Search This Blog


Thursday, December 18, 2014

A Black Swan from "Black Gold"

If there was one thing that could not be found among the myriad forecasts for the financial/commodity markets for 2015 it would have been the near 50% drop in oil prices since five year lows:

And if one would have presented the scenario of such a drop in oil prices to analysts and asked them to enumerate the impact on the financial markets. Some predictions would have been relatively easy.'

VDE (energy stocks)

But of course there have been some very very large moves in parts of the financial markets that probably would not have immediately come to mind among analysts. And given the rapidity of the moves it seems clear many were caught by surprise.

Emerging Markets

The massive impact of the decline in oil prices on the Russian currency and economy has been well reported...the impact on emerging market debt and equity indices perhaps less.


I have mentioned before a preference for emerging asia (etf GMF) vs the overall emerging market ETFs like IEMG because of the large exposure to Russia and commodity exporting Latin America. The difference in performance between the two is apparent below.



Emerging market debt indices and thus ETFs have a very high weighting in Rusian debt. And the damage is apparent below in both the local currency emergigng market ETF and the US $ denominated etf (EMB). It is quite interesting that the last time there was a major selloff related to Russian bonds it was in 1998 it primarily involved hedge funds (including the demise of Long Term Capital(LTCM). This time around "mom and pop" retail investors as well as pension funds and others are investors in Russian debt through ETFs or through actively managed mutual funds such as the Pimoc fund reported on in the WSJ which has lost 9% this month.



High Yield Bonds

Companies related to energy particularly oil shale production (fracking) have made up a large proportion of recent high yield debt issuance. Energy related bonds make up 15% of the high yield bond indices. Many of these fracking companies are unable to produce oil profitably at current price levels under $50. Hence fear of future defaults and large drops in emerging market ETFs. Here is HYG the broadest high yield bond ETF.


Even more adversely affected has been HYLD an actively managed high yield bond ETF which has a 30% weighting in energy.


Another area that has sold off is limited partnerships most of them involved in the energy industry. Here below is AMLP the mlp index instrument.

There are several factors that have contributed to make these moves quite large,

  • Time of year as I noted in my previous post end of year markets are prone to low liquidity and volatile trading.
  • Large investment in relatively illiquid markets. The "search for yield" and growth of ETFs and other instruments to allow relatively easy access to what were small sectors of the financial markets has been a two edged sword. On the one hand the investment options have expanded for investors. On the other hand massive amounts of money has moved into what are potentially very illiquid markets...especially when everyone tries to get out at the same time. MLPs , emerging market bonds and high yield bonds all fall into this category,.

The future direction of energy prices is no doubt uncertain and the implications of movements in energy prices will likely have more unexpected consequences in the future,

Bloomberg has a great set of graphics related to the energy markets here


Wednesday, December 10, 2014

A Note on The Markets This Time of Year

By this time of year the senior portfolio managers and traders are off to Vail, the Alps, Palm Beach, Fiji or other luxurious vacation retreats. Many have received the bonus and are just interested in holding onto their gains for the year.

Left on the trading desks are the younger less experienced folk. They have the following  instructions

1, Don't initiate any new positions no matter how many opportunities you may see,
2. If you are a dealer get rid of anything sold to you in the market as soon as possible.
3. Execute if securities fall to levels left by the boss or in the case of short positions rise to the specified level
4 Make every effort NOT to disturb the boss on vacation unless the securities held in the portfolio start dropping sharply..or in the case of short positions rising sharply.

Enjoy your holiday even though your vacation will be far shorter than mine.

The net result markets: are extremely volatile and moves. They  can be intense particularly on the downside especially when reversing the trend during most of the year.. Any picking through "values " in the market will come in January

In the currency markets one can see this in the Euro/Dollar Exchange Rate

Euro per $

Of course the biggest example is Oil:

In the equity markets one can see the fallout in lower energy stocks (VDE) below.

VDE Energy Stock Index

In the bond market the impact can be seen in the high yield bond market whose biggest industry representation is in energy.

HYG high yield bond index

Thursday, November 27, 2014

Europe Positive Headlines

A post here earlier this week  reviewed the positive possibilities for European stocks.

A series of positive news items from Europe today from Bloomberg

Economic sentimentin the euro area unexpectedly increased in November, a sign theEuropean Central Bank’s bid to boost growth and inflation is starting to hit home with companies and consumers.

German unemployment fell and the jobless rate reached a record low as businesses and investors become more confident that Europe’s largest economy will keep growing.

DAX Revival Draws Believers After 11 Days Without Decline
German stocks, up 16 percent since mid-October and rallying for 11 straight days, have further to run, according to the options market.
Contracts (DAX) that pay off shouldGermany’s benchmark DAX Index continue its advance cost the most since January relative to bearish ones, three-month data compiled by Bloomberg show. The German gauge has rallied 6.9 percent this month, almost twice as much as the Euro Stoxx 50 Index.
Investors have flocked to German stocks as they speculate theEuropean Central Bank will boost stimulus, further weakening the euro. Exports make up more than 80 percent of revenue for Siemens AG and Daimler AG, while Bayer AG and BASF SE get at least 44 percent of their sales outside Europe. The DAX also rallied as stronger-than-forecast data in Germany and the U.S. signaled an improving global economy.
“The best bang for buck in markets now are German blue-chip exporting companies with exposure to global growth,” said Lorne Baring, who helps oversee $500 million at B Capital SA in Geneva. “Global growth will be OK, and the ECB’s comments didn’t hurt. A weaker euro will help them.”

The Expensive Poorly Performing Investment Once Available Only to the Mega Rich Now Available to Main Street

Maybe you should take a pass on this one

Hedge Funds Lose Money for Everyone, Not Just the Rich

Hedge funds have lagged behind stocks while still charging fees of up to 2 percent of assets and 20 percent of gains. For the rich and their advisers, "the sex appeal of hedge funds has worn off," says Kobak, now head of Main Line Group Wealth Management.
Guess what the hedge fund firms are doing now?
Hunting for new, less skeptical customers. 
While only those with at least $1 million are allowed to invest in hedge funds, anyone can buy a mutual fund with a hedge fund strategy. Unfortunately, these “alternative” funds come with the same disadvantages hedge funds have: high fees, inconsistent performance and strategies that take a PhD to decipher.
By starting alternative funds, mutual fund companies get a chance to bring in revenue they’re losing to cheap index funds and exchange-traded funds. 

Tuesday, November 25, 2014

Europe Lowers Interest Rates...Time For European Stocks to Catch Up ?

The WSJ and the FT have published  with analyses of the implications of policies of "easy money"/
lower  interest rates in Europe. The WSJ notes that the policy is at least partly in response to evidence that seems to indicate the low rate policy has "worked" US economic growth is back on track and at this point the predicted inflation has not come about. Certainly the low rates have fuelled rises in the prices of financial assets with the ubiquitous "bubble" terminology in the words of many.

What are the implications for investors ? the WSJ writes

Though the moves toward easier money in Europe and Asia are good for investors, they come with multiple risks. They could perpetuate or spark asset bubbles, or stoke too much inflation if taken too far. Also, they don’t address structural problems that policy makers in each economy are struggling to fix.Though the moves toward easier money in Europe and Asia are good for investors, they come with multiple risks. They could perpetuate or spark asset bubbles, or stoke too much inflation if taken too far. Also, they don’t address structural problems that policy makers in each economy are struggling to fix.

The FT writes that many analysts looking at the results of aggressive lowering of rates did to the US equity market as well as the low valuations of European stocks and see potential for a strong move upwards in European stocks.

European equities are not an obvious buy for US investors, who see their own economy forging ahead, corporate earnings beating expectations and a stronger dollar.
Yet with company earnings for the eurozone not as bad as expected, some believe the sector is now undervalued, creating pockets of opportunity in the continent....


Analysts at Barclays believe European equities could rally “significantly” if the European Central Bank embarks on full-blown quantitative easing, which they believe is not yet priced into stocks. They predict European markets, not including the UK, will grow at the most rapid rate of any other major market next year with a total return of 18 per cent, compared twith just 5 per cent in the US and 9 per cent for global and emerging markets.
Jack Ablin, chief investment officer at BMO private bank, is optimistic QE can help the eurozone.
“QE was effective in the US and if we see the ECB act, that should be cause for optimism,” he says, estimating that developed world equities trade at a 25 per cent discount to the US market.

But, as the article notes, the dilemma for US investors is that those low rates that might push up equity prices will also likely mean a lower Euro so that for dollar based investors a good deal of the gain on equities will be lost in the adverse currency movement.

As I noted in a previous article even individual investors have a vehicle  ETF HEDJ which lets them hold European stocks but hedge the currency risk. Apparently investors are incrreasingly looking at this instrument
The most popular exchange traded funds this year include the WisdomTree Europe Hedged Equity, which saw some of its largest daily net inflows in November, according to data from

And even without the currency hedge: 

Some believe European equities have further to rise than the euro has to fall, making them still worth buying even without a hedge. A rule of thumb investors use is that a 10 per cent fall in the euro against the dollar boosts earnings per share for European companies by 10 per cent.

One should of course be cautious about drawing too many conclusions from short term data it is often the case that the moves immediately after major economic events point a way towards long term movements.They often mark inflection points. This may be the case with regard to Europe. The weaker Euro trend continues. European stocks have rebounded quite a bit since October and accelerated more since the ECBs November 21st announcement of a bond buying program but still significantly lag US stocks.

Here are some one year charts

Unhedged Eurozone ETF FEZ

Currency Hedged Euro ETF  HEDJ

Germany (EWG) unhedged

And the Euro/US $ Exchange Rate

What's Been Going on Since Stock Connect Started Last Week

The beginning of stock connect and the announcement of lower interest rates in China has put a significant wind behind Chinese stocks especially the A shares.

Here is ASHR which holds only A shares

And here is GXC which includes all Chinese shares except A shares.

Sunday, November 16, 2014

More on China