Time to Exit Emerging Markets? (Koesterich)

Thursday, April 12th, 2012

“Is it time to sell emerging market equities?” That’s what many investors are wondering given that emerging market stocks are up significantly since fall lows and have modestly outperformed developed markets year to date.

Despite emerging markets’ strong recent performance, I believe there are two major reasons why investors should still consider overweighting select countries relative to their weight in the MSCI ACWI benchmark.

Cheap Valuations: First, and most importantly, emerging markets remain cheap compared both to their own history and to developed markets. Currently, the MSCI Emerging Market Index is trading for around 12x earnings. As the chart below indicates, this is a significant discount to the index’s long-term average multiple of 16.

The current valuation of roughly12x earnings is also a 22% discount to where the MSCI World Index is trading. And historically, when emerging market stocks have been at a 20% or more discount to developed market equities, they have significantly outperformed over the next year.

Falling Inflation: A second factor supporting emerging market equities is that inflation continues to decline in most emerging markets, India being a noticeable exception. For instance, over the past nine months, inflation in China has fallen from 6.5% to roughly half that level, while inflation in Brazil has decelerated to around 5% from 7.5%. Lower inflation should provide for some multiple expansion in emerging market stocks.

However, since not all emerging markets currently look attractive, I continue to advocate overweighting only certain areas through a regional and country implementation.

In particular, I like Latin America, Brazil, China and Russia, and I prefer to access these markets through the iShares MSCI Emerging Markets Latin America Index Fund (NASDAQGM: EEML), the iShares S&P Latin America 40 Index Fund (NYSEARCA: ILF), the iShares MSCI Brazil Index Fund (NYSEARCA: EWZ), the iShares MSCI China Index Fund (NYSEARCA: MCHI) and the iShares MSCI Russia Capped Index Fund (NYSEARCA: ERUS).

Meanwhile, investors looking for a lower risk alternative for accessing emerging markets may want to also consider the iShares MSCI Emerging Markets Minimum Volatility Index Fund (NYSEARCA: EEMV).

Source: Bloomberg

The author is long EWZ and ERUS

Investing involves risk, including possible loss of principal. Past performance does not guarantee future results.

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.

Tags: America Index, Amp, Brazil Index, Earnings, Emerging Market Stocks, Emerging Markets, Ewz, Index Fund, Inflation In China, Ishares Msci Brazil, Latin America, Lows, Msci Acwi, Msci Emerging Market, Msci Emerging Market Index, Msci World Index, Nasdaqgm, Nine Months, Valuations, Year To Date
Posted in Markets | Comments Off

Volatility: The Pulse of the Market

Tuesday, September 20th, 2011

The extreme volatility in U.S. equity markets and other global equity markets prompted me to analyse the current situation in comparison with history and to ascertain what causes significant changes in volatility.

The CBOE S&P 500 Volatility Index, better known as VIX, is constructed by using the implied 30-day volatilities of a wide range of S&P 500 Index put and call options. With the VIX only available from 1990 I have extended the volatility index by adding the CBOE S&P 100 Volatility Index or VXO from 1986 to 1989 to the VIX series.

The VIX is generally used as an indicator of greed/complacency or fear. I call it the pulse of the market. Any move above the average of 20.8 is a reflection of anxiety, while a move below is a reflection of calmness. The current anxiety of the market is clearly evident in the graph below.

Sources: CBOE; Plexus Asset Management.

In the graph below I indicate the average VIX since 1986 (20.8) with one standard deviation above (28.8) and one below the average (12.8). It is evident that VIX values greater than one standard deviation above the average can generally be associated with a large amount of volatility as a result of significant events – as is the case currently.

Sources: CBOE; Plexus Asset Management.

During sustained bull markets the pulse of the market is calm but moves towards neutral and anxiety towards the end of rising markets and the commencement of declining markets. It was evident in the run-up to the 1987 crash when the market went into anxiety mode nine months prior as well as at the end of 1989. In 1997 the VIX started trending towards neutral and anxiety mode three years prior to the spectacular end of the extended bull market in 2000. Anxiety persisted until the first quarter of 2003 before calmness set in. In the second quarter of 2007 the VIX started to trend to neutral and anxiety mode 12 months before the S&P 500 topped out and entered a declining trend. Although the market briefly went into a period of calmness in the first quarter of last year this was followed by brief snaps of anxiety and calmness, ending in the current state of anxiety.

Sources: CBOE; I-Net Bridge; Plexus Asset Management.

But what is the main determinant of volatility as measured by VIX? Greed and fear from my point of view as investor is not indifferent to expanded or contracted market valuation levels. I therefore used Robert Shiller’s PE10 where the price level of the S&P 500 is expressed as a ratio to the average trailing earnings of the past ten years as valuation model and compared it to VIX.

Sources: CBOE; Robert Shiller; Plexus Asset Management.

Timeline:

• The significant jump in the PE10 from 13.4 in 1986 to 18.3 in 1987 was accompanied by a significant increase in volatility and therefore anxiety as measured by VIX. The volatility only returned to neutral levels after the crash of 1987 induced by program trading when the PE10 retreated to 13.4 or to pre-blow-off levels.
• 1990 mirrored 1987’s situation with the Gulf Crisis the trigger to bring valuation levels back to levels that restored calm in the markets. In 1997 the VIX started trending towards neutral and anxiety mode as the PE10 rose.
• Although the Asian crisis in 1997 increased anxiety or volatility it had no lasting effect on the PE10. The Russian crisis of 1998 also had no lasting impact as the PE10 briefly fell from 38 times to 33.5 and rose further afterwards.
• Volatility remained at anxiety levels until the market topped out early in 2001 with a PE10 of 44.2 when the Dotcom bubble burst. The tragic 9/11 followed and corporate scandals such as Enron kept the anxiety levels high but the PE10 remained at elevated levels above 30.
• The September 2002 market crash led the PE10 to bottom in February 2003 at 21.2 – levels similar to that of 1995 when the market last experienced “calmness”. The VIX dropped significantly and the PE10 thereafter remained stable at around 26 for the next 4 years.
• In June 1997 the VIX again rose to and reached anxiety levels in July that year. As anxiety increased the market finally cracked in January 2008 as the PE10 started to fall as the subprime crisis unfolded and crashed in October as volatility increased significantly on the back of the Lehman saga and ensuing interbank collapse. Anxiety started to subside only when the PE10 dropped to a level of 13.3.
• The debt crisis in Greece in June last year saw a significant increase in volatility but the PE10 retreated moderately to 19.7 from 21.8 in April. Calmness was restored and the PE10 rose to 23.7 in May.
• Since then anxiety levels have increased as the European debt crisis deepened and a consumer confidence crisis in the U.S. developed. At the same time the PE10 dropped to 19.8, which is where we are now.

I also assessed the impact of the underlying economy on volatility or VIX. I identified two major indicators of the underlying economy in my analysis, namely consumer sentiment and my calculated GDP-weighted PMI for manufacturing and non-manufacturing combined.

Until the end of 2007 the Conference Board Consumer Sentiment Index (please note the reverse axis) and VIX maintained a narrow relationship but it broke down early in 2007. In August 2007 the Consumer Sentiment Index started to weaken when VIX entered anxiety territory and continued to weaken through March 2008. Sentiment only started to improve when the S&P 500’s volatility started to subside.

Sources: CBOE; Conference Board; Plexus Asset Management.

It is evident that high volatility is consistent with a GDP-weighted PMI below 57 (please note the reverse order of the PMI axis). From July 2006 the PMI started to falter but the VIX remained in “calmness” territory until a year later when the VIX caught up.

Sources: CBOE; ISM; Plexus Asset Management.

The relationship since July 2007 when the VIX entered anxiety level is evident in the following graph (please note the reverse order of the PMI axis). Until September 2008 the VIX reflected the underlying level of the PMI, but since then it has led the PMI by approximately one month. A major diversion is evident in March this year, though. The PMI weakened significantly from February to April but the VIX kept on declining and only started to play catch up in July. Currently the VIX is pointing to the PMI falling to 50 and below in September/October.

Sources: CBOE; ISM; Plexus Asset Management.

In summary, it is clear to me that the volatility of the equity market and that of the S&P 500 in particular as measured by VIX is influenced by valuation levels and the underlying economic trends. But what are the mechanics behind it and who is responsible for the increase in volatility?

Suffice it to argue that when the majority of investors become concerned about extended valuation levels and/or the threat of weaker economic circumstances ahead, the demand for derivatives to lock in profits and to reduce downside risk increases. The demand for, say, put options increases, resulting in higher prices of the options. The higher value investors are willing to pay for put options theoretically implies a higher value for volatility. The implied volatility of the options therefore increases and so does VIX. Therefore it can be said that investors are willing to pay more for the same option and thus are inclined to accept higher volatility.

On the other hand the writer or grantor of the option has the choice of leaving the option naked, thereby effectively going long of the market or to delta-neutral hedge the option by selling sufficient exposure of the underlying asset or the S&P 500 against the written option. The writers of put options who are bullish in a strong rising market tend to do so to collect the premium on the option to boost income.

When the S&P 500 starts to lose momentum or fall, the grantors of the options need to neutralise their positions by selling the underlying asset or buy put options as their value at risk increases. A vicious circle ensues. The price of the underlying asset (in this case the S&P 500) drops and actual volatility increases, while the implied volatility soars due to higher demand for put options. The volatility and downside of the market is often exacerbated by investment banks and other institutions who granted far out of the money put options for plain premium income considerations that all of a sudden threatens the balance sheets of the grantors. The grantors are then forced to sell indiscriminately to protect their balance sheets at all costs.

The price of the underlying asset continues to drop until it finds a level where the majority of investors become less risk averse and comfortable enough to buy the underlying asset. Demand for protective measures falls away and so does VIX as implied volatility drops.

What about the current situation? Where is the VIX heading? What are the implications for the S&P 500?

The current situation is similar to that of the middle of last year with concerns about the global economy given the debt stress in Europe, a weakening trend of the U.S. GDP-weighted ISM PMI and weakening consumer sentiment. The rating of the S&P 500 as measured by the earnings yield (inverse of PE10) is at levels similar to those in July/August last year.

Sources: CBOE; Robert Shiller; Plexus Asset Management.

The current rating is in the same region as in 2003 after which the market turned for the better and volatility dropped. It is evident that the market is extremely vulnerable to further shocks that could see a surge in volatility and a further massive derating. Barring any other unforeseen crisis that could lead to a further spurt in volatility, I believe the S&P 500 offers value at this stage. But do the majority of other investors share my view? Only time will tell, as calm needs to be restored before we will see any sustained upward momentum in the S&P 500 and other global equity markets. What is clear to me is that the market has entered a period of above-average volatility that is likely to be sustained in coming years �’ similar to that of 1997 – 2003.

Sources: CBOE; I-Net Bridge; Plexus Asset Management.

Tags: Anxiety, Bull Markets, Calmness, Cboe, Commencement, Complacency, Current Situation, Extreme Volatility, First Quarter, Global Equity Markets, Greater Than One, Greed, Nine Months, Plexus Asset Management, Second Quarter, Significant Events, Standard Deviation, Vix, Volatility Index, Vxo
Posted in Markets | Comments Off

Brazil: Restarting the Hikes

Thursday, January 20th, 2011

This post is a guest contribution by Gray Newman of Morgan Stanley.

When Brazil’s central bank meets this week to review monetary policy, there is little doubt now that the authorities will raise interest rates. After having begun a hiking cycle just nine months ago – and then stopping the cycle just months later – the authorities now appear to be on track to resume with a series of hikes. We believe the most likely outcome is that the authorities will hike the overnight reference rate by 50bp to 11.25% on Wednesday, January 19. And while we reiterate our call that rates will rise to 12.50% during the year, we are concerned that the path is far from clear.

Inflation’s Origin? The Growth Mismatch

Last year when the central bank decided to abort the hiking cycle in early September, many argued that the hiking cycle was over. We maintained then and maintain now that more rate hikes would be needed in 2011. Our concern was simple: at the core of Brazil’s inflation problem was a mismatch between robust demand and sluggish supply (the Growth Mismatch). With limited visibility of any significant fiscal tightening, we argued that Brazil’s central bank would have little choice but to hike interest rates during 2011.

Brazil’s Growth Mismatch, in turn, is the result of the positive wealth shock, thanks to multi-decade high terms of trade and with it a multi-decade strong exchange rate. While a positive wealth shock sounds like good news, it also poses challenges. Indeed, it is what we refer to as the ‘risk of abundance’. A strong currency (along with credit expansion, consumer confidence and strong job and wage growth) has boosted the purchasing power of Brazilian consumers and produced consumption indicators as robust as we have ever seen in Brazil. The flipside, however, of a strong currency is the threat to domestic producers faced with new import competition. The result: robust demand side-by-side with sluggish supply.

Indeed, the latest data from Brazil released in the first weeks of the New Year continue to highlight the presence of Brazil’s Growth Mismatch. Industrial production in November was off -0.1% from the previous month, the fifth monthly downturn in the past eight readings. Industrial output, after peaking in March, has been largely stagnant since then. In contrast, retail sales growth remains robust. This past week we learned that retail sales in real terms rose by 1.1% in November: that is an annualized pace of more than 13%. And preliminary data suggest that demand for consumer credit remained robust in December.

Preliminary data and anecdotal evidence from December – from measures of heavy vehicle traffic on toll roads to car production and packaging paper demand – suggest that December’s industrial output could show an upturn after November’s disappointing downturn. That is certainly possible, but we would warn that we have been hearing advocates argue that industrial production was about to turn up – always next month – ever since we first began to highlight the Growth Mismatch at mid-year. There are indeed signs of an improvement in December, but we doubt that one month’s report will fundamentally change the broader picture that Brazil is facing – that of a stagnant industrial plant – which we suspect is due in part to the strength of the Brazilian real to levels that we have not seen in decades.

With uninterrupted evidence of the Growth Mismatch, it is still somewhat puzzling that the authorities stopped the hiking cycle with the last move in interest rates in July. The authorities have since argued that concerns over a failed bank played an important role in the decision to abort the hiking cycle. But by later last year, it seemed clear that the banking concerns had been contained and the drivers of inflation – robust consumer demand, boosted by stimulative fiscal and credit policies – all remained in place.

Three Factors Behind the Delay

We suspect that three factors delayed the move to restart the rates hiking cycle. An examination of these factors also suggests the risks present in 2011.

First, it is difficult to avoid the conclusion that political considerations played some role in the timing of the move to restart the hiking cycle. The regularly scheduled Copom meeting in October fell precisely between a two-round presidential election process: it is understandable that the central bank might have felt that a move on the rates front between rounds of voting could have cast an unnecessary spotlight on the actions of the monetary authority. At the next meeting in December, the case again could have been made that the Growth Mismatch (strong consumer demand side-by-side with sluggish supply) was present. But again, the political timetable might have played a role in the delay in December: a hike just before a change in central bank leadership could have been read as a sign that the new team needed the help of the outgoing leadership to jump-start the hiking cycle.

Second, monetary policy actions are rarely taken in a vacuum: monetary policy takes into account other policy actors – and on that front there has been some uncertainty over future non-monetary policy actions. The decision to hike rates as well as the timing and the magnitude of the hikes is also a function of other policy measures, including fiscal and ‘macro-prudential’ policy. In December, on the eve of what many rates watchers thought was the restart of the hiking cycle, the authorities announced a series of “macro-prudential” measures – hikes in reserve requirements and higher capital ratios designed to slow credit expansion. That move led the central bank in its December minutes to argue that while the credit measures were not “perfect substitutes” for monetary policy they were powerful and that the central bank needed “additional time” to “better measure” the impact before deciding on the course of monetary policy.

Of course, the macro-prudential measures are not the only policy actions the central bank is monitoring. There has been significant talk from the new administration of an important commitment on the fiscal front that would not only ease pressure on the rates front, but could be the catalyst to allow Brazil to lower interest rates. That policy uncertainty likely played a role as well in the decision to delay until now the restarting of the hiking cycle.

Third, identifying Brazil’s inflation dynamic has been challenging. After a significant uptick in inflation in the first months of 2010 – consistent with our call that demand was growing well above potential – monthly inflation turned down sharply during June, July and August when it averaged near zero percent for three consecutive months. There was some confusion: demand continued to outstrip supply and yet headline inflation appeared contained. Then at the end of the year, the uptick was largely centered in food and in part exaggerated in the year-over-year reports, given an unfavorable base of comparison. Indeed, we expect to see some reversal in the year-over-year reports in the first months of the year. It’s worth noting that food, which accounts for just under one-quarter of the Brazilian consumer price index IPCA basket (23.1% at the end of 2010) accounted for nearly half of the 5.91% inflation result for the year. But it would be a mistake to blame this simply on food: service and non-tradable inflation has been consistently running near 7% for much of the year – well above the 4.5% overall target. In the end, we suspect that the magnitude of the upturn in inflation as well as the deterioration in inflation expectations played a role in bringing the central bank back to the hiking cycle.

Macro Is Back

Our concern, however, is that it is far from clear how this cycle will end. While we have a central forecast of a series of hikes bringing rates to 12.50%, we suspect that there is still significant uncertainty surrounding that path. Brazil has had limited experience in which a hiking cycle was the proximate cause of a slowdown in demand: as often as not either events from abroad or domestic political concerns were the culprit in turning the business cycle. Add to this the political cycle as well as the potential tension with other policy measures – a hiking cycle can easily put undesired pressure on the currency to strengthen further – and the path becomes murky. And there is still considerable support within the administration that enough will be accomplished on the fiscal front so as to allow a reduction in interest rates.

Bottom Line

Some may read this week’s move to hike rates as a victory for the central bank in regaining the upper hand after Brazil’s inflation moved close to 6% and approached the upper end of the inflation targeting band. We would be wary about overplaying the significance of the move. Instead, we suspect that the Brazilian policy response will be tested by the powerful wealth shock hitting the economy – simultaneously boosting domestic demand even while limiting the growth in supply. It is far from certain what exactly the mix of policies will be in response or how successful they will be.

Source: Gray Newman of Morgan Stanley, January 19, 2011.

Tags: Abundance, Brazil, Consumer Confidence, Credit Expansion, Currency, Domestic Producers, Early September, Exchange Rate, Flipside, Import Competition, Inflation Problem, interest rates, January 19, Mismatch, Monetary Policy, Morgan Stanley, Nine Months, Purchasing Power, Rate Hikes, Robust Demand, S Central, Visibility
Posted in Brazil, Markets | Comments Off

If PIIGS Could Fly

Tuesday, February 2nd, 2010

This article is a guest posting from Niels Jensen*, Absolute Return Partners.

“A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy…”

Alexander Fraser Tytler, Scottish lawyer and writer, 1770

It was always naïve to believe that a crisis so deep and profound was going to go away with a whimper; however, an increase of more than 50% in global equity prices can be very seductive, and nine months of virtually uninterrupted gains have led many to believe that the problems of 20 08-09 are now largely behind us.

Well, not quite everybody. Friend and business partner John Mauldin remains a sceptic. I have had the pleasure of travelling across Europe with John over the past week or so and, as the week progressed, my mood swung decisively towards a state where Prozac would probably be the most appropriate remedy.

Now, John and I do not agree on absolutely everything. For example, I believe – and have believed for a while – that he is too bearish on equities. But, before we go there, allow me to share with you the essence of John’s views which can be summed up quite nicely by two charts, courtesy of BCA Research.

Chart 1: De-leveraging has a long way to go in the US

Source: BCA Research

In John’s opinion – and I do not disagree – we are still only in the second or third innings of the de-leveraging process (chart 1). Years of excessive debt accumulation cannot be reversed in 18 months, and it will take at least another 5-6 years to play out, possibly longer.

Chart 2: US Government borrowing has replaced private borrowing

Source: BCA Research

The other part of John’s argument – and again it is hard to disagree – is that it remains an open question how much de-leveraging has in fact taken place. As you can see from chart 2, US sovereign debt has…

Read the complete article here.

*Niels C. Jensen is a founding partner at London, England-based Absolute Return Partners. For more information visit, www.arpllp.com.

Tags: 6 Years, Absolute Return, Alexander Fraser Tytler, Business Partner, Democracy, Excessive Debt Accumulation, Form Of Government, Generous Gifts, Global Equity, John Mauldin, Loose Fiscal Policy, Niels Jensen, Nine Months, Partner John, Prozac, Public Treasury, Remedy, Sceptic, Scottish Lawyer, Whimper
Posted in Markets | Comments Off

Which Way Now? Hard Assets or Government Bonds?

Sunday, January 31st, 2010

The debate in the market between inflationists (majority) and deflationists (minority) continues to complicate investors’ ability to make decisions about where to deploy funds.

During the course of the year, inflationists benefited from the tailwind provided by the declining value of the dollar. The rally in risk assets came thanks to Bernanke’s deflation-busting policy, and, ironically, therefore, as long as the news remained dire on GDP growth and unemployment, we could count on interest rates to remain around zero percent, and the dollar to continue lower as faithless investors ditched it.

For nine months, the dollar declined as the market put risk back “on.” At the very beginning of the rally, in March 2009, the market’s mood was very dark. The genesis of the rally was the short covering of bank stocks and financials, and the full scale launch of the dollar funded carry trade, mostly taking place in institutional and hedge fund trading rooms. Except for the wiliest, it most certainly was not driven by retail investors. The retail investor is usually late to the party once fear of missing opportunities sets in.

The rally in the dollar as of late November has confused the inflationist view as the tailwinds appear to have reversed. This has been, and remains a difficult time to make risk-based investment decisions.

Read the whole article here.

by Pierre Daillie (AdvisorAnalyst.com), GlobeAdvisor.com, January 31, 2010.
http://www.globeadvisor.com/advisoranalyst/aa20100131.html

Tags: Bank stocks, Bernanke, GDP, GDP Growth, Genesis, Globeadvisor, Government Bonds, Hedge Fund, interest rates, Investment Decisions, Late November, Launch, Nine Months, Rally, Retail Investor, Retail Investors, Short Covering, Tailwind, Tailwinds, Zero Percent
Posted in Markets | Comments Off

The Dollar Carry Trade is Collapsing

Friday, January 22nd, 2010

This article is a guest post by Vince Fernando, The Business Insider.

Dollar strength at the end of 2009 sent the dollar carry trade (where by one borrows in dollars, then parks the proceeds in higher yielding assets) into a tailspin. This is why even small upward moves in the dollar could instigate substantial selling for 2009′s star currencies. For example, for the Australian dollar shown to the right.

Bloomberg: Funding the carry trade with the greenback lost money in December for the first time since February as the U.S. currency gained 4.8 percent against the euro amid growing confidence in the U.S. economy and expectations that the Federal Reserve will raise borrowing costs by June. Futures trading on Dec. 31 suggested a 62 percent chance the Fed would increase its benchmark to at least 0.5 percent by mid-year from a range of zero to 0.25 percent, up from 30 percent in November, Bloomberg data show. The Bank of Japan’s target rate is 0.1 percent.

Buying and selling high- and low-yielding currencies to take maximum advantage of global rate moves gained 19 percent from February to November, the carry trade’s best nine months since 2003, a Royal Bank of Scotland Plc index shows. The index fell 0.9 percent in December.

Few engaged in such an arbitrage will want to hang around should last year’s prevailing weak-dollar expectations be substantially reversed by persistent dollar strength.

[AA] Looking at the chart below of the dollar index, you can see that the dollar has rallied since the end of November, as a result of the accumulation of large short positions, not being covered. This has been a very profitable trade on both a currency pairs as well speculation in last year’s winning trades.

Currencies fared vary well against the dollar from an exchange rate standpoint as you can see in the following table:

* reflects the percentage change in the value of the non-USD currency compared to USD

Is it really a surprise that risk assets (commodities, the Canadian and Aussie dollars, equities, emerging markets) are selling off as institutional and hedge fund traders unload this increasingly squeezed short trade?

Read Bob Janjuah’s updated outlook for more insight on the short squeeze raising the dollar’s value – Janjuah points out that Senator-elect Scott Brown’s GOP victory in Massachusetts upsets Obama’s applecart so much so, that the resulting backlash will be for Obama to speed up plans for fiscal tightening, which means possibly a more rapid windup of the Fed’s quantitative easing, monetary tightening later this year.

Axel Merk puts it nicely, saying “In that context, the conventional wisdom that a country needs to have economic growth to have a strong currency is, in our assessment, wrong. Such a relationship only applies to countries that depend on foreigners to finance their deficits. In the U.S., foreigners finance the twin deficits; one of the reasons why the U.S. has economic growth as a top priority is to entice foreigners to keep financing U.S. deficits. Australia also has a current account deficit and, as a result, has a currency that is sensitive to economic growth prospects. Japan, however, traditionally finances its deficits domestically; as a result, the value of the yen is not very sensitive to changes in growth forecasts. The same can be said for the euro zone: because the euro zone does not have a significant current account deficit, in our assessment, the euro can do well in the absence of economic growth.

Source: StockCharts

Add my twitter feed: @vincefernando

Tags: Arbitrage, Australian Dollar, Bank Of Japan, Bank Of Scotland, Benchmark, Bloomberg, Business Insider, Canadian Market, Carry Trade, Commodities, Currency Pairs, Dollar Index, Dollar Strength, Emerging Markets, Federal Reserve, Futures Trading, Global Rate, Greenback, Maximum Advantage, Nine Months, Percentage Change, Profitable Trade, Royal Bank Of Scotland, Royal Bank Of Scotland Plc, Tailspin, Target Rate, Weak Dollar
Posted in Commodities, Markets, Outlook | Comments Off

The Key to Normalcy in World Markets?

Wednesday, January 13th, 2010

The yen must replace the dollar in carry trades to restore normalcy to the global economy and markets, including Canada’s.

For nine months we were trapped in the bizarre world of “bad news is good news.” To the puzzlement of investors, stock markets rallied despite deteriorating economic fundamentals, negative GDP growth, 10%-plus unemployment, and the erosion of the dollar’s value globally.

Here’s why…

Read the whole article here.

Pierre Daillie (AdvisorAnalyst.com) GlobeAdvisor.com, January 13, 2009

Tags: Bad News, Bizarre World, Canadian Market, Dollar Value, Economic Fundamentals, Erosion, GDP, GDP Growth, Global Economy, Globeadvisor, Investors, Nine Months, Normalcy, Puzzlement, Stock Markets, Trades, Unemployment, World Markets, World News, Yen Dollar
Posted in Canadian Market, Markets | Comments Off

Japan’s Misfortune Good News for Canadian Market

Sunday, January 10th, 2010

Commodities and the Canadian dollar have continued to strengthen despite the rally in the U.S. dollar. That’s odd, because for nine months, the U.S. dollar was involved in an inverse relationship with commodities, the Canadian dollar, equities, and emerging markets.

That relationship ended in late November as the dollar began its now, six-week old recovery.

It was often reported, from March to November 2009, that commodities prices were rising as a by-product of the falling U.S. dollar. That, indeed was doubly so. Speculative interest in commodities was driving prices higher, while rising short interest in the U.S. dollar, and record deployments of institutional cash were sending the currency lower, against the yen, and euro…

Find out why its possible Canadian stocks, bonds, the loonie, the commodity complex could remain relatively stable, and possibly go higher, though modestly.

Read the whole article here…

Pierre Daillie (AdvisorAnalyst.com), GlobeAdvisor.com, January 11, 2009

Tags: Canadian Bonds, Canadian Dollar, Canadian Market, Canadian Stocks, Commodities, Commodities Prices, Commodity, Currency, Deployments, Emerging Markets, Globeadvisor, Inverse Relationship, Japan News, Late November, Market Commodities, Misfortune, Nine Months, Rally, Short Interest, Speculative Interest, Stocks Bonds, Yen
Posted in Canadian Market, Markets | Comments Off

Carry Trades Make and Break Markets

Monday, December 21st, 2009

Financial markets have been swept up during the last nine months by the Fed’s easy money policies, particularly its zero-interest-rate policy, which fostered a carry-trade in the dollar. Now, as the dollar rallies, and the Japanese economy and yen falter, the short term appointment of the dollar as the primary funding currency may be ending. Some say that it will be dire for markets. Perhaps the best news right now for the US and Canada is the bad news from Japan, of record deflation, and the BoJ’s need to devalue the yen. There’s a good chance the yen will replace dollar, and resume its decade-plus-long position as the world’s primary funding currency, and that’s good news for the market in the longer term. In the near-term transition period, however, markets will be volatile, as one carry unwinds, and the other re-winds.

Read more here:  Carry Trades Make and Break Markets, GlobeAdvisor.com, December 21, 2009

Tags: Advertisement, Bad News, Best News, Boj, Canada News, Canadian Market, Carry Trade, Currency, Decade, Deflation, Easy Money, Financial Markets, Good Chance, Interest Rate Policy, Japanese Economy, Japanese Yen, Nine Months, Rallies, Term Appointment, Trades, Transition Period, Yen, Zero Interest
Posted in Canadian Market, Markets | Comments Off

The Retirement Lottery

Sunday, October 25th, 2009

On January 1, 1980, Jim and Jane Smith sold their business and retired on $1,000,000. Peter Jones, their financial advisor, determined that they needed $48,000 a year – increasing annually with inflation – to fund their lifestyle. Balancing growth with protection, the couple invested in his recommended portfolio of 60% large cap U.S. stocks and 40% intermediate-term Treasury Bonds. Peter then rebalanced the portfolio every year to this target mix.

Nine years and nine months later, Jim and Jane discussed with Peter how delighted they were with his strategy. Not only had their income kept pace with inflation, increasing to $75,000 in 1989, but their portfolio had skyrocketed in value. As illustrated in the following Exhibit, every $1.00 they had invested in 1980 was worth $2.78 by 1989. Jim and Jane were worth $2,780,000 despite nearly a decade of growing withdrawals. Even the October 1987 market crash was just a bump on the road to success.

Fast forward to January 1, 2000, and Jim and Jane’s nephew, Bill Smith, also retired with $1 million. Having listened for years about the success of Peter’s winning investment strategy, Bill invested in the identical asset mix. He also withdrew $48,000 in the first year and increased his withdrawals annually by inflation. Given his uncle’s and aunt’s experience, he was confident he had a winning plan.

Nine years and nine months later on September 30, 2009, Bill sits down with Peter and complains bitterly as he contemplates the vestiges of his $1 million. As illustrated in the following Exhibit, every $1.00 he invested in 2000 is now worth only $0.65. His million has shrunk to $650,000 and he is glumly contemplating a return to work.

Identical retirement strategies implemented just twenty years apart – yet with dramatically different outcomes. With hindsight, we now know that Jim and Jane Smith had the good fortune to have retired just prior to the great stock bull market of the 1980′s. They also caught a once-in-a-lifetime uplift in bond prices as inflation fell. Conversely, Bill had the horrible luck to have retired on the cusp of the tech meltdown, itself followed by the greatest global financial crisis since the 1930′s.

The paradox is that in each case the outcome was polar opposite of the investment sentiment at the time of retirement. Jim and Jane retired in troubled economic times where fears of inflation and chronic slow growth were rampant. Stocks and bonds had done poorly for years. Bill retired in a bullish era of prosperity and stunning returns.

Unfortunately, investor sentiment is usually in direct contrast to asset valuation levels and it is valuation levels that are of primary importance in assessing the risk of a retirement plan. The Exhibit following displays the rolling 10-year real price-earnings (PE) ratio of the S&P 500 and long-term interest rates, prepared by Robert Shiller, the noted finance professor.

When Jim and Jane retired, stocks were the most inexpensive that they had been in four decades while bond prices, offering double-digit yields, were the lowest on record. Although there was no guarantee that these bargain valuations would translate into high realized returns, cheap acquisition prices created much greater upside than downside. It would only take sound monetary and taxation policies – something about to occur under the helmsmanship of Fed Chairman Volcker and President Reagan – for falling interest rates and rising PE ratios to fuel superior returns.

Bill, on the other hand, bought stocks at their highest valuation level in history. His entry pricing was fraught with risk – anything but economic perfection would result in subpar returns. The bursting of the tech and credit bubbles was ruinous as valuations plunged.

Investors need to know that retirement is a lottery where the chance of winning is more dependent on asset valuations at the time of retirement than the soundness of the investment plan. Individuals planning for their retirement today need to soberly assess their return expectations since stock prices are moderately above the historic average while long-term interest rates are near record lows. Winning tickets will only be available to those who can keep their expenditure levels in line with this reality.

October 23, 2009

www.tacitacapital.com

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.

Tags: Asset Mix, Bill Smith, Bump On, Good Fortune, Hindsight, inflation, Investment Strategy, Jane Smith, January 1, Market Crash, Nephew, Nine Months, Nine Years, Peter Jones, Plan Nine, Recommended Portfolio, Retirement Strategies, Target, Treasury Bonds, Uplift, Vestiges, Withdrawals
Posted in Markets | Comments Off