Indexation Risks II

Wed, 2016/10/26 - 1:21pm | Your editor

The second indexation risk is stupidity.


The Swiss National Bank, their central bank, in August increased its investment in equities, focused on US equities to SwFr 127 bn, 41% of its reserves, to spread its risks. Half of the total, $62 bn, is supposed to be in US stocks.
The idea was to buy US equities and it is now the 8th largest equity investor. They use the $650 bn in foreign currency--mostly greenbacks--amassed by buying dollars to keep the franc from
appreciating and hurting the sales of Swiss firms like UBS, Swiss Re, Credit Suisse, Swatch, Nestle, Novartis.

But instead of buying red white and blue shares they are buying pure Star of David stocks.

The strategy is based on buying an index and not trying to pick individual shares. So the SNB owns more shares in Facebook than its founder, Mark Zuckerberg, $741 mn worth, 0.28% vs Zuckerberg's 0.17%. It started buying stocks in 2005 after it was allowed to add them to its bond holding under a new law.

By the end of the second quarter in July, the SNB reported to our SEC that it had $61.8 bn of US equities vs 54.5 bn a month earlier and a mere $41.3 bn at the end of 2015, a rise of 50% in H1. But the SNB is using funny money to buy stocks and moreover has no idea what it is buying. Welcome to the world of indexation!

Jim Grant (of Grant's Interest Rate Observer) commented: "The SNB creates Swiss francs out of thin Alpine air. Then they go and call their broker and go on a tour of the US Stock exchange. They get involved in important companies from the S&P which create real profits, and they do that with money created out of nothing." Jim Grant was talking to Finanz und Wirtschaft newspaper.

Grant's firm sponsored a conference and research by Horizon Kinetics, a related company which writes about the SNB's purchases:

Does the Swiss National Bank have a special affinity for Israel? or a subtle asset allocation sub-strategy? why does it hold 17 Israeli stocks in its US equity portfolio? B Communications Ltd; Caesarstone Ltd; Cellcom Israel Ltd; Check Point Software Tech; Cyberark Software Ltd; Elbit Systems Ltd; Israel Chemical Ltd; Ituran Location & Control; Kormit Digital Ltd; Mellanox Tech Ltd; Neuroderm Ltd; Orbotech Ltd; Radware Ltd; Taro Pharma Industries; Tower Semiconductor; and Wix Com Ltd.

The Bank's 2581 stocks are not chosen by actual analysts. They're chosen by machine. The machine must be programmed.

Do the programmers in Zurich know that a cusip that begins with a letter, as opposed to a number, signifies a foreign company? why would they? So the Swiss National Bank affects the clearing prices of Israeli as well as US stocks. And they don't even seem to know it.”

Actually the situation is worse than that. The SNB's misplaced purchases were not confined to Israel although there was another Israeli firm Grant's didn't spot, Gazit Globe.

The SNB loaded up on Canadian funds from Brookfield Asset Mgm; Hortonworks; Denison Mines; Intrepid Potash; Barrick Gold; Pico Holdings and dozens more.

The SNB bought non US shares like Euronav nv of Belgium; Liberty Global plc of Britain; Indian bank ICICI; and Fang Holdings, a Chinese real estate portal (covered by both Credit Suisse and UBS analysts!)

Does the fact that Wilhelm Tell's aim is bad affect anything more than the Swiss themselves? The answer is yes. There are relatively few stocks with enough liquidity and market value to be bought by index funds in big volume. They are very much in demand, mostly because they are going up. And the reason they are going up is that index funds are buying. This becomes a self-fulfilling prophesy.

The foreign companies put into the SNB's supposed US portfolio are particularly vulnerable now that Jim Grant and Vivian have exposed the rotten apple at the core of SNB's portfolio. The Swiss will exit with some rapidity and the result will be a drop in the share price for not good reason.

Today I will start by telling my readers about mistakenly purchased shares that Swiss will sell. Then I cover two shares which reported today.

Tomorrow I will continue the run-down of indexation risks covering country funds; and Friday I will write about bond funds and about factors to watch when tracking indexes.

We have news from Canada, Israel, Bermuda, Britain, Spain, Cuba, India, Brazil, Sweden, Colombia, and Finland.

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Indexation Risks

Tue, 2016/10/25 - 12:08pm | Your editor

Today I begin a series about the problems of Index Funds. They are a major cause of US investors moving into exchange-traded funds and away from high-fee managed mutual funds. But the system which works in a large market like the USA may not work in smaller foreign markets, or even for foreign markets as a whole. Or even always in the USA because of weighting.

This results from the fact that many markets are overweight in one sector or even one stock. Start with our near neighbor Canada. Until about the year 2000, Canadians could watch their money rise thanks to one single stock, Nortel, which accounted for about 35% of the total Toronto 300 stock index. Then--boom-- Nortel lost 94% of its value in one fell swoop in 2001 taking the index funds down with it.

The same thing happened a second time more recently with Blackberry, which became a hugely overweight part of any Canadian index-tracking fund. Even today every index fund covering Canada is overweight energy, materials, and financials—not the safest sectors currently.

And in an admittedly much smaller Finnish market, for years the index was dominated by as much as half the money going into a single vulnerable stock: Nokia.

Even in the bigger USA investors using indexes lost on almost all financial stocks: Lehman Brothers, WaMu, AIG, General Growth Properties, Fannie Mae, Freddie Mac, Ambac, XL Capital, and others all of which lost over 90% of their value.

The US SEC is investigating the risks from the dependence on US stock funds on ETF inflows and worries about the failure of tracking programs to properly value bonds in ETF portfolios. Index ETFs have gained because traditional mutual funds charge high fees for underperformance. So led by Vanguard's John Bogle, successful creator of mutual funds to track indexes back in 1976, investors are buying indexes and benchmarks. It's not that easy.

Tomorrow we will address the vulnerability of US index tracking ETFs. But for those aiming to go global, the message is simple: you need stock pickers, not indexers. As my newsletter practices in stock-picking, so my message is also self-serving.


More for paid subscribers today from India, Australia, Brazil, Germany, Switzerland, Britain, Israel, Ireland, Finland, Sweden, the Netherlands, Bermuda, Panama, and the Cayman Islands.

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Updated Portfolio Tables Posted

Sun, 2016/10/23 - 12:53pm | Your editor

I have just updated our model portfolios on the website. There were serious problems because of a distributed denial of service hack attack Friday against the Dyn system. Dyn allows you to write the name of the website you want to visit rather than the numberical DNS code, for convenience.

The attack took down major news sites: The New York Times, the Financial Times, Dow-Jones, my brokerage, and probably yours as well. It also cut off social media: Twitter, Netfli, Spotify, Airbnb, Reddit, Etsy, SoundCloud, and many fund manager websites.

The attack appears to have used unsecured Internet of Things devices connected to the internet like baby monitors, cameras, home routers,and others. These were used to overwhelm legitimate sites with abnormally large demands to connect--without their owners being aware of it.

So be aware that the net asset values shown for our closed-end funds may not have been updated, being marked with a P, for prior week valuation. Some of our UK shares traded on the pink sheets did not have their prices updated by the market-makers. I worked out the exchange rate and ratio based on the London prices. More on this for paid subscribers reporting on a 4-leaf clover share we own.

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Bloomberg Businessweek Readers

Fri, 2016/10/21 - 12:48pm | Your editor

My “Scenario” posting yesterday was widely applauded by readers—including one benighted fellow who insisted he still will not vote for Hillary Clinton—plus newsletter editors asking to reprint it, and a rabbi writing his sermon for tomorrow's Sabbath. Thanks to all who wrote to me, a likely record. I only hope nothing like my imagined last stand by Donald Trump and his followers will ever come to pass.


*My note quoting an obscure Canadian academic on how Theresa May can call a snap election to get out of Brexit was picked up by Pieter Cranenbroek of, Bill Bonner's UK blog. It's nice to be quoted even if he didn't give me and the Toronto Globe and Mail credit.


The EU trade deal with Canada has been vetoed by the Sovereign Assembly of Wallonia, one of Belgium's triad of congresses, this one representing French-speakers. In theory, that is enough to block its signature but the entire European Union. This will also affect any Brexit deal which will also have to be approved by every EU national sovereign representative body.


I began reading Business Week when I was a child and my father subscribed. I worked for this publication when it belonged to McGraw-Hill, at my first journalistic job. Now I am a paid subscriber to what is called Bloomberg-Businessweek. And its marketing people think that their business publication is read by idiots.

I got a mailed BB promotion offering me a “No additional cost renewal if I signed somebody up at $60 for a gift sub.”

“You save $239.50 off the cover price for both subscriptions,” it promised. So I called the number and learned first that my sub had more than a year to run. And secondly that if I were to renew it, the bite would be $30, so the two-fer offer if you buy a gift is NOT free. For a publication directed at business people that “way of thanking friends for giving it as a gift” deserves to backfire. Hizzoner Michael Bloomberg should be ashamed of that campaign and end it.


Meanwhile the latest upgrade from Mozilla Firefox is blocking me from logging into my brokerage account. Monday is a holiday (the last of the spate for Jews) called Shemini Atzeret-Simchat Torah when among other things you are supposed to overindulge. So there will be no blog.


More for paid subscribers follow from Ireland, the Dutch Antilles, Mexico, Brazil, Israel, Switzerland, Britain, and a few other places like Argentina, Japan, Canada, and Australia.

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Thu, 2016/10/20 - 1:22pm | Your editor

Here is a scenario. Donald Trump reacts to losing the presidential election by calling the result rigged—something that Al Gore refrained from doing the last time that really happened, for the good of the country.

Trump then holes up in a mountain fastness called Trump Hideout with Melania and a posse of armed NRA pistol packers, border guards, and unemployed coal miners. They constitute themselves into a private police force armed with handguns, rifles, and his airplane.

Trump calls for an attack on the USA by nuclear armed Vladimir Vladimirovich Putin with whom he is in telephone contact, thanks to Melania's fluent Russian. This is backed by some investors in Trump Soho real estate from mafiosi from Kazakhstan and Russia. Paul Manafort, former consultant to Ukrainian tyrant Viktor Yanukovych, is back in Trump's team, acting as his chief strategist.

But Trump soon becomes a loser for real. President Obama calls Angela Merkel and she requires that German American Capital, a sub of Deutsche Bank, call its loans to Trump to get needed support from Berlin.

The lame duck president then calls the daughter of his Chinese counterpart, Xi Jinping, Xi Mingze, formerly at Harvard, reached through its efficient alumni organization. Mingze gets her daddy on board for stopping Trump who has misrepresented Chinese exchange rate policy. The state-owned Bank of China calls its Trump loans too.

After the stampede, even Goldman Sachs and Wells Fargo call their loans too. Now the limited partners of NYC's 1290 Avenue of the Americas and the former Federal Office Building in DC and other sites want to end their Donald partnerships. They demand that he cash them out. But Trump doesn't have the money.

Instead of bombing Washington, Putin sends his airplane carrier to bomb Trump Hideout, not however using nukes. Putin can recognize a lost cause outside Syria. The NRA guys and the border guard posses disperse. The coal-miners go on strike against Trump.

Melania and Manafort elope by flying away in the Trump airplane to Yalta. She says that Trump was never any good in bed. And he hasn't got enough money to fulfill his pre-nuptial contract with her.

Trump fulminates on social media sites but becomes increasing erratic. The IRS launches a probe into his tax deductions, and calls in the Feds when he stiffs them. FBI agents take him away, after first combing his hair back so people can see his low forehead, and put him in an orange onesy so people can see his fat behind. His handcuffed small hands keep him from grabbing at agents' private parts.

The Mexican peso and Mexican stocks soar.

More for paid subscribers follows from Brazil, Panama, Mexico, Singapore, Israel, Australia, Japan, Denmark, Canada, Britain, and Switzerland. It is a low news day because everyone is still rubbing their eyes after the Third Debate. But we have two company reports all the same.

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Fund Flows

Wed, 2016/10/19 - 2:29pm | Your editor

The third quarter saw escapism by investors from the brutalities of Brexit and the comedy of the US campaign for president. So naturally they went in for a different kind of investment, returning to the stocks from emerging markets. Helping the trend was the US Fed's caution on hiking interest rates, which could hurt debtor companies from the Third World.

In the September quarter, “emerging markets equity funds posted their biggest quarterly inflow” since the same quarter in 2014, while “emerging markets bond funds [had] their biggest [inflow] ever”, wrote Cameron Brandt of EPFR Global, a firm which tracks flows into funds. He writes also that US investors were net buyers of both stock and bond funds from developing countries. The only exceptions were Canada and Australia which are counted as beneficiaries from higher oil prices.

Japan equity funds had a tought quarter with foreigners taking out $5.4 bn from Japan funds. Meanwhile Japanese domestic investors were placing their money in a tiny handful of index-tracking funds to mimic the way the Bank of Japan was operating its stimulus program by buying the Nikkei.

Meanwhile developed country markets saw net outflows via redemptions from funds, with Western Europe hit hardest with outflows of $45.23 bn and the USA losing $23.32 bn. Global emerging markets equities had inflows of $22.86 bn.

By sector, there were inflows into commodity funds, notably ones holding gold and precious metals, and into tech and real estate. Spooked by scandals, investors took more than $5 bn out of healthcare funds, and much smaller amounts out of financials, utilities, and even infrastructure.


Beside mastering Bible lore my eldest granddaughter Ella is also fast, one of two Cleveland Heights girls who took home the Lake Erie League Championship title coming in second in the 5 km course at 21:17. The girls won 5 of the top 11 places. Mazel Tov Ella.

More for paid subscribers follows from Switzerland, Sweden, Colombia, Brazil, Spain, Argentina, Brazil, Israel, Hong Kong, Canada, Britain, and Spain.

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Double Issue

Tue, 2016/10/18 - 2:33pm | Your editor

Today and next Tuesday are double issues because of the Jewish holiday.

When she was a little girl, my eldest granddaughter Ella taught me that the Biblical city of Nineveh is now called Mosul. During the Jewish High Holy Day of Yom Kippur we read the story of Jonah, who was instructed by God to go the “Nineveh, that great city” and warn the people there to repent lest their city be destroyed. Jonah as is well known opted to go in the other direction, sailing from Jaffa into the Mediterranean. There he wound up swallowed by a great fish or a whale before he wis spat out. He reluctantly decides to do what he was told.

The message of the Bible story is not merely that if God tells you to do something, do it. It is also that we are responsible for one another on this earth. The people of Nineveh would have been pagans in this pre-Islamic period.

After he went to Nineveh and successfully preached repentance to its inhabitants, Jonah continues to challenge God, objecting to His having spared the Big City sinners. He sits under a bush complaining. Then it dies and he suffers from sunburn and heat and laments that the bush has died.

God then tells him that he is mourning for a bush that he had no role in planting whereas he was ready to write off Nineveh with its huge population including many too young to know their right hands from their left. We are all responsible for liberating Mosul, which was thrown to the ISIS dogs by mistaken policies by our two most recent presidents.

Inflation annualized is up 2.2% in the USA and 1.5% in Britain. Inflation is baaack and interest rates will rise to match it, according to Marc Chandler of Brown Brothers Harriman (writing in today's

Meanwhile the Eurozone is suffering from Japan-style deflation and low growth which John Llewellyn attributes to mistakes made earlier: interest rate rises in 2008 and 2011, and delay in moving toward quantitative easing compared the the US and the UK. He also cites “overkill” fiscal consolidation imposed on Greece and Portugal while leaving Germany's continuing budget surpluses un-addressed. John heads in London and is formerly deputy chief economist of the OECD.


More today from Britain, Mexico, Israel, Denmark, Belgium, Switzerland, Australia, Japan, China, Hong Kong, South Korea, South Africa, Canada, Colombia, and the Dutch Antilles.

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Sunday Tables Posted

Sun, 2016/10/16 - 12:10pm | Your editor

I posted the tables on our website today, where readers may view them. Note that we have had a lot of difficulty sending out the daily blog from our website late last week, and the webmaster is still working on getting the site up. Meanwhile, when you are visiting the site you can also view the blogs from Thursday and Friday. They have been combined in an effort to overcome the blockage--which did no good. More for paid subscribers follows: Read more »

Market and Elections

Fri, 2016/10/14 - 1:25pm | Your editor

Yesterday Britain faced a Marmite crisis. If you are not married to a Briton like I am you may be unaware of the national taste for this muddy yeasty sandwich spread. It apparently is imported by the maker, Unilever, which has attempted to raise its wholesale price to UK Tesco supermarkets by 10%. Tesco refused and also removed other UL products from its shelves. Both shares are down because of the row.

The UK supply of Marmite will resume without a 10% price increase. Tesco and Unilever have worked out a compromise—details unknown—to restore UL products to TSCDY's supermarket shelves after banning them to block a 10% rise in the price of the smelly brown spread beloved of Britons. It goes to show that all the effects of Brexit will not be bad. I had hoped a ban on the stuff might persuade my husband to give up his addiction to Marmite, but no such luck.

Note that during the row UL also stopped deliveries to Tesco of other produces like Hellman's Mayonnaise, Persil detergent, and Flora margarine. So I suspect Tesco is paying more than 5% more. Its stock rose 4.41% at the London close.


Here is more information about how Interactive Brokers keeps its commission levels low. First of all their regular website charges customers for foreign stock prices. To trade on the site without being disadvantaged by the “counter-party” you have to subscribe to get market data by the month—and it is not cheap. Moreover the normal counterparty to your trades is not an outside market-maker, but IB itself which runs its own Dark Pool. It uses a SmartRouting system that supposedly searches all available exchanges to find the best price available at the time you place your order. But given that foreign markets do not observe Wall Street hours, there may not be any quotations for some obscure or thinly traded foreign stocks, putting you are the mercy of the IB Dark Pool. You can insist on routing your order directly to an exchange, but there may be a gap in price discovery if it is closed when you are placing your order—which may not go through.


More follows for paid subscribers from India, South Africa, Thailand, Brazil, Argentina, Australia, Ireland, Britain, Israel and a few other places. There will be no blog Monday. After today's newsletter I am also pasting Thursday's because many readers did not get it for some mysterious reason. By combining them I avoid the overload causing the letters to be viewed as spam.

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Yom Kippur A Day Early

Tue, 2016/10/11 - 1:39pm | Your editor

The fast day began a day early as Wall Street collapsed in the wake of rotten earnings from bellwether Alcoa--and general uneasiness about politics and finance.


European banking regulators made special exceptions to the rules of their stress test to ensure that Deutsche Bank looked more solvent than it is, report today's Financial Times. The British newspaper writes that the tier 1 equity of Germany's troubled major bank was boosted by counting $4 bn “proceeds” from DB selling Hua Xia as part of its capitalization by the European Central Bank stress tests.

This preferential treatment came because the China sale was not completed and the $4 bn not paid over by the stress test deadline of Dec. 31, 2015. In fact, the sale of Hua Xia is still pending and the German bank still has not received the money. So its common stock equity stress test capital ratio was not an alarming 7.4%, but a slightly less alarming 7.8%. However lesser banks from other countries like Spain were subject to stricter stress-test rules which meant that their pending deals did not improve their capitalization ratios. DB would immediately fail any future US stress tests under existing rules, because the US relies on foreign regulators to do homeland stress testing for banks operating here.

The ECB insisted that it “treats all bank equally in line with the regulation”--which reminds me of Donald Trump saying he respects all women.


Today the ECB, the Fed, and the Bank of England are working on a new way to cooperate over a major bank failure to preserve financial stability. Before they work on their reactions they may just want to improve the quality of the information they are getting from each other.


Meanwhile a Swiss banking arm has been shut down in Singapore as part of the investigation into the diversion of money from the Malaysian sovereign wealth fund to individuals in the government. The Singapore Monetary Authority (which counts as the island state's central bank) shut down the Falcon Private Bank in Singapore while imposing a fine on its Swiss parent. The managing director of Falcon in Singapore was jailed. This was reported by today's Neue Zuercher Zeitung.


Wells Fargo is not alone. Nor are problems confined to the banking sector:


My son the chartered financial analyst is raising cash levels in managed client accounts because of “nervousness about valuations, interest rates globally, corporate financial engineering, and dearth of real revenue or profit growth.” To say nothing of attacks, so far mostly verbal, on the US military from The Philippines, Russia, and Afghanistan, and at the USS Mason in international Red Sea waters with missiles fired by rebel Houthis from Yemen.


More for paid subscribers follows from Britain, South Africa, South Korea, Spain, Canada, Denmark, Mexico, Brazil, and—a first—Croatia. No blog tomorrow as it is the real Yom Kippur!

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