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Vivian Lewis is editor and founder of Global-Investing.com, the daily blog newsletter for Americans and others seeking to internationalize their portfolios. She brings unique experience and competence to the business of picking foreign stocks.
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Welcome to the Real World
Felix Goltz PhD and Véronique Le Sourd published a ground-breaking study for EDHEC-Risk Institute now in English questioning whether finance theory supports capitalization-weighted indexing. EDHEC is in Nice, France. The study concludes:
Proponents of cap-weighted stock market indices (or indexes) argue that only they provide efficient risk/return portfolios. But in fact only under very unrealistic assumptions could such indices be efficient investments. With realistic constraints and frictions, cap-weighted indices cannot be efficient investments as supposed under financial theory.
This undermines the literature supporting the Sharpe ratio which holds that a portfolio made up of all existing risky assets, weighted by their market capitalisation, named the market portfolio, offers an efficient risk/return tradeoff. Here is part of the study: the Capital Asset Pricing Model assumes
that no other combination of risky assets makes it possible to obtain a better return for the same degree of risk, or a lower risk for the same expected return. Portfolios divided into a market portfolio and a risk-free asset (two-fund separation theorem) often rely on the Capital Asset Pricing Model which tells them to use indexes weighted by capitalization to manage risk.
Like many theories, the CAPM relies on assumptions that seek to simplify reality and thus that do not resemble real market conditions. In addition, indexation could not use the true market portfolio. Indeed, this portfolio is not observable, since it would have to include traded assets (stocks, bonds, and so on), as well as non-traded assets (human capital) or illiquid assets (real estate).
Investment managers use cap-weighted stock market indices as a proxy for the market portfolio. The objective of this paper was thus to answer two questions. Is the market portfolio still efficient if one of the assumptions on which the model relied does not bear out? Can a market index serve as a valid proxy for the market portfolio?
The authors concluded that as CAPM assumptions no longer hold, financial theory does not predict that a cap-weighted market portfolio will be efficient. It assumes that investors have identical preferences and that they all have the same investment horizons. It also assumes unlimited borrowing, tradability of all existing assets, and no taxes or transaction costs.
Investors are unlikely to have the same preferences and the same investment horizons. In addition, the existence of taxes and transaction costs is quite real. Nor is unlimited borrowing feasible for most investors.
The second key point was to establish whether an index could serve as a good proxy for the market portfolio. According to the CAPM, only the market portfolio is efficient. Stock market indices appear to be very poor proxies for the market portfolio. The true market portfolio is assumed to contain a vast collection of assets, including unlisted and illiquid assets; stock market indices include only a small fraction of listed assets. Thus, the many empirical studies done to test the CAPM have attempted to come up with reasonable proxies for the market portfolio, including not only many more stocks than [are in] indices, but also bonds, real estate, and non-tradable assets such as human capital.
Stock market indices are far from being the market. Even if it were possible to build and hold the market portfolio that includes all assets, the market portfolio would be efficient only if a set of highly unrealistic assumptions held. And not even under more realistic assumptions does financial theory necessarily conclude that the market portfolio is efficient. In view of these arguments, it seems that financial theory alone does not justify the current practice of using cap-weighting indices.
Welcome to the real world.
Writes Maurice, a reader from Vancouver BC, Canada:
It looks like you are getting some over-the-top emails about stimulus. Here's my two cents worth. There is no doubt that having contributed to the financial crisis the Bush Administration had no choice but to do the TARP although it seemed they were making it up as they went along.
The current administration has sensibly followed through and the US banks look a whole lot better now after the actions taken last year. Where I think they have screwed up is their stimulus which has been hugely wasteful. I agree that extending unemployment payments was a good idea - particularly as so many people lost their jobs simply because of a massive loss of confidence caused by this crisis. In many ways, this was the corollary of the TARP -but for Main Street.
The problem, however, is that most countries have created temporary stimuli and that means every one worries about the exit strategy - so confidence is likely to be impaired as people hold back in anticipation of the tap being turned off.
As a result, stimulus should be aimed at creating stable, reliable, and permanent conditions such that industry or commerce has the confidence and incentive to expand. The one plus of the recent UK budget is a cut in corporate tax rates, but increase in VAT is a (regressive) negative.
In Canada, the minority government felt impelled to spend money to prevent a vote of confidence (their initial reaction was to do nothing), but then proceeded to spend the stimulus in Tory constituencies. Thankfully they also introduced corporate tax cuts. Canada will probably have lowest rates in the G7 by 2012. Furthermore and Ontario and BC have just introduced a VAT (or harmonised sales tax, HST), replacing existing provincial sales taxes and combining them with federal sales tax. The result should cut the cost of capital for businesses which previously could not offset provincial taxes (paid at 7%) against output PST (what they pay against what they charge). The hope is that investment will increase. Such measures are more likely to stimulate permanent economic improvements.
There may be shovel ready infrastructure projects that will improve the economy, but the problem is that politicians cannot resist introducing distortions, sometimes with the best of intentions, but most of the time without them.
The Tory spending in Canada is a bad example of this but so is the fiasco of the stimulus spending in Australia on new schools and home insulation which has turned out to be hugely wasteful and one of the key reasons Kevin Rudd's popularity fell.
Any government which fears that it must continue to spend to keep the economy afloat will end up with the Japanese problem, spending on projects no one needed, helping keep defunct construction and property companies alive. This stimulus also pleased rural constituencies dominated by the ruling party.
Here in Canada, the money allocated to infrastructure has to be spent this year - so local councils are rushing to spend - but of course next year there will be nothing to spend and what impact will that have?
Vivian adds: the big problem I have with stimulus measures is that the Obama Administration has signally failed to explain its plans to the public, over healthcare, over the stimulus, over the pending financial reforms, or even over the need to continue to pay unemployment benefits to the victims of the crisis. That has left the door open to brutal politicking. Obama has “a bully pulpit” but he has failed to use it to win popular support, unlike Theodore Roosevelt, a progressive Republican who coined the term.
More from Asian markets, India, Poland, Switzerland, Britain, Brazil, Portugal, Spain, Australia, and even Nevada for paid subscribers follows:
Independence Day
Gold bug alert. Here is ValuEngine's Richard Suttmeier's take on the yellow metal:
Being long gold was another popular strategy, but I warned that the high of $1266.5 in June was a failed test of monthly resistance. Quarterly support is $1140.9 with my semiannual pivot at $1218.7, and semiannual, weekly and monthly resistances at $1260.8, $1275.9 and $1279.3. Gold closed below its 21-day and 50-day simple moving averages at $1235 and $1212.1 on Thursday.
I warned that gold was peaky two weeks ago here and in a broadcast for Hedge Fund Radio (with John Thomas).
Because it is published by Covestor, I can also share with you my most recent trading history in the Interactive Brokerage account. On Monday I bought a couple of hundred shares of Portugal Telecom at $10/sh paying as well one whole dollar in commission. Yesterday, prematurely of course, I sold them at $10.57/sh again paying that buck to IB. The return for 4 days was 5.6% net of commission. Any naïve reader who wants to annualize this can work out that it comes to 51%.
My other trades are not public and will be summarized for paid subscribers only.
Over PT's extraordinary shareholder meeting on the 30th, the Lisbon government intervened to prevent a sale of Brazilian assets to the Spanish telco, Telefonica. It used its 'golden share' issued at PT's privatization. Golden shares were used by Maggie Thatcher to ease British privatizations although she was not an advocate of state controls over the economy. They were used also in France, Holland, Spain and Portugal for the same purpose by governments of the right and the left. BP, the villain in the Gulf of Mexico, once had such shares too.
Here is a first reader note which I think is important as we go into the Independence Day weekend:
"Americans are not investing directly in foreign markets. They are sucked into US institutions to do so. If an American has more than $10k aggregate held in offshore financial accounts (banks, brokers, etc.) he is required by law to report this to the US Treasury on a form separate from and in addition to checking the box on his IRS return. This terrifies people because they know that after filing this form with the Treasury they are automatically added to a list of “people of interest” who need to be watched. I am convinced this is the primary reason Americans keep their money in US institutions and, of course, is exactly why the government requires this reporting. The system is totally unfair. It’s as if Americans must stay in a designated turf – or else! Big Brother is in total control."
I think this reader, PS, has a point.
I am being lambasted by two other readers for supporting the current US Administration. So I will note that political pressure on corporations is normal not just in the USA, but globally. Politics is part of markets and cannot be left out; hence Pres. Obama's talk about “kicking ass” over BP. Or Portuguese Prime Minister Socrates' intervention against Spain's ambitions in Brazil.
The way to control political intervention is not by voting for right-wing parties (because politicking occurs with them too.) The solution is for courts to limit violations of shareholder rights by the executive or the legislature. The European Court of Justice and the EU competition authorities are taking up the cudgels against the Socratic intervention, but because it will be a slow process, I opted to take my profits (and those of my copycat followers).
Frida Ghitis and I wrote yesterday about another case in everyone's favorite Alpine democracy. Swiss courts are also having to intervene to protect shareholders following an unfair share deal between Nestle and Novartis involving a US listed company.
Now for the other mail, from reader LK, whom I do not agree with:
To be quite clear: this Administration is the worst in history. Obama – which many are beginning to call “Zero” has the least experience in running anything – he never ran a business, never had a substantive job, and, his advisors have the least experience in running anything of any administration as well (I have the figures if you need to see them to attempt to dispute them). The one good thing is: it is causing people across America to wake up and begin to rise up against this lunacy. My suggestion: don’t mention Zero anymore… it is not an advantage to you and doesn’t do you any credit any longer. It causes people to lose confidence in your decisions – all of them – because support of his policies lacks wisdom.
I hope you too begin to gain some revelation of the direction in which this country is heading with Zero at the helm along with his corrupt entourage. Bribery, payoff, lies and deception have become the name of the game out of Washington, but, I believe (thank goodness) that the people of this nation are started to say, “No way – no longer.” Your Dems are going to be thrown out where they belong – on the street. Perhaps then they will take a good look at themselves and see what a bad – disgusting example they’ve been to us all.
There will be no newsletter Monday because of the holiday. News below about Switzerland, Greece, China, India, Britain, France, Belgium, Italy, and The Netherlands. Read more »
Deficits and Death Cross
Instead of continuing to fight with reader over my taste for expansionary fiscal and monetary policy, I will quote John Thomas, writer of The Diary of the Mad Hedge Fund Trader. He is a former colleague of mine from The Economist and recently interviewed me on his radio program, but don't hold that against him. John writes first about a chart he reproduced above from Clusterstock, which I am too hamfisted to insert here. It is a PDF file. John writes:
Out of a current projected budget deficit of $1.3 trillion, $700 billion, or 54% comes from the Bush era tax cuts, $320 billion (25%) from a tax revenue fall off caused by the Great Recession, $200 billion from the wars in Iran and Iraq (15%), and $50 billion (4%) is generated by Obama's recovery measures. The TARP and the bailout of Fannie Mae and Freddie Mac are so small, they don't even register on the chart. All of the angst, complaining, moaning, blustering, and carping is about the 4%. You often see this in politics, where the debate gets focused on where the problem isn't, not where it is, and is a big reason why I'm not in that business. Markets have a fascinating way of seeing straight though this impenetrable fog.
He adds:
So while the noise out of Washington is trying to convince us that these deficits are ruinous, the ten year Treasury bond yields we saw yesterday at a stunning 2.97% are telling us that, in fact, they are no problem at all, and that the government can now borrow nearly infinite amounts of money at the lowest interest rates in history. There are some other really interesting things that this chart and the bond market are telling us. The Bush tax cuts expire next year, and a recovering economy will bring a return of tax revenues, eliminating 79% of the deficit. The scheduled withdrawal from Iraq next year will cut another 7%. This assumes that Obama is unable to get a single additional piece of legislation through the congress, a distinct possibility if he loses control of congress in November. This is the writing on the wall the bond market is attempting to focus our blinkered eyes on. If anyone else has another set of believable numbers that reaches a different conclusion, I am all ears.
Vivian adds: According to CNN News, Federal spending, about 25% of GNP this year, is to drop by 2013 to about 23%. Under Ronald Reagan, in 1983 it was 23.5%. Moreover 60% of what the Federal budget is spent for is Social Security and Medicare, defense, and interest on debt. Interest cannot be cut; it involves the full faith and credit of the USA. Defense costs $700 bn and probably is also uncuttable. That leaves insurance. The main reason Medicare and Social Security cost so much is that people are living longer.
One argument for a comprehensive national health program is to better integrate care of the old into the system as a whole. But having overpaid for healtcare protection most of my working life as a freelance journalist and a self-employed businesswoman, I cracked a bottle of Cava when I finally qualified for Medicare at 65. (For some reason you get Medicare at 65 even if you cannot retire until you are older. )
The rest of the US budget has jumped from about 7% of GDP before the great contraction to 10% now. But it jas been in the 6- 9% range for decades and is forecast to fall to about 8% again in a few years.
Yesterday, Federal Reserve Bank of Atlanta Prexy Dennis Lockhart said US economic recovery isn't yet sustainable enough to allow interest rates to be raised or the Fed's balance sheet to be shurnk. This apparently triggered a 3pm market plunge which was all that window-dressing month-end outfits needed to get selling.
Note that Tom McClellan of the McClellan Market Report (and the McClellan Oscillator) says of the Death Cross we reported yesterday: “the crossing of the 50-day MA below the 200-day MA has about as many whipsaws as good signals”.Tom is cautiously bullish based on his proprietary charts comparing the present selloff to that of August 1998 and the boost in lumber prices.
More for paid subscribers from Switzerland, Brazil, Israel, Britain, India. Italy, Spain, and Portugal.
Red Rooster Falters
We've had (according to Barry Ritholz) what technicials call a death cross. This tech specialists think means more trouble. There was not much here or in Europe to justify the fall. Sure the bank reform bill is in trouble. And consumer confidence is lagging.
But China had the real bad news. Shanghai fell on revised numbers for GNP growth from the Conference Board . That body corrected a leading index of Chinese growth of 1.7% calculated in April right down to a mere 0.3% now.
But in fact the Chinese market had slumping before this. The bears then escaped all over Asia, and hurriedly released their fellows in Europe and later in the US, where there was nothing particularly awful happening.
But if the Red Rooster is not a strong enough locomotive to pull the world economy out of its malaise, we are in trouble. Instead of watching the stock market sink I attended an alternative energy conference.
A new fund that may be of interest came out from Bank of New York-Mellon's Dreyfun Corp. whose chief economist I have been quoting lately. Dreyfus Global Real Return Fund will invest globally in pursuit of absolute return. It will be managed by Newton Capital Mgm Ltd, a London boutique which already manages similar multi-asset absolute return funds for non-US investors. Newton is known for its thematic investment approach seeking total return (both capital appreciation and income) using a multi-asset strategy to get real returns with less volatility. The aim is to work over a market cycle (typically 5 years.) It does not use benchmarks or indexes and the goal is to get returns that do not depend on the movement of markets (or beta.) . Jeams Harries is the primary portfolio manager at Newton.
Meanwhile investors in Invesco Powershares ETFs discovered today that its managers have shifted indexes for their funds which keep the same ticker symbols. You no longer own what you thought you bought with this ETF family.
A trio of global funds are affected. Power Shares Autonomic Growth (PTO) will track Ibbotson Alternative Completion IndexTM in place of a New Frontier index; PowerShares Autonomic Balanced Growth (PAO) will drop New Frontier for RiverFront Tactical Balanced Growth Portfolio, and PowerShares Growth and Income (PCA) will drop New Frontier for a different RiverFront Index. Also affected are two Power Shars US portfolios linked to Value Line Timeliness and Rotation which are being linked to Morningstar indexes instead.
The renewable conference lobbied for the US to extend or replace cleaner energy programs which were part of the stimulus bills. They are slated to sink into the sunset by the end of 2010 unless what one delegate called “the Pearl Harbor” impact of the BP Deepwater Horizon gets Washington to change tack.
The American Council On Renewable Energy and the US Partnership for Renewable Energy Finance worried about potential deceleration and loss of jobs as green for green runs out. To say nothing of money for their members. In a joint press conference they called for extension of 1603 Renewable Energy Treasury Grants (AKA Grants in Lieu of Investment Tax Credit) to run out at the end of this year at a time of continued financial crisis and capital scarcity. Conferees, many of them lawyers and financial pros, clamoured for the1603 cash grants program to be renewed and for other loan guarantees and manufacturing incentives. Continued uncertainty and disorder in the US tax equity and credit markets are constraining financing for solar, wind, and other renewables, they say.
If BP is the best argument for money, the worst was the presence of so many foreign investors coming to feed at the trough: engineers, banks, utes, manufcturers of solar and wind equipment, pernsion plans. Even a Spanish Caixa turned up, from Madrid, presumably not in distress and about to be merged into the super-Caixa.
Antonio Garcia Mendez, CFA, of Santander Investment Securities (a US firm), cited the zeal shown by Europe's “government-intervened banks” for more environmental deals. I had assumed European renewables would find funding hard to get now but he claims “inactive banks are active again” in Europe, and that liquidity, down in 2009, is on the rise along with “a higher risk appetite.” Against that, he noted that despite a strong pipeline of deals, “there are regulatory uncertainties in Spain and Italy.” To say nothing of the US.
Another European, the British-educated German, Gisela Kroess (of UniCredit, an Italian bank) warned that European banks face higher funding costs because of what she called “the Greek crisis” and the resulting lower euro. She thinks the time has come for longer-tenure financing involving mixes of loans, grants and equity. She wants to see a standardized system of funding and protection (maybe called collaterized debt obligations?)
She noted that so far this year there have been 10 US deals with a total funding of $3.4 bn in the USA vs 20 deals with a total funding of only $4.3 bn last year. (Of course this may only be because the funding will soon run out.)
Your editor was interested in how other countries encourage renewables without direct grants. Canada and many Euro countries make local utilities contract long-term to buy green energy and fold it into electricity sold, at a fixed price higher than non-renewables get. Sometimes utes finance the green plant. According to Daniel Soper, CFO of Carbonfree Technology (of Toronto) such pass-through pricing has less impact for example on German retail electricity prices than the bill for upgrading transmission sytems. So it can slip into your electric bill without your noticing.
But he warned that a weak economy makes it harder to contract for passthrough rate payment for renewables because politicians fear supporting it. A tax is a tax when it is contracted for even if it later is hidden.
The industry is frustrated mainly by lack of volume. Canada for example produces zero mW of solar vs 400mW or so in the USA, said Soper. The price of clean rooms and solar panels and cells has fallen sharply as the silicon industry finally woke up to new opportunities from solar. But solar prices are still too high for unaided investment.
Another thought: Consumers could cut their household electricity use by 2-12% and save up to $35 bn over the next 20 years if U.S.utes use smart meters and a range of energy-use feedback tools to educate us to use less energy.This according the nonprofit American Council for an Energy-Efficient Economy .We need at-home or on-line displays to inform and motivate us to cut down on juice consumptiom. ACEEE likes enhanced billing daily or weekly feedback,on- or off-line. But these programs are rare with no US ute providing the full gamut. Most have barely learned about smart meters.
Matters of subsidy and taxation are complicated in the main thing to take away from the above. Simplistic rants against government programs or taxes make no sense. In a period of shrinking investment somebody has to take the initative and right now the designated driver is government.
Stay the course. This is buy time not sell time. News of our companies follows from Israel, Britain, Canada, Spain, Portugal, France, Belgium, and Brazil.
Meeting the Challange
From Adam Carr of ICAP, the Australian brokerage, some views on where monetary policy is going:
"The Bank of International Settlements always seems to know what's what. While the G20 meeting may have yielded a flimsy 'do as you wish', there was no confusion from the BIS. The Bank is worried about a new crisis developing, but the rhetoric is far from what we've become used to. In contrast, the BIS are more worried about heading to the exit too late, which as regular readers know, is my concern also.
"The BIS acknowledged the difficulty policy makers had, especially as the banking system was fragile in some cases. 'But the longer that policy rates in the major advanced economies remain low, the larger will be the distortions they create, both domestically and internationally.' The BIS argued that extremely low real rates altered investment decisions, postponed the recognition of losses, increased risk-taking in the search for yield and encouraged high levels of borrowing. There was also the problem that central bankers would underestimate inflation risks given the crisis may have lowered potential growth rates.
"The UK illustrates this view perfectly. Rates are historically low, the economy is recovering, the land registry is reporting house price growth of 8.2%y/y to May (consistent with other house price measures) and inflation is well above target. All the while the governor of the Bank of England insists there is no problem."
The US is not in the same situation on inflation and house prices. Challenged by a reader on what I would want to see from the Obama Administration now I made a little list, which he called “Porkulus Spending”. TM thinsk any measures would increase the size and reach of governmetn and add new bureaucrats and new regulations which would hamper future economic growth.
This is a challenge, But the US is not in the same boat over inflation and housing prices as Britain. Challenged by a reader to tell what I want the Obama Administration to do, I created a list, which TM thinks is nothing but "porkulus spending. Any measures he fears will add to the size and reach of governments and add new bureaucracy and regulations that hamper future economic growth prospects. But I do not agree.
I think our country is in a crisis because of a lack of liquidity and a lack of what Lord Keynes called “animal spirits” leading to extremely risk-averse investment in no-yielt Treasury bills and keeping corporate cash undewr the mattress rather than investing it. Because there is no way for the consumer to take up the cudgels and invest in this climate, because of American household's probems with underwater housing mortgages and unemployment, I want the government to act, preferably in ways that stimulate employment, and require the private sector to join in.
The cheap funds are there. I did not create the lack of animal spirits in the bond market or the unwillingness of corporate America to spend the money it has rather than hiding it under a mattress. household oversaving is the likeliest to stop when my proposals are in place but they will also encourage capex by gun-shy corporate America.
Just for the heck of it, here is my list which I think will put people to work and pay them.
We can borrow to invest in the future of America. for my 5 grandkids without burdening them with debt. Here's how:
We extend unemployment insurance payouts so people can continue to eat while they look for work.We get businesses to come on board with training programs and internships or apprenticeships.
We figure out a way to refinance home loans. I am far too stupid to know how but I do not like families living on the street.
We improve education by cutting down the vacations and extending the school day. Teachers then can continue to get the high pay they collect regardless and produce something in return.
We don't stop healthcare reform with the first incomplete round and try to avoid taxing elderly Medicare folks at the highest incremental tax rate in the USA.
We invest the borrowed money to replace bridges which are falling down and build toll roads. These will pay for themselves with tolls but meanwhile will put unemployed Las Vegas condo construction workers to work building them. WPA for today.
We beam everyone up to the internet. We reopen closed libraries and offer web access and e-books..I hear America learning.
We build a high-speed railway running from LA to San Francisco (and maybe further north to TM's area). Another line down the Florida coast to Key West. Maybe even one from NYC to Boston or Washington DC or both. Again we charge fares to repay. And meanwhile people get jobs doing useful things for th country.
We restore breakfasts in school for hungry children so they can learn without their grumbling stomachs getting all their attention. Corporate America can help.
We resume bus service to take people from poor neighborhoods to their jobs, get kids to school without mama-chauffeurs, and get old codgers out of the house. The auto industry can build the buses.
We build nuclear power plants and wind and solar plants. Maybe even hydroelectric dams.
We finish the job in Afghanistan.
We finance the SEC and the new bank lending overseers properly.
We start out by doing a real investigation of the Flash Crash to figure out what happened, what the role of arbitrageurs and electronic was. (That's the one for us.)
The government is no bigger today than under Ronald Reagan as a part of GNP. US debt is falling without any need for rigorous cutbacks in spending.
The goal is not to grow the government or its reach. the goal is to gorw the economy. Rright now relying on private spending is not working. the cost of borrowing money for even sound and stable companies is way too high. firms which have cash are not spending it out of funk and fear. We have to let the government act as the counter-cyclical force because there ain't no other. It would be better if there was capex and a functioning bond market. There isn't one. so I am crying uncle (or Uncle Sam) .
The cheap funds are there. I did not create the lack of animal spirits in the bond market or the unwillingness of corporate America to spend the money it has rather than hiding it under a mattress. household oversaving is the likeliest to stop when my proposals are in place but they will also encourage capex by gun-shy corporate America.
More for paid subscribers from India, Australia, Singapore, Britian, Israel, and Switzerland.
Tip from the Bond Market (version 2)
The first version of this blog was posted 3 hours ago but did not take. Here we go again.
Today Bloomberg wrote:
“The percentage of corporate bonds considered in distress is at the highest in six months, a sign that debt investors expect the economy to slow and defaults to rise.
“The number of speculative-grade companies worldwide with yields at least 10 percentage points more than government bonds climbed to 399 this month, or 16.7% of the total, the highest share since Dec., according to Bank of America Merrill Lynch index data. The ratio compares with 9.2% on April 30, which was the lowest since Nov. 2007.”
This move into Treasuries and foreign equivalents marks market panic. The first thing it tells us is that the government should use the cheap funding it can get to relaunch the economy because the private sector is being ovrcharged for money. If lenders are frightened of inflation, they wouldn't lend to Uncle any more than to Bank of America or Goldman Sachs, which have to pay a spread of 257-8 basis points over Treasury bonds for 2020 maturities.
The other lesson is for investors. After hesitation for fear of margin calls, I'm taking full advantage of the leverage provided by the Interactive Brokerage account to borrow at 1.28% for my portfolio of non-US corporate and convertible debt, and foreign real estate and emerging market debt, yielding around 8%. So with care, I've added to positions and now have 35% more invested than I started out with. I am being opportunistic using investment vehicles like funds, ETFs, and high yielding foreign common or preferred stocks. While I am still in a defensive mode, I think I am being less risk-averse as the bond market correction proceeds.
Since govt bond yields are so low, it is hard to argue that it is “crowding out” the private sector. What we are seeing is a collapse in confidence that corporations will continue to earn more money and repay their debts. These are Wall St.'s upscale finance finest. Morgan Stanley pays even more;2.96% extra, but only to 2015; JPMorgan-Chase pays only 1.51 over 2020 T-bonds. All bond data from today's Barron's.)
Moreover those corporations which do have cash to hand are hoarding it. The US Association for Financial Professionals did a survey in May which shows that corporate execurives plan to expand their cash holdigns over the next 6 months rather than spending it, according to today's Financial Times.
Another anomoly is that foreign non-finance sector borrowers, with the exception of houndogs like BP, are not having to pay anywhere as much as the giant sucking squid, again according to Barron's.
Borrow more to gain more yield.As determined by the Ottawa Summit, U.S. fiscal and monetary tightening will come, in 2013. That is something like St. Augustine writing in his Confesisons: “Make me chaste, O Lord, but not yet.”
The Fed has won world permission to keep rates down for the foreseeable future. That is what they want to do anyway, Ben Bernanke, NY Fed Pres. William Dudley, and maybe the future vice-chairman Janet Yellen, all of whom combine a Keynesian taste for countercyclical moves with a Friedmanite understanding of the errors of the 1930s. They will take their time tightening in a period of low growth and low inflation according to Richard Hoey, chief economist of BNY-Mellon and The Dreyfus Funds.
He argues that any long-term structural risks like a future fiscal train wreck will not hit until 2013. The cyclical conditions would have to be the exact opposite of those prevaliling today. You would need to see high and rising inflation, restrictive (rather than expansionary) official monetary policy, and Treasury auctions being crowded out by strong croporate credit demand. Such factors may arise in 2014-6 but they do not exist today.
If you insist on buying low yield Treasury bonds, buy ones which are inflation protected due in 5 years or more.
The “union” trend affecting Chinese east coast factories producing for export with disputes over higher wages and better working conditions reflects a labor shortage. The workers come from the inland provinces which are shorthanded, an unintended consequence of the one-child policy imposed on China three decades ago. While China is not supposed to run out of young workers for another decade according to the tables, in fact the shortage is already emboldening dorm-hoursed workers making parts for Japanese and Taiwanese global manufacturers. One solution is for Chinese plants to open inland nearer to the home villages of young people with less gumption and get-up-and-go, who are less likely to down tools and walk out. Another solution is to find an alternative to China.
It may be months before the impact on commodity prices of slowing Chinese exports hits. But since much of the raw materials China imports are re-exported in the form of semi-finished goods or parts, the higher labor costs renminbi will cut imports as well as exports. This will reduce the appeal of commodity companies and currencies. Adjustments will be made in the portfolios during the summer to get ready for risign Chinese prices.
We have the first of a two part series on a country likely to replace some of China's production in today's paid blog. We also will think about how the new China will import less from Japan.
My apologies for leaving out a decimal point in Friday's blog note about the huge gold coin sale in Vienna. It was bought for the exact equivalent of its gold content, one third below the auctioneers' estimates, not 30% below.
More for paid subscribers from Scotland, Spain, Portugal, South Korea, Canada, Israel and Thailand follows. Join them by signing up on our website to receive stock information as well as macroeconomic ideas.
Gold Auction Disappointment
The world's largest gold coin sold for $4.02 mn in Vienna at the venerable Dorotheum auction house. This was significantly below the pre-sale estimate of $4.90 mn for the auto-wheel-sized Maple Leaf monster coin showing Queen Elizabeth II, worth C$1 mn (face value) minted in 2007 before the gold price rose, and bought by an Austrian financier who was jailed for fraud and embezzlement. It also sold for less than the current price of the gold in it.
Chartist Richard Suttmeier writes in Valuengine on gold:
“The daily chart shows declining MOJO and Monday’s all time high of $1266.5 was a failed test of my monthly resistance at $1265.9. The 21-day and 50-day simple moving averages provide key supports at $1230.4 and $1202.9.”
Amidst all the news about the Supremes overruling the law which makes it a crime to fail to provide “honest services” in managing a company, another bit of jurisprudence may not be noticed. Read more »
Trading Alert
A trading alert for paid subscribers follows.
No Free Lunch; No Free ETFs
There is no such thing as a free lunch. Or free trading in exchange-traded funds. Commission-free ETF trading, the hot new way to invest, is now offered by Schwab, Fidelity, and Vanguard which have lured in billions of dollars worth of business. Other brokers like E-trade, Scottrade and T-D Ameritrade may follow suit.
ETFs are supposed to highly liquid, and are allegedly the favorite investment vehicle of day traders and small players.
But in fact the trades are not free. The ETF management groups in fact pay for trading activity. That means, in fact, that others holding the ETF incur the costs of rapid trading of these funds. But there is more.
And rapid-fire trigger happy trading of ETFs without having to pay commissions hurts markets.
As is by now well known, in the May 6 “flash crash”, when the Dow Jones fell 100 points in a few minutes after 2:30 pm close to 10%, the world of ETFs was more seriously affected. Over 68% if the trades “busted” by Nasdaq involved ETFs, starting with the biggest ETF of all, SPDR S&P 500, SPY. The situation was similar on the NYSE where 64% of the busted trades involved ETFs or Exchangte-traded notes, their close relatives These are called “questionable” or “spurious” trades but they were perfectly ordinary at the time they were booked. The only way to decide which trades are busted is linked to the amount the price fell during the crash.
So the integrity of markets is also subject to question. There is more. Thomas Petterffy, the head of Interactive Brokers, which offers $1 commissions on all trades. has testified that ETFs were the cause of the May 6 crash, not just a symptom.
And, while I cannot prove it, I think that the extreme volatility we have seen in US markets in recent weeks is linked to shot-gun ETF trading, usually in the final hour of the market day. With ever more variations of ETFs like ETNs, which also were mispriced during the May crisis, and leveraged and inverse ETFs, the risks ae higher. So too with managed ETFs which are less transpartent. Ditto for small cap ETFs, or ones investing in the bond market. The rush to replicate all the variations which exist in the closed-end and open-end fund space increases the ETF risk to the integrity of markets. Brokers (like IB) allow you to use margin to trade options on ETFs and ETNs. So the risks are even greater which is why the FINRA has been implementing new rules on margin for ETFs.
But that is only a first step.
More news from our companies follows a first batch showing how hard it is to deal with global corporate news from funndy countries like Spain, Portugal, France, Brazil, and India, as well as news from Israel and Britain and South Korea.
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