blog01may2009

Hot Off the Web-May 1, 2009

In the Financial Times’ “Real news to be had from demographics”, John Dizard writes that we should pay more attention to demographic data as an economic and market indicator. “Demographic information, in contrast, is more reliable because much of it has already happened. Births and deaths aren’t falsified like company accounts, or tweaked up like governments’ growth and inflation projections.” “Demography tells us that the housing market is not just toast, but burnt toast “and he concludes with “So the “takeaway”, in business-graduate-speak, would be that housing will not be the engine of the recovery. By next year, though, there should be enough usable consumer spending power for a recovery in autos, appliances and now-postponed services such as travel and entertainment.”

Jonathan Chevreau in the Financial Post quotes Rob Arnott that “2008 was one of the worst years ever for active investment management” . Hedge funds lost 21%, comparable to loss of balanced portfolios. Arnott’s “Research Affiliates expects the disappointment with active managers in 2008 will reignite the active/passive debate and that “many investors will come down on the side of passive management.” More investors will be favoring simplicity, transparency and liquidity. The “beta” exposure provided by index funds or exchange-traded funds “can get most investors in the ball park of their long-term return targets, without the risks and costs of active management,” the newsletter concludes.”  Nevertheless, the WSJ’s Anne Tergesen reports that “Advisers ditch ‘buy-and-hold’ for new tactics”. What are the new tactics they propose instead? Here are some: (1) 90% low risk (cash-like) the rest In leveraged ETFs, (2) abandon risk control by diversification and instead they advocate “products” with downside protection, (3) opportunistic trading, structured products, currencies, managed futures, principal protection, etc (Good luck to these advisors and especially their clients; unlikely, especially from the current relatively low market price base, that they’ll beat a diversified low-cost ETF based equity and fixed income portfolio with an asset allocation which matches the investor’s risk tolerance. If you need a little excitement in your investment portfolio, you might consider the use a core-satellite approach, where the core reflects your risk tolerance and the (10-20%) satellite is available to use for tactical asset allocation.)

David Oakley writes in the Financial Times’ “Investors warm to ETFs”that at end of February ETF assets were almost $600B compared to close to $800B at the 2007 peak, despite the dramatic drop in asset prices. “After the Lehman bankruptcy, the concern over counterparty risk was very high, investors did not want to put money into structured products or swaps, and there was a dislocation in the prime brokerage business. This encouraged funds to switch more money into ETFs. It is also a case of back to basics, as these funds are cost-efficient; the fees are less expensive than actively managed funds. It is the right time for ETFs.”

The February S&P Case Shiller Home Price Index was out this past week and many interpreted it as good news (the 10/20 city composites were down “only 2.2/2.1% for the month and 19% for the previous 12-month period, while Miami was down 3% for the month and 30% for the 12-month period) and U.S. housing market bottoming out? I have some difficulty seeing the good news. The Financial Times’ Stephen Lewis shares my lack of enthusiasm in “US housing woes not over”, where he indicates that “Since September last year, the three-month average of [existing home] sales has fallen almost continuously from 5.01m to a low point in March, after the latest data, of 4.59m. What is more, a larger proportion of sales so far this year has been related to foreclosures than was the case last summer…..a negative indicator for the housing market.”

On the Canadian housing front the National Post reported that “House-price index shows it’s a buyer’s market”. The Teranet- National Bank housing index is off 7.4% at end of February compared to the August 2008 peak, for the sixth consecutive monthly drop in the index. Calgary, Vancouver and Toronto showed year-over-year declines of 8.1%, 6.4% and 5%, respectively; Montreal and Ottawa gained 3.2% and 2.8%, respectively. (Still not Miami!)

Ken Hawkins brought to my attention Rob Arnott’s  “Bonds: Why bother?” article where he presents some surprising data about bond performance (or rather stock performance?) for those who believe in the 5% annual equity risk premium.  With the data he collected he argues that: equity risk premium (1802-2009) was not 5% but 2.5%, and while equities did do better than bonds there were many 20 year and one 68 year periods when this was not the case; also “from the peak in 2000 to year-end 2008, the equity investor lost nearly three-fourths of his or her wealth relative to the investor in long Treasuries. “ Other bits of useful data provided is that while bonds are used as a diversification tool in the portfolio the balanced 60:40 portfolio has 98% correlations with the S&P500 and that BarCap Aggregate is a better tool than cash (zero stock return intercept at 2% instead of 0.6%). Other observations were that an even better approach to diversification is “a naive portfolio holding all (of these) asset classes equally would have delivered 5 percentage points more return, at a lower volatility, than our 60/40 investor. We can achieve true diversification by holding multiple risky markets with uncorrelated risk premia, and so lower our risk without simply relying on low-volatility markets. Achieving true diversification requires broadening our horizons well beyond conventional allocations to stocks resembling the S&P 500 and bonds resembling the BarCap Aggregate. Mainstream bonds alone don’t get us there.” Also bond indexes have a “small” but fundamental flaw, which is that weakest creditors are often the largest borrowers and so very highly weighted in a cap-weighted index; not an endearing property of bond indexes for prospective owners. Arnott also predicts that “we will see the division between active and passive management become ever more blurred.” Well worth reading.

Still on bonds, WSJ’s Brett Arends in  “Bonds’ 30 year hot streak begins to cool” is somewhat less enthusiastic about bonds and “anyone hoping for a repeat of the last thirty years (of bond performance) is probably dreaming.” Starting in the early 80s when 20 and 30 year Treasuries yielded 10% and 15% respectively gave you a great run to the current 3 and 3.8% yields offered by the bonds of the same maturity. Arends argues that the combination of much lower current yields and a risk of increasing (rather than decreasing as in the previous 20-30 years) inflation, makes these “secure” Treasuries not quite what they are drummed up to be.

And continuing on bonds the Financial Times’ John Authers also challenges some of Rob Arnott’s bond enthusiasm in “Bonds not yet due for reversal”. However he adds that given the uncertainty of how long the current deflationary forces will prevail, there is a possibility that the lower treasury yields still result, but eventually the reflationary forces now unleashed will eventually reverse the current downtrend in bond yields.

Nouriel Roubini’s presentation at the annual CFA conference on “Global Systemic Risk: What we learned and the way forward”(and you have to remember that he was one of the few who predicted the severity of the current financial crisis over a year ago) was available as a live webcast. It could be summarized as:

-the worse of financial instability is behind us and we have likely avoided a depression, but unemployment will rise from 8.0% to 11-12%

-negative growth rate of -6% at in Q4’08 and Q1’09 (predicted by him before the data was announced the following day) will continue negative but will run at -2% annualized rate by end of year; next year will be 0 growth for full year, with likely positive growth in H2’10

-Goldman Sachs’ four indicators for turnaround are still all bad: job losses, retail sales, industrial production and housing (expect another 15-20% drop)

-ROW (rest of the world) economic situation is as bad or worse than the US- we have first global synchronized recession in 60 years

-despite fears of inflation, deflationary theme will continue longer than expected because: supply/demand imbalance continue to aggravate, wage pressures continue downward (unemployment growing), commodity prices down 1/3 (oil by 2/3), and now synchronized global recession; while inflation perceived by many as a potential saviour from all the debt, the more likely outcome will higher taxes and lower spending

-implication for asset classes: we are in a bear market rally (earnings surprises will be negative, earning are actually worse than reported due to financial gimmickry, negative or zero growth will continue longer than anticipated, hedge fund deleveraging will continue..for near term (2009) play it safe with government bonds,  cash, short-term bond until better view forward.

And finally, this really depressing article from Der Spiegel “Crisis plunges US middle class into poverty” which reports that “The financial crisis in the US has triggered a social crisis of historic dimensions. Soup kitchens are suddenly in great demand and tent cities are popping up in the shadow of glistening office towers. Even drug dealers are feeling the pinch.” (Is this what the Germans call schadenfreude?)

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