3 Trends to Watch for Global Investors

Thursday, April 5th, 2012

Bloomberg announced over the weekend that China’s manufacturing grew at the fastest pace in a year. We follow the government’s Purchasing Managers’ Index (PMI) closely, as we believe it is a better indicator of China’s domestic demand than the HSBC PMI. Whereas HSBC PMI surveys 400 small and mid-sized companies, which are typically export-oriented, the government’s PMI surveys 820 mostly large, state-owned enterprises across 20 industries.
Though manufacturing activity exceeded analysts’ estimates, some China bears focused on the fact that the March 2012 number is lower than the average during the third month from 2005 through 2011. What’s important for investors to consider is that the trend is your friend: It is the fourth month in a row where the PMI landed above the three-month PMI, and shows the economy is on the right path.

Below are three additional constructive trends we see in China.

1. China Returns Poised to Revert to the Mean

Over the past few years, Chinese stocks have lagged compared to their emerging market peers. However, the Periodic Table of Emerging Markets perfectly illustrates how last year’s loser can be this year’s winner. Historically, every emerging country has experienced wide price fluctuations from year to year. Over time, though, each country tends to revert to the mean.

In the visual below, we highlighted China’s performance pattern over the past 10 years. Chinese stocks landed in the top half four out of 10 years—2002, 2003, 2006 and 2007. In 2003, China climbed an astounding 163 percent; in 2007, it was the top emerging market again, returning nearly 60 percent.
Since then, the country has fallen to the bottom half of the chart. If you apply the principle of mean reversion, history appears to favor China landing in the top half during this Year of the Dragon.

See the original Periodic Table of Emerging Markets here.

2. Liquidity Cycle Could Benefit Stocks

Yet China leaders won’t leave its success to pure luck. If the Dragon doesn’t breathe fire into markets, it may be a shot of liquidity injected by policy easing that could drive stock prices higher. Macroeconomic theory states that when a country’s money supply exceeds economic growth, the excess liquidity tends to drive up asset prices, including stocks.

BCA Research documented this trend in China over the past eight years. The research firm compared the difference between the change in money supply growth and nominal GDP growth and Chinese stock prices. In both instances when the change in excess liquidity fell to a low, so did stocks. Conversely, the rise of money supply growth compared to GDP growth “coincided with major rallies” for China’s stock market, according to BCA.

Today, it appears that the change in excess liquidity is just beginning to bounce off another low, as are stocks, indicating another potential inflection point.

3. Incentive to Maintain Growth

BCA hedges China’s possible stock advancement in the short-term if signs of economic improvement continue because they “reduce the odds of aggressive policy easing.” A few weeks ago, I discussed how investors seemed to overlook China’s focused macro policy strategy, with its actions deliberate and purposeful. This year, the government has extra incentive to sustain meaningful growth as it transitions to a new leadership by the end of the year. As President Hu Jintao and Premier Wen Jiabao depart, Xi Jinping and Li Keqiang are expected to take over.

Looking at historical GDP growth per year since 1978, Deutsche Bank finds there’s precedence for this idea. During the fifth year of the leadership transition cycle, “high or stable” GDP growth was maintained, with the exception being the Asian Financial Crisis in 1997.

These trends will be covered in my upcoming webcast on China with CLSA’s Andy Rothman. Join us as we discuss what investors should expect from China in terms of long-term GDP growth, fixed asset investment, exports and the housing market.

When I was in Singapore at the Asia Mining Congress last week, I was fortunate to be among a group of sharp and intelligent experts across the financial and mining industries. A China bull presenting an excellent case for the country was Jing Ulrich, JP Morgan’s managing director and chairman of China equities and commodities group. She’s the Oprah Winfrey of the investment world, as for the past three years, Forbes Magazine has ranked her among the 50 Most Powerful Women in Business.

Ulrich expressed similar views toward China and its political will in a recent “Hands-On China Report” following her attendance at the China Development Forum in Beijing. She said that the government ministers emphasized their commitment to rebalancing the economy toward consumption. While “fundamentals are currently sound, the nation must modify its ‘imbalanced, uncoordinated and unsustainable’ course of development,” says Ulrich. What investors should remember is that the government had the financial resources to effect this change and considered it important to maintain sustainable growth.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The Purchasing Manager’s Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The Hang Seng China Enterprises Index is a capitalization-weighted index comprised of state-owned Chinese companies (H-Shares) listed on the Hong Kong Stock Exchange and included in HSMLCI index (Hang Seng Mainland Composite Index).

Tags: China, Chinese Stocks, Commodities, Commodity, Dragon, Economy, Emerging Market, Emerging Markets, Estimates, Global Investors, Gold, History China, India, liquidity, Loser, Mining, Pace, Periodic Table, Pmi, Price Fluctuations, Principle, Purchasing Managers Index, State Owned Enterprises, Surveys, Year Of The Dragon
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Investors Rushing In … and Out … Together

Tuesday, January 3rd, 2012

One of the major themes since 2008 has been the immense increase in correlations among asset classes. While this was already a growing trend since mid decade with the proliferation of computerized trading techniques and the rise of the ETF (i.e. when an ETF is bought en masse, all underlying equities are bought regardless of individual merits…. and vice versa) – it has accelerated in the 2008-2011 period. Headline risk and macro movements have come to dominate causing neck breaking whiplash. We call this “risk on”, “risk off” – although I’ve called it ‘student body left (right) trading’ before the former terms became popular. While there have been times these correlations lessened during 2010 and early 2011, the back half of 2011 brought the return of this action in force. To wit, James Grant has noted that in the entire history of the S&P 500 there have been 11 instances where 490+ of the 500 stocks traded in the same direction. Of those 11, 6 have happened since July 2011. An incredible statistic. Essentially each day you “buy risk” (risk on) or you “buy US Treasuries” (risk off) – and every 24 hour period is unto itself, with no memory of the previous day.

This type of movement has created havoc for anyone trying to outperform the index, because often the market moves down (en masse) than 48 hours later a rumor or a ‘rescue’ will move all the same assets up en masse. And this gyration continues day after day, week after week, making it impossible to ride this bucking bronco. To that end, both mutual funds [Dec 20, 2011: Average Mutual Fund Down 5.9% with a Handful of Days Left in the Year] and hedge funds [Dec 20, 2011: Every Major Hedge Fund Strategy Also a Loser in 2011] have had a horrid year trying to beat the indexes. Last evening, I went through the Morningstar top fund performers of the year to see what I could glean. Not much. It was a whose who of utility (yield) mutual funds – trailed by dividend paying (yield) large cap healthcare and REIT (again a reach for yield) funds. These are now the most crowded trades on earth, now that gold has been bludgeoned of late. As these ‘safe’ sectors become ever more crowded, they are becoming less safe by the week – we all know how these crowded trades end. It is just a matter of when.

As I analyze the back half of the year, there has been no place for trend trading or creating multi month strategies – it has been “get in, scalp, and get the hell out” – preferably in 72 hours or less. Rinse, wash, repeat. Only a market the daytrader or very short term scalper can thrive in and even he/she has had trouble because so many of the movements occur overnight due to Europe, so U.S. markets usually gap up or down at the open and within 20 minutes go sideways the rest of the session.

But back to the lemming like behavior of risk on, risk off – the NYT takes a closer look:

(note: for some reason, I cannot embed a nice graphic from the NYT story – so go here to take a look)

• The prices of stocks, bonds and a host of other financial assets, which in normal conditions more often than not move in a diversity of unpredictable directions, are increasingly surging up or down in lockstep. The rise in correlation between individual stocks, but also between completely separate asset classes like stocks and gold or stocks and oil, “has been one of the big themes of the investment climate this year,” said Marc Chandler, a market strategist at Brown Brothers Harriman in New York.
• The chief explanation for the correlation is the great uncertainty facing investors — mainly over the crisis in Europe, which has raised the specter of the potential bankruptcy of governments and a collapse of the banking system.
• With every bit of bad news, nervous investors around the globe have been selling many of their positions across all asset classes, no matter what they are, driving prices down, and rushing into perceived safe havens like cash and United States bonds. But sometimes just a day or so later, with a glimmer of hope that Europe is pulling away from the abyss or that the United States is picking up steam, newly optimistic investors turn around and rush back from cash into harder assets, like stocks, foreign bonds or commodities, pushing prices higher together.
• “When things are less stressed, stocks and other investments move according to other more fundamental factors like a company’s earnings or its balance sheet,” said Maneesh Deshpande, managing director for global equity derivatives strategy at Barclays Capital. “But when macro fears take over, they move in flocks.”
• In November and December, a common measure of correlation within the Standard & Poor’s benchmark 500-stock index reached as high as 90 percent, the highest since 1996, according to Barclays calculations.
• For much of the decade leading up to the financial crisis in 2008, the measure of correlation between the 50 biggest stocks in the S.& P. 500 generally stayed between 10 percent and 40 percent.
• With so much money sloshing around from one day to the next, the high degree of correlation poses a challenge for active fund managers or other stock pickers who pride themselves on their ability to discriminate between stocks or other assets. It may be one reason that some hedge funds are having a tough time.
• It is also a problem for ordinary investors who have traditionally tried to protect their portfolios by spreading risk over a broad basket of assets, so that if some go down in price, others will increase. But how can you protect yourself in a world where investments rise or fall together?
• The realized correlation within United States equities in the S.& P. 500 is now higher than in 2008, Mr. Curnutt said. But, he said, it was not just stocks: there has also been an increased correlation between oil and the euro, for example, and other assets like stocks and gold, and between Italian government bonds and Italian bank stocks. “The commonality they have is they are not cash,” Mr. Curnutt said. Investors are “jumping out of cash and into something else.”
• The official monetary policy in the United States — keeping interest rates close to zero — is also exaggerating the phenomenon, Mr. Curnutt said, because savers have little incentive to stay in cash and instead rush en masse into other investments when they see glimmers of stability and higher returns elsewhere. “During this crisis, there has been one big trade out there. Either risk on or risk off,” Mr. Chandler said.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Tags: Asset Classes, Bucking Bronco, Computerized Trading, Correlations, Days Left In The Year, Gyration, Havoc, Hedge Fund Strategy, Hedge Funds, James Grant, Loser, Merits, Morningstar, Mutual Fund, Mutual Funds, Proliferation, Risk Risk, Statistic, Treasuries, Whiplash
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Charles Ellis: Ten Basic Rules for Investing Success

Tuesday, December 13th, 2011

On this week’s WealthTrack, Consuelo Mack interviews legendary financial consultant Charles Ellis. His “Winning the Loser’s Game: Timeless Strategies for Successful Investing” is an investment classic. Now he’s written a new investment primer with Princeton economist Burton Malkiel, “The Elements of Investing”. Ellis offers basic rules to succeed in the financial markets.

Source: Wealthtrack, December 9, 2011.

Tags: Basic Investing, Burton, Consuelo Mack, Economist, Elements, Financial Consultant, Financial Markets, Game Strategies, Investment, Loser, Princeton, Success, Timeless Strategies, Wealthtrack
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Fifty common mistakes traders make

Tuesday, September 29th, 2009

An interesting survey has just found its way into my inbox, courtesy of Ratio Trading. The survey of more than 500 experienced futures brokers asked what, in their experience, caused most traders to lose money. There are some repetitions in the list, but it is nevertheless a worthwhile exercise to give it a quick read to again remind ourselves of the many investment pitfalls out there.

1. Many futures traders trade without a plan. They do not define specific risk and profit objectives before trading. Even if they establish a plan, they “second guess” it and don’t stick to it, particularly if the trade is a loss. Consequently, they overtrade and use their equity to the limit (are undercapitalized), which puts them in a squeeze and forces them to liquidate positions.

Usually, they liquidate the good trades and keep the bad ones.

2. Many traders don’t realize the news they hear and read has already been discounted by the market.

3. After several profitable trades, many speculators become wild and aggressive. They base their trades on hunches and long shots, rather than sound fundamental and technical reasoning, or put their money into one deal that “can’t fail.”

4. Traders often try to carry too big a position with too little capital, and trade too frequently for the size of the account.

5. Some traders try to “beat the market” by day trading, nervous scalping, and getting greedy.

6. They fail to pre-define risk, add to a losing position, and fail to use stops.

7 .They frequently have a directional bias; for example, always wanting to be long.

8. Lack of experience in the market causes many traders to become emotionally and/or financially committed to one trade, and unwilling or unable to take a loss. They may be unable to admit they have made a mistake, or they look at the market on too short a time frame.

9. They overtrade.

10. Many traders can’t (or don’t) take the small losses. They often stick with a loser until it really hurts, then take the loss. This is an undisciplined approach…a trader needs to develop and stick with a system.

11. Many traders get a fundamental case and hang onto it, even after the market technically turns. Only believe fundamentals as long as the technical signals follow. Both must agree.

12. Many traders break a cardinal rule: “Cut losses short. Let profits run.”

13. Many people trade with their hearts instead of their heads. For some traders, adversity (or success) distorts judgment. That’s why they should have a plan first, and stick to it.

14. Often traders have bad timing, and not enough capital to survive the shake out.

15. Too many traders perceive futures markets as an intuitive arena. The inability to distinguish between price fluctuations which reflect a fundamental change and those which represent an interim change often causes losses.

16. Not following a disciplined trading program leads to accepting large losses and small profits. Many traders do not define offensive and defensive plans when an initial position is taken.

17. Emotion makes many traders hold a loser too long. Many traders don’t discipline themselves to take small losses and big gains.

18. Too many traders are under financed, and get washed out at the extremes.

19. Greed causes some traders to allow profits to dwindle into losses while hoping for larger profits.
This is really a lack of discipline. Also, having too many trades on at one time and overtrading for the amount of capital involved can stem from greed.

20. Trying to trade inactive markets is dangerous.

Click here for the full list.

Source: Ratio Trading, September 4, 2009.

Tags: Committed To One, Day Trading, Directional Bias, Futures Brokers, Futures Traders, Hunches, Long Shots, Loser, Losses, Market 3, Mistake, Pitfalls, Profit Objectives, Profitable Trades, Repetitions, risk, Speculators, Squeeze, Time Frame, Worthwhile Exercise
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Beating the Market

Thursday, July 30th, 2009

By Michael Nairne, Tacita Capital

For many investors, beating the market is the holy grail of investing. In fact, google the phrase “beating the market” and you get 14 million hits, more than seven times “passive investing”. Yet, beating the market over the long-term is extremely difficult. By definition, the market includes all stock owners and hence, investors as a group earn the market return – for every winner there must be a loser. In confirmation, a litany of studies has found that fund managers in aggregate achieve market-like returns less fees and costs.

However, the potential to beat the market does exist. Over the past several decades, the painstaking examination of historic stock performance in numerous countries has pointed the way to outpacing the market. The findings indicate that value stocks – those low-priced in relation to earnings, dividends and book value – have higher expected returns than growth stocks – those high-priced in relation to earnings, dividends and book value. Over the long-run, value investors are the winners; they earn a premium to growth investors who are the losers.

This premium is evidenced in the following graph which illustrates the growth of $1.00 U.S. invested in large value stocks (in red) compared to large growth stocks (in green)

and to the S&P 500 (in blue) from August 1927 to May 2009. The investment in value stocks grew to $4,454 – more than four times the $868 of the growth stocks and nearly three times the $1,578 of the S&P 500 which, although growth-tilted, contains both value and growth stocks.

The historic outperformance of value stocks is not restricted to the U.S. market. In a study on the United Kingdom stock market from 1900-2000, Dimson, Marsh and Staunton (DMS) found that value stocks achieved an annual return of 11.5 percent, a 2.9 percent premium to the 8.6 percent return of growth stocks and a 1.4 percent premium to the market overall. They conclude that “over the long term, the historical record of value investing has been positive … we now know that value stocks did better than growth stocks in the earlier as well as later parts of the twentieth century.”

In fact, in a sweeping review of the research on the value premium in international markets, DMS found that value stocks outperformed growth stocks in thirteen out of fourteen countries including Canada. Italy was the only exception. The value premium is therefore a global phenomenon.

But this begs the question … why? Without a meaningful explanation, it is possible (although not probable given the length and breadth of its occurrence) that the value premium is a statistical fluke or worse, an historic anomaly now widely known, avidly pursued by knowledgeable investors and hence as prices are bid up, no longer available to future investors.

Economic theory offers us two explanations for the value premium. First, behavioural finance experts argue that cognitive biases hardwired into the human psyche often lead to the systematic mispricing of value stocks. David Dreman, a leading apostle of this view, believes that investors routinely overreact to recent news concerning a given stock. If it is good news, they tend to project a continuance of this favourable trend and bid up the price of the stock. When bad news confronts investors, an opposite reaction is triggered. Believing a negative trend to be firmly in place, investors either hold or sell and the stock price subsequently languishes. Yet, inevitably, some negative event occurs to cause the higher-priced growth stocks to tumble while conversely, enough positive surprises occur to send the value stocks spiralling upwards.

Investors appear to naively extrapolate recent earnings trends and only adjust their expectations slowly as recurrent surprises occur. One study by Fuller, Huberts and Levinson

found that while high-priced glamour stocks initially have much stronger earnings growth rates than low-priced value stocks, after five years or so this difference becomes negligible. As the market slowly adopts scaled-down earnings expectations as the new norm, value stocks enjoy superior returns as their price moves up at a relatively faster pace than that of the slackening growth stocks.

Another behavioral view holds that investors often confuse the characteristics of a good company (e.g. powerful brand, positive image, superior growth) with the elements of a good stock (i.e. a price that is low in relation to discounted future cash flows). One study found that the stocks of companies considered “excellent” according to the standards outlined in the best-seller In Search of Excellence materially underperformed the stocks of “unexcellent” companies!

The second explanation for the value premium comes from the efficient market school of thought. Under the efficient market hypothesis, the prices of stocks reflect all available information and hence, higher expected returns must rationally reflect higher risk. Originally, efficient market supporters did not believe there was sufficient evidence of a value premium. Then, in a 1992 landmark study covering the period 1963-1990, Professors Eugene Fama and Ken French found that value stocks outperformed growth stocks by a statistically significant margin. In 2000, a second study covering 1929-1963 contributed strong out-of-sample confirmation of the existence of a value premium.

According to Fama & French, however, value stocks are generally shares of companies that are in comparatively worse financial shape than companies whose shares are growth stocks. Investors demand a higher return for their investment in value stocks because of the greater risk the company will deteriorate financially or even go bankrupt. This is no different from bankers or bondholders who charge a higher rate of interest to companies in poor financial shape. The poor performance of value stocks during the Great Depression may be indicative of this risk.

Both the behavioral and efficient market explanations for the value premium are compelling. In academia, a vociferous debate exists as to which is the foremost cause of the value premium. From an investor’s perspective, however, the critical aspect of both explanations is that each supports an enduring value premium that is unlikely to disappear. However, the exploitation of the value premium rests on one key characteristic – patience – since the premium is highly volatile and can disappear or even go negative for years.

This volatility is evidenced in the following graph which depicts the 36-month rolling average annual return of the Fama-French Large Value Premium (i.e. the return of large value stocks minus large growth stocks) for the U.S. market for the period August 1929 to May 2009. Although value stocks outperformed growth stocks by an average annualized 3.24 percent, there are intermittent periods where growth stocks outperformed, sometimes by a significant margin, and some of these periods can persist for a number of years, such as occurred through much of the 1930′s and 1990′s.

To the thoughtful investor, the volatility of the value premium is reassuring. A premium which showed up with any regularity would disappear almost immediately since it would be arbitraged away by traders. Instead, the value premium is available to patient, long-term investors who are interested in beating the market. Impatient investors will need to look elsewhere.

July 23, 2009

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

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

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Tags: Aggregate, Canadian Market, Dividends, Dms, Fund Managers, Google, Growth Investors, Growth Stocks, Holy Grail, Investment Stocks, Litany, Loser, Losers, Marsh, Outperformance, S Market, Seven Times, Stock Market, Stock Owners, Stock Performance, Tacita, Value Investors, Value Stocks
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World Markets Performance (January 7, 2009)

Friday, January 9th, 2009

Below are charts from the Economist detailing the overall comparative performance of world markets in World equity markets for all of 2008, followed by YTD, the first week of 2009. Overall, the first week of the new year to January 7, was a decent week.

Saudi Arabia turned in the biggest gain on the week with a gain of 10.8%, most likely on hopes that oil prices would recover. Since then, that has not materialized. Denmark turned in a respectable 9.4%, South Korea gained 9.2%, and Brazil was up 8.7%.

Canada turned in a modest gain of 1.5%, while US results were mixed, with the Nasdaq up 1.4%, the S&P 500 up 0.4%, and the Dow a slight loser with a tiny loss of -0.1%.

The week’s losers turned out to be Mexico with a loss of -1.2% and the World Bond Index, losing -2.0%.

Tags: Brazil, Canadian Market, Comparative Performance, Denmark, Dow, Dow 30, Economist, Loser, Losers, Mexico, Nasdaq, Nasdaq 100, New Year, Oil Prices, S&P 500, Saudi Arabia, South Korea, United States, World Bond, World Bond Index, World Equity Markets, World Markets
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