May 16th, 2012

Equity Invest­ing: From Style Box to Global Unconstrained

by Andrew Pyne, PIMCO

• ​ PIMCO sees greater poten­tial ben­e­fit to global port­fo­lios in strate­gies that are uncon­strained by a bench­mark, and with man­agers who think about absolute return at least as much as they think about rel­a­tive return.
• We believe the style box approach resulted in too great a focus on returns rel­a­tive to a very nar­row index and led investors to have too short of an invest­ment time hori­zon in which to eval­u­ate their man­agers, and that the cycles of style per­for­mance and the nar­row bench­marks in the style box world encour­ages man­ager turnover and under­mines long-term port­fo­lio return potential.
• Even though many man­agers have become less active, many con­tinue to charge active fees, and as a result, we believe, the style-box frame­work basi­cally became an expen­sive index strategy.
• At PIMCO, our active equity strate­gies are posi­tioned for this evolv­ing equity land­scape. All of our strate­gies are global, uncon­strained by the bench­mark (seek­ing at least 80% active share), and con­sider down­side risk mit­i­ga­tion as a crit­i­cal part of the client experience.

Most investors are prob­a­bly famil­iar with the “style box” approach to equity invest­ing, but they may not know that the unin­tended con­se­quences of this con­struct may result in underperformance.

In our view, style boxes have con­strained man­agers and lim­ited their oppor­tu­nity set. Instead, PIMCO sees greater poten­tial ben­e­fit to global port­fo­lios in strate­gies that are uncon­strained by a bench­mark, and with man­agers who think about absolute return at least as much as they think about rel­a­tive return. We believe that step­ping out­side the style box allows an active invest­ment man­ager the oppor­tu­nity to lower volatil­ity and improve down­side risk mitigation.

Inside the style box

Let’s quickly review how the style box was often con­structed, sim­pli­fy­ing to three basic steps.

First, the world was divided by region, style and mar­ket cap. Sec­ond, an empha­sis was placed on the investor’s home mar­ket (in this exam­ple the U.S.), with inter­na­tional equity added for diver­si­fi­ca­tion. And third, man­agers were hired to fill a very spe­cific and nar­row role within the port­fo­lio (see Fig­ure 1).

For exam­ple, to fill the large cap value box, often sev­eral man­agers were hired – for man­ager diver­si­fi­ca­tion – and each man­ager typ­i­cally was instructed to stay within that mar­ket seg­ment. They were told not to drift down the mar­ket cap spec­trum, as mid cap and small cap man­agers were play­ing those roles within the port­fo­lio, and they were told not to drift over to growth, as that was the ter­ri­tory of other man­agers. And impor­tantly, these man­agers were mea­sured against a mar­ket cap and style spe­cific bench­mark, in this exam­ple the Rus­sell 1000 Value index.

The attrac­tive­ness of the style box was twofold. In the­ory, it allowed investors to pre­cisely con­trol their equity expo­sures and to hire “spe­cial­ist” man­agers who were expected to deliver strong per­for­mance in their spe­cific area of focus. How­ever, we believe this style box approach has failed investors.

Unin­tended con­se­quences of the style box approach

We believe this approach resulted in too great a focus on returns rel­a­tive to a very nar­row index and led investors to have too short of an invest­ment time hori­zon in which to eval­u­ate their man­agers. By mea­sur­ing man­agers against just a slice of the mar­ket, the cycles of style per­for­mance often dic­tated man­ager success.

Con­sider investor behav­ior in the tech­nol­ogy bub­ble of 1999 to 2000. As tech stocks dom­i­nated the mar­ket, aggres­sive or momentum-oriented man­agers tended to out­per­form their more valuation-sensitive growth-at-a– reasonable-price (GARP) com­peti­tors. These GARP man­agers on aver­age had good absolute returns that in many cases exceeded that of the broad mar­ket, but indus­try flows show that investors tended to hire the more aggres­sive growth man­agers to fill their growth boxes. As the bub­ble burst, though, the val­u­a­tion dis­ci­pline that kept many GARP man­agers largely out of tech stocks helped lessen, for many, dra­matic losses. GARP man­agers appeared “smarter,” hav­ing nav­i­gated the tech bub­ble bet­ter, and as a result they even­tu­ally replaced the momen­tum play­ers as the growth man­agers in many invest­ment portfolios.

This dynamic of the tim­ing of man­ager selec­tion has repeated itself over time, as observed in a 10-year study of man­ager per­for­mance pre– and post-hiring and fir­ing (Fig­ure 2).

These charts sug­gest an ele­ment of per­for­mance chas­ing in the hir­ing and fir­ing of equity man­agers. PIMCO believes that the cycles of style per­for­mance and the nar­row bench­marks in the style box world encour­ages man­ager turnover and under­mines long-term port­fo­lio return potential.

Another draw­back of the style box con­struct is that it may have been the cat­a­lyst for man­agers to “play the game” and become bench­mark ori­ented. It seems many active man­agers rec­og­nized that assets and rev­enues were at risk if they devi­ated too far from the bench­mark, and so they became closet indexers.

Research shows that man­agers have become less active over time (see Fig­ure 3). Accord­ing to Antti Peta­jisto of the NYU Stern School of Busi­ness, Decem­ber 2010, thirty years ago, nearly all U.S. equity fund assets were with man­agers defined as “active” or “highly active,” based on their active share, or the per­cent­age by which their hold­ings dif­fer from the bench­mark. The chart above shows the rise of index funds, which makes sense – we know there has been an increase in pas­sive invest­ing – but sur­pris­ingly, assets in closet index­ers have grown at an even higher rate, such that closet index­ers today rep­re­sent approx­i­mately one-third of all U.S. equity fund assets! At the other end of the spec­trum, assets in highly active man­agers, who tend to invest based on research con­vic­tion and do not have a bench­mark ori­en­ta­tion, have declined from 60% of over­all fund assets to less than 20% today. In other words, it is eas­ier to find man­agers that are bench­mark con­strained than man­agers that are highly active.

Even though many man­agers have become less active, many con­tinue to charge active fees, and as a result, we believe, the style box frame­work basi­cally became an expen­sive index strategy.

The dan­gers of bench­mark hug­ging

The prob­lem with a bench­mark ori­en­ta­tion is that it can cause man­agers to be reac­tive to the mar­ket. Con­sider that indexes fre­quently become dis­torted – think of the weight­ing of Japan in inter­na­tional equity indexes in the late 1980s, the weight­ing of tech­nol­ogy in the U.S. equity and growth bench­marks in the late 1990s, and of finan­cials in value bench­marks prior to the finan­cial cri­sis in 2008.

The closet indexer defines risk pri­mar­ily in bench­mark terms, or track­ing error, and there­fore tends to fol­low the bench­mark weights, i.e., buy­ing more Japan equity as it becomes a larger part of the index, buy­ing more tech­nol­ogy and finan­cials as they become larger parts of the index. While these man­agers are focused on min­i­miz­ing bench­mark risk, they may be cre­at­ing sig­nif­i­cant absolute risk, and when these bub­bles burst their investors learned the painful les­son that low track­ing error does not nec­es­sar­ily mean low risk.

The per­for­mance prob­lems asso­ci­ated with bench­mark ori­en­ta­tion and mea­sur­ing man­agers rel­a­tive to a nar­row index can cre­ate a sig­nif­i­cant chal­lenge for investors. A recent McK­in­sey & Com­pany study (August 2011) cites a grow­ing aware­ness that the struc­ture and mind­set that is entrenched in the invest­ment man­age­ment indus­try needs to change, that bench­marks cre­ate the wrong incen­tives, that man­ager focus should not be just on beat­ing the index, and that fight­ing the rel­a­tive invest­ment mind­set is a con­stant battle.

The case for global unconstrained

Why global? Remem­ber that tra­di­tion­ally equity port­fo­lios tended to be built with a home-market focus, with inter­na­tional equity added as a diver­si­fier. How­ever, cor­re­la­tions between stocks glob­ally have increased over the last decade and have stayed at this ele­vated level (see Fig­ure 4).

In addi­tion, the lines between what it means to be a U.S com­pany and a non-U.S. com­pany are blur­ring, with over 30% of S&P 500 com­pany rev­enues com­ing from out­side the U.S., accord­ing to Gold­man Sachs (2010). As the world has become more inter­con­nected, and as diver­si­fi­ca­tion ben­e­fits fade, we believe the equity clas­si­fi­ca­tions of “domes­tic” and “inter­na­tional” have become out­moded. The impli­ca­tion is that as the world is evolv­ing, man­agers who are not con­strained to a spe­cific region and have a global oppor­tu­nity set may be bet­ter posi­tioned to find the most attrac­tive invest­ment ideas regard­less of com­pany domicile.

Why uncon­strained? Below we show a mea­sure of per­for­mance of global man­agers vs. those that are region­ally con­strained and the per­for­mance of all cap man­agers vs. those that are mar­ket cap con­strained (see Fig­ure 5). The per­for­mance shown is the infor­ma­tion ratio, or excess return over a bench­mark, or alpha, divided by the stan­dard devi­a­tion of that alpha. Infor­ma­tion ratio is one of the risk-adjusted returns employed by con­sul­tants and institutions.

Tags: Absolute Return, Active Share, Benchmark, Benchmarks, Box Approach, Client Experience, Downside Risk, Equity Strategies, Index Strategy, Investment Manager, Investment Time, PIMCO, Portfolio Return, Relative Return, Risk Mitigation, Style Boxes, Term Portfolio, Time Horizon, Unintended Consequences, Volatility
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May 16th, 2012

by Guy Lerner, The Tech­ni­cal Take

Fig­ure 1 shows a weekly chart of the S&P Depos­i­tory Receipts (sym­bol: SPY).  The indi­ca­tor in the lower panel is con­structed from the 9 SP500 sec­tor ETF’s (data hid­den).  The indi­ca­tor assesses the rel­a­tive strength of each sec­tor uti­liz­ing a 13 week look back period.  As you can see, the indi­ca­tor is rolling over.

Fig­ure 1. SPY/ Rel­a­tive Strength/ weekly

Now look at fig­ure 2 which is the same graph, but this time I have added an ana­logue of our “dumb money” indi­ca­tor in the lower panel.  (When the value is “up”, that means there are too many bears, which is a bull sig­nal.)  Going back to 2000, the break­down in the indi­ca­tor is asso­ci­ated increas­ing num­ber of bears.  The gray ver­ti­cal lines indi­cate those two times where the break­down in mar­ket inter­nals failed to bring about the bears.  As mar­ket inter­nals (i.e., sec­tor ETF’s) are break­ing down, it is my expec­ta­tion that investors will turn bear­ish.  Shortly after that, it will be time to buy.

Fig­ure 2. SPY/ Rel­a­tive Strength/ Investor Sentiment/weekly

Tak­ing another per­spec­tive, I still con­tend that it is too early to “BTFD”.  Look­ing at this data, we still need to wait for investors to turn bearish.

Copy­right © The Tech­ni­cal Take

Tags: Amp, Analogue, Bears, Copyright, Depository Receipts, Dumb Money, Expectation, Figure 1, Graph, Guy Lerner, Investor Sentiment, Investors, Nbsp, Perspective, Relative Strength, S&P500, Spy, Vertical Lines
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May 16th, 2012

by Peter Tchir, TF Mar­ket Advisors

In the movies there are these great bat­tles fought out between the trans­form­ers and decep­ti­cons. As cool as the bat­tles are, there must be some inno­cent bystanders won­der­ing what the heck is going on amid all the destruc­tion. That to me is how the credit mar­kets are trad­ing right now.

None of the core sto­ries have changed. Europe is a mess and has got­ten weaker. The U.S. econ­omy is doing okay, and ZIRP is here to stay even if QE3 isn’t immi­nent. Into that already com­plex world we have thrown the JPM trade into the mix. There seems to be a bat­tle between JPM and those against JPM. That bat­tle is caus­ing car­nage across the credit mar­kets. We are see­ing big and weird moves on a reg­u­lar basis. IG gaps out while stocks do noth­ing. MAIN goes wider while XOVER is tighter, only to go back to mov­ing in lock-step. JNK saw its sin­gle biggest share redemp­tion. Both HYG and JNK chug along all day only to have big fades late into the day. MUB has a steep drop only to bounce right back. What­ever bat­tle between the big guys is going on drags every­one else into it. Stop losses are being hit. The price move is caus­ing con­cern that this is just like 2011 again.

It isn’t like 2011 right now for a cou­ple of key rea­sons. The trans­form­ers and decep­ti­cons aren’t bat­tling over the fun­da­men­tals, they are bat­tling over posi­tion­ing. That is real and has con­se­quences, but once that bat­tle is over, the mar­ket will look at the fun­da­men­tals. So that is one key dif­fer­ence, that in addi­tion to the usual fight between the bulls and the bears, this mas­sive unwind, or poten­tially fake unwind, or unwind of the hedge of the alleged unwind, or some­thing, is adding to the volatil­ity and mak­ing the fixed income mar­ket seem more scary than it is.

LTRO is the other big dif­fer­ence. For all the talk about LTRO being a “carry” game to buy sov­er­eign debt, LTRO at its core was designed to ensure that banks have enough money. While the debate rages about what Greece will do, and how bad the sit­u­a­tion in Spain and Italy is, there is vir­tu­ally no talk about banks not being able to fund them­selves. Peo­ple can look at 2 year swap spreads for signs of stress, and they are there, but be care­ful not to over-react. LTRO is there so that we don’t see a “run” on the banks. I doubt another LTRO would be cre­ated merely to try and sup­port sov­er­eign debt, but if there is a need to get money to banks, the ECB will do that. The ECB, with­out a doubt, is lender of last resort to banks, and is happy and able to ful­fill that func­tions, so that is a big dif­fer­ence between now and 2011.

Greece leav­ing the Euro would be a big deal because of what it would do for all the cor­po­rate loans that have been made. That is yet another rea­son that leav­ing the Euro will take more time than peo­ple want to think. Even if it was easy at the sov­er­eign level, which it isn’t, and the cor­po­rate level it has the poten­tial to cause immense con­fu­sion. All of this can be addressed over time, but real plans need to be put in place and solu­tions to prob­lems thought out, and some resources set aside to deal with unex­pected prob­lems. While that prepa­ra­tion is going on, look for the ECB, and the Troika to soften their tone as they decide that they can­not eas­ily deal with the losses they would face on their own Greek exposure.

So, I would be look­ing to add expo­sure to credit, par­tic­u­larly U.S. high yield, and pos­si­bly in IG, as I think the mar­ket has been dri­ven around too much by noise of this alleged unwind (I still think there is a real pos­si­bil­ity that prior to the press con­fer­ence JPM pre­pared them­selves well for the obvi­ous mar­ket reac­tion and is ben­e­fit­ting greatly from the widen­ing and the volatility).

The fact that we tried to rally and then failed yes­ter­day is a sign of how ten­u­ous the over­all mar­ket is, but right now I can’t help but think the same sto­ries will have less of an effect, and that we are close to the point where Europe man­ages to take some steps that at least seem to help the prob­lems, if not resolve them.

Tags: Big Guys, Carnage, Credit Markets, Decepticons, Enough Money, Fades, Fixed Income Market, Great Battles, Hyg, Innocent Bystanders, Jpm, Key Reasons, Mub, Price Move, Sovereign Debt, Steep Drop, Transformers, Volatility, Weird Moves, What The Heck
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May 16th, 2012

Via Nic Colas of Con­vergEx,

Sum­mary: India is known for its his­tor­i­cally high per capita demand for gold, par­tic­u­larly before fes­ti­vals and the wed­ding sea­son, which peaks in the months of Octo­ber to Decem­ber. With more than ¼ of the entire global world mar­ket for the metal, the coun­try has long been lead­ing world demand, though fel­low BRIC mem­ber China is catch­ing up. But recent devel­op­ments in India have gold bugs stir­ring – protests, boy­cotts, and a pro­posal for a tax on the sale on gold jew­elry has severely damp­ened demand ahead of one of the most lucra­tive fes­ti­vals in the coun­try. And with global gold prices down more than 10% since their Feb­ru­ary high of $1,787.75, there seems to be good rea­son to worry about India’s role in the decline. But a longer-term analy­sis of Indian demand, global gold prices, and global GDP yield some sur­pris­ing results about the country’s con­nec­tion to the metal. While accel­er­a­tion in gold prices and Indian GDP seem to link up as do Indian demand and global GDP growth, increases in demand have lit­tle cor­re­la­tion to gold price growth. Sim­i­larly, ram­pant infla­tion has almost no role in sti­fling demand for the metal. If these cor­re­la­tions hold true in 2012, gold investors might be able to sleep a lit­tle easier.

Gold trend-adjusted sea­sonal per­for­mance...

Note from ZH: We did a lit­tle sea­son­al­ity check (chart above — black dot­ted line) and noted three things: 1) 2012 (orange) so far is look­ing a lot like 2009 (green) — which neared its trough around this period; 2) Trend adjusted, the period from late Feb­ru­ary to early June is a weak cycle (red arrow on regres­sion chan­nel) which is fol­lowed by a trend-adjusted upwards bias through the sum­mer; and 3) Trend adjusted, the period from mid-October to early Decem­ber is a very strong cycle

Note from Nic:  A recent arti­cle in The New Yorker about a sur­pris­ing find in an ancient Indian tem­ple got me think­ing about gold, the sub­con­ti­nent, and Char­lie Munger’s recent com­ment that “Civ­i­lized peo­ple” don’t buy pre­cious met­als, but rather finan­cial assets like stocks.  Gold has, in fact, been in a bit of a freefall of late, so I asked Sarah to pick up these dis­parate thoughts and see where they lead.  Her note, on Indian gold demand, fol­lows here...

In the sum­mer of 2011, while U.S. politi­cians were hotly debat­ing the lat­est increase in the Fed­eral debt ceil­ing, Indian author­i­ties were fac­ing quite the oppo­site sit­u­a­tion: what to do with $22 bil­lion worth of gold and rare jew­els dis­cov­ered under a tem­ple in the south­ern state of Ker­ala. Rumors that the Sree Pad­man­ab­haswamy tem­ple sat on top of a horde of riches go back cen­turies, the result of mil­len­nia of dona­tions to the gods, but the sto­ries were only con­firmed after a for­mer Indian Police Ser­vice offi­cer peti­tioned the Indian Supreme Court to order the open­ing of the tem­ple to ensure “trans­parency in the run­ning of the Trust” which over­seas tem­ple finances. The dis­cov­ered wealth – which exceeds the annual edu­ca­tion bud­get for the entire coun­try – is now in limbo as two par­ties face off for own­er­ship of the for­tune. The Tra­van­core Royal House, charged with the main­te­nance of the tem­ple since the 18th cen­tury, assert that the riches belong to the gods they were offered to – and many Hin­dus in the region sup­port their cause. Oth­ers think the wealth should be dis­trib­uted to the poor; that $22 bil­lion (and it could be far more once def­i­nitely val­ued) could poten­tially feed, clothe, and shel­ter every cit­i­zen of the region for years to come. The deci­sion is ulti­mately up to the Indian Supreme Court, who have already sta­tioned two dozen police offi­cers around the tem­ple for 24/7 sur­veil­lance. Just in case.

The $22 bil­lion trea­sure found in Ker­ala is astound­ing, to say the least, but it rep­re­sents barely half of the $46.4 bil­lion Indi­ans spent on gold in 2011. And while you may have read about West­ern cen­tral banks, Chi­nese cit­i­zens, and scores of other buy­ers for the yel­low metal, India in fact out­paces every other coun­try on the planet in gold consumption:

• In 2011, India was the clear leader in global gold demand with 27.1% of the mar­ket, accord­ing to the World Gold Council’s statistics.
• 61% of this spend­ing went to jew­elry, while 39% went to coins, bars, and other invest­ments. This ratio has been con­verg­ing for sev­eral years: in 2006 73% went to jew­elry and 27% to other investments.
• China has been slowly clos­ing in on the lead, how­ever, with 22.3% of the global gold mar­ket last year. 67% of this went to jew­elry and 33% to other investments.
• Gold ETFs got their start in India in 2007, and the seven such funds on offer to Indian cit­i­zens now have $1.9 bil­lion in assets under management.
• The next clos­est coun­try in the ranks after India and China is the US, rep­re­sent­ing a much smaller 5.7% of global demand.

Clearly, India and China together are imper­a­tive to the global gold trade, as they account for almost half of all global demand.

In fact, as we show in the charts fol­low­ing above and below and the few data points below, the gold trade is a use­ful proxy for Indian eco­nomic growth, and demand from both of these coun­tries is strongly con­nected to global GDP acceleration.

• Annual Indian GDP accel­er­a­tion or decel­er­a­tion has a 0.4 inverse cor­re­la­tion with accel­er­a­tion or decel­er­a­tion in gold prices. In other words, when gold prices increase by a greater amount than the year before, it’s likely that Indian GDP will decel­er­ate that same year. We’ve used the last six years as the base­line for this com­par­i­son, encom­pass­ing both the tur­moil of the Finan­cial Cri­sis in west­ern economies and India’s volatile GDP growth rates of any­where from 6–10% over the period in question.
• China’s accel­er­a­tion, on the other hand, is vir­tu­ally uncon­nected to gold prices with a 0.03 R² over the same period. Clearly India is sig­nif­i­cantly more depen­dent on gold’s price appre­ci­a­tion than their neigh­bors to the East.
• When this same cor­re­la­tion is lagged by one year – 2011 gold price accel­er­a­tion matched up with 2010 GDP accel­er­a­tion, for exam­ple – the cor­re­la­tion is essen­tially per­fect: 0.9965. So if the Indian econ­omy accel­er­ated in 2011, you can prob­a­bly expect gold prices to fol­low suit in 2012, and vice versa. In China, this cor­re­la­tion is much weaker at 0.53, but still sig­nif­i­cant for a one vari­able eco­nomic analysis.
• Annual accel­er­a­tion and decel­er­a­tion in Indian and Chi­nese gold demand also have an almost per­fect cor­re­la­tion to annual global GDP growth: 0.94 and 0.95, respec­tively. Essen­tially, when demand in these two coun­tries drops, based on this cor­re­la­tion you might see global GDP fall as well.

Given this data, it is under­stand­ably con­cern­ing to fans of the yel­low metal that Indian gold demand has not been as robust as expected so far this year. Part of the slow­down is due to a series of shut­downs by gold mer­chants, who closed shop for 20 days at the end of March to protest a rise on an excise tax on gold jew­elry sales and a dou­bling of the import duty on the metal to 4%. And though the excise tax is now off the table, by one esti­mate (from the Bom­bay Bul­lion Asso­ci­a­tion) gold mer­chants were see­ing 50% less vol­ume than the year ago period just before the Akshay Tri­tiya fes­ti­val in late April, a tra­di­tion­ally strong period for gold sales. Some of the decline can also be attrib­uted to ris­ing infla­tion, accord­ing to some ana­lysts: at 7.18% year-over-year so far in 2012, the rupee is down 8% in dol­lar terms and there­fore rep­re­sents a dimin­ished source of gold pur­chases which are dollar-based.

But there are sev­eral rea­sons not to be pes­simistic about gold prices even with the recent rel­a­tive decline in Indian demand:

• Gold prices are heav­ily cor­re­lated to the U.S. dol­lar – a strong green­back hurts gold demand around the world by lift­ing local prices.  The Indian Rupee has fallen vic­tim to the global “Risk off” trade in recent weeks, falling below 54/dollar for the first time since last Decem­ber.  At the same time, the Reserve Bank of India has report­edly launched aggres­sive inter­ven­tions in the cur­rency mar­ket to sup­port the local cur­rency.  And while we’re reluc­tant to base any invest­ment analy­sis on the counter-market moves of any cen­tral bank’s activ­i­ties, there is a lot at stake for the RBI in this case.  India, you see, has very lit­tle in the way of energy reserves and must import most of its oil – 80% by some counts – from over­seas.  And those prod­ucts are also priced in dol­lars, just like gold.  A stronger Rupee is there­fore crit­i­cal to con­tin­ued eco­nomic growth, with gold demand in India an inci­den­tal ben­e­fi­ciary of this dynamic.
• China is more than mak­ing up for the loss. Indian demand dropped by –7.2% in 2011, from 1,006.3 total tons in 2010 to 933.4. Chi­nese demand increased 21.7%, from 666.8 to 811.2. That’s a net gain of 71.5 tons. And with an annu­al­ized demand increase of 22.9% since 2006, it’s likely that China may sur­pass India as the largest gold con­sumer in the world in the next few years.

There is even cause to be bull­ish, if our Indian GDP cor­re­la­tion can be believed. The IMF projects that the Indian econ­omy will decel­er­ate by –0.9% this year, to 6.9% from 7.8% in 2011. If we plug in this –0.9% decel­er­a­tion into the for­mula derived from “Change in annual Indian GDP growth vs. change in annual gold price growth”, we find that gold prices may actu­ally accel­er­ate by 2.8% in 2012 – mean­ing they will grow an addi­tional 2.8% to the 27.2% appre­ci­a­tion from last year, result­ing in a 30% increase. Based on yesterday’s clos­ing prices, that puts the metal at $2,022.15 – just above the $2,000 mark some ana­lysts have forecast.

The thought that a decline in the rate of Indian eco­nomic out­put would cause an increase in local demand is not as tor­tured as it might seem.  The appeal of gold is largely based on its long-proven value as a store of wealth.  The vaults at the Indian tem­ple where we started this note weren’t filled with IOUs from Roman traders or shares of stock from the old East India Com­pany.  That’s good news for the Hindu gods that first received these gifts, as well as their mod­ern adher­ents who may ben­e­fit from the cen­turies of dona­tions.  Gold does hold its value over long peri­ods of time, and no coun­try has a bet­ter case study of that fact at the moment than India.  So even if the econ­omy there does slow­down in 2012, the resul­tant uncer­tainty doesn’t pre­or­dain a decline in gold demand.  It may even help.

While none of this guar­an­tees that gold will expe­ri­ence some kind of mete­oric rise to $2k, espe­cially given all the other fac­tors that con­tribute to prices, I think it’s safe to say that the sup­posed soft­en­ing demand in India shouldn’t be too con­cern­ing. China is emerg­ing as a crit­i­cal con­sumer of gold on the world stage, and may even sur­pass India this year if trends con­tinue. The coun­try has more than off­set declines in demand from their south­east­ern BRIC part­ner, and has helped drive up world con­sump­tion at a time when many other coun­tries – par­tic­u­larly our own – are drop­ping out. The US has bought 42% less gold than it did in 2006. So when it comes to declin­ing gold prices, don’t jump to blame India. After all, it isn’t even wed­ding sea­son yet...

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Tags: Boycotts, Charlie Munger, Colas, Gdp Growth Increases, Global Gdp, Global World, Gold Bugs, Gold Investors, Gold Jewelry, Gold Price, Gold Prices, Indian Temple, Member China, Performance Note, Period 2, Rampant Inflation, Red Arrow, Seasonal Performance, Seasonality, Wedding Season
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May 16th, 2012

Via Mark J. Grant, Author of Out of the Box,

“I'm not upset that you lied to me, I'm upset that from now on I can't believe you.”

                                          –Friedrich Nietzsche

The words were spo­ken by many; Juncker, the Ger­man Finance Min­is­ter, Merkel, Bar­roso, Monti and you can just keep going. They all said the same thing about the Greek PSI, “This is the best and final offer.” Each into­na­tion was made with great moral sua­sion; each speech was directed toward the world’s insti­tu­tional investors as we were reminded again and again that there was no “Plan B.” In the end most money man­agers swal­lowed the bit­ter pill, given such force­ful pro­nounce­ments and took the deal offered on the $261 bil­lion swap only to watch the value of the new bonds sink into hori­zon but no choice was given so there was noth­ing else, really, that could have been done.

“Trust ... plays a key role in eco­nomic exchange and pol­i­tics. In the absence of trust among trad­ing part­ners, mar­ket trans­ac­tions break down. In the absence of trust in a country's insti­tu­tions and lead­ers, polit­i­cal legit­i­macy breaks down. Much recent evi­dence indi­cates that trust con­tributes to eco­nomic, polit­i­cal and social success.”

                –The sci­en­tific jour­nal, Nature

Of all of the events of yes­ter­day, of all of the news, the most sig­nif­i­cant in my view was the announce­ment that Greece had paid off the $554 mil­lion bond matu­rity that was due yes­ter­day and paid it off in full; 100 cents on the Dol­lar. With approx­i­mately $6 bil­lion left in inter­na­tional bonds out­stand­ing gov­erned under some law besides Greek law two things are now obvi­ous; there was a Plan B and it was just imple­mented and that Brus­sels and Berlin sup­ported the Greek pay-off as there was not one peep of objec­tion from any cap­i­tal in Europe. What we were told, con­se­quently, was not the truth and no finan­cial par­a­digm can last for long when they lie to investors and breach the trust that had been placed in them.

"If you take a broad enough def­i­n­i­tion of trust, then it would explain basi­cally all the dif­fer­ence between the per capita income of the United States and Soma­lia. That sug­gests that trust is worth $12.4 tril­lion dol­lars a year to the U.S., which, in case you are won­der­ing, is 99.5% of this country's income.”

                 –Steve Knack, Senior Econ­o­mist at the World Bank

With the yield on the Ital­ian ten year hov­er­ing around 6.00% now and the yield on the Span­ish 10 year fluc­tu­at­ing around 6.50% the mar­kets are clearly react­ing to the breach of faith that has been demon­strated by Europe. This morn­ing the Prime Min­is­ter of Spain said that “Spain faces the seri­ous risk of being shut out of the mar­kets.” This com­ment, by the way, may be the pre­cur­sor to Spain turn­ing to the EU/ECB/IMF for help and then between the total break­down in gov­er­nance in Greece and a plea for finan­cial assis­tance from Spain is a spot, a line in the sand, where not only Angels but any ratio­nal man should well have great fear to tred.

If indi­ca­tions become real­ity then we are faced with a left­ist gov­ern­ment in Greece that will either rene­go­ti­ate a new bailout agree­ment with Europe or it will head back to the Drachma or be forced there by the refusal of Euro­pean Union to pro­vide any addi­tional funds. In Spain we are faced with bare bones arith­metic where the coun­try can­not bailout its Regional debt and its back debt because they do not have the cap­i­tal to do either; much less both. Both coun­tries can flop about for a brief period of time but the con­clu­sions are unavoid­able I am afraid and so a very unpleas­ant land­scape awaits us in the com­ing days. I have warned about all of this for quite some time and I have ham­mered upon it in recent days as equi­ties, credit/risk assets, the Euro have all declined in value as I had pre­dicted. There may well be a bounce or two along the way but I con­tinue to main­tain that dark days lie ahead based not only upon fun­da­men­tals but based upon a union in Europe that has been decep­tive in pre­sen­ta­tion and deceit­ful in prac­tice. Much of this could have been avoided, should have been avoided, but whether it was the Euro­pean bank stress tests, the inac­cu­rate debt to GDP ratios or the state­ments on the Greek bailout; Europe has sys­tem­i­cally, method­olog­i­cally and pur­pose­fully tried and tried hard to mis­lead not only investors but the pub­lic in the most shame­ful of man­ners. The lia­bil­i­ties that they have deemed “con­tin­gent” which have not been counted or used as a part of any bal­ance sheet are now begin­ning to come home to roost and the fal­si­fi­ca­tion by omis­sion can no longer be denied as real losses are taken. The lies of the State always give way to the truth of the num­bers in the end and the end is nigh on a num­ber of fronts. Long live the Emperor with­out any clothes but the poor fel­low is naked no mat­ter what is said.

In the last 10 days there has been a run on the Greek banks with the Pres­i­dent of Greece announc­ing this morn­ing that almost $1.27 bil­lion has been pulled from their cof­fers in the last 10 days. The same kind of sit­u­a­tion is begin­ning in Spain as peo­ple and insti­tu­tions react to the unfold­ing truth. Bloomberg reports this morn­ing that Mr Papou­lias said he had been warned by the cen­tral bank and finance min­istry that the coun­try faced “the risk of a col­lapse of the bank­ing sys­tem if with­drawals of deposits from banks con­tinue due to the inse­cu­rity of the cit­i­zens gen­er­ated by the polit­i­cal sit­u­a­tion”. Wolf­gang Schauble, the Ger­man finance min­is­ter, stated his view quite clearly this morn­ing, warn­ing that unless Greece deliv­ers a gov­ern­ment that hon­ors the terms of the bail-out, that “the coun­try will have to leave the Euro.”   Chris­tine Lagarde, head of the IMF, warned she was “tech­ni­cally pre­pared for any­thing” and said the effect was likely to be “quite messy” with risks to growth, trade and finan­cial mar­kets. “It is some­thing that would be extremely expen­sive and would pose great risks but it is part of options that we must tech­ni­cally con­sider.” If Greece defaults on its debts it is a $1.3 tril­lion dol­lar num­ber, for­get the dri­vel that you read in the press because it will not just be the sov­er­eign debt but the munic­i­pal debt, the deriv­a­tives, the bank debt, the cor­po­rate debt and all of the oblig­a­tions of the coun­try that will fall into the sink­hole of no return.

Actu­ally the cor­rect response to all of this will sur­prise you. You must go out and get the cor­rect pair of sun­glasses. That is the answer.

“Joo Janta 200 Super-Chromatic Peril Sen­si­tive Sun­glasses have been spe­cially designed to help peo­ple develop a relaxed atti­tude to dan­ger. At the first hint of trou­ble, they turn totally black and thus pre­vent you from see­ing any­thing that might alarm you.” 

               –Dou­glas Adams, The Restau­rant at the End of the Universe

Tags: Absence Of Trust, Bitter Pill, Bond Maturity, Economic Exchange, Friedrich Nietzsche, German Finance Minister, Greek Bank, Greek Law, Institutional Investors, International Bonds, Intonation, J Grant, Journal Nature, Juncker, Market Transactions, Money Managers, Moral Suasion, New Sunglasses, Political Legitimacy, Social Success
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May 15th, 2012

May 14, 2012

by Liz Ann Son­ders, Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.

Key Points

• We believe the stock market's cor­rec­tion is likely to be less severe this year rel­a­tive to 2010 or 2011.
• Be aware of the pos­si­ble per­ils of fol­low­ing a "sell in May" trad­ing strategy.
• For now, macro concerns—including Europe and the loom­ing "fis­cal cliff"—are trump­ing bet­ter micro news.

The stock mar­ket is in cor­rec­tion mode and investors are on edge. There are likely sev­eral rea­sons for the weak­ness, includ­ing what we pointed out in our early-April report on ele­vated opti­mistic sen­ti­ment. Since sen­ti­ment tends to work a con­trar­ian magic on the mar­ket, we were antic­i­pat­ing a period of con­sol­i­da­tion after the stel­lar six-month, 30% run off the early Octo­ber 2011 low—and we're get­ting it.

Of course, we're also yet again deal­ing with the euro­zone debt cri­sis, but also chop­pier eco­nomic indi­ca­tors in the United States recently, a volatile elec­tion sea­son and con­cerns about the so-called "fis­cal cliff" head­ing into the end of this year. But one of the ques­tions I've got­ten most often recently has been about the sea­sonal phe­nom­e­non called "sell in May and go away," and whether the market's in store for another sum­mer swoon like we've had the past two years.

Macro trump­ing micro

I'll start with "sell in May," but before I do, I want to address an impor­tant gen­eral obser­va­tion. As we've noted many times recently in reports and media appear­ances; and as detailed in a ter­rific recent report by Wall Street research firm Wolfe Tra­han, macro is trump­ing micro. One of the rea­sons for this is the decline in guid­ance investors are receiv­ing from com­pany managements.

In the past, guid­ance was often an anchor of rea­son in volatile times. Events like Euro­pean elec­tions or spik­ing euro­zone sov­er­eign bond yields might not have been such big market-moving events when we could rest on US com­pa­nies' guid­ance as to the future. Add to that rapid-fire trad­ing, short­ened time hori­zons, greatly increased access to infor­ma­tion, greatly increased speed of news' dis­sem­i­na­tion, and much more glob­al­ized eco­nomic and finan­cial sys­tems, and you have a recipe for increased volatil­ity around macro events.

Sell in May?

Much is made every year of the "sell in May" phe­nom­e­non. Its basis is rooted in the fact that the best per­for­mance for the mar­ket has gen­er­ally come in the Novem­ber through April period, while the worst has come between May and October.

There is some truth to the adage. Accord­ing to data com­piled by Ned Davis Research (NDR), through the begin­ning of May this year the aver­age per­for­mance for the period from May 1 through Octo­ber 31 each year since 1950 was 1.2%. The aver­age per­for­mance for the period from Novem­ber 1 through April 30 each year since 1950 was 7.0%.

As com­pelling as those num­bers may seem, there are many things to con­sider, espe­cially if it's your incli­na­tion to develop a trad­ing strat­egy around those sea­sonal pat­terns. First, the cal­en­dar months indi­vid­u­ally tend to fall into either the "hot" or "cold" columns for per­for­mance, as you can see in the table below. Three of the six months that fall into the "all out" period span­ning from May through Octo­ber are actu­ally his­tor­i­cally strong months, while three of the six months that fall into the "all in" period span­ning from Novem­ber through April are actu­ally his­tor­i­cally weak months.

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of 1928-April 30, 2012.

As you can see, all of the sea­sons seem to be ade­quately rep­re­sented in both columns. And what we know for a fact is that time hori­zons have become much shorter over the recent years, and the reac­tion func­tion gets trig­gered more often. It's likely that many investors may find their patience tested when expe­ri­enc­ing either a great month (or two) dur­ing the May-October "all out" period and/or a poor month (or two) dur­ing the November-April "all in" period. Of course, the sea­sonal trad­ing strat­egy must con­sider trans­ac­tion costs and tax impli­ca­tions.

Sec­tor per­for­mance May-October

For investors who like to take a tac­ti­cal approach to the sea­sonal ten­den­cies, a sec­tor bias strat­egy may be worth con­sid­er­ing. Before I get to the details, let me remind our clients that we moved toward a more sector-neutral strat­egy back in early April when we became more cau­tious about the mar­ket in the short term. Presently the only out­per­form rat­ing we have is on the infor­ma­tion tech­nol­ogy sec­tor, while the only under­per­form rat­ing we have is on the util­i­ties sector.

As you can see in the table below, cour­tesy of The Leuthold Group, cycli­cal groups have tended to out­per­form dur­ing the market's tra­di­tion­ally strong November-April period, while defen­sive sec­tors have been the rel­a­tive win­ners dur­ing the cus­tom­ar­ily weaker May-October period. In fact, the size and per­sis­tence of these effects have been impres­sive (at least since 1989, the span of the analy­sis).

S&P 500 Sec­tor Seasonality

Source: The Leuthold Group, Octo­ber, 1989-April, 2012. Defen­sive sec­tors: con­sumer sta­ples, health care and util­i­ties. Cycli­cal sec­tors: con­sumer dis­cre­tionary, indus­tri­als and mate­ri­als.

Buy in May in elec­tion years?

There's also the rub of this being an elec­tion year, dur­ing which sit­ting out the May through Octo­ber period has his­tor­i­cally not worked well. Using the Dow Jones Indus­trial Aver­age because of its longer his­tory, the mar­ket has been up 4.5% dur­ing elec­tion years in the May-October span ver­sus 2.6% for all years (includ­ing elec­tion years). And for what it's worth, accord­ing to NDR, the mar­ket has bucked sea­sonal weak­ness even more when the incum­bent pres­i­dent has won, with a median gain of 7.6% ver­sus 0.5% when the incum­bent pres­i­dent has lost.

NDR pro­vides a clue as to why this is the case: A cor­rec­tion has occurred dur­ing the sec­ond quar­ter of elec­tion years, on aver­age (sound famil­iar?). But the cor­rec­tion has tended to be con­cen­trated in the sec­ond quar­ter, set­ting the stage for a sum­mer rally.

2012's pos­i­tive off­sets to present weakness

I actu­ally think the sce­nario noted above is more likely than not this year. Mus­cle mem­ory has many investors fret­ting a repeat of 2011 and 2010, when eco­nomic weak­ness in the spring led to bru­tal cor­rec­tions each year, to the tune of –19% and –16%, respec­tively. But there's a long list of pos­i­tive off­sets this year rel­a­tive to the past two years:

• Infla­tion is com­ing down, espe­cially among com­mod­ity prices.
• Credit growth is quite strong, espe­cially for consumers.
• Hous­ing has improved markedly.
• The US man­u­fac­tur­ing sec­tor is humming.
• NFIB's small busi­ness sur­vey made recent upside breakout.
• Job growth is much better.
• Con­sumer con­fi­dence is improving.
• Private-sector lever­age ratios are much improved (debt ser­vic­ing costs are extremely low).
• Recov­ery in state/local gov­ern­ment spending.
• The US econ­omy some­what decou­pling from rest of world; at least Europe.
• US bank capital/health is much bet­ter than Europe's.
• The Euro­pean Cen­tral Bank's Long-Term Refi­nanc­ing Oper­a­tions have reduced like­li­hood of global finan­cial contagion.
• Ger­many appears more will­ing to accept higher infla­tion, open­ing the door to eas­ier mon­e­tary pol­icy for the eurozone.
• Val­u­a­tions are quite cheap, espe­cially on for­ward earnings.
• Investor sen­ti­ment has improved sharply with the cor­rec­tion to-date (mean­ing pes­simism has kicked back in).

I don't think the present cor­rec­tion is over, but do believe it could be kept to within the nor­mal 5–10% range. Since the cur­rent bull mar­ket began in March 2009, the S&P 500 has had 15 cor­rec­tions of more than 5% that were pre­ceded by at least a 5% rally (con­sis­tent with this year's pat­tern). The table below high­lights their dura­tion and ulti­mate per­cent­age drop.

S&P 500 5% Cor­rec­tions

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of May 11, 2012.

Wall of worry being rebuilt

Tem­per­ing my short-term con­cern has been the afore­men­tioned improve­ment in sen­ti­ment con­di­tions. That said, I think there's likely a bit more pes­simism needed to estab­lish a short-term bot­tom for the mar­ket. As you can see, the well-watched NDR Crowd Sen­ti­ment Poll (CSP) has moved deci­sively lower, but not yet to the extreme pes­simism zone:

Bye-Bye Opti­mism

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as May 8, 2012.

NDR noted in a recent report sev­eral key rea­sons to expect the cor­rec­tion to be within the nor­mal 5–10% range:

• Ini­tial rever­sals in CSP extremes are con­sis­tent with median declines of about 8% within six months.
• The first half of elec­tion years have shown median declines of just less than 10%.
• Once "pre-waterfall" highs have been exceeded, as occurred in Feb­ru­ary of this year, median mar­ket declines have ranged between –3% and –7% within six months.

Sav­ing the worst for last

I think investors and the media may be under­es­ti­mat­ing the impact the com­ing "fis­cal cliff" is hav­ing on mar­ket and busi­ness psy­chol­ogy. The fis­cal cliff refers to the near-simultaneous Jan­u­ary 2013 expi­ra­tion of the Bush tax cuts, the pay­roll tax cuts, emer­gency unem­ploy­ment ben­e­fits and the sequester (auto­matic spend­ing cuts) estab­lished in last summer's debt-limit agreement.

The range of esti­mates for its ulti­mate impact are, unfor­tu­nately, quite wide. The low­est esti­mate I've seen comes from NDR, using Con­gres­sional Bud­get Office assump­tions, with the impact at a rel­a­tively "low" 2.4% of US gross domes­tic prod­uct (GDP). Most esti­mates tend to clus­ter around 3.5% of GDP.

It's impos­si­ble to know what's right because dif­fer­ent assump­tions are being used. But the con­sen­sus is clos­ing in on a worst-case sce­nario of about 4% of GDP. ISI recently put the num­bers into three dis­tinct buck­ets, each with about $200 bil­lion of impact:

1. Pro­vi­sions likely to cre­ate a fis­cal drag (approx­i­mately (≈) $221 bil­lion or 1.4% of GDP):
   • Cuts to dis­cre­tionary spend­ing (≈$84 billion)
   • Tax increases on upper-income Amer­i­cans included in the Afford­able Care Act (≈$21 billion)
   • Pay­roll tax cut (≈$116 billion)
2. Bush tax cuts (≈$200 bil­lion or 1.3% of GDP, although likely impact would be spread over sev­eral years)
3. Items unlikely to be allowed to take affect and thus aren't likely to cre­ate a fis­cal drag (≈$179 bil­lion or 1.1% of GDP):
   • Huge increase in num­ber of Amer­i­cans pay­ing the alter­na­tive min­i­mum tax (≈$94 billion)
   • Sequester cuts (~$85 billion)

There are three addi­tional items that don't fall neatly into ISI's three buck­ets, includ­ing tax exten­ders, extended unem­ploy­ment insur­ance ben­e­fits and the "doc fix," which would together total about $75 bil­lion. These items are not expected to cre­ate a sig­nif­i­cant fis­cal drag.

I actu­ally think this is hav­ing a larger impact on psy­chol­ogy than many believe, espe­cially on the con­fi­dence of cor­po­rate lead­ers and their abil­ity to plan (and guide Wall Street's ana­lysts) for the future.

Mus­cle mem­ory may fail us this year

In sum, there's much to fret about, and volatil­ity is likely to remain ele­vated until this cor­rec­tion has run its course. But a lot has changed in the past two years—much for the better—particularly for domes­ti­cally ori­ented US com­pa­nies. There's at least a lit­tle bit of decou­pling under­way, cer­tainly between the United States and Europe, and that's likely to assist in keep­ing the cor­rec­tion from mir­ror­ing the ones in 2010 and 2011.

Impor­tant Disclosures

The infor­ma­tion pro­vided here is for gen­eral infor­ma­tional pur­poses only and should not be con­sid­ered an indi­vid­u­al­ized rec­om­men­da­tion or per­son­al­ized invest­ment advice. The invest­ment strate­gies men­tioned here may not be suit­able for every­one. Each investor needs to review an invest­ment strat­egy for his or her own par­tic­u­lar sit­u­a­tion before mak­ing any invest­ment decision.All expres­sions of opin­ion are sub­ject to change with­out notice in reac­tion to shift­ing mar­ket con­di­tions. Data con­tained herein from third party providers is obtained from what are con­sid­ered reli­able sources. How­ever, its accu­racy, com­plete­ness or reli­a­bil­ity can­not be guaranteed.Examples pro­vided are for illus­tra­tive pur­poses only and not intended to be reflec­tive of results you can expect to achieve.

Tags: Anchor, Bond Yields, Charles Schwab, Chief Investment Strategist, Debt Crisis, Economic Indicators, Election Season, European Elections, Liz Ann, Media Appearances, Micro News, Perils, Seasonal Phenomenon, Senior Vice President, Sentiment, Stock Market, Swoon, Trading Strategy, Trahan, Volatile Times
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May 15th, 2012

The Hid­den Rally in Cana­dian Equi­ties
Using a Low Beta Strat­egy to Increase Port­fo­lio Efficiency

Alfred Lee, CFA, CMT, DMS, Vice Pres­i­dent & Invest­ment Strate­gist
BMO ETFs & Global Struc­tured Invest­ments
BMO Asset Man­age­ment Inc.
alfred.lee[@]bmo.com

May 15, 2012
Recent Developments:

• Cana­dian equi­ties got off to a strong start this year with the S&P/TSX Com­pos­ite Index (TSX) ral­ly­ing 6.1% on a total return basis in the two months ended Feb­ru­ary 29, 2012. The opti­mism of a global eco­nomic recov­ery has stalled since then and Cana­dian equi­ties have been weak as a result, with the TSX falling 6.6% on a total return basis. U.S. equi­ties, on the other hand, which we have rec­om­mended over­weight­ing over the last 16 months, have been more resilient in the face of the resur­fac­ing of Euro­pean sov­er­eign debt issues. The S&P 500 Com­pos­ite Index (SPX) was down only 0.5%, also out­per­form­ing the MSCI World Index's –3.5% loss since March 1, 2012. (Chart A)
• Tra­di­tional Cana­dian equity bench­marks have shown weak­ness as of late, given the large expo­sure to sec­tors such as energy and mate­ri­als. These com­mod­ity inten­sive areas tend to be highly sen­si­tive to eco­nomic con­di­tions as they are widely used in con­struc­tion and urban­iza­tion projects. With increased polit­i­cal grid­lock, espe­cially in the Euro­zone nations, there may be less clar­ity in the direc­tion of pol­icy that will be imple­mented in address­ing the eco­nomic malaise. As a result, com­mod­ity and commodity-related areas have recently shown both weak­ness and increas­ing volatil­ity, despite the fun­da­men­tals in some sub-groups, such as cop­per, remain­ing favourable. The implied volatil­ity lev­els of the TSX have recently moved above that of the SPX, as indi­cated by the S&P/TSX Implied Volatil­ity Index (VIXC) and the CBOE/S&P 500 Implied Volatil­ity Index (VIX) respec­tively. (Chart B)
• Though the fun­da­men­tals of the TSX remains attrac­tive, with a cur­rent price-to-earnings (P/E) ratio of 13.8x, momen­tum has remained weak over the last sev­eral quar­ters. How­ever, there have been areas within the Cana­dian equity mar­ket that have shown sig­nif­i­cant strength. On a rel­a­tive level, the con­sumer dis­cre­tionary, con­sumer sta­ples, util­ity and health care sec­tors have all gained con­sid­er­ably against the TSX so far this quar­ter, which has largely gone unno­ticed. Low beta sec­tors, or those that are less sen­si­tive to mar­ket move­ments, have been strong year to date (Chart C). These areas, how­ever, tend to be under-represented in major Cana­dian indices and also in the port­fo­lio of many Cana­dian investors. Also, inter­est­ing to note, a com­par­i­son of rel­a­tive strength trends, show that both the energy and mate­r­ial sec­tors under­per­formed the TSX even dur­ing the first quar­ter, when the appetite for risk was strong.

Invest­ment Idea:

• The port­fo­lios of many Cana­dian investors remain highly exposed to com­mod­ity related areas. While we are not sug­gest­ing that investors aban­don com­modi­ties, espe­cially con­sid­er­ing that fur­ther stim­u­lus would cause com­mod­ity prices to rally sharply, we are how­ever rec­om­mend­ing also adding expo­sure to less-cyclical areas to reduce poten­tial volatil­ity that may arise. More­over, given the afore­men­tioned rel­a­tive strength trends, some tra­di­tional mea­sures of Cana­dian beta may strug­gle as com­mod­ity related sec­tors have lagged the TSX. Investors should there­fore have expo­sure to both com­mod­ity and non-commodity related areas to reduce volatil­ity in their Cana­dian equity exposure.
• The BMO Low Volatil­ity Cana­dian Equity ETF (ZLB) is an effi­cient way for investors to diver­sify into less cycli­cal areas and sec­tors under-represented in tra­di­tional market-cap weighted indices. Some of the largest sec­tor weight­ings in ZLB are con­sumer sta­ples (20.9%), con­sumer dis­cre­tionary (12.5%) and util­i­ties (11.0%). There­fore, ZLB may be used as a com­ple­men­tary posi­tion for many investors, giv­ing them expo­sure to a wider range of sectors.
• In addi­tion, given ZLB has a much lower beta than the TSX (0.48 vs. 1.00 respec­tively), it may be used as a com­ple­men­tary posi­tion to reduce equity volatil­ity and poten­tially improve the risk-adjusted returns of an over­all port­fo­lio strategy.

Chart A: VIXC Has Moved Above VIX

Source: Bloomberg, BMO Asset Man­age­ment Inc.

Chart B: VIXC Has Moved Above VIX

Source: Bloomberg, BMO Asset Man­age­ment Inc.

Chart C: Market-Cap Weighted Indices Are Under­weight Sec­tors That Have Outperformed

Source: BMO Asset Man­age­ment Inc.

*All prices as of mar­ket close May 11, 2012 unless oth­er­wise indicated.

Dis­claimer:
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 and admin­is­tered by BMO Asset Man­age­ment Inc, an invest­ment fund and port­fo­lio man­ager and sep­a­rate legal entity from the Bank of Mon­tréal. Com­mis­sions, man­age­ment fees and expenses all may be asso­ci­ated with invest­ments in exchange-traded funds. Please read the prospec­tus before invest­ing. The indi­cated rates of return are the his­tor­i­cal annual com­pound total returns includ­ing changes in prices and rein­vest­ment of all dis­tri­b­u­tions and do not take into account com­mis­sion charges or income taxes payable by any unit holder that would have reduced returns. The funds are not guar­an­teed, their value changes fre­quently and past per­for­mance may not be repeated.

Tags: Alfred Lee, Asset Management Inc, BMO, Canadian Equities, Canadian Equity, Cboe, Cmt, Composite Index, Debt Issues, Economic Malaise, Implied Volatility, Intensive Areas, Investment Strategist, Msci World Index, Political Gridlock, Return Basis, Sovereign Debt, Structured Investments, Volatility Index, Volatility Levels
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May 15th, 2012

by Bespoke Invest­ment Group

The sec­ond quar­ter of 2012 has so far been a com­plete rever­sal of the first quar­ter.  As of ear­lier this morn­ing, just one stock-related ETF in our matrix below was up for the quar­ter — Util­i­ties (XLU).  Major US index ETFs are all down 4–5% for the quar­ter, while sec­tors like Energy (XLE) and Finan­cials (XLF) are down 7%+.

Inter­na­tional mar­kets have done much worse than the US.  Brazil (EWZ), France (EWQ), Ger­many (EWG), India (INP), Italy (EWI), Spain (EWP) and Rus­sia (RSX) are all down dou­ble digit per­cent­ages since the start of April, and they're down 5%+ over the last week alone.  The only asset class that is solidly in the green for the quar­ter is fixed income, which many investors shunned like the plague as recently as March.  Oh how quickly things change.

Tags: asset class, Etf Performance, Ewg, Ewi, Ewp, Ewq, Ewz, First Quarter, Inp, International Markets, Investment Group, Percentages, Plague, Qtd, Rsx, Second Quarter, Sectors, Us Brazil, Xle, Xlf
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May 15th, 2012

 
Jim Rogers is hedg­ing his gold (and sil­ver) posi­tions reflect­ing that this is nor­mal, fol­low­ing such a tremen­dous run, and that this is good for the pre­cious metal in the long-run. In his dis­cus­sion with Maria Bar­tiromo this after­noon, he notes India's anti-gold 'pro­tec­tion­ism' (and its poten­tial bal­ance of pay­ments issues) that are try­ing to force the hoard­ing into risky 'pro­duc­tive' assets (as oth­ers might say). The immutable com­mod­ity maven sug­gests JPMor­gan (and its peers) could be behind the drops in the over­all com­mod­ity com­plex as the uncer­tainty of their posi­tions (and liq­ui­da­tion poten­tial to raise cash as bank exam­in­ers begin their foren­sics) becomes more impor­tant. He holds the USD, which he hates; has a num­ber of equity shorts; and is most fear­ful of banks — specif­i­cally admit­ting he is a ser­ial seller of calls on JPMor­gan.

His advice, and per­haps Maria should look into it given their rat­ings recently, is to become a farmer; own farm­land; and spec­u­late on agri­cul­ture. On the dis­mal 'eth­i­cal' state of our lead­ers and man­age­ment, the thought­ful Rogers opines, "You can read world his­tory for decades. There are always peo­ple doing things wrong. We have not changed our human nature and we will con­tinue to have scan­dals and prob­lems" and in a follow-up to CNBC's stan­dard 'money-on-the-sidelines' argu­ment he crushes the money-honey's dreams: "Finance had a great 30 years. That's fin­ished. Now to advance, we have too many peo­ple, too many MBAs, too much lever­age and too many gov­ern­ments that don't like us". A must-see rebut­tal to the 'nor­mal' CNBC hopium with more on China's slow­down, a US reces­sion, Europe and a Greek exit, QE3, and 'tractors'.

Tags: Balance Of Payments, Bank Examiners, Cnbc, Farmland, Forensics, Gold And Silver, Hoarding, Human Nature, Jim Rogers, Maria Bartiromo, Maven, Money Honey, Precious Metal, productive assets, Protectionism, Qe3, Rebuttal, Sidelines, Slowdown, World History
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May 15th, 2012

I went to cir­cle back today to look at what has been among the weak­est areas of the mar­ket, and chart after chart came up in the com­mod­ity space.   Here is a chart of the per­for­mance of the futures in var­i­ous mar­kets (mostly com­modi­ties) over the past month (via Fin­viz) and it's a mess.  Iron­i­cally, nat­ural gas – the most hated com­mod­ity of most of the first quar­ter, was the stand­out.  Rever­sion to mean trade.   Coal is not listed, but that group looks as bad as solar stocks… ironic since the lat­ter was sup­posed to sup­plant the for­mer at some point.

There is an in depth story on the sec­tor in the WSJ today as well.

• Com­modi­ties fell to nearly two-year lows last week, mea­sured by a widely used bench­mark, prompt­ing investors to pon­der whether the mas­sive rally that began in 1999 may be faltering.
• China is cool­ing down at the same time the U.S. is strug­gling to heat up, cloud­ing the out­look for the world's two biggest con­sumers. And pro­duc­ers of some raw mate­ri­als have ramped up sup­plies enough to cre­ate at least tem­po­rary gluts, par­tic­u­larly if appetites falter.
• For more than a decade, invest­ing in com­modi­ties was prac­ti­cally a sure thing. Prices rose in nine of the 12 years start­ing in 1999. Even down years had expla­na­tions, such as the Sept. 11 attacks in 2001 and the global finan­cial cri­sis in 2008.
• On Fri­day, the Dow Jones–UBS Com­mod­ity Index, which tracks futures con­tracts for 20 basic goods, fell 1% to the low­est level since Sep­tem­ber 2010. U.S. crude oil, gold and cotton—all com­po­nents of the index—helped lead the way down, as each hit fresh lows for 2012. The index is down 4% this year after a 13% drop last year, putting it on track for the first con­sec­u­tive declines since 1997 and 1998.

Tags: Appetites, Commodities Prices, Commodity Index, Commodity Space, Crude Oil, Declines, Dow Jones, Futures Contracts, Global Financial Crisis, Gluts, Investing In Commodities, Lows, Massive Rally, Natural Gas, Raw Materials, Sept 11 Attacks, Standout, Sure Thing, Ubs, Wsj
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May 15th, 2012

by Peter Tchir, TF Mar­ket Advisors

So now what?

Greece. Will they pay the bond due today or not? Will they form a new gov­ern­ment or not? Does any­one care? That is becom­ing the ques­tion. The mar­ket is grad­u­ally becom­ing numb to the news. I don’t think Greece can leave just yet. It would cause too much con­fu­sion, and no one within Greece or out­side has done enough to pre­pare. They will get some con­ces­sions. They will stick to the pro­gram for now. Europe needs an orga­nized exit. A lot comes down to the ECB. They could make a lot of con­ces­sions, at almost no cost in their fan­tasy world of account­ing, and take a lot of pres­sure off. With­out a gov­ern­ment, Papademos will con­tinue the exist­ing plan. The PSI bonds con­tinue to be weak and are trad­ing to epic dis­as­ter lev­els, but I guess they are about the only Greek thing out there that has enough value left to be worth shorting.

JPM has the share­holder meet­ing today. Never has there been so much noise over an announce­ment that isn’t even a full month’s worth of income. The other Mor­gan, MS lost money in Q3 and Q4 of last year and yet Gor­man isn’t being asked to resign? Which is worse, to have 6 months of losses, or 1 month of breakeven? The entire con­ver­sa­tion has become devoid of real­ity. The fact that it is CDS, Europe, Vol­cker, and Fortress involved has cre­ated a frenzy around the story that is blown all out of pro­por­tion. I have heard all the argu­ments about how the issue is big­ger than the money, but that is a fee­ble argu­ment. In a month, once the story has played out, peo­ple will look at the earn­ings, how lit­tle they play in the DVA game, how con­ser­v­a­tive their reserves seem, that they are buy­ing back stock, and get a nice div­i­dend yield, and like the stock. TFMkts Best Ideas took off the IG 9 10yr ver­sus IG18 short and is likely to leg out of the HY17 ver­sus HYG trade which at least in part had to do with JPM’s alleged position.

Spain and Italy are still real prob­lems. Their economies remain weak and their banks are a total mess. We didn’t need Moody’s to tell us that (I guess bet­ter late than never on the part of Moody’s, though more and more peo­ple would like to see Moody’s and Never be a used together a lot). In spite of how bad it is, we seem to have reached a crescendo for this round of sell­ing. With­out ECB inter­ven­tion in the bond mar­kets, I don’t see any cat­a­lyst for a big move tighter as there are no nat­ural buy­ers, but there are also few nat­ural sell­ers left, other than shorts, and cer­tainly Spain is get­ting to the point that fear of ECB inter­ven­tion makes pil­ing on a very dan­ger­ous propo­si­tion. A period of sta­bil­ity could cause a nice wave of CDS sell­ing as the short base has grown and the real­ity of how expen­sive it is to short these coun­tries kicks in. There was some talk about smash­ing together 4 bad banks and mak­ing one gigan­tic bad bank. I really have no clue what that would do, but it would be viewed as “tak­ing some action” and mar­kets like “action”. Although noth­ing is resolved, and I think most sce­nar­ios lead to another round of weak­ness, the cur­rent sell-off seems to have reached a peak and is likely to rally on any good news, no mat­ter how fee­ble. With Span­ish stocks being uni­ver­sally shunned, TFMkts Best Ideas has on IBEX ver­sus the DAX. TFMkts Best Ideas cov­ered Ital­ian short yes­ter­day and is now com­pletely out of Span­ish and Ital­ian bond shorts. It is short the 10 year bund, and really think­ing of sell­ing CDS on Spain.

China had mediocre data all last week that didn’t seem to come into play. China eased and no one seemed to care. As talk about JPM and Europe winds down, China could have a big influ­ence on the mar­ket again. Again, I doubt the rate cut will do much, but since that is recent, the mar­ket may grav­i­tate to that, espe­cially if they are able to con­jure up some data that the “soft land­ing” crowd can glom on to. I remain rel­a­tively neu­tral on what sort of land­ing China will have, but after the rate cuts, and last night’s bounce, China may help any rebound story.

The U.S. econ­omy, only a few weeks ago was at the core of the bull story. Now no one is talk­ing about it. For those of us who thought the 1^st quar­ter data was over­stated and wasn’t reflec­tive of the real econ­omy, it looks like we were right. The econ­omy is allegedly slow­ing down on many fronts. I use the term “allegedly” because I think it was never that strong, and might not be quite this weak, so the slow­ing is a func­tion of data adjust­ments. The econ­omy, I believe has been more sta­ble than that, and chug­ging along at a mediocre, but sta­ble pace. The data is weak enough to keep ZIRP in place even if not weak enough to war­rant QE3. But not so bad that com­pa­nies can’t gen­er­ate some prof­its. High Yield and Lever­aged Loans remain attrac­tive to me though expect a bit more volatil­ity as the JPM unwind con­tin­ues. While the IG9 long posi­tion has attracted the most atten­tion recently, there were posi­tions across a vari­ety of indices across the globe, includ­ing posi­tions in the high yield mar­ket. They may also have loans they choose to sell to mon­e­tize some gains and because they had to reduce the size of the hedge against them. TFMkts Best Ideas has longs in S&P, IG18, and a trea­sury short. If any­thing I will be look­ing to add risk here.

The morn­ing trad­ing is half hearted at best. Early rally, faded, re-rallied, re-faded. I think that descrip­tion applies to vir­tu­ally every “risk-on” asset out there. The mar­kets are still a lit­tle bet­ter across the board, but no enthu­si­asm. With all the uncer­tainty, and the weak­ness over the past week, that makes sense. I’m not sure the mar­ket is going to be squeezed higher with­out some real news or big liq­uid­ity injec­tion, but right now, it feels that a lot of the bad news has been absorbed to the point that a drift higher is the next direc­tion, though with some head­line induced gaps up and down.

Copy­right © TF Mar­ket Advisors

Tags: Bonds, Concessions, Confusion, Dividend Yield, Earnings, ECB, Fantasy World, Fortress, Frenzy, Gorman, Ig, Jpm, Losses, Proportion, Psi, Q3, Q4, Shareholder Meeting, Tf, Volcker
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May 15th, 2012

 
Berk­shire 2012: The Times They Are A-Changing and Other Observations<

by Jeff Matthews

Editor’s Note—

This year we’re uti­liz­ing a shorter, snap­pier way to sum­ma­rize the Berk­shire Hath­away annual meet­ing as a way to spare read­ers the redun­dan­cies in Buf­fett and Munger’s question-and-answer session.

After all, the com­men­tary over­lap with past meet­ings is prob­a­bly 75% nowadays—we’ve even devel­oped a sort of Berk­shire short­hand for our note-taking, writ­ing sim­ply “Gra­ham story” when Buf­fett launches into his dis­ser­ta­tion on the impor­tance of cer­tain chap­ters in Ben Graham’s “The Intel­li­gent Investor,” for exam­ple; “MBA joke” when­ever Buf­fett or Munger make fun of the mean­ing­less (and dan­ger­ous) risk-evaluating mod­els of the aca­d­e­mic world; and “IBK joke” when they go after invest­ment bankers, another favorite target.

Nev­er­the­less, the meet­ing was, as always, interesting.

For one thing, atten­dance was down, notice­ably, even if Buf­fett wouldn’t say so—probably a side-effect of his high, and highly con­tro­ver­sial, polit­i­cal pro­file these days. Also, there was the added (and, we thought, wel­come) pres­ence of insur­ance ana­lysts ask­ing ques­tions for the first time since the very old days when a few pro­fes­sion­als would show up at the Berk­shire cafe­te­ria and fire away.

Over­all, there was a detectable “thrill is gone” sense hang­ing over the week­end. Buf­fett him­self did not show up at some of the side-parties that many of his most loyal share­hold­ers rou­tinely sched­ule, as he did in the past, and even the press com­plained about the tight restric­tions on their cameras.

But Char­lie Munger, push­ing 90, was in great form, and Bono was spot­ted in the crowd, a step up from last year when George Lucas made it.

So there.

—JM, May 2012

Berk­shire Hath­away 2012

Biggest Change: Tighter secu­rity and more of Buf­fett The Ana­lyst than Buf­fett The New-Age Spir­i­tual Guru.
Gone, unfor­tu­nately, was Buffett’s pre-meeting stroll to a seat in the mid­dle of the floor of the arena to watch the kick-off movie (instead he was kept inside the Board of Director’s gated pen, up front near the stage, where beefy guards with ear­pieces and zero smiles stood watch).
Gone, for­tu­nately, were ques­tions like “What should I do with my life?” and “Do you believe in Jesus Christ and do you have a per­sonal rela­tion­ship with God?” (That was actu­ally asked—and answered by Buffett—a few years ago: you can read the answer in our book.)

Best Change: Three insur­ance ana­lysts ask­ing geeky busi­ness ques­tions about Berkshire’s operations—the first time in years Buf­fett has been ques­tioned in depth about the guts of Berk­shire Hath­away.
And while there was grum­bling from the sightseeing-types in the crowd about the tech­ni­cal dis­cus­sion (as well as from ace finan­cial analyst/money man­ager John Hemp­ton, who thought it was not tech­ni­cal enough and wrote about it here, although I knew what John thought before he wrote that because I sat with him), the fact is Buf­fett has got­ten away with very few hard ques­tions about Berkshire’s oper­a­tions in the years since he became a CNBC sta­ple.
Expect fewer atten­dees next year, and the year after, and the year after…but bet­ter questions.

Most Fun: Get­ting to see and hear War­ren Buf­fett dis­cuss the insur­ance busi­nesses in detail thanks to those geeky ques­tions. He didn’t cre­ate the track record of a life­time by luck.

Least Fun: Two rants, both by peo­ple from Boston (where else?)—one about the Lib­erty Mutual scan­dal and the other about Fan­nie Mae/Freddie Mac, both of which Buf­fett and Munger han­dled far more patiently than the crowd.
Also, way too many ques­tions about Berkshire’s lag­ging stock price (it’s a con­glom­er­ate with a bunch of low P/E busi­ness for gosh sakes, not a closet mutual fund run by War­ren Buf­fett any more.) Speak­ing of which...

Most Deli­cious Moment: Char­lie Munger blow­ing off a well-known hedge fund man­ager who used the micro­phone to talk up Berkshire’s stock before lob­bing a soft­ball, “what-am-I-missing” type of ques­tion about the lag­ging stock price.
Rather than respond in Typ­i­cal Pub­lic Com­pany CEO Fash­ion about how Berk­shire was “exe­cut­ing its strate­gic objec­tives” or com­plain­ing the stock was “not reflect­ing the under­ly­ing val­ues of the busi­ness” or reas­sur­ing us that man­age­ment would “pur­sue all means to enhance share­holder value,” as most CEOs would do, Munger sim­ply said: “I wouldn’t worry too much. I think you aren’t really wel­come in this room if that sort of short-term ori­en­ta­tion turns you on.”
And that ended the dis­cus­sion about Berkshire’s stock price.

Least Appre­ci­ated Line: “If you make your buy and sell deci­sions based on what a busi­ness is worth, you’ll make money.”—Warren Buffett.

Most Appre­ci­ated Line: (In response to a ques­tion about suc­ces­sion at Berk­shire after Buffett’s death.) “The good for­tune is not going to go away just because War­ren hap­pens to die. It won’t help him, but...”—Charlie Munger.

Weird­est Moment in the Open­ing Movie: The car­toon, in which the Uni­ver­sity of Nebraska foot­ball team (Buffett’s favorite) plays a Uni­ver­sity of Wash­ing­ton team made up of robots coached by failed/disgraced pres­i­den­tial can­di­date Her­man Cain. (I am not mak­ing this up.)
Worse, dur­ing his half-time pep-talk, Coach Cain made a bunch of 9–9-9 jokes and then urged his men to hit hard, yelling “Take that, sucka!” like a, well, like a stereo­typ­i­cal African-American.
Who thought that would be funny?

Best Com­ment on the Open­ing Movie: “Are they that corny every year?”—John Hempton.

Oh Puh-leeze Moment: When War­ren Buf­fett defended “the Buf­fett Rule” with talk of “shared sac­ri­fice” and the curi­ous claim that his rule applied only to “a very few” peo­ple, mean­ing those with “the 400 largest incomes in the U.S.” which of course is no longer the case, as every­one in the place knew.

You-Could-Hear-A-Pin-Drop Moment: When Buf­fett casu­ally said Todd Combs and Ted Weschler, the recently hired money man­agers at Berk­shire, are being paid “one mil­lion dol­lars a year,” plus incen­tive fees. Buffet’s no fan of “shared sac­ri­fice” when it comes to incen­tiviz­ing his own moneymakers…

A Les­son For Every Money Man­ager Depart­ment: Buffett’s rev­e­la­tion that in all of his and Munger’s years of man­ag­ing Berk­shire together (47 and count­ing), “We’ve never talked about macro stuff.”

Most Sur­pris­ing Applause Line: Becky Quick’s ques­tion on behalf of a man who first noted that his 84 year old father wouldn’t buy Berk­shire stock because of Buffett’s con­stant yap­ping about a Buf­fett tax, and then asked what impact Buffett’s high pro­file might be hav­ing on the stock price. (This got spon­ta­neous, fairly loud applause despite the Buffett-friendly crowd.)

Least Sur­pris­ing Applause Line: Buffett’s response to the young man, which was “I don’t think any­one should have their cit­i­zen­ship restricted” sim­ply because they run a pub­lic com­pany, plus this zinger about the young man’s 84 year old father: “Maybe he oughta own Fox.” (This got louder applause than the ques­tion, naturally.)

Feel-Good Ques­tion, Lit­er­ally and Fig­u­ra­tively: From Andrew Ross Sorkin, on behalf of “many” in the crowd who had urged him via email to ask, “War­ren, how’re you feeling?”

Feel-Good Answer, Lit­er­ally and Fig­u­ra­tively: Buffett’s response to Sorkin, “I feel great.”

Best Munger Retort: (To Sorkin after Buf­fett said “I feel great.”) “I’m jeal­ous. I prob­a­bly have more prostate can­cer than he does.”

Least Inter­est­ing Ques­tion: About gold. ‘Nuf said.

Most Inter­est­ing Ques­tion: “How do the large sov­er­eign debts get bal­anced, and do they con­cern you?”
Buffett’s answer was, “I don’t know how it plays out in Europe…I would totally avoid buy­ing medium or long term gov­ern­ment bonds.” Munger added, “He’s ask­ing the really intel­li­gent ques­tion of the day and we’re hav­ing a hard time answer­ing it.”
For the record, this “really intel­li­gent ques­tion” actu­ally drew applause from the crowd when it was asked, which tells you what’s on people’s minds regard­less of which party they’re vot­ing for in Novem­ber.
Also, for the record, the fel­low who asked it was from Boston, which just goes to show not every­one in that Com­mon­wealth is certifiable.

Least Con­vinc­ing Answer: Buf­fett, asked by the fear­less (and good friend of Buf­fett) Carol Loomis whether buy­ing the Omaha World-Herald news­pa­per was “some self-indulgence?”
The Ora­cle spent a good five min­utes explain­ing how the paper “still tells me some things I can’t find out about else­where,” such as—and I am not mak­ing this up—the obit­u­ar­ies and the wed­ding notices. Nobody was buy­ing it.

Most Con­vinc­ing Answer: Buf­fett and Munger, when asked by one of those geeky insur­ance ana­lysts whether Berk­shire would ever be sub­ject to the Invest­ment Com­pany Act of 1940.
Buf­fett said he’s read the Act “20 times” (and when Buf­fett says he’s read some­thing 20 times, he’s not kid­ding), and “I see no way Berk­shire comes close to that.” Munger said flatly, “We are NOT just an invest­ment company.”

Some­thing Every Investor Should Always Keep in Mind: Asked about why Berk­shire keeps such a large cash reserve, Buf­fett said, “We don’t ever want to go back to ‘Go.’”

Worst Answer: Buf­fett, when asked how Amazon.com will affect Berkshire’s var­i­ous busi­nesses, said, among other things, “It won’t affect Nebraska Fur­ni­ture Mart.”

Best Answer: Munger, to the same ques­tion, “I think it’s ter­ri­ble for most retailers—not slightly ter­ri­ble, really terrible.”

Most Con­cise Answer: Munger, when asked how a busi­ness can “build bar­ri­ers” around itself: “It’s tough. We sort of buy bar­ri­ers, we don’t build them.”

The Sin­gle Most Reveal­ing Com­ment About What Made Berk­shire A Growth Stock And Why It Is No Longer One: “There were times when Ajit [the genius who runs Berkshire’s rein­sur­ance busi­ness] would gen­er­ate bil­lions of float and War­ren would gen­er­ate 20% returns on that float, and that would hap­pen over and over and over…and that was fun.” —Char­lie Munger

One More Mun­gerism Before We Go: “I rejoiced the day I got rid of a stock quot­ing machine. I like this idea of own­ing busi­nesses forever.”

And War­ren Buffett’s Suc­ces­sor as CEO of Berk­shire Hath­away Is Who? The answer is clear. Read all about it in the forth­com­ing 99c mini-eBook on Amazon.com, “Buffett’s Suc­ces­sor: Who it Will Be, Why it Mat­ters.” To be pub­lished by eBooks on Invest­ing this summer.

Jeff Matthews

Author “Secrets in Plain Sight: Busi­ness and Invest­ing Secrets of War­ren Buffett”

(eBooks on Invest­ing, 2012) Avail­able now at Amazon.com

© 2012 Not­Mak­ingTh­isUp, LLC

Tags: Academic World, Answer Session, Berkshire Hathaway, Berkshire Hathaway Annual Meeting, Buffett, Charlie Munger, Dangerous Risk, Insurance Analysts, Intelligent Investor, Investment Bankers, Jeff Matthews, Loyal Shareholders, Political Profile, Redundancies, Shorthand, Spare Readers, Spiritual Guru, Target, Tight Restrictions, Tighter Security
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May 15th, 2012

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

May 15, 2012

I received so many requests to put last Tuesday’s ver­bal strat­egy com­ments into writ­ten form, and that’s exactly what I have done this morn­ing. To wit, I was always entranced with the 1970’s TV show “Kung Fu” star­ring David Car­ra­dine as Kwai Chang Caine. The show cen­tered on an orphaned Amer­i­can boy (Kwai Chang) that is admit­ted as a stu­dent to the Shaolin tem­ple in China. There his men­tor, Mas­ter Po, teaches him the ways of the Shaolin priests. In addi­tion to learn­ing the mar­tial arts Kwai Chang, affec­tion­ately named “grasshop­per,” is also instructed in the ways of life. In one such les­son Mas­ter Po says, “Bal­ance, grasshop­per, bal­ance” – imply­ing that every­thing in life needs to be “in bal­ance.” Sim­i­larly, investors’ port­fo­lios need to be “in bal­ance,” or more appro­pri­ately rebal­anced periodically.

Port­fo­lio rebal­anc­ing, when done cor­rectly, is an art form. Sim­ply stated, port­fo­lio rebal­anc­ing is the strate­gic redis­tri­b­u­tion of asset classes within a port­fo­lio to keep said portfolio’s objec­tives in line with its orig­i­nal objec­tive. As John Valen­tine, of Valen­tine Cap­i­tal, notes:

To pro­vide a sim­pli­fied alle­gory, think of invest­ment plan­ning for the future as an auto­mo­bile, con­vey­ing an investor to his or her finan­cial goals. The invest­ment port­fo­lio is its motor, the asset allo­ca­tion model is the fuel mix­ture and the assets invested are the fuel. The more effi­ciently the motor runs, the greater the speed with which the whole vehi­cle trav­els toward the des­ti­na­tion. Should the fuel mix­ture, or asset allo­ca­tion run too rich, the motor wastes pre­cious fuel. Should it run too thin, the car has trou­ble achiev­ing enough for­ward momen­tum. ... Many indi­vid­u­als on the road to their finan­cial goals fail to make these peri­odic adjust­ments and still even­tu­ally arrive. Not sur­pris­ingly, the investor who rebal­ances his port­fo­lio at reg­u­lar inter­vals may arrive sooner and with more fuel in his tank. ... Rebal­anc­ing a port­fo­lio is cru­cial to the investor seek­ing to reduce the volatil­ity in a port­fo­lio and increase cash flow simul­ta­ne­ously. ... The longer a port­fo­lio is left unbal­anced, the more com­pro­mised its asset allo­ca­tion may become. There are two poten­tially neg­a­tive reper­cus­sions asso­ci­ated with a com­pro­mised allo­ca­tion. Being over­ex­posed to the down­side and under­ex­posed to the upside. Don’t let this hap­pen to you!

Regret­tably, most indi­vid­ual investors don’t have the dis­ci­pline, or the skill sets, to actively rebal­ance their port­fo­lios. That’s why indi­vid­u­als are best advised to seek pro­fes­sional assis­tance in rebal­anc­ing their port­fo­lios, or for that mat­ter seek a pro­fes­sional advi­sor to help them with all of their invest­ment needs. Man­i­festly, cor­rect asset allo­ca­tion can increase invest­ment returns and lower risk when “bets” are scaled to the advisor’s skill level. Most good invest­ment pro­fes­sion­als have suc­cess­ful “hit rates” of around 60%. That means they make a lot of mis­takes and there­fore should make smaller allo­ca­tion bets. His­tory sug­gests that large bets will even­tu­ally cause large losses and the end of an asset allo­ca­tion pro­gram. Nev­er­the­less, most clients and many advi­sors want to make big­ger bets than their prov­able skills justify.

Clearly, asset allo­ca­tion plays a key role in the invest­ment process; how­ever, I have some other thoughts I think you should con­sider. For exam­ple, a lot of what passes for bril­liance, or incom­pe­tence, in invest­ing is the ebb and flow of invest­ment style (growth, value, for­eign, small cap, etc.) and/or sec­tor per­for­mance. Since oppor­tu­ni­ties by style and sec­tors tend to regress, past per­for­mance is often neg­a­tively cor­re­lated with future rel­a­tive per­for­mance. Still, many investors feel com­pelled to go with past per­for­mance and there­fore rotate into pre­vi­ously strong styles, and strong sec­tors, which then regress leav­ing them with losses. A good advi­sor can mit­i­gate this ten­dency, but a good advi­sor is harder to pick than a good stock.

To this point, good advi­sors often inter­nal­ize deci­sions while ama­teurs learn all the rules and pro­ce­dures. It fol­lows that ama­teurs can often pre­cisely explain what they are doing and why they are doing it. An expert, how­ever, often just knows when they are right. Since investors typ­i­cally want to hear a log­i­cal and clear-cut invest­ment process, many tend to end up with an elo­quent ama­teur rather than a sometimes-incomprehensible expert. Ladies and gen­tle­men, never under­es­ti­mate the effec­tive­ness of an eccen­tric or unusual advi­sor since “knack” tends to win out over learned skill in the invest­ment arena. Most impor­tant is get­ting the big pic­ture right and the best long-term pre­dic­tor of future “big pic­ture” equity returns is the cur­rent value of the mar­ket – things like, price/earnings, price/dividends, price/sales, price/replacement cost (Tobin’s Q ratio), etc. Cur­rently, all of these mea­sure­ments indi­cate the equity mar­kets are rea­son­ably priced.

To this rebal­anc­ing port­fo­lios point, I rec­om­mended doing so after the “buy­ing stam­pede” ended in late Jan­u­ary. My sug­ges­tion was to raise some cash before the envi­sioned 5–8% cor­rec­tion. At last Wednesday’s intra­day low the S&P 500 (SPX/1353.39) was off 5.5% from its April 2 high, and in my ver­bal strat­egy com­ments I rec­om­mended start­ing to put some of that cash back to work in equi­ties. While the “set up” wasn’t per­fect, because we never got that porno­graphic plunge type of hour into the 1320–1340 sup­port zone, at Wednesday’s low of ~1343 the SPX was close enough for gov­ern­ment work. More­over, the NYSE McClel­lan Oscil­la­tor was prob­ing over­sold ter­ri­tory (see chart on page 3) and there was a huge down­side non-confirmation. Ver­ily, last week the SPX broke below its April 10 reac­tion low of 1357.38, yet all of the other indices I mon­i­tor did not vio­late their respec­tive recent reac­tion lows (read: down­side non-confirmation). Then there is the con­tin­u­ing diver­gence between the McClel­lan Oscil­la­tor and the pric­ing action of the SPX, which often occurs at an intermediate-term bot­tom. And, then there was this from my friend Jim Kennedy, cap­tain of the astute Atlanta-based hedge fund con­sult­ing firm of Diver­gence Analy­sis, whose pro­pri­etary stock mar­ket ana­lyz­ing soft­ware I use and embrace:

After we sent out our email prices con­tin­ued to slide last Fri­day. At the close, our S&P 500 and NYSE mod­els closed the day with some diver­gence bot­tom­ing sig­nals. Mon­day should be the test as to whether prices hold here and rally, or fail (see his charts on page 3).

Plainly, I agree with Jim’s com­ments for as stated, “While the ‘set up’ wasn’t per­fect, it was close enough for gov­ern­ment work.” I too think the first part of this week is crit­i­cal because the SPX has tested over­head resis­tance at 1366 twice and has not had any suc­cess in trav­el­ing above that level. This lack of rebound energy sug­gests the SPX could drop into the often men­tioned 1320–1340 sup­port zone, which should mark the bot­tom for this cor­rec­tion and pro­vide another good entry point for long stock posi­tions. Last week, how­ever, the only major index that was pos­i­tive was the D-J Util­ity Index ($UTIL/472.01). Mean­while, of the 10 macro sec­tors only Health­care, Util­i­ties, and Telecom­mu­ni­ca­tion were up on the week. The strength in Telecom­mu­ni­ca­tion was likely dri­ven by the upside chart break­outs in AT&T (T/$33.59/Market Per­form), Ver­i­zon (VZ/$41.16/Market Per­form), and Cen­tu­rylink (CTL/$39.52/Strong Buy). Speak­ing to indus­try groups, of the 63 groups I mon­i­tor the ones cur­rently on “buy sig­nals” for the short/intermediate term are: REITs, Insur­ance P/C, Banks, Restau­rants, Build­ing Mate­ri­als, Spe­cialty Chem­i­cals, Food, Health­care Supply/Equipment, and Phar­ma­ceu­ti­cals. Some names from Ray­mond James’ research uni­verse that screened pos­i­tively on both their fun­da­men­tal and tech­ni­cal met­rics accord­ing to my work, and are favor­ably rated by our fun­da­men­tal ana­lysts, include: All­state (ALL/$34.83/Strong Buy), Simon Prop­erty (SPG/$156.08/Outperform), Abbott Labs (ABT/$62.04/Outperform), Cerner (CERN/$79.92/Outperform), Intu­itive Sur­gi­cal (ISRG/$558.95/Outperform), Hunt­ing­ton Banc­shares (HBAN/$6.54/Strong Buy), and Kimco Realty (KIM/$19.61/Outperform).

The call for this week: The stock mar­ket has been con­sol­i­dat­ing its huge gains from the Octo­ber 4 under­cut low for roughly three months in a ~75 point range (1350–1420). That con­sol­i­da­tion has allowed the market’s inter­nal energy to be rebuilt and the over­sold con­di­tion to be worked off. Because of that process, I con­tinue to think the odds that we will see a move below the 1320–1340 zone remain pretty dim. Accord­ingly, I sus­pect the stock mar­ket is going to put in an inter­me­di­ate bot­tom prob­a­bly this week.

Tags: Allegory, Art Form, Asset Allocation Model, Asset Classes, Chief Investment Strategist, David Carradine, Financial Goals, Fuel Mixture, Grasshopper, Investment Planning, Investment Portfolio, jeffrey saut, John Valentine, Last Tuesday, Periodic Adjustments, Portfolio Rebalancing, Precious Fuel, Raymond James, S Tv, Shaolin Temple In China
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May 15th, 2012

Two value investors with excep­tional long-term track records dis­cuss the unusual oppor­tu­ni­ties they are find­ing in the global mar­kets. Bernard Horn, final­ist for Morningstar’s Inter­na­tional Stock Fund Man­ager of the Year award, explains the inter­na­tional strat­egy he is fol­low­ing in his Polaris Global Value Fund and Thun­der­storm Capital’s John Dorf­man tack­les bar­gains avail­able in the U.S.

Tags: Bargains, Bernie Horn, Global Markets, Global Value, International Stock, International Strategy, John Dorfman, Morningstar, Polaris, Stock Fund, Thunderstorm, Value Investors
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May 15th, 2012

by James Mon­tier, GMO

This paper is based on a speech deliv­ered at the 65th Annual CFA Insti­tute Con­fer­ence in Chicago on May 6, 2012.

As a child, watch­ing my par­ents write post­cards whilst we were all on hol­i­day was an instruc­tive expe­ri­ence. My mother would metic­u­lously write out the card, scat­ter­ing a few inter­est­ing hol­i­day tid­bits within the text. My father, whose sum total of post­cards sent was invari­ably just one (to his office), opted for a con­sid­er­ably more effi­cient approach. His method is shown at the left in Exhibit 1.

I think we can con­struct a sim­i­lar dia­gram to explain the Global Finan­cial Cri­sis (GFC), rep­re­sented at the right in Exhibit 1. In essence, the GFC seems to have sprung from the inter­ac­tion of the fol­low­ing four “bads”: bad mod­els, bad behav­iour, bad poli­cies (which is really just bad behav­iour on the part of cen­tral banks and reg­u­la­tors), and bad incentives.

In an effort to rethink finance, I want to exam­ine each of these fac­tors in turn, begin­ning with bad mod­els. Bad Mod­els, or, Why We Need a Hip­po­cratic Oath in Finance

The National Rifle Asso­ci­a­tion is well-known for its slo­gan “Guns don’t kill peo­ple; peo­ple kill peo­ple.” This sen­ti­ment has a long his­tory and echoes the words of Seneca the Younger that “A sword never kills any­body; it is a tool in the killer’s hand.” I have often heard fans of finan­cial mod­el­ling use a sim­i­lar line of defence.

How­ever, one of my favourite come­di­ans, Eddie Izzard, has a rebut­tal that I find most com­pelling. He points out that “Guns don’t kill peo­ple; peo­ple kill peo­ple, but so do mon­keys if you give them guns.” This is akin to my view of finan­cial mod­els. Give a mon­key a value at risk (VaR) model or the cap­i­tal asset pric­ing model (CAPM) and you’ve got a poten­tial finan­cial dis­as­ter on your hands.

The intel­li­gent sup­port­ers of mod­els are always quick to point out that finan­cial mod­els are, of course, an abstrac­tion from real­ity. Just as physi­cists can study worlds with­out fric­tions, finan­cial mod­el­ers should not be attacked for try­ing to reduce the com­plex­ity of the “real world” into tractable forms.

Finance is often said to suf­fer from Physics Envy. This is gen­er­ally held to mean that we in finance would love to write out com­plex equa­tions and mod­els as do those work­ing in the field of Physics. There are cer­tainly a large num­ber of mar­ket par­tic­i­pants who would love this outcome.

I believe, though, that there is much we could learn from Physics. For instance, you don’t find physi­cists bet­ting that a feather and a brick will hit the ground at the same time in the real world. In other words, they are acutely aware of the lim­i­ta­tions imposed by their assump­tions. In con­trast, all too often peo­ple seem ready to bet the ranch on the flim­si­est of finan­cial models.

Read the whole let­ter in the slid­edeck below (Fullscreen for the eas­ier read, or download)

JM_FlawsofFinance_512

Tags: Asset Pricing, Bad Behaviour, Bads, Capital Asset Pricing Model, Capital Asset Pricing Model Capm, Central Banks, Cfa Institute, Eddie Izzard, Financial Disaster, Financial Modelling, Financial Models, Global Financial Crisis, Hippocratic Oath, James Montier, Line Of Defence, National Rifle Association, Rebuttal, Sum Total, Value At Risk, Value At Risk Var
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May 14th, 2012

Just because it is always amus­ing to watch the cog­ni­tive dis­so­nance in the head of a per­mab­ull, here is Jim 'Soon to be head of the BOE... allegedly' O'Neill's lat­est mis­sive to (what?) GSAM clients. Yes, the same O'Neill who week after week, let­ter after let­ter kept on say­ing that 2012 is noth­ing like 2011, finally being forced to admit that 2012 is, as we have been say­ing since Jan­u­ary 1, noth­ing but 2011, as the cen­tral plan­ners' script writ­ers prove painfully worth­less at com­ing up with any­thing orig­i­nal. That, of course, and that the life­long ManU fan had to suf­fer the indig­nity of inter­City rivals pick­ing up the tro­phy this year after a mirac­u­lous come back win against QPR. Oh, the horror...

Is it One of Those May’s Again?

Not another one, surely? It is almost too sim­ple to be true. I have been say­ing to peo­ple all year that we would have a great rally into May. Then, it might be quite a chal­lenge for the Sum­mer and, like clock­work, we could come back in the Autumn to take the mar­kets to fresh highs. I had expected that the S&P would get to the 1470–1480 area before the cor­rec­tion would set in. In this sense, it has hap­pened quicker, because of the fact that “May” started in April, just as it did last year? While I have read a few arti­cles recently try­ing to dis­miss the “May” fac­tor, the evi­dence is annoy­ingly per­sua­sive that if the May to Octo­ber months could just be 6 month hol­i­day peri­ods, and we picked up our invest­ments as though noth­ing had
changed, the long term annu­al­ized return would be notably higher. Of course, it is dif­fi­cult to find a coher­ent rea­son why this occurs so often. And, as some doubters cor­rectly point out, it often doesn’t occur.

Any­how, as can be seen in the attached chart, the momen­tum in the S&P has clearly turned lower, but inter­est­ingly, we sit just above trend line sup­port (and well above the 200-day mov­ing aver­age). So, this is prob­a­bly just a correction.

For some of us spoilt Man­ches­ter United fans, for the best part of the past 20 years at least, we have been able to take solace with the May issue, because around about this time, we are usu­ally pick­ing up the Pre­mier League Tro­phy, and often there is a Euro­pean Cham­pi­ons League Final to be thrown in as well as an FA Cup Final. Alas, this year, the cup­board might be empty and, of course, City could be pick­ing up the League for the first time in 44 years.

Europe. Could it get any Messier?

I went to visit a rather weird play with my wife early last week, and I found myself think­ing at one point “This is nearly as screwed up as the Euro Area.” I did warn last week­end that the French, and espe­cially the Greek elec­tion, might have some impact this past week. It is quite ironic, as a cou­ple of peo­ple pointed out to me given that I am always dis­miss­ing Greece’s eco­nomic rel­e­vance, that I sug­gested it might be more impor­tant in the short term than the French elec­tion. I shall dis­cuss the French elec­tion issue more below, but given we all knew this was com­ing for months, and that Hol­lande won with the major­ity rea­son­ably sim­i­lar to the polls, I am not sure what was really new last week on this score (except for the Ger­man reaction).

Greece

Greek vot­ers appear to now face another elec­tion in a few weeks with some sim­ple choices. Do you want to remain in the EMU and stick with the com­mit­ments and sup­port that your inter­na­tional allies have gen­er­ously given you? Or, do you want to recre­ate the Drachma and run the risk of a mas­sive bank­ing col­lapse and lots of other unpre­dictable con­se­quences? Polls appear to sug­gest the far left is likely to do well, so these ques­tions are pretty real ones. As for the Euro, as I argued last week, it is not entirely clear to me that, once the dust set­tles, Greece leav­ing would be mate­r­ial either way. But we shall see.

French Elec­tion and Germany.

As I said above, there was not really a lot of new infor­ma­tion about Hollande’s plans last week. There­fore, in some ways, it was all dis­counted. Quite a few con­tacts of mine sug­gested that, despite the rhetoric, France under Hol­lande will not do any­thing dra­matic against the spirit of the Fis­cal Com­pact, although they will push the issue of a sup­ple­men­tary plan for a Growth Pact. And as I reminded many of my col­leagues, they are prob­a­bly more fun­da­men­tally “pro Euro” than Sarkozy, which many peo­ple seem to have for­got­ten. Impor­tantly, in this regard, this Admin­is­tra­tion is another one now in power in Europe that sup­ports a true

Euro bond at the core of a more inte­grated Europe.

As I found myself think­ing as the week wore on, this means that the Ger­man elec­tions in the Autumn of 2013 are going to be really impor­tant. Any­one who wants to be in a coali­tion with either the SPD or Greens (or both) is going to have to sup­port the idea also. I sus­pect Chan­cel­lor Merkel will be more than happy to sup­port it. A num­ber of meet­ings that I coin­ci­den­tally had this week added to my con­fi­dence on this score.

Against this “big pic­ture” back­ground, the most inter­est­ing aspect of the French elec­tion is how Ger­man pol­i­cy­mak­ers responded. Sud­denly there is a fresh tone of what I would regard as wel­come real­ism and open mind­ed­ness. First of all, Finance Min­is­ter Schauble talked about the need for higher Ger­man wages, which would help rebal­anc­ing within the EM. And a few days later, some Bun­des­bank offi­cials acknowl­edged that Ger­many would prob­a­bly have to accept infla­tion above 2 pct for some time. As one of the peo­ple I was refer­ring to above put it to me, it would be through “grit­ted teeth,” but the real­ity is that they really have no alter­na­tive if the EMU is to per­sist fol­low­ing the shift­ing ground demanded by Euro­pean vot­ers. All of this should be good, and it will prob­a­bly mean that the ECB will be less hawk­ish as a result.

Tags: Amp, Annualized Return, Autumn, Boe, Central Planners, Cognitive Dissonance, Coherent Reason, Goldman, Holiday Periods, Indignity, January 1, Manu, Missive, Momentum, Moving Average, O Neill, Rally, Rivals, Script Writers, Trend Line
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May 14th, 2012

Wee­bles wob­bling, spin­ning tops run­ning out of energy, run­ning out of room to kick the can, what­ever anal­ogy you want to use, the world seems like an incred­i­bly dan­ger­ous place.

Greece is going to leave the Euro. That is now pretty much everyone’s expec­ta­tion. I con­tinue to believe that although they are highly likely to leave, it isn’t for a few more months, and that there will be some real effort from the Troika, led by the ECB to resolve this sit­u­a­tion. This isn’t about help­ing Greece. This is about sav­ing what is left of Europe. What does a new cur­rency really do for Greece? It sounds excit­ing and the con­ven­tional wis­dom is that it lets them inflate their way out of their prob­lem. I think all it will do is inflate them into a “Mad Max” world. How is Greece going to be able to afford gas and food if they revert to the Drachma on short notice? Greece doesn’t export enough to get a huge imme­di­ate ben­e­fit. Yes, it will be cheaper to pro­duce in Greece, but very lit­tle is set up to take advan­tage of that right now.

But it is the ECB and the rest of Europe that need to worry. Greece needs fur­ther debt cuts even more than it needs a new cur­rency. Not only would the ECB’s and IMF’s exist­ing hold­ings be con­verted to the new cur­rency, Greece may decide to default out­right. The ECB and IMF are both star­ing at mas­sive losses. If Greece goes to the Drachma and doesn’t change the debt to Drachma, then they will have killed them­selves. That just isn’t pos­si­ble. So switch­ing to drachma, and then pos­si­bly even default­ing is what is nec­es­sary. How will the ECB and IMF deal with it? The ECB might have to make a cap­i­tal call. That would send tremors through the sys­tem. The IMF will deal with it, but expect talk about coun­tries pulling out of the fire­wall. There is talk about hav­ing the EFSF make the ECB whole. That’s not even tak­ing money from one pocket and shift­ing it to another, it’s the same damn pocket. The mar­ket will not like that.

Short­ing Ger­many, prefer­ably bunds, is my favorite way to play this (with French bonds a close sec­ond). I think the next leg if it occurs wipes out the myth of Ger­many as “safe haven”. If Greece goes, losses to the Troika will be real and any attempt to paint over them will be too obvi­ous. The stag­ger­ing size of the com­mit­ments that will ulti­mately flow onto the shoul­ders of Ger­many and France will end the idea that some­how their credit is some­how bet­ter. The guar­an­tees mat­ter, and these bonds will be affected.

I still expect some “sur­prise” head­lines bring­ing all the peo­ple involved to some form of res­o­lu­tion, that won’t obvi­ously fix every­thing, but will buy time. Notice Draghi has not once said any­thing about this, and really he seems far and away the most com­pe­tent per­son at the ECB.

Then back here, we can focus more on JP Mor­gan. Since 2007, JPM had a loss in one quar­ter only. They lost 9 cents in Q4 2008. The just made 1.70 in Q1 of this year. Citi had 9 quar­ters of losses in that period. Their worst quar­ter was –23.80 per share com­pared to a tiny 1.11 per share in Q1. MS had 6 quar­ters of losses, with the biggest being 3.61 AND they lost money in 2 quar­ters last year. Yes, $2 bil­lion is a big num­ber. It may have grown, it may turn out smaller. In any case, it is unlikely JPM will have a loss this quar­ter. This group and the over­all risk man­age­ment of the firm is part of why they have done so well rel­a­tive to their peers. If you want to focus on the fact that $2 bil­lion is a huge num­ber to a nor­mal per­son, that is fine, but you may be get­ting more angry than you should. The real­ity is that JPM, with $2.3 tril­lion in assets is huge, and every busi­ness they are in is big, and P&L swings will be large in $ terms, but seem com­pletely rea­son­able in per­cent­age terms.

Yes, reg­u­la­tory scrutiny will inten­sify, but this is a prob­lem at all big banks. The spe­cific risk of this trade has been over­done. Unfor­tu­nately it is hard to tell how much of the price move is spe­cific to one aspect or the other, so I can’t quite get com­fort­able with the sit­u­a­tion in terms of get­ting long JPM, but will be look­ing at out­per­for­mance trades.

Futures have already had a wild ride, and I would expect that to con­tinue through­out the day. MAIN is out to 169 +12 bps on the day. XOVER is at 718 +36 bps on the day. It is ugly, with min­i­mal liq­uid­ity – even the best mar­ket mak­ers are back to mak­ing 1 bp mar­kets in MAIN. IG18 is open­ing at 112, which is 3.5 bps wider, and HY18 is at 94 3/8, so down about 5/8. The moves in XOVER and HY rel­a­tive to MAIN and IG seem more nor­mal than Fri­day, when we saw almost amaz­ing out­per­for­mance in the HY space (where JPM is allegedly short).

Spain and Italy are under attack again. Ten year yields have hit 6.26% and 5.70% respec­tively while CDS is at 640 and 480 respec­tively. Scary num­bers, though Span­ish 10 year may be get­ting to the point where we see some ECB inter­ven­tion in the sec­ondary markets.

So with prob­lems across the globe and the mood so dim, I can’t help but think we are set up for a rally on the back of any scrap of good news. I don’t see Greece hit­ting the break­ing point just yet, and the mar­ket will digest the JPM loss as it thinks more ratio­nally, and Spain and Italy are not so heinous that they should respond well to any ECB intervention.

Tags: Analogy, Axis, Conventional Wisdom, Currency, Dangerous Place, Drachma, ECB, Efsf, Expectation, Firewall, Gas And Food, Greece, Imf Deal, Mad Max, Massive Losses, Max World, Spinning Tops, Tremors, Troika, Weeble, Weebles
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May 14th, 2012

Panic Is Not a Strategy—Nor Is Greed

Updated May 10, 2012
by Liz Ann Son­ders, Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.

Key Points

• Orig­i­nally pub­lish­ing in 2008, it's time for a refresher about the per­ils of panic.
• Asset allo­ca­tion, diver­si­fi­ca­tion and rebal­anc­ing are as close to a "free lunch" as you can get as an investor.
• In a world where time hori­zons have shrunk pre­cip­i­tously, think longer-term.

If mar­kets are good at one thing, it's remind­ing investors that they don't go up unin­ter­rupted for­ever. We wit­nessed sev­eral bruis­ing cor­rec­tions in 2011 before the market's strong rally between Octo­ber 2011 and April 2012. As the chart "Fear Spikes Again" below illus­trates, the CBOE Volatil­ity Index® has picked up again, but remains below the unpar­al­leled heights of the 2008 credit cri­sis and the more-recent ele­va­tion in 2011.

Fear Up, But Well Down From Highs

Source: Fact­Set, as of April 20, 2012. The CBOE Volatil­ity Index ("VIX") is a reg­is­tered trade­mark of the Chicago Board Options Exchange. The VIX Index shows the market's expec­ta­tion of 30-day volatil­ity. For more infor­ma­tion on the VIX, visit www.cboe.com/micro/vix/

We're always quick to remind investors that nei­ther panic nor greed is an invest­ment strat­egy, and that the best foun­da­tion to help pro­tect a port­fo­lio against the unpre­dictable is having—and stick­ing with—a long-term strate­gic asset allo­ca­tion plan.

Mind­set mat­ters: strate­gic trumps tactical

In real­ity, investors should rarely, if ever, react to a dra­matic short-term move in the mar­ket. As intrigu­ing as it may seem to try to catch bot­toms and get out at tops in order to reap big prof­its (or so you think), the "tac­ti­cal" (or shorter-term) approach to invest­ing has its lim­i­ta­tions ... and its risks.

We believe it's the "strate­gic" asset allo­ca­tion decision—and the abil­ity to stick with it through the dis­ci­pline of rebalancing—that will ulti­mately reap the great­est rewards. These deci­sions are not a func­tion of short-term mar­ket gyra­tions or fore­casts (mine, yours or any­one else's), but are tied to your risk tol­er­ance and long-term goals. Devel­op­ing and main­tain­ing the right long-term asset mix is by far the most impor­tant set of deci­sions a client will ever make.

Never before has infor­ma­tion about the global econ­omy and mar­kets been more read­ily avail­able and dis­sem­i­nated. As a result, global mar­kets have become very inter­con­nected. In turn, our reac­tion mech­a­nisms have kicked in, and investor time hori­zons have short­ened dramatically—but not nec­es­sar­ily to our advan­tage. Yes, the long term is really just a series of short-term events, but it's how we react to them that decides our ulti­mate fate as investors.

Asset allo­ca­tion and diver­si­fi­ca­tion: investors' "free lunch"

One of the most impor­tant areas where Schwab offers advice is the devel­op­ment of a long-term strate­gic asset allo­ca­tion plan. Many investors assume that their posi­tion along the risk spec­trum from con­ser­v­a­tive to aggres­sive is largely based on their age and time hori­zon. But a more impor­tant fac­tor is their risk tol­er­ance. Also impor­tant is judg­ing the dif­fer­ence between an investor's finan­cial risk tol­er­ance (their abil­ity to finan­cially with­stand volatile mar­kets) and their emo­tional risk tolerance—a spread that's often quite wide and only acknowl­edged dur­ing tumul­tuous mar­ket environments.

I've known plenty of older investors who thrive on the risk asso­ci­ated with an aggres­sive invest­ment stance. I've also known plenty of young investors who can't stom­ach any losses. Too often, investors use a rearview mir­ror to make their invest­ing deci­sions, by look­ing at past per­for­mance as a guide to future results. A mir­ror is a valu­able tool but only when turned on your­self to judge your own circumstances—tolerance for risk, time hori­zon, income needs, etc. As I've often said, there are very few free lunches in invest­ing. Asset allo­ca­tion, diver­si­fi­ca­tion and peri­odic rebal­anc­ing are as close as you get.

Risk tol­er­ance: Know what you can stomach

In the chart "Schwab's Strate­gic Asset Allo­ca­tion Mod­els" below, you'll see our long-term rec­om­men­da­tions regard­ing dif­fer­ent asset classes for three types of investors: con­ser­v­a­tive, mod­er­ate and aggres­sive.¹ Note the vast dif­fer­ences in allo­ca­tions to riskier asset classes, includ­ing inter­na­tional equity, as you move up the risk spectrum.

Clearly, over the long term, given the bet­ter per­for­mance by the riskier asset classes, a more aggres­sive allo­ca­tion has his­tor­i­cally reaped higher rewards in terms of returns. But there is a dark side to an aggres­sive posture's higher returns—the risk taken in get­ting there.

Tags: Allocation Plan, Cboe Volatility Index, Charles Schwab, Chicago Board Options, Chicago Board Options Exchange, Chief Investment Strategist, Credit Crisis, Diversification, Free Lunch, Greed, Investment Strategy, Liz Ann, Perils, Rewa, Senior Vice President, Strategic Asset Allocation, Term Approach, Time Horizons, Unparalleled Heights, Vix Index, Volatility Index Vix
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May 13th, 2012

Here We Go Again....or Not?

May 11, 2012

by Liz Ann Son­ders
Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.,
Brad Sorensen
CFA, Direc­tor of Mar­ket and Sec­tor Analy­sis, Schwab Cen­ter for Finan­cial Research, and,
Michelle Gib­ley
CFA, Direc­tor of Inter­na­tional Research, Schwab Cen­ter for Finan­cial Research

Key Points

• Softer eco­nomic data has prompted con­cerns that the mar­ket may be headed for a sum­mer swoon—similar to the pre­vi­ous two years. We believe the back­drop is decid­edly dif­fer­ent (and bet­ter) this time around but investor and busi­ness con­fi­dence will con­tinue to be important.
• Some appear to be hop­ing for weaker data in order to spur the Fed to enact another round of quan­ti­ta­tive eas­ing (QE3). We believe the bar is much higher and that the Fed should look to return to a more nor­mal mon­e­tary stance. Com­pli­cat­ing the over­all pic­ture and the Fed’s job is the com­ing "fis­cal cliff" out of Wash­ing­ton at the end of this year.
• The polit­i­cal sit­u­a­tion in Europe has injected even more uncer­tainty into an already ten­u­ous envi­ron­ment. Pub­lic cries for a reduc­tion in aus­ter­ity, despite many pro­posed mea­sures not tak­ing affect yet, raises ques­tions as to the sus­tain­abil­ity of the euro­zone as is. Spend­ing cuts are impor­tant, but must be accom­pa­nied by seri­ous struc­tural changes that encour­age growth and inno­va­tion to pro­vide hope for the future.

NOTE: The next Schwab Mar­ket Per­spec­tive will be pub­lished one week later than normal—June 1, 2012.

We've seen this movie before … or have we? After start­ing out the pre­vi­ous two years in a pos­i­tive direc­tion, stocks expe­ri­enced dis­ap­point­ing down­turns begin­ning around this time of each year and con­tin­u­ing through­out the sub­se­quent sum­mers. Recently we've seen eco­nomic data soften, global con­cerns rise, Trea­sury yields fall, and stocks cor­rect, prompt­ing more ques­tions as to whether we're see­ing a very unwel­come sequel. We believe not.

Before get­ting into why we don't believe we're in store for Sum­mer Swoon III (a sequel, like many, that no one wants to see), we want to again point out that try­ing to time the mar­ket is largely a los­ing game for investors. And we also con­tinue to remind investors that stick­ing to a dis­ci­plined long-term plan is key, rather that chas­ing crowd psy­chol­ogy or past returns. We're reminded of the con­tin­ued chas­ing men­tal­ity that almost inevitably leads to dis­ap­point­ment as ISI Research reported that bond mutual fund inflows were at a record high dur­ing the first four months of the year, while equity fund out­flows were the third largest on record.

Cur­rently, investor appre­hen­sion is ris­ing, indi­cated by increas­ing volatil­ity and a stock mar­ket in cor­rec­tion mode, as the pos­si­bil­ity of a replay of the pre­vi­ous two years is con­sid­ered. How­ever, we believe there are sev­eral impor­tant fun­da­men­tal dif­fer­ences that help to sup­port a renewed mar­ket advance before too long. First, we aren't deal­ing with any major nat­ural crises such as the Japan­ese earth­quake and tsunami we saw last year; or the spike in food infla­tion that unleashed the "Arab Spring." In fact, com­mod­ity prices are largely mov­ing lower, allow­ing cen­tral banks around the world to ease mon­e­tary pol­icy, as we’ve seen in Brazil, Aus­tralia, and India among oth­ers. And while there are still major con­cerns regard­ing the debt cri­sis in Europe, dis­cussed in fur­ther detail below, the Euro­pean Cen­tral Bank (ECB) has made moves that indi­cate they will be aggres­sive to pre­serve some sem­blance of sta­bil­ity in the Euro­pean mar­kets. Finally, in the United States we're see­ing fur­ther signs of hous­ing sta­bi­liza­tion, a con­tin­ued improv­ing job sit­u­a­tion, and a rebound in auto sales, which is now a larger dri­ver of GDP than res­i­den­tial investment.

But there's the impact of "mus­cle mem­ory" given the past two years' volatil­ity; and per­cep­tion can become real­ity. There is a risk that investors increas­ingly lose con­fi­dence in the eco­nomic recov­ery, pres­sur­ing stocks, and caus­ing busi­nesses to again pare back. In the short term, mar­ket per­for­mance can have more to do with sen­ti­ment than fun­da­men­tals, again illus­trat­ing the folly of short-term timing.

Tem­po­rary Soft­ness or a New Trend?

Data has been mixed lately, with regional man­u­fac­tur­ing sur­veys largely dis­ap­point­ing: the Chicago PMI fell to its low­est level since Novem­ber 2009, although remain­ing in expan­sion­ary ter­ri­tory and the Dal­las Fed Index slipped into neg­a­tive ter­ri­tory. The national index pro­vided more encour­age­ment as the ISM Man­u­fac­tur­ing Index rose to 54.8, the best level since June 2011, while the for­ward look­ing new orders com­po­nent rose to 58.2, the best level since April 2011. This is dis­tinctly bet­ter than the trend in most global PMIs. How­ever, more con­cern came in the form of the ISM Non-Manufacturing Index, which soft­ened to 53.5 from 56. But while the impor­tant ser­vice sec­tor showed some soft­ness, we con­tinue to see con­sumers improve their bal­ance sheets, which should help to sup­port spend­ing going forward.

Con­sumers' debt posi­tion is much improved

Source: Fact­Set, Fed­eral Reserve. As of May 7, 2012. Includes mort­gage and con­sumer debt, auto lease pay­ments, rental pay­ments, home­own­ers insur­ance, and prop­erty tax payments.

Key to con­sumer spend­ing con­tin­u­ing to hold up is likely the con­tin­ued improve­ment in the job mar­ket, which has been in ques­tion lately. Job­less claims started to creep higher before expe­ri­enc­ing a rel­a­tively sharp rever­sal recently and remain­ing well below the crit­i­cal 400,000 level. How­ever, pay­roll growth con­tin­ued to be dis­ap­point­ing as a soft read­ing for March was fol­lowed with another one in April. We saw ADP report a mere 119,000 pri­vate jobs were added, while the Bureau of Labor Sta­tis­tics (BLS) reported that non­farm pay­rolls expanded by a weak 115,000 posi­tions; although the pre­vi­ous two months were revised higher. The unem­ploy­ment rate fell to 8.1% due largely to a drop in the labor par­tic­i­pa­tion rate, which now stands at 63.6%—the low­est level since 1981.

Tags: Austerity, Backdrop, Business Confidence, Charles Schwab, Chief Investment Strategist, Economic Data, Eurozone, Global Concerns, Liz Ann, Market Perspective, Monetary Stance, Political Situation, Positive Direction, Research Key, Sector Analysis, Senior Vice President, Sequel, Sustainability, Swoon, Treasury Yields
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May 13th, 2012

ECRI's Lak­sh­man Achuthan was mak­ing the rounds yes­ter­day, with yet another defense of his firm's reces­sion call – the first claim which came early last fall.  I do think (from mem­ory) he has pushed out the time frame a bit from when the ini­tial call came, but since early this year has claimed we will see it by mid year.  Per­haps the very warm win­ter hurt the call as well – who knows with these black boxes.  Below we have a video with CNBC and there is one nugget in there I did not know.  Con­ven­tional wis­dom is a reces­sion is back to back quar­ters of neg­a­tive GDP… but accord­ing to the NBER (and Achuthan) that is but one of a group of poten­tial signals.

The Com­mit­tee does not have a fixed def­i­n­i­tion of eco­nomic activ­ity. It exam­ines and com­pares the behav­ior of var­i­ous mea­sures of broad activ­ity: real GDP mea­sured on the prod­uct and income sides, economy-wide employ­ment, and real income. The Com­mit­tee also may con­sider indi­ca­tors that do not cover the entire econ­omy, such as real sales and the Fed­eral Reserve's index of indus­trial pro­duc­tion (IP).

10 minute video – email read­ers will need to come to site to view

Tags: Black Boxes, Cnbc, Conventional Wisdom, Economic Activity, Economy, Federal Reserve, GDP, Lakshman, Lakshman Achuthan, Measures, Memory, Nber, Nugget, Quarters, Real Gdp, Recession, Signals, Time Frame, Video Email, Warm Winter
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