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Wednesday, December 22, 2010

Stock Pickers Market ? According to the WSJ The Answer is Yes...or No

wsj sept 24, 2010

'Macro' Forces in Market Confound Stock Pickers


wsj Dec 18, 2010:

The Return of The Market-Beating Fund Manager

The Stage Is Set for Stock Pickers to Shine. Here's What You Need to Know to Find the Best 


an analysis of the December 18 article is forthcoming

A Peek At the Future For the US ?

 No movement on the budget deficit and I certainly wouldn't rule it out. This is the scenario smart people have been warning of for years. Of course in more subtle ways than this (below) it may already be happening.

 from the FT:

China extends help to tackle euro crisis

By Jamil Anderlini in Beijing and Peter Spiegel in Brussels
Published: December 21 2010 13:00 | Last updated: December 21 2010 18:44
China has promised to take further “concerted action” to support European financial stabilisation, including continuing to buy the bonds of countries at the centre of the sovereign debt crisis, according to senior European officials....

Beijing has emerged as one of the more enthusiastic backers of distressed European sovereign debt in recent months.....

Mr Wang’s comments boosted the euro’s value against the US dollar, but China’s public support for Greece and Portugal over recent months has not prevented their bond yields remaining near record highs.
European officials said that although China had not explicitly linked its bond purchases to any specific issues, Beijing asked in the talks for the EU to grant it “market economy” status and lift a long-standing arms embargo.

Monday, December 20, 2010

Bond Funds: Exactly As I Expected

 In my view this (below)was totally predictable: investors piled into bonds with the rationale that they were seeking a "safe investment" while in fact they were simply chasing the outperforming asset class. And with low yields at the short end of the yield curve they piled into longer term bonds...which are the riskiest once rates start to rise. Meanwhile corporations rebuilt their balance sheet by selling billions of $ in low interest rate long term debt.

WSJ reports:

Bond Funds Take It on the Chin 

Bonds are supposed to be safe,(in my view anyone that understands bonds knows that long duration bonds are in fact quite risky remember a 20 year duration bond falls 20% in value with a 1% increase in rates)
but the world's five largest bond mutual funds have all posted losses in the past two months—with three of them losing more in December than in November.
And now surprise here the retail investors are bailing from the bond funds.
As the losses mount, investors are pulling back. They yanked $5 billion out of bond funds during the week ended Dec. 15, pushing the five-week total outflow to a record $7.6 billion, according to EPFR Global, a Boston fund-flow tracker.
A selloff in U.S. Treasurys is spreading to most bond sectors, including corporate and municipal bonds. The yield on the benchmark 10-year Treasury, which moves in the opposite direction of price, has jumped about a full percentage point in the past month on fears that aggressive monetary and fiscal stimuli could trigger inflation and higher interest rates down the road.
"This is the first time you've seen a broad selloff across bond sectors since October 2008," says Miriam Sjoblom, an analyst at investment-research firm Morningstar Inc. Back then, at the worst of the financial crisis, the Barclays U.S. Treasury Index lost a fraction of a percent, while other credit sectors got slammed.
While the five biggest bond funds are still up for the year, they have performed poorly of late. The $250 billion Pimco Total Return Fund, the world's largest bond fund, lost 3.42% from Nov. 4 through Dec. 17, compared with a 2.51% loss in the BarCap U.S. Aggregate Bond Index over the same period, according to Morningstar. The second- and fourth-largest bond funds, the $89 billion Vanguard Total Bond Market Index Fund and the $38.4 billion American Funds Bond Fund of America Fund, respectively, have lost 2.64% and 2.79%.

and investors learned the meaning of duration and the relative risk of short vs long term bonds:
The losses were smaller in the $38.3 billion Vanguard Short-Term Investment Grade Fund, which lost 0.91% over the period in part because of the fund's shorter-duration securities, ...
Three of the five largest funds have lost more so far in December than they did in November. Through Dec. 17, Pimco Total Return, Vanguard Total Market Bond Index and American Funds Bond Fund of America were down 1.31%, 1.60% and 1.34%, respectively, while the Vanguard Short-Term Investment Grade Fund was down 0.40%, according to Morningstar.

The interesting question is how the flood of retail performance chasing investors has changed the behavior of a market usually dominated by insurance companies, pensions and endowments. It is quite possible that much like the commodity markets which have more retail investors due to the growth of etfs, we will see a more extreme move in bonds caused by the retail outflow. At some point this will provide an opportunity for savvy buyers of bonds just as the low rates caused by the retail buyers created an opportunity for corporations to float cheap debt..


Steepening Yield Curve Economic Optimism....Or Something Else

WSJ reports on the steepening yield curve,

Economic Optimism in Treasury Yield Curve

NEW YORK—A closely watched gauge in the Treasury-bond market is signaling the U.S. economy may gain more traction.
The spread between shorter- and longer-maturity U.S. government-bond yields has widened to near a record high as longer-dated yields rise on expectations that inflation pressures will revive....

The common theory is that when yield spreads widen, which is when the so-called yield curve steepens, it suggests investors are optimistic about the strength of the economy. They are demanding higher yields in longer-dated Treasurys than in shorter-dated ones in order to compensate for the risk of inflation, which is a main threat to bonds' fixed returns over time.

When yield spreads widen, banks are the big winners because the lower short-dated yields mean they can borrow cheaply to fund short-term obligations while lending out to businesses and consumers at higher rates.
Higher long-dated Treasury yields also help pension funds and insurance companies cover their long-term obligations. The flip side is that higher yields push up mortgage rates. Homeowners' mortgage rates tend to track the 10-year Treasury yield, and higher rates hurt the already-struggling housing market. It also gets more expensive for companies to borrow in capital markets.
A couple alternative  or additional explanations:

  • The selloff in long bonds corresponded with the passage of the tax cut extension. While it may spur growth the tax cuts will almost certainly increase the deficit (sorry Mr. Laffer I'm not a believer in your curve. After all the tax cut is really keynesian it is deficit spending or has the same effect, perhaps more efficiently than a stimulus plan... perhaps not.

  • So perhaps the bond vigilantes of the Clinton era are back fearing more supply coming on the market pushing down prices and raising yields. This is probably a mixed blessing remember that the bond vigilantes pushed the administration to close the budget deficit. The treasury stopped issuing long term bonds during that period (no need to fund a large deficit) and rates fell.
  • The large retail flows into bonds came from investors who were ignorant that it is quite easy to lose money in bonds particularly in the longer maturities I wouldn"t rule out large outflows from the funds pushing  bond prices down.
  • \By contrast the natural buyers of bonds pensions, endowments and insurance companies who constantly have new inflows look at higher rates as a welcome respite since the higher rates make it easier to meet their futuere obligations, 
  • The otrher group to have a natural benefit from a steep yield cuve  as they borrow short (deposits and cds) and lend long with mortgages. Of course the higher mortgage rates are likely to slow down whatever recovery exists in the real estate market/
  • While retail investors likely got burnd with rising long term rates, corporations, as I noted were playing the low long term rates correctly. Those that issued long term bonds throughout the year benefited from record low rates. Unfortunately for the economy they have been using the cash for stock buybacks and dividends not job creating investments.
Of all the arguments for the yield steepening I find the inflation argument the weakest. First off I have faith that signs of economic growth will be swiftly met with contractionry monetary policy.

Mr. Market has expressed an increase in inflation expectations . This cambe seen in terms of the TIPS/Conventional Treasuries doens't indicate a particularly strong forecast of inflation The real yiield on the 10 yr tip  moved up this month from .83 to 1.05% that puts the implied inflation forecast for the next 10 years of 2.83% within the Fed's target inflation rate but quite a good sized move from 2.12% at the beginning of the month.

Saturday, December 18, 2010

When Is A Bond Fund Not Exactly A Bond Fund ?

Seems like the answer is most of the time when it comes to actively managed bond funds. I have long been a critic of the Pimco Total Return Fund. I pointed out that due its lack of transparency and mandate to go anywhere in the fixed income arena, one never really knows how one's bond allocation is invested,

Bloomberg reports that the "go anywhere " fund can know venture into securities directly linked to the equity market:

Bill Gross’s Pimco Total Return Fund, the world’s largest mutual fund, is expanding its policy to allow investments in equity-linked securities for the first time since 2003.
Pimco Total Return may put as much as 10 percent of assets in securities including preferred stock and convertible bonds as early as the second quarter of next year, according to a filing today with the U.S. Securities and Exchange Commission. The fund won’t invest in common stock, the Newport Beach, California- based firm said.
The article mentions a point I have been making for quite a long time. Holding this fund is more of a act of faith in Bill Gross's asset management skill than a choice of bond allocation. Gross can pretty much invest in any type of bond he wants dollar or non dollar denominated:

Gross, who said in October that asset purchases by the Fed will probably signify the end of the 30-year rally in bonds, has invested the Total Return fund in a mix of government-related debt, mortgage securities and emerging market bonds. A top performer over the past five years, the fund trailed most of its large rivals during a debt selloff in the past month.
What was particularly strking to me was that according to Morningstar venturing into convertible bonds and preferred stock is commonplace among actively managed fund. And the Morningstar analyst whose role is supposedly to look out for the interests of the retail investor sees nothing wrong with this:

“This brings Pimco in line with other bond funds in the same category and gives them more flexibility,” Miriam Sjoblom, an analyst with Morningstar Inc. in Chicago, said in an interview. “In moderation, this could increase returns without adding considerable risk to the portfolio,” she said.

Despite all the evidence that Morningstar research produces on the advantages of indexing somehow their analysts always seem to repeat the party line of the active managers : in this case the assertion that it is possible to increase returns without adding risk.. I would look at this fact as more evidence that a proper allocation should include the exact opposite of these "go anywhere " bond funds, The use of index instruments with clear limitations on what they hold is the better path to transparency and managing risk.

Wednesday, December 15, 2010

I Agree With Him....But At Least So Far We Have Both Been Wrong

I wrote on Nov. 29 that the selloff in muni bonds may represent a longer term buying opportunity. Apparently "bond guru" Bill Gross, the world's largest bond manager agrees with me (or should I say I agree with him) Investment News reports

Bill Gross bets big on muni bonds

Plows $4.4M of his own money into tax-exempt funds; 'optimism about a recovery'

December 14, 2010Bill Gross, the co-chief investment officer of Pacific Investment Management Co., spent $4.4 million of his own money this month to purchase shares of five municipal-bond funds run by his firm after tax-exempt debt tumbled.
Gross, 66, who manages the world's biggest bond fund at Pimco, has more than doubled his holdings of the firm's closed-end municipal bond funds, according to Securities and Exchange Commission data. He bought about 451,000 shares of Pimco municipal bond funds in December, bringing his total holdings to about 878,000 shares.
The municipal bond market has dropped in the past two months due to a jump in new bond issuance and rising Treasury rates. Tax-free holdings lost 2.29 percent in November, the third consecutive monthly slide and the longest since 2004, according to the Bank of America Merrill Lynch Municipal Master Index, which accounts for price changes and interest income.
“Bill Gross's leadership in being a buyer is notable as it reflects his optimism about a recovery in the underlying fundamentals of municipal bonds,”....

He bought 50,000 shares of the Pimco Municipal Income Fund III on Dec. 10 at an average price of $9.75, according to public records. That fund hit a 52-week high of $12 on Sept. 8

At least for now it looks as if we bothwere a bit premature. 3 month chart of MUB municipal bond etf is below

Tuesday, December 14, 2010

Chasing Returns as Asset Allovcation....Late to the Party ?

As is almost always the tendency of retail investors their footprint is seen in chasing top performing assets. This was clearly the case in November. Index Universe reviews the flows in November. Money flowed to (surprise !) emerging markets and small cap stocks in November quite late to the party after these asset classes are closing out a year strongly outperforming the broad based stock and bond indices.

As I have mentioned there is a strong tendency for such flows to continue at year end and the beginning of the new year. After that it is anyone's guess but the large flows of funds into the market that is late to the party leaves the market vulnerable to a sharp selloff should these asset classes start to fall.

Looking at the ytd  relative performance of the funds with the major inflows vs the sp 500, total us stock market (vti) and aggregate bond index (AGG) it's pretty clear the flows chased performance

Here is the table with dollar inflows in millions.:

VWO Vanguard Emerging Markets Vanguard 1,734.80

VO Vanguard Mid-Cap Vanguard 1,322.14

IWM iShares Russell 2000 BlackRock 1,201.37

VB Vanguard Small-Cap Vanguard 833.40

IWD iShares Russell 1000 Value BlackRock 669.54

SLV iShares Silver BlackRock 567.84

VBR Vanguard Small-Cap Value Vanguard 494.27

VBK Vanguard Small-Cap Growth Vanguard 484.19

FAS Direxion Daily Financial Bull 3x Direxion 404.85

MINT PIMCO Enhanced Short Maturity Strategy PIMCO 403.29

Monday, December 13, 2010

Performance Chasing Bond Fund Money Is Starting to Flee

As I have pointed out much of the massive retail flows into bond funds likely doesn't reflect as much of a search for "safety" vs stocks as simply chasing the asset class with the most recent outperformance. Therefore as the bond market has reversed it didnt surprise me to see the following in Barron's

Since the Pimco Total Return is by far the largest bond mutual fund (and often shockingly the only bond fund choice in some 401k plans I have seen). The outflow from the fund is likely indicative of a larger trend among bond funds.

from the Barron's article

Pimco Total Return Fund Slips In Past Month; Investors Pull Money

The Bill Gross-led Pimco Total Return Fund (PTTRX) faced $1.9 billion in redemptions during November — its first month of net outflows in two years, according to Morningstar.
Another aspect of the large exodus from this fund is another issue I have raised before. As a "go anywhere fund" investors have no idea how the portfolio is allocated as to credit quality, bond category, duration and even nationality of the bond's held in the portfolio, The investment in this fund is less an investment in an asset class and more a bet that manager Bill Gross would continue his market beating record. It was inevitable that the fund would stumble and inevitable that hot money would flee the fund once that happened, The fund is down around 6% mtd,  underperforming the index (see 3 month chart vs the the total bond market etf AGG) 

Of late it is underperforming the other large active funds as wel more from Barron'sl:

A separate report by Bloomberg comparing return data over the past 30 days, through Dec. 8, found that PTTRX lost more than all but one of the 10 largest bond mutual funds.
The only top 10 bond fund that did worse was the Vanguard Inflation-Protected Securities Fund (VIPSX).
 The reason behind the decline may be because Pimco has revised it's much publicized forecast of the "new normal with lower returns and slow growth. It seems plausible based on this view they would hav been positioned on the long end of the yield curve. The fact that their performance underperformed the indices in a month when the long bond sold off sharply is additional evidence leading to that conclusion,

As for the forecast the never shy Mohammed el Erian of Pimco is back in the media with what I guess is his "new,new normal:

Equities climbed on Dec. 9 when Mohamed El-Erian, the chief executive officer and co-chief investment officer of Pimco, raised his forecast for next year’s U.S. growth as policy makers spend up to $600 billion to buy Treasuries through so-called quantitative easing. Pimco said the economy may grow 3.5 percent in the fourth quarter of 2011 from the year-earlier period, up from 2.5 percent.
Pimco, manager of the world’s biggest bond fund, said since May 2009 that gains in financial assets would be below historical averages for years to come. Bill Gross, the other co- chief investment officer, said on Dec. 3 that a Labor Department report showing hiring trailed forecasts in November shows gross domestic product isn’t expanding fast enough to sustain market rallies.
‘Stable Wings’
The old normal was 6 to 7 percent,” Gross said in a Dec. 3 radio interview on “Bloomberg Surveillance” with Tom Keene. “The new normal is a 3 percent plus or minus nominal GDP. It speaks to 2 percent growth and 1 percent inflation. We are running at a half-size-paper-airplane type of economy as opposed to one with stable wings and full thrusting jet engines.”

That bond funds in general and PTTRX specifically should see such large outfolows after one bad month indicates that further declines in bonds will lead to more outflows which could lead to further bond declines which in turn could cause more outfolows triggering a negative circle.

The question is where the money will go. My feeling is that historical patterns will continue and the money will flow into stocks with investors particularly chasing the outperforming categories: emerging markets, small caps and commodity related companies as well as commodities themselves.

Two tendencies that tend tto occur and at year end and the beginning of the new year are likely to push these classes higher,

1.The practice  of window dresssing by money managers who want to show they hold little cash and own the top performers 

2. The retail readjustments that often occur at the beginning of the year when investors put new IRA contributions to work and readjust their allocations.

This should lead to some momentum through the beginning of the year...after that who knows. My inclination would not to be to add to these asset classes to ride the momentum but rather to rebalance holdings of these asset classes sometime early in the year to capture that rebalancing premium. Year end is probably not the best time to do the rebalancing. As this article points out the argument for tax harvesting before year end my in some cases  not be as persuasive as generally thought.

Thursday, December 9, 2010

Long Term Bond Bubble Bursting ? What Will Retail Investors Do ?

I have written for quite awhile that in the bond market it has been the dumb money buying long term treasury and corporate bonds and "smart money" corporations grabbing the cheap money by issuing record amounts of corporate bonds. The low long term rates were unsustainable. Yesterday's bond sellofff attributed by some to the higher growth and larger deficits that may come out of the tax proposals show how violent the moves can be in long term bonds.

Retail investors have been flocking into bond funds for the last year or more. Supposedly this was in search of "safe investments" compared to the volatile stock market where they had suffered losses. In fact I would argue they weren't looking for safety but rather chasing returns of the most recently outperforming asset class.

These investors were simply riding the last wave of a massive decline in interest rates/rally in bonds. The positions were hardly "safe investments" particularly if they extended maturities in their bonds to avoid the paltry yields in the short maturities., As rates went down the longer duration bonds gained disproportionately compared to other bonds, I assume for some investors this was evidence their bond investments were ""safer" than stocks.

But as these investors are probably just starting realize, what goes up the most can go down the most, Those long duration bond holdings will suffer greatly should rate rise. Just the relatively modest increase in long term rates of late has been quite damaging to holders of long term bonds. Over the last 3 months TLT the 20 year+ treasury bond etf has declined 8.3% while the short term treasury bond etf SHY is unchanged. Surely all bonds are not equally "safe" investments

One very interesting question is how the "new" bond market filled with many,many more returns chasing retail investors (as opposed to a market in the past dominated by institutional investors) will react when rates bottom and they start to seee losses in their bond funds. If many of them run for the exits at the same time it could get ugly, More on that in the future.

Monday, December 6, 2010

How Dumb Money Could Get Smarter

I have noted many times how retail investors chase hot asset classes and wind up buying high and selling low. WSJ reports on some research that supports that observation and recommends a remedy:

Over the years, the funds research company Morningstar Inc. has found that investors can profit if they invest in the most-unloved stock-fund categories and hold on for the next three to five years. Sometimes, the least-popular categories can be narrow ones on which you might not want to place a big bet.
But this year, through October, the biggest redemptions by investors have been in three bread-and-butter categories focused on large stocks in the U.S. and abroad: Morningstar's large-growth, large-value and world-stock groupings.
If your gut reaction is, "Thanks, but I don't do charity cases," think again. It's an old story: Ugly-duckling mutual fund transforms into profitable swan.
Chicago-based Morningstar found that buying what other investors sell generated a 3.7% annualized gain over the decade through July, while the most-loved fund categories lost an average 1.2% a year and the Standard & Poor's 500-stock index shed 0.8%. (The most-loved categories this year through October: diversified emerging markets, commodities and foreign large blend.)

More Evidence That Past Performance of Actively Traded Mutual Funds is a Poor Predictor of the Future

from the wsj
We looked for diversified U.S.-stock funds in the top 20% of their Morningstar Inc. category for the past five or 10 years but now in the bottom 10% of their peer group so far in 2010. There are more than a dozen such funds that recently had at least $500 million in assets.

No Surprise For Me in this Report

my post of Nov 29

Next Asset Class For the "Dumb Money" to Flee: International Bond Funds ?

While some are voicing concerns about retail investors soon fleeing corporate and high yield bonds my view is that the next asset class to see the outflow is foreign bond funds. Investors flocked into this asset class in search of higher yields and I have never liked this asset class. Specidfically I argued that investors were better off in emerging  market bonds and stocks.

WSJ today
Money left bond mutual funds in the two weeks through Nov. 23, according to the Investment Company Institute, the first outflows since December 2008, roughly when the bond bull market began.
Even seemingly bulletproof emerging markets have suffered bond-fund outflows for two straight weeks, according to data tracker EPFR Global.

The Pain of Contango in the VXX But Not Time to Throw In the Towel

The VXX short term volatility etn rolls over contracts on an ongoing basis selling the near term futures as it nears expiration and buying the near one. As a consequence, when the volatility curve is steep indicating investors are nervous about long term volatility in the form of  a sharp selloff even if the near term market is stable and moving upwards.

This has been the case with the VXX which has the strange characteristic of sharply increasing volume despite sharply declining price. This to me is a sign longer term professional investors are making use of the instruments since retail investors would have long ago sold out of an instrument with such large declines.

Barrons reports

These risk-avoiding hiding places include the obvious— high-grade bonds and gold—but also stretch to tactical asset allocation strategies and owning "volatility" as an asset class, through such things as futures on the CBOE Market Volatility Index, or VIX.
Zlotnikov pointed out a few months ago that investors "will go to great pains to avoid repeating the most recently made mistakes, but have few qualms about repeating mistakes from long ago. Today, this shows up as investors' extrapolating of the historically highest volatility" of 2008 into 2009.
Gordon Fowler Jr., CEO and chief investment officer at wealth manager Glenmede, made a similar point, suggesting last month that "protection against extreme outcomes…has become unprecedentedly expensive."
This is the muscle memory of the crisis still animating investor behavior. The iPath S&P 500 VIX Short-Term Futures exchange-traded note (ticker: VXX), which profits from rising volatility, has more than $1.4 billion in assets, despite having launched in January 2009 and the fund having lost almost 90% since inception. For more than a year, prices on the relatively newly tradable futures on the VIX—which measures the options market's implied forecast of stock index jumpiness—have shown a steep premium in more distant contracts. This means traders have consistently bet on a surge in market turmoil a month or three or six hence.
This market activity has made the medium term volatility etn far less painful in price declines, ytd the vxz is -10.7% and the vxx -69.7% (chart below) Athough should volatility in the markets heat up on a large stock decline the vxx will offer more leverage than the vxz in a positive direction as the hedge makes its impact/

 Even at these numbers a small position in VXX would have not been devastating a position equal to 3% of a portfolio would have shaved 2.1% off overall portfolio performance. A 5% position which I would deem the upper limit in a portfolio would have knocked 3% off portfolio return. And a mix of 3% vxx and 2% vxz would  drag down portfolio performance by a bit under 2.5%.

One analyst from Sanford Bernstein wonders whether the investors in the volatility etns are fighting the battles of past markets that may not be appropriate now. 

Zlotnikov pointed out a few months ago that investors "will go to great pains to avoid repeating the most recently made mistakes, but have few qualms about repeating mistakes from long ago. Today, this shows up as investors' extrapolating of the historically highest volatility" of 2008 into 2009.

As one whose clients hold these instruments I would argue that the threat of a black swan is a constant in the market and a small position in these as part of a portfolio makes sense. I certainly have company a large number of volatility related etfs have come to market, a number of fund companies and hedge funds have established "black swan funds". And there is an effort which I applaud to construct a broader volatility/fear index than the VIX which is linked only to the S+P 500. The Barrons article notes:

Just last week, BofA Merrill Lynch introduced a Global Financial Stress Index, "a comprehensive, cross-market gauge of risk, hedging demand and investment flows. The index is designed to help investors identify market risks earlier and more accurately than commonly used risk indicators, such as the VIX index," according to its news release.

The index might well do just that, perhaps even better than well-established indicators such as the Bloomberg Financial Conditions Index. (It certainly does the job in back tests, of course.) Yet the fact that, to the research folks at the No. 2 U.S. brokerage house, this seemed a propitious time to initiate an early-warning system for financial upheaval says plenty about the mindset of investors.

With the uncertainties in Europe and  potentially elsewhere a period of market turmoil certainly one as severe as this summer's Greek related decline is certainly a strong possibility , During that period the VXX increased over 90% and the vxz increased in value over 30%.Perhaps it is not the best time to give up on black swan hedging and maybe even a time to look like initiating such a position,

An interesting new ETN from UBS has a strategy for reducing the impact of contango by shorting 50% of the notional amoount in short term volatility futures and going long the medium term. Based on historical data (but not real world trading yet) shows the strategy merits investigation.

Advisor's clients hold positions in botb VXX and VXZ,

Thursday, December 2, 2010

What Would Milton Friedman Say ?

As I have noted before, those that invoke Milton Friedman in warning of inflation as a consequence of Fed policy have a limited knowledge of Friedman's monetary theory. They are looking at only one measure of money M1 rather than the broader measures of money.. It also doesnt reflect the velocity money.

This is explained well in the FT's alphaville

Effective money, our favored broad money aggregate for the US, is the sum of plain old bank money – M2 or savings and checking deposits – and shadow money, which is based on the outstanding value of liquid debt securities which can be repo’d quickly for cash. (The thought is if a $100 security is so liquid that you can borrow, say, $95 in cash by posting the security as collateral, then owning the security will affect your behavior just like owning $95 in cash.)
Because effective money is influenced by monetary policy, fiscal policy, bank balance sheet expansion, and shadow bank credit expansions (e.g. ABS funding of auto loans), our aggregate is broad enough to tell us something useful about the economy and the possible direction of inflation.
Effective money was $27.7 trillion in February 2007 and collapsed to $25.7 trillion by late 2008. Much of the fall was in private shadow money, which suffered from a collapse of funding liquidity (rising haircuts), a sharp fall in bond prices, and very weak net issuance. However, this deflationary shock was offset by a public balance sheet expansion. Later in the recovery private shadow money rebounded, and our latest estimate of effective money is now $33.8 trillion

, parts of the expansion – especially on the monetary side – are easily reversible with central bank balance sheet and interest operations including the payment of interest on reserves, which could cull any sharp increase in bank credit expansion.
Fourth, although credit expansion has begun to revive in certain places, there really is no sign yet of runaway demand growth in the US. And unemployment and the output gap remain very high.
But of all these reasons, the one we would urge monetarists and inflation worriers to ponder most is the first....

So far at least, we suspect that there has been nowhere near enough money printing to raise the risk, let alone guarantee, runaway inflation.

As for Friedman himself, hats off to the blogger who dug up this (below) from a Q+A after a speech by Friedman:

As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.

During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
Of course in the case of the US the Fed didnt raise rates (gradually one would have hoped ) to burst the buuble, the US bubble was burst by the collapse in the financial and housing markets, but the subsequent dilemma was similar.

It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.(why?  because velocity did not increase)

In other words if interest raes at zsero as a consequence of the first  tool of central bank monetary policy, the appropriate action is to use "quantitative easing" not to  sit still.

Well, at least about this issue

If Muni Bonds Had a Terrible Month in November...How Would One Describe the Month for International Bonds

The Financial Times reports on November in municipal bonds.:

Munis see worst falls since Lehman collapse
By Nicole Bullock and Michael Mackenzie in New York
Published: November 30 2010 18:34 | Last updated: November 30 2010 18:34
US municipal bond markets have suffered their worst month since the collapse of Lehman Brothers, amid rising interest rates, a flood of new issuance and fears over possible defaults by cash-strapped states and cities.
The Barclays Capital municipal bond index was on track on Tuesday for a fall of 2.2 per cent in November, the biggest monthly loss since September of 2008, when Lehman Brothers went bankrupt and the index dropped 4.7 per cent.
The poor performance was driven, in part, by higher Treasury yields as US government debt prices fell for the second month in a row during November. The total return for US Treasuries was -0.87 per cent for the month according to Barclays Capital and the yield on 10-year notes was set to close out the month at 2.77 per cent, up from 2.60 per cent at the end of October.
Other asset classes also dipped last month, with US corporate and mortgage bonds lower.
But as I have mentioned in an earlier post the losses investors are facing in another "hot" asset class: international bonds particularly those of developed countries. Here are returns for the month of november for bond etfs:
MUB muni bonds, IGOV developed market intl, WIP developed markets inflation protected, EMLC emerging markets, and PICB international corporate bonds. The losses in all of the developed market categories are far in excess of those losses in munis.