U.S. Equity Market Radar (January 23, 2012)

Sunday, January 22nd, 2012

U.S. Equity Market Radar (January 23, 2012)

The domestic stock market as measured by the S&P 500 Index was higher this week by 2.04 percent. We have seen a global rally in January with much of this performance coming this week. When trying to decipher the underlying cause it is often helpful to look at significant government policy actions.

On December 21, 2011 the European Central Bank (ECB) implemented the first tranche of the three-year long-term refinancing operation (LTRO) of approximately $635 billion, as the ECB attempted to secure long-term funding for banks that would allow them time to work through their current difficulties without the fear of a run on the bank. Another round of funding is scheduled for February. The chart below compares the timing of the current LTRO to the Federal Reserve’s quantitative easing and TARP program in 2008. The LTRO program is a form of quantitative easing and judging by the effect on the global equity markets, it appears to be working. The chart below looks at the global equity risk premium as a proxy for equity risk aversion and as can be easily seen in the chart , the end of 2011 was a very fearful time for equity investors. If 2008 and 2009 set precedent, then 2012 is shaping up to be a good year.

Strengths

• The information technology sector was the best-performing sector this week as several bellwether technology companies reported earnings that were well received by the market.
• The semiconductor equipment group was particularly strong, increasing by more than 8 percent as strong earning results combined with increased orders or capital expenditure announcements from Intel and Taiwan Semiconductor.
• The investment bank and brokerage industry group was also strong with Goldman Sachs and Morgan Stanley both up around 10 percent for the week on the back of well received earnings reports.

Weaknesses

• The utilities sector underperformed and was the only sector to post negative performance for the week, as the market rotates away from defensive areas.
• The auto parts and equipment industry group underperformed as Johnson Controls lowered guidance on weak European production and currency effects.
• The educational services group also underperformed as talk surfaced on possible legislation that would reduce incentives for for-profit colleges to target and aggressively recruit veterans and service members.

Opportunities

• Early earning results have been encouraging so far and the market has responded, and we move into the heart of earnings season next week.

Threats

• An escalation in concerns over sovereign debt obligations in Europe would be negative for stocks.

Tags: Brokerage Industry, Capital Expenditure, Domestic Stock Market, Earnings Reports, Equity Investors, Equity Risk Premium, Global Equity Markets, Goldman Sachs, Good Year, Government Policy, Industry Group, Information Technology Sector, Investment Bank, Market Radar, Morgan Stanley, Policy Actions, Risk Aversion, Semiconductor Equipment Group, Set Precedent, Taiwan Semiconductor
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Chinese Purchases of Gold Leap Six Fold – Country Purchases as Much Gold in 1 Month as Almost Half of 2010

Tuesday, November 8th, 2011

Looks like with the relatively small dip in gold prices (considering the move the past 3-4 years), the Chinese swooped in to load up in September.  In September alone, they bought as much as they did during half of 2010, the FT reports.  With the U.S. working overtime since 2008 to trash its currency, and Europeans most likely eventually forced to, this looks like a logical move.  Also keep in mind how small of a horde of gold has relative to other countries. [Oct 13, 2009: Largest Gold Reserves by Country]

As important for investors, it is good to have such a large buyer providing a floor in the metal.

• Chinese gold imports from Hong Kong, a proxy for the country’s overall overseas buying, leapt to a record high in September, when monthly purchases matched almost half that for the whole of 2010.
• The buying spree follows a sharp drop in the price of the precious metal. After hitting a nominal all-time high of $1,920.30 a troy ounce in September, gold fell to a three-month low of $1,534 an ounce later in the month. Chinese investors snapped up the metal as prices fell.
• Analysts expect the September import surge to continue until the end of the year as Chinese gold buyers snap up gold in advance of Chinese New Year, China’s key gold-buying period.  “In September we saw some bargain hunters come back into the market on the price dip,” said Janet Kong, managing director of research for CICC, the Chinese investment bank.
• China is the world’s second largest gold consumer and demand has grown rapidly over the past year as Chinese investors buy gold to hedge against inflation and consumers buy more gold jewelry. Beijing does not publicly disclose its gold imports, but analysts consider the Hong Kong import figures a good directional proxy for the country’s total gold overseas buying.
• Data from the Hong Kong government showed that China imported a record 56.9 metric tons in September, a sixfold increase from 2010. Monthly gold imports for most of 2010 and this year run at about 10 metric tons, but buying jumped in July, August and September. In the three-month period, China imported from Hong Kong about 140 metric tons, more than the roughly 120 metric tons for the whole 2010.
• China has liberalized regulations for importing gold over the past year, widening the number of banks authorized to import gold. “China’s gold demand will continue to increase as per capita income increases,” said Shi Heqing, a Beijing analyst with Antaike. “There aren’t many investment channels available in China other than the stock market, property market and some commodities.”

Tags: Bargain Hunters, Chinese Investment, Chinese Investors, Chinese New Year, Commodities, Director Of Research, Ft Reports, Gold, Gold Buyers, Gold Imports, Gold Jewelry, Gold Prices, Gold Reserves, Hong Kong Government, Horde, Import Surge, Investment Bank, Logical Move, Metric Tons, Precious Metal, Troy Ounce, Working Overtime
Posted in Commodities, Gold, Markets | Comments Off

James Montier (GMO): Investment Perspective (June 2011)

Tuesday, June 28th, 2011

James Montier’s (GMO) latest, “A Value Investor’s Perspective on Tail Risk Protection: An Ode to the Joy of Cash,” provides an excellent perspective on risk management tenets most often overlooked by investors. Montier’s behavioural science background make him one of the most interesting cross market strategists in the investing world.

Long ago, Keynes argued that the “central principle of investment is to go contrary to general opinion, on the grounds that, if everyone is agreed about its merits, the investment is inevitably too dear and therefore unattractive.” This powerful statement of the need for contrarianism is frequently ignored, with disturbing alacrity, by many investors.

The latest example in the long line of such behavior may well be the general enthusiasm for so-called tail risk protection. The range of tail risk protection products seems to be exploding. Investment banks are offering “solutions” (investment bank speak for high-fee products) to investors and fund management companies are launching “black swan” funds. There can be little doubt that tail risk protection is certainly an investment topic du jour.

I can’t help but wonder if much of the desire for tail risk protection stems from greed rather than fear. By which I mean that it seems one of the common reasons for wanting tail risk protection is to allow investors to continue to “harvest risk premium” even when those risk premiums are too narrow. This flies in the face of sensible investing. A safer and less costly (in terms of price, although perhaps not in terms of career risk) approach is simply to step away from markets when risk premiums become narrow, and wait until they widen before returning.

The very popularity of the tail risk protection alone should spell caution to investors. Keynes’s edict with which we opened would suggest that the degree of popularity of tail risk protection helps to undermine its benefits. Effectively, you should seek to buy insurance when nobody wants it, rather than when everyone is excited about the idea. An alternative way of phrasing this is to say that insurance (and that is exactly what tail risk protection is) is as much of a value proposition as any other element of investing.

As always, a comparison between price and value is required. One of the nice aspects of insurance in an investment sense is that it is generally cheap when its value is highest (although this may no longer be the case given the rise of so many tail risk products). That is to say, because most market participants appear to price everything based on extrapolation, they ignore the influence of the cycle. Thus they demand little payment for insurance during the good times because they never see those times ending. Conversely, during the bad times, the average participants seem willing to overpay for insurance as they think the bad times will never cease.

You can continue reading this in the slidedeck below, or download it from the link underneath the slidedeck. You may fullscreen the document for reading by clicking the fullscreen icon.

JM_TailRisk_611

Visit GMO.com for more information; a free registration is required.

Download PDF

Tags: Alacrity, Behavioural Science, Black Swan, Central Principle, Cross Market, Edict, Fund Management Companies, Investment Bank, Investment Banks, Investment Perspective, Investment Topic, James Montier, Market Strategists, Offering Solutions, Risk Approach, Risk Premium, Risk Premiums, Risk Protection, Science Background, Value Investor
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David Einhorn Squashed by Ben Bernanke: Throws in Towel on Many Short Positions

Tuesday, May 3rd, 2011

by Trader Mark, Fund My Mutual Fund

Boy, this article on Marketwatch pretty much says it all – it’s very difficult to run any form of ‘free market’ portfolio when you are living in a market where the Fed head writes op-eds about his mission to inflate asset prices.  It looks like wonder”kid” David Einhorn of Greenlight Capital has thrown in the towel on many of his shorts.  He runs a concentrated portfolio so perhaps this is the majority of his shorts.  That marks 2 prominent “bears” to give up in the past week – David Rosenberg being the other.   (to be fair Einhorn is not a BEAR as much as someone who runs a long-short book)  The Bernanke Put is putting (pun intended) the Greenspan Put to shame.

• David Einhorn, head of hedge fund firm Greenlight Capital, closed more than a dozen short positions recently because rising stock markets have made it more difficult to hedge and bet against companies.
• Greenlight covered short positions in which he had “lower confidence”during the first quarter, including four negative bets against companies in the for-profit education industry, Einhorn wrote in an April 29 letter to investors. MarketWatch obtained a copy of the letter on Monday.
• “We are in a particularly difficult environment for shorting stocks,” Einhorn said in the letter, which didn’t identify the positions that were closed.  “Much like Charlie Sheen, who seems to believe that all publicity is good publicity, recent market behavior suggests that we are in the part of the cycle where ‘all news is good news,’ ” Einhorn wrote earlier in the letter.
• The head of Greenlight Capital became one of the most-watched hedge fund managers after he warned Lehman Brothers was under-capitalized in 2008, several months before the investment bank collapsed, triggering the global financial crisis.
• Stocks slumped in late 2008 and early 2009. But the market has surged since then, helped by trillions of dollars in monetary and fiscal stimulus. Those gains have made it difficult for hedge funds to short stocks — an important tool for protecting against potential losses. Greenlight Capital’s hedge funds lost at least 2.5% in the first quarter, one of the firm’s toughest opening quarters.
• “This quarter we were repeatedly confuzzled when we read company news announcements that we expected to cause falling stock prices, only to see them rise instead — and sometimes sharply at that,” Einhorn wrote in his April 29 letter.
• In addition to profitably exiting four short positions in the for-profit education sector, Einhorn said Greenlight closed two foreign bank shorts, a domestic bank short and a technology short. Two of the bank positions were closed at losses, as was the tech position, he noted.
• “We also covered several others where performance exceeded our expectations,” Einhorn wrote.  Still, the hedge fund manager stuck to two of his most-prominent negative bets — against credit-rating company Moody’s Corp and Florida land giant St. Joe .  Greenlight also kept short positions on two energy-technology companies, which the firm expects to “dramatically” miss earnings forecasts this year. These stocks weren’t identified in the letter. “We believe that this environment is cyclical, and that it will continue this way … until it doesn’t,” Einhorn wrote.
• In April, Einhorn was up 0.8%, leaving him down 2.6% in the first four months of 2011.  Also, Greenlight disclosed a position in shares of Yahoo Inc.(YHOO) as Einhorn highlighted bullish prospects for the Internet company’s exposure to China.

For Greenlight’s full investor letter, head over to Dealbreaker.

Copyright © Fund My Mutual Fund

Tags: Asset Prices, Ben Bernanke, Charlie Sheen, David Einhorn, David Rosenberg, Education Industry, Fed Head, Global Financial Crisis, Greenlight Capital, Hedge Fund Managers, Investment Bank, Lehman Brothers, Market Behavior, Market Portfolio, Marketwatch, Profit Education, Shorting Stocks, Stock Markets, Trillions, Wonder Kid
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Ontario Teachers’ Neil Petroff on Active Management

Tuesday, April 19th, 2011

by Leo Kolivakis, Pension Pulse

On Monday, after S&P issued an unprecedented warning to the United States government, I was lucky enough to find Neil Petroff, Executive Vice-President, Investments and CIO at Ontario Teachers’ Pension Plan (OTPP). Mr. Petroff only had a few minutes but was kind enough to discuss some issues which I will get to below.

First, Paula Vasan of aiCIO reports, Ontario Teachers’ Petroff: ‘Active Management Outperforms’:

The Ontario Teachers’ Pension Plan (Teachers’) chief investment officer Neil Petroff, riding a 14% annual return in 2010, claims the fund’s active strategy has added more than C$23 billion to the bottom line since its inception in 1990.

In a wide-ranging interview with Petroff, the CIO of Canada’s third-biggest retirement-fund manager claims: “If we were a passive fund, we’d be C$23.2 billion lower in value, with liabilities at the same level. That really speaks to the value of active management – you add value when you pay for active management.”

This seeming evidence of the effectiveness of active management also supports the fund’s mix of external vs. internal structures that come at a time of stellar growth for the fund. Regarding the value of internal vs. external management, Petroff replies that all departments of the fund outperformed last year due to their embrace of both processes of active management. “As long as the internal team earns appropriate risk-adjusted returns given the cost, I’m indifferent to which approach is utilized,” Petroff tells aiCIO.

Furthermore,Teachers’ benefitted from a range of transactions and investments in 2010, such as the fund’s purchase of UK’s national lottery operator, Camelot, a UK high-speed rail, and interest in a Brazilian investment bank. “All those investment from 2010 have great potential to help pay our pensions going forward.”

“This was the best year in the past 20 years in terms of dollar-value added,” Petroff states, noting that large increases in real estate and private capital fueled the superior returns. According to a statement released by the fund today, Teachers’ achieved its double-digit return in 2010 thanks to rising stock prices and gains in real estate. Net investment income totaled C$13.3 billion ($13.8 billion) last year, up from C$10.9 billion in 2009. The fund managed C$107.5 billion in assets as of December 31, compared with C$96.4 billion a year earlier.

Teachers’ revealed that real assets such as infrastructure and timberland returned 13.9% for the year, followed by stock and private-equity investments (10.4%), fixed-income (9.9%), and commodities (3.2%). At the end of 2010, Ontario Teachers’ equity portfolio holdings were C$47.5 billion, up from C$41.2 billion a year earlier. Fixed-income assets were C$45.9 billion, up from C$35.3 billion. Meanwhile, the fund’s allocation to commodities rose to 5% last year from 2% in 2009, and was valued at C$5.2 billion at year end, up from C$1.9 billion.

Still, Petroff knows such high returns can’t last forever. “This kind of return is something that’s tough to repeat,” he says. Despite the optimistic returns, the plan said it continues to face funding challenges due to factors such as member longevity, retirement periods that exceed working years, and low real interest rates, with an estimated funding shortfall that increased to C$17.2 billion from C$17.1 billion a year earlier.

Nevertheless, Petroff will try to repeat 2010′s strong results. In terms of asset allocation, Petroff asserts that emerging markets will continue to be an area of intense interest for the fund. “I’d say that from a global perspective, emerging markets will do better than North American markets, and North America will do better than Europe,” he claims, emphasizing his confidence in the long-term value of the sector. “We took most of our exposure in 2005 and 2006. Emerging markets are overheating now from an inflation perspective, but long-term, with their young populations and growing middle classes, the asset class is growing rapidly.”

When questioned about the embrace of alternatives, which have enjoyed heightened popularity among institutional investors, Petroff voices his belief that the sector serves not as an asset class but more as an investment strategy. “We started our research in alternatives in 1995, and entered our first hedge fund in 1996. It’s been an area that adds diversification to the total fund and it will always have a place in our portfolio.”

It’s interesting that Mr. Petroff mentioned the focus on emerging markets because I was reading an excellent white paper by AIMCo’s Brian Gibson, a former colleague of Mr. Petroff, on how investing in emerging markets “is not what it used to be”. Mr. Gibson concludes that “emerging markets are certainly not what they used to be, but they still represent a fertile area for generating attractive amounts of value added.”

As far as hedge funds, it’s no secret that Teachers’ is one of the best institutional investors in the world (along with others like ABP). Claude Lamoureux and Neil Petroff hired Ron Mock in 2001 and he has done an outstanding job allocating billions to external hedge funds. Ron is now Senior Vice-President, Fixed Income and Alternative Investments, and one of the best pension fund managers I ever had the pleasure of meeting.

Back to Neil Petroff. We didn’t have much time to chat but I did listen carefully to his comments. First, we talked about liabilities. He told me that every pension fund is different and has different liabilities. The duration of a plan’s liabilities should determine the asset allocation and the benchmarks they use for their investment portfolios.

Teachers’ has one client and manages both assets and liabilities. The profile of their liabilities has changed since now the ratio of working-to-retired members is 1.5 to 1 (was 4 to 1 when he first started working there). And those retired teachers are living much longer, placing additional pressure on the plan. Great news for teachers but you still have to pay out pensions longer. But the biggest problem with liabilities has been the decline in real rates (read my comment on Teachers’ 2010 results for details).

He explained to me how benchmarks are set in accordance with liabilities and are routinely reviewed by senior staff and the board. I mentioned the case about T-bills in money markets and how prior to 2008, some Canadian pension fund managers were investing in illiquid non-bank asset backed commercial paper (ABCP) to easily beat their benchmark. He told me that Teachers’ uses OIS rate instead and manages liquidity risk extremely well, especially after 2008.

I let him know that I’ve been tough on Teachers’ in regards to private market benchmarks. We talked a lot about benchmarks. He explained that Teachers’ Private Capital does use a spread over public markets. As for real estate, infrastructure and timberland, they’re long-term cash flow providers and the benchmark (CPI+575 bps) “isn’t easy to beat over the long-term”. True but I’ve seen some funny things in real estate where pension fund managers took big risks to easily beat their CPI+ benchmark. Mr. Petroff explained that Cadillac Fairview still has an operating benchmark of IPD and their operations focus on stable cash flows, just like infrastructure and timberland.

On this last point on benchmarks, one senior pension fund manager shared these thoughts with me:

Leo, I now you are very involved in comparing benchmarks. The more important difference is leverage implied by gross versus net assets.

OTPP made a lot of money on being able to run a leveraged balance sheet (150 B gross versus 100 net assets). They effectively borrowed 50 billion at an average cost of around 2% and made a decent 10% on that capital in 2010 and 2009, not so well in 2008.

If one is restricted from non-real estate borrowing, as some provincial rules require, that road for return/risk is closed. OTPP unlevered returns work out to about 10%, which is what I got to, with a lot of historical j-curve baggage.

One can argue whether it should be or how big it should be but those are the facts. Not sure where CDP (Caisse) fits on that scale, but my guess is that between recovering 2008 write-offs and leverage, you have a big part of the differential.

Finally, and most importantly, I liked what Neil Petroff told me about being “non-conventional and opportunistic”. I mentioned that I wrote about the time Teachers’ took a big position in Transocean Ltd. and publicly commended them for having the guts to take that position. “We did our homework and found that Transocean had virtually no liabilities”. That position alone earned Teachers’ nearly 80%.

Here is where the discussion got interesting. I told Mr. Petroff that I like asset managers who take concentrated positions. Teachers’ did their homework, saw an opportunity and bought Transocean shares as they tanked. Did they also consult their external hedge fund partners? Maybe, but the point is they took a big position in a company that most institutional investors were steering clear from at that time. “We won’t always be right but if we’re right 60% of the time, making more on average than we lose, then we come out ahead.”

Mr. Petroff added that unlike mutual funds “who churn their portfolio every 18 months” pension fund managers have a long horizon – ten years – and should be compensated that way. “The reason we can take concentrated positions is that we’re not looking at quarterly returns like most mutual funds that are closet indexers.” He also noted that a four or six years horizon is too short to evaluate a pension fund’s performance.

I then proceeded to discuss how I see ideological warfare going on against traditional defined-benefit plans. He mentioned that the Economist did a special report on pensions falling short, and agreed with me that defined-contribution plans aren’t the solution to the retirement crisis. “The value added we generated over the years would not have been available to teachers doing their own investing.”

As we ended our discussion, I thanked him and asked him why Teachers’ isn’t a lot more transparent on their operations. “We can’t share all our secrets because the minute we do, everyone is trying to mimic us.” I agree, they can’t share all their secrets, but pension funds can learn a lot from Teachers’ and for me the most important lesson is to invest opportunistically with a long-term view and not be afraid of taking concentrated positions after doing your homework. If you’re right most of the time, you come out ahead. That explains a big part of Teachers’ success and why more and more plans are trying to emulate their active management style.

Tags: Active Management, Brazil, Canadian, Canadian Market, Chief Investment Officer, Dollar Value, External Management, Great Potential, High Speed Rail, Incr, Infrastructure, Internal Structures, Investment Bank, Lottery Operator, National Lottery, Ontario Teachers Pension, Ontario Teachers Pension Plan, Passive Fund, Petroff, Retirement Fund, Risk Adjusted Returns, Stellar Growth, Teachers Pension Plan, Vasan
Posted in Brazil, Canadian Market, Commodities, Infrastructure, Markets | Comments Off

Have Hedge Funds Grown Too Large?

Tuesday, March 29th, 2011

Have Hedge Funds Grown Too Large?

The Vancouver Sun published an article from Laurence Fletcher of Reuters, Have hedge funds grown too large?:

The hedge fund industry’s strong rebound from the credit crisis has prompted investors to ask whether some funds have grown too large and inflexible to keep delivering bumper returns for which the sector is famous.The growth of big funds — helped by strong returns during the credit crisis and some clients’ belief that risks are lower than in start-ups — helped push industry assets to $1.92 trillion at end-December, close to the all-time high in 2008, according to Hedge Fund Research.

However, with the growth of big funds has come the old question of whether they could be stuck if another crisis hits, whether liquidity forces them into less profitable markets and whether their prized trade ideas will be discovered by rivals.

“By definition a supertanker can’t be as nimble as a speedboat,” said Ken Kinsey-Quick, fund of hedge fund manager at Thames River, part of F&C, who prefers to invest in funds below $1 billion in size.

“They won’t be able to respond to market conditions, especially as markets become illiquid. They can’t get access to smaller opportunities, for example a new hot IPO coming out of an investment bank — if everyone wants it then you’ll only get a few million dollars (worth).”

Funds betting on bonds and currencies, and CTAS — which play futures markets — in particular have grown strongly.

Brevan Howard’s Master fund, which is shut to new clients, has grown to $25 billion after gaining around 20 percent in 2008 and 2009, while Man Group’s computer-driven AHL fund is now $23.6 billion, helped by a 33 percent return in 2008.

Meanwhile, Bluecrest’s Bluetrend fund, which has temporarily shut to new investors in the past, has nearly tripled in size since the end of 2007 to $8.9 billion after a 43 percent gain in 2008. And Louis Bacon’s global macro firm Moore Capital has grown to $15 billion after a good credit crisis.

LIQUIDITY

While capacity varies between strategies, some clients worry about the time it can take a big fund to sell a security in a crisis. Even in today’s markets a small fund can sell a position with one phone call while it may take a big fund a morning.

“It’s even more difficult than before the crisis to turn around your portfolio. Liquidity in the market is not back to where it was. A fund of $20 billion in 2007 was easier to manage than it is now,” said Philippe Gougenheim, head of hedge funds at Unigestion.

“Because of poorer liquidity you’re paying a higher price to get in and out of positions. Given the current political and macroeconomic environment it’s important to be able to turn around your portfolio very quickly.”

Big funds may find it hard to keep trades secret long enough to implement them, especially when buying or shorting stocks.

One hedge fund executive told Reuters his firm’s flagship fund, once several billion dollars in size, used to break up trades between a number of brokers or initially sell a small amount of the stock — which could give the market the impression it planned to sell more — before buying heavily.

Meanwhile, Unigestion’s Gougenheim said fixing a meeting with managers of big funds can be hard — if a manager runs most of the money they can be hard to pin down, while if they run a small part it can be hard to find out who runs the rest.

“NOT AN ISSUE”

However, fund executives say markets are liquid enough.

“Size is not an issue whatsoever,” Nagi Kawkabani, founding partner at Brevan Howard, told Reuters, adding that the fund’s gross exposure — the sum of bets on rising and falling prices — was lower than at the start of 2008.

“Markets are much bigger and deeper than they were five or 10 years ago.” Brevan would return money to clients if funds became too big, although there are no plans at present, he said.

Thames River’s Kinsey-Quick said big CTAs could find it hard to trade smaller markets, although they may take small bets in these markets to show clients they can play them.

An AHL spokesman said size was “a major advantage… It gives us great purchasing power with brokers which translates into tighter spreads whilst paying pay lower commissions.”

Hedge funds are one of my favorite topics. One of the best jobs I ever had in the pension industry was working with Mario Therrien’s group at the Caisse de dépôt et placement, allocating to external hedge funds. I was the senior analyst responsible for analyzing and covering directional hedge funds: Long/Short equity, short sellers, global macro and commodity trading advisors (CTA) funds. It’s a fun job because I met a lot of managers from different backgrounds and talk markets with them. I also learned about their strategies and the differences between directional and market neutral alpha strategies.

Tags: Commodities, Credit Crisis, Ctas, Futures Markets, Global Macro, Hedge Fund Manager, Infrastructure, Investment Bank, Ipo, Kinsey, liquidity, Man Group, Profitable Markets, Rebound, Reuters, Speedboat, Start Ups, Supertanker, Thames River, Trillion, Ups, Vancouver Sun
Posted in Commodities, Credit Markets, Infrastructure, Markets | Comments Off

Do Past 10-Year Returns Forecast Future 10-Year Returns?

Sunday, October 3rd, 2010

This article is a guest contribution by Bill Hester, CFA, Hussman Funds

Can the process of forecasting long-term stock market returns be simplified to include just one step – calculating the prior decade’s return? This is one of the arguments that analysts are currently using to convince investors that the coming decade will offer above-average returns. It’s important to take a closer look at the argument because it’s become widely discussed and reported. A strategist at a major investment bank argued recently that poor 10-year trailing returns is reason enough to expect lofty returns over the next decade. A similar argument was recently made in Barron’s, and by various mutual fund companies.

Some of the research is structurally flawed. One piece examines the 50 worst 10-year returns since 1871 to construct a sample to calculate subsequent 10-year returns. The study used monthly data, so many of the observations clustered within a single year. 11 of those “worst” returns occurred during the past decade. Of the remaining 39 months for which the subsequent 10-year stretch of returns is known, 32 of them occurred around 1920, so the study is heavily influenced by a single period. The implicit argument is that the next decade will look much like the Roaring 1920′s.

But even using a broader set of periods with poor trailing returns, the average return during the decade that followed has typically been slightly above average. In fact, some of the individual periods have provided strong returns, especially when they marked the beginning of secular bull markets, like in 1942 and the early 1980′s. The graph below shows the 10-year rolling total return of stocks since 1929.

Looking at the graph, it is clear that 10-year returns for the market have varied a great deal, creating long “secular” periods of above-average and below-average returns. There are just few periods where 10-year trailing returns fell to very low levels – after the stock market crash of the early 1930′s, in the early 1940′s, and again during the late 1970′s and the early 1980′s (on an inflation-adjusted basis, the 10-year returns during these last two periods were also negative). A cyclical bull market followed the low returns of 1933, and secular bull markets followed the low returns of the early 1940′s and early 1980′s. When looking at the data below, we’ll include the 100 worst months of 10-year trailing total returns beginning in 1929. This group of months will capture the bulk of the periods just mentioned.

The Drivers of Returns

Once the observation is made that long periods of negative trailing returns have been followed by strong subsequent returns, it’s logical to ask whether there are other characteristics that those strong decades shared. To that end, it makes sense to begin with the fundamental underpinnings of stock prices: growth and valuations.

Tags: Barron, Bull Markets, Cfa, Closer Look, Graph, Hester, Hussman Funds, Implicit Argument, Investment Bank, Investors, Mutual Fund Companies, Next Decade, oil, Periods, Reason, Roaring 1920, Stock Market Returns, Stocks, Strategist, Term Stock, Year 11
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off

What’s Driving Russia?

Friday, September 10th, 2010

Russia’s publicly-traded gold companies may more than double their production in the next five years, and the country’s uranium output may increase even more over that same time period.

That’s the outlook offered by the Moscow-based investment bank Troika Dialog in a recent research note.

The way Troika sees it, Russia has four key growth drivers at work for investors – low penetration in the domestic sectors, mining growth, fiscal reforms and market consolidation that allows companies to get bigger and benefit from scale.

By sector, publicly-traded retail companies are seen as most poised for strong growth through 2015 – Troika predicts 25 percent annual growth for the five years. Rationale: organized retail only accounts for 40 percent of sales, compared to more than 90 percent for Europe as a whole.

The same low-penetration story is seen in broadband (6 percent nationwide), banking (few people have credit cards or bank loans), automotive (44 cars per 100 households, well less than half of Germany’s rate), pharmaceuticals (per-capita spending only 25 percent of Europe’s rate) and more.

Rising commodity prices, which in the past decade had been Russia’s biggest growth driver, are not seen as much of a factor in the next five years. Instead, mining sector growth is expected to be more a story of production growth.

Tim Steinle recently took a research trip to the Krasnodar region of Russia to discover more information about the growing retail sector. Watch what Tim had to say following his trip.

Tags: 44 Cars, Bank Loans, Commodity Prices, Domestic Sectors, Fiscal Reforms, Gold, Gold Companies, Growth Drivers, Investment Bank, Krasnodar Region, Market Consolidation, Next Five Years, Research Trip, Retail Companies, Retail Sector, Russia, Russia Russia, Same Time Period, Sector Growth, Steinle, Troika Dialog, Uranium Output
Posted in Gold, Markets, Outlook | Comments Off

Matt Taibbi: Wall Street’s Naked Swindle

Tuesday, November 3rd, 2009

In his latest feature, Matt Taibbi, who earlier this year authored of the brilliant “Giant Squid” article about Goldman Sachs, lights up another fire under Wall Street and regulators, about massive [conspiratorial] naked short selling activities designed to bring down Goldman Sachs. Taibbi’s investigative style is eye-opening, and this is a must-read.

Here are the opening paragraphs:

On Tuesday, March 11th, 2008, somebody – nobody knows who – made one of the craziest bets Wall Street has ever seen. The mystery figure spent $1.7 million on a series of options, gambling that shares in the venerable investment bank Bear Stearns would lose more than half their value in nine days or less. It was madness – “like buying 1.7 million lottery tickets,” according to one financial analyst.

But what’s even crazier is that the bet paid.

At the close of business that afternoon, Bear Stearns was trading at $62.97. At that point, whoever made the gamble owned the right to sell huge bundles of Bear stock, at $30 and $25, on or before March 20th. In order for the bet to pay, Bear would have to fall harder and faster than any Wall Street brokerage in history.

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The very next day, March 12th, Bear went into free fall. By the end of the week, the firm had lost virtually all of its cash and was clinging to promises of state aid; by the weekend, it was being knocked to its knees by the Fed and the Treasury, and forced at the barrel of a shotgun to sell itself to JPMorgan Chase (which had been given $29 billion in public money to marry its hunchbacked new bride) at the humiliating price of … $2 a share. Whoever bought those options on March 11th woke up on the morning of March 17th having made 159 times his money, or roughly $270 million. This trader was either the luckiest guy in the world, the smartest son of a bitch ever or…

Read the whole article here.

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Birth of the Credit Monster

Monday, May 4th, 2009

Gillian Tett, of FT.com has written an in-depth exposé about the birth of innovative securities that gave rise to the markets’ abuse of leverage finance and ultimately, the catastrophic rise of debt. Here is the first excerpt from Tett’s new book, Fool’s Gold provided by FT.com, Genesis of the Debt Disaster, May 1, 2009.

In the 1990s, a young team at Wall Street investment bank JP Morgan pioneered a new way of making money – credit derivatives. Within a decade, the market for these exotic securities had exploded to more than $12,000bn – and some people later blamed them for fuelling the global financial fiasco. In the first of two extracts from her book, Fool’s Gold, the FT’s Gillian Tett reveals how the innovation genie was first let out of the bottle – and eventually devoured the system, to the horror of its creators.

The first sign that there might be a structural problem with the innovative bundles of credit derivatives that bankers at JP Morgan had dreamed up emerged in the second half of 1998. In the preceding months, Blythe Masters and Bill Demchak – key members of JP Morgan’s credit derivatives team – had been pestering financial regulators. They believed that by using the new credit derivative products they had helped create, JP Morgan could better manage the risks in its portfolio of loans to companies, and thereby reduce the amount of capital it needed to put aside to cover possible defaults. The question was by how much. (Though these bundles of credit derivatives later went under other names, such as collateralised debt obligations [CDOs], at that time these pioneering structures were known as “Bistro” deals, short for Broad Index Secured Trust Offering). Masters and Demchak had done the first couple of Bistro deals on behalf of their own bank without knowing the answer to their question for sure. But when they were doing these deals for other banks, the question of reserve capital became more important – the others were mainly interested in cutting their reserve requirements.

The regulators weren’t sure. When officials at the Office of the Comptroller of the Currency and the Federal Reserve had first heard about credit derivatives and CDOs, they had warmed to the idea that banks were trying to manage their risk. But they were also uneasy because the new derivatives didn’t fit neatly under any existing regulations. And they were particularly uncertain over what to make of the unusually low level of capital available to cover losses on the derivatives.

When the team did their first Bistro deal, they pooled more than 300 of JP Morgan’s loans, worth a total of $9.7bn, and issued securities based on the income streams from these loans. The lure of the idea was clear: the team had calculated that they only needed to set aside $700m – a strikingly small sum – against the risk of defaults among the 300-plus loans. After much debate, the credit rating agencies had agreed with the team’s assessment of the risks, and the deal had gone ahead on the basis that if financial Armageddon wiped out the $700m funding cushion, JP Morgan would absorb the additional losses itself. To Masters and Demchak, the chance that losses would ever eat through $700m were minuscule…

Read the entire article here, or PDF version here.

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