Posts Tagged ‘Risky Asset’
Sunday, November 20th, 2011
by Matt Tucker, iShares
A few weeks ago, my colleague Russ blogged about the preference skittish investors are showing for cash. Given the volatile market conditions and uncertain political environment, it’s understandable that investors are finding comfort in cash.
But Russ gave three reasons why moving to cash might be a mistake, and he said it is worth considering keeping some equity exposure. I agree with Russ that staying on the sidelines could be a mistake, and I would emphasize that for investors looking to reduce portfolio risk there are a number of fixed income ETF solutions available.
For investors who crave the comfort of cash, short duration vehicles could be a good way to dip your toes into the fixed income market. Here are three reasons why:
1. No long-term commitment
Fixed income ETFs trade throughout the day on a stock exchange, giving you flexibility and the ability to nimbly adjust your exposure. Say, for instance, you become concerned about risk. You can sell a risky asset class and access a fixed income ETF intra-day. If the market changes, you can then sell the ETF and re-deploy your proceeds.
2. Potential for higher yields than money market funds
iMoneynet reports that the 30-day average yield on money market funds as of November 8 is 2 basis points. Investors who do not seek a stable net asset value and who are looking for higher yields may find fixed income ETFs to be an interesting option. For investors who want to keep interest rate risk low, but who are comfortable taking on some credit risk, the iShares Floating Rate Note Fund (FLOT) offers investors a 30-day SEC yield of 1.45% as of November 10 with a duration (a measure of interest rate sensitivity) of only 0.14 years. For investors comfortable taking on a low level of both interest rate and credit risk, the iShares Barclays 1-3 Year Credit Bond Fund (CSJ) has a 30-day SEC yield of 1.42% as of November 10 with a duration of 1.85 years. There are also lower risk options like the iShares Barclays Short Treasury Bond Fund (SHV) that has a 30-day SEC yield of 0.04% as of November 10 but that invests solely in US Treasury securities. Past performance does not guarantee future results. For standardized fund performance, please click on the following tickers: FLOT, CSJ, SHV.
The key is that an investor has the control to select exactly the exposures they want, and, by extension, avoid the exposures they don’t want.
3. Less volatile than longer-term funds if interest rates rise rapidly
Short-duration investments will have lower interest rate sensitivity than longer-term funds. For example, the 0.12 year duration of FLOT means that we can generally expect FLOT’s price to decline by 0.12% if interest rates rise by 1%. By comparison the iBoxx $ Investment Grade Corporate Bond Fund (LQD) has a duration of 7.51, meaning that we could generally expect its price to decline 7.51% if interest rates rose by 1%. (Potential iShares solutions: FLOT, SHY, or CSJ)
The bottom line is that investors who are looking for yields above those provided by money market funds have a range of options to choose from. Just keep in mind that yield isn’t free — it always comes along with some type of extra risk. By understanding what risks you are willing to take and constructing a short duration portfolio appropriately, an investor can design a wide range of potentially higher yielding alternatives to traditional cash vehicles.
Disclosure: Author is long FLOT and SHV
The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com.
An investment in fixed income funds is not equivalent to and involves risks not associated with an investment in cash or money market funds.
For differences on mutual funds and ETFs, please click here.
Buying and selling shares of iShares Funds will result in brokerage commissions.
Bonds and bond funds will decrease in value as interest rates rise. Securities with floating or variable interest rates may decline in value if their coupon rates do not keep pace with comparable market interest rates. Narrowly focused investments typically exhibit higher volatility and are subject to greater geographic or asset class risk. The Funds may be subject to credit risk, which refers to the possibility that the debt issuers will not be able to make principal and interest payments. The iShares Floating Rate Note Fund’s income may decline when interest rates fall because most of the debt instruments held by the Fund will have floating or variable rates. An investment in the Funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
Tags: asset class, Asset Value, Basis Points, Bond Fund, Credit Risk, Csj, Equity Exposure, Fixed Income Market, Interest Rate Risk, Interest Rate Sensitivity, Ishares, Market Changes, Matt Tucker, Money Market Funds, Net Asset, Political Environment, Portfolio Risk, Risky Asset, Skittish Investors, Term Commitment, volatile market conditions
Posted in ETFs, Markets | Comments Off
Thursday, April 14th, 2011
From Nomura’s Bob Janjuah
In Bob’s World USDs are not welcome
My last report (The Sceptical Strategists: Time to fade Jackson Hole) was published nearly two months ago, and after another hectic travel schedule here is an update.
1 – Overall, the issues leading to the 2007-09 crises are still present, and are even worsening in some places. Namely very large global, regional, sectoral and national imbalances (in areas such as incomes, earnings, wealth, trade and financial health); excessive levels of, and excessively narrow concentrations of, debt primarily in Western economies; and significant fat tail risks in the market when it comes to the price of and the levels of assumed volatility. It seems that collectively we learnt nothing from the 2007-09 experience, and the apparent solution to the crisis has been to implement more of the same policies that caused the mess in the first place.
2 – Therefore, as we have said throughout the past four years, we think the key drivers of markets and economies are still the cost of capital (CoC) and balance sheet (BS) strength/financial health. The rising CoC over 2006-09 led to exactly what it always leads to: slower growth, weaker earnings and incomes, and ultimately a default cycle and poor risk asset performance. Since early 2009, primarily through quantitative easing (QE), the CoC fell and has been artificially mispriced in our view since then. This lower CoC also had the usual consequences: more leverage, more debt, and artificially supported, or mispriced, (risky) asset valuations.
3 – As we have discussed previously, the key current global macro themes occupying the market are still:
- In emerging markets (EM) will there be a soft or a hard landing? There is no doubt that a landing is needed in order to address inflation problems, excessive and speculative asset bubbles, approaching cyclical capex peaks, and very real labour squeezes/positive output gaps. But what sort of landing this will be remains to be seen.
- In developed markets (DM) we expect, for the next few years, lower trend growth rates. Already excessive debt levels have worsened, and we continue to expect a weak U-shaped recovery in domestic sectors overlaid by a temporary and highly cyclical super-cycle in manufacturing based largely on demand from the big three EM nations, the BICs (Brazil, India and China).
- In Europe, although we do eventually expect a credible and sustainable solution to Europe?s excessive debt/insufficient equity problem, we expect the crisis to continue for a while yet.
To the above three themes we can now add two more. Firstly, the outlook for Japan after the tragedy, and how it may impact the global economy and any global asset allocation. Second, Arabic unrest/oil price spikes and how such price moves are affecting growth and inflation in both the DM (where growth is the bigger risk), and the EM world (where, in energy and food, inflation is the bigger risk).
Other than the recent shock in Japan, all of the above are clear iterations of the issues discussed in (1) above. Nomura analysts are constantly assessing the shorter-term and medium-term impacts of the triple tragedy in Japan. Of course the nuclear problems are ongoing, but for the Sceptical Strategists the longer-term risk is that Japanese repatriation of its huge net overseas asset position may be hastened by these events. In this context even Japan is an iteration of the problems and issues summarised in (1). Japan has been one of the biggest current account surplus economies for decades, and has as a result been supplying the global economy, especially in the DM, with large amounts of cheap capital. If repatriation becomes a meaningful trend over the next five to ten years as Japan seeks to “service” its domestic deficit and significant (gross – for now the current net position is comfortable) debt burden, then this repatriation will cause the CoC to rise globally. Those predicting the collapse of the Japanese economy should realise that the West is not just addicted to cheap capital from Chinese excess savings/reserves or from the Fed. It has also, over the decades, become very reliant on Japan?s exports of capital!
4 – Our secular asset allocation theme is unchanged – a rising CoC period is, broadly, a risk-off phase, where the strongest BS entities (be they corporate, financial, government or consumer) should relatively (at least) outperform. A falling CoC phase is broadly about risk-on and favours the weakest BS entities. The period from 2007 to early 2009 was a rising CoC, risk-off phase. Early 2009 to the present has been a falling CoC, risk-on phase, albeit punctured by some brutal sell-offs that ultimately forced the Fed into QE2. We strongly believe that the next major secular trend, which will likely begin in 2011 and last through 2012 and maybe even into 2014, will be a rising CoC, risk-off phase where the weakest BS entities will underperform the most.
5 – We discussed at length our tactical asset allocation themes in our previous report two months ago, and we now update them. The first big call we made in late January was that the risk-on trade, expressed via global equity indices, would reach a top of some form in February; we set the S&P 500 target for this February top at 1330/1350. This has worked out well, with the S&P 500 peaking so far this year at 1344 on 18th February. We then expected a (minimum 10%) sell-off in risk assets, with the key risk periods likely to be March and/or April. This call has also worked out well. From the February highs global equity markets sold off close to 10% into the mid-March lows, with some markets well over 10% down but with the US major indices down a little less than 10%. Thereafter we saw two possible paths, either the soft landing path or the hard landing path:
- In the soft landing scenario, where we expect voluntary global policy tightening, driven by EM, we would expect 1350 S&P to act as a ceiling, and this sell-off to end with a 20% fall (from the February) peak to (the end-Q2) trough. Such a sell-off would in our view create a very positive TACTICAL buying opportunity for risk, as it would be the ideal “pause that refreshes” and would take the pressure off global commodity prices, the building global inflation risks, stretched risk asset valuations, and reduce the pressure on rising bond yields in DM.
- Under the hard landing scenario we would expect global policymakers to make even more policy mistakes by failing to tighten, and even more worryingly, by accommodating price shocks, especially in EM. Under this scenario we would expect the 1220 support level to hold for the S&P in Q2 2011, and we would look instead for another melt-up in risk assets over Q2 2011, with the S&P peaking at 1400/1440 by end-Q2. This then would be followed by a very difficult and bearish H2 2011 for risk, as the melt-up in commodities, valuations, expectations, sentiment, inflation, positioning and bond yields would together give the perfect backdrop for a severe hard landing in risk assets. Key here is that QE3 would be delayed until late 2011/early 2012 because of the extremely negative impact that the Fed’s QE2 has had on inflation (globally) and the significant concerns already building about the Fed’s credibility. We think QE3 is still likely, but judge that risk asset markets and the US economy (notably unemployment) will have to worsen considerably before the Fed can make a “credible” case and garner consensus support for QE3. Our view is that over H2 2011, under the hard landing scenario things will get a lot worse. It seems to us that very large amounts of debt and money printing are being used to “buy” a recovery which itself has no real legs (in particular as EM – the BICs – are forced to slow because of their domestic inflation, thus stopping dead the global manufacturing super-cycle which is the only real source of strong growth in the US). And once QE2 stops and other such stimuli are also turned off (fiscal boosts have already had their day, in our view) we think the emperor?s new clothes will be revealed for what they are. Although in this hard landing scenario, in the initial melt-up we think the S&P 500 could reach 1400/1440 by end-Q2, by end-2011 it could be below 1000.
All the evidence of the past few weeks points to the “melt-up then hard landing” path as being the most likely, although for now 1220 and 1350 are still holding, so we still see some hope – albeit diminishing rapidly – for the soft landing outcome. To reiterate, four consecutive S&P 500 closes above 1350 would to us signal the melt-up (1400/1440 S&P 500 by end Q2 2011), to be followed by the hard landing in H2 2011 (1000/sub-1000 S&P 500). Equally, if 1350 provides resistance and the S&P 500 trades below 1220 on four consecutive closes, then in this soft landing path we would expect to see low-1000s on the S&P 500 by end-Q2 2011. The big difference is that under the soft landing path, we would be buyers (tactically, into year-end) of the S&P 500 in the mid-1000s, expecting a bounce back to the 1300s by year-end. Under the hard landing path, a 1000 – even a sub-1000 – S&P 500 would likely not entice us back into high beta DM risk, even tactically, let alone on a secular basis.
6 – Why are we so bearish under the hard landing outcome? The key is that the policy tools needed to respond to a hard landing now are very limited, in our view, perhaps even non-existent in DM (EM/stronger BS nations, e.g. Brazil, Australia, still have plenty of policy flexibility/tools). In the UK and euro zone, we see virtually zero credible policy options from here on in. We think the only “hope” for the West is another policy mistake – in the form of QE3 in the US. But as mentioned above, the “hurdle” over which Mr Bernanke would have to jump to get agreement for QE3 is now much higher because of both domestic and international concerns. So, almost by definition (for us) more QE3 is likely, but only once the situation has become really bad in markets (1000/sub 1000 S&P 500; the UR starts rising again; the hard landing). In our view, the Fed has already put at significant risk its independence and its credibility, which in turn risks leaving both the US dollar and US Treasuries unanchored and as increasingly risky claims on an increasingly risky sovereign balance sheet. We judge that QE3 would significantly increase such concerns.
7 – We think QE3 will be both unavoidable and a grave policy mistake in the hard landing outcome. We think it (QE3) is unavoidable because under this outcome, where we expect a significant slowdown in global growth in H2, driven by an EM slowdown and an end to the global super-cycle in manufacturing, it is the only „stimulative? policy option left, and Bernanke and Obama both seem fixated with stimulus, at any cost it seems. Once this slowdown is apparent it should quickly become obvious that risk asset valuations are way too high, only supported by both overly optimistic growth expectations, and, as a result of QE, by a mispriced CoC; that the Fed has destroyed its credibility; and that there is no, or nowhere near enough “sustainable” growth in the US, in the UK, or in any of the DM. And we think it would be a policy mistake because it would represent all-out debasement and monetisation, which would seriously risk the safe-haven/risk-free/reserve status of the US, of the US dollar and of US Treasuries. And this would only be made worse if the euro zone does indeed solve its problems over the rest of this year, as we expect. We feel that QE3 would risk a very negative outcome whereby US Treasuries start being priced as a risky credit asset (with real yields rising sharply) and where the US dollar would no longer be viewed as any sort of useful store of value. We find it extremely worrying that over the mid-February to mid-March global equity sell-off, where the drivers of the sell-off were not particularly US-centric, the US dollar nonetheless sold off over this period. This is the exact opposite of what has been seen for more than the past two years, and not what the market expected. We worry that it may reflect growing concerns about the US sovereign and US policymakers who may now be turning into the central risk. If this is the case, and, as a result of QE3 the US dollar and US Treasuries become unanchored and are no longer seen as the world?s risk-free assets nor as the ultimate stores of value, then the entire foundations for valuations in financial markets could be at risk.
8 – In summary, the key driver of market returns right now and since early 2009 has been the Fed and its “intentional” mispricing of the true CoC through QE, but we think the Fed is fast approaching the limits of its credibility. We think the Fed is asking investors:
- to lever up at the wrong price;
- to take on risk at the wrong price; and
- to do this at precisely the wrong time in the business cycle.
For this to succeed, the Fed needs to convince investors it can keep the QE-fed Ponzi growing forever, permanently misprice the true CoC without any negative or unintended consequences. The US housing market seems quite clearly to be rejecting this proposition, but the equity market in particular has not. History shows no successful precedent, so under the hard landing path, when the CoC and pricing of risk normalise, as we would fully expect them to, asset prices, especially equities, should be hit very hard. We see this starting in Q3 2011, and likely lasting through 2012/2013 and maybe even into 2014, with QE3 becoming the central risk/problem, rather than the apparent solution. In this significant down move we should expect new lows in weak BS DM and EM equities (not strong BS countries) as in these weak BS nations policymakers, especially the Fed, would likely have little/no credibility and no/extremely limited policy options left (we see QE3 as the Fed?s last big stand). And all it will have achieved in our view, since QE1 and especially QE2 was flagged, is to have encouraged many more investors to wrongly load up on risk, at the wrong price and at the wrong time.
Assuming that the QE3 option is eventually exercised (as we do under the hard landing outcome) and assuming it does what we fear to the credibility and status of the US, the US dollar and US Treasuries, then we think the result, most likely at some point between 2012 and 2014, will be major fx regime changes and significant paradigm shifts in global fx markets. As these changes and shifts occur, gold could perform very well, as could other scarce physical assets (possibly super prime real estate). And the highest quality (by BS strength) nominal corporate assets – top quality equities in other words – may at least on a relative basis (if not absolute) perform fairly well.
Tags: Asset Performance, Asset Valuations, Brazil, China, Coc, Commodities, Emerging Markets, Excessive Levels, Global Macro, Gold, Hectic Travel, India, Investment Outlook, Jackson Hole, No Doubt, Nomura, oil, Output Gaps, Poor Risk, Qe, Risky Asset, Sectoral, Strategists, Travel Schedule, Usds, Western Economies
Posted in Brazil, Commodities, Credit Markets, Energy & Natural Resources, Gold, India, Markets, Oil and Gas, Outlook | Comments Off
Wednesday, March 2nd, 2011
Oil Plays: Short and Long-Term Oil Trades
by Alfred Lee, CFA, DMS, Vice President & Investment Strategist, BMO ETFs & Global Structured Investments
BMO Asset Management
March 2, 2011
- Market concerns of upheaval in the Middle East have led the price of Brent crude to rise given the fear that any revolts may cause disruptions in supply. While the more commonly quoted West Texas Intermediate (WTI) has also gained, a wide spread remains between the two types of oil contracts.
- The current spread between WTI and Brent crude is in excess of three standard deviations from its normalized mean spread. (Chart A) Thus in a mathematical sense, a difference between these contracts or more occurs just 0.5% of the time.
Potential Investment Opportunity:
- Oil tends to be recognized as a “risky-asset” having a tendency to rise and fall with equity market confidence. Its recent surge is due to concerns of political uncertainty in the Middle East choking off crude supplies. Most recently, both Brent crude and WTI gains have outpaced those of oil related equities. In addition, since crude prices began surging on February 22, larger cap oil companies have appreciated, while the smaller-cap oil names have lagged. As demonstrated below in Chart B, there is a correlation breakdown between the larger cap NYSE Arca Oil Index and the Dow Jones North American Select Junior Oil Index. The differential between the large-cap and small-cap indices is partially a result of the market’s recognition that the small-cap names are higher beta names and clearly more akin to “risky assets.” Therefore, larger-cap names have been driven more by oil-beta whereas small cap oil names have been driven by market-beta.
- In addition, smaller-cap companies in the Dow Jones North American Select Junior Oil Index tend to be locally involved businesses and as such produce lighter and sweeter North American style WTI crude. Brent crude prices on the other hand are more reflective of Middle Eastern, European and African production and larger-cap oil companies tend to have global operations. With WTI recently gaining, it will be interesting to see whether market-beta or the WTI will be more of a factor in driving the price of small-cap oil companies.
- While civil unrest in the Middle East may not be resolved overnight, both Brent crude and WTI will likely outperform oil related companies for the time being. Investors looking for a short-term trade may want to consider futures-based exchange-traded funds (ETFs), such as the BMO Energy Commodity Index ETF (ZCE) which incorporates a “smart-roll” feature to mitigate some of the contango related concerns. For investors looking further out, we believe the gap between WTI and Brent crude will eventually narrow, particularly because Saudi Arabia has promised to produce any shortfall in supply. When market risk eventually comes off the table, small-cap oil companies will likely outperform large caps, as we anticipate junior oil companies to continue to price in increased merger and acquisition activity. We therefore think longer term investors should consider the BMO Junior Oil Index ETF (ZJO) and suggest investors look to both the S&P/CBOE Implied Volatility Index (VIX) and CBOE Oil Implied Volatility (Oil VIX) Indicators for appropriate entry points. See Chart C for the recent performance comparison of the two ETFs mentioned in relation to near month ICE Brent Crude.
Chart A: Brent-WTI Crude Spread of This or More is Extremely Rare Occurrence
Source: Bloomberg, BMO Asset Management Inc.
Chart B: Small Cap and Large Cap Oil Correlation Breakdown
Source: Bloomberg, BMO Asset Management Inc.
Chart C: ZJO and ZCE vs. Near Month ICE Brent Crude
Source: Bloomberg, BMO Asset Management Inc.
*All prices as of market close March 1, 2010 unless otherwise indicated.
Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.
BMO ETFs are managed by BMO Asset Management Inc, an investment counsel firm and separate legal entity from the Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange-traded funds. Please read the prospectus before investing. The funds are not guaranteed, their value changes frequently and past performance may not be repeated.
Tags: Alfred Lee, BMO, BMO ETFs, Brent Crude Prices, Cap Companies, Cap Oil, energy, ETF, ETFs, Investment Strategist, Junior Oil, Market Confidence, Mathematical Sense, Nyse Arca, oil, Oil Contracts, Oil Index, Political Uncertainty, Risky Asset, Risky Assets, Spread Chart, Standard Deviations, Structured Investments, Term Oil, West Texas Intermediate, Wti Crude
Posted in Energy & Natural Resources, ETFs, Markets, Oil and Gas | Comments Off