Productivity increased in the first quarter (see Investment News article). It could be argued that the higher number was due in part to companies needing to get the job done with less employees and less hours worked after massive layoffs, but it does signal that companies are becoming more efficient, just at a time when labor costs are down - given the lower head counts. Therefore, while the numbers are not encouraging for employees since hours worked have also decreased, a jobless recovery could result in higher productivity, lower wage growth, and smaller labor costs for companies, helping to stimulate corporate profits going forward. While employment and wage growth will eventually need to increase to bolster consumer spending and further economic growth, productivity-based higher corporate earnings may be enough to help drive a summer rally for select stocks, or at least explain the recent rally over the last few months.

According to the recent TIM (Trade Ideas Monitor) report, over the last five trading days, institutional brokers are continuing to becoming more bearish (see note below, previous post, or the youDevise website for additional information on the TIM report). For the five trading days ending June 4, the number of short ideas as a percentage of new ideas sent to investment managers increased 41.35%, compared to 35.88% just a week ago. The TIM reflects which direction brokers are expecting a stock to move over the next 1-3 weeks. The TIM Long-Short Index, measuring the total number of long ideas compared to the total number of short ideas sent to clients, decreased 35.4%, further highlighting negativity and bearishness from brokers. As for individual securities, Palm (PALM), Freeport McMoran (FCX), and Petroleo Brasileiro (PBR) were the stocks most recommended as shorts by institutional brokers.

Note: The Trade Idea Monitor (TIM) is an application for measuring "ideas from authors (mainly brokers) to recipients (mainly buy-side clients)" (see youDevise website). It is used by institutional brokers to send long and short equity and ETF trade ideas to clients. The TIM Report is based on the number of real-time equity trading ideas sent to over 4,300 equity sales people, sales traders, and analysts at over 300 institutional brokerage firms to more than 100 hedge funds, quant funds, and investment managers.

In the CNBC video below, Bill McIntosh, editor of the Hedge Fund Journal, outlines the state of the hedge fund industry, with a focus on those strategies that have been doing well since the market correction last year. Equity-based strategies, arbitrage, and long-only emerging markets have been doing the best (see Hedge Funds Review article for more on emerging market funds). Not surprising, funds investing in banking and energy stock have been doing well. Defensive funds have underperformed, even though they have at least been able to preserve capital as advertised. The increased optimism is also causing most hedge funds to remove gates and lockups that were put in place late last year.

Source: CNBC Video

As reported at both Reuters (see article) and Bloomberg (see article), and discussed in a previous post, redemption request have decreased, and there is an expectation that investors will add $50 billion into hedge funds this year in an effort to catch the current wave, and hopefully recoup some losses suffered last year. Whether this is a bullish or contrarian indicator remains to be seen. Given the recent market moves, along with inflation and debt worries (see previous post), there are concerns of near term bearishness (see previous post). Yet, if "panic buying" starts occurring from the nearly $3.8 trillion currently sitting in retail and institutional money market funds (see Huffington Post article), a nice summer rally may still be in the cards.

As for the hedges, it will be interesting to see if the smaller funds can regain their out-performance status over larger funds, after falling behind last year (see Hedge Funds Review article). Even with their flexibility, this may be difficult given the trend for skittish investors to now require a track record of accomplishments, which is sometimes easier for the larger funds to provide (see Financial Times article). Of course, if the market continues to rally, greed may starting winning out over fear of loss (possibly replaced by the fear of missing out), regardless of the managers style or size.

While General Motors bondholders are still angry over what they, and many others feel is unfair treatment, those holding other bonds are beginning to think about how they are going to price in what is being labeled as a new level of risk - which could be called the "shared sacrifice" risk (see Bloomberg article). As mentioned in the article, "Bondholders are told to give up legal rights, and cash, as part of a government-mandated tradeoff that favors a politically connected special-interest group." This has some worried that such an undermining of long-standing legal agreements could extend beyond the corporate world, where a new precedent seems to have been set. Those holding equity should also be worried, as raising capital through debt offerings will get more expensive. As mentioned recently by David Einhorn, it is a “quixotic idea ... that creditor recoveries in troubled situations can be determined by an arbitrary sense of shared sacrifice rather than legal agreements and long- established prior practice." Could Treasuries and Municipal debt be next? Would problems with covering local payrolls for city employees such as firefighters and police cause political leaders to ask municipal bondholders to share in the sacrifice? Outcomes such as these, which seemed unlikely to bond holders just 12 months ago, have some considering various new risk factors when pricing bonds. Now the size of the workforce, the level of unionization, and political importance (swing state, home district of a powerful chairperson) are all being consider with greater interest. And you though determining credit risk was hard before. Just wait until a new CDS-like derivative starts to be offered to help manage such risk.

Institutional brokers are becoming more bearish on equities over the last five trading days according to the Trade Ideas Monitor (TIM, see Hedge Funds Review article). The TIM is an application for measuring "ideas from authors (mainly brokers) to recipients (mainly buy-side clients)." (see youDevise website). Short ideas as a percentage of all new ideas sent to investment managers through TIM increased from 28.55 percent to 35.88 percent over the last five days. During the same five day period, the TIM Long-Short Index decreased 28.6% from 2.50 to 1.79, signaling more negativity on the market as a lower index reading implies that brokers are more bearish. The TIM Long-Short index measures the total number of long ideas sent to clients, compared to the total number of short ideas, with the ideas focused on market moves covering on average the next 1-3 weeks. This seems to correlate with some of the recent sentiment from technical analysts who predict that the markets may experience a short-term sell-off as they consolidate around key technical levels, even though the upward trend still appears to be in place.

The gap in yield between the 10-year TIP (Treasury inflation-protected security) and the regular 10-year Treasury surpassed two percentage points, as investors begin to price in expectations of inflation (see WSJ article). This comes on the day that Federal Reserve Chairman Bernanke warns of how longer-term deficits are threatening the financial stability of the U.S., as yields on longer-term Treasuries and fixed-rate mortgages rise (see Bloomberg article).

U.S. 10-Year Treasury

iShares Barclays TIPS Bond Fund

In an effort to take advantage of increased investor interest in Treasuries, Pimco (Pacific Investment Management Company) is launching its first ETF, the Pimco 1-3 Year U.S. Treasury Index Fund (ticker TUZ, see MarketWatch article). The current Pimco ETF was developed for investors with a focus on maintaining stable principle with little or no credit risk. The new ETF is one of approximately 65 fixed-income exchange traded funds listed in the U.S., a small number compared to the much larger equity ETF universe. In addition to the new ETF, Pimco filed prospectuses with the SEC for six additional ETFs. Three of the new ETF will cover the 3-7 year, 7-15 year, and 15+ year Treasuries. The remaining three will be tied to the U.S. TIPS, including a general TIPS Index Fund, a short maturity U.S. TIPS Index Fund, and a long maturity TIPS Index Fund. The Pimco TIPS funds are expected to compete with the iShares Barclays TIPS Bond Fund (ticker TIP, see chart above). Such products will give investors betting on hyperinflation, such as Nassim Taleb (see previous post), a new vehicle for placing their bets.

While the effects of government bailouts and spending is still to be determined, Treasury Security Geithner does seem to be responsible for stimulating at least one industry - the exchanges. Since the announcement of his intent to shift more over-the-counter derivative trading onto the exchanges, the share price for the CME Group is up 27 percent, while the share price of Deutsche Borse (owner of the Eurex derivative exchange) is right behind, up 21 percent (see Financial Times article).

CME Group Daily Chart (1 year)
Source: Big Charts

In addition to the exchanges being able to trade more credit derivative products, such as credit default swaps, massive stimulus spending will also make it likely that demand will increase for interest rate products that are traded on the futures exchanges. In particular, the CME should do well given its trading in the popular Eurodollar contract. Yet, all is not rosy, as the introduction of new multilateral trading facilities will also require many of the existing exchanges to modify the way they currently do business, possibly also forcing a cut in fees. The "final" proposed regulations will also have to be carefully examined. For instance, if CDS trading is limited to only those with a direct interest, as opposed to third party speculators, then liquidity will be a fraction of what it is expected, offering less benefit to the exchanges. If, on the other hand, regulations are less restrictive, which seems necessary in order to maintain some type of relatively efficient and liquid market, then the exchanges will certainly benefit from the increased volume, even with a slight reductions in fees. Any rebound in the economy, or continuation of the current new bull / existing bear market rally will also have investors once again dreaming of $700 CME quotes. Let's hope so. After all, an increase in trading and retail participation in the market would certainly be good for more stocks than just the CME Group.

As insurance companies, banks, and endowments continue to scale back hedge fund investments, a new survey from Barclays finds that pension plans and wealthy families may be increasing their investments. Such investors have about 14 percent of their assets in cash, with almost 80 percent of this group planning to allocated money to hedge funds during 2009 (see Bloomberg article). With pension plans having around $437 billion in assets, and wealthy families controlling another $72 billion, potential investments could result in over $50 billion being added to hedge funds this year. While $50 billion is not anyway near current Government spending levels, it is certainly enough to generate its own form of market stimulus, adding additional buying pressure as the major indexes continue to flirt with key levels.

Universa Investments L.P., run by Mark Spitznagel (with no ownership, but a significant investment from Black Swan author Nassim Taleb), is opening a new inflation fund, named the "Black Swan Protection Protocol - Inflation" fund (see WSJ article). While worries that inflation will be caused by increased deficit spending are nothing new (see recent blog post), the fund is making bets on what is expect will be hyperinflation - similar to, and possibly worse, than what was observed in the 1970s. Investments in the aptly named fund will include options tied to what are believed will be volatile commodities, such as corn, crude oil, and copper, in addition to associated stocks, such as the gold miners and oil drillers. The inflation fund is also making negative bets on Treasury bonds in expectation of higher yields and lower bond prices. While most investors believe that the economy will have to deal with inflation at some point, the timing is still a matter of debate. Given the use of options in the fund, which in the past tended to be deep-out-of-the-money puts when looking for a sell-off, it would seem that Spitznagel and Taleb are looking for a much quicker and, in this case, higher move to the upside for assets tied to inflation.