In their research paper "The Value of Enterprise Risk Management," Robert Hoyt and Andre Liebenberg attempt to uncover whether there is firm value in implementing Enterprise Risk Management (ERM). As the authors discuss, ERM has generated considerable interest from the media in recent years as organizations begin implemented enterprise-level risk management programs, and consulting firms and universities look for ways to offer support, guidance, courses, and services related to ERM. Rating agencies have also begun to consider ERM in the rating process, and regulators are taking notice. The ideas of enterprise and system-wide "systemic" risk are also now being given serious consideration at the economic system level.

Put simply, ERM is focused on the idea that instead of managing and examining individual and separately managed silos of risk, firms are now looking at managing risk in a more integrated, enterprise-wide fashion. It is believe that doing so will help to avoid duplication of risk management expenses by exploiting natural hedges, and allow firms to better understand the aggregate risk. ERM programs also have the benefit of allowing firms to better inform outsiders (investors, regulators) of their risk profile, compared to firms that are more operationally complex. It is expected that such added visibility has the benefit of decreasing earnings and stock price volatility, increasing capital efficiency, and increasing enterprise risk awareness - allowing for more holistic operational and strategic decision-making. But enough flowery language. Does it work, and will it increase shareholder wealth?

[Note: I have offered university-level ERM courses in the past, and will do so again in the near future. Unfortunately, up until now there has not been an empirical study regarding the impact of ERM programs on firm value. Needless to say, I was interested in the results of the research.]

First, a little research background. For the study, the authors focused their attention on U.S. insurers in order to control for regulatory and market differences across industries. Financial institutions and insurers have been some of the first industries to adopt ERM, so this focus makes sense. Without going into further specifics of their modeling and analysis (please refer to the paper), the authors found:

"ERM usage to be positively related to factors such as firm size and institutional ownership, and negatively related to reinsurance use, leverage, and asset opacity. By focusing on publicly-traded insurers we are able to estimate the effect of ERM on Tobin’s Q, a standard proxy for firm value. We find a positive relation between firm value and the use of ERM."
In fact, beyond just adding value, the ERM premium was 16.5%, and found to be both statistically and economically significant, as well as being robust to a range of alternative specifications of both the ERM and value equations. In summary, it appears that added risk management disclosures inherent in ERM add value to the firm. As a bonus, by adding additional risk management transparency, firms are likely to reduce the expected cost of regulatory review, along with the amount risk capital that is allocated for less productive/profitable uses, each of which no doubts helps to increase firm value. Certainly something the proponents of ERM believed, but now there is some initial evidence to back up the claims - at least for insurance companies.

Of course, as investors, knowing that ERM adds value to a firm is good, but now it is necessary to determine which firms are in fact using ERM. Even the authors mention that identifying firms engaging in ERM is a challenge. Nonetheless, absent official disclosures, a search of financial reports and news wires (as performed by the authors) can help to locate candidates for study. Even with relatively strict filtering of data, the researchers were able to identify 117 out of 275 insurance firms that met the requirements of being classified as firms engaging in some type of ERM. As regulators begin to require additional transparency regarding risk management activities, such identification will become easier, and hopefully profitable to investors.

According to the recent TIM (Trade Ideas Monitor) report for August 13th, the TIM Sentiment Index (TSI) in North America was 52.13, down 2.42 points, but still over the critical 50 mark (see last post, and previous post and the youDevise website for additional information on the TIM report). The TSI Worldwide Index averaged 53.40. Total new long ideas as a percentage of all new ideas sent to investment managers by way of the TIM remained high at 65.68%, but down slightly.

As for individual securities in the U.S. and North America, Cbeyond (CBEY), TW Telecom (TWTC), and Williams-Sonoma (WSM) were stocks with long broker sentiment, while Allegiant Travel (ALGT), Tellabs (TLAB), and Arch Coal (ACI) had short broker sentiment. In general, the utility, telecommunication, and consumer staples sectors had long broker sentiment, while the financial, material, and consumer discretionary sectors had short broker sentiment.

Below are some links of interest for 8/14/09, just in case you missed them. Some have already been posted to Twitter.

  • U.S. foreclosure activity hits a new record in July, increasing 7% from June and 32% for the year (Financial Times). The increase is being blamed in part on a lifting of previous foreclosure moratoriums.
  • Retail sales fell 0.1% in July, even with the Cash for Clunkers program being considered - although August may include more data (WSJ). There were large declines in housing-related retailers and electronic stores. Stripping out autos, retail sales dropped 0.6%. Yet, there were some gains. Auto and parts sales increased 2.4% in July. In addition to autos, health and personal care stores, restaurants and bars, clothing, and mail order and Internet retailers were also up.
  • The Federal Reserve plans to conclude its purchases of $300 billion in U.S. Government debt by the end of October (WSJ), in what may be both an admission that the Fed believes that the worst is over, and also a way to begin allowing long-term rates to move up, even as it plans to keep short-term rates near zero for the foreseeable future.
  • Unemployment duration just keeps getting longer, even in good times (The Financial Ninja). This is increasing the need to emergency unemployment compensation (second The Financial Ninja article).
  • Hotel occupancy fell 7.5% to end the week at 65.9%. RevPAR (Revenue per available room) for the week decreased 16.5% (Calculated Risk). Given that peak travel time is passing us by, this is not good news.
  • When looking at quarterly report for Regions Financial, one wonders if the company is insolvent, even though the government says it is well capitalized (Bloomberg). Of course, that has not stopped investors from valuing the company near $6 billion. Meanwhile, looking at CDS market, 5-year protection written on Region's tier-2 debt is trading at spreads of 722bp over swaps (Reuters - Felix Salmon). What this implies (to Salmon) is "that bonds are the new stocks, and stocks are the new call options." Bonds are now giving you a high return for high risk. On the other hand, stocks run the risk of being wiped out entirely in return for the leveraged possibility that your investment could multiply in value in a matter of months. Of course, none of this seems to bother the stock or its investors. In the face of the Bloomberg story, the stock was up 7.9% Thursday, along with a 3.1% increase in the KBW Bank Index - much to the amazement of Michael Panzner (Financial Armageddon).
  • Weak retail sales data caused an early correction in the futures market Thursday morning, but the market still rallied back on essentially no news (The Pragmatic Capitalist). This comes as rail data was also weak (second The Pragmatic Capitalist article). Is the market resilient or complacent? Is the move just short-covering and/or hedge fund managers trying not to get left behind?
  • Based on available trading data, there seems to be a disconnect in short interest volume readings. The BATS short volume reading is accounting for over 46% of total volume, much more than the short interest data disclosed by the NYSE and Nasdaq ( Zero Hedge).
  • Bespoke Investment Group has a list of the most heavily and least heavily shorted Russell 1,000 stocks. Chipotle Mexican Grill (CMG), and not surprisingly, AIG, top the most shorted list. CMG is still up 46.35% YTD. Of interest is that the average 2009 change for the most heavily shorted stocks, i.e., more than 20% of float, is 26.23%, almost double the gain for the overall market.
  • In general, as the market has been moving up, the short interest ratio on the S&P 500 has been dropping, signaling a possible topping formation (The Disciplined Investor).
  • The Pragmatic Capitalist worries that a weak hurricane season could cause crude oil prices to fall, dragging the stock market with it.
  • The Coppock Curve technical indicator is continuing to rise and act bullish (Trader's Narrative). Then again, the S&P 500 would have to fall 200 points below 780 for the curve to stop climbing, so we could get the much talked about August/September correction before continuing to move higher later in the year, as some are expecting.
  • The ratio of insider buying to selling transactions is 10 to 136 ($60.1 million buys to $1,146 million sells). There have been over $2.1 billion in insider sales over the last two weeks (Zero Hedge).
  • Looking at inter-market returns YTD, crude oil is the best performer in 2009 - up almost 60%, followed by the Nasdaq - up 27% YTD, and the CRB Commodity Index - up 15% YTD (Afraid to Trade). The S&P 500 has risen 11% during the same period.

  • In what seems to be daily hedge fund data, the Financial Times takes its turn reporting how traditional strategies such as equity long-short and convertible arbitrage continue to be the best hedge fund strategies for the year. Emerging market and fixed income arbitrage strategies are also doing well. Dedicated short sellers, not surprisingly, are getting killed. As the market continues to trend, black-box commodity trading advisers (managed futures) are once again generating interest after what has been a difficult year (Reuters). Anyone seen a SuperFund commercial lately?
  • Looking at a recent 13-F, the John Paulson portfolio is heavily weighted towards three sectors: gold, financial stocks, and health care (The Pragmatic Capitalist). This basically results in three bets on seemingly different macro themes, possibly betting on re-inflation (gold, health care), while at the same time speculating on a recovery (banks).
  • Researchers Mokoaleli-Mokoteli, Taffler, and Agarwal test whether sell-side analysts are prone to behavioral errors when making stock recommendations, as well as the impact of their investment banking relationships on judgment. The authors find that new buy recommendations on average have no investment value, whereas new sell recommendations do have value, although it takes time for the information to be assimilated by the market. Interesting research, and somewhat intuitive - or at least it should be. It looks like buy recommendations involve selling, and sell recommendations involve selling, ......., just different kinds (Bull Bear Trader).
  • The MarketSci blog provides a nice breakdown of the quant analysis blogosphere into three components - situational analysis, mechanical strategies, and academic thinkers - and provides references for each.
  • New Morningstar 5-star stock: SunPower Corporation (SPWRA).

In their paper "Behavioural Bias and Conflicts of Interest in Analyst Stock Recommendations," Journal of Business Finance and Accounting, authors Mokoaleli-Mokoteli, Taffler, and Agarwal tests whether sell-side analysts are prone to behavioral errors when making stock recommendations, as well as the impact of their investment banking relationships on judgment. The authors find that new buy recommendations on average have no investment value, whereas new sell recommendations do have value, although it takes time for the information to be assimilated by the market. They also find that new buy recommendations are distinguished from new sells both by the level of analyst optimism and conflicts of interest (no surprise there). Of interest, successful new buy recommendations are characterized by lower prior returns, while successful new sells do not differ from their unsuccessful counterparts in terms of these measures.

Interesting research, and somewhat intuitive - or at least it should be. New buy recommendations involve selling, and sell recommendations involve selling, ......., just a different kind.

Below are some links of interest for 8/13/09, just in case you missed them. Some have already been posted to Twitter.

  • Imports were up in June, in part due to a spike in oil prices. Exports were also up in June. On a year-over-year basis, exports are off 22% and imports are off 31% (Calculated Risk).
  • The duration of unemployment chart is getting scary, and at record levels (Trader's Narrative). Can you say jobless recovery?
  • Statistics indicate a recovery with no jobs, no pay increases, and therefore no increases in tax receipts for struggling state and local governments (Washington Post).
  • As of April, less than 13% of the largest 1,100 hedge funds had reached their high water mark, while more than 18% were more than 30% off their peaks (WSJ). Even after the recent market run, more then 70% of hedge funds have not recovered from 2008 losses, making it difficult for firms to generate extra fees, pay bonuses, and retain talent.
  • Natural gas hedges that locked into higher prices helped a number of companies report better than expected earnings, but this could be harder in the future if speculators have a more difficult time participating in the market going forward (WSJ). This is certain to affect "cash-flow certainty" for companies, affecting not only their ability to manage risk, but their ability to provide some level of stability to consumer energy prices.
  • Even if the efficient market hypothesis does not get in your way, it is not that simple to technically and fundamentally trade your way to being "really" rich, ......., but "merely" rich is possible (Abnormal Returns).
  • If revenue growth is to have a V-shaped recovery, shouldn't CapEx spending increase? Zero Hedge looked at the data. Not only is CapEx spending not increasing, it is continuing to fall.
  • The Baltic Dry Index has been down nine of the last ten trading days (The Financial Ninja). There is suspicion that China has pretty much completed their commodity restocking.
  • World stock market capitalization is up another $4 trillion in July (Carpe Diem).
  • Are option flash orders the next big thing to worry about (WSJ)? Maybe not (Daily Options Report, here and here).
  • Has the no volume bear market rally finally ended? The Pragmatic Capitalist believes so, and lays out the case why. The 50% move in the S&P 500 is somewhat typical for a secular bear market rally - declining volume, low quality asset gains, little leadership, and the move has been swift. With no volume confirmation, negative seasonal trends, no real catalysts in view, and extreme bullish sentiment, the market may be ready for a correction.
  • Don Fishback ran some numbers and found that the average return of the S&P 500 during earnings season was -0.11% (Don Fishback's Market Update, HT marketsci tweet). So why are stocks and index options more expensive going into earnings season? It could be explained by how far each period's returns deviate from the average. In fact, market returns during earnings season do not really resemble a bell curve.
  • During the second half of July, the NYSE experienced a 10.27% decline in short-selling positions not closed out, while the Nasdaq had a more than a 5% fall in short interest (WSJ).
  • In a challenge to iShares, Vanguard has filed a registration statement with the SEC to offer seven bond index ETFs, illustrating in part current trends, and how investors are looking more towards corporate bonds (Bull Bear Trader). While some investors are simply chasing returns, others are looking for new ways to diversify away from equities.
  • The natural gas ETF, UNG, has decided to not issue new units on worries of new stringent CFTC rules (WSJ). The shortage of shares may continue to cause the fund's value and price to diverge.
  • Actively managed quantitative strategies currently account for 9% of all U.S. equity AUM, as automation is becoming a competitive necessity (FINalternatives).
  • A forthcoming academic paper from SUNY professors Greg Gregoriou and Razvan Pascalau suggests that the optimal number of underlying hedge funds within a fund of hedge fund portfolio may actually be as low as 6-10 (All About Alpha). Among other conclusions, the paper demonstrates empirically that the number of hedge funds included in a FoF has a negative and significant impact on the volatility of returns, while having less of an impact on actual returns.
  • Bob Prechter of Elliott Wave International is quite sure the next wave down will be bigger and the March lows will break (The Big Picture).
  • After calling the bottom in March, Doug Kass is bearish again ( since cost cuts and fiscal stimulus are limited, cost cuts threaten the consumer, the net worth of individuals has been damaged, the credit shock will continue, the outcome of the Fed monetarist experiment is uncertain, a housing recover will be muted - there are no other drivers right now, commercial real estate is just now entering its downturn, municipalities may not provide the necessary economic stability, and taxes will be rising, along with health and energy bills, further hurting the consumer.
  • Money managers collectively have 18.5% of the long portfolios in the Financial sector, 16.8% in Technology (Bespoke Investment Group). Utilities and Telecommunications round out the bottom at 3.0% and 2.9% respectively.
  • S&P 500 YTD returns by sector (Value Expectations). Technology, Consumer Durables, and Basic Materials are leading the way with 39.73%, 36.77%, and 32.82% average returns, respectively, while the Financial and Utility sectors are bringing up the rear at average returns of 10.81% and 5.87%, respectively. The Applied Finance Group's Value Expectations (VE) interface provides sector expectations for the S&P 500 (Value Expectations).
  • From the latest update of the four bear recovery comparison (check out the chart at, it appears that the S&P 500 lows in 1974 and 2002 market sustained recoveries. The Dow low in 1929 failed 11 months later. The current market is now 47% above the March 9 low, and has outperformed the 1974 and 2002 rebounds over the same period. Doug Short ask: Will the rally continue to show resilience? That is the question.
  • New Morningstar 5-star stocks include Cisco Systems (CSCO), ExxonMobil (XOM), and Regions Financial (RF).
  • American Association of Individual Investors (AAII) sentiment survey results (as of Aug 6): Bullish 50% (rose above long-term average of 38.9%), Neutral 14.84%, Bearish 35.16% (rose above long-term average of 30.0%). It looks as if investors are jumping off the fence.
  • Even though the Dow Theory is giving bullish signals - since both the Dow Industrials and Dow Transports are moving above previous significant highs, signaling that the primary trend is bullish and stock price are likely to move higher - the signal may not have occurred since the corrections that followed the May and June highs failed to retrace even one-third of the rise since the March lows. As mentioned Monday, Jeff Saut just thinks it is a contrarian indicator.

The Battle Of The Dr. Doom's

Posted by Bull Bear Trader | 8/12/2009 03:40:00 PM | , , , | 0 comments »

The battle of the Dr. Doom's on CNBC (CNBC Video), between Marc Faber and Nouriel Roubini, was uneventful, but did provide some interesting comments. While Dr. Roubini views are pretty well known, even if he is currently a little less pessimistic, Dr. Faber's views may not be as well known, and are worth mentioning. Some observations from the Faber portion of the interview include the following:

  • There was a bull market in assets from 2002-2007, along with a weak dollar. In 2008, we had the opposite - a strong dollar, with all assets going down except for bonds. Now, in 2009, assets have rallied, especially in emerging markets as the dollar has weakened.
  • For the next couple of months we should see the dollar recover as assets correct downward.
  • The dollar will strengthen not because the U.S. economy is the best, but because it is the least cyclical. As the dollar strengthens, global liquidity will tighten.
  • As liquidity tightens, growth will begin to disappoint, and emerging markets will become vulnerable, especially after being a favorite of momentum investors who may flee the trade.
  • Nonetheless, even with slower economic growth, markets may still go up given that there are a number of worldwide central bankers who are nothing more than money printers and continue to feel the need to intervene when prices go down (except for crude oil).
  • To exit this cycle, we may still need a crisis to cause us to fully change behavior and clean the system. Therefore, a total breakdown of the system is likely ahead of us (even if 1, 5, or 10 years away) since we have not let those who caused the problems fail. We cannot continue to provide bailouts that do not help the average person.
  • Nonetheless, the Fed and other central bankers will most likely leave rates too low for too long, as household deficits continue to increase.
  • Finally, when asked what would have happen if central banks would not have stepped in to stop the credit and market collapse, Faber believes that the market would have dropped more, but the system would be healthier, in part because the debt load on taxpayers would be less.

Nassim Taleb was interviewed on CNBC's Squaw Box Wednesday morning (CNBC Video), along with Nouriel Roubini. Some observations from Taleb include the following (the first one still worth repeating, especially given the recent market moves and short covering, the remaining ideas being essentially repeats from other interviews/columns):

  • Short-term markets mean nothing. They are driven by the marginal buyer/seller.
  • The risk and problems that we had before - debt, poor leadership - are still there.
  • Converting private debt to public debt is just causing more problems.
  • Structural problems have not been addressed.
  • Too much reliance / susceptibility to forecast errors for the recovery, budget, and debt forecast.
  • Policy makers are still not working on the main problems and there cures, just the symptoms.
  • We are continuing to reward those who got us into our current problems.
  • Nouriel Roubini is usually correct, except for wanting to reappoint Federal Reserve Chairman Bernanke (comment after some praise - to easy, just cannot help himself).

Vanguard To Offer New Bond Index ETFs

Posted by Bull Bear Trader | 8/12/2009 09:09:00 AM | , , , | 0 comments »

In a challenge to iShares, Vanguard has filed a registration statement with the SEC to offer seven bond index ETFs (Investment News). Three of the ETFs will invest in U.S. Treasuries (1-3 year, 3-10 year, and longer dated), three in corporate bonds (1-5 years, 5-10 years, and long dated), and one in MBS. Each of the ETFs comes with an expense ratio of 0.15%. The company is trying to take advantage of current investment trends, one of which has investors moving into corporate bonds (Forbes). Bonds funds in general have received $58 billion in May and June, up from $19 billion over the same two months last year. The junk-bond market itself has climbed 40% this year. While some investors are simply chasing returns, others are looking for new ways to diversify away from equities after the market sell-offs in the second half of 2008 and first quarter of 2009.

Below are some links of interest for 8/12/09, just in case you missed them. Some have already been posted to Twitter.

  • According to Boston Consulting Group, institutional investors will demand "innovations" such as alternative investments, i.e., hedge funds, private equity, infrastructure, commodities, absolute return, and quantitative products, among others (All About Alpha). The group also mentions that "Perhaps the foremost trend in actively managed products is the continuing shift out of long-only equity allocations."
  • Why have hedge funds underperformed the markets? Apparently, some managers are taking money off the table and proceeding with caution after several months of gains (Investment News). Even with good performance this year, hedge fund fees continue to slide (Wealth Bulletin).
  • The Fed exit strategy will amount to paying interest on balances held by banks at the Fed (Bearish News). Essentially, when it comes time to tighten policy, the Fed can raise the rate paid on reserve balances as they increase their target for the federal funds rate. Of course, this will in a sense continue to reward the banks for past failures.
  • After two years, some believe that we have failed to learn the three lessons taught by the economic downturn: imbalances in global trade and finance have real consequences, debt brings risk, and globalization does not manage itself, but needs guidance (Telegraph UK).
  • China's economy slowed a little in July as large banks rein in lending, with volume of new lending in China dropping 77% from a month earlier, as fears of bubbles persist (Financial Times). Chinese exports fell 23% from a year earlier (Bloomberg). Singapore is not slowing down, with GDP spiking 20.7% (The Straits Times).
  • General Motor's Volt could be a game changer if it gets the 230 miles per gallon that is being advertised - as long as you stay close to home (WSJ).
  • The KBW bank index hit an 8 month high, up 144% from the March lows (Carpe Diem).
  • The Congressional Oversight Panel is warning that smaller banks, which hold a greater concentration in commercial real estate, have the potential for much higher defaults going forward (Calculated Risk). Some small banks will need to raise significant capital (Zero Hedge).
  • Can the PPIP be used to explain the strong rally in AA-rated CMBS (Clusterstock)? Is a new toxic asset bubble around the corner?
  • From Comstock (by way of The Pragmatic Capitalist), deleveraging will continue to take a major toll on the U.S. economy and could wind up producing a couple lost decades, not unlike what Japan has experienced over the last 20 years.
  • Brazil's coming rebound (Fund My Mutual Fund).
  • What about the technology sector? Jim Farrish believes that while short-term there is the reason to tighten stocks, long-term (6-18 months) the sector is still in a bullish uptrend (greenfaucet). Any current correction may be an opportunity to add.
  • Crude oil and gold both bounce of Fibonacci retracements (market folly), for those of you that care about crude, gold, or trading patterns/sequences.
  • The housing mess is not yet over (The Big Picture). mentions that almost one-quarter of mortgage holders are underwater, with the figure rising to 30% by mid-2010 (Bloomberg). Ginnie Mae and FHA are becoming $1 trillion subprime guarantors, not unlike taxpayer owned Fannie Mae (WSJ).
  • More details on Goldman Sach's amazing winning streak (Here Is The City News). Apparently, Goldman lost money on only two trading days during April, May and June. They also made more than $50m on 58 of the 65 trading days in the period, and at least $100m on 46 days. Amazing.
  • The Baltic Dry Index has fallen for its 9th straight day (The Big Picture).
  • We are all traders now (Trader's Narrative). The average holding period for a stock on the NYSE continues to fall.
  • NYSE Bullish Percent Index and NYSE Percent of Stocks Above 200 Day MA Index are near 3 year highs (ES and EC Futures Analysis).
  • A look at the importance of normalizing put/call ratios, whether they are going up or down (Quantifiable Edges).
  • Short are decreasing as the average stock in the S&P 500 had 4.97% of its float sold short by the end of July (Bespoke Investment Group), the lowest level since January 30th. The reduction in shorts represents a decline of 17% from the peak levels in July 2008.
  • September can be a cruel month for stocks (WSJ).
  • Is the money supply (M1) a good indicator for short- and medium-term stock market behavior (CXO Blog)? Maybe not.
  • Obama's derivative plan (WSJ).
  • Greg Mankiw provides some wonky talk about carbon taxes (Greg Mankiw's Blog).
  • Gamma decay and smiles for levered options (Quantivity).
  • VIX calls attract some attention (VIX and More).
  • Finally, an interesting link (at least to me) of the changes in WSJ dot portraits (Reuters - Felix Salmon).

On average, hedge funds were up 2.44% July and 11.89% for the first seven months of the year according to data from (see hedgeweek article). This was the best seven month performance data since 1999, driven in part by the rising equity markets and near record performance in directional fixed income. Convertible arbitrage returned 6% in July and is the best strategy year to date, while managed futures have lagged equity-based strategies. Nonetheless, even with the current out-performance, 54% of funds are still below January 2008 levels.