The Importance of Being Earnest (Columbia)

Thursday, April 12th, 2012

Tags: Bias, Bonds, Bulls, Columbia Management, Corporate Pension Funds, Dividends, Great Depression, Inclination, Market Gyrations, Maxim, Meltdown, Nasdaq, Oil Crisis, Portfolio Managers, Portfolios, Rich Rosen, Spite, stagflation, Trough
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David Rosenberg: “It’s a Gas, Gas, Gas!”

Monday, February 27th, 2012

Once again, if one wants to get nothing but schizophrenic noise from several momentum chasing vacuum tubes which very way may take the market to all time highs on 1 ES contract churned back and forth, by all means focus on the “market” which for the past three years is merely a policy vehicle of the monetary-fiscal fusion regime (thank you Plosser for confirming what we have been saying for years). For everyone else, here is the traditionally solid economic commentary from David Rosenberg. Considering that the central planners have pumped $7 trillion, or 50% of their balance sheet, in the stock market in the past 4 years, to offset precisely the warnings that Rosenberg issues on a daily basis, we are far beyond debating whether or not those who observe the economy realistically are right or wrong. The only question is whether the central banks can continue to expand their balance sheet at an exponential phase to offset the inevitable. Answer: they can’t.

From Gluskin Sheff’s David Rosenberg

IT’S A GAS, GAS, GAS!

“There are fluctuations in the market that don’t mean anything.”

Ira Gluskin, February 14, 2012

If there was a Rule #11 added to Bob Farrell’s list of gems, this would be it. We have added this ditty before from Ira, and will continue to do so as a reminder. A reminder of what you ask? A reminder of how the stock market can be divorced from economic realities for a period of time. The stock market ignored the perils of the busted tech bubble for a good eight months back in 2000, ultimately to its own chagrin. It ignored the meltdown in the housing and mortgage market for at least 10 months back in 2007. The examples can go on, but hopefully the point is taken.

At any given moment of time, the market is driven by a variety of factors. Some are more important than others, and they include technicals, seasonals, sentiment. fund flows, valuations and, Of course, the fundamentals. The key driving force this year has been the expanded P/E multiple, in line with a 16 reading on the VIX index, as the markets seem to believe that the massive expansions of global central balance sheets will end up saving the day for dilapidated sovereign government balance sheets and woefully undercapitalized European banks. Too bad the Graham and Dodd classic text on value investing didn’t include a chapter on central bank money-printing.

From our lens, liquidity-based rallies are fun to trade, but tend to have a relatively short shelf life. Imagine what is on everyone’s minds for the coming week is not the economic data or earnings results but instead the second LTRO round on Wednesday — this is what investors are biting their nails over: will it be 1 trillion euros or ‘just’ 300 billion? Page M10 of Barron’s dubs this the ‘LTRO put’, which “sparked a massive risk-on rally in global markets”. Incredible how easy it is to avert a bear market why didn’t the Fed do this in 2007 and 2008, simply print money — and help us avoid the Great Recession?

What about the fundamentals? Well, let’s have a look at earnings. It is completely ironic that we would be experiencing one of the most powerful cyclical upswings in the stock market since the recession ended (the S&P 500 is now up 25% from the October 3rd nearby low) at a time when we are clearly coming off the poorest quarter for earnings, in every respect. The YoY trend in operating [PS is now below 6%, and without Apple, growth has basically vanished altogether (down to a mere +2.8%). Corporate guidance over the past three months is at the lowest point since August 2009 — before the term ‘green shoots’ was invented! Only 44% of companies beat their revenue targets, the weakest since the first quarter of 2010: and 64% surpassed their profit estimates and this too is the lowest since the third quarter of 2008.

If memory serves me correctly, you did not want to go long the market heading into either the second quarter of 2010 or the fourth quarter of 2008 with these factoids in hand. I have to admit that I find it perplexing as to why so many folks dub this a tech-led rally when we came off a week that saw both Hewlett- Packard and Dell disappoint in their Q4 earnings results — the former with a 7% YoY revenue dive.

All that said, the S&P 500 did manage to close out the week at 1,365.74 and establish a level not seen since June 5, 2008 (only 200 points shy of setting a new all-time high —Jeremy Siegel must be licking his chops). If you are wondering why it is that consumer sentiment jumped to 75.3 in February (better than the reading that was widely expected), this is the reason. The University of Michigan index does a much better job tracking the equity market than it does the labour market or consumer spending for that matter.

Page 13 of the weekend FT quotes a strategist as saying

“… we also had a combination of a couple of good earnings reports and little bright signs coming from the housing and labour markets. Some people are even talking about the S&P 500 hitting the 1,400 mark.”

Actually, earnings growth and earnings estimates are going down on net. As is corporate guidance, what little of it there is. The bright signs from housing are really a commentary on the balmy weather skewing the seasonally adjusted data and there is certainly no sign of any recovery in prices (it’s incredible how so many people get excited over a 321,000 new home sales tally — never mind that they are still near record lows in per capita terms). To be sure, the new housing inventory is down to a six-year low of 5.6 months supply, but taking into account the supply coming down the pike from foreclosures, the entire backlog in the pipeline is at least double that posted number.

…

The precious metals market is hardly signalling good times ahead — rather more turbulent times ahead — as gold finished last week near a three-month high (silver has been behaving even better and platinum has hit its best level in five months).

Meanwhile, what is largely being ignored is the rapid move up in oil prices as Iran-based tensions escalate further. The WTI crude price rose to nearly $110/bbl and more importantly. Brent has soared over $125/bbl (highest level since August 2008), and forward contracts are pointing to gasoline breaking back above $4 a gallon in the next two to three months (already there in California and within 10 cents in New York state). The nationwide average has already risen 37 cents in just the past month and 7 cents last week alone — it hasn’t been long enough to show through in the confidence surveys, though let’s face it, we are seeing early signs already of some fraying at the edges in the retail sector — despite the apparent improvement in the labour market (indeed, it is income that people spend, and growth on this front, let’s be honest, has been less than stellar).

Meanwhile, as if to represent the consensus of opinion out there. page A2 of the weekend WSJ quotes a pundit as saying “$4 probably isn’t going to be the threshold that changes peoples’ behavior this time. I think people have gotten used to $4″.

What claptrap. Its not that people have gotten used to $4 — it’s only there in the Golden State, Hawaii and Alaska … wait until it grips the whole country. And consumers have yet to fully process this rapid move up in gas prices, but recall what happened a year ago. To be sure, there was no recession, but economic growth came to a virtual halt in the first half of the year because of the impact that energy costs exerted on the GDP price deflator. Second, it is not the level but the change in prices at the pump that influences the growth rate of the economy — every penny at the pumps siphons away around $1.5 billion from consumer wallets into the gas tank. Moreover, a little history lesson for the pundit quoted above. According to work conducted by the University of California at San Diego and cited on page 14 of the weekend FT. all but one of the 11 post-WWII recessions followed an oil shock (the lone exception was the 1960 downturn). Recall what happened the last two times Brent hit current levels — in 2008 (recession) and 2011 (stall speed). Neither outcome was very good.

The key is how long this elevated energy price environment sticks around in terms of overall economic impact. Brent had already been hovering near $110/bbl for 12 months but this most recent price run-up has actually taken the 200-day moving average higher now than it was in the 2008 recession year. Let’s keep in mind that the jump in crude prices has occurred even with the Saudis producing at its fastest clip in 30 years — underscoring how tight the backdrop is. Even with slowing demand in the weak economies of the ‘developed world’, continued rapid growth in emerging markets is providing an offset on the demand side (which does little good for the American or European consumer).

Meanwhile, estimates of spare capacity are all over the map but what we do know is that just to meet the burgeoning demands of the emerging market world requires a further 1 mbd this year of production — and yet supplies are being withdrawn. It will not be very difficult to see oil retest $150 a barrel, and we are talking WTI here, not Brent.

…

It is also fascinating to watch the action in the much-despised Treasury market (the net speculative short position on the 10-year 1-note is 63,328 contracts on the CBOT while the comparable for Dow contracts is net long 14.803 contracts). Despite the slate of supply last week ($99 billion of new issue activity) the yield on the 10-year T-note closed at 1.98%. Someone out there (Bernanke?) is
coming in and buying whenever the yield pops above 2% — a level that simply is not being sustained on apparent break-outs. The long bond yield actually finished the week lower in yield at 3.1% from 3.14% (the 10-year was down 2bps).

At a time when energy prices are spiking, this is a clear sign that the bond market is treating this as a deflationary shock rather than a durable increase in inflation. That makes total sense to us. It’s not as if global consumption is going up — even with higher auto sales, Americans are spending less time on the road: miles driven are down 1% over the past year. And the IEA (International Energy Agency) has cut its 2012 forecast for global oil demand twice since the beginning of the year. This is an exogenous supply shock, pure and simple.

…

And now the consensus is that the recession in the euro area will be mild because of one month’s worth of diffusion indices. Such is human nature — extrapolate the most recent economic indicator into the future. The region suffers from a credit shock, a fiscal shock, and now an oil shock and at the same time, an overvalued currency. What is the euro doing at an 11-week high and how does this help the region export its way out of its economic downturn? Yet there are still a net short 137,479 speculative euro contracts on the CME, which could have a further impact as they cover in the near-term; there are 17,136 net long yen contracts and 29,101 net long speculative U.S. dollar contracts.

Brent crude oil hit a record high in euro terms (in Sterling as well) last week and has surged 11% in just the past month on this basis, and even if prices stay where they are, what energy is going to absorb out of Eurozone GDP this year will be 5.5%, which would surpass the 2008 recession shock of 4.8% (the highest drainage from the economy in three decades — see Soaring Oil Price Threatens Recovery on page 14 of the weekend FT).

…

The U.S. economy is either generating jobs in low-paying service sector jobs or the employment that is coming back home in manufacturing is doing so at lower wage rates than when these jobs left for Asia years ago. So much for wage stickiness. Throw in rising gasoline prices and real incomes are in a squeeze, and there is precious little room for the personal savings rate to decline from current low levels. On a year-to-year basis, real after tax incomes are running fractionally negative and in the past that was either associated with an economy in recession, about to head into recession or just coming out of recession. So perhaps there is no contraction in real GDP just yet. but there is one in real incomes.

What else do people spend? Their wealth. And here too, courtesy of a flat equity market performance and renewed declines in home values, household net worth also contracted in the past year. So here we have real incomes and wealth both deflating and the masses believe that recession is off the table because of a liquidity-induced four-month rally in the stock market. Go figure.

Tags: All Time Highs, Bob Farrell, Central Banks, Central Planners, Chagrin, Daily Basis, David Rosenberg, Ditty, Economic Commentary, Economic Realities, Eight Months, Fund Flows, Gluskin Sheff, Inevitable Answer, Meltdown, Mortgage Market, Perils, S David, Stock Market, Vacuum Tubes
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Print-Or-Panic: TrimTabs On The Market’s Meltup

Friday, January 20th, 2012

As retail investors continue to appear significantly pessimistic in their fund outflows ($7.1bn from US equity mutual funds in w/e January 4th – the largest since the meltdown in early August) or simply stuff their mattresses, David Santschi of TrimTabs asks the question, ‘who is pumping up stock prices?‘ His answer is noteworthy as a large number of indicators suggest institutional investors are more optimistic than at any time since the ‘waterfall’ decline in the summer of 2011. Citing short interest declines, options-based gauges, hedge fund and global asset allocator sentiment surveys, and the huge variation between intraday ‘cash’ and overnight ‘futures market’ gains (the latter responsible for far more of the gains), the bespectacled Bay-Area believer strongly suggests the institutional bias is based on huge expectations that the Fed will announce another round of money printing (to stave off the panic possibilities in an election year). The ability to maintain the rampfest that risk assets in general have been on (and the cash-for-trash short squeeze that has been so evident) must be questioned given his concluding remarks.

While we fully expect QE to come, we can’t help but question the willingness to meet market expectations so head on (remember when the Fed used to like to surprise) but with ever blunter (and seemingly weaker) tools, what more can they do – leaving a market (and note here we did not say economy as that is clearly not benefiting) that needs exponentially more ‘juice’ (EUR10tn LTRO?) just to keep from the post-medicinal crash.

Tags: Asset Allocator, Believer, Declines, Early August, Election Year, Futures Market, Institutional Bias, Institutional Investors, Market Expectations, Mattresses, Meltdown, Money Printing, Qe, Retail Investors, Short Interest, Short squeeze, Stock Prices, Trimtabs, Waterfall, Willingness
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The Trouble With Quants (Brightman)

Wednesday, August 17th, 2011

`by Chris Brightman, Research Affiliates

Oliver Wendell Holmes’ 1858 poem “The Deacon’s Masterpiece”¹ describes a perfected one-horse “shay,” a highly engineered carriage designed so that the failure of a single part could not cause an untimely breakdown. By eliminating the weakest links, the carriage performs flawlessly, at first. But the shay does not have a happy ending. It suddenly disintegrates with all the parts failing at once, leaving its rider dazed atop a pile of rubble. Holmes—the father of the eminent U.S. Supreme Court Justice— mocked the pseudo-scientific efforts of the overeducated Deacons of his day to engineer impractical structures.

In our domain, the Deacons are quants (financial engineers) and their Masterpiece is an overly complex quantitative investment strategy. The second week in August marks the four-year anniversary of the quant meltdown of 2007. While the events of 2008, including nationalization of Fannie Mae and Freddie Mac, the failure of Lehman, the bailout of AIG, creation of TARP, etc., have rightly received more scrutiny, August 2007 foreshadowed the global financial crisis and deserves more attention by today’s investors. Analyzing the underlying causes of the quant meltdown helps reveal the perils of complex quantitative strategies and highlights the difference between transparent and rules-based alternative beta strategies such as the Fundamental Index® methodology and newer optimized approaches.

The Quant Meltdown
During the week of August 6, 2007, many large and previously successful hedge funds were forced to de-lever their portfolios and liquidate commonly held securities, resulting in
simultaneous drawdowns of 30%, 50%, or worse. To make matters worse, these investments had been sold as risk-controlled and uncorrelated to the market. Khandani and Lo concluded that a “… deadly feedback loop of coordinated forced liquidations leading to deterioration of collateral value took hold during the second week of August 2007, ultimately resulting in the collapse of a number of quantitative equity market-neutral managers, and double-digit losses for many others.”² Quantitatively managed enhanced index funds experienced similar simultaneous traumas, though the magnitude of losses was lower due to the lack of leverage.

None could have forecast the precise timing of the sudden liquidation of a large trading desk that catalyzed the quant meltdown.³ But should we have been surprised that those funds failed catastrophically? After all, the quant funds of 2007 shared the same structural flaws as the highly engineered financial trading strategies that caused the stock market crash in 1987 and the implosion of Long-Term Capital Management in 1998.⁴

Inside the Black Box
To help avoid future meltdowns in our portfolios, we need to look inside the black box of quant strategies. Simply put, quants use advanced statistical methods and high frequency data to create complex financial models. With experience, skill, and some luck, a few of these models successfully forecast future security price changes. In the short term, these strategies provide consistent trading profits and gather assets into associated funds. Consistent profits can hide inherent risks, however. Most complex quant strategies have proven to be unstable. Markets evolve in response to the creation and adoption of these strategies. At first, the identified predictability in security price movements is reinforced as funds using the quant model, along with similar funds using similar models, begin buying and selling the same securities. Early success and clever marketing attracts large flows into the funds, which, in turn, drives the prices of securities held by these funds to unsustainable extremes. The result is a brittle price structure awaiting the inevitable crisis.

Leverage creates an even more toxic brew. In the years leading up to the quant meltdown in August 2007, the same models used to manage enhanced index funds (with relatively low tracking errors and high information ratios) were increasingly employed to create levered absolute return-oriented long/short funds. To facilitate the use of leverage, risk models were used to minimize country, sector, and other common factor risks. With all the risk seemingly wrung out of the strategy, ever more capital and leverage were applied.

Paradoxically, quantitative risk management was part of the problem. While risk models are useful tools for measuring risk, using models to tightly control risk is misguided and dangerous. Because no model is, or ever can be, a complete description of the complex dynamic system that is a market, all risk models fail to capture some risk. By eliminating all of the risks measured by their models, the quants transferred the risk in their funds into the areas their models could not measure and they did not understand.

Quant strategies produce remarkable profits in the early stages. But inevitably, the process becomes unstable and often ends with violent illiquidity events, such as the stock market crash of 1987, the Long-Term Capital Management-induced crisis in September 1998, and the quant meltdown in August 2007. The largest losses in those episodes were suffered by the most recent investors who were attracted by dazzling early performance records. Instead of consistent profits, the later investors were stuck with shocking losses realized during fund liquidation as investors fled from the imploding strategies.

As Harry Markowitz stated in the middle of the crisis, “…the layers of financially engineered products… combined with the high levels of leverage, proved to be too much of a good thing.”⁵

Fundamental not Quant Only four years after the last quant meltdown, over-engineered quantitative investment strategies are back. The latest incarnation is complexly optimized alternative betas. Such strategies attempt to engineer indices with the lowest possible volatility, the highest possible Sharpe ratio, or the maximum possible diversification. The more complex the engineering, the better the model performs in the backtest. As investors begin to adopt such narrow indices, early performance may be rewarding. Fund inflows will create buying and selling pressure on the same narrow set of securities. This pattern will create a brittle price structure resembling the Deacon’s Masterpiece and will set the stage for the next wreck.

Recognizing the trouble with quants, should we eschew quantitative study of security price movements and abandon risk models? Of course not! Advanced statistical methods are invaluable tools to help us understand securities markets. Likewise, risk models help us measure, monitor, and decompose the risks in our portfolios. For example, with regard to the Fundamental Index methodology, we use quantitative methods to demonstrate how and why companies with low market prices relative to fundamental measures of company size provide higher returns than companies with high market prices relative to fundamentals. We use risk models to examine whether and how value priced companies have different risk characteristics than other companies.

The Fundamental Index methodology is far less complex and therefore less risky than a highly engineered quant model. Fundamental weights are simple, logical, and stable. Fundamental Index portfolios are transparently constructed and broadly diversified. The Fundamental Index strategy uses the time-tested technique of systematic rebalancing to capture the long-term return premium offered by the market’s excess volatility.

The following passage from Holmes’ poem descries the end of the one-horse shay. But it could easily be a fitting narrative to the quant strategies during that fateful week in August 2007.

“…it went to pieces all at once, —
All at once, and nothing first, —
Just as bubbles do when they burst.
End of the wonderful one-hoss shay.
Logic is logic. That’s all I say.”

The performance of Fundamental Index strategies may break down occasionally over the long winding road to investment success, just as traditional index funds can create some nasty surprises. However, these setbacks are just that and eventually the Fundamental Index strategy’s simple and stable rebalancing process puts the portfolio back on track. That’s our logic. What do you say?

Endnotes
1. Oliver Wendell Holmes, 1890, The Deacon’s Masterpiece or The Wonderful “One-Hoss Shay”: A Logical Story, New York: Houghton, Mifflin and Company. Illustrations by Howard Pyle.
2. Amir E. Khandani and Andrew W. Lo, 2007, “What Happened to the Quants in August 2007?” Journal of Investment Management, vol. 5, Fourth Quarter
3. Khandani and Lo, 2007.
4. Richard Bookstaber, 2007, A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, New York: Wiley.
5. Harry Markowitz, 2008 “The Father of Portfolio Theory on the Crisis,” Wall Street Journal, November 3. http://online.wsj.com/article/SB122567428153591981.html?mod=djemEditorialPage

Copyright © Research Affiliates

Tags: Bailout, Collateral Value, Deacons, Fannie Mae, Fannie Mae And Freddie Mac, Feedback Loop, Financial Engineers, Global Financial Crisis, Hedge Funds, Index Methodology, Investment Strategy, Liquidations, Meltdown, Nationalization, Oliver Wendell Holmes, Quantitative Investment, Quants, Research Affiliates, Shay, Supreme Court Justice
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Silver Is Getting Too Popular… Right?

Friday, April 8th, 2011

by Jeff Clark of Casey Research

Silver Is Getting Too Popular… Right?

It’s no secret that the silver market is red-hot. As I write, silver American Eagles and Canadian Maple Leafs are sold out at their respective mints. Buying in India has gone through the roof, especially noteworthy among a people with a strong historical preference for gold. Demand in China continues unabated. Silver stocks have screamed upward.

So, as an investor looking to maximize my profit, I have a natural question: is the silver trade getting too crowded, meaning we’re near the top? Have the masses finally joined the party such that we should consider exiting? After all, it’s not a profit until you take it, and you definitely want to sell near the top.

There are several ways to measure how crowded the silver market might be. I prefer to look strictly at the big picture and not get caught up in the weeds. This means I’m looking for signs of market exhaustion or the masses rushing in. Nothing says “peak” more than an investment everyone is buying.

So how crowded are silver investments right now? Let’s first look at the ETFs.

At $35 silver, all exchange-traded funds backed by the metal amount to $20.7 billion. You can see how this compares to some popular stocks. All silver ETFs combined are less than a quarter of the market cap of McDonald’s. They’re about 10% of GE, a company that still hasn’t recovered from the ’08 meltdown. Exxon Mobil is more than 20 times bigger. And this isn’t even apples-to-apples, as I’m comparing the entire silver ETF market to a few individual stocks.

This is even more interesting when you consider that it’s the ETFs where most of the public – especially those that are new to the market – first invest in silver. So while the metal has doubled in the past seven months, total investment in the funds is still far beneath many popular blue-chip stocks.

Okay, maybe all this money is instead going into silver mining stocks. How does the market cap of the silver industry compare to other industries?

While you fetch your magnifying glass, I’ll tell you thatthe market cap of the silver industry is $73.1 billion. It barely registers when compared to a number of other industries I picked mostly at random. The dying newspaper industry is over 26 times bigger. Drug manufacturers are 213 times larger. Heck, even the gold market is 19 times greater. And here’s the fun one: the market cap of the entire silver market, with all its record-setting prices and stock-screaming highs, represents just one-third of one percent of the oil and gas industry.

To be fair, there are a number of sectors that are smaller than silver. Radio broadcasters ($43.2B), video stores ($10.9B), and sporting goods stores ($2.5B) have puny market caps, too. But then again, who’s buying DVDs or baseball mitts to protect their wealth from a coming inflation?

Silver hardly resembles the picture of an investment that is too crowded.

I’m not saying one should rush to buy silver right now. After all, it has doubled in seven months. Unless this is the beginning of the mania, prudence would certainly be called for at this juncture. The price will always ebb and flow in a bull market, and an ebb is overdue.

The question, of course, is from what price level it occurs. What if a correction doesn’t ensue until, say, a month from now, and the price falls back to… where it is now? I remember some articles in January that insisted silver would fall to as low as $22, and, well, they’re still waiting and have in the meantime missed out on some huge gains. For silver to fall back to $22 now would require a 40% drop; not impossible, but I wouldn’t hold my breath.

Fixating on market timing takes your focus off the ultimate goal. In my opinion, instead of worrying about what will happen next week or even next month, focus on how many ounces you have, and then buy at regular intervals until you reach your desired allocation. This has the added benefit of smoothing out your cost basis. And don’t forget to buy more as your assets and income increase.

This is a market where you’ll want to be well ahead of the pack. Someday in the not-too-distant future, average investors will be tripping over themselves to join in. That will make the market caps of our silver investments look more like some of the others in the charts above. And that will do wonderful things to our portfolio.

Copyright © ZeroHedge.com

Tags: Apples To Apples, Blue Chip Stocks, Canadian, Canadian Maple Leafs, China, ETF, ETFs, Exchange Traded Funds, Exxon Mobil, Gold, Gold Demand, India, Market Cap, Meltdown, Mints, Natural Question, oil, Research Silver, Seven Months, Silver American Eagles, Silver Etf, Silver Etfs, Silver Investments, Silver Market, Silver Mining, Silver Stocks, Silver Trade
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Meredith Whitney’s Muni Meltdown Scenario: Paranoia?

Tuesday, January 25th, 2011

Discussing whether Meredith Whitney’s predictions on the muni bond market are overblown, with Thomas Doe, Municipal Market Advisors CEO, and Doug Dachille, First Principles Capital Management CEO.

Source: CNBC, January 20, 2011.

The chart below, courtesy of Barclays Capital (via Business Insider – Clusterstock) illustrates the “The Meredith Whitney Effect”.

Click here or on the image below for a larger chart.

Source: Barclays Capital (via Business Insider – Clusterstock), January 20, 2011.

Tags: Barclays, Barclays Capital, Bond Market, Business Insider, Capital Management, Ceo, Chart Source, Cnbc, Doe, First Principles, January 20, Meltdown, Meredith Whitney, Muni Bond, Paranoia
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Hungary Meltdown – Euro Contagion Spreading

Friday, June 4th, 2010

Euro-contagion has spread to Hungary. Parity for the euro may come sooner than anyone expected. Here are notes and analysis from a variety of sources on the unfolding euro/Hungarian meltdown, Round 2:

To all those who listened to Hugh Hendry’s recommendation to panic a week ago, congratulations- you are well ahead of the market today. Hungary CDS is now offerless as investors are shocked, shocked, that the country (and continent) is actually really bankrupt, as opposed to just make believe. IMF’s comments yesterday that it does not have the funds to rescue all of Europe are not helping. Hungary CDS is now essentially bidless last seen 120 bps wider, around 430/460 with the bid/ask spread at 30bps, and only dealers daring to take on any risk exposure as the risk off brigade has kicked the optimists out of the building. The one thing up today so far? Gold. NFP better be north of 100 million or else the stick save today will be a tad problematic.

Europe Tremors Resume: Spain Bund Spreads At All Time Wides, China Exporters Ditch Euro As CHF Surges, from ZeroHedge.com.

Another horrendous day shaping up for Europe. Spanish Bund spreads have surged to all time highs just south of 200 bps, Hungary confirms that it was not exaggerating comments about chances of (not) avoiding Greek situation, pushing its CDS even wider, the EURCHF has dropped to under 1.40 and the SNB has not intervened yet, while the EURUSD is down to 4 year lows below 1.21. The nail in the euro coffin is a report by Reuters that a growing number of Chinese exporters turn down euro payment, flatly refuting anything SAFE may be saying officially.

Chinese exporters who made a big push only a year ago to bill in euros are increasingly turning their backs on the wounded European currency and demanding dollars instead.

By contrst, Beijing last week said a report it was reviewing the euro portion in its mountain of foreign exchange reserves was groundless and it calmed markets by saying that Europe remained a key investment market.

But Chinese exporters and the local governments that oversee them are less confident. They are trying to keep a wider berth from the euro, at least for now.

Oh, and now the French PM is quoted as saying that he only sees good news in parity between the dollar and the euro. Too bad none of his bank share the sentimentm realizing all too well none of them will exist in that situation.

Add Hungary to the PIIGs List, from Big Picture.

The market needs a new acronym to replace PIIGS to include Hungary as a spokesman for the PM of Hungary said their economy is “in a grave economic situation” and the possibility of default is “not an exaggeration.” Markets rolled over after the comments and the euro fell to a new 4 year low vs the US$. Hungary 5 yr CDS is higher by 15 bps to 323 bps, the highest since July ‘09. Hungarian stocks are lower by almost 4% and European banks are all lower. With respect to the US jobs data, it’s not the headline number that will matter but what’s under the hood as census workers may add 500k+ to the figure. The private sector is expected to add 180k jobs and that is the only thing that matters as the census workers will be off the gov’t rolls by Sept. The birth/death model will also contribute as 186k jobs were added in May ‘09. The unemployment rate is expected to tick lower by .1% to 9.8%.

Now it’s Hungary’s Turn, from TraderMark.

Well this one came out of the blue. Looks like they pulled a Greece in their statistics department. Hmm, governments worldwide fudging the numbers to create an alternate sense of reality? Whodda thunk!

• Hungary’s is in a “grave situation” because the previous government “manipulated” figures and “lied” about the state of the economy, said Peter Szijjarto, spokesman for Prime Minister Viktor Orban. The forint fell for a second day, dropping as much as 2.1 percent against the euro.
• A fact-finding panel will probably present preliminary figures on the state of the economy this weekend, Szijjarto said today at a news conference in Budapest. The government will publish an action plan within 72 hours after the committee reports its findings, he said.
• “It’s clear that the economy is in a very grave situation,” Szijjarto said. “We need a clean slate to formulate our economic action plan, and the fact-finding committee will provide just that.”
• “It’s no exaggeration” to talk about a default, Szijjarto said today.
• Hungary needed a 20 billion-euro ($24 billion) international bailout to avert a default in 2008. Orban, who took over May 29 after winning elections by pledging to cut taxes and stimulate the economy, yesterday failed to get European Union approval for looser fiscal policy.
• “Investors are losing their patience,” Gyorgy Barta, a Budapest-based economist at Intesa Sanpaolo SpA, said in a phone interview. “This is part of a communications strategy that wants to tell voters one thing and the markets another. It’s getting too complicated, and the government now needs to come clean and present a convincing plan of fiscal consolidation.”

Oh well, nothing a hundred or two billion euro won’t fix. Get to work US taxpayer… err IMF.

Biggest Hungarian Commercial Bank Trading Halted On Budapest Stock Exchange, from ZeroHedge.com.

All trading in shares of OTP Bank, Hungary’s largest commercial bank, has been halted on the Budapest stock exchange after a plunge greater than 10%. Nothing to see here, go back to reading Goldman’s spin on things, and why everything all of this really should be priced in already.

Austria Next On The Implosion Radar; German, France CDS Blow Out, from ZeroHedge.com.

Austria, the country most exposed to weakness in Central and Eastern Europe, is back on the radar. After having avoided skeptical investor scrutiny even as the bulk of Europe was collapsing all around it, the country is today’s top CDS widener, yet still stunningly trades inside of France and Belgium. Look for this spread to blow out over the next week. Then again, the biggest CDS wideners are precisely the countries formerly seen safe: Austria, France, Germany and Belgium are all the top movers in CDS. So much for the whole North vs South division in Europe.

Goldman Sachs’ Desperate Attempt at Hungary Damage Control, courtesy of ZeroHedge.com.

Goldman Sachs to save the day…

Hungary – Greek-like crisis has already happened; Fidesz tries to free itself from campaign promises

Yesterday’s comments by Fidesz vice-president Kósa alleged that Hungary stands on a brink of a sovereign default due to its very precarious budget situation and continuously appearing ‘skeletons’ in the fiscal accounts while Michaly Varga, a deputy PM, claimed again that the ‘true’ 2010 budget deficit is closer to 7%-7.5% of GDP rather than the 3.8% assumed in the IMF-led program or 4.3%-4.5% forecasted by the NBH. Given the seriousness of the situation, Kósa declared that within a week the new government will announce a two-year crisis management plan that would include deep constitutional and structural reforms. Nevertheless, Kósa did not withdraw the plans to lower taxes which was one of the key election promises. He also declared that countries that were successful at crisis management ‘rejected the requirements of the World Bank and the IMF’ and expected the European Union to foot the bill for a potential external rescue of Hungary.

On the same day, European Commission President Barroso urged the new Hungarian government to speed up fiscal consolidation and implement structural reforms that would help maintain long-term fiscal sustainability and support economic recovery.

The Hungarian PM, Victor Orban, followed with declarations that the new government is committed to restoring fiscal stability and that the new economic plan, to be published within 72 hours after revealing the budget report, will include structural measures to boost growth and competitiveness as well as significant tax cuts.

IMF mission chief is due to arrive in Budapest for informal talks with the government. His visit is not a part of a formal review mission, which was postponed because of the parliamentary elections.

COMMENT: We believe that yesterday’s dramatic comments were intended for domestic consumption and were used to build a dramatic backdrop that would let Fidesz backtrack on a large share of its campaign promises and broadly continue with the fiscal policies of the previous government, as well as preparing the ground for another round of IMF talks. Exaggerating the state of public finances left by the previous government, pretty common as it is (the incoming UK government used very similar tactics), supports the arguments against fiscal expansion and, in the future, will back up the claims that the crisis management plan was successful in reducing public deficit. The party faces local elections in October and not following up on the election promises risks alienating the voters, while blaming the ‘imminent crisis’ and ‘fiscal skeletons’ helps it save its face. At the same time, inflating the deficit forecast gives it space for negotiations with the international lenders and increases the chances that the potential new program will allow for some fiscal loosening in 2010 and 2011.

The claim that the country is on a brink of sovereign default and risks following the Greek path does not hold up against the facts. Hungary has already faced a crisis and asked for IMF and EU assistance in late-2008. In this context, Hungary is some 18 months ahead of Greece. Next, Hungary is not an EMU member and by having its own currency and domestic and external debt benefits from having a captive investor base. Finally, Hungary still has access to the undisbursed tranches of the IMF/EU loans. Our analysis (New Markets Analyst 10/04) shows that under the current policies debt stock is stable and that the country will be able to rollover its maturing debt without a problem.

It seems that Fidesz has taken a major decision on the path of macroeconomic policy and is now preparing the stage for its announcement – first, by revealing the ‘true’ size of the deficit and, second, by following up with the two-year plan. We believe that the ‘good scenario’ is more likely, namely a new agreement with the IMF and the EU and broad continuity of the fiscal consolidation plans, although with some loosening due to the cost of the yet to be announced structural reforms and to accommodate some of the election promises. We continue to believe that a stabilization program is the most likely outcome, which should significantly reduce the perception of the Hungarian sovereign risk (for more information, please see New Markets Analyst 10/05).

The risk here is that the new government attempts to follow the Ukrainian and Romanian examples, leading to protracted and rocky discussions. The other risk is that the new government is too confident in its ability to influence the Forint (in earlier comments, Fidesz said that weaker currency will support Hungary’s competitiveness) and may be careless in its communications (as shown by yesterday’s comments from Kósa). The punishment from the market may come quickly and weakening of the currency beyond the pain level of banks and households (about EURHUF of 300) – which hold significant amounts of FX debt – would serve as a warning to the new government. Our research shows that among CE3 countries, Hungary is most exposed to risk sentiment and the widening of risk premia would hurt Hungary’s growth.

The ‘negative scenario’ in which the new government abandons the IMF program and lets the fiscal situation get out of control would actually help fulfil the claims that the country is indeed unable to access financing; we find that unlikely, though.

The news that the IMF mission chief will hold informal talks with the new government is neutral. Such a visit had to happen regardless of the course of Fidesz’s macroeconomic plans. IMF needs to learn more about these plans and both sides need to decide how they want to proceed. This should clarify the situation and help us know whether the next program is going to happen. We expect some follow-up news within the next couple of days.

Tags: All Time Highs, Bps, China, China Exporters, Chinese Exporters, Coffin, Contagion, Ditch, ETF, Eurchf, Eurusd, Gold, Hugh Hendry, Imf, Lows, Meltdown, Optimists, Parity, Reuters, Risk Exposure, Snb, Surges, Tremors
Posted in ETFs, Gold, Markets | 1 Comment »

Chart of the Week: China Exports

Tuesday, May 18th, 2010

This article is a guest contribution by Frank Holmes, U.S. Global Investors.

The government in Beijing has been aggressive in using money policy to damp down property speculation as a way to steer China’s hot economy away from a meltdown.

Avoiding dangerous bubbles makes long-term sense, but there have been short-term costs:  the benchmark Shanghai Composite Index is down more than 20 percent year-to-date. It fell 5 percent on Monday alone.

The chart to the right shows the growth rate over the past eight years for China’s imports and exports (lines), along with the nation’s trade balance (vertical bars). After a huge contraction in 2008-09 during the global recession, both imports and exports have bounced back strongly.

In April, imports (which include raw materials for manufacturing) were up 51 percent year over year and exports were up 30 percent.

Four straight months of strong year-over-year recovery in China’s exports was likely a key factor considered by the government when it imposed anti-property speculation policies last month.

But the sovereign debt crisis in the eurozone is another key factor. Europe is China’s largest trading partner, and the debt crisis has led to a significant devaluation of the euro against the Chinese yuan.

The yuan, which is pegged to the U.S. dollar, is up 14 percent against the euro in just the past four months. The stronger yuan makes Chinese-made products more expensive in the eurozone, and this hurts exporters.

The three-month trend of China’s imports, a leading indicator of future exports, has already headed down. Should a meaningful export deceleration occur in the intermediate term, Chinese authorities may reverse policies to protect economic growth.

Copyright (c) 2010 U.S. Global Investors

Tags: China, Chinese Authorities, Chinese Yuan, Contraction, Debt Crisis, Deceleration, Devaluation, Eurozone, Frank Holmes, Global Recession, Imports And Exports, Leading Indicator, Meltdown, Money Policy, Property Speculation, Raw Materials, Shanghai Composite Index, Sovereign Debt, Trade Balance, U S Global Investors, Vertical Bars
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ETF Trading Idea For A Crumbling Euro

Thursday, May 13th, 2010

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This article is guest contribution by Michael Johnston, of ETFdb.com

And so the carousel ride continues. In 2008, the U.S. was the center of the investing world as the financial sector meltdown began. Then it was China’s turn, as earlier this year investors focused on Beijing’s plan to continue the impressive growth without overheating. Now Europe is clearly in the spotlight, with every development from Greece and the ECB rippling throughout global equity markets.

The recent turmoil across the pond has investors pondering the viability of the common currency system and reconsidering allocations to European equities (see ETF Options For An Ex-Europe Portfolio). Although the euro has stabilized in recent sessions, the consensus opinion among investors is that the currency faces a tough battle ahead. BNP Paribas is now forecasting the the euro will hit parity with the dollar in 2011. Barclays and UBS also have a pessimistic view, anticipating that the euro will decline to $1.20 within three months.

For investors who think the euro will continue its slide and take European stocks down with it, there is no shortage of trading ideas. The ProShares UltraShort MSCI Europe (EPV), which seeks to deliver daily returns equal to 200% of the inverse movement in the MSCI Europe Index, has seen an increase in interest over the last week. And there are a handful of ETF in the Europe Equities ETFdb Category that can be sold short to profit from declines in value.

Playing The “Euro Drag”

Some investors think that the euro has a rocky stretch, but aren’t quite convinced that weakness in the currency will dim the underlying fundamentals of European companies. “I think the euro is in trouble,” says Wharton finance professor Jeremy Siegel. “But that doesn’t necessarily mean that European stocks are not a buy.” For investors bearish on the euro, but not convinced that European equities are a “sell,” we present a unique market neutral ETF trading idea:

* Long Global X FTSE Nordic 30 ETF (GXF)
* Short iShares MSCI EMU Index Fund (EZU)

Both ETFs invest in European equities, but in the current environment the risk profiles of these securities are very different. GXF’s holdings are split between four Nordic countries: Sweden, Denmark, Norway, and Finland. While Finland (which makes up about 16% of total assets) has adopted the euro, the other four countries represented have avoided doing so. EZU tracks the MSCI EMU Index, a benchmark that measures the performance of equity markets of EMU member countries–those members of the European Union who have adopted the euro as its currency. An x-ray look at EZU’s holdings reveals allocations to many of the countries mentioned in the “next domino to fall” discussion: Spain, Italy, and Greece.

When considering international ETFs, most investors don’t give much thought to the impact that currency exposure will have on their bottom line returns. But because most equity ETFs are unhedged (HEDJ and DFJ being the exceptions), movements in exchange rates can either create strong headwinds or give an added boost (see EFA vs. HEDJ: A Better EAFE ETF? for a closer look at this issue).

The currency exposure obviously isn’t the only difference between GXF and EZU; these two ETFs have virtually no overlap among individual holdings. But the sector breakdown is relatively consistent between the two, with financials and industrials accounting for significant portions of total assets. If the euro continues to weigh on markets as it has in recent weeks, EZU will have a hard time keeping up with GXF (investors looking to make a more symmetrical market neutral play against the euro might consider going long HEDJ and short EFA or DWM).

Diverging Fortunes

Both GXF and EZU offer exposure to European stock markets, and the correlation between the two funds is relatively strong. But these ETFs have delivered very different performances in 2010; GXF is actually up slightly on the year, while EZU is down about 15%:
For more actionable ETF ideas, sign up for our free ETF newsletter .

Disclosure: No positions at time of writing.

ETF Database is not an investment advisor, and any content published by ETF Database does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. From time to time, issuers of exchange-traded products mentioned herein may place paid advertisements with ETF Database. All content on ETF Database is produced independently of any advertising relationships. Read the full disclaimer here.

Tags: Barclays, Bnp Paribas, Carousel Ride, China, Currency System, ECB, Epv, ETF, ETFs, European Equities, European Stocks, Finance Professor, Financial Sector, Global Equity Markets, Impressive Growth, Jeremy Siegel, Meltdown, Michael Johnston, Msci Europe Index, Pessimistic View, Professor Jeremy, Proshares Ultrashort, Tough Battle, Wharton
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The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going

Thursday, April 22nd, 2010

This article is guest contribution from Jesse Eisinger and Jake Bernstein, of ProPublica.

In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe.

At just that moment, a few savvy financial engineers at a suburban Chicago hedge fund helped revive the Wall Street money machine, spawning billions of dollars of securities ultimately backed by home mortgages.

When the crash came, nearly all of these securities became worthless, a loss of an estimated $40 billion paid by investors, the investment banks who helped bring them into the world, and, eventually, American taxpayers.

Yet the hedge fund, named Magnetar for the super-magnetic field created by the last moments of a dying star, earned outsized returns in the year the financial crisis began.

How Magnetar pulled this off is one of the untold stories of the meltdown. Only a small group of Wall Street insiders was privy to what became known as the Magnetar Trade . Nearly all of those approached by ProPublica declined to talk on the record, fearing their careers would be hurt if they spoke publicly. But interviews with participants, e-mail, thousands of pages of documents and details about the securities that until now have not been publicly disclosed shed light on an arcane, secretive corner of Wall Street.

Read the whole story here.

Tags: American Taxpayers, Company Shares, Dying Star, E Mail, Financial Crisis, Financial Engineers, Hedge Fund, Home Mortgages, Housing Bubble, Housing Market, Investment Banks, Jake Bernstein, Jesse Eisinger, Magnetic Field, Meltdown, Mortgage Company, Mortgage Securities, Street Insiders, Street Money Machine, Suburban Chicago
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