David Rosenberg: The Record Quarter

Tuesday, April 3rd, 2012

from David Rosenberg, Gluskin Sheff

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Copyright © Gluskin Sheff

Tags: Bank Of America, Basis Points, Bull Run, Canadian, Canadian Market, China, David Rosenberg, Financial Disaster, Fiscal Stability, Fund Portfolios, Global Scale, Gluskin Sheff, Hedge Fund, Internet Revolution, Low Quality, Lows, Msft, Nasdaq, Political Stability, Quality Names, Quality Stocks, Record Quarter, Sears Holdings
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Will Seasonal Slump Drive Derisking?

Tuesday, January 31st, 2012

The so-called January-Effect is almost at an end and if the market closes near these levels, the S&P 500 will have managed a 4.4% gain or its 20th best January since 1928 (84 years) and best since 1997. The outperformance of banks and sovereigns (LTRO) and the worst-of-the-worst quality names (most-shorted Russell 3000 stocks +9% YTD vs Russell 3000 +5.2%), as Morgan Stanley noted recently, is not entirely surprising since the January effect is considerably larger in mid-cap and junk quality names than any other size or quality cohorts. We have pointed to the seasonal positives in high-yield credit and volatility and along with the obvious short squeeze in S&P futures (which has seen net spec shorts come back to balance recently), we, like MS, are concerned that the tailwinds of exuberance that virtuously reflect from seemingly pivotal securities (such as short-dated BTPs now or Greek Cash-CDS basis previously) very quickly revert to a sense of reality (earnings and outlook changes) and perhaps the slowing rally and rising volatility of the last few days is the start of that turbulence.

The most-shorted stocks (tracked by the red lines on the above chart) have dramatically outperformed the broad markets they are part of with the Russell 3000 most-shorted (thick red) massively outperforming (almost 400bps in the month!).

Morgan Stanley: January Effect

January is often a month for risk taking since optimistic investors believe that any underperformance during the month can be reversed by year-end.

In light of the sharp rally in the equity market thus far this year, we took some time to study the concept of a “January Effect.” Since 1901, the S&P 500 has averaged a 1.2% return during January with a standard variation of 4.3%. In the remaining eleven months of the year, the index has averaged a 0.5% monthly return with a 5.2% standard variation (Exhibit 2).

After accounting for the standard deviations, the return spread between January and the remaining eleven months is marginally statistically significant: With a T-stat of 1.73, it is significant at the 10%-level but insignificant at the 5%-level. In fact, 2012’s rally to date is only a 0.8 standard deviation event, and studying history, we would expect such a move to occur in slightly over 20% of January’s. We studied the “January Effect” by market cap cohort, quality-junk status, and value-growth status. Since 1970, the spread between the January return and the return for February through December has been highest in mid-cap stocks (Exhibit 3). None of the three cap cohort’s return spread is statistically significant—the mid-cap spread has the highest T-stat at 1.46. Year-to-date performance so far this year by cap cohort is consistent with smaller-cap outperformance.

We analyzed returns by quality cohort since 1981 and found that both quality and moderate quality, on average, perform worse in January than during the remainder of the year. Low quality slightly outperforms in January, while junk is by far the largest outperformer on average (Exhibit 4). The more positive performance of junk relative to the other quality quintiles is not surprising given that junk stocks are generally smaller than quality stocks, and the January effect is stronger in these small stocks. Still, none of the quality cohorts’ return spreads are statistically significant after accounting for volatility and the number of observations.

Tags: Btps, Cohorts, Exuberance, Futures, January Effect, Months Of The Year, Morgan Stanley, Outperformance, Quality Names, Russell 3000, Sense Of Reality, Short squeeze, Slump, Sovereigns, Standard Deviations, Tailwinds, Turbulence, Volatility, Year End, Ytd
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Oakmark’s David Herro: Quality Has Been Trampled Upon (Morningstar)

Friday, September 16th, 2011

The Oakmark manager says the fund is able to pick up quality names at 60% to 70% discounts amid a market that’s selling first and asking questions later.

Here are some highlights:

• I think the biggest worry, and I heard this from one of my friends who is in the hedge fund business in New York, the biggest worry is people don’t want to get caught like they were in 2008 and perhaps ’09. So they are extrapolating what was the situation in 2008 and 2009, and they are selling first and they are asking questions later.
• Despite the fact, what we are seeing in the real economy, despite all these fears, despite all this volatility and market instability in the financial markets, in the real economy we’re not yet seeing what we saw in ’08 or ’09–nothing like it.
• In fact, in August, BMW reported their best August monthly sales ever. And this is after the August we had in the financial markets. So what we are seeing in the financial world is not transferring to the real economy at this stage, and market participants are behaving like the real economy has already adjusted downward 16 notches, when that is not the case. So you have that going on.
• Number two, this volatility I think was caused by … instantaneous information, instantaneous, and people respond and react instantaneously. Now, I think eventually we are going to get to the “boy who cried wolf” syndrome, where people are going to quit instantly responding because they are going to realize that it is erroneous to do so. So maybe this is why BMW sold more cars in August than ever before, because the consumer says, “oh, yeah, that’s the financial markets again.”
• So … as investors, how do we utilize this environment? What can we do with the volatile environment? We try to take advantage of it. As an example, besides the financials that have been destroyed in August and early September, lot of the industrials in Europe. You take a company like Daimler. Daimler going into August–and this is one of the largest producers of trucks and commercial vehicles as well as Mercedes automobiles–was trading at nine times earnings and had a dividend yield of about 5%, payout ratio of about a third. So, plenty of room on the dividend, still yielding 5%. Today, the dividend yield of Daimler is probably closer to 6% or 7%, and its P/E is about 6. That is, the stock dropped over 35% in one month. Now, is Daimler worth 30% or 35% or 40% less today than it was in the middle of July? Our view is no, but the markets are so scared they just wanted out of any European industrial, and you could see it across the board. A company like Akzo, which is Dutch company that makes paints and coatings, same thing.
• So, we try to take advantage of that. Again, our view is the value of the business is not the next couple of quarters of free cash flow and earnings. It’s the next three, five, 10, 15 and into perpetuity, discounted to the present value. That’s what makes the business valuable. Mr. Market, unfortunately or fortunately, fortunately because we like to take advantage of it, is concerned about the next couple of weeks, months, and quarters. However, value is derived from today to perpetuity, and that is where a patient long-term investor could profit.

Source: Morningstar, Inc., September 13, 2011

Tags: Bmw, Boy Who Cried Wolf, Daimler, David Herro, Early September, Fears, Financial Markets, Fund Business, Hedge Fund, Industrials, Market Instability, Market Participants, Morningstar, Notches, Oakmark, Quality Names, S David, Volatile Environment, Volatility, Wolf Syndrome
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Choose Quality Names in Economic Turbulence

Monday, June 6th, 2011

by Vikash Jain, ArcherETF

iShares CDN S&P/TSX 60 ( Ticker: XIU )

What a rough start to an otherwise beautiful summer. Markets around the world fell sharply on Wednesday on a torrent of weak economic data. But there are good reasons for equities to rise after this setback. For investors, a continued focus on ETFs holding quality names is essential.

Renewed fears of an economic slowdown triggered last Wednesday’s sell-off. New data showed US manufacturing did not grow as fast in May as it had in prior months. Housing data from the day before had showed US home prices were down 4% this year, bringing the average home value back to 2002 levels. The poor numbers pushed up US bond prices as investors looked for safety. Demand for 10 year bonds pushed their yields below the significant 3.00% level for the first time this year. The irony is that the US has hit its debt ceiling and the US Federal Reserve will end its bond purchases at June-end: both factors that should be pushing yields higher. All this, plus persistent unemployment, left Americans feeling glummer than they did in April.

And misery loves company. Europeans watch in fear as the SS Athena sinks slowly. A year since the first life rafts set out and the Greeks have done little to improve their finances. Now under duress, they are considering selling assets (Get your islands here!). In the meantime, the yields on Greek sovereign bonds hit 16.5%, the highest ever, while German bunds are at 3%. Turns out the cruise ship Athena was really a junk.

This turmoil has confirmed what our central banker, Mark Carney, said in his statement last week: that the economy is growing, in both Canada and globally, but the recovery is still fragile, especially in the US and the Euro-periphery, and that while food and gas prices have pushed up inflation, it should moderate from here. As a result, Mr. Carney left rates unchanged but said a rate hike would come as soon as possible. As I wrote last week, this wait-and-see policy is exactly what the US Fed has adopted.

Which brings us to the good news. Central bankers are worried and ready to do anything to avoid a repeat of 2008. They will keep rates low. They may even keep the stimulus tap open longer than they say they will. Both Mr. Carney and Ben Bernanke, the US’ central banker, have said they have no firm timeline for withdrawing stimulus funds. I don’t argue the merits of the policy. I simply accept it. Since the lows of March 2009, low interest rates and government stimulus have fed the rally in equities, commodities, even, some would say, the surge in merger activity. As long as money supply remains plentiful, it is better to be in equities.

The benign financial conditions bode well for equities. Yield spreads – the difference between short and long term interest rates – are wide. Typically, they narrow when financial stress is high. Corporate profits are strong, as the latest earnings showed. Corporate balance sheets are flush, as the boom in merger activity shows. Even US housing values are at or near their bottom as renting has  become costlier  than owning.

There are other positive signs. Commodity prices, victims of their own success, have fallen from their March highs as they suppressed economic growth. OPEC, for the first time since 2007, is considering boosting production to help ease prices. Good news for the US, China and India – all net importers – whose growth has suffered from $100+ crude.

In this investment environment, investors would do well to select ETFs of quality stocks of companies that can sustain some turbulence. For Canada, that means the S&P TSX 60 index of the 60 biggest companies. It avoids the smaller firms that make up a quarter (by weight) of the S&P TSX Composite. There are two TSX 60 ETFs to consider: 1) the iShares S&P TSX 60 ETF (XIU), the oldest, largest, most liquid ETF in Canada; and 2) the Horizons S&P/TSX 60 TR (HXT). HXT is much smaller and not as liquid as  XIU but has a couple of advantages: its annual MER, at 0.07% ($7 per $10k), is less than half of XIU’s; to defer taxes, rather than paying out, it reinvests its dividend.

The archerETF Global Tactical Portfolio

archerETF offers Global Tactical Portfolio Management.

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

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

Copyright © ArcherETF

Tags: 10 Year Treasury, Beautiful Summer, Bond Prices, Bunds, Canadian Market, Crude Oil, Cruise Ship, Debt Ceiling, Economic Data, Economic Slowdown, Economic Turbulence, Ishares, Life Rafts, Mark Carney, Misery Loves Company, Persistent Unemployment, Poor Numbers, Quality Names, Rate Hike, Sovereign Bonds, Summer Markets, TSX 60
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Get Ready to Load the Boat With Tech Stocks

Wednesday, May 26th, 2010

This article is a guest contribution by John Thomas, Mad Hedge Fund Trader.

There is one sector that hedge funds have an absolute laser focus on in the melt down and that is technology stocks. This is where they will be pouncing at the first sign of an upturn, like a famished tiger. Some of the highest quality names have had the biggest falls, and they are now flaunting dividend yields greater than the 3% found on 10 year Treasury bonds. Look at Intel (INTC), which at $20 is selling at a paltry 11 times earnings and a 3% dividend yield, and generates the bulk of its sales in the highest growth sectors of the global economy. After the dotcom bust of 2000, these bad boys spent nearly a decade in the penalty box, shunned by the investing world as the poster boys for wild excess. Think Robert Downey, Jr. on steroids. During this time, cash balances doubled, free cash flows soared, outstanding shares shrank, and multiples fell to a tenth of their bubblicious peaks.  I started recommending this group at the absolute bottom of the market last March (click here for the call), and it was no surprise to me when they outperformed almost every sector on the upside. With 60%-80% of their earnings coming from abroad, primarily Asia, I saw them really as foreign stocks wearing cowboy hats, pearl snap buttoned shirts, and Ray Ban aviator sunglasses. They did not need banks, as they are almost entirely self financed, immunizing them from the credit crunch. They avoided many of the management errors that torpedoed so many other US firms, like derivatives books, leveraged real estate exposure, and LBO debt. While their American customers were getting poorer, hundreds of millions more overseas were getting richer.

The industry represents the last, best hope that America has for competing globally, as it is our only means of staying on top of the international value added chain. It seems that in addition to bulk commodities like corn, wheat, soybeans, coal, timber, aircraft, weapons, and movies, tech companies are among the few that make things foreigners want to buy. The lessons of the bubble made them ultra conservative in their capital spending, which will lead to product shortages and much higher prices in any recovery. Memory, for example, has seen no capex at all for three years. They are surfing the wave of innovation, and will cash in big time from the mobile computing revolution, cloud computing, and the virtualization of data centers. During the last tech bubble, the industry did not have the global market that it does today. Now, demand from the rising emerging market middle class is kicking in, as it is for commodities. The 13 month tech rally we saw from the 2009 lows could just be the down payment of a decade long bull market in these stocks, which will end with another bubble. When John Chambers, a first class manager, discussed Cisco’s (CSCO) outlook after announcing blowout Q4 earnings, he was so effusive he sounded like he was on ecstasy. Take a look at IBM (IBM), Juniper Networks (JNPR), JDS Uniphase (JDSU), Sandisk (SNDK), Micron Technology (MU), and lithography toolmaker (ASML). Long dated call spreads in any of these make sense on a decent dip. You can also look at the Technology Select Sector SPDR (XLK), the PowerShares QQQ (QQQQ), or the leveraged ProShares Ultra Technology (ROM).

Copyright (c) May 27, 2010 – MadHedgeFundTrader.com

Tags: 10 Year Treasury, Commodities, Corn Wheat, Cowboy Hats, Credit Crunch, Derivatives Books, Dividend Yield, Dividend Yields, Dotcom Bust, Fund Trader, Growth Sectors, Intc, Laser Focus, Management Errors, Poster Boys, Quality Names, Ray Ban Aviator, Ray Ban Aviator Sunglasses, Robert Downey, Robert Downey Jr, Technology Stocks
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