There was a great interview with Mohamed El-Erian this morning on CNBC. El-Erian always presents a well though-out, articulate, and accessible perspective on various financial issues. This morning's interview was no different as he discussed the recent market rally and whether the economy is beginning to recover. As for the recent moves in the stock market, El-Erian believes that the run-up in prices, especially the July portion of the equity market rally, is part of a "sugar high," implying a correction is in order. As for the economy, El-Erian believes the current optimism is based on some false assumptions, including:

  • Corporate profitability can be maintained with additional cost-cutting. Not true. You need revenue growth.
  • The stimulus spending will have a permanent effect. Not true. Just look what happen in China on Wednesday when they decided to cut-back stimulus spending.
  • The stabilization of housing is sufficient to get the economy growing again. Not true. A housing recover is necessary, but is not sufficient by itself.
El-Erian goes on to say that what we need is final demand, producing longer-term and sustainable demand sources. We also need to know that deleveraging in the private sector has completed its course. People need to feel comfortable to once again to engage in consumption and investment. Furthermore, the recovery is no longer just about the financial sector. It is about the real economy, in particular wages and employment. Until those recover, we can only have tepid growth, but not the level of growth necessary to turn the economy around. Finally, El-Erian mentions how the helium in the growth balloon is being driven mainly by public debt. For the balloon and growth to stay afloat, you need the private sector to kick-in and take over, as well as have the public sector begin dealing with its debt issues. Simple, to the point common sense. Good stuff as always.

Source: CNBC Video

Below are some links of interest, just in case you missed them. Some may have already been posted to Twitter.

  • Economic calendar for Wednesday, July 29th ( Economic); Durable Orders at 8:30 AM EST, Crude Inventories at 10:30 AM EST, and Fed's Beige Book at 2:00 PM EST.
  • Earnings calendar for Wednesday, July 29th ( Earnings)
  • Small investors in the UK are turning to absolute return funds as they attempt to protect themselves against another downturn (UK Daily Mail).
  • Betting on positive GDP. Intrade odds for positive Q3 GDP growth are at 73% (Carpe Diem). On the other hand, even though some are optimistic on positive GDP, those betting on whether a Government run health care plan with a public option will be signed into law by the end of the year is down to 25% (Bespoke Investment Group).
  • The recession may be close to being "technically" over, but does that matter? (The Pragmatic Capitalist)
  • Don't fool yourself, earnings are in their worst decline in history (Trader's Narrative).
  • This seems to be an interesting "recovery" given that all the usual economic/sector suspects are missing in action (Financial Armageddon).
  • Sam Zell gives his thoughts on real estate (Calculated Risk). CNBC interview with Sam Zell below (CNBC Video).

  • The Nasdaq vs S&P 500 trend-following strategy (MarketSci Blog).
  • PIMCO takes its bond prowess into active management with the PIMCO 1-3 Year U.S. Treasury Index Fund (TUZ). (ETF Trends)
  • Microsoft and Yahoo! may be near a new search deal (WSJ). Does anyone care anymore?
  • Alpha/beta separation does not actually require separating anything (
  • A negative divergence between energy stocks and the S&P 500 (The Financial Ninja). Energy stocks take a slide on lower consumer confidence numbers (WSJ).
  • Don't over think light volume rallies (The Big Picture).
  • How are SPXU and UPRO being traded? Bill Luby at VIX and More provides some insight.
  • SEC issues new rules on short-selling (WSJ).
  • CFTC Chairman Gensler considers enacting limits on traders who place bets on energy contracts (WSJ). In other CFTC news, previous reports which had the CFTC blaming speculators instead of supply and demand for the crude oil run-up in 2008 may have been premature.
  • Wilber Ross sounds off on FDIC regulations and Tier 1 capital rule requirements, and whether anyone will buy banks again (CNBC Video).

Below are some links of interest, just in case you missed them. A few have already been posted to Twitter.

  • Economic calendar for Tuesday, July 28th ( Economic); S&P/Case-Shiller Home Price Index at 9:00 AM EST, and Consumer Confidence at 10:00 AM EST.
  • Earnings calendar for Tuesday, July 28th ( Earnings)
  • Hedge funds investing in Asia now appear to be a popular asset class among the wealthy in the region, with AUM expected to rise from $14 billion in 2001 to $160 billion by the end of the year (HFMWeek).
  • Jeremy Grantham's quarterly letter (GMO, The Pragmatic Capitalist). Always insightful. This one is no different given his views on China and emerging markets.
  • Even with the relatively positive housing news Monday, U.S. efforts to modify mortgages has faltered (WSJ).
  • Are there two housing bottoms, one for activity, and another for price? If so, the price bottom may not have been reached yet, even if housing activity is picking up (Calculated Risk, Clusterstock).
  • Potential problems with commercial real estate rears its ugly head again (Fortune). As it turns out, banks in the U.S. hold $1.8 trillion of commercial loans, with regional banks set to take the biggest hits. Some large regional banks with exposure include PNC of Pittsburgh, KeyCorp of Cleveland, and BB&T of Richmond, Va., each with more than half their loan books in commercial loans. Ouch.
  • Bank failures appear to be accelerating (The Big Picture).
  • Bank of America plans to cut 10% of its branches (WSJ).
  • Lending continues to slow as bankers and borrowers refrain from taking risk (Financial Armageddon).
  • There has been a 585% year-over-year change in CMBS delinquencies (Zero Hedge).
  • The next financial crisis is on its way and will be triggered by commercial real estate, credit cards, and student loans, says Kirby Daley, fromNewedge Group ( The Pragmatic Capitalist).
  • The truck tonnage index declined 2.4% in June (Calculated Risk). What does this mean for the recovery?
  • "The End Of The End Of The Recession" (Zero Hedge). A pretty detailed macroeconomic presentation from Zero Hedge in collaboration with David Rosenberg, Chief Economist & Strategist at Gluskin Sheff and Associates. The link is a few days old, but worth a look if you have not seen it.
  • The SEC issued new rules on short-selling that will require more transparency, albeit delayed (WSJ, Financial Times). This comes as the CFCF pins the blame for the 2008 crude oil spike on commodity speculators (WSJ).
  • The VIX was up on a quiet day (The Financial Ninja), and looking oversold as equities appear stretched.
  • Looking at the individual sectors, everything except energy seems overbought (Bespoke Investment Group).
  • Apparently the FX market is slowing down as Forex trading volume shrinks (Kathy Lien).
  • When breaking the S&P 500 into 10 deciles (10 groups of 50 stocks), the two deciles with the most institutional ownership are up the most, while the two with the lowest institutional ownership are up the least (Bespoke Investment Group). Is this institutions standing behind their bets and adding more, simply staying strong during a short squeeze, or something else? Or nothing else?
  • The AirShares EU Carbon Allowances ETF (ASO), which gave investors a way to play the cap-and-trade market, is calling it quits and liquidating (ETF Trends).
  • Traders are not happy with plans to limit natural-gas trades (WSJ), with some market makers considering pulling out of the market.
  • Is it dispersion time - the idea being to go long options gamma in individual names or sector specific ETF's, and go short gamma in index ETF's or index options (The Daily Options Report).
  • Hedge fund replication for all (Bull Bear Trader, greenfaucet). MIT Professor Andrew Lo discusses hedge fund replication and his SG Global Alternatives A (GAFAX) fund that is available to average investors.

Dr. Andrew Lo , MIT Professor and founder of Alpha Simplex, was recently on CNBC's Fast Money program discussing hedge fund replication using a combination of exchange traded futures and currency forwards.

Source: CNBC Video

In essence, hedge fund replication attempts to mimic the betas and returns of either individual hedge fund strategies, or the entire hedge fund industry, using common and liquid exchange traded assets, such as futures, forwards, swaps, and even ETFs. In using such assets to replicate returns, is it hoped that one can not only replicate betas and returns, but do so with comparable or less risk, and of course, less cost that a traditional hedge fund.

The specific fund that Dr. Lo helps manage, along with Jeremiah Chafkin and Robert Rickard, is a long/short replication mutual fund named the Natixis ASG Global Alternatives A (GAFAX) fund. The fund is relatively new, with an inception date of September 30, 2008, and has an expense ratio of 1.64% and an initial sales fee of 5.75% - not cheap, but less than your typical 2/20 hedge fund fee structure for longer holding periods. Year to date the GAFAX fund is up only 4.86% compared to a positive 8.74% return for the S&P 500. Nonetheless, the diversification effects of the fund have helped its returns be relatively flat since inception, compared to roughly a 20% loss in the S&P 500 over the same period. Given that the fund is less than one year old, extensive risk-return data is not yet available.

While replication strategies can attempt to replicate either single or multiple strategies, the GAFAX fund is broad-based in that it does not try to mimic one specific type of hedge fund strategy, but instead tries to get the beta and return of the diversified exposure of the entire hedge fund industry. Therefore, such a fund will not report returns that match the top outperforming funds each year, but will also hopefully avoid significant exposure to strategies that may have recently blow-up due to current market or macroeconmic factors. Furthermore, even though the fund is using reported past return data to develop its replication, the lag in performance is not expected to be as dramatic since the fund is modeling more broad-based returns, and once again is not subject to the investment changes of one hedge fund or strategy.

Hedge fund replication has been an active area of research for a number of years, both in academia and industry. It will certainly be interesting to see how such techniques perform outside the labs of academia and closed doors of industry, and whether or not such investment strategies catch on with the retail investing public. If you are looking to learn more about the field of hedge fund replication, there are a number of places to start. First, check out Dr. Lo's MIT homepage and Laboratory for Financial Engineering website were you can download some recent abstracts, publications, and working papers on hedge funds. Second, check out the wonderful blog and its various articles on alternative beta and hedge fund replication strategies. The following academic papers - available on the Internet (there are others as well) - will also given you an idea of a few hedge fund replication research approaches and modeling techniques.

Can Hedge-Fund Returns Be Replicated?: The Linear Case, Hasanhodzic and Lo
Alternative Routes to Hedge Fund Return Replication: Extended Version, Harry Kat

A few books on the subject include the following:

Hedge Funds: An Analytic Perspective, Andrew Lo (includes a chapter on replication, content from his papers)
Alternative Beta Stategies and Hedge Fund Replication, Lars Jaeger

Once again, these are just a few resources available on the Internet or at your local bookstore. As mentioned, the field has been active over the last few years, and subsequently has produced a number of good articles, books, and online resources. Enjoy.

Below are some links of interest (at least to me), just in case you missed them. A few have already been posted to Twitter.

  • Economic calendar for Monday, July 27th ( Economic). New Home Sales at 10 AM EST.
  • Earnings calendar for Monday, July 27th ( Earnings).
  • Investors await data on GDP and housing this week (Financial Times). Consensus forecast project a 1.5% fall in GDP for Q2, with falling inventory levels and lower production dragging the number down (WSJ). Anything much worse could stall and reverse the recent rally. Calculated Risk finds a little sunshine in some of the recent economic numbers. Nonetheless, even government meddling in the housing market may have its limits (Bearishnews). In somewhat related news, Barry Ritholtz also covers some issues with National Association of Realtors and the use of appraisers (The Big Picture).
  • The total amount of loans held by the 15 largest U.S. banks fell by 2.8% in Q2 (WSJ), with more than half of the loans in April and May coming from refinancing and renewing existing business credit, and not from making new loans.
  • More news about how investors are continuing to move their money into emerging market ETFs (ETF Trends).
  • Looking for an ETF with global exposure? Now there are two to choose from, but they are not exactly the same, even though they appear so (ETF Trends).
  • Demand for emerging market debt has risen to record levels, offering an encouraging sign for the world economy (Financial Times).
  • Are unemployment statistics meaningless? Are spillover effects zero? Econbrowser tackles the questions.
  • A look on how the "cash for clunkers" is going to work (The Big Picture).
  • U.S. Pay Czar begins looking to rework / renegotiate contracts deemed excessive. Seven banks and companies, including Citigroup, Bank of America, American International Group, General Motors, Chrysler, Chrysler Financial, and GMAC Financial Services must submit proposals for their compensation packages (WSJ).
  • Information Arbitrage takes on the wall street trader compensation model - arguing that the issue is inextricably tied to risk-taking, where the "heads I win; tails you lose" payout paradigm rewards risks taking and places little premium on risk management.
  • In an attempt to get its pension back to a solid footing, CalPERS is looking to double down on recent bets as it is considering pouring "billions more into beaten-down private equity and hedge funds. Junk bonds and California real estate also ride high on his list. And then there are timber, commodities and infrastructure. That’s right, he [CalPERS fund manager, Joesph A. Dear] wants to load up on many of the very assets that have been responsible for the fund’s recent plunge." (Fundmastery Blog)
  • Content is still king. Apple working with record labels to boost digital sales of entire albums by bundling interactive booklets, sleeve notes, etc., with music (Financial Times). Also, the company is planning to offer a tablet-sized computer by Christmas.
  • Even videogame makers are now starting to feel the recession, with sales down a record 29% year over year (WSJ). Xbox 360 and Nintendo's Wii sales are down 38%.
  • Stocks and corporate bonds are benefiting from the upbeat market mood, with yields on higher-quality company bonds lower - with prices higher (WSJ), as some investors who are not on-board for the "V-shared" recovery are choosing to hedge their bets with corporate bonds over stocks.
  • The Relative Strength Index (RSI) has traded 9 days in a row at an extreme RSI(2) reading over 90 (MarketSci). So is this an obvious bearish signal? Maybe not, given the non-normal forces that may be driving the market.
  • Has the long awaited Dow Theory bull market signal finally arrived? Apparently so (Investment Postcards).
  • Constructing a portfolio wisely and safely by building a macro view (The Pragmatic Capitalist).
  • Exactly what are the forces acting on the VIX? VIX and More elaborates.
  • A nice summary of links on portable alpha and alpha/beta separation is available at
  • Finally, Nouriel Roubini believes Ben Bernanke deserves reappointment (Economist's View). Nonetheless, he is still bearish ........ I think. As for Bernanke, it appears that most of the motivation for his moves came from not wanting to be the Fed Chairman presiding over the second great depression, even though it made him angry to bailout the very bankers that made the mess in the first place (WSJ). Yes, it made us angry too. The Pragmatic Capitalist also chimes in on whether or not Bernanke should be reappointed - let us say that the PG is not quite on the same page as Roubini (The Pragmatic Capitalist). Michael Panzner believes that the moves show that we did not learn enough much over the last two years (Financial Armageddon).