As a counter to FINRA’s legislative maneuvering to become the SRO for investment advisors, House Democrats have introduced legislation that would expand the SEC’s role. Specifically, it would authorize the SEC to assess user fees as a way to expand its advisor examination capabilities.
For the full article, go to the following link:
“Restricting or eliminating the [ETF] business will not solve the sovereign debt crisis in Europe, will not balance the US budget, will not restore bank balance sheets, will not add jobs, and will not repay consumer debt and get them spending again. There are very large, very real uncertainties that are driving global financial market volatility.”
-Eric Noll’s testimony before the Securities Subcommittee of the Senate Banking Committee
In the froth of all financial innovations, fact becomes blurred with fiction. The evolving ETF story has been no different. Recently, however, the froth has lathered itself into a crescendo of misinformation. Indeed, the last year reads like a thriller novel — an imprisoned rogue ETF trader from a Swiss bank, a US congressional hearing and, even globe-trotting stock picker Mark Mobius has taken a swipe at ETFs¹.
Most of the mud-slinging focuses on ETFs’ ostensible link with “unprecedented” market volatility. While these claims have enriched the ETF narrative, critics are confusing causality with correlation. Fortunately, these imagined aspects are wearing down, leaving exposed the bare facts.
The real culprit of increased volatility? By far, it is driven by human responses to global macro instabilities, not the emergence of ETFs or any other investment vehicle … “mutual” funds included. Consider the following counterpoints:
•Volatility spikes are nothing new. Like maple syrup for Canadians, “animal spirits” — that colorful name Keynes gave to human overconfidence — are a staple of financial markets. In periods of prosperity, this naive optimism naturally leads to higher complacency and a broad underestimation of risk. However, these are the timeless and essential ingredients for surges in volatility, as instabilities “unexpectedly” surface (when, in fact, they have likely been building for some time).
Looking at the chart, the misuse of the term “unprecedented volatility” since 2008 is apparent. We have been here before. In fact, the peak in market volatility dates back to “Black Monday’s” crash of 1987 — prior to ETFs’ foray into financial markets. Several macroeconomic events since then have triggered episodes of similar magnitude. Extending this chart further back would also reveal comparable volatility spikes and regime changes.
•ETF data is non-correlated with volatility. The growth in ETF assets shows no correlation to broader market volatility. Looking at the period 2000 – 2005 is illustrative. The chart shows total ETF assets under management rising from USD 74.3 billion at year-end 2000 to more than USD 400 billion by the end of 2005. At that same time, volatility was moving in the opposite direction — trending lower. Since then, total ETF assets steadily marched higher to USD 1.45 trillion, yet volatility has been … well, volatile — again showing no correlation.
What’s more, in today’s globalized financial markets, volatility measures — whether taken in the US, Japan or Europe — are all highly correlated. Yet, the ETF spaces have developed very differently in these regions and account for very different ratios of domestic market capitalization.
•Periods of increased volatility correspond with regime changes. In financial markets, a law of excess applies. Prices — and emotions — tend to run to extremes. Capital becomes braver in bull markets and more timid in bear markets. And, like the present, volatility becomes more pronounced as uncertainties remain stubbornly high. In fact, this has been the case since the turn of this century.
Not surprisingly, this corresponds with the onset of the current secular bear period. Since 2000, intraday price volatility of 4% or more occurred at 6 times the average frequency during the 1960 – 2000 period². Expect this trend to continue as we enter the third period — the most emotionally charged — of the current secular bear. Importantly, these are trends clearly unrelated to ETF development.
•Volatility soars on government wings. It is no secret that government activism has surged since the onset of the global financial crisis. But, less known, is that deficit-driven economies will experience more frequent bursts and lapses in growth, speeding up the cyclical rhythms compared to “normal” cycles. Why? Because private sector driven expansions typically produce organic, sustainable, and long-lasting recoveries.
Government-fueled expansions do not.
The above observation is closely correlated with trends in volatility. Currently, world economies have trouble returning to “normal” growth, despite enormous monetary and fiscal stimulus. 2010, 2011 and 2012 witnessed a similar pattern. The year begins with hopeful expectations (driven largely by renewed stimulus initiatives) and, by mid-year as growth fades, pessimistic outlooks and attendant volatility resume. This merely reflects the tug-of-war between economic realities and increasingly frantic policy responses. Expect these episodic surges in volatility to continue.
What to make of the above? In short, “macro” continues to matter. During periods of heightened volatility like today, security prices are largely driven by big picture factors. That leads to shared fundamentals and higher correlations among individual securities — a key reason for the booming popularity in ETFs. In this environment, the static 60/40 portfolio construct is increasingly dissonant with economic and financial realities. A better approach dynamically allocates by risk factors, instead of rigidly clinging to traditional asset class definitions.
Endnotes:
1. http://business.financialpost.com/2011/10/25/brace-for-volatility-and-beware-etfs/
2. Data from the New York Times.
I attended my wife’s 45-year high school reunion Saturday night. Smallest reunion we’ve been to (we both attended the same high school and both our graduating classes were large). Everyone seemed quite a bit older, moving slower and showing their age. But it wasn’t all negative… there was plenty of happy talk of retirement and grand kids, and those attending were in high spirits and seemed genuinely pleased to see those old faces and hear more about “the rest of the story.”
At the same time, according to the latest American Association of Individual Investors poll, only 22% of investors are happy (bullish). It’s easy to understand this pessimism. Friday’s market was certainly negative, with the Dow sinking 120 points. This morning, prior to the market opening, a 200-point down day looked possible.
The reason being given for the decline was that Spain and Italy were showing further signs of financial crisis. What we termed a temporary fix last month by the European Central Bank has turned out to be – surprise – not enough. And their problems are turning out to be bigger and more widespread than just the real estate and financial industries.
Of course, when the stock market goes down, except for 9/11-type days, it’s usually for a number of reasons. Earnings have been just OK for most companies (about 61% are beating expectations). While revenues (sales) have been dismal – the number of reports beating projections is down to just 44% –that’s 2008 levels. Finally, company guidance on future earnings has been more bad than good – again, the spread is at the 2008 level. 2008 is not a year that stock market investors want to hearken back to, so pessimism is understandable.
This lack of investor enthusiasm is evident in many ways in the technical underpinnings to today’s market. As prices rose during the June-July summer rally, our market breadth indicators failed to confirm the advance. Advance-decline lines, volume and small-cap indices all lagged far behind the popular indices as stock drove higher. This usually means weakness ahead in these same measures.
We had some very positive economic report numbers early last week, but the last four or five were weaker than expected. And at week’s end, the number of reports with weaker-than-expected results exceeded the better reports nine to five. By that time, building permits, unemployment claims, home sales, leading indicators and the Philadelphia Federal Reserve’s report on the economy all had come in weaker than expected.
With all of this economic negativity (including 8%-plus unemployment throughout his term, an almost quadrupling of the debt, and talk of another recession on many investors’ lips), you’d think the Obama’s would be making moving plans. But no, most of the polls the media report show the President leading by a few percentage points.
However, I would point out a little tip I learned from almost 50 years of poll watching in my other life as a political advisor. When the media starts reporting polling results in a Presidential race, they start with polls that are inclusive of everyone. About this time of the year they move on to polls of registered voters only. At the same time, however, all the political insiders care about are the few scattered polls that survey only “likely voters.” These have the best track record of calling the election, but the general public is not usually exposed to them until the last month or so of the election.
As you might guess, the broader, earlier polls normally have a Democrat bias. Democrats believe their party to be more inclusive and these earlier polls tend to bear this out, as more people self identify with that party and these early results favor their candidates. Yet, a higher percent of Republicans generally vote, so the “likely voter” tallies tend to favor that party more and the results have been closer to the final election totals.
Eight years ago the polls showed John Kerry with a 48.8% to 43.5% lead over President Bush. Of course, the final result was reversed.
Right now the average poll (in the 7/5-7/12 period) shows President Obama with a 1.2% lead over Mitt Romney. The registered voter polls have him up by 2% with a range of -1% to 6%. At the same time, the likely voter polls have Romney up 0.7% with a range of -1% to 3% in the latest poll with the biggest sample size of all the polls in the period.
Now, note all but one of these poll results is within its margin of error. And things can change quickly (the VP choice looms large for Mitt Romney, for example). Still, to add a new dimension to your 2012 election watching, make a point in the next three and a half months to watch for the “likely voter” polls – it’s always disclosed in the fine print.
I have to admit, the positives are few and far between right now. It does appear that the market today has weathered most of the storm, recovering from the big down opening but still closing down 100 points.
Interest rates are moving still lower with mortgages and bonds at record levels. This is normally positive for stocks in the intermediate term as they compare very favorably with bonds on a yield basis.
And …have you refinanced lately?
The dollar continues to move higher and inflation (other than in the farm commodities and a resurgent oil market) has been flat.
US stocks continue to outperform most of the world markets and large-cap US stocks have been the place to be. Even on the earnings front, the large caps are encouraging, as 76% of the S&P 500 companies have been beating analyst estimates this quarter. We continue to operate under a golden cross environment and prices remain above their best indicator of a positive trend – the 50-day moving average.
Last week’s Century Theater massacre saddens America’s hearts once again. The daughter of one of our Financial Advisors, Petra Anderson, was caught in the cross fire Thursday night. Hit in the arm and head, we hear her operation Friday afternoon was a success and that she is recovering. Our prayers are with the family and friends of those involved in this tragedy and most particularly for this very talented recent grad of the University of the Pacific and her loved ones.
http://www.pacific.edu/About-Pacific/Newsroom/2012/May-August-2012/Statement-on-Petra-Anderson.html
Donations to help: http://www.indiegogo.com/readytobelieve?c=home
So yes – it isn’t all negative, is it? … But, I understand … sometimes it sure feels that way.
All the best,
Jerry
Daily State of the Markets
Wednesday, July 25, 2012
By David Moenning
On Monday afternoon, I heard an awful lot of talk about the “great action” seen in the major indices. While I initially argued that a drop of 240 Dow points could hardly be considered “constructive action” in my book, I knew full well that I was being petty due to the fact that it was the big rebound from the lows that was being referenced. And while I countered with the idea that much of Monday’s eye-popping bounce was due to rumors of this and that, the bottom line to pure market technicians was and always will be the action on the chart.
To be sure, I am not a pure technician. No, I’m more like the kiddy version of a technician. While I would never dream of taking a position without consulting a chart and I will admit to spending the vast majority of each day poring over six screens full of squiggly lines and flashing quotes, I prefer the old-school stuff like trendlines, support and resistance, and some almost-fancy moving averages. So, before I hung up the phone with my techy buddy, I did manage to slip in the idea that if Monday’s rumors proved false (again) then the bulls might be in for some trouble.
Then came Tuesday. To put it mildly, the news flow was abysmal and stocks reacted appropriately. Suddenly the “great action” – which, to me at least, was indeed tied to the rumors du jour on Monday – was gone. There was some good news to report in the early going as China’s PMI was the best in several months. But after that, things went downhill in a hurry.
So let’s review. First, after the bell on Monday, Moody’s, having gotten bored with the easy stuff, decided to up the ante and cut their ratings outlook on Germany, Netherlands, and Luxembourg (I know, even Luxembourg!). Moody’s cited “rising uncertainty regarding the outcome of the euro area debt crisis” and “the increased susceptibility to event risk stemming from the increased likelihood of Greece’s exit from the euro area” as reasons to hint that they may soon be downgrading Europe’s biggest and baddest economy.
Next came the early morning earnings where DuPont (DD), Altria (MO), and AT&T (T) all followed the current trend of missing revenue estimates. Then came United Parcel (UPS), which hit the trifecta by missing on both the top and bottom lines, cutting their guidance for next quarter, and then talking of uncertainty going forward. Thus, even the most enthusiastic bulls are going to have a hard time arguing that earnings continue to be great.
Next up was the economic data, which wasn’t pretty on either side of the Atlantic. The European Flash PMI’s were weak with the Eurozone Manufacturing number at 44.1 and the Services at 47.6. And then the new Flash version for the U.S. (aka a guesstimate for the ISM numbers to come) came in at the weakest level in 19 months. Ouchie. Now toss in nothing short of an implosion in the Richmond Fed index and PIMCO’s Bill Gross was prompted to suggest that that the U.S. economy might be getting dangerously close to the zero-line.
Oh, and lest we forget, Greece somehow made a big comeback on Tuesday as EU officials, who were auditing Greece’s books to check on the progress the country had made on its fiscal targets, basically said there is no way in heck that Greece was going to hit their targets. I know what you’re thinking – who cares, right? The point is that with the IMF saying this week that it just might cut off aid to Greece and Athens only having cash to cover expenses through September, well, it looks like that “Grexit” everyone was talking about a while back could become a reality. And with the ECB and Europe’s central banks still holding a big batch of debt at par, this could become a problem.
Speaking of bond yields, the 10-year bonds of Spain and Italy closed the day at all-time Euro-era highs (not a good thing) while the benchmark 10-year in the U.S. moved to an all-time low during the session. And then yields in Germany remain negative on paper with durations up to 2 years. Thus, analysts looking for the flight-to-safety trade didn’t have to look very far yesterday.
Finally, there is the fact that the pattern being traced out in the stock market right now is eerily similar to that seen a year ago. And with my calendar showing that August 1st is right around the corner, there is a certain segment of the trading population that expects things to get downright ugly again – and soon.
All of the above brings me to the question of the day. We all know that Mr. Bernanke likes to lead the cavalry charge to come to the rescue when things look bleak. And to be fair, stock prices in the U.S. are hardly in trouble from a longer-term standpoint. However, based on the big-picture macro view, there are those who argue that now is time for Bernanke, Draghi, et al to pull the trigger on “the bazooka” (aka a globally coordinated central bank response with some “shock and awe” involved) before things get out of hand. And while I can argue both sides here, there are a great many traders who are wondering if now is the time to go ahead and pull that trigger. (And the WSJ’s Jon Hilsenrath’s late-day rumor that the Fed is “getting closer to taking action” certainly supported this thesis into yesterday’s close.)
Thought for the day…Courage is knowing what not to fear. -Plato
Have a great day!
Dave M.
David Moenning
Direct: 303-670-9761
email: DaveM@StateoftheMarkets.com
www.StateoftheMarkets.com
Positions in stocks mentioned: none
For up to the minute updates on the market’s driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)
The opinions and forecasts expressed are those of David Moenning, President of Heritage Capital Management (HCM) and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security or Heritage Capital program. No part of this material is intended as an investment recommendation. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any of HCM’s programs. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that investment objectives outlined will actually come to pass. Investors should consult an Investment Professional before investing in any investment program. Neither Mr. Moenning or Heritage Capital Management nor any of their employees shall have any liability for any loss sustained by anyone who has relied on the information contained herein. Mr. Moenning and employees of HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while this publication is in circulation. The analysis contained is based on both technical and fundamental research. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
When to Move Back to Stocks?
By Wilfred J. Hahn , CIO
Our title echoes a question most will fondly remember from Sesame Street. Our query here, however, deals with much more ponderous matter than an assortment of animal pictures or some such. We’re referring here to the various factors underpinning bond markets these days. Some of these just don’t belong together. As we’ll show, this dissonance is likely to mark a major turning point to higher equity weightings. We’ll outline our reasoning on this point.
For the time being, a high bond weighting has again served to counteract equity market declines. As interest rates have plummeted to new lows — in the case of the U.S. long-term rates falling to 220-year lows at one point— bond holdings have soared in value. As such, our defensively postured portfolios have benefited from out-performance in recent months. While our views on bond market trends have been spot on these past 3 years, really, just how much lower can rates go? Yes, rates can fall further. But likely not much.
Consider these five trends as of late. We challenge you to pick “which are not like the other” … in other words, incompatible with expectation that bonds will continue to outperform stocks.
Imaginative as one might like to be, common sense would argue that this last observation is one “that just doesn’t’ belong” according to the Sesame Street jingle. Outperforming bond markets are not sustainable.
That observation sharpens our attention, as anything “non-sustainable” should be a call to prepare for action. “What cannot continue, will stop” according to the famous Herb Stein quote. Yes, of course, timing is crucial. When primal investor emotions run rampant due to fears of bank bankruptcy, sovereign default, another economic recession … etc., there is no telling how extreme market distortions may yet become. But, as mentioned, what cannot continue will stop and stop it will … some day.
Consider the following comparatives between equities and bonds right now (we here focus upon U.S. statistics):
Which of the above eight factors don’t belong together? Actually all of them do. And, they all indicate that equity markets stand to sharply outperform bond markets markedly over a 3 to 5 year view. In our case, with an underweight in equities, it may not be too early to begin to increase holdings, especially so that investor pessimism remains deep. Eventually, future market actions will again serve to change sentiment and opinion amongst private and institutional investors.
Daily State of the Markets
Monday, July 9, 2012
By David Moenning
I recognize that regular readers of my meandering morning market missive may very well roll their eyes at the idea of comparing the opening lines of the soliloquy in William Shakespeare’s Hamlet to the current macro mess investors find themselves facing. Clearly the question of whether or not “to be” had a far deeper meaning in Hamlet. However, if you are interested, give the first few lines a quick read through and tell me that if by substituting “QE” for the word “be,” the lines don’t have some meaning in today’s rather heavy hearted and dramatic global macro environment.
To be, or not to be, that is the question
Whether ’tis Nobler in the mind to suffer
The Slings and Arrows of outrageous Fortune,
Or to take Arms against a Sea of troubles,
Yes, you are correct; applying one of literature’s most famous quotations to the problems facing today’s central bankers is the very definition of trite. But after reading the four lines and making the referenced substitutions, I’m guessing that even an Econ 201 student can see what I’m getting at.
While I’m guessing that the members of the Federal Open Market Committee don’t spend a lot of time quoting Shakespeare, the questions facing those in charge of keeping the world’s most important economy out of the soup seem to apply. For it is clear that our hero, aka “The Bernank,” has made keeping the USofA out of a self-reinforcing deflationary spiral his life’s calling. One might even say that he is deeply passionate about his current quest as he once proclaimed that he would drop dollar bills from a helicopter in order to keep the economy moving.
The problem is that our economy’s champion is faced with a monumental problem that doesn’t seem to have an obvious answer and very little in the way of history to guide him. Thus, “The Bernank” may have to go with his heart on this one. And the good news is that for those awaiting his decision, the wait is likely to be rather short (the next Fed meeting is scheduled for July 31 – Aug 1).
To be sure, the stock market is also hanging on the question of whether or not “to QE.” Rarely has this been as apparent as it was on Friday. With interest rates, spreads and CDS in Spain and Italy heading in the wrong direction, the stock market was predisposed to continue heading south. And then when the Labor Dept. announced that the economy had produced just 80,000 jobs in June, it looked like things could get ugly. And ugly they got as the Dow found itself down 195 points around the time the lunch bell rang on Friday.
The problem was that the gain of 80,000 jobs wasn’t strong enough to give investors hope that the economy would soon rebound. Nor was the number weak enough to cause the Fed to take action. Thus, investors were left with the idea that the economy would perhaps “muddle through.” And cutting to the chase, this just wasn’t good enough. So, with Europe looking like it might implode, China slowing and the U.S. economy in “zombie” mode, things were not looking good.
At about 2:30 eastern time on Friday, the Twittershpere started joking about the idea of a rumor hitting the tape in order to spruce things up into the close. In its usual sarcastic tone, ZeroHedge opined that the market needs a Hilsenrath article to save the day (this was a reference to the fact that the WSJ’s chief Fed watcher, Jon Hilsenrath, has become notorious for giving the algo bots something to work with whenever things look bleak). I joined in the fun by tweeting, “Paging Mr. Hilsenrath… Mr. Jon Hilsenrath… Please report immediately to the bull camp trading desk for your assignment.”
While this was all in good fun on a summer Friday, I wasn’t completely surprised to read that one hour later Mr. Hilsenrath had indeed been quoted as saying, “Weak jobs data increase likelihood of Fed action, but don’t ensure”… and “Some officials interested in Fed mortgage bond purchases.” In English, these two quotes meant that Hilsenrath, who is said to have an inside line to the Fed’s inner circle, felt that the odds of QE3 had improved and that the Fed would target MBS (mortgage backed securities) in its next program of security purchases.
Being nothing if not diligent, the computers picked up the quotes and before you could confirm the spelling of quantitative easing, the S&P was moving up. Suddenly there was hope again. Hope that our story’s hero would come to the rescue with yet another plan to do something (anything!) to keep the economy from following Europe into recession.
So, if you find yourself confused by the volatility we will undoubtedly see in the markets over the next three weeks, just remember the key to the game right now in the U.S. is one very simple question…
Thought for the day… “The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” — William Arthur Ward
Have a great day!
Dave M.
David Moenning
Direct: 303-670-9761
email: DaveM@StateoftheMarkets.com
www.StateoftheMarkets.com
Positions in stocks mentioned: none
For up to the minute updates on the market’s driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)
The opinions and forecasts expressed are those of David Moenning, President of Heritage Capital Management (HCM) and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security or Heritage Capital program. No part of this material is intended as an investment recommendation. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any of HCM’s programs. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that investment objectives outlined will actually come to pass. Investors should consult an Investment Professional before investing in any investment program. Neither Mr. Moenning or Heritage Capital Management nor any of their employees shall have any liability for any loss sustained by anyone who has relied on the information contained herein. Mr. Moenning and employees of HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while this publication is in circulation. The analysis contained is based on both technical and fundamental research. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
The Investment View from Prescott, Arizona
By Will Hepburn
The tug of war in the bond market continues with the Federal Reserve insisting that they have enough ink in the printing presses to generate the dollars needed to continue buying bonds in the attempt to keep the interest rates low.
Actually, Operation Twist, as they call it, is a smart move by the Fed, even if it is for reasons other than what they state.
Many of us who remember the Savings and Loan collapse 20-some years back have had an eerie feeling of deja-vu watching the fed finance the long range federal debt by buying up the Treasury’s short term bills and notes as fast as they are printed – keeping short term rates low in the process.
The risk they run is that if interest rates ever do slip out of their control and short term rates spike up as the short term notes mature, they will need to be replaced by higher and higher paying notes, right then, or there will be a default. That was the mistake of S&L managers 20-some years ago, borrowing short term (CDs) and making long term loans.
With 2-year notes paying only 3/10%, this dynamic has the potential to increase the cost of servicing the government debt by as much as 20 times if rates move quickly to the historic average yield on Treasuries which is close to 6.0% since WWII.
Our current federal budget is around $3.8 trillion, and current interest on the Federal debit is a little over $500 billion. What do you think would happen to this country if that $500 billion of interest became 20 times more – $10 trillion? Now that would be a problem.
By buying longer term bonds instead of shorter term bonds, not only does the Fed hold down longer term interest rates, but they can avoid having many of their IOUs come due within a short time – probably when interest is highest if Murphy’s Law still holds true.
So, as easy as it is to pooh-pooh those guys in Washington, with Operation Twist, which is their name for selling short term notes to buy long term bonds, at least they are locking in those oh-so-low interest rates for the U.S. while the locking is good.
That is a smart move.
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