrels per day. In the year-to-date, South Korean demand growth has thus crept into positive territory, with the third quarter-to-date demand higher year-over-year by 4 percent.
• The American Institute of Architect’s Architecture Billings Index rebounded sharply in August to 51.4, shooting back above 50 (which indicates growth) for the first time since February.
• Despite a vicious bout of selling of stocks and commodities this week, the Global Resources Fund performed relatively compared to many of its peers over the past week as the fund management team has taken a more defensive position in the portfolio since early August.

Weaknesses

• Base metals prices fell sharply this week. The release of weak Euro area flash PMI data for September, suggesting a contraction is possible, combined with both a sub-50 China PMI reading for the same month and ill-received comments from the Fed on the state of the U.S. economy weighed heavily on broad market sentiment and drove risk aversion. Copper fell 17 percent this week to under $3.28 per pound, a 52-week low.
• The agriculture complex tumbled across the board as the downbeat economic outlook took its toll on market sentiment. Prices for corn futures fell 7 percent on the week.
• This week, metals giant Rio Tinto reported that some of its clients have begun asking to delay shipments of iron ore and other metals. Demand for coal is also decreasing, suggesting Asian activity could be waning.

Opportunities

• Peru’s government said it will not levy additional taxes on the country’s mining industry beyond those currently being debated in its Congress. Under the new law, mining companies will have to pay a sliding scale percentage of operating profits instead of the previous royalty system of 1 to 3 percent of revenue.
• At its Brazil Infrastructure Conference, Goldman Sachs estimated nearly R$85 billion of infrastructure projects will be executed over the next three to four years, including projects related to the 2014 FIFA World Cup, the 2016 Olympics in Rio de Janeiro, airports, subways, and highways.
• Oil supermajor Royal Dutch Shell’s CEO Peter Voser said in both the Financial Times and the Wall Street Journal that oil demand growth will outpace the growth in supply, so we should see “rising energy prices for the long-term.” Voser said that the reason for the shortage of supply was a lack of investment after the global financial crisis.
• Analysts at Macquarie noted the chance of another (albeit weaker) La Nina is starting to build in the Australian coal space. The latest median rainfall probability forecasts from the Bureau of Meteorology give a 65 to 70 percent chance of above average rainfall for the northern Bowen Basin between October and December 2011 versus a 70 to 75 percent probability for the same period last year. The probability of above median rainfall is lower in the Hunter Valley and Gunnedah Basin at 55 to 60 percent. The forecast raises the possibility that the Queensland met coal chain could again be disrupted by inclement weather, while steel mills’ inventories remain low.

Threats

• The IMF forecast a decline in commodity prices in the second half of 2011 and in 2012 based on bigger harvests of food crops and slower economic growth weighing on demand for base metals. The IMF’s index of non-fuel commodities is forecast to slip about 5.5 percent in the second half of 2011 on better harvests, while base metal prices are expected to decline “modestly” in 2012 on improved supply, the IMF said in its World Economic Outlook report. The world economy will expand 4 percent this year and the next, the IMF said, down from June forecasts of 4.3 percent in 2011 and 4.5 percent in 2012.

Tags: Base Metals, Brazil, Broad Market, Cheat Sheet, Commodities, Contraction, Corn Futures, Defensive Position, Early August, Economic Outlook, Fund Management, Giant Rio Tinto, Global Resources, Gold, Infrastructure, Iron Ore, Market Sentiment, Metals Prices, mining companies, Mining Industry, Oil Demand, Outlook, Resources Fund, Risk Aversion, Stocks And Commodities
Posted in Brazil, Commodities, Gold, Infrastructure, Markets, Outlook | Comments Off