June 28, 2010

How Risk Management Works In Practice

Lack of transparency has often been quoted as one of the big issues in terms of regulating financial institutions. But the lack of transparency is not only a problem for regulators, it is a potentially bigger problem for executives in the ivory towers of our largest financial institutions. The so-called black boxes in the trading floors of the big investment banks and trading houses are not only spooky to us. Aside from a few rocket scientists who may only operate within the realm of balancing complex equations, the executives who make final risk management decisions often don’t have a clue of what is going on inside of these boxes either.  In addition, communication issues can fog understanding of risk further. Ergo, the institutions we entrust our money with sometimes operate on this basis: The left hand doesn’t know what the right hand is doing...

This story from the popular Blog: Macro Man is point in case.  Because it is so exemplary, I’d like to quote it verbatim.

Another story starts with a chap from a bank's product control department visiting a trading desk and asking them why they are losing money on client trades. The trader replies that the head of sales had told him that the desk needs to be aggressive in its pricing so that business can be won for the bank in "more-profitable" areas, such as exotics. At this point, the risk manager remembers that one of the exotics desks he is responsible for has just started posting some very large losses which he was going to investigate that very afternoon. So he goes to the exotics desk and asks the trader why they are losing all this money, who replies because of xyz there was a big correlation breakdown, the markets jumped and there was no way to hedge the risk. The risk guy replies "But I've been sending you these reports each day with all your correlation risk etc. Why didn't you take this into account?". The exotics guy replies "well, the head of exotics sales told us we had to be aggressive in our pricing to win business and warehouse the risk, the head of trading was fine with it". So the risk guy goes to find the head of trading and asks him why he was fine with them having all this risk? The head of trading replies "huh?". After a brief conversation it turns out that the head of trading doesn't understand the risk the exotics desk were running and thought everything was OK. Net result: flow desk loses money, exotics desk loses money, both flow sales & exotic sales get a big bonus.

Good luck and good trading!

June 26, 2010

Overhauling The Financial Services Industry – Really?

We're almost there... US House and Senate lawmakers agreed on the terms of the biggest overhaul of US financial regulation since the 1930s. The Wall Street Journal reported on the major provisions of the proposed bill on Friday.  How the new regulations will play out in practice is anyone's guess at the moment.  It is also questionable whether more regulation and bigger regulators will do a better job at preventing fraud, bubbles & busts and whether the consumer will actually be better off after all new rules are set in place.

There are many reasons to have a healthy dose of skepticism when it comes to regulators and regulatory reform.  And being skeptical about regulators is not unique to the US.  Other countries have raised equally strong calls for financial services reforms.  Just last week, the new Chancellor of the Exchequer, George Osborne, abolished the Financial Services Authority (the UK's main financial services regulator) and gave more regulatory powers to the Bank of England. 

Yet, it was just in1997 when the FSA was created by Gordon Brown, which was supposed to be the regulator par excellence then as well.  Prior to that, it was the financial services "Big Bang of 1986" which led to the creation of the Securities and Futures Authority (SFA) promising equally strong and consumer oriented regulatory reform.  Having personally dealt with regulators right before and after the creation of the FSA, I can tell you that more often than not, regulatory reform simply meant different tick boxes, slightly different terminology and just a lot more paperwork.  In typical British demeanor, some of my colleagues then said:  All they did was shuffle around the letters from SFA to FSA; everything else was business as usual except for the #$&% load of additional paper work...

Historically, regulators have always been running behind the curve.  To make the case in point with a simple example, let's look at the FDIC, the Federal Deposit Insurance Corporation.  As part of the financial service overhaul bill, the FDIC deposit insurance would be permanently increased to $250,000, retroactive to January 1, 2008 – BRAVO!

Created in 1933 as part of the Glass-Steagall Act, the FDIC guarantees deposits in checking and savings accounts of its member banks.  The initial insurance coverage was $2,500 in 1934 but that amount was subsequently raised numerous times throughout the decades. Using inflation as a gauge, we examined how the deposit insurance has kept up with the general rise in prices over the years.  As the chart below shows, the first few decades generally kept pace with inflation.

FDIC_coverage

However, there were periods starting in the mid 70’s and from thereon for almost 3 decades until 2008 when the official FDIC coverage was nowhere near in line with inflation. The most recent adjustment of the deposit insurance to $250,000 did nothing to give more credibility towards banks, it simply brought things on level terms with the perception of the required safety amount in 1980.  In essence, the financial regulator has been running a couple of decades behind the curve.  Unrealistically low coverage does not exactly spur consumer confidence in banks and two additional questions come to mind...

  • Could the severity of the recent financial crisis have been reduced if coverage limits had been adjusted earlier?
  • What if the recent financial crisis was not as severe - would the FDIC still get away with the laughable $100,000 coverage limit?

Going back to the main point of this article, more regulation in itself does nothing to improve investor confidence nor would it protect consumers any better. It doesn’t even do the environment any good - think about all the trees that could be saved with less paper work (yes some regulators still require those paper filings).  As I pointed out on a number of occasions, most recently in a general criticism towards a new Super Regulator:

I believe the concept of regulation has to be smart, efficient and it must focus on some key components i.e. protecting the general public and investment community from too much risk and from fraud.  To improve the efficiency of financial regulation, another fundamental change has to take place. Instead of recruiting accountants and lawyers, both of whom are often clueless about the financial instruments they’re supposed to oversee (they only need to understand trading and risk from reading a book), regulators should find ways to attract real talent, real brokers, traders and market practitioners who can feel and smell when something isn’t kosher.

Until that happens, I’m afraid it will be business as usual - just another acronym for yet another government agency and definitely more paperwork...

Good luck and good investing! 

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

June 25, 2010

Market Wrap: for the week ending June 25, 2010

Noteworthy... 
• US House and Senate agree on the terms of a financial overhaul bill (Washington Post)
• Swiss Franc climbed to a fresh record high against the Euro, rising 1.5% this week (FT)
• US consumer sentiment increased to 76, the highest since January 2008 (Bloomberg)
• Australia's new prime minister, Julia Gillard, first woman to lead her country (Reuters)
• BP market losses hit $100 billion on spill cost fears, stock at 14 year low (Reuters)
• US government lowers growth estimate for 1st quarter, up 2.7% (AP)
• Industrial new orders up by 0.9% in the Euro area (Eurostat)
• US durable goods orders in May 2010 decreased 1.1% from April, to $192 bn (ESA)
• US 30-year fixed mortgages rates fall to 4.69%, lowest level on record (AP)
• UK Banks hit by £2bn annual levy, starting in January 2011 (FT)
• US new home sales plunged 33% in May as tax credits expire (AP)
• China unshackles its currency, the yuan, ahead of the G20 meeting (Reuters)

Weekly Market Barometers    
stock-2010-0625   FX-2010-0625

Chart Of The Week
A number of difficult economic data hit the wires this week.  The revised GDP data, lower durable goods orders and gloomy news from the housing sector put a damper on the market.  As expected, the expiration of the tax credit for new home purchases in the US led to a sharp decrease in New Home Sales.  The May figures declined to a seasonally adjusted annual rate of just 300,000, a 33% decline and the smallest number of homes sold on record.  At the same time, 30-year fixed mortgages rates fell to 4.69%, a record low as well.  If lower home prices and record low financing rates cannot stimulate the housing market, should you still follow the advice of Jim Gillespie, CEO of Coldwell Banker, when he says: Now's the "Absolute Best Time" to Buy a Home...

NHSsalesMay2010
Source:  http://www.calculatedriskblog.com/

Good luck and good investing! 

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

June 23, 2010

Price Return Versus Total Returns

Looking at historic returns is always an “iffy” business.  No matter how great returns may have been in the past, there is absolutely no guarantee that historic returns can be matched in the future.  In our previous post DIAmonds are forever, I suggested an average investor should consider allocating his entire stock portfolio towards one major market index such as the ETF SPDR DIAMONDS TRUST (DIA).  This ETF is a low cost index tracking fund that matches the index components of the Dow Jones Industrial Average.  I also suggested to forget about any additional international diversification on the basis that the vast majority of the companies in the Index derive a substantial part of their income from outside the US. 

Instead of using some fancy quantitative model to gauge the most appropriate international diversification and having to rebalance that exposure at least once a year, just let the companies in the Index determine your international allocation on the basis of finding the best international markets for their products.  That method is easy to understand and equally easy to implement. 

We received a number of inquiries questioning whether the method made any sense considering the poor stock returns during the past decade.  Quite rightly so, the overall market, measured by its benchmark S&P500, is down almost 25% for the decade ending June 22.  Factoring in the dividends, total returns are still negative at about 10% for the decade, but still much better than loosing a quarter of the portfolio.

SPY-decade2010-0622
Source: www.etfreplay.com

Further, let’s not forget that the vast majority of fund managers are not able to outperform the benchmark as has been documented at length; why bother paying those extra fees...

At an expense ratio of 0.18% DIA is among the lowest cost ETFs and it still had an upper hand over many Mutual Funds with active trading strategies and higher fees.  But we looked at DIA as a target index for the following reasons:

Simplicity: The Index is only made up of 30 companies, easy to oversee and to assess in terms of like/dislike and specific company risk.  Compare that to the 500 companies of the S&P 500 or the 2000 companies making up the Russell 2000 Index.  Simplicity is also compelling for a more sophisticated investor.  It is far easier to assess a specific risk or concern with say one of the 30 companies; that risk could then easily be hedged by buying an insurance via a put option against the stock based on the same ratio of the weighting within the Index.

Historic performance: In the end, the numbers speak louder than words.  However you may feel about the Dow not reflecting the entire market, this mother of all indexes has weathered the last few financial storms better than the S&P 500.  It clearly outranked the broader market both in terms of price return as well as overall return.  As a bonus, it did so at a slightly lower volatility i.e. less risk.

SPY_vs_DIA
Source: www.etfreplay.com

Factoring in Dividends: Dividends may not have played a big role during the roaring 90’s when every investor was purely chasing growth stocks, ignoring any yield from dividends.  During the past decade and particularly since the great recession, the need for sensible yields from stock dividends has made a come back. With regard to overall returns, the yields from the DIA clearly made the difference.  In the case of the past decade, the difference was about 25%, reversing the small negative return substantially towards the upside. 

DIA-compare

Source: www.etfreplay.com

As these charts indicate, it is not realistic to just look at a price chart and forget about the impact of dividends on overall returns.  In the case of DIA, dividends were a significant factor in the overall performance throughout this rather volatile decade.  Factoring in dividends towards overall returns for DIA, it wasn’t a lost decade after all.  Overall Return in the past 10 years has not been stellar, but gains are still gains. With the lower cost and slightly lower historic volatility, this ETF is definitely worth considering for an average investor.

Next, we will examine whether a traditional dollar-cost averaging method, i.e. buying a fixed dollar amount of DIA shares each year, could skew the results further to the upside.  Stay tuned...

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

June 19, 2010

DIAmonds are forever

The Federal Reserve Bank of St. Louis just released the latest compilation of economic data from the G-7 countries and the Euro area. No great secrets have been revealed. Still, a set of charts comparing the historic performance of the major stock indices is worth taking a closer look in terms of how these markets are correlated.  Reason being, ever since the credit crisis, investors have been plagued by this question: “Should we still bother with diversification?” 

To answer a part of that question, I would like to re-quote from a source I have used before.  Douglas Short of  www.dshort.com  famously said:

“Diversification works – Until it doesn’t”.  And the proof is in the pudding as the chart shows. 

div-failure

Reviewing the latest update from the Fed of St. Louis research comparing the stock indices of various countries, we can see that the trend towards higher correlation did not just start in 2007. Ever since the European Union countries worked on aligning their economic policies in the run-up to their single currency, the major European markets moved essentially in tandem. 

Diverse-1

Examining a few other G7 countries, their stock markets also showed a relatively high correlation especially since the burst of the internet bubble. 

Diverse-2

Then 2007 came along, and as we saw in the first chart, there was simply no place to hide during the credit crisis, hence the run for the exit move into cash and short-term Treasuries. In the face of all this then, the main tenets of Modern Portfolio Theory need at least some refinement.  But that is something institutional and high net worth investors should undertake.  In terms of giving a typical stock portfolio for the average investor a good amount of international diversification, I have a slightly more controversial but certainly much easier to implement proposition:

First, re-examine what your traditional advisor might have told you for a moment.  Most advisors and planners generally suggest an international portfolio allocation based on a tick box approach where your answers to their risk and customer questionnaires are massaged by some black box metrics and an appropriate allocation is then suggested.  Your typical planner will put you into one of 5-6 pigeonholes from conservative to aggressive investor. Hence, your international component might be anywhere from 0% – 25% depending on which allocation model is chosen and obviously how you answer their questions.  A lot of that tick box approach is highly questionably to begin with and in the face of the higher inter-connectedness of all markets, unnecessary to a certain extent.  It also makes, managing your portfolio a lot more difficult and expensive (remember a planner also has to justify his fees). 

Instead of the usual Spiel, consider DIAmonds. In other words, consider investing your entire stock portfolio with only one major market index such as the Exchange Traded Fund SPDR DIAMONDS TRUST (DIA) which matches the index components of the Dow Jones Industrial Average. Then forget about any additional international diversification completely. 

Here's why...

Looking at the list of the 30 Dow components, there may be just a handful of companies with limited or no international exposure. 

DIA-Holdings

The vast majority of the Dow component stocks however, derive a substantial part of their income from outside the US.  So why bother trying to fine tune your international exposure correctly.  Let the companies determine that allocation.  After all, successful companies will go to those countries where they can achieve the best returns on their assets.  Just follow their lead and take advantage of the built-in international exposure that comes from the large number of multi-national component stocks in the Dow.  Warren Buffet once said: "My preferred holding period of a stock is forever". 

With a traditional dollar-cost averaging method, buying a fixed dollar amount of DIA shares each year, DIAmonds are ideally suited to fit that bill.  After all, DIAmonds are forever...

Afterword: There are various other Indices and other ETFs one can consider in bringing some international exposure to a stock portfolio.  DIA is used as an example because of its relatively small number of holdings, making it easier to understand what the ETF is actually comprised of, something that is getting increasingly difficult with some of the more recent ETFs.  DIA also has a low expense ratio of 0.18% and no built-in incentives for financial advisors to earn commissions. That is why these types of low-cost funds are typically more attractive to the investor rather than the broker or financial advisor. There are certain risks when purchasing any security including ETFs.  As always, know what you are buying and remember to read the prospectus before considering an investment in any ETF or Mutual Fund.  For the purpose of this article, international diversification via currencies is not discussed here. Please contact info@fxistrategies.com to receive some information on how to include currencies in your portfolio.  You can also click on the following Labels to read prior FXIS articles about currencies:  Currencies, US Dollar, Euro, Australian $, Canadian $, Swiss Franc and Japanese Yen

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

June 18, 2010

Market Wrap: for the week ending June 18, 2010

Noteworthy... 
• Gold reached a new all time high of $1262 per ounce on Friday (Reuters)
• Europe to publish stress test results of 25 big European banks (FT)
• UK will abolish the FSA giving more power to the Bank of England (Business Week)
• US current account deficit increased to $109.0 billion, or 3.0% of GDP in Q1 (ESA)
• Leading Economic Index (LEI) for the US increased 0.4 % in May (Conference Board)
• US consumer prices declined 0.2% in May on a seasonally adjusted basis (BLS)
• BP agrees on a $20 billion fund to compensate victims of the oil spill (AP)
• Russia may add Australian & Canadian Dollars to its international reserves (Bloomberg)
• Euro area employment was stable and EU27 down by 0.2% in Q1 of 2010 (Eurostat)
• Euro area annual inflation was 1.6% in May 2010, EU annual inflation was 2.0% (Eurostat)
• The Producer Price Index in the US moved down 0.3% in May, seasonally adjusted (BLS)
• US Industrial production advanced 1.2% in May after having risen 0.7% in April (NBER)
• US Building permits in May 2010 were 574,000, a decrease of 5.9% from April (ESA)

Weekly Market Barometers    
Stock-2010-0618   FX-2010-0618

Chart Of The Week  
Scotia Capital draws a slightly optimistic chart from Canada’s perspective while painting a rather gloomy picture of the risk profile for US sovereign debt.  The US is still the benchmark for typical assumptions towards investing in “risk-free” debt at this point.  While the perceived risk toward US government debt is nowhere close to the chart below, one should consider the possibility that the safe haven status might crumble somewhat and that the bull run of US Treasuries will slow down.

SC-Chart
Source:  http://www.scotiafx.com/conference/CS-Monthly_FX_ConfCall_June_2010.pdf

Good luck and good investing! 

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

June 16, 2010

Is The Euro Catching The Curve?

The Euro made a nice little recovery since the June 7 when it reached the lowest point in 4 years.  At the end of European trading on Wednesday, the Euro was holding above 1.2300 which is about 3.5% up since early last week.

EUR_2010-0619

Looks like the Euro has been catching a nice ride on this short-term uptick so far.  Indeed, the massive selling pressure in this worst crisis of Euro confidence has decreased - thanks in part to the media attention which has shifted somewhat to the BP oil disaster.  Or was it the soccer world-cup which seemed more pressing and led hedge fund managers to cover some or their short positions? 

Jim Rogers, the famous hedge fund manager, announced his contrarian move last week:

“Everybody is so bearish about the euro that it looks like now is a good time to buy the single European currency.”

And he did indeed follow through on his announcement confirming his trade in an interview from Madrid on Wednesday:

"I bought the euro Friday and Monday, I don't know if it's just a trading bounce or if it's going to be fundamentally sound from now on"

Whether Jim Rogers is just talking his book (as all traders do in fact) or whether this is a case of perfect timing, the Euro has indeed bounced a bit more to the upside since Rogers took his position. 

The more important question though is: where do we go from here? 

Fundamentally, nothing has changed since the darkest moments of the Greek credit crisis.  The Southern European nations are still facing the same daunting economic and fiscal challenges as they did a few weeks ago.  Further, we don’t see any signals indicating that the announced austerity measures throughout the Eurozone would turn things around, nor that these measures would in fact be upheld.

Taking a look from a different perspective, technicians would point to the fact that the Euro has simply returned home to the current trend channel.  That channel however, is still sloping downward for now.

EUR-2010-0616

June 11, 2010

South Africa 2010

This year’s FIFA World Cup 2010 hosted by South Africa has prompted numerous sites to look into possible investment opportunities in South Africa and other countries on the African continent.  We are not trying to advise on the merits of investing in South Africa but would rather like to point out a few possible avenues one could consider. 

As you might have guessed, there are certain ETFs providing some exposure to South Africa and its currency the South African Rand.

The South Africa Index Fund (EZA) by iShares tracks the MSCI South Africa Index with holdings of some of the largest South African companies. Among their top ten holdings are the following firms:

 

EZA-Holdings
Source: http://us.ishares.com/product_info/fund/overview/EZA.htm

South Africa’s economy is largely driven by raw materials, mining (South Africa is the largest producer of gold, platinum and chromium), agriculture and the banking sector supporting these industries.  This ETF’s holdings are therefore skewed towards the sectors directly involved with materials and mining etc.

 

EZA-Sectors
Source: http://us.ishares.com/product_info/fund/overview/EZA.htm

Another easy option to get some exposure is via the currency South African Rand.  You could trade Spot Foreign Exchange, or Futures and Options via the Chicago Mercantile Exchange (CME).

 

ZAR-Fut
Source: http://www.cmegroup.com/trading/fx/emerging-market/south-african-rand.html

Easier still, try the currency play with an ETF.  SZR is the ticker symbol for WisdomTree’s South African Rand ETF.  Albeit more volatile than other major currencies, SZR has an added incentive from a positive yield differential compared with the major currencies like US Dollar or Euro.  Similar to the Australian Dollar, the South African Rand is also a commodity driven currency and it has profited to some extent from the major bull market in Gold and other precious metals.  

There is another ETF tracking the Dow Jones Africa Titans 50 Index offered by Market Vectors Africa Index (AFK).  Although South Africa has the largest component weighting with almost 30%, there are many other African nations at play here, most of which would defeat the investment objective i.e. direct exposure to South Africa – not an ideal choice then...

 

AFK
Source: http://www.vaneck.com/funds/AFK.aspx

If I was to consider some exposure to South Africa however, I would try a play on one of South Africa’s most revered products, namely Gold.  Let's face it, South Africa’s economic achievements are not based on the fact that they have been chosen to host the World Cup but rather that the country has been a leading exporter of minerals, jewels, precious metals and other raw materials, most of which have been consumed up by massive demand from countries like China.  The South Africa Index, EZA may be a viable candidate but Gold has been an even better performer particularly because it was somewhat insulated from the credit crisis and the bear market in stocks.  The chart below reflects the performance of Gold versus EZA since its inception in 2005.  Quite a positive surprise with this comparison is the fact that Gold nearly tripled the returns of EZA but did so with about just half the volatility

 

ETF-Replay
Source: www.etfreplay.com

The jury is still out on whether South Africa’s soccer ambitions will pay off. But in terms of giving an investment towards South Africa some thought, I might stick with Gold for now.

For additional info about the ETFs and currency discussed here, please email: info@fxistrategies.com

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Market Wrap: for the week ending June 11, 2010

Noteworthy... 
• US retail and food services sales in May 2010 decreased 1.2% to $362.5 billion from April (ESA)
• The ECB raised its GDP growth forecast for 2010 but lowered its prediction for 2011 (WSJ)
• Chinese exports surged 48.5% in May from a year earlier, while imports rose 48.3% (Reuters)
• Brazil's central bank raised its benchmark interest rates to 10.25% from 9.50% (FT)
• The Reserve Bank of New Zealand raised rates 0.25% to 2.75% (WSJ)
• The Australian jobless rate fell to 5.2% in May from 5.4% in April (Reuters)
• Bank of England kept its key lending rate at a record low 0.5% (Reuters)
• US trade deficit widened to $40.3 billion in April, up by 0.6 percent from March (ESA)
• The European Central Bank left its key interest rate unchanged at 1% (AP)
• Bernanke points to modest US recovery, federal budget deficit is on an “unsustainable” path (FT)
• Gold reached a new high Tuesday, with Spot Gold as high as $1,252.10 (Reuters)
• Brazil's GDP expanded 9% from a year earlier and 2.7% from the previous quarter (Bloomberg)
• Emirates places record $11bn order for 32 Airbus A380 superjumbo jets (Telegraph-UK)
• Global economy spends over $550bn in energy subsidies each year, 75% more than expected (IEA)

Weekly Market Barometers    
Stock-2010-0611   FX-2010-0611

Chart Of The Week  
Just in time for the FIFA World Cup 2010 in South Africa, Paul Hickey and Justin Walters from the Bespoke Investment Group came up with a neat table. They reviewed the historical performance of the markets during and immediately after past World Cups.  You can't really expect anything conclusive from this, but as an admirer of the "beautiful game" it's one of those trivia that might stick.

wcup610
Source: http://www.bespokeinvest.com/

Have a great week-end and enjoy the beautiful game!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

June 08, 2010

Here’s why you are getting sick from the markets

Most average investors have a hard time grasping some of the more abstract concepts such as Market Volatility.  But everyone knows when the market crashes it hurts the portfolio and ultimately your own wallet.  During the financial crisis of 2008/09 the VIX Index, also known as the fear index, was one of the new trendy financial terms you could hear at cocktail parties.  Instead of the talk about the Lakers or the Dodgers, I remember hearing “How about that VIX” at more than a handful of social events in 2009.

So what exactly is this VIX measuring and what is volatility?  You can “google” the word volatility and results along the lines of “annualized standard deviation of daily returns” will pop up. Lingo aside, it is easier to understand the concept with this analogy: A roller-coaster ride and its up and down movements at relatively high speeds is what volatility feels like. That combination of up/down as well as sharp turns at the high speeds is what makes our stomachs turn.  And you typically get more sick in a fast down turn because of the fear of tumbling all the way to the ground.  The VIX expressed that fear of tumbling most vividly in 2008; as the markets were crashing the index for fear was at an all-time high.

VIX-2010-0608

Ever since the summer of 2008 however, another dimension has made the most die hard market participants sick to the stomach as well.  It is the intraday price swings which have led to a different kind of shake-out no longer resembling a roller coaster but rather something like this…

mogul-skiing2

The traditional measure of volatility in terms of comparing the daily returns does not fully capture the challenges which have been increasingly similar to skiing down a hill of moguls at high speeds. Best example was the fat-finger flash crash on May 6 when the Dow fell nearly 700 points only to recoup most of the losses by market close.  The S&P500 on that day only dropped 3.2% from the previous day but the intraday price swing, as measured by the difference between High and Low versus the opening price, was a stunning 8.7%. 

Examining the price difference between High and Low relative to the opening price of the market gives us a better view of how things have changed in the markets.  Historically that daily High/Low range has not been nearly as challenging as it was in the past two years.  There were certain spikes, most notably the 20.5% daily range on Black Monday of 1987. However, examining daily data since 1962, we found that 96% of the trading days had a daily price range of no more than 3%.

SPX_All_Daily

By contrast, the daily price ranges since 2008 have seen higher oscillations more frequently. A particularly volatile period was between October 1, 2008 and March 31, 2009.  In the 146 trading days during that period, 64% of the time (93 days) showed a daily price range of more than 3%. 

SPX_daily_2008

Putting that into perspective, 1987, perhaps mistakenly known as one of the worst periods of the stock market history, saw only 25 days out of the 253 trading days in that year (about 10%) with a daily price range of more than 3%.  While these data bear no reflection as to actual stock market returns, they are clearly an argument towards learning some mogul skiing-type trading skills or alternatively avoiding the bumps altogether.

June 05, 2010

A Few Words On The Euro

$1 trillion worth of a Euro/Greek-Tarp, coordinated efforts by Germany, France and the European Central Banks, bans on naked short sales and other combined Eurozone efforts to stem the outflow of confidence in the Eurozone and its flagship, the Euro, have not been enough.  Despite temporary upticks, the Euro has now dropped precipitously fast to the lowest level in 4 years.  After crashing through an important technical support at $1.2000, the market appears to be pushing down the Euro further towards a previously strong support area of about $1.1650, a level which may be tested as early as next week if the current market sentiment continues.

EUR-2010-0604

While there have been many reasons to be bearish on the Euro, one particular perspective seems worth a little examination.  The number of futures contracts held by large traders (institutions, hedge funds and speculators) being net short on Euro has increased dramatically since the beginning of the year.  See the red line below in the COT (Commitment of Trader’s Report) data.

Euro_fut_2010-0604

What the chart does not reflect is a recently re-occurring theme.  The Euro has been trading steady during Asian and European market hours, but has seen more net sellers during North American trading hours.

Meanwhile currency futures make up only a tiny percentage of the overall global currency market. However, the data are somewhat of an indication as to what the bigger picture in the $3 trillion a day global currency market looks like.  To that end, it appears that net sellers of the Euro are still holding the upper hand for now.

Is One ETF Really All You Need?

Referring to a post on Seeking Alpha, a recently established exchange traded fund promises to be the one and only ETF investors need to get an overall exposure in the stock market.  Paul Hrabal, President of U.S. One (ONEF) explains:

Our firm wants to give small investors (under $100K in investable assets) access to the same professional portfolio management that high net-worth investors receive from their dedicated advisors, but at a fraction of the cost, packaged in a way that is easy to understand and buy and which follows the time tested approach of passive index investing. ONEF would be suitable for someone looking for an all- in-one buy-and-hold stock fund that handles the asset allocation and securities selection for them. This single fund gives exposure to nearly the entire investable global equity market. It's geared towards the 30-50 crowd - people that are still far from retirement – and most in need of long-term growth through stocks. Obviously anyone who buys this fund is still on their own for fixed-income exposure. U.S. One hopes to also launch similar 'one-and-done' bond and balanced ETFs to provide a full range of investment solutions to small investors.

The concept is certainly worth considering.  It is true that, on average and over time, the vast majority of investors do NOT outperform the major market indices, something we have also concluded on numerous occasions.  That is why, on average, it makes more sense to invest in a low-cost index fund that is simply matching the performance of the market at minimal expense to the investor.  This strategy is typically a better choice than stock picking, certainly for smaller and unsophisticated investors. 

It also beats owning mutual funds on average because the majority of Mutual Fund managers do NOT outperform the benchmark over time either.  On top of that, management fees and fees in various forms, typically 1% or higher will eat into returns further.  Hence, the idea of a single product with a balanced exposure of the entire stock market exposure sounds appealing.

There are still a number of caveats with U.S. One however.  To begin with, you're entrusting your money with a fund manager that has never managed a fund before.  Ron Rowland of AllStarInvestor.com notes:

“The Advisor has no prior experience managing, or administering, an investment company. One Fund also has no prior experience with assets under management and no track record. The portfolio manager currently does not manage any other accounts. When buying an actively managed fund, most investors base part of their decision on the manager’s experience. In the case of ONEF, there does not appear to be any."

And Paul Hrabal plainly admits:

Ron is right. This is my first foray into the portfolio management industry. That being said, my methods are time-tested and supported by long-term data analysis in terms of being a buy-and-hold follower of passive indexing, with minimal portfolio activity. People can go see for themselves how the underlying components have performed. I'm not trying to be the best stock picker out there. My aim here is simply to track the global equity market as cheaply as possible. Having a single fund which limits the commissions you'd pay to own each of the underlying components separately and then to have to rebalance annually, we are offering a very compelling value proposition to small scale investors.

In the increasingly competitive arena of Exchange Traded Funds where a large number of funds have a hard time getting off the ground (some of them have been closed due to lack of investor demand), a newbie is facing an uphill struggle.  That shows in the minute value of the fund which has been conveniently omitted from the fund’s website (they only display the value of shares outstanding).  At the close of this week, ONEF was worth just $2,371,200, a value so low that it would normally not allow covering the fund’s own administrative expenses at a reasonable ratio, certainly not at the proposed 0.51% expense ratio to investors.

That said, there are other reasons to be cautious.  While smaller investors these days are better served than ever in terms of being able to get a broad market exposure with a number of ETFs at lower cost than Mutual Funds, one must still question: what is the point of paying someone to select just 5 ETFs and come up with a relatively simple weighting and annual rebalancing?  U.S. One has the following holdings as of 3 June 2010:

OneF-Weights

Then there is that old question of diversification.  What is the best asset allocation, what weightings should be employed and how often and how much should the portfolio be rebalanced.  As the past few years since the financial crisis showed, diversification does not always work and certainly within just the equity side, it remains questionable whether it really makes much of a difference for the smaller investor.  As Doug Short of www.dshort.com puts it:  Diversification works until it doesn’t...

diversificationfailure4

As the chart above implies, perhaps a John Bogle approach (John Bogle was the founder of the Vanguard Fund family) which is a simple aged based asset allocation strategy, wherein the fixed income component matches an investor’s age is probably the best way to create an easy and relatively safe way to balance a portfolio.  Any investor should be able to achieve that without having to pay a fund manager.

In closing, Ron Rowland who maintains the ETF Deathwatch List has the following comments:

ONEF has huge obstacles to overcome. The sponsor has entered an extremely competitive ring, yet appears unprepared for the battle ahead. I predict ONEF will be near the top of my ETF Deathwatch when it becomes eligible in December 2010.

Given the investor mood these days, it is questionable whether ONEF can stick around that long...

June 04, 2010

Market Wrap: for the week ending June 4, 2010

Noteworthy... 
• The Euro closed the week at a new 4 year low below $1.2000 (Reuters)
• US total nonfarm payroll grew by 431,000; unemployment rate edged down to 9.7%  (BLS)
• The pace of U.S. bankruptcies in May reached the second-highest daily level since 2005 (Reuters)
• BP’s share price dropped 34% since April 20th, $62bn wiped from its market value (Economist)
• Unemployment in the Euro area was 10.1% in April, compared with 10.0% in March (Eurostat)
• Australia's first-quarter seasonally-adjusted GDP growth slows to 0.5% (MarketWatch)
• Japanese Prime Minister Yukio Hatoyama resigned after just eight months in office (WSJ)
• The Reserve Bank of Australia as expected left interest rates unchanged at 4.5% (WSJ)
• China to “gradually” levy a tax on property holdings in an effort to prevent speculation (Economist)
• Canadian GDP up 6.1% in Q1 of 2010 - strongest quarterly rise in over 10 years (Economy.com)
• Canada the first G-7 nation to raise its interest rates post-financial crisis (AP)
• Estimated Euro area annual inflation at 1.6% in May; it was 1.5% in April (Eurostat)

Weekly Market Barometers    
Stock-2010-0604   FX-2010-0604

Charts Of The Week  
A major sell-off on Friday after a less than encouraging US jobs report drove the major market indexes more than 3% lower.  The S&P 500 was down 2.25% for the week.  China’s Shanghai Composite Index fell even further with a drop of 3.85% for the week.  Many traders reported an acute  nervousness in the market which can also be found in the strange trading patterns with up and down oscillations of more than 1% at any given moment.  Perhaps some of the larger traders had seen the following chart analysis by Doug Short before trading this morning.  Scary stuff...

3 Different S&P Valuations   A Hypothetical Bottom
Q-Ratio-PE10-SP-Composite-mean   Q-Ratio-PE10-SP-Composite-mean-bottom
     

Good luck and good investing!

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The Real Recovery Is Still About Jobs

The US employment report was the most anticipated economic info for the week.  Non-farm payrolls rose by 431,000 in May, lower than the consensus forecast for a 540,000 rise, but at least the unemployment rate fell to 9.7%. As the Bureau of Labor Statistics reports:

Total nonfarm payroll employment grew by 431,000 in May, reflecting the hiring of 411,000 temporary employees to work on Census 2010, the U.S. Bureau of Labor Statistics reported today. Private-sector employment changed little (+41,000). Manufacturing, temporary help services, and mining added jobs, while construction employment declined.  The unemployment rate edged down to 9.7 percent.

In reality then, this is a rather gloomy employment report.  Stripping the over 400,000 temporary jobs for the Census 2010, things haven’t really improved.  The US needs to create about 150,000 new jobs each month just to keep up with the (still) growing demographics; so in real terms, this represents a net loss of jobs for the month of May.  Looking ahead then, with several million new graduates entering the labor force this summer, employment still presents a major uphill battle for the US economy. 

You may recall that we dissected the US Budget forecast earlier this year (Market Insights 6 February 2010). We were looking at the projected improvements in employment data, assumption of which many of the economic and fiscal forecasts were based upon.  The chart below reflects those very optimistic views.

ObamaUnemploymentForecast[1]

In keeping a positive attitude one could say that these employment improvements are still possible, particularly if enough incentives are provided for the private sector to hire again. 

However, there are two very big hurdles to take.  For one, demographic trends are not going to change drastically in this decade i.e. more new job entrants coming to the labor market while older people are forced to delay retirement for economic reasons. 

Equally concerning is the number of long-term unemployed.  As of last month, it hit yet another record wherein now 46% of the unemployed have been out of work for more than 27 weeks – see graph below.

Unemployed_over_27weeks

In conclusion, there will be no real sustainable recovery until enough private sector jobs are created and a solution for the long-term employed is found.