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.
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 TreasurySource: BigCharts.com
iShares Barclays TIPS Bond FundSource: BigCharts.com
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
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.
In the wake of the 2008 financial meltdown, it was easy to look the other way as governments and regulators considered nearly every course of action for keeping the engines of the economy from totally falling off the tracks, let alone from moving too fast in the wrong direction. But now, after massive stimulus spending, failures, and private-company ownership stakes, governments are dealing with numerous unintended consequences, forcing them to perform a difficult balancing act between immediate stimulus and long-term growth and stability.
This is now becoming evident in the Treasury market, where rising interest rates are putting pressure on the Fed's plan to bring down borrowing costs and help revive the housing market (see Bloomberg article). Mortgage rates, which have been increasing recently (see Bloomberg article and Reuters article), are now reaching high enough levels (if 5.25% is high) where they are beginning to decrease the number of new refinancing, not to mention making new home purchases more expensive and less attractive. While the increasing yield curve has been good for the net interest margins of the banks, the higher rates are coming at a bad time. It was recently reported that the number of homeowners who are getting behind on their mortgages is increasing, causing a spike in foreclosures (see NY Times article). Also, while the median price of a new home was up 3.7 percent in April, the general longer-term trend is still down, and will require a few more positive months to confirm a reversal. Sales of new homes also rose less than expected in April, with a downward revision of the March figures adding additional concern. Durable goods orders did see their largest gain in 16 months in April, but the March number was revised down sharply, causing concern for the accuracy of the current April reading.
Commodities and commodity-related stocks, on the other hand, have been rallying, with gold marching towards $1,000 an ounce, and oil rising above $65 a barrel (see WSJ article), up nearly 50 percent over the last five weeks (see Reuters article). The moves have come in part due to the falling greenback, with the dollar index down 10 percent over the last 3-months. Higher commodity prices have helped resource-rich emerging markets, lifting specific international indexes and causing a rally in emerging market bonds as the higher prices reflect an improved outlook concerning these nations ability to repay their debts (see Bloomberg article). Yet domestically, rising crude oil prices may slow down consumer spending as U.S. consumers find they once again have less disposal income (see Reuters article). Further increases in commodity prices, especially crude oil, will certainly draw concern from the Federal Reserve as it wrestles with the balancing act of growth and inflation, and subsequent worries about stagflation, making it difficult to raise rates. Capacity utilization is still low enough to make one believe that broad-based inflation is at least a year away, yet higher gasoline prices will influence consumer spending - which is vital to GDP and growth - with higher market rates adding extra pressure on spending.
In the area of "the news is good since it was not as bad as expected" camp, reported revisions highlight that GDP only contracted 5.7 percent in Q1, less than expected and previously reported, while corporate profits after taxes increased by 12.9 percent after falling 28.4 percent in Q4 (see WSJ article). Yet, not everything is rosy. Within the last few days, Tiffany posted a 64 percent drop in Q1 earnings, as margins slumped (see WSJ article). Cintas, the uniform maker, gave a weak Q4 outlook, saying that it also expects to have another round of layoffs, bringing its total workforce reduction to 12 percent over the past year (see WSJ article), and signaling further expected weakness in the broader labor market. As for technology, Dell warned that the PC market has not yet hit bottom (see WSJ article). Isolated, insignificant, and cheery-picked? Possibly. But certainly cause for concern.
All of this leaves the Fed and the Treasury with a difficult balancing act going forward. Fortunately for the Fed, or maybe unfortunately depending on your perspective, they may be off the hook, as investors and the markets take action themselves, and in the process drive up Treasury yields on debt and inflation fears (see Financial Post article). As equities enter the summer and currently appear to be stuck in a range as traders collectively make a market, the Fed may also find that it too could benefit from a little monetary consolidation. Unfortunately, the dollar, Treasuries, and commodity prices seem to have a mind of their own, with traders spotting the handwriting on the wall, and taking matters into their own hands. Quite possibility, the inflation train may have already left the station. Maybe the most the Fed can hope for is to make sure it simply arrives later than expected. Even those that feel inflation is a distant reality, see it as a reality, nonetheless. As investors and traders, we can prepare, and maybe make a little money along the way. Gold and commodity traders, as well as those shorting the dollar, are off to a good start.
As the Obama Administration considers ways to pay for their proposed universal health care system, and everything else for the matter, old habits like cigarettes, and growing ones like soda consumption, are being considered for new and/or higher taxes. While it seems like everything is currently on the table, the administration may only need to look up for inspiration, and another source of revenue. Greg Mankiw and Matthew Weinzieri, both from Harvard, have proposed taxing people based on their height (see the Fox Business News article). Crazy and arbitrary? Maybe not.
To backup their proposal, Mankiw and Weinzieri cite studies that show a correlation between height and income. As it turns out, previous research found that each inch of height added about 2 percent to a man's income on average (sorry ladies, only men were considered in the study). Statistical data snooping? Once again, maybe not. According to the theory, it is believed that exhibiting height early in life allows adolescences to develop characteristics such as self-esteem that are later rewarded in the labor market. Others, conducting similar studies, hypothesize that proper pre-natal and childhood nutrition also helps to explain the correlation between growth (height) and cognitive ability (also helpful in the labor market).
Carrying things forward, since tall people are more desired by the labor market, they of course will earn more money, and subsequently pay higher taxes. So who cares you might say. Even if tall people do make more money, they are already paying more taxes. How do you generate more revenue? Simple. Tax those who are tall, regardless of their current income level. After all, as the researchers mention, if the goal is to “maximize the level of happiness through a redistribution of income,” then why not tax those people who are not only already happy (i.e., rich), but also those that are most likely to eventually be happy down the road.
While some may be thinking that this is just another academic study, and therefore a waste of time, it does offer some important points, even if we never tax people based simply on height (at least I hope not, given that I am over 6 feet tall myself). Weinzieri asked the question: "Does government have the right to ask those who have the ability to earn more to pay more?” When taxes on cigarettes and soda are consider to pay for health care, are we not in many cases penalizing healthy individuals because we think that they have a higher chance of getting sick down the road? Could we do the same for tall people, in the name of spreading the wealth and happiness? Carried further, why should someone buying a new car pay more personal property tax than someone with an older car, when the new one is probably more fuel efficient and better on the environment (and the health of everyone)? Are we taxing the correct source, or promoting the behavior we desire?
In conducting and publishing their latest research, Mankiw and Weinzieri have not simply pointed out a statistical correlation, or helped to justify a new tax system. Instead, they have done something far greater and more useful. They have introduced new questions for everyone impacted by the existing tax code, or those looking for new ways to justify taxing one group over another. In short, they have created a dialog. Socrates would be proud ......... as would a few flat tax proponents.
According to a Financial Research Corporation report, equity funds and ETFs posted April net inflows of $8.5 billion and $6.9 billion, respectively, reversing the trend of outflows in March (see Investment News article). Corporate-bond funds had the largest net inflow in April at $16.6 billion, while international fixed-income funds had the largest net outflows at $447 million. As posted earlier, risk taking is back - at least it was in April.
The State Street Global Investor Confidence Index rose 3.1 points from the April reading of 103.2 (see Hedge Fund Review article). The North American version of the index rose 9.6 points to 104.9. For the index, anything over 100 indicates that institutional investors are increasing allocations to risky assets, indicating that investors in North America, and in general across the globe, are adding more risky assets (i.e., more equities) to their portfolios. On the other hand, the indexes for Europe and Asia are still below the 100 benchmark. While the Europe index rose 7.5 points to 84.3, the Asia index fell 4.9 points to 93.1. Time will tell which regions are leading or lagging indicators of the global markets, or if a contrarian move is in order.
Even though on average hedge funds had a down year last year, they still outperformed the broader market and many other asset classes. As a result of this out-performance, the money allocated to hedge funds had become one of the larger positions within many investment portfolios, causing portfolio managers with defined asset weighting to reduced exposure to their hedge fund investments in order to get portfolio allocations back in-line. Now, as a result of broader market and other asset classes rallying over the last few months, the allocation to hedge funds is smaller than required, reducing redemption requests which began increasing last fall (see the NY Times article). With fewer redemption requests, hedge funds can quit hording cash (in anticipation of new withdraws), and instead start putting capital to work in the market. As mentioned by the authors of the NY Times article, given their high fees, new regulations, and negative press, it may take some time before new money makes it way into hedge funds at the same pace managers saw just a few years ago. Nonetheless, the reduced selling alone could be enough to start increasing returns and attracting new interest among investors. This alone could be good for all investors, regardless of their individual exposure to hedge funds and other alternative investments.
Andrew Lo, the director of the MIT Laboratory for Financial Engineering, and founder of the AlphaSimplex hedge fund, believes the next big meltdown will be in commercial mortgages (see Reuters article). While many traders and investors have been predicting that the CMBS market would be the next one to take a hit after blowups in the residential market, Lo is predicting that the losses will accelerate later this year as rates begin to be reset higher. Also of note is how Lo believes that it will be pension funds, and not the banks, that will be hurt the most when commercial real estate comes under additional pressure. In an effort to increase yield when the markets were more static, pension funds loaded up on CMBS in the years before the market meltdown. There is an expectation that many pension funds will now have a difficult time meeting liabilities, forcing the government to once again step-in with some type of bailout. While this is certainly not good news for the economy if the commercial real estate market was to play out as predicted by Lo, given the hits commercial real estate has already taken, the pressure pension funds are already under, and the number of bailouts which have already occurred, it is difficult to know - even in general terms - what the reaction and impact on the markets will be. Maybe this is the saddest realization of all.
While companies seem to spend a lot of time and money on finding the proper valuation for the company being acquired during mergers and acquisitions, boards can increase their chances of getting the deal done and approved by focusing on one simply, and very public benchmark. Researchers at Harvard finds that the 52-week high of the stock price of the company being acquired seems to be what matters most when valuing a company during M&A negotiations (see WSJ article). As it turns out, regardless of data from other valuation measures and techniques, many boards will insist that any purchase price is at, or above the 52-week high. To make their case, researchers at Harvard looked at 7,500 deals from 1984 to 2007 and found that psychology and irrationality helped to drive price, and that the company's 52-week high stock price seems to be the starting point for valuation negotiations. In fact, approximately three-fourths of the deals studied were priced above the 52-week high (it should be more random), with those deals also having about the same three-fourths chance of getting shareholder approval. The findings may help to explain why many deals in hindsight seem to not work out for the acquiring company - who appear to be over-paying and/or buying at the high. For traders, the time honored tradition of selling on the news seems justified once in the trade, with the 52-week high helping to provide a reference point when considering risk and return before taking a position. For companies and boards, the most rational thing, as written by the WSJ, it to "use the market's irrationality to its advantage," and not let the opportunity pass. Just ask Yahoo!'s board.
Today, President Obama is expected to sign new legislation that will place limits on the fees and interest rates charged to consumers using credit cards (see WSJ article). While we can argue the benefits and unintended consequences of such legislation (doesn't it seem like we are using the term "unintended consequences" a lot lately), from a trading and investment perspective, there is an expectation that revenue generated by the fees and interest rates - which are now being scaled back - will begin to dry-up for many credit card companies. Subprime borrowers and others holding balances are the cash cows for credit card companies, given that those that don't really need credit tend to use the cards more for convenience, or as a way to gain points and a month of "free" float before paying off their balance in-full.
Estimates have the credit card industry losing $10 billion in revenue from overall interest income. In addition, companies such as Bank of America, Citigroup, Discover, and Capital One Financial are estimated to get between approximately 27-30 percent of their business from subprime customers. Others potentially hit by the new legislation include General Electric - the biggest issuer of private-label cards in the U.S., and Target, which issues its own cards to customers. Unfortunately, Citigroup also issues about 22 percent of all private label cards - not that they need another reason to lose revenue.
While the market still needs to shake out this latest development, it seems that taking away a large source of revenue, and making it more difficult for companies to price their risk, cannot be good for the credit card companies. The general impact on retail sales, increased costs to credit-worthy customers (annual and monthly fees), and the availability of credit for everyone, also seem to be things that cannot be ignored.
The announcement a few days ago by President Obama to increase fuel consumption by 2016 (see CNBC article) still has some scratching their heads, given the head-winds the automakers already face. Nonetheless, it is what it is, so you might as well start considering investment opportunities. A few days ago, Phil LeBeau, the CNBC Automotive Reporter, posted a nice article at his Behind The Wheel blog outlining a few companies that are poised to take advantage of the lower emission and higher fuel economy standards coming down the pike (see the post). The main idea behind the investment opportunities is that to lower emissions and increase mileage, cars will need to become lighter and/or more efficient. Five companies that could offer help in these areas include the following:
These companies have also been pumped on CNBC's Fast Money recently, causing them to run-up a little, although each are still off their 52-week highs (then again, who isn't). A few are also still consolidating somewhat after the October 2008 sell-off, allowing for some opportunity to move. Of course, in this economy and market, anything related to automakers has to be given pause and due diligence, but each is still worth a look.
- Alcoa (AA): positioned for the push for lightweight steel and aluminum, while still maintaining strength.
- Borg Warner (BWA): maker of turbochargers that will give engines the desired performance while still providing for fuel efficiency.
- Eaton (ETN): auto parts supplier who makes camshafts and valve trains that help improve combustion engine efficiency for existing non-hybrid/electric designs.
- Honeywell (HON): for the same reasons as Borg Warner.
- Magna International (MGA): leader in hydroforming, which allows parts, including body panels, to be lighter.
In another example of "unintended consequences," some bond holders are beginning to avoid companies such as General Motors, after the recent moves by the Obama administration to short-change its creditors (see Bloomberg article). Companies with strong unions or extensive medical and pension legacy cost, similar to those at GM, may find it difficult in the future to obtain the funding they need from those labeled by the administration as "speculators". Even those that are still willing to lend will now do so only on their financing terms, which will most likely involve higher rates to compensate for the added credit risk each investor is now taking for the possibility of being "leapfrogged in a bankruptcy," according to those at Schultze Asset Management. In addition to the other automakers, including Chrysler and Ford Motor, companies such as AMR are also being shunned. The irony is that each of the car companies will probably be looking for financing in the future to help fund new energy efficient technology, such as hybrids and more efficient engines, yet they may find the terms offered in the markets unacceptable for making a profit. This of course will no doubt result in Joe tax payer once again making up the difference.
Just as the media and regulators continue to discuss the use of alternative investments and the active trading of hedge funds in contributing to the downfall of the economy and the stock market, many private investors are seeing each as a way to help protect themselves from recent market uncertainty (see New York Times article). While a more conservative trading mentality has been the norm for high net worth investors, many are now questioning its usefulness in the current market environment. Many investors who in the past have relied on a simple mix of stocks, bonds, and cash, and now turning to managed futures, financial futures, hedge funds, funds-of-funds, mutual hedge funds, currencies, commodities, and other avenues for gaining exposure to alternative investments.
Maybe even more interesting is how these same investors are becoming aggressive in moving away from a strict buy-and-hold approach, and instead are looking to take advantage of short-term trading opportunities - a move that indicates in part that such investors are not only opportunistic, but also worried about placing longer-term bets on the markets. As mentioned by Paul Speargas, senior client at WMS Partners:
“The buy-and-hold strategy, which was almost universally accepted by the investment and academic community over the past several decades, is no longer the sole investment strategy to be employed in order to deliver solid investment returns. A thoughtful balance between long-term investing and short-to-intermediate term trades is likely the recipe for investment success in the volatile years ahead.”Given the interest by clients to still utilize hedge funds, commodities, futures, and alternative investments, not to mention the desire of the Fed and Treasury to have investors step-up and provide capital to purchase distressed assets, it might be good to pause and reflect before slapping or over-regulating the trading hands that are still willing to check the temperature of the investment waters.
