Thursday, October 23, 2014

Look Who Decided to Show Up to the Party…

We’ve done testing going back 100 years or so (so has AQR in their paper ) and I was delighted to see a new book out by the crew at ISAM (up a whopping 28% this year) that has a 800 year backtest!  Looking forward to reading it.

If you want some background reading on Trendfollowing search the archives, lots and lots in there including some of the below:

Podcast interviews that are excellent
Dual Momentum Investing – Antonacci
Following the Trend – Clenow
Trendfollowing Bible – Abraham
Global Investment Returns Yearbook – Dimson, Marsh, Staunton
Trendfollowing – Michael Covel
The Capitalism Distribution – LondBoardFunds

returns
- See more at: http://mebfaber.com/2014/10/21/look-who-decided-to-show-up-to-the-party/#sthash.qr8sG2g1.dpuf

Wednesday, October 08, 2014

Here’s The Problem With Underperformance


“A relative-performance-oriented investor is generally unwilling or unable to tolerate long periods of underperformance and therefore invests in whatever is currently popular.” – Seth Klarman
Active mutual funds continue to lag the market this year. This chart from BMO Capital Markets, courtesy of MarketWatch, shows the percentage of active stock managers that are outperforming the market over the past six years or so:
Active
This is nothing new, but there are some risks for investors in active funds to consider that can result from this underperformance. Brian Belski, the chief investment strategist at BMO, had this to say about the implications of these numbers:
We believe fund managers being too inactive and defensive with their portfolio positioning this year is largely responsible for this. However, given the level of underperformance, fund managers will likely have an added incentive to position portfolios more aggressively between now and year-end to play “catch-up” – something we believe will be a strong positive for market performance.
Ignoring the market implications (why would the market go up just because portfolio managers shift their stock holdings around?), this brings up a risk that few investors consider when making fund selections – career risk.
Whether right or wrong, if you underperform the market for an extended period of time, it will be much harder to attract new investors and keep current investors from selling out of the fund. Lower assets means lower fees which all compounds into more and more pressure on the manager to bring returns back up to stop the bleeding.
The risk for investors in underperforming funds is exactly what Belski outlines here – which is that portfolio managers take more risk to try to make up for their underperformance. Once a manager becomes fixated on short-term relative performance, risks can become magnified. Instead of performing rational analysis, they turn into speculators. They speculate on what other investors are going to do and try to get their first. They’re trying to forecast what the other forecasters are forecasting.
In essence, when you play the short-term relative performance game, you have to be able to guess the psychology of other people…not an easy task.
Obviously, this isn’t an optimal way to run a portfolio. This is why it’s so important for investors to understand what they are getting themselves into with any fund offering. A few points to consider when you’re involved with an underperforming fund or strategy:
Does the portfolio manager/firm have a disciplined process? A deep understanding of the fund and strategy is always important, but this is especially true when a period of poor performance hits. You must consider whether the manager will stick to their knitting or change course and go a new direction. Style drift is acceptable when it’s been sold as part of the strategy, but that’s rarely the case. More often than not style drift is a huge red flag for an underperforming fund.
Do you have the correct expectations for fund performance? Being out of favor isn’t that surprising. Nothing outperforms forever. Just as markets are cyclical, so too are strategies and investment styles. These things go in and out of style. It all depends on how willing you are to wait for things to turn around, which may or may not happen.
Do you have a plan for an underperforming fund? There’s no easy answer to the question of when to cut your losses in an underperforming fund. Investors always preach process, process, process until a bad outcome hits. At that point, process goes out the window and emotions take over. Emotions are the enemy of buy and sell decisions.
Playing catch-up to the market isn’t a great position to be in from a fund manager’s perspective. But adding risk for the sole purpose of getting even is not the solution.
Remember, trying harder doesn’t lead to better returns in the market.

ANATOMY OF A MARKET TOP

“If it keeps on rainin’, levee’s goin’ to break.” – Led Zeppelin 
Crashes get all the headlines, but the reality is that a breakdown in markets is more often a process than an event. It takes time to break the back of a strong uptrends as there are many buyers on the sidelines eager to “buy the dip.” This is why you tend to see a period of back and forth, a rotation from strong hands to weak hands, before the sharper declines ensue.
If we look at the average stock in 2014 as reflected by the Russell 2000 Index, this is precisely what we have been witnessing for the entire year.
Top1
Where have we seen this before?
2000…
Top2
2007…
Top3
The First 7 months of 2011…
Top4
But It’s Different This Time
The perception today is that it’s different this time. This belief stems from the view that the Fed has repealed the business cycle and eradicated market corrections through nearly six year of 0% interest rates and multiple rounds of quantitative easing. The validation for this narrative comes in the form of price action and the longest uptrend in the history of markets. At 471 trading days above the 200-day moving average in the S&P 500, most cannot remember a time when equities did anything but go up.
Streak 10-8
Perhaps the Fed true believers are right, you say, and the uptrend will last forever. Anything is possible in markets but the more likely scenario is that it’s finally coming to an end here.  The sustained weakness in small caps, high yield credit, and cyclical sectors is becoming too much for large caps to ignore (see here for comparison to 2007).
Small caps, mid-caps, Emerging Markets, and European equity markets have all tested their 200-day in recent days/weeks. All that remains is large caps; it is the last shoe to drop. I have been arguing for much of the year that investors have been rotating into U.S. large caps and defensive areas, hiding in anticipation of the end of QE in October (see “Fed Prisoner’s Dilemma”).
Well, October is here and investors may soon come to understand that U.S. large caps are not a risk-free asset class, in spite of what Fed has done over the past six years.
The chart below of the Russell 2000 is likely to become very important in the coming months. It illustrates the back and forth action that is reminiscent of 2007.
I’ve heard a number of perma bulls call this a “beautiful consolidation,” just a pause before the next sharp move upward. Perhaps, but if they are wrong and the levee of support (YTD lows in February and May) is broken, there could be significant downside ahead.
Top6
Will it break or will it hold? On this question I’ll defer to the wisdom of Page and Plant: “If it keeps on rainin’ [negative intermarket relationships persist], levee’s goin’ to break.”

Tuesday, October 07, 2014

Global Diversification: Accepting Good Enough to Avoid Terrible


The U.S. stock market is once again trouncing the broader international markets this year. Through the end of September, the total U.S. stock market, as measured by the Vanguard Total Stock Market Fund, is up nearly 7% while the Vanguard Total International Fund is basically flat on the year.
Since the beginning of 2013, the U.S. market it up almost 43% against a 15% gain for foreign markets. It’s tempting to look at these numbers and assume you’ll be fine just holding U.S. stocks and forgetting about the rest of the globe.
Investors have a short memory at times, so it’s easy to forget that everyone hated U.S. stocks in the middle part of the last decade as foreign stocks, led by emerging markets, were up almost three times as much on a total return basis:
Intl 4
Over the entire 2002 to 2014 period the total returns are fairly close, with the U.S. market up 139% against a gain of 133% for international stocks. These numbers show how mean reversion works over time.
It’s also instructive to break out the international markets by different regions to show how certain geographies have performed over time. MSCI data goes all the way back to 1970 and they have an index for both Europe and the Pacific region (made up of Japan, Australia, Hong Kong and Singapore).
Looking at the performance of these two markets along with the S&P 500 over forty plus years, we find that the annual returns are fairly similar:
Intl 3
Any long-term investor would have done great in these markets had they been invested over the entire time frame. But breaking the numbers down by different periods shows how cyclical the annual returns have been over time:
Intl 1
Until the latest period, European stocks have actually been the most consistent performers while the U.S. and Pacific markets have taken turns going from top to bottom.
These numbers are a good reminder of why it makes sense to diversify globally and avoid a home country bias. There could be long stretches of severe underperformance if you invest in a single geography at the wrong time.
No one can predict if U.S. returns on stocks will be as high as they’ve been historically or if another country or region will outperform in the coming decades. There are far too many factors that are unknown.
It’s impossible to know ahead of time if the down periods in one market will coincide with your spending needs when you need to start drawing down your portfolio. Selling in a down or underperforming market only compounds your problems when a market runs into a bad stretch.
Not only are there long stretches of underperformance for some regions, but there is Japan-style underperformance which is in a league of it’s own. Japan currently makes up about 60% of the MSCI Pacific Index so it makes for a pretty good proxy. Here are the annual returns for the Pacific Index and  S&P 500 broken out by pre- and post-Japanese bubble:
Intl 2
Anytime you bring up the benefits of being a long-term stock investor, someone will play devil’s advocate by pointing out that Japan has been a terrible long-term investment for some time now. But it really depends on your definition of long-term because the returns are so close over the entire data-set.
Sometimes it comes down to luck and what period you happen to be saving and investing your money in. You have no control over this whatsoever. Pacific shares were an amazing investment for two decades, but have been working off those excesses ever since.
It would be great if we were all guaranteed a smooth ride with no variation in performance, but markets don’t function that way. They’re extremely cyclical and can go from worst to first and back again over any month, quarter, year, decade, etc.
It’s intelligent to utilize diversification so you don’t get stuck with a portfolio that only earns the Pacific returns since 1990. You have to give up the chance for exclusively earning the returns from 1970-1989, but that’s the trade-off.
Diversification is about accepting good enough while missing out on great but avoiding terrible.

Why the Gross vs Ivascyn comparison is misleading


A lot has been made of the track records of Bill Gross and Dan Ivascyn managed funds since the sudden departure of Gross from PIMCO. Mainstream media has covered the aftermath in great detail, but explanations of the performance have gone relatively untouched. Was the performance of Bill Gross really that awful? Was it entirely attributable to a poor call on US Treasuries? Is the Ivascyn magic touch now about to change all of PIMCO’s bond funds? Let’s sort through the facts and establish some pragmatic views on the subjects.
1. Ivascyn knocked it out of the park
Make no mistake about it, the management of Dan Ivascyn’s funds the since the crisis has been nothing short of superb. The PIMCO Income Fund (PIMIX) is up an average of 12.8% over 5 years versus the category average of 7.2%, ranking it better than 99% of peers according to Morningstar. Fund assets grew from $300mil in 2008 to $6.5bil at the end of 2011, and now $38.6bil at the end of September 2014.
Ivascyn and co-PM Alfred Murata targeted beat up credit assets that would benefit from a reflating of the financial markets. As central banks moved interest rates to zero and removed government bonds from the system, investors were forced to incrementally move out the credit curve.
An example of something that PIMIX has owned and done extremely well on is Spanish Covered Bonds. This is one the larger holdings in PIMIX. As shown, in three years, the price has risen from ~50 cents on the dollar to ~120 as the Euro debt crisis calmed.
image
Arguably the largest source of returns for the PIMCO Income Fund has been from non-agency MBS. There’s been arguably no better place for outsized returns in fixed income than non-agency MBS since 2009. Ivascyn and team made shrewd bets that these assets would recover and they did.
All in all, Ivascyn’s bets have been credit related and have centered around risk premium compression in the junkiest areas of credit. He has not been without misses - as his PIMCO funds held large amounts of Brazilian entrepreneur Eike Batista’s bankrupt OGX, as well Mexican homebuilder Homex. The point is not that he got a few wrong, but that he bet big on a recovery in the weakest areas of the credit markets and has largely been correct. Gross himself recognized & apparently liked this opportunity set as he is the largest owner of the Ivascyn managed PIMCO Dynamic Income fund (I consider it a leveraged version of PIMIX) with over 1.6mil shares held.
2. Gross’ Total Return Fund was not comparable to Ivascyn’s Income Fund
The objective of the PIMCO Total Return Fund is to "maximize total return, consistent with preservation of capital and prudent investment management. The fund invests at least 65% of its assets in investment grade fixed income".
The objective of the PIMCO Income Fund is to "maximize current income and to seek for long-term capital appreciation…"
These objectives are not anything similar to each other. The Gross managed Total Return Fund by mandate must seek preservation capital and may only hold a maximum of 35% in non investment grade bonds. In contrast, the Income fund is seeking to maximize current income and long term capital appreciation.  Gross was forced to hold a substantially larger amount of government bonds and lower yielding IG credit.
3. Even if he wanted to, the Total Return Fund was too large to buy the bonds that Ivascyn bought
Peaking at $293billion, the Total Return Fund is an absolute behemoth. Bottom line is that the types of bonds which had the most outsized returns (such as non-agency MBS) were not able to be purchased in great enough size to move the needle.
The size of the entire non-agency universe has fallen to under $750billion. After accounting for legacy holders, hedge funds, and banks, the universe to buy is very small. As an example, the large Maiden Lane auctions where the Government sold off amounts of non-agency MBS were only around $7bil if I recall correctly.  If the Total Return Fund bought that whole thing it still would’ve been a very small allocation to the fund. 
4. The performance of the Total Return Fund was largely based on duration calls
With a fund so large as Gross managed, the relatively performance of it came down to his call on duration. It’s been well documented that he was wrong about US rates a few years ago and that lack of duration hurt his relative performance. Regardless of QE or “the new normal”, his views on how much duration to take was the big determinant. He bet that rates would rise and inflation would as well (Gross funds were heavily long TIPS).
Yes, Gross and team made some mistakes but comparison to Ivascyn’s funds are misleading. They were playing in very different areas of the bond market and the size of Gross’ Total Return Fund were a big headwind. Astute readers will note that Ivascyn isn’t on the PM team for the Total Return fund & that’s probably a smart choice. Ironically, as Gundlach mentioned yesterday, the biggest mistake that Gross made might have been letting his flagship fund get too large.

Sunday, October 05, 2014

Tech Stocks help Hedge Funds justify their Existence


How important is the tech-sector to hedge fund value added? Far more than their allocations would suggest.
Tech’s share of the S&P 500 is roughly 17%, and on the face of it, according to the Symmetric universe, hedge fund investors are only slightly overweight technology, coming in at 19%. 
But the tech-sector contributes more than 27% of the total stock picking dollar value generated by hedge funds. Some 27% of all the dollars that the hedge fund industry generated picking stocks that outperform their corresponding sector come from picking tech stocks. It’s far more than the contribution from any other sector and, given the allocation, far more than you would expect.
image
Either hedge funds tend to be good at picking stocks in the technology industry or technology stocks may just be more conducive to the investment strategies employed by hedge funds.

The Ten Golden Rules of Argument


​​You don’t have to attend every argument you’re invited to.” — Anonymous
Arguments are tricky. We spend a lot of our time trying to persuade others. We think that if we show them the facts that we have they will, logically, reach the same conclusions we did. Unfortunately that’s not how it works. When is the last time someone changed your mind this way? 
Sometimes we don’t want to argue. We’d rather avoid. This doesn’t make the problem go away. In fact the suppressed resentment that builds up can poison a relationship.
In his book, How to Argue, Jonathan Herring outlines positive ways of understanding and looking at arguments.
They needn’t be about shouting or imposing your will on someone. A good argument shouldn’t involve screaming, squabbling or fistfights, even though too often it does. Shouting matches are rarely beneficial to anyone.
We should treat the ability to argue as a skill that needs to be practiced and developed.
​​“The aim of an argument, or of a discussion,
should not be victory but progress.”
— Karl Popper
Arguments, and for that matter discussions, should be about seeing things through the other person’s eyes. They should lead to a better understanding of another person’s view.
With that in mind, here are what Herring calls the Ten Golden Rules of Argument.
1. Be prepared
Make sure you know the essential points you want to make. Research the facts you need to convince your opponent.
Also, Herring advises: “Before starting an argument think carefully about what it is you are arguing about and what it is you want. This may sound obvious. But it’s critically important. What do you really want from this argument? Do you want the other person to just understand your point of view? Or are you seeking a tangible result? If it’s a tangible result, you must ask yourself whether this result you have in mind is realistic and whether it’s obtainable. If it’s not realistic or obtainable, then a verbal battle might damage a valuable relationship.”
2. When to argue, when to walk away
I’m sure you’ve had an argument before and later felt that it was the wrong time and place. “Knowing when to enter into an argument and when not to is a vital skill.”
Think carefully before you start to argue: is this the time; is this the place?
3. What you say and how you say it
Spend time thinking about how to present your argument. Body language, choice of words and manner of speaking all affect how your argument will come across.
One clever thing to do here, that shows you’ve done the work, is to address the arguments against your position before they arise.
4. Listen and listen again
Listen carefully to what the other person is saying. Watch their body language, listen for the meaning behind their words.
As a general rule, Herring writes, “you should spend more time listening than talking. Aim for listening for 75 percent of the conversation and giving your own arguments 25 percent.” And listening doesn’t mean that you’re thinking about what you’re going to say next.
This is often where a lot of arguments, and discussions for that matter, veer off course. If you’re not listening to the other person and addressing their statements, you’ll just keep making your same points over and over. The other person won’t agree with those and the argument quickly becomes frustrating.
5. Excel at responding to arguments
Think carefully about what arguments the other person will listen to. What are their preconceptions? Which kinds of arguments do they find convincing.
There are three main ways to respond to an argument: 1) challenge the facts the other person is using; 2) challenge the conclusions they draw from those facts; and 3) accept the point, but argue the weighting of that point (i.e., other points should be considered above this one.)
6. Watch out for crafty tricks
Arguments are not always as good as they first appear. Be wary of your opponent’s use of statistics. Keep alert for distraction techniques such as personal attacks and red herrings. Look out for concealed questions and false choices.
7. Develop the skills of arguing in public
Keep it simple and clear. Be brief and don’t rush.
8. Be able to argue in writing
Always choose clarity over pomposity. Be short, sharp, and to the point, using language that is easily understood.
9. Be great at resolving deadlock
Be creative in finding ways out of an argument that’s going nowhere. Is it time to look at the issue from another angle? Are there ways of putting pressure on so that the other person has to agree with you? Is a compromise possible?
10. Maintain relationships
This is absolutely key. What do you want from this argument? Humiliating, embarrassing or aggravating your opponent might make you feel good at the time, but you might have many lonely days to rue your mistake. Find a result that works for both of you. You need to move forward. Then you will be able to argue another day.
Another approach to end arguments is to simply ask the other person to explain their thinking.

A Poor End to a Bad Month


With the month of September and the third quarter now in the books, below is a look at the performance of various asset classes using key ETFs traded on US exchanges.  It was a rough month for stocks, especially for smallcaps.  The Russell 2,000 (IWM) finished the month down 6.19% and the quarter down 7.96%.  
Six sectors finished the quarter lower, while four traded higher.  Health Care and Technology were the winners of Q3, while Energy was the big loser.
Foreign markets didn't fare well in September either.  The Brazil ETF (EWZ) was by far the worst with a decline of 19.09% for the month.  Australia (EWA) fell the second most at -11.86%.
Commodities and fixed income fell as well in September.  For the quarter, commodities took it on the chin, with declines of more than 10%.  
About the only thing that did well in September was the US dollar index.

Not new: Money has been leaving PIMCO TR for a while....


Shorting GoPro Is One Pricey Bet


Short sellers have to pay a pretty hefty premium these days to bet against camera maker GoPro Inc.
GoPro’s stock has more than tripled from its trading debut in June and is the best-performing U.S.-listed initial public offering this year, according to Dealogic. The rally has made GoPro a ripe target for short sellers to bet on a drop from such elevated levels.
But to do that, the shorts need to pay a hefty price tag.
“GoPro is currently one of the most expensive stocks to borrow among all U.S. equities,” Andrew Laird, analyst at securities-financing tracker Markit, said in an email to MoneyBeat. Nearly all of the shares available for lending have been borrowed, he said, and the cost to borrow the stock has surged to among the highest levels since GoPro’s IPO in June.
“Currently investors are willing to pay close to 100% (annually) of the value in order to borrow shares,” Mr. Laird said. “This is extremely high by any standard and is a factor of both strong demand to short from the buyside and limited supply.”
Short sellers borrow shares to sell them in hopes of buying them back cheaper at a later date, aiming to profit from a price decline.
While the demand for shares to short is pushing against the available supply, the percentage of GoPro shares on loan — a proxy for short-selling activity — isn’t wildly outside the norm. As of Wednesday, it stood at about 2.5% of shares outstanding, according to Markit. That’s above the average short interest for the S&P 500 at about 2.2%.
Markit
GoPro makes wearable high-definition videorecorders that first appealed to surfers and cyclists seeking ways to record cool tricks before surging in popularity among the general public.
Shares are up about 250% from GoPro’s $24 IPO price. But trading in the stock also has been erratic. The stock fell as much as 14% on Thursday after the company said its founder, Chief Executive Nicholas Woodman, and his wife, Jill Woodman, gave 5.8 million Class A shares worth about $500 million to a charitable foundation.  The couple had been restricted from selling the shares until six months after the June IPO, but sidestepped a so-called lockup agreement and transferred the stock.
Shares rose about 11% on Sept. 29 after the company unveiled a slew of new cameras. The stock also fell 15% on Aug. 1 after the company reported earnings.
GoPro shares rose 3.1% to $88.14 Friday afternoon.

Thursday, September 18, 2014

47% of NASDAQ Stocks in a Bear Market / 1% of S&P 100

Percentage of Stocks in a Bear Market: Nasdaq vs. S&P 100
Yesterday, Bloomberg published a provocative article indicating that 47% of Nasdaq stocks were currently in bear markets, i.e., at least 20% off of their 52-week high. As stats wonks, we are attracted to these types of studies (and a little jealous when someone else discovers them). Thus, we were immediately intrigued by the article and the data point, particularly as, on the surface, it appeared to lend evidence to the thinning market meme that we have been describing.
The first step was to run the test to independently verify the 47% figure. We did so and found around 45% of Nasdaq stocks were down 20% from their 52-week high — close enough. Suffice it to say that sounds like an alarmingly high number.
That leads us to the second step: determining context. 47% sounds high but is it really? Well, we ran the test since the beginning of the year and as it turns out, the percentage has been above 40% for most of the time since March. So it may be high, but it isn’t an extremely recent development. If it is one of those divergences that we’ve observed so often lately, it is apparently another one that can persist for some time before causing real damage to the major averages.
Speaking of major averages, one of the takeaways from this study is how the averages can mask broad weakness throughout the market. Due naturally to their high weighting, the biggest stocks by market cap can keep the averages afloat, or rising, if they are doing well — even as much of the broad market is mired in a bear market.
More evidence of that effect is seen from the other series on the chart. Measuring the percentage of stocks in the S&P 100 (the very largest companies) that are in a bear market, we get exactly 1%, i.e., 1 stock (it is General Motors, if you are wondering). That is testament to the strength of the large caps and the resilience of the major averages. It also speaks to another takeaway from this study: stick with the relative strength leaders.
Lastly, to truly determine the significance and context of this statistic, we would have to view its historical data. In the article, Bloomberg mentioned that the number of Nasdaq stocks in a bear market in October 2007 was “about 45%”. However, since we do not have data with timely constituent changes for the Nasdaq going back several years, we cannot generate historical numbers. We could theoretically reproduce it by rebuilding the Nasdaq week-by-week, but that would be too time-consuming a task for us. It would be great if anyone had the data and could share the figures or chart so that we could get a true historical perspective.
__________
More from Dana Lyons, JLFMI and My401kPro.
Yesterday, Bloomberg published a provocative article indicating that 47% of Nasdaq stocks were currently in bear markets, i.e., at least 20% off of their 52-week high. As stats wonks, we are attracted to these types of studies (and a little jealous when someone else discovers them). Thus, we were immediately intrigued by the article and the data point, particularly as, on the surface, it appeared to lend evidence to the thinning market meme that we have been describing.
The first step was to run the test to independently verify the 47% figure. We did so and found around 45% of Nasdaq stocks were down 20% from their 52-week high — close enough. Suffice it to say that sounds like an alarmingly high number.
That leads us to the second step: determining context. 47% sounds high but is it really? Well, we ran the test since the beginning of the year and as it turns out, the percentage has been above 40% for most of the time since March. So it may be high, but it isn’t an extremely recent development. If it is one of those divergences that we’ve observed so often lately, it is apparently another one that can persist for some time before causing real damage to the major averages.
Speaking of major averages, one of the takeaways from this study is how the averages can mask broad weakness throughout the market. Due naturally to their high weighting, the biggest stocks by market cap can keep the averages afloat, or rising, if they are doing well — even as much of the broad market is mired in a bear market.
More evidence of that effect is seen from the other series on the chart. Measuring the percentage of stocks in the S&P 100 (the very largest companies) that are in a bear market, we get exactly 1%, i.e., 1 stock (it is General Motors, if you are wondering). That is testament to the strength of the large caps and the resilience of the major averages. It also speaks to another takeaway from this study: stick with the relative strength leaders.
Lastly, to truly determine the significance and context of this statistic, we would have to view its historical data. In the article, Bloomberg mentioned that the number of Nasdaq stocks in a bear market in October 2007 was “about 45%”. However, since we do not have data with timely constituent changes for the Nasdaq going back several years, we cannot generate historical numbers. We could theoretically reproduce it by rebuilding the Nasdaq week-by-week, but that would be too time-consuming a task for us. It would be great if anyone had the data and could share the figures or chart so that we could get a true historical perspective.

Monday, September 08, 2014

Howard Marks - Risk Revisited

http://www.oaktreecapital.com/MemoTree/Risk%20Revisited.pdf

Saturday, September 06, 2014

Beware of the Coming Winter of Discontent


In investing, as in life, timing can be everything. The cycles of the capital markets are as immutable as are the seasons of the year. Those who commit risk capital while the cycle is enjoying its risk-on spring will prosper; those who avoid risk-taking during the spring would be well advised not to do so as the autumn chill approaches.
Shockingly, as critically important as it is to take the measure of financial and economic cycles, there is precious little insight offered in terms of understanding what drives them. The ability of our institutions to forecast, much less control, cycles has been exceedingly poor. Need proof? Inspect the pronouncements of our high priests and priestesses of finance at the Federal Reserve. In June 2008 — three months before the failure of Lehman Brothers and the takeover of Fannie Mae and Freddie Mac — the Fed expressed its concern over rising inflation and reiterated its expectation that growth would continue.
My point isn’t to lambaste the Fed, which — like the U.S. government, Wall Street and the media — failed to perceive the severity of the financial fragility that had developed during the housing bubble. Rather, my purpose is to remind that the customary ways of understanding and measuring cycles are nearly useless and investorsneed to examine them in a new, or at least different, way.
Traditionally, two basic narratives have been used to explain cycles: Recessions happen because businesses become infused with an excess of animal spirits. Overexpansion begets an unwanted build in inventory, forcing the shuttering of production until inventory is worked down to a manageable level, at which point normal growth is restored. Now, does that sound like any business cycle you’ve seen in the past 30 years?
Alternatively, some claim that the imbalance comes not from business but from consumers. They get exuberant, go on a shopping spree and spur inflation, compelling the Fed to pull the punch bowl. Once it is removed, consumer spirits dampen, and the cycle concludes. Well, does this sound like 2008? Was inflation such a menace that the Fed raised rates to flatten growth?
So if the usual suspects have little to do with the demise of the cycle, then investors ought to look elsewhere to more properly gauge its longevity. A study of the deleveragings of the past quarter century provides the necessary guidance: Simply put, we have lived for some time in an integrated global economy mirrored by a globalized financial system. This means that the credit cycle and the business cycle have become almost one and the same.
Provided that the capital markets are willing and able to extend the frontiers of credit that one extra step, so long as one more marginal loan can go to that one more marginal borrower, we maintain growth. But once the high-water mark in credit is reached, a deleveraging inexorably builds momentum (either over several quarters or within the context of a market crisis, when it happens over days or weeks), and an economic downturn is under way.
The implications for investors are clear. Main Street economic indicators — car sales, purchasing manager surveys, employment data, housing market activity, asset prices — are highly dependent upon the willingness of the capital markets to engage in the lending activity that fuels a releveraging economy. The notion that high asset prices and a low level of unemployment inoculate the economy from downturns is belied by history. Did such a peak in stock and real estate prices prevent the cataclysm of 2008? Did the sub-5 percent unemployment of early 2008 mean that the virtuous jobs-income-jobs cycle had firmly and forever established itself? Obviously not.
If you want to understand how old the current cycle is — that is, how risky a commitment to risk-based assets might be — then it is critical that you judge the quality and durability of underwriting standards in the capital markets. A recovery that is predicated on the continued production of loans, too many of which will ultimately go bad, is no recovery at all. Rather, it is a condition that supports current economic activity at the expense of a future write-down in loan and asset valuations.
Yes, conditions appear better, but the house of recovery is increasingly being built out of credit straw rather than brick and, consequently, will not withstand the gales of the tighter credit to come. Whether these tighter conditions come naturally, via a capital markets self-realization of the excesses, or by the Fed’s need to raise rates in response to the risk or reality of higher inflation, the result will be the same: a deleveraging and possibly recession. For this reason, we at TCW have steadily reduced our exposure to rates and to risk-taking in credit with the expectation that an inevitable winter of higher rates, wider risk premiums and higher volatility lies ahead.• •
Tad Rivelle is CIO for fixed income at TCW, which manages over $140 billion in assets globally.

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.