Saturday, December 15, 2012
A James Grant Two Fer
I think one ignores James Grant at their own peril. I will usually make it a point to read or watch columns/videos written by Grant or discussing his thoughts.With that, here is a James Grant two fer.
The first is a column posted to the CFA Institute, written by Julie Hammond, CFA, discussing Grant's view of interest rates, the Fed, etc. at the Fixed Income Management 2012 conference.
“The Fed has somehow managed to take the income out of fixed income and the yield out of high yield,” said bond market maven James Grant at the Fixed-Income Management 2012 conference held last week in San Francisco. His topics were the political and policy dimensions of interest rates and the unintended consequences of current monetary policies, lessons from history and human error that endures.
“Muscle memory should be required of all CFA candidates,” said Grant. “For 150 years interest rates have risen and fallen at generation-like intervals.” From 1861 to 1899 rates fell, and the United States enjoyed a 38-year bull market in bonds. Painfully long bear markets included the periods 1900–1920 and 1946–1981. In the current bull market — which started in 1981 and is now 32 years old — “interest rates have fallen, and they can’t get up,” Grant said. “Ain’t it grand!”
Grant gave a “cook’s tour” of the “reigning errors and foibles” that are being made in today’s bond markets and that have led us astray in committing capital.
Under what Grant calls “Cochrane’s postulate” he said, “The real value of government debt must equal the present value of investor expectations about the future surpluses that the government will eventually run to pay off the debt.” It makes sense, but how do we calculate the present value when there’s no free market for interest rates? Professor Alan J. Auerbach at UC Berkley and William G. Gale of the Brookings Institution in their August 2012 paper, “The Federal Budget Outlook: No News is Bad News,” made a good estimate of the real value of debt as the present value of unfunded liabilities (or the long-term “fiscal gap”) at roughly $115.5 Trillion. (For comparison the IMF calculates world GDP at about $72.5 trillion today!) Has Mr. (Bond) Market done the math? Can anyone imagine, Grant asked, a US Congress that would set in motion the realization of budgetary surpluses anywhere close to the projected budgetary shortfalls?! Yikes!
Grant closed with several observations about today’s investment environment: (1) For the first time in history, Fidelity is managing more money in bonds than equities; (2) Bernanke has 100% confidence in the Fed’s ability to reverse its radical monetary policy in a timely manner; and (3) you “just never know” in finance. Given all of this, Grant believes that US government bonds at 3% do not afford a margin of safety. Rather Grant is eyeing investments outside the bond market for income. For example, he likes those very adaptive companies selling at market multiples.
The second is an interview he conducted over at RT.com.
The first is a column posted to the CFA Institute, written by Julie Hammond, CFA, discussing Grant's view of interest rates, the Fed, etc. at the Fixed Income Management 2012 conference.
“The Fed has somehow managed to take the income out of fixed income and the yield out of high yield,” said bond market maven James Grant at the Fixed-Income Management 2012 conference held last week in San Francisco. His topics were the political and policy dimensions of interest rates and the unintended consequences of current monetary policies, lessons from history and human error that endures.
“Muscle memory should be required of all CFA candidates,” said Grant. “For 150 years interest rates have risen and fallen at generation-like intervals.” From 1861 to 1899 rates fell, and the United States enjoyed a 38-year bull market in bonds. Painfully long bear markets included the periods 1900–1920 and 1946–1981. In the current bull market — which started in 1981 and is now 32 years old — “interest rates have fallen, and they can’t get up,” Grant said. “Ain’t it grand!”
Grant gave a “cook’s tour” of the “reigning errors and foibles” that are being made in today’s bond markets and that have led us astray in committing capital.
- The Fed’s problem with the price mechanism. “Interest rates are prices, and they are under the thumbs of our monetary mandarins,” Grant said. “How many of you eat organic? Free-range chickens are of course the most tasty and desirable. It is apparent that Chairman Ben Bernanke does not like ‘free-range interest rates.’ The Fed even has its hooks in the stock market, and plugs the ears of equity investors to warnings of impending poor corporate earnings.”
- Overreliance on econometric models. Economists have an obsession with mathematics. “When I am chairman of the Federal Reserve — it could happen — none of my hires will have ever received higher than a B in calculus!” The dominant model for the economy used by the Fed and the economics profession as a whole is the dynamic stochastic general equilibrium (DSGE) model. As the Committee on Science, Space, and Technology of the US House of Representatives aptly told us in July 2010, “The DSGE model excludes from the model economy almost all consequential diversity and uncertainty — characteristics that in many ways make the actual economy what it is.”
- A single-minded focus on the Great Depression. It blinds us to conflicting and contrasting evidence. Why not look at other periods in history? As examples, in the depression of 1920–21, after a devastating drop in industrial production and wholesale prices, and a significant rise in unemployment, the government took a hands-off approach, and a rapid and vigorous rebound in the economy followed.
- The belief that economic slack means no inflation. With today’s exceptionally low volatility, the bond market seems to have it in its head that: (1) The Fed is “in charge” (command and control); and (2) if there is slack in the labor and product markets, then there is no need to worry. Grant’s research shows, however, that over time there is a slightly less than zero correlation between slack in the economy and the amount of inflation. For example, inflation and unemployment fell together between 1992 and 2001. Inflation and unemployment accelerated together in the 1970s.
- Faith that the Fed will see inflation coming and prevent it. Grant said the QEs matter and are either intrinsically inflationary or contingently inflationary. “If the QEs are only inflationary in a contingent manner, the markets believe that surely the Fed will see it coming and take action to forestall it,” he said. Grant quoted John H. Cochrane of the University of Chicago about the possible path of inflation going forward and what the spiral of inflation may look like as Cochrane described in an article in the fall 2011 edition of National Affairs.
Under what Grant calls “Cochrane’s postulate” he said, “The real value of government debt must equal the present value of investor expectations about the future surpluses that the government will eventually run to pay off the debt.” It makes sense, but how do we calculate the present value when there’s no free market for interest rates? Professor Alan J. Auerbach at UC Berkley and William G. Gale of the Brookings Institution in their August 2012 paper, “The Federal Budget Outlook: No News is Bad News,” made a good estimate of the real value of debt as the present value of unfunded liabilities (or the long-term “fiscal gap”) at roughly $115.5 Trillion. (For comparison the IMF calculates world GDP at about $72.5 trillion today!) Has Mr. (Bond) Market done the math? Can anyone imagine, Grant asked, a US Congress that would set in motion the realization of budgetary surpluses anywhere close to the projected budgetary shortfalls?! Yikes!
Grant closed with several observations about today’s investment environment: (1) For the first time in history, Fidelity is managing more money in bonds than equities; (2) Bernanke has 100% confidence in the Fed’s ability to reverse its radical monetary policy in a timely manner; and (3) you “just never know” in finance. Given all of this, Grant believes that US government bonds at 3% do not afford a margin of safety. Rather Grant is eyeing investments outside the bond market for income. For example, he likes those very adaptive companies selling at market multiples.
The second is an interview he conducted over at RT.com.
Reversal in the ISI Company Survey of China Sales- Sober Look
This comes via Sober Look- jives nicely with what I saw in some China focused funds reaching new/ or recent highs.
On page 4 of this publicly available ISI report (here) from September, there is a chart of the ISI company survey of China sales (US companies exporting to or selling in China). The comment says: "Our China Survey was unchanged this week, but is just 4 pts off the 2009 low" - as the index approached its all-time low. It never quite made it. In a remarkable turnaround, the index (according to ISI) has its biggest 3-week increase in 3 years. There is clear evidence of this improvement from companies like Yum Brands, who saw large declines in China sales that are now expected to stabilize (see Barrons post). This provides further support to the thesis that China's economic output growth has bottomed (see discussion).
On page 4 of this publicly available ISI report (here) from September, there is a chart of the ISI company survey of China sales (US companies exporting to or selling in China). The comment says: "Our China Survey was unchanged this week, but is just 4 pts off the 2009 low" - as the index approached its all-time low. It never quite made it. In a remarkable turnaround, the index (according to ISI) has its biggest 3-week increase in 3 years. There is clear evidence of this improvement from companies like Yum Brands, who saw large declines in China sales that are now expected to stabilize (see Barrons post). This provides further support to the thesis that China's economic output growth has bottomed (see discussion).
How Do Cramer's Recommendations on Mad Money Perform
Abstract
Jim Cramer’s recommendations on CNBC’s Mad Money affect the price of the stocks he recommends, but only for a short period. His buy recommendations are positive and significant for 1 day and then fade into losses over the subsequent 29 days. His sell recommendations continue to lose value in the subsequent 29 days. Cramer is sensitive to momentum effects because his buys (sells) increase (decrease) in value in the 30 days prior to his recommendations. Regardless of which model the authors use, they find that Cramer fails to deliver statistically significant alpha, and their evidence suggests that Cramer joins the Wall Street analyst herd when he makes his recommendations.
PdfB99A.tmp
Jim Cramer’s recommendations on CNBC’s Mad Money affect the price of the stocks he recommends, but only for a short period. His buy recommendations are positive and significant for 1 day and then fade into losses over the subsequent 29 days. His sell recommendations continue to lose value in the subsequent 29 days. Cramer is sensitive to momentum effects because his buys (sells) increase (decrease) in value in the 30 days prior to his recommendations. Regardless of which model the authors use, they find that Cramer fails to deliver statistically significant alpha, and their evidence suggests that Cramer joins the Wall Street analyst herd when he makes his recommendations.
75% Chance U.S. Goes over the Fiscal Cliff- Intrade
Speaker Boehner conceded and offered raising the tax rate on millionaires, conditionally set on reducing entitlements. As Politico reports....
Despite this pseudo- concession, it looks like traders (at least on Intrade) are not putting much faith in all sides reaching agreements by Dec 31. or more appropriately before Congress breaks for Christmas.
Speaker John Boehner has proposed allowing tax rates to rise for the
wealthiest Americans if President Barack Obama agrees to major
entitlement cuts, according to several sources close to the talks.
It
is the first time Boehner has offered any boost in marginal tax rates
for any income group, and it would represent a major concession for the
Ohio Republican. Boehner suggested hiking the Bush-era tax rates for top
wage earners, including those with annual incomes of $1 million or more
annually, beginning Jan. 1, two sources said.
Despite this pseudo- concession, it looks like traders (at least on Intrade) are not putting much faith in all sides reaching agreements by Dec 31. or more appropriately before Congress breaks for Christmas.
High Volume High 12/14/12
A few large-cap names made the list in Friday's trading, including ADBE and PPG. Also of note- although not one made the final cut- there were a number of China-centric funds reaching new/recent highs on somewhat higher volumes. You can find more about China here.
Volume Off the High 12/14/12
Sort of steady mix of new stocks or funds coming off the highs on volume.
Friday, December 14, 2012
Somebody Always Knows More than You- Apple Edition
Remember when I stated that the downdraft in Apple's shares, which was attributed at the time to changes in margin requirements- is likely due to somebody knowing something..... well we are starting to see a peek at that possible something.....
First, we had Street analysts cutting their price targets due what they saw as weakness in the supply chain. For instance here and here.
Then we had reports from earlier today stating that the Chinese launch of the iPhone5 has been hitting with a thud.
Now we have word that Apple will sell the iPhone5 in Wal-Marts at a steep discount.
So this calls into question shipment volume, pricing, and margins. Never sell yourself short, but listen to what the market and the price/volume dynamics are telling you. Someone always knows more.
First, we had Street analysts cutting their price targets due what they saw as weakness in the supply chain. For instance here and here.
Then we had reports from earlier today stating that the Chinese launch of the iPhone5 has been hitting with a thud.
Now we have word that Apple will sell the iPhone5 in Wal-Marts at a steep discount.
So this calls into question shipment volume, pricing, and margins. Never sell yourself short, but listen to what the market and the price/volume dynamics are telling you. Someone always knows more.
All that that Glitters- Inching Closer to the Goal
Without getting into the numbers right away, we are getting closer to a full on buy situation in gold and precious metal shares. In fact, depending on your own portfolio construction, trading prowess, trading funds, risk taking willingness, etc. purchasing or building some small positions in gold stocks could be warranted at this juncture. For myself, I would prefer a sign of strength in either (or both) gold/GLD and the Gold Miner indexes to commit funds. This leaves me on the sidelines for the time being.
That said, we are likely to see some interesting dynamics in the weeks ahead. First off, non-seasonally adjusted money supply increased a whopping 1% for the most recently reported week. This may not seem that much but increases of 1% or more have occurred in only 8% of the weekly money supply figures since the 1980's. This, all else equal, makes gold and precious metal stocks more appealing.
More interesting is the increase in the Federal Reserve's balance sheet, up more than 4% on the week. Now before I discuss the Fed's balance sheet I should note that the database I use only goes back 5-years. Although the database only covers five-years, it encompasses the most important years in my opinion. Namely the QE years where the Fed has expanded its balance significantly. Looking back over these five years, the Fed's balance sheet has expanded by more than 2% in only 10% of the weeks examined. And yes, the 2% break point is arbitrary but by making the break point greater than 2% creates very small samples in which the subsequent data is skewed significantly by QE1 and QE2.
What I found is that following significant increases in the Fed's balance sheet there appears to be a resulting boost in money supply growth, as one would expect. However, this increase occurs with a lag and reaches a maximum in or around three months following the the initial increase. This leads me to conclude that the significant increase of the Fed's balance sheet is likely to lead to an accelerated rise in money supply in the weeks and months ahead. This analysis does not factor in the potential for further Fed balance sheet increases with QE to infinity, which may add up to $85 billion monthly. This adds a dynamic not seen in prior periods, but will likely add to money supply growth.
All in all, the expected increase in money supply should make gold stocks more attractive. However and per my modelling convention, I only look out two weeks from the reported money supply figures. Any more and the timing models I employ will need incorporate all sorts of estimated data including the size the Fed balance sheet, lagged money supply estimates, gold prices, and gold stock index prices. Any increase in estimated data points would likely add forecasting errors to the model and make the insights garnered near worthless. I would much rather use actual data, but keep in my mind the dynamics of a changing investing landscape.
Now with all that said, the timing models improved on the week and continued their move into the buy zone.
3-month model
The three month model finished the week at a -1.45. This is the strongest of the measures I employ and suggests stronger than average future performance in gold stocks.
1-year model
The one-year model finished this week at a -0.66. Looking back at historical results, the average returns following occurrences similar to this week's results outpaced the average buy-and-hold return. However, the batting average is more or less inline with the average buy-and-hold case.
6-month model
The six month model was the weakest of the indicators at a -0.56, but in the buy zone. Similar to the one year model, the six month model's average return following similar historic occurrences outpaces the buy-and-hold. But also like the one-year model, the batting average is more inline with the buy-and-hold case. This comes with one caveat, the longer the time frame the better the results- both return and batting average. So to round the discussion back to my initial thought, committing small long-term funds to gold stocks is not out of the question, but I would not go firing it all of now. I would either wait for better model result (be it from money supply growth, lower gold prices, or some combination there in) or a sign of strength in gold/gold stocks.
That said, we are likely to see some interesting dynamics in the weeks ahead. First off, non-seasonally adjusted money supply increased a whopping 1% for the most recently reported week. This may not seem that much but increases of 1% or more have occurred in only 8% of the weekly money supply figures since the 1980's. This, all else equal, makes gold and precious metal stocks more appealing.
More interesting is the increase in the Federal Reserve's balance sheet, up more than 4% on the week. Now before I discuss the Fed's balance sheet I should note that the database I use only goes back 5-years. Although the database only covers five-years, it encompasses the most important years in my opinion. Namely the QE years where the Fed has expanded its balance significantly. Looking back over these five years, the Fed's balance sheet has expanded by more than 2% in only 10% of the weeks examined. And yes, the 2% break point is arbitrary but by making the break point greater than 2% creates very small samples in which the subsequent data is skewed significantly by QE1 and QE2.
What I found is that following significant increases in the Fed's balance sheet there appears to be a resulting boost in money supply growth, as one would expect. However, this increase occurs with a lag and reaches a maximum in or around three months following the the initial increase. This leads me to conclude that the significant increase of the Fed's balance sheet is likely to lead to an accelerated rise in money supply in the weeks and months ahead. This analysis does not factor in the potential for further Fed balance sheet increases with QE to infinity, which may add up to $85 billion monthly. This adds a dynamic not seen in prior periods, but will likely add to money supply growth.
All in all, the expected increase in money supply should make gold stocks more attractive. However and per my modelling convention, I only look out two weeks from the reported money supply figures. Any more and the timing models I employ will need incorporate all sorts of estimated data including the size the Fed balance sheet, lagged money supply estimates, gold prices, and gold stock index prices. Any increase in estimated data points would likely add forecasting errors to the model and make the insights garnered near worthless. I would much rather use actual data, but keep in my mind the dynamics of a changing investing landscape.
Now with all that said, the timing models improved on the week and continued their move into the buy zone.
3-month model
The three month model finished the week at a -1.45. This is the strongest of the measures I employ and suggests stronger than average future performance in gold stocks.
1-year model
The one-year model finished this week at a -0.66. Looking back at historical results, the average returns following occurrences similar to this week's results outpaced the average buy-and-hold return. However, the batting average is more or less inline with the average buy-and-hold case.
6-month model
The six month model was the weakest of the indicators at a -0.56, but in the buy zone. Similar to the one year model, the six month model's average return following similar historic occurrences outpaces the buy-and-hold. But also like the one-year model, the batting average is more inline with the buy-and-hold case. This comes with one caveat, the longer the time frame the better the results- both return and batting average. So to round the discussion back to my initial thought, committing small long-term funds to gold stocks is not out of the question, but I would not go firing it all of now. I would either wait for better model result (be it from money supply growth, lower gold prices, or some combination there in) or a sign of strength in gold/gold stocks.
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