Thursday, September 20, 2012

QE3 and interesting stats on Gold

Given that Fed­er­al Reserve Chair­man Ben "Heli­copter Make it Rain Dol­lar Bills" Bernanke just announced QE3 (quan­ti­ta­tive eas­ing) that sent the price of gold high­er, we were sent an inter­est­ing info­graph­ic with some facts on every­one's favorite pre­cious metal.

For years now, we've high­light­ed how many promi­nent hedge fund man­agers have owned gold in some capac­i­ty (either phys­i­cal­ly, or via prox­ies like exchange trad­ed funds GLD orIAU).

John Paul­son start­ed a gold fund as a bet against the US dollar.  Oth­ers bought gold as an uncer­tain­ty hedge.  Green­light Cap­i­tal's David Ein­horn con­tin­ues to own gold as a top hold­ing.  And Third Point's Dan Loeb con­tin­ues to own gold as his 2nd largest posi­tion

Here's some notable recent facts about gold: 

- Cur­rent mar­ket value of all gold is $8 tril­lion 

- All avail­able gold is equal to approx­i­mate­ly half of the pub­lic debt of the USA

US gold reserves amount to 77% of the nation­al for­eign exchange reserves

- China's gold reserves account for only 1.8% of its total reserves 

- Annu­al gold con­sump­tion for invest­ment: 1,640 tonnes (about 50 mil­lion gold coins) 

And here's the info­graph­ic: 

Infographic Gold Facts

The magnitude of the mess we're in

By George P. Shultz, Michael J. Boskin, John F. Cogan, Allan H. Meltzer and John B. Taylor

Sometimes a few facts tell important stories. The American economy now is full of facts that tell stories that you really don't want, but need, to hear.

Where are we now?

Did you know that annual spending by the federal government now exceeds the 2007 level by about $1 trillion? With a slow economy, revenues are little changed. The result is an unprecedented string of federal budget deficits, $1.4 trillion in 2009, $1.3 trillion in 2010, $1.3 trillion in 2011, and another $1.2 trillion on the way this year. The four-year increase in borrowing amounts to $55,000 per U.S. household.

The amount of debt is one thing. The burden of interest payments is another. The Treasury now has a preponderance of its debt issued in very short-term durations, to take advantage of low short-term interest rates. It must frequently refinance this debt which, when added to the current deficit, means Treasury must raise $4 trillion this year alone. So the debt burden will explode when interest rates go up.

The government has to get the money to finance its spending by taxing or borrowing. While it might be tempting to conclude that we can just tax upper-income people, did you know that the U.S. income tax system is already very progressive? The top 1% pay 37% of all income taxes and 50% pay none.

Did you know that, during the last fiscal year, around three-quarters of the deficit was financed by the Federal Reserve? Foreign governments accounted for most of the rest, as American citizens' and institutions' purchases and sales netted to about zero. The Fed now owns one in six dollars of the national debt, the largest percentage of GDP in history, larger than even at the end of World War II.

The Fed has effectively replaced the entire interbank money market and large segments of other markets with itself. It determines the interest rate by declaring what it will pay on reserve balances at the Fed without regard for the supply and demand of money. By replacing large decentralized markets with centralized control by a few government officials, the Fed is distorting incentives and interfering with price discovery with unintended economic consequences.

Did you know that the Federal Reserve is now giving money to banks, effectively circumventing the appropriations process? To pay for quantitative easing—the purchase of government debt, mortgage-backed securities, etc.—the Fed credits banks with electronic deposits that are reserve balances at the Federal Reserve. These reserve balances have exploded to $1.5 trillion from $8 billion in September 2008.

The Fed now pays 0.25% interest on reserves it holds. So the Fed is paying the banks almost $4 billion a year. If interest rates rise to 2%, and the Federal Reserve raises the rate it pays on reserves correspondingly, the payment rises to $30 billion a year. Would Congress appropriate that kind of money to give—not lend—to banks?

The Fed's policy of keeping interest rates so low for so long means that the real rate (after accounting for inflation) is negative, thereby cutting significantly the real income of those who have saved for retirement over their lifetime.

The Consumer Financial Protection Bureau is also being financed by the Federal Reserve rather than by appropriations, severing the checks and balances needed for good government. And the Fed's Operation Twist, buying long-term and selling short-term debt, is substituting for the Treasury's traditional debt management.

This large expansion of reserves creates two-sided risks. If it is not unwound, the reserves could pour into the economy, causing inflation. In that event, the Fed will have effectively turned the government debt and mortgage-backed securities it purchased into money that will have an explosive impact. If reserves are unwound too quickly, banks may find it hard to adjust and pull back on loans. Unwinding would be hard to manage now, but will become ever harder the more the balance sheet rises.

The issue is not merely how much we spend, but how wisely, how effectively. Did you know that the federal government had 46 separate job-training programs? Yet a 47th for green jobs was added, and the success rate was so poor that the Department of Labor inspector general said it should be shut down. We need to get much better results from current programs, serving a more carefully targeted set of people with more effective programs that increase their opportunities.

Did you know that funding for federal regulatory agencies and their employment levels are at all-time highs? In 2010, the number of Federal Register pages devoted to proposed new rules broke its previous all-time record for the second consecutive year. It's up by 25% compared to 2008. These regulations alone will impose large costs and create heightened uncertainty for business and especially small business.

This is all bad enough, but where we are headed is even worse.

President Obama's budget will raise the federal debt-to-GDP ratio to 80.4% in two years, about double its level at the end of 2008, and a larger percentage point increase than Greece from the end of 2008 to the beginning of this year.

Under the president's budget, for example, the debt expands rapidly to $18.8 trillion from $10.8 trillion in 10 years. The interest costs alone will reach $743 billion a year, more than we are currently spending on Social Security, Medicare or national defense, even under the benign assumption of no inflationary increase or adverse bond-market reaction. For every one percentage point increase in interest rates above this projection, interest costs rise by more than $100 billion, more than current spending on veterans' health and the National Institutes of Health combined.

Worse, the unfunded long-run liabilities of Social Security, Medicare and Medicaid add tens of trillions of dollars to the debt, mostly due to rising real benefits per beneficiary. Before long, all the government will be able to do is finance the debt and pay pension and medical benefits. This spending will crowd out all other necessary government functions.

What does this spending and debt mean in the long run if it is not controlled? One result will be ever-higher income and payroll taxes on all taxpayers that will reach over 80% at the top and 70% for many middle-income working couples.

Did you know that the federal government used the bankruptcy of two auto companies to transfer money that belonged to debt holders such as pension funds and paid it to friendly labor unions? This greatly increased uncertainty about creditor rights under bankruptcy law.

The Fed is adding to the uncertainty of current policy. Quantitative easing as a policy tool is very hard to manage. Traders speculate whether and when the Fed will intervene next. The Fed can intervene without limit in any credit market—not only mortgage-backed securities but also securities backed by automobile loans or student loans. This raises questions about why an independent agency of government should have this power.

When businesses and households confront large-scale uncertainty, they tend to wait for more clarity to emerge before making major commitments to spend, invest and hire. Right now, they confront a mountain of regulatory uncertainty and a fiscal cliff that, if unattended, means a sharp increase in taxes and a sharp decline in spending bound to have adverse effect on the economy. Are you surprised that so much cash is waiting on the sidelines?

What's at stake?

We cannot count on problems elsewhere in the world to make Treasury securities a safe haven forever. We risk eventually losing the privilege and great benefit of lower interest rates from the dollar's role as the global reserve currency. In short, we risk passing an economic, fiscal and financial point of no return.

Suppose you were offered the job of Treasury secretary a few months from now. Would you accept? You would confront problems that are so daunting even Alexander Hamilton would have trouble preserving the full faith and credit of the United States. Our first Treasury secretary famously argued that one of a nation's greatest assets is its ability to issue debt, especially in a crisis. We needed to honor our Revolutionary War debt, he said, because the debt "foreign and domestic, was the price of liberty."

History has reconfirmed Hamilton's wisdom. As historian John Steele Gordon has written, our nation's ability to issue debt helped preserve the Union in the 1860s and defeat totalitarian governments in the 1940s. Today, government officials are issuing debt to finance pet projects and payoffs to interest groups, not some vital, let alone existential, national purpose.

The problems are close to being unmanageable now. If we stay on the current path, they will wind up being completely unmanageable, culminating in an unwelcome explosion and crisis.

The fixes are blindingly obvious. Economic theory, empirical studies and historical experience teach that the solutions are the lowest possible tax rates on the broadest base, sufficient to fund the necessary functions of government on balance over the business cycle; sound monetary policy; trade liberalization; spending control and entitlement reform; and regulatory, litigation and education reform. The need is clear. Why wait for disaster? The future is now.

The authors are senior fellows at Stanford University's Hoover Institution. They have served in various federal government policy positions in the Treasury Department, the Office of Management and Budget and the Council of Economic Advisers.

A version of this article appeared September 17, 2012, on page A19 in the U.S. edition of The Wall Street Journal, with the headline: The Magnitude of the Mess We're In.

Sell everything and buy stocks

We give up. We’re throwing in the towel and recommending everyone sell their managed futures investments and put it all in the stock market. Ok, not really, but can we really ignore this rally anymore. It is almost begging people to sell everything and get involved.
But would you recommend that to anybody in their right mind? Would anyone in their right mind do that?  Given the internet bubble burst, financial crisis, flash crash, and so on;  most people we talk to believe a 50% allocation to the stock market is heavy these days. Yet the market goes onwards and upwards.
Whether it is because of just this malaise towards stocks, or because of the hundreds of billions pumped into the U.S. system by Bernanke & Co. – the U.S. stock market has been the best thing going for investors since March of 2009.
While most of us were (smartly) preparing our portfolios for the next leg down in the crash, for the incredible volatility when China’s economy slowed, for the contagion in Europe when countries there started falling like dominoes – the U.S. stock market has laughed it off, returning to the highs attained before the financial crisis.

But, again, does anyone really trust these past 3.5 years? Does anyone really think the next 3.5 years will be that good for stocks? 
Where do we go from here?
Most people we talk to sure don’t think this is a permanent up move in the stock market (perhaps in and of itself an argument for it to continue).  The common thread is the thought that prices have just come too far too quickly since the 2009 bottom.
We decided to take a look at just how far that is – analyzing the S&P 500’s return since March 2009, or 43 months ago, versus all the previous 43 month periods back to the 1950s. You can see in the chart below that this rally is quickly becoming one of the most impressive of our time. But, you can also see that the last times we were up in this area were in Aug/Sep of 1987 (yeah, that 1987, the one where stocks lost 21% in a day), and in the summer of 1999, right before the internet bubble burst and the Nasdaq fell over -70%.
Does this mean doom is upon us and these levels signal a sharp sell off right around the corner? Not likely. The market could stay elevated at these levels for quite some time. Indeed, the S& P spent 15 out of 26 months at a rolling 43 month return of over 100% during 1997, 1998, and 1999. However, the differences between now and then are well documented. Then, we had an investor driven bubble in the midst of a growing economy and near full employment. Now, it's a government fueled bubble in the midst of a flat to shrinking economy with hefty unemployment.
Relative Performance
Most investors we talk to feel like they missed this stock rally. They tell us how it seemed to risky to get in at the lows in 2009, had come to far too fast to get in during 2010, looked like the world was ending in 2011, and how it would just be chasing at this point… after missing all the other entry points. While they weren’t plowing into stocks because of the perceived risks, many investors were adding protection to their portfolios in the form of non correlated alternative investments such as managed futures.
But this isn’t just about stock market performance, it is also about how managed futures have performed during the up move; and while the stock market was gaining back everything it lost and then some during the financial crisis – managed futures, generally speaking, were not keeping up on a relative basis.
We saw above that the S&P has outperformed the DJCS managed futures index by xxx% since March 2009 – but what is a normal amount of overperformance (after all, we should expect some outperformance of stocks on a pure return basis – given they are roughly 4 times as volatile as the managed futures index).
To explore this, we charted the cumulative return of the S&P 500 total return index with the DJCS managed futures index back to 1994 and highlighted the periods of maximum differences between the two. 
You will see stocks running clear and away better than managed futures from 1994 through 1999, with a max difference in cumulative performance of 242% right before the internet bubble burst and managed futures clawed back the bulk of that difference.
From that crisis period, stocks again started their more aggressive rise, outpacing managed futures for 4.3 years from roughly 2003 through 2007 until peaking at a difference of 182% before the financial crisis hit and brought stocks all the way below managed futures on a cumulative basis since 1994.

Which brings us to the current 3.3 year run up period for stocks, where they have again pried open a significant spread over managed futures, being about 127% better right now than managed futures since 1994.
What do we see in all of this? A pattern of sorts, whereby U.S. stocks outperform managed futures for a 3 to 5 years, followed by a sharp downturn where managed futures catch up, followed by another "expansion" of the spread by stocks into another downturn/convergence, and so on.  Ignoring the current period, the previous two saw an average stock expansion period of 4.8 years and an average max divergence of 212%.
Does that mean this current stock outperformance over managed futures has another 1.5 years and 80% to go? If that’s the case, then you may want to heed our sarcastic advice at the beginning of this piece and ditch your managed futures for a long stock portfolio.  
Or does it mean stocks have put in the bulk of any outperformance over managed futures both in terms of cumulative return (130% out of 200%?) and time (3.3 out of 4.8 years) since the last cross over in performance, and a reversion to the mean is due? Remind us to give the real stock buy signal next time the stock and managed futures equity lines converge...
Or, lastly – does it mean nothing… (always a distinct possibility, but less fun to talk about) and both stocks and managed futures will continue to do what they do independent of one another?
The Managed Futures Seat Belt
Whatever it means, this boom time for stock investors and flat period for managed futures investors has caused more than a few investors to start asking some difficult questions (despite managed futures continuing to add to total assets under management and stock mutual funds continuing to bleed assets).
You see, the sale made to investors was, and the sale still made to this day; is something along the lines of, "You need managed futures in the portfolio to protect against another 2008 type environment.  You need managed futures as a seat belt of sorts to protect against an accident."
Now, we’ve been as guilty as anyone at making that “seat belt” claim and espousing the benefits of managed futures during crisis periods such as 2008. But the thing is – the entire rest of the world is essentially setup to keep the markets from having such crisis periods.  Just think of currency interventions, QE1-3, changes to accounting rules to mask bank losses, bans on short selling, and so on. 
But, the question being asked more and more by those invested in managed futures and seeing the big underperformance of managed futures versus the stock market is a variation of, "What have you done for me lately?" Investors want to know what they're supposed to do in the space until the next big outperformance period comes along. They realized the need for protection against another crisis, but that crisis hasn’t come, and despite all apparent evidence to the contrary, still isn’t here. The question on many investors’ minds is what can this "seat belt" investment do for me when there is no crash imminent. Do I take it off and risk crashing through the windshield? Or maybe I just shift it around a little bit to make it more comfortable (likely lessening its safety profile a bit)?
In short, investors want the crisis period performance of managed futures – but they don’t want to just sit around during non-crisis times – they want returns during those times, too!
Crisis Period vs Absolute Returns
Nobody ever said clients have to have rational expectations. Sure, it helps people in our business if they do, but you can’t blame investors for wanting their cake and eat it, too. In this case, many investors are sick of waiting for the next crisis for performance out of their managed futures portfolio, and want some performance out of it now. They don’t care if the program they are invested in is the largest in the world with 100 phDs on staff and did great in 2008. Most would rather trade in that pedigree for performance in 2009 and here in 2012.
And there are plenty of programs which fit the bill, having done well historically and  doing well during the past 3.5 years when stocks have outperformed the managed futures index. Give us a call to find out which programs our specialists have been recommending to some clients who are looking for performance in the non-crisis period, not just when another 2008 comes.
That is one important point to consider – all of the stats and discussion above centers around the imperfect managed futures index, which we believe to be a good snapshot of the asset class, but a snapshot nonetheless.  The index is also comprised mainly of trend following and multi-strategy type programs which have the long volatility, crisis period performance profile most have come to expect out of managed futures.
Not represented meaningfully in the main managed futures indices are Ag traders, spread traders, short term CTAs, and specialty CTAs dealing exclusively in markets like meats or softs. And wouldn’t you know it – these are the type of programs which have, generally speaking, outperformed the managed futures indices since 2008. These are the types of programs not waiting for the next 2008 – they are giving it a go at earning a decent return right now, in 2012.
But like all things in life, such programs come with a cost, and the question we ask such customers looking at these alternative managed futures strategies… are you willing to forego some of the crisis period performance managed futures is known for in return for some "absolute returns." It isn’t always an either/or proposition, but more often than not – if you want returns during non crisis periods, you are less likely to get the positive returns in the crisis periods. That which makes money in crisis periods is less likely to also be able to make money when volatility is falling and there is no crisis.
So look yourself in the mirror and ask what you want out of your managed futures portfolio. Crisis period performance or Absolute Returns. Your answer may open up new opportunities for you to consider. 


The Investor Sentiment Wheel

The Investor Sentiment Wheel Infographic

Tuesday, September 11, 2012

Monday, September 03, 2012

August -- Another Bad Month for Dividend Stocks

The average stock in the S&P 500 gained just over 3% in August.  But there was a pretty big discrepency in performance between high yielders and low or no yielders.  Below we have broken the S&P 500 into deciles (10 groups of 50 stocks each) based on dividend yield.  We then calculated the average performance of the stocks in each decile during the month of August.  As shown, the decile of the highest yielding S&P 500 stocks rose an average of just 0.62% in August.  Conversely, S&P 500 stocks that pay no dividend rose an average of 5.45%!  A few months ago, investors couldn't get enough of high dividend payers.  Now they want nothing to do with them.

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.