Some Numbers Worth Thinking About

Thursday, August 16th, 2012

What Are Investors Thinking About Coming Into the Home Stretch?

Whether it is right or wrong, many still think of investing on a calendar year basis. So as we crawl through this period of incredibly low volatility and low volume it is time to start thinking about the home stretch. Coming into year end there are some striking numbers that investors and money managers must be thinking of and are likely to influence their decisions for here on out.

Equities

The S&P 500 is up 11.8% for the year. The Nasdaq is up 16.3%. Had you been lazy and just bought AAPL (which is allegedly the most owned stock by hedge funds), you would be up 55.8%. Had you “tried to lose client money” by buying banks, you would have failed there too. XLF is up 16.4% and even JPM, with the whale trade and LIBOR is still up 11.5% this year (remember how bearish everyone was on banks at the start of the year?).

Okay, what about Europe? Well an investment in the STOX 50 would be down 1% in USD, but still up 4.9% in Euro. The Nikkei is up 7.5% in Yen terms and 4% in dollars.

China, with all of its problems and daily headlines of various types of landings, is down only 4% in local terms and 5% in USD.

In many ways it would have been hard to lose money investing in equities. Just simple equity investments and that’s without timing any of the bigger moves. Yet the composite hedge fund ytd return is only about 3%.

Fixed Income

The fixed income case is even more depressing for hedge funds. It has been almost impossible to find a losing investment here. The 10 year treasury return is over 2.5%, Investment Grade bond index is 7.9%, High Yield bond index is 8.6% and even boring, senior secured, floating rate leveraged loans have generated 7.1%. The Municipal bond index is up only 5% but some of that income is tax-free. Emerging markets have been stellar with core dollar denominated debt up 11.9% and even local currency debt now up 4.4%.

Even an investment in a 5 year Italian bond would be up 8.8% so far. I haven’t converted that to dollars where it is less, but this number is worth thinking about. Close your eyes, but Italian 5 year bonds at the start of the year, and you would be up 8.8% so far in Euros. At least Spain has had the decency to be down. Had you bought 5 year Spanish bonds at the start of the year you would have a 2.1% loss in Euros (slightly less in dollars). All the time and focus spent on how bad Spain is and you would only be down 2.1% on a five year bond, strikes me as surprising.

On fixed income, I continue to believe that specific credit and bond selection is necessary here, as the “go go” bonds have gone about all they can. The ETF’s are underperforming the benchmarks in many cases now, at least in part because the “beta” has been played out.

Others

The dollar has done well this year. Investing in DXY would have produced a 3.2% return. Investing in commodities would have lost 3.3% based on the CRB index. That surprised me, given how much talk there is about inflation.

Can You Sell Sharpe Ratio?

At a glance, the hedge fund composite index returns are pretty lackluster. Obviously some funds have done a great job, some are designed for low volatility or tail risk environments, etc., but some are designed to generate total returns for their investors. It must be getting hard for some investors to wonder why they are paying 2 and 20 to get returns that just aren’t that good. So many investments have outperformed, and there are so few losers, some investors will question how it was possible to achieve such low returns.

That is the key game that is getting played out now. The weaker hedge funds, those without long track records and good relationships with their investors are racking their brain on how to outperform coming into year end. Clients may say they want steady returns, especially in bad times, but we all know that many of them are as likely to chase returns as stick with that philosophy.

These weak funds need returns, not sharpe ratio. They need to keep assets under management. They need to justify their existence. It is reasonably safe to assume that many of the laggards have been short the market, since so much has gone up. They can add to that position, or they can decide not to fight the Fed and ECB and go long chasing returns that way. I think every day now that we continue in this low volume, low volatility environment, these funds will become more and more tempted to chase returns from the long end and will scrounge the world for the highest beta assets that they can buy and push up in this low liquidity environment.

Clearly the good funds remain in the driver seat, but they have the luxury of being patient and figuring out what they want to do. It is those most desperate for returns into year-end that are likely to swing for the fences, and I think it is becoming more likely that means another big push higher in risk assets.

I wouldn’t do it if I was them. I remain between 0% and 50% now and continue to be tempted to set shorts (I’m now eyeing the S&P Sept 1,370 puts since they are cheaper than when I started watching the 1,350′s). For now I remain long and biased towards Spain, Italy, banks, and continue to think CDS can have a capitulation tighter (low trading volumes will turn the big banks into net income hogs again, reducing their desire to hedge).

Tags: Aapl, Client Money, Currency Debt, Emerging Markets, Equity Investments, Fixed Income, Hedge Fund, Hedge Funds, High Yield Bond, High Yield Bond Index, Home Stretch, Investing In Equities, Landings, Leveraged Loans, Libor, Money Managers, Municipal Bond, Nasdaq, Stox, Whale Trade
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On Fx (Krasting)

Monday, July 23rd, 2012

I’ve been running a short EURUSD for the past six weeks. I got in at 1.2650 on June 30, and doubled up on July 8 at 1.2260. I was delighted to see the Euro get cheap in Friday’s trading, but the market action forced a decision. I wrote some things down on a pad, thought about it a bit, and said, “Screw it”, and cut the whole position. Some of my thinking:

I hate trading FX at the end of July . The markets shut down with the approaching European August vacations. The last week of the month is about cleaning up positions, not putting new ones on. August is never a time to be involved, unless you have to.

There was something odd about the EURUSD trading Monday through Thursday. Tyler Durden, at Zero Hedge, made note of this.

The red arrows that Tyler drew bother me. This stinks of “official guidance”. It’s tough to make a buck at the FX casino, it’s tougher still when the tables are rigged.

In May and June the Swiss National Bank (SNB) bought CHF 110Bn worth of Euro’s. That’s a staggering amount. I’m convinced that the intervention was heavy in July as well. Reserves are headed up another CHF50Bn. I think these numbers still understate what is happening, as the SNB has been writing calls on the Franc.

In the course of just three months ¼ Trillion Euros have crossed into the Alps. This is unsustainable. At some point it will have to result in a messy blow up. But not necessarily in the month of August.

I don’t think the SNB is going to fold its cards just because they are under attack. If the SNB were to quit intervening, the EURCHF would be nearing par in a matter of days. The cost to the SNB would be CHF40Bn (15% of GDP).

Before taking a loss of this magnitude, the SNB, (with the blessings of the government), would implement a variety of exchange controls. I think this is a something that could come sooner than the market believes.

It is my understanding that there is significant macro hedge fund positioning in the EURCHF. I don’t believe that the SNB is going to simply write a monster check to some fat cats up in Greenwich. There will be (at least) one more chapter in this story.

Should there be something that makes people blink on the CHF, it could end up causing short positions in the EURUSD to get jumpy. I’d rather not be part of a jumpy crowd.

I’m worried about what Bernanke may do on August 1st. We could see something that brings the US negative short-term interest rates. (My thoughts on this). It’s very difficult for me to be a dollar bull. I’m much more comfortable playing the dollar from the short side.

The Euro weakness on Friday was related to a big selloff in Spanish bonds. The Spanish ten-year ended up at 7.27%. This means that a Spanish bailout is not far off and Italy is next in the crosshairs.

Really? I don’t think so. It’s not going to be that easy.

The Euro technocrats are not going to fold in August. They may be going down, but I fear more battles are in the offing first. SMP purchases of sovereign debt is likely next week.

Realized gains have been elusive for me this year.

Now that I don’t have a position to worry about, I’m worried about not having a position. I will be looking for an opportunity to re-load a short Euro exposure. Hopefully it will be at higher levels than Friday. Either way, I will act before September rolls in. The Euro is still toast.

Tags: Alps, Bank Snb, Blessings, Eurchf, Eurusd, Franc, GDP, Guidance, Hedge Fund, Magnitude, Monday Through Thursday, Month Of August, Red Arrows, S Trading, Six Weeks, Swiss National Bank, Three Months, Trillion, Tyler Durden, Vacations
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Ray Dalio’s Bridgewater On The “Self Re-Inforcing Global Decline”

Thursday, July 19th, 2012

The world’s largest hedge fund is not as sanguine about the hope that remains in the markets today. The firm’s founder, Ray Dalio, who has written extensively on the good, bad, and ugly of deleveragings, sounds a rather concerned note in his latest quarterly letter to investors as the “developed world remains mired in the deleveraging phase of the long-term debt cycle” and has spread to the emerging world “through diminished capital flows which have weakened their growth rates and undermined asset prices”. Between China, Europe, and the US, which he discusses in detail, he sees the lack of global private sector credit creation leaving the world’s economies highly reliant on government support through monetary and fiscal stimulation. The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country’s decline tends to reinforce another’s, making a self-reinforcing global decline more likely and a reversal more difficult to produce. After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. Lastly he believes the common-wisdom – that the Germans and the ECB will save the day – is misplaced.

Bridgewater Q2 Letter: Outlook and Markets Discussion

by Ray Dalio, Bridgewater Associates

The developed world remains mired in the deleveraging phase of the long-term debt cycle. The European deleveraging has been badly managed and is escalating, bringing Europe closer to either a debt implosion or a monetization and currency collapse. The impact of the European deleveraging has spread to the emerging world through diminished capital flows which have weakened their growth rates and undermined their asset prices. In the US, the deleveraging is progressing in a more orderly fashion but continues to weigh on the economy’s ability to grow without the monetary support of the Fed. Our studies of deleveragings have proven to be invaluable through this period (let us know if you would like a copy of the expanding library). Because the dynamics of deleveragings are understandable and observable throughout history, one can reasonably assess the nature of their outcomes over time. But because highly-indebted systems that are in deleveragings are also inherently unstable, the timing of discrete events is always highly uncertain (e.g., the shift from austerity to monetization, an exit from the euro, etc.). Through these studies we have continued to refine the indicators we use to measure how the forces of deleveraging are impacting various economies and markets, and we continue to make the relevant adjustments to our investment process that both allow us to anticipate these shifts and to control our risks through the unpredictable twists and turns.

At this point in time Europe is in the most critical stage of the deleveraging process, without a credible plan that will allow a transition from an “ugly” deleveraging, where incomes fall faster than debts decline, to a “beautiful” one, where income grows faster than debts. A transition from an “ugly” to a “beautiful” deleveraging requires an acceptable mix of default, redistribution and monetization. Steps have been taken in this direction, but they remain well short of what is necessary. The range of potential outcomes for Europe and the impacts on the global financial system are wide, so navigating this environment will require flexibility and an understanding of how new policy decisions will affect the path of the deleveraging.

The unresolved European imbalances and the differences in their impacts on each country have produced widening differences in the self-interests of these countries, which have led to political divergences that have magnified the risks. Unlike a year ago, Germany and France no longer stand in solidarity as backstops behind the euro system, but have been divided in their self-interest by divergent financial conditions which are leading to conflicting rather than unified political orientations. France’s deteriorating finances and economy have shifted its self-interest toward alliances with “recipient” (lower credit rated) countries like Italy and Spain and away from “contributor” (higher credit rated) countries like Germany and the Netherlands, leaving Germany more isolated as a guarantor of the risks in the euro system and in its views about how to manage the imbalances. Given these shifts in the alliances between contributor and recipient countries we think that the popular assumption that the Germans and the ECB (which requires agreement of the key factions within it) will come through with money to make all of these debts good should not be taken for granted. Said differently, we think that there are good reasons to doubt that European bank and sovereign deleveragings will be prevented from progressing to the next stage in a disorderly way, without a viable Plan B in place. This fat tail event must be considered a significant possibility.

Given the lack of global private sector credit creation, the world’s economies remain highly reliant on government support through monetary and fiscal stimulation. Now that the most recent round of global monetary stimulation has ended, world economic growth has slowed and central bankers are in the process of stimulating again. We estimate that in the past few months, global growth has slowed from about 3.3% to 1.9% and that 80% of the world’s economies have slowed, including all of the largest. The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country’s decline tends to reinforce another’s, making a self-reinforcing global decline more likely and a reversal more difficult to produce. And at this point, while actions have been taken, none of the world’s largest economies are stimulating aggressively via either monetary or fiscal policy, further reducing the odds of a reversal.

About half of the global slowdown has been due to slower growth in China. In recent years, China has been the locomotive of world growth and its recent sharp slowdown has had knock-on impacts on numerous countries and markets. China itself now makes up 12% of world GDP and its interactions with the rest of the world add to its impact. China is a large export destination for many countries and is the largest marginal consumer of raw materials in the world, so its slowdown has disproportionately hurt the economies which export to China, and its weaker commodity consumption has hurt the commodity producers. In response to this slowdown, China has begun to ease monetary policy and is contemplating more aggressive fiscal stimulation, but the actions have so far been gradual and have not yet been sufficient to produce a notable economic response.

US conditions have slipped with the rest of the world and the Fed has decided to extend its Twist operation; to end it would have been an inappropriate tightening. Last year’s hump in growth has passed as numerous temporary forces have faded, and private sector credit growth remains weak, so growth is converging on the growth of income of around 1.5%. Besides the drag from Europe and the potential for a contagious debt blowup there, numerous US federal programs will expire in the fourth quarter, and given the likely political divisions after the election it will be a challenge for the new Congress to deal with these in a timely manner. Without action, the expiration of these programs represents a fiscal drag on growth of about 2.5%. Given the lack of new aggressive Fed stimulation, the threat from Europe, the simultaneous decline in major country growth rates and the fiscal cliff, the risks to US growth are skewed to the downside.

Over the past 18 months what markets are discounting has changed radically, with a clear bias toward discounting much weaker growth for a longer period of time. This shift is reflected in the rise in credit spreads, fall in bond yields, much lower discounted future earnings growth, flattening of the yield curve, currency moves and shifts in commodity prices. But such price changes simply reflect a transition from the discounting of one set of future economic conditions to the discounting of another set of future economic conditions. After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. This pricing is the midpoint of discounted expectations and each market has an equal probability of outperforming or underperforming. By balancing the portfolio’s exposure to discounted growth and inflation, a disappointment in one asset class will be offset by gains in another, without the necessity of predicting which it will be.

Tags: Asset Prices, Bridgewater Associates, Capital Flows, Commodity Prices, Connectedness, Credit Creation, Currency Collapse, Debt Cycle, Earnings Growth, ECB, Global Decline, Government Support, Hedge Fund, Imminent Return, Implosion, Monetization, Quarterly Letter, Ray Dalio, Return To Normalcy, Term Debt
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Don’t Overthink How Cheap Procter and Gamble is

Monday, July 2nd, 2012

Tags: Abbreviated Version, Anthony Abbate, Business Risk, Capital Hedge, Fiscal Years, Fund Location, Hanover Nh, Hedge Fund, Inelastic Demand, Intrinsic Value, Intrinsic Values, Nyse, Procter Amp Gamble, Procter And Gamble, Procter Gamble, Quality Companies, S Sales, Stock Price, Target Price, Valuation Analysis
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A Risk-Meh Morning (Tchir)

Thursday, June 14th, 2012

by Peter Tchir, TF Mar­ket Advisors

Credit Mar­kets Mixed: Spi­taly vs Cor­po­rates

The first thing most peo­ple are notic­ing today is the weak­ness in Span­ish and Ital­ian bond yields. Span­ish and Ital­ian CDS are both wider as well. There is a lot of talk about what it means to hit 7% on 10 year bond yields. For Por­tu­gal, Ire­land, and Greece that was more or less a trig­ger of worse to come. Ire­land actu­ally crossed 7% again in May hav­ing been below that since Jan­u­ary. Since it spiked above 7% on the 15^th it has been sta­ble. Italy, last year’s poster child, went above 7% are returned below mul­ti­ple times. Yes, 7% does make a nice head­line, and it is the pre-fee return a hedge fund has to make before the investor starts earn­ing more than the fund, but it is far from clear that it is the point of no return for bond­hold­ers, espe­cially after the EU and ECB appar­ently learned their les­son last year.

It is def­i­nitely a big con­cern, and yet MAIN and XOVER are both basi­cally unchanged this morn­ing, and IG18 and HY18 are both tighter. I’m not sure what the expla­na­tion is. IG and HY prob­a­bly got over­sold into the close, but it is far from obvi­ous why MAIN and XOVER would be so calm in the face of ris­ing yields in Spain and Italy.

Other “Risk-On” Assets Mixed As Well

Euro­pean stocks are down on aver­age, but Span­ish stocks are up. It is just a strange sig­nal to see weak­ness in sov­er­eign debt yet for the stocks to do well.

Greek bank stocks have been up solidly, though why any­thing would be left for exist­ing share­hold­ers no mat­ter who wins the elec­tion is beyond me.

JPM was up solidly yes­ter­day, and XLF was almost unchanged, yet the broader mar­ket sold off hard into the close, which again seemed to break with the idea of finan­cials being a leader.

Oil is down, but gold is up, though I have been los­ing track now of whether gold is a risk-on or risk-off asset.

Even the Euro is some­how bet­ter today, which is in line with U.S. stock futures but not mov­ing as you would expect given the mess in Spain and Italy.

Weak Data vs Pol­icy Inter­ven­tion

Noth­ing has changed in this respect. The global eco­nomic data con­tin­ues to come in weak and is not sup­port­ive at these lev­els. Small pol­icy steps have been taken and the threat of more pol­icy action is sup­port­ive of the mar­ket here.

Is “whale trade” done trend­ing?

Mr. Dimon’s tes­ti­mony seemed to go about as well as one could hope. They tone wasn’t as acri­mo­nious as peo­ple feared and with only a cou­ple weeks left in the quar­ter the esti­mate of a “solidly prof­itable” quar­ter is prob­a­bly pretty accu­rate. By the end of the tes­ti­mony, many pun­dits were ask­ing what the point was? Exactly, there was no real point. This is a pri­vate com­pany that had a trade that mor­phed into some­thing big and wrong, but it still prof­itable and never put any “tax­payer” money at risk.

If the scape­goat­ing is over, and the trade is under con­trol (and I believe it is), then this should be a chance for JPM to start a recover back to at least the lev­els of when the made the announce­ment. In a nor­mal world, I would expect it to drag other risk assets with it.

Bailouts, Sub­or­di­na­tion, and SMP

There remains a lot of con­fu­sion about what is going on in Europe. Asides from the con­fu­sion over how “sub­or­di­nated” Span­ish bond investors will or won’t be, there is even greater con­fu­sion about how the bailout is funded. Yes­ter­day we explained how Italy isn’t bor­row­ing at 6% to lend at 3%. We also once again look at the errors in how peo­ple are look­ing at subordination.

There are a lot of very influ­en­tial peo­ple out there neg­a­tive on the bailout. I can under­stand that, but many are bas­ing it on incor­rect infor­ma­tion (how EFSF and ESM work) or overly pes­simistic views – that Spain is the bor­rower and gets no value while sub­or­di­nat­ing every­one else. Just like in the past, peo­ple have decided to be opti­mistic and not dig into details, now peo­ple have decided to be pes­simistic and not dig into details. That didn’t work out well when peo­ple thought the orig­i­nal EFSF deal was good, it may not work out well now think­ing that the use of FROB is trivial.

On the other hand, I have heard peo­ple ask­ing about SMP today with yield hit­ting new highs. SMP will not be used by the ECB. If peo­ple are wor­ried about sub­or­di­na­tion, the worst tool is for the ECB to use SMP. The ECB spends money that doesn’t even go to the sov­er­eign, and sub­or­di­nates all hold­ers. SMP is real sub­or­di­na­tion as the bor­rower receives noth­ing, and the exist­ing hold­ers are in worse shape.

If any­thing, look for EFSF to assume the role of sec­ondary mar­ket pur­chases. That would have the ben­e­fit of tak­ing prices higher with­out the de facto sub­or­di­na­tion of remain­ing bondholders.

It is more likely that they let yields hang out up here for a bit. It really doesn’t cost the coun­tries any­thing and may be a good strat­egy to get remain­ing longs out and cre­ate a solid short base ahead of some new EFSF pro­gram or new LTRO. If the LTRO was designed to cre­ate a “carry” trade, now is much bet­ter time than in February.

We may even seen some inter­ven­tion in the pri­mary mar­kets, but I sus­pect they would wait until ESM is launched because ESM has a much eas­ier time get­ting lever­age, espe­cially if it is finally given the bank­ing license so many want it to get.

Copy­right © TF Mar­ket Advisors

Tags: Appar, Bank stocks, Being A Leader, Bly, Bond Yields, Cern, Cials, ECB, Finan, Greek Bank, Hav, Hedge Fund, Morn, Pean, Ple, Point Of No Return, Poster Child, Taly, Trig, Xlf
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And Now, Courtesy of Bridgewater … It’s Italy’s Turn

Tuesday, June 5th, 2012

Earlier today, by way of a simple graphic, the world’s biggest hedge fund, Bridgewater, was kind enough to remind the world just how pointless any debates about Europe’s future viability are if the primary funding conduit: the EFSF/ESM hybrid can not provide the cash needed for even half the combined funding needs of Italy and Spain. Now, Bridgewater strikes at Europe once again, this time redirecting the general attention to where it is long overdue: Italy.

Because while Spain has for months now, ever since the publication of the ‘Ultimate Doomsday Presentation‘ right here in Zero Hedge on April 7, been punished with ever widening bond and CDS spreads, and a local stock market which recently hit a 12 year low, Italy has largely avoided the vigilantes and general bearish scrutiny so far. The main reason for this is the assumption that Italian Banks had loaded up on enough LTRO cash that they had sufficient dry powder to buy up Italian bonds in the primary and, more importantly, the secondary market for at least a few more months. We bold “the assumption” because as Bridgewater calculates, the ‘dry powder’ number is far, far less than conventional wisdom had been expecting. In fact, at negative €48 billion in residual LTRO capital, Italy flat out has no additional cash with which to plug ongoing debt funding needs.

And with that, it is time to wave goodbye to the always wrong conventional wisdom, and to wave in the arrival of the vigilantes, who had been so missed in Milan since the fall of 2011 when they nearly toppled Europe’s fulcrum economy, and only the sacrifice of Silvio Berlusconi prevented an all out catastrophe on November 8, 2011. This time, the token replacement of an unelected token technocrat (and Goldman crony) will no longer appease anyone.

Source: JP Morgan’s Michael Cembalest

Tags: Assumption, Bridgewater, Catastrophe, Conventional Wisdom, Crony, Debates, Doomsday, Efsf, Fulcrum, Gold, Goldman, Hedge Fund, Italian Banks, Jp Morgan, Sacrifice, Scrutiny, Silvio Berlusconi, Stock Market, Strikes, Technocrat, Viability
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So How Are JPM’s Prop “Counterparties” Faring?

Friday, May 18th, 2012

We already know that JPM has lost billions on its prop trade, and as suggested earlier (and as the FT picked up subsequently), JPM’s prop desk (not to mention its actual standalone hedge fund, $29 billion Highbridge, which nobody has oddly enough discussed in the mainstream press yet) is so large that unwinding the full trade, as well as all other positions held by the CIO, would be unwieldy, allowing us to mock “the fun of negative convexity - especially when you ARE the market and there is no-one to unwind the actual tranches to.” The FT then phrased it as follows: “I can’t see how they could unwind these positions because no one can replace them in terms of size. It’s a bit of the same problem they face with the derivatives trade,” said a credit trader at a rival bank. “They pretty much are the market.” Which actually is funny, because if the media were to actually read a paper or two on how the market works, and puts two and two together, it just may figure out that the biggest beneficial counterparty for JPM is none other than the Fed, using the conduits of the Tri-Party repo system. But that is for Long-Term Capital Morgan^TM and its new CIO head Matt “LTCM” Zames to worry about. In the meantime, a question nobody has asked is how have the purported JPM counterparties, the most public of which are BlueMountain and BlueCrest who leaked the trade to the press in the first place, and are allegedly on the other side of the IG9 blow up doing. Well, according to the latest HSBC hedge fund update looking at the week ended May 11, not that hot.

Now one thing we know is that when it comes to reporting one’s results to an aggregator: when you have a profit you never under-represent it. And in this special case, since the funds are likely eager to recruit more like-minded hedge funds to their side of the trade, the best way to do it is by showing profits.

Which, for the early part of May, when the bulk of the JPM losses took place, are oddly missing for the two biggest players across from JPM…

So: where are the profits really going?

And is there much more here than the “access journalism” press has been let on to know?

Tags: Aggregator, Billions, Blow Up, Bluecrest, Bluemountain, Conduits, Counterparty, Derivatives, Desk, Hedge Fund, Hedge Funds, Hsbc, Jpm, Long Term Capital, Losses, Ltcm, Mainstream Press, Negative Convexity, Profits, Tranches
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The Value of Sentiment Polls (Smead)

Wednesday, April 4th, 2012

by William Smead, Smead Capital Management

We (at Smead Capital Management (SCM)) have made the case that the poor performance of the US stock market from the end of 1999 to the end of 2008 has caused most institutional and individual investors to dramatically shorten the duration of their equity investments. In many cases, we are hearing that institutions and individuals want their advisors to help them insulate or “prevent” them from having another 2008. In a world of short duration common stock investing, sentiment polls have an increased importance. We like to say that an eye on the crowd is important if you have one foot out the door at all times. Professional investors have been forced by the power of the rebound in the stock market since March 9, 2009 to get invested, but they haven’t trusted the durability of this rebound along the way.

Individuals and financial advisors practice short duration through go-anywhere managers, exchange-traded funds and low-cost trading of individual common stocks. Institutional investors have done this by allocating a large part of their asset base to equity managers who attempt market timing and alternative investments in the hedge fund world. Studies show that the money in “alternative strategies” now dwarfs what is held in US long-only equity. See the chart below:

In a wonderful April 1, 2012 article in the New York Times, Julie Creswell presents the facts about pension fund performance in relation to how committed plans are to alternative investments:

“Searching for higher returns to bridge looming shortfalls, public workers’ pension fund across the country are increasingly turning to riskier investments in private equity, real estate and hedge funds.

But while their fees have soared, their returns have not. In fact, a number of retirement systems that have stuck with more traditional investments in stocks and bonds have performed better in recent years, for a fraction of the fees.”

What Julie describes as “riskier” investments have also contributed to these very low levels of participation in long-only US stocks and especially long-only US large capitalization strategies.

When you breakdown the long-only participation, it is spread between US large cap, US mid cap and US small cap. Since small and mid-cap strategies have outperformed since the peak of the US stock bubble in 1999, it is safe to assume that institutions are the most committed to small-cap and mid-cap long-only strategies relative to the total equity long-only mix as at any time since the 1990’s. You can see this in Request for Proposal (RFP) mandate notices for small cap managers in periodicals like Emerging Manager Monthly. Institutional investors seem to like to close the barn door after the animals have run out. After ten years of outperformance by small-mid strategies, they are vigorously looking to increase their participation. Since small and mid-cap strategies are historically more volatile than large-cap strategies, this triggers an additional urge to time the market and has increased the importance of sentiment polls.

The Investor’s Intelligence (II) poll of investment newsletter writers is the oldest of the major sentiment polls and is the one I have followed during my nearly 32 years in the investment business. Our general view at SCM, as long-term investors by nature, is to not be interested in changing what we own based on 6-12 month stock market gyrations. For this reason, our view is that the sentiment polls are only useful at extremes. Therefore, everything that happens in between the extremes is just noise.

This week’s II poll showed that those writers who are bullish total 50.5% and those that are bearish equal 22.6% of the newsletter writers. Our observation is that it is very meaningful historically when the bullish sentiment reaches 60% or greater. In August of 1987, at the end of a run up in the Dow Jones Industrial Average from below 800 in August of1982 to over 2700, bullish sentiment broke 60%. By October 19th of the same year, the Dow fell to 1738. In February of 1999 and in February of 2001 at around 1240 on the S&P 500 index, bullish sentiment exceeded 60%. The S&P 500 index fell to 761 in October of 2002, a decline of 38.6%.

If history is any guide, it would take a large additional spurt to the upside in today’s US stock market to trigger a 60% bullish reading. We feel this could only come through a dramatic increase in long-only institutional large-cap US stock market participation and/or an end to the massive move into bonds made by US individual investors over the last four years. The bond market devotion would have to be replaced by a very meaningful move into US equities.

In 1987, institutions got heavily committed because of the comfort that derivative -related “portfolio insurance” provided many of them. The insurance was designed to protect against “normal” bear markets, not a drop in the Dow Jones average from 2700 to 1700 in 78 days! Both of these instances (August 1987 and February 1999), where the 60% bullish sentiment marker hit an extreme, saw price-to earnings (PE) ratios at historic highpoints. Warren Buffett, in his Allen and Co. talk at Sun Valley in the summer of 1999 mentioned that the Fortune 500 traded at 30 PE.

In our opinion, those who are very bearish about the US stock market need a substantial price increase to trigger historically extreme newsletter writer sentiment. Those who are optimistic should prefer a temporary correction or sideways movement to reinforce fear on the part of the crowd. This would cause the bullish and bearish readings to gravitate to toward each other and remove the risk of having some temporary “hell to pay” for those of us who seek to practice long-duration common stock investing.

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. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

Tags: Alternative Investments, Asset Base, Capital Management, Common Stock, Common Stocks, Creswell, Equity Investments, Equity Managers, Hedge Fund, Hedge Funds, Individual Investors, Institutional Investors, New York Times, Pension Fund Performance, Poor Performance, Professional Investors, Retirement Systems, Stocks And Bonds, Traditional Investments, Us Stock Market
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David Rosenberg: The Record Quarter

Tuesday, April 3rd, 2012

from David Rosenberg, Gluskin Sheff

What a quarter! The Dow up 8% and enjoying a record quarter in terms of points — 994 of them to be exact and in percent terms, now just 7% off attaining a new all-time high. The S&P 500 surged 12% (and 3.1% for March; 28% from the October 2011 lows), which was the best performance since 1998. It seems so strange to draw comparisons to 1998, which was the infancy of the Internet revolution; a period of fiscal stability, 5% risk-free rates, sustained 4% real growth in the economy, strong housing markets, political stability, sub-5% unemployment, a stable and predictable central bank.

And look at the composition of the rally. Apple soared 48% and accounted for nearly 20% of the appreciation in the S&P 500 (it now makes up 3% of the 200 largest hedge fund portfolios — three times as much as any other name; 4% of the S&P 500 market cap; and 11% of the Nasdaq). Not since Microsoft in 1999 was one stock this dominant, though the valuations are not comparable (MSFT then was trading with a 70x P/E multiple).

But outside of Apple, what led the rally were the low-quality names that got so beat up last year, such as Bank of America bouncing 72% (it was the Dow’s worst performer in 2011; financials in aggregate rose 22%). Sears Holdings have skyrocketed 108% this year even though the company doesn’t expect to make money this year or next.

What does that tell you? What it says is that this bull run was really more about pricing out a possible financial disaster coming out of Europe than anything that could really be described as positive on the global macroeconomic front. Low- quality stocks in the S&P 500 outperformed high-quality stocks in Q1 by 500 basis points and high-beta stocks within the Russell 1000 outperformed low- beta by 900bps. On a global scale, what has been a poorer place to put capital to work than Japan? And yet the Nikkei posted a ripping 19% advance in Q1, the best start to any year since the pre-bubble-burst times of 1988. Emerging markets are up 13% year-to-date. Greece rallied 7% in Q1 — that also tells you something about this rally. It’s called a dead-cat bounce. Meanwhile, the stodgy sectors that worked so well last year are biding their time — utilities so far in 2012 are down 3%, telecom is flat, and staples are up a mere 5%.

Most investors can dig back to 2000 if they really try. It was not uncommon for typically risk-averse investors such as retirees to be insistent that at least half of their portfolios consisted of Microsoft, Intel, Cisco and Dell. Each of these stocks had gone parabolic and none of them paid dividends, which was a good thing because that left them with all those earnings to plow back into the business. If you needed to buy groceries, you could just sell a few shares for cash flow.

My how things have changed. Today, “dividend paying stocks” are all the focus of attention — not to mention fund flows. Indeed, what is still so fascinating is how the private client sector simply refuses to drink from the Fed liquidity spiked punch bowl, having been burnt by two central bank-induced bubbles separated less than a decade apart. Investors continue to use stock price appreciation as an opportunity to rebalance and diversify rather than chase performance — pulling $15.6 billion from U.S. equity mutual funds so far this year while taxable bond funds have seen net inflows amounting to $59 billion.

The lack of any real significant back-up in bond yields suggests that the asset allocators have been idle as well.

It would then seem as though this is a market being driven by traders. Then again, it has been a very tradable rally, just as the post-QE1 and post-QE2 jumps were. Ditto for the current post-LTRO rally. But liquidity is not an antidote for fundamentals. And a market that lacks breadth, participation and volume is not generally one you can rely on for sustained strength, notwithstanding the terrific first quarter that risky assets delivered. We lived through this exactly a year ago.

Meanwhile, we have real estate deflation rearing its ugly head in China, a spreading European recession (for all the talk of German resilience, retail sales volumes sank 1.1% in February and have contracted now in four of the past five months), acute debt problems in Portugal and Spain (there is already talk in Greece about the need for a third bailout), and the U.S. data have been coming out rather mixed (it should have enjoyed a much bigger bounce than it did in recent months from the extremely warm weather — it was the fourth warmest winter since 1896; 15% warmer than usual.

In Chicago, it was the warmest March ever and second balmiest March on record in New York City. For the latter, it was 9 degrees above normal and would have lined up in the top 10 for any April!). That the employment, housing and spending data weren’t even stronger than what they showed — likely little better than a 2% pace for Q1 real GDP — is the real story beneath the story. The fact that the 10-year note yield stopped at 2.4% and has since rallied 20 basis points instead of making the expected technical challenge of 2.65% suggests that the bond market crowd may be figuring out what this means for the Q2 landscape as the weather skew to the data subsides.

U.S. DATA ON SHAKY GROUND
Yes, yes, U.S. personal spending jumped an above-expected 0.8% in February, above the 0.6% increase that was generally expected and the largest monthly gain since August 2009 when the shoots were green. But if truth be told, this as we would say in market parlance, was a “low multiple” increase. The reason? Personal incomes were soft and that is what counts most — income fundamentals remain dismal. Not only did income come in soft at +0.2% (half what was expected) but not even enough to cover the cost of living, but January and February were both revised lower. Real disposable income also declined 0.1% — the third decrease in the past four months and on a per capita basis is down 0.4% YoY, a far cry from the +2% trend of a year ago. The economy is building momentum. Right.

Let’s just say that had the savings rate stayed the same in February, nominal consumer spending growth would have come in at a puny +0.2% and guess what? Real PCE would have been -0.1%. Thanks for coming out. As we said, a “low quality” spending performance, absent the income fundamentals, there is no sustainability.

Then we got yet another spotty regional manufacturing index in the form of the Chicago PMI (the national figure comes out today). It came in below expectations at 62.2 for March (consensus was 63.0) — a 1.8 point drop from the previous month, and the third decline in the past four months. New orders slid from 69.2 to 63.3 — the largest one month drop since last May and the lowest level since October (this is now the fifth manufacturing survey to show a drop in new orders). If not for the inventories, which jumped from 49.6 to 57.4 — the sharpest run-up since December 2010 and the highest levels since last September — the headline decline would have been much worse. And in a signpost of how corporate executives (or the Human Resource departments in any event) are responding to negative productivity growth, the employment index dropped from 64.2 to 56.3— largest drop since April 2008 and it has fallen in two of the past three months.

Then we got the University of Michigan consumer sentiment index which was revised higher for March to 76.2 from 74.3 in the preliminary reading — this the highest level since February 2011. What was interesting were the details beneath the surface, such as auto buying plans being revised down from 123 to 122 — first decline in three months; and buying conditions for large household items being revised lower from 127 to 125— a four-month low.

Finally, the best Canada could muster up was a 0.1% gain in real GDP for January. At least it was positive — but barely. It reveals an economy that right now is uneven and sputtering. It’s a good thing there was a solid handoff from the tail-end of Q4, as that is what is keeping Q1 GDP estimates close to a 2% annual rate. If there is a piece of information that Canadian dollar bulls can put in their back pocket it is that manufacturing output, even with the loonie at par, managed to post a solid 0.7% advance — factory output up now for five months running. Now that is impressive.

Copyright © Gluskin Sheff

Tags: Bank Of America, Basis Points, Bull Run, Canadian, Canadian Market, China, David Rosenberg, Financial Disaster, Fiscal Stability, Fund Portfolios, Global Scale, Gluskin Sheff, Hedge Fund, Internet Revolution, Low Quality, Lows, Msft, Nasdaq, Political Stability, Quality Names, Quality Stocks, Record Quarter, Sears Holdings
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Cliff Asness: Uncertainty is Not the Problem Holding Back the Economy

Monday, April 2nd, 2012

Nick Schulz, editor-in-chief of American.com, recently interviewed Cliff Asness, the managing and founding principal of the hedge fund AQR Capital Management. Last year, Asness wrote a provocative piece in the Wall Street Journal about what’s holding the economy back, arguing that “Uncertainty is Not the Problem.” He said: “Many commentators blame our continuing economic woes on ‘uncertainty.’ They allege that recent and anticipated dramatic policy changes make business planning difficult, and that this is retarding growth and employment. This view is not wrong—but our main problem is not the uncertainty surrounding new policies. It is the policies.” Schulz asked Asness to expand on this idea as shown below.

Source: The American, March 27, 2012.

Tags: Capital Management, Cliff Asness, Commentators, Economic Woes, Economy, Employment, Hedge Fund, Nick Schulz, Principal, Provocative Piece, Uncertainty, Wall Street, Wall Street Journal
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