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Thursday, October 15, 2015

While You Were Likely Not Watching

Since September 1:

Emerging Asia (GMF) +9.6%
Emerging Markets (VWO) +8.3%
China (FXI) +11.9%
S+P 500 (SPY) +4.5%

China (blue) Emerging Asia (gold) Emerging Markets (green) S+P 500 (black)

Monday, October 12, 2015

Emerging Markets Home of the Performance Chasers

I have pointed this out so many times. Here is the latest example via bloomberg

Emerging Market ETF Inflows Near $1 Billion Wipe Out 2-Week Loss

Investors added $936 million to U.S. exchange-traded funds that buy emerging-market stocks and bonds, erasing two weeks of losses.
Deposits into emerging-market ETFs that invest across developing nations as well as those that target specific countries totaled $936 million in the week ended Oct. 9, compared with withdrawals of $828 million over the two previous periods, according to data compiled by Bloomberg. Stock funds collected $982.4 million and bond funds declined by $46.4 million.
The MSCI Emerging Markets Index advanced 6.9 percent in the week, the most since the week ended Dec. 2, 2011. A measure of developing-nation currencies rose the most in 17 years.
Here is a chart of VWO the overall Emerging Markets ETF
And here is GMF Emerging Asia

Wednesday, October 7, 2015

One Approach to Expected Future Returns

Research Affiliates runs a regular analysis of expected risk and return using valuations making use of the “Schiller CAPE”. For all its faults the Shiller P/E is the “best we have” in predicting long term returns. But not as a market timing tool. The basic premise is that high current returns which is accompanied in most cases by high valuations is a predictor of low future returns and vice versa.
Of course the model doesn’t have as an input forecasts of Federal Reserve Policy or other economic and political developments so it always makes sense to always ask “what can go wrong”.
As a short term predictive tool the model as not been particularly useful. It has produced an analysis of US stocks and bonds as highly valued and thus lower future returns for several years and the opposite for non US equities. Needless to say that did not turn out to be the case.
It is useful to note that the most widely cited reason for the ability of US stocks to produce high returns despite high current valuation is because of the low level of interest rates…raising a note of caution for those that expect US rates to rise in the near future.

Expectations for returns on US Treasuries are also predicted to be low going forward despite the fact that short term traders/investors have benefited from positions in long term bonds despite their past high valuation. With 10 Year Treasury Bond yields at 2% well below their long term average it is not hard to see why the analysis forecasts both low returns and high volatility for US long term bonds going forward.

Country data is included in this graph and shows US stocks with low expected returns relative to non US stocks. In terms of the “sweet spot” in terms of prospective risk and return the cluster would include emerging markets in Asia and Western Europe. Notably two members of the BRIC club….Russia and Brazil would be in the highly speculative category of high expected return and high risk…something not only justified “by the numbers” but also with regards to the political economic situation.
Of course China is the “elephant in the room” factoring in all the uncertainty not “in the numbers” it would probably be prudent to increase the volatility number in light of political and economic uncertainty for China.

It is also useful to have perspective on recent and historical returns for asset classes. While of course there is no guarantee there is a tendency for asset class returns to "revert to the mean".

The SEC On "Robo Advisors"

I have written several times on "Robo Advisors". In one of those analyses I pointed out that the information gathered through the short on line questionnaire severely limits the extent to which the portfolio chosen does a good job in meeting the clients specific circumstances. It seems like the SEC agrees with many of these points. In an document entitled

Investor Alert: Automated Investment Tools

It notes
3. Recognize that the automated tool’s output directly depends on what information it seeks from you and what information you provide.
Which questions the tool asks and how they are framed may limit or influence the information you provide, which in turn directly impacts the output that an automated investment tool generates.  If any of the questions are unclear or you do not understand why the information is being sought, ask the tool sponsor.  Be aware that a tool may ask questions that are over-generalized, ambiguous, misleading, or designed to fit you into the tool’s predetermined options. 
In addition, be very careful when inputting your answers or information.  If you make a mistake, the resulting output may not be right for you.
4. Be aware that an automated tool’s output may not be right for your financial needs or goals. 
An automated investment tool may not assess all of your particular circumstances, such as your age, financial situation and needs, investment experience, other holdings, tax situation, willingness to risk losing your investment money for potentially higher investment returns, time horizon for investing, need for cash, and investment goals.  Consequently, some tools may suggest investments (including asset-allocation models) that may not be right for you. 
For example, an automated investment tool may estimate a time horizon for your investments based only on your age, but not take into account that you need some of your investment money back in a few years to buy a new home.  In addition, automated tools typically do not take into account that your financial goals may change. 
If the automated investment tool does not allow you to interact with an actual person, consider that you may lose the value that human judgment and oversight, or more personalized service, may add to the process. 

Another observer has made a very sharp critique arguing that the "Robo advisors" do not meet the fiduciary standard required of Registered Investment Advisors.

Robo advisors do not adhere to the high standard of care under fiduciary investment law, particularly the Uniform Prudent Investor Act. They do not evaluate an investor’s total financial circumstances in light of all relevant factors and do not reasonably verify all facts relevant to a client as required by the Act.
The Act requires a fiduciary to make investment decisions “not in isolation” but in the context of the portfolio “as a whole” and as a part of an overall investment strategy having risk and return objectives suited to the trust. Robo advisors do just the opposite — they make isolated investment decisions that do not necessarily consider the investor’s total portfolio. Robo advisors also do not monitor client investments for suitability on an ongoing basis.
Regardless of whether you choose to handle your investments on your own with a brokerage account ,through a robo advisor or through a human advisor it is important to understand the very different services each provides.

Tuesday, October 6, 2015

Third Quarter Market Review and Prospects

There is no way around the fact that 3Q 2015 was an ugly one for equity markets. After a second quarter of "boring” markets with little fluctuation volatility came back massively in the third quarter...and on the downside. This was the worst three month period for the equity markets since 2011.

Between February and mid-August the SP 500 traded in a range of less than 3%. That changed in mid-August including a one day drop in the first hours of trading on August 24 of 7.5%  for the S+P 500 (the market closed down over 4% that day) Throughout the rest of the quarter daily movements of 1.5-2.5% were extremely frequent in the US and international markets,

The rationale/explanation is tied to the collapse in China's stock market and issues related to it.

After a period of massive increases much based on local speculation, government policy to encourage stock investment and to a lesser extent foreign investors, the Chinese stock market took a sharp drop from "bubble territory" and dropped 22.1% in the third quarter.

 It should be noted that even with this decline the Chines market as measured by the ETF FXI is down just 5.7% in the last 12 months. The fall caused both forced liquidation of stock positions by leveraged investors, Government policies that attempted to prop up the market had the opposite of the intended result and led to liquidations by foreign investors.

The fall in the stock market led to "China experts revising sharply downward the estimates of Chines economic growth in some cases to as low as 3% vs. official figures in the 6% range. The estimate for by the IMF remains above 6% although it has been revised slightly downwards, Whatever the exact numbers it is clear that the Chinese economy will be moving from one oriented towards infrastructure to one geared to growing the consumer economy. The impact has been felt in sharp falls in commodities and the stocks and currencies of commodity exporting countries and companies.

The impact of the China selloff had the most extreme impact on emerging market stocks. 

The impact on commodity prices was immediate as it was on other emerging markets particularly the commodity exporting countries and their currencies.

The outflow from emerging market stocks was massive estimated as high as $1 trillion and 2015 the first year of net capital outflows in 27 years. The decline in emerging markets pushed the 10 year total return down from outperformance vs US stocks to underperformance. 

For 2015 the outperformance of 15% for emerging markets vs the US seen earlier in the year dropped to an underformance of 10%  It remains to be seen of course if this will be the case going forward and the large outflow an indication of oversold conditions. The fundamentals for Asian countries including China seem not be as bleak as current markets reflect.

Here is VWO (emerging markets) vs. SP 500 year to date with emerging markets crossing from outperformance to underperformance during the past quarter.

Even with lower growth expectations the massive outflows from emerging markets have produced historically low valuations that may be an opportunity for the longer term investor, The MSCI China index forward P/E is calculated at 7.8% vs a long term average of 9... GDP growth as estimated for China and the rest of emerging Asia even after being revised slightly downwards remains above 6%.  compares to  growth estimates in the 2- 2.5% range for the US.

The growth prospects for commodity exporting countries such as Latin America and Russia are far more uncertain. The argument for making distinctions between emerging markets particularly the distinction among the "Brics" Brazil Russia India and China seems stronger than ever.

Low interest rates in the US have underpinned the US stock market rally leading to high valuations vs historical levels. After the long rally and high historical valuations the US market was ripe for a decline and the developments in China provided a catalyst. The fall in the S+P 500 was 7.2% for the third quarter. With the prospect of higher interest rates, lower earnings due to a decline in exports and more mixed investor sentiment the potential for a further drop remains high although not of the magnitude seen in the third quarter.

The bullish case for US stocks is based on a continuation of low US interest rates and strength in earnings to be reported for the third quarter

European stocks  joined the global selloff with the European market (ETF VGK) falling 8.9% in the third quarter. They erased all of their outperformance vs US stocks which had reached as much as 8% . The European stock selloff reflects the view that European companies are more exposed to Chinese export markets than the US.

German stocks now trade at a roughly 3% discount in valuation vs the US . They have been hurt of late due to the crisis related to Volkswagen which has had impact on the entire market despite it's low weighting in the country index of 3%. For the first time in a decade German stocks have turned to an underperformance vs the overall European index. 

The Euro has also recovered from a low of $1.05 earlier in the year to the current $1.12 levels as the prospect for higher US rates has diminished most recently.  This pushed the performance of the currency hedged Europe Etf to -12.6% for 3 Q.

As far as the European Central Bank is concerned there is a near certainty the low interest rate policy will continue. Higher rates in the US would likely lead to a lower Euro reversing the recent Euro strength. A resumption of the Euro's long term downtrend (it is still down over 10% over the past 12 months) helping European exporters but cutting into returns for dollar based investors.

Performance of Selected Equity ETFs

3Q 2015
1 Yr
3 Yr
Total World Stocks (ACWI)
US S+P 500 (SPY)
Emerging Markets (VWO)
Europe (VGK)

Fixed Income

The US bond market continued to have difficulty gauging the timing of the "liftoff" from the Federal Reserve in raising interest rates. The Fed somewhat surprised markets by not raising rates in September citing uncertainties related to China and the global markets. This gave a lift to longer term bond prices/drop in yields. In statements after the September announcement Fed governor Yellen indicated the high likelihood of a hike in rates in December. But a disappointing jobs report on October 2 which some attribute to the impact of China has pushed back expectations of interest rate hikes.

The uncertainty for further interest rate increases and a ten year Treasury bond yield of 2% makes long term bond unattractive as an investment even if traders have managed gains in their trading of longer term bonds. Investors are better off keeping maturities short reducing volatility and the impact of rate increases on their holdings.

The extreme fluctuations in the US stock market created a "flight to quality" in the credit markets as spread as High Yield bonds increased in yields/fell in price vs Treasuries. HYG the intermediate term high yield bond index (ETF HYG ) fell 5.3% in the third quarter vs a gain of 1.4% for intermediate term Treasuries .The yield spread over US treasuries is now above 6.5% well above long term averages,.

Emerging market bonds suffered from poor economic prospects and the impact of depreciating currencies. EMLC the largest emerging markets bond ETF fell 9.7% in the third quarter. Continued weakness for the economies of commodity exporters and their currencies the outlook for emerging market bonds remains unfavorable. The prospects for recovery in the equity markets of countries with currency account surpluses such as China and much of Asia seems much greater than recovery in the bond or stock market of debtor countries such as Turkey, Brazil and Russia.

Performance of Selected Bond ETFs

3Q 2015
1 Yr
3 Yr
Aggregate US Bond (AGG)
High Yield (HYG)
Long Term US Treasury (TLT)
Short Term US Bonds (BV)
Emerging Markets (EMLC)

Thursday, October 1, 2015

Emerging Markets a "Favorite" Place for Performance Chasing Investors

Emerging markets are a sector of extreme volatility, In a bit of a dysfunctional self reinforcing cycle the volatility causes performance chasers to buy high and sell low which in turn exacerbates the moves. Historically this performance chasing is a recipe for terrible long term performance.

Here is the recent data on emerging markets flows:

Traders dumped exchange-traded funds tracking emerging-market stocks at the fastest pace in over a year last quarter amid concerns over the slowdown in China, a selloff in commodities and the prospect of higher interest rates in the U.S.
Investors pulled $6.1 billion from U.S.-traded ETFs that offer exposure to a basket of developing-nation equities in the three months through September, the most since the first quarter of 2014, according to data compiled by Bloomberg. Exchange-traded funds that invest in both emerging-market stocks and debt as well as individual countries saw outflows in 12 out of 13 weeks ending Sept. 25, with losses totaling $12 billion, the data show

Bloomberg reports on an interesting analysis which concludes that as in the case in many areas of investing buying the most unloved assets produces the best returns.

A buy signal seen only four times in the past 12 years is flashing again in emerging-market stocks, according to Ian Scott of Barclays Capital.
Things got so bad, they’re going to turn around, according to the London-based equity strategist. In the worst quarter for equities in four years, money flows in emerging-market funds are trailing developed nations by a degree unmatched except in 2004, 2005, 2008 and 2014, Scott says, citing EPFR Global data. Yet on every one of those occasions, shares outperformed developed markets by at least 9 percent in the following six months, he says.

Wednesday, September 30, 2015

A Note on HYLD

HYLD, the advisorshares short term high yield ETF has taken a sharp price decline over the last few days. The ETF went ex dividend on September 24  with a $.32 dividend. Morningstar's analysis puts the 30 day SEC yield at 10.92%.

Since the duration is 2.8 years  the ETF should be less exposed to changes in the overall level of interest rates than longer duration bonds  such as  those in the high yield bond index ETF JNK which has a 4.2 year duration, And its yield is  close to 4% higher than the JNK

Last year HYLD eliminated stocks from its portfolio and significantly reduced its exposure to the energy sector. Its assets under management have declined sharply and are now under $300 million.      This means the instrument can be extremely volatile and thus are definitely not for short term investors/traders. And poor execution in trades in HYLD can be particularly costly.

As yields have moved up/prices declined funds have flowed out of high yield ETFs. JNK  the largest high yield ETF lost just under $600 million in assets in the week from September 22 -28 second only to XLV the healthcare SPDR ETF (more performance chasing). But because the fund is liquid the price of the ETF has remained close to intrinsic value, In fact according to Morningstar it traded at a slight premium on September 29.This is despite the fact that the trading volume was 11.8 million shares vs an average of 8 million

HYLD however suffered from a lack of liquidity. When there is a spike in volume it can move to a large discount to intrinsic value as traders react to price regardless of value. Therefore as of market close on September 29 it is trading at a discount of 3.26% to intrinsic value. This is compared to an average discount of .21%. In other words $1 worth of the bonds in HYLD was selling at $.9674 

While there is no guarantee the discount will close in the near term long term investors would certainly be advised not to sell with the ETF trading at such a large discount. It is not surprising that the large price decline occurred on a day of high volume on September 28 . On that day HYLD fell from 37.05 to 35.90  a decline of  2,8% pushing it to a large  discount vs intrinsic value You can see below the volume compared to previous days. listed are high, low close and volume.

Sep 29, 201535.6236.6335.6235.8852,60035.88
Sep 28, 201537.0537.0535.8035.90170,60035.90
Sep 25, 201536.9237.2436.8837.1021,40037.10
Sep 24, 201537.1737.4936.9236.9447,30036.94
Sep 24, 20150.322 Dividend
Sep 23, 201537.6937.7537.5037.5177,10037.19
Sep 22, 201537.7237.8037.5237.6151,60037.29
Sep 21, 201537.8238.0437.7237.9545,10037.62
Sep 18, 201537.9638.0537.7837.9070,60037.57
Sep 17, 201537.8038.1937.7838.0874,30037.75
Sep 16, 201538.0838.1837.5237.8872,70037.55
Sep 15, 201538.3238.3237.9237.9382,30037.60
Sep 14, 201538.3338.3338.2338.249,10037.91

What could have happened to cause this move ? it seems the best explanation is poor execution by a seller/sellers of HYLD. I have written before about the importance of trade execution. In this case it seems pretty clear that whoever was selling HYLD on September 28 wasn't practicing good trade execution,. HYLD fell 2.4% in the first two hours of trading with a large spike in volume during that period. On this 2 day chart below you can see the price decline on the spike in volume (bottom scale). It is also clear something very strange went on during the open on Tuesday the 29th..another example of the rule of avoiding trading during the opening hour of trading.

What conclusions can be drawn from this:

  • HYLD is definitely not a short term trading instrument, in order to benefit from its high yield it needs to be held longer term to capture the dividend flow and not to be overly concerned with short term movements such as those that push the ETF to large discounts vs intrinsic value. In order to benefit from the high yield one must have the fortitude to hold through the price fluctuations
  • Trade execution is crucial particularly in relatively low liquidity instruments like HYLD,
  • Sales at the current discount of 3% are certainly does not look to be a good point to sell, those looking for an entry point might find the price reflecting the heavy discount an attractive one,

On the WIsdom of Those Forecasts By Wall Street "Experts"


Strategists had barely changed their views through the middle of the year. It wasn’t until the S&P 500 sharply dove more than 10% in the middle of August that Wall Street started becoming less optimistic on the path for equities in 2015.

Since it is always hard to find a Wall Street Expert working at a brokerage firm who isnt optimitic, there isnt a single analyst surveyed in the article that doesnt see the market ending the year higher than current levels with the average of those surveyed with a year end targe of 2177 for the S+P 500 which is around 15% higher than the current 1884.

Tuesday, September 15, 2015

More on Trade Execution

In an earlier post I reviewed best practices related to trade execution that a good advisor would avoid and that robo advisors, human advisors, and individual investors may miss. The drag on performance may be well in excess of anything you might pay to a "more expensive" advisor that is more sophisticated in his trade execution.

The WSJ reviews another "bad practice" in trade execution: trading on the market open especially on a Monday morning.

Rising stock-market volatility is proving especially costly for retail investors who typically buy and sell stocks soon after the market opens—often the most perilous time of the trading day.
Buying and selling by individual investors is especially heavy in the minutes immediately after the market opens in the U.S. at 9:30 a.m. Eastern time, when the chances of getting the best price for a stock are lower and swings tend to be bigger, traders and other market observers said.
But within minutes, the gap between the price sellers want for a stock, known as the “ask” price, and what buyers are offering, the “bid,” shrinks sharply and continues to narrow up until the end of the trading session. This quirk in the market has been amplified in recent weeks amid the big market swings.
The smaller gap, or spread, is better for investors because they are less likely to overpay for a stock or sell below the prevailing price in the market. The wider the spread, the more exposed investors are to high costs, which can erode returns at a time when major stock indexes are down for the year.
Of course it doesnt matter whether the market is up or down for the year, these costs reduce the return on the portfolio.
Trades for individual investors tend to be executed in the morning, because they put in orders the previous evening through their online brokerage accounts or their financial advisers, often after they have been able to catch up on the news after work. About 15% of average daily trading volume is driven by individual investors, according to TABB Group, a research and consulting firm focused on financial markets....
And Mondays are even worse:
“Mondays are generally going to be some of your busiest market opens as well because you’re queuing up orders over the weekend,” said Gregg Murphy, senior vice president of retail brokerage at Fidelity. “A large percentage of trade activity takes place in the first 30 minutes of market open.”

Thursday, September 10, 2015

Goldman Sachs Forecasts $20 Oil..You Be the Judge of How Reliable that forecast is

  • September 11, 2015
  • Surplus seen persisting into next year 
  • Goldman Sachs Group Inc. cut its oil price forecasts as it sees a global glut persisting into 2016 on further OPEC production growth that may force prices to drop as low as $20 a barrel.
    The bank trimmed its 2016 estimate for West Texas Intermediate to $45 a barrel, from a May
  •  projection of $57, according to an e-mailed research note Friday. 
  • Goldman also reduced its 2016 Brent crude prediction to $49.50 a barrel, from $62
Over the last several weeks, crude has been whipsawed by conflicting expectations out of the Middle East: Iran is seen as potentially increasing exports as it reaches a deal that curbs its nuclear ambitions, but at the same time, instability in Iraq and Libya have knocked more than 1 million barrels per day (bpd) of oil offline.

Where to next? Forecasts for crude, gas, and natgas: Goldman

WTI Crude Oil$99$96$90
Brent Crude Oil$108$105$100
RBOB Gasoline$3$3$2
NYMEX Heating$3$3$3
NYMEX Nat. Gas$4$4$4
UK NBP Nat. Gas$71$72$78
Source: Goldman Sachs Global Investment Research
  • Brent crude ended 2014 at a bit under $60