Macro Tsimmis

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Archive for April, 2010

Change we can believe in? U.S. gets serious about financial regulatory reform

Posted by intelledgement on Tue, 20 Apr 10

One of the most disheartening aspects of the extended financial crisis we are in is how poorly the US government has responded. Of course, it’s fair to ask why anyone should be disappointed, given the record of consistently bad choices the government has compiled:

But wait! Maybe—now that the health insurance legislation has finally been passed—we are expending some attention on regulatory reform to address systemic risk issues.

In our view, to be effective reforms must address five main points:

  1. Create an exchange for trading derivatives such as credit default swaps and collateralized debt obligations
  2. Ban ratings agencies from accepting remuneration from equity issuers aside from for subscriptions to ratings info
  3. Establish more stringent capital requirements for financial services companies doing business in the USA
  4. Clean house at the enforcement agencies to ensure that existing regulations—e.g., against naked short selling—are actually enforced
  5. Encourage improved corporate governance—e.g., for government contracts, prefer financial services providers who compensate top management more with stock and less with cash bonuses and high salaries

The first and second reforms are intended to increase transparency and create a more robust pricing mechanism for derivative securities. Having a market where everyone can bid on whatever is offered for sale applies the collective wisdom of the market to the complex problem of determining a fair price for these instruments. You can’t fool all of the people all of the time. And it is a blatant conflict-of-interest that most of the income for most ratings agencies is provided by the issuers of the securities being rated. Ridding ourselves of the bogus AAA ratings that were the predictable result of this incestuousness will go a long way towards unmuddying the waters.

The third reform is intended to reduce the level of risk it is kosher to undertake from the obscene, bet-the-farm-and-all-my-neighbors’-farms-too heights scaled in the recent crisis down to something manageable. The fourth and fifth reforms are intended to reward socially responsible behavior among market participants and better align the interests of management with not only shareholders, but all the stakeholders in their enterprise.

We are not too keen on the consumer protection agency concept currently being promoted the President. We believe that with the notable exceptions of the need for more stringent capital requirements and the need to corral derivatives trading into an exchange, there are already generally sufficient regulations in existence—but the problem is that they have not been effectively enforced. Adding a new agency to a broken SEC and a broken CFTC and a Fed with a schizophrenic mission is a recipe for spending a lot of money achieving not much besides a big turf war. We’d be a lot better off putting Harry Markopolos in charge of the SEC, Patrick Byrne in charge of the CFTC, and instructing Ben Bernanke and company to focus on controlling inflation and protecting the dollar.

We don’t much care for the concept of establishing a permanent mechanism to coddle “too-big-to-fail” companies, either. Management of these enterprises should not be operating with the presumption that they will be bailed out if they screw things up. Can you say “moral hazard”? In a world of transparent markets, stringent capital requirements, and firmly enforced rules against chicanery, it ought to be rare for management to run large enterprises into the ground…but when and if they do, let them fail! That is the way capitalism is supposed to work: if you succeed, you are rewarded; if you fail, smarter, more adaptable competitors will take advantage of the opportunity to win your former customers by serving their needs better. Propping up the failures is bad for everyone: bad for the customers who continue to get suboptimal service, bad for the competitors who are not rewarded for working harder and smarter, and bad for the failing organization’s personnel, who instead of moving on to something they can better succeed at are in effect bribed by government largess to persist to fail at something they are bad at.

OK, maybe it’s not bad for literally everyone—to the extent this sort of irrational behavior renders us less efficient, perhaps it is good for China.

But leaving aside the details, the combination of President Obama’s new focus on financial regulatory reform and the SEC’s filing of a civil suit against Goldman Sachs for fraud last week is very heartening. The timing may be coincidental, but it’s not a coincidence that the SEC’s decision to press charges comes now—after two years of investigations and negotiations with Goldman over the matter—just as Obama sent an e-mail to folks who had signed up to support his efforts in office on the subject of financial regulatory reform which stated, in part: “With so much at stake, it is not surprising that allies of the big banks and Wall Street lenders have already launched a multi-million-dollar ad campaign to fight these changes. Arm-twisting lobbyists are already storming Capitol Hill, seeking to undermine the strong bipartisan foundation of reform with loopholes and exemptions for the most egregious abusers of consumers. I won’t accept anything short of the full protection that our citizens deserve and our economy needs. It’s a fight worth having, and it is a fight we can win—if we stand up and speak out together.” Both actions clearly reflect a decision by the administration to make this a priority.

Cognizant of the U.S. government’s consistent record of getting this stuff wrong, we are not overly optimistic that this time will be different. But we do find it ironic that the stock market—which is up 70% in the last year on what seems to us scant evidence that we are out of the woods—reacted to Friday’s news of the SEC suit against Goldman with a sharp decline. LOL this is the most bullish development of 2010 so far! The Obama administration’s first major action was—continuing along the course set by W—to prop of the rotten financial system, which was a counter-productive thing to do, but they did it well (unfortunately). Their second major initiative was health insurance reform, which while a shockingly low priority given the problems that beset us had the potential of being a good thing to do, but they screwed it up (unfortunately). Now, at last, they are focusing on an important problem to which a good solution has the potential to make life appreciably better for most everyone.

This, potentially, is change we can believe in.

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Activision Blizzard (ATVI) update #13—1Q10 results beat guidance

Posted by intelledgement on Fri, 16 Apr 10

Our game publishing company, Activision Blizzard (ATVI), is not due to announce 1Q10 results for another few weeks, but they did issue a press release yesterday stating that “March quarter 2010 GAAP and non-GAAP net revenues and earnings per share are tracking ahead of the company’s prior outlook.” And no wonder, given the outstanding performance of the “Call of Duty” franchise, which experienced over one million downloads of the latest expansion pack in the first 24 hours for the Xbox LIVE platform according to an ATVI press release last week. “According to Microsoft, Call of Duty: Modern Warfare 2 players have invested more than 1.75 billion hours of gameplay on Xbox LIVE alone since the title’s release in November, which is equal to more than 200,000 years of gameplay,” stated the press release. Not sure what that says about the state of modern civilization, but ATVI stock closed yesterday at $11.67, which is up 6% YTD (counting a fifteen-cent dividend issued in February).

Speaking of “Call of Duty,” the Infinity Ward co-founders fired by Activision Blizzard last month, Jason West and Vince Zampella, announced on Monday that they have formed a new game design studio—archly monikered Respawn Entertainment—and signed an exclusive distribution deal with ATVI arch-rival Electronic Arts. It will be interesting to see how many Infinity Ward design staffers follow their ex-bosses into exile.

Previous ATVI-related posts:

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1Q10 Intelledgement Macro Strategy Investment Portfolio Report

Posted by intelledgement on Wed, 14 Apr 10

Summary of Intelledgement’s model macro strategy model investment portfolio performance as of 31 March 2010:

Position   Bought   Shares Paid Cost Now Value Change     YTD         ROI       CAGR  
FXI 03-Jan-07 243 37.15 9,035.45 42.10 10,719.81 -0.36% -0.36% 18.64% 5.40%
IFN 03-Jan-07 196 45.90 9,004.40 31.54 9,180.64 1.83% 1.83% 1.96% 0.60%
DBA 13-Mar-08 235 42.50 9,995.50 24.22 5,691.70 -8.40% -8.40% -43.06% -24.04%
TBT 21-Jan-09 233 42.84 9,989.72 48.69 11,344.77 -2.39% -2.39% 13.56% 11.30%
EWM 21-Jul-09 1,062 9.41 10,001.42 11.68 12,554.96 9.85% 9.85% 25.53% 38.86%
EWZ 3-Aug-09 165 60.39 9,972.35 73.64 12,531.42 -1.30% -1.30% 25.66% 41.57%
IYW 29-Sep-09 208 51.86 10,794.88 58.39 12,168.42 1.58% 1.48% 12.72% 27.00%
cash 31,206.28 51,763.29
Overall 31-Dec-06 100,000.00 125,955.00 -0.58% -0.58% 25.96% 7.37%
Macro HF 31-Dec-06 100,000.00 119,357.61 1.68% 1.68% 19.36% 5.60%
S&P 500 31-Dec-06 1,418.30 1,169.43 4.87% 4.87% -17.55% -5.77%

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2009 inclusively) provides a CAGR of around 14.0%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.3%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance.

Transactions: We had another quiet quarter, with only a couple of sales:

Performance Review: An indifferent quarter for IMSIP, as we were down 1%, while the S&P 500  was up 5% and the macro hedge funds up 2%.Tactically, despite our deep skepticism about the validity of the continued strong market rally, we remain mildly bullish here. Our emerging market ETFs overall were slightly up: Malaysia (EWM, +10%), India (IFN, +2%), and China (FXI, flat), and Brazil (EWZ, -1%). As mentioned previously, we sold our gold and silver commodity ETFs—prematurely in the event, as both ended the quarter higher than they were 9 Feb when we sold—but our remaining commodity play, agriculture, was down (DBA, -8%). The US Technology ETF (IYW) was up 1% for us; if it continues to lag the NASDAQ index—which was up 4% in the quarter—we will likely trade it in. Our one short position, the UltraShort Lehman 20+Year Treasury ETF (TBT), which goes up when the value of long-term treasuries decline, as they tend to do when long-term interest rates rise, was down 2% and rates remained stubbornly low during the quarter despite torrents of fresh debt offerings by the U.S. Treasury.

Overall, we are now 44 points ahead of the market in terms of total return-on-investment: +26% for us and -18% for the S&P 500 in the three years and three months since the inception of the IMSIP at the end of 2006. We are seven points ahead of our benchmark, the GAI Global Macro Hedge Fund Index, +26% to +19%. In terms of compounded annual growth rate, after three years IMSIP is +7%, the GAI hedgies are at +6%, and the S&P 500 is -6%.

Analysis: The market doggedly continues to accentuate the positive, up yet another 5% in the quarter, while volatility—a good fear indicator, which set a new all-time high in 4Q08—declined for the fifth straight quarter, actually reaching the historical average. While the U.S. unemployment rate remained unchanged at 9.7% in March—which was good compared to the steady increases in 2009—there was actually job growth (+162,000 non-farm jobs). Corporate profits were strong again in 1Q10 and consumer spending—evidently powered by the Energizer bunny—somehow continues to outstrip gains in personal income month-after-month:“Personal income increased $1.2 billion, or less than 0.1 percent, and…[p]ersonal consumption expenditures (PCE) increased $34.7 billion, or 0.3 percent,” in February, according to the latest Bureau of Economic Analysis data. Inflation and interest rates (except for credit card debt) remain low, and the stock market has now recovered 75% since the March 2009 low (S&P 500 666.79 on 6 Mar 09).

As we continue to point out, we got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. In previous reports, we have lamented that the U. S. government’s attempts to solve our problems have generally made things worse, whilst creating the temporary illusion that things are getting better. We recently came across a presentation by Dylan Ratigan of MSNBC that does a good job illuminating this sad situation, which Mr. Ratigan ascribes to evil intent (presented below in two parts):

We expect there are some bad actors but in general, it is our belief that most of what has happened is due to ignorance and unintended consequences. Mr. Ratigan is spot on in lamenting that most members of Congress have no clue how our financial system functions…but in that lack, they well reflect the populace at large. Our political leaders surely intended well, for example, when they mandated that mortgage loans be made available to folks who previously did not qualify back in 1999, and the Fed fed the housing bubble in the 2000s by keeping interest rates low. Get more folks owning their own homes, stimulate the economy, what’s not to like? But the resulting poisonous stew of insidious incentives for everyone involved to act in their own short-term best interests—inveigling folks to overpay for properties they couldn’t afford in the first place with the expectation that with prices sure to keep rising, they could sell to the greater fool for a profit—then packaging the resultant mortgage-backed securities, mislabeling them a high-grade with the connivance of the ratings agencies and selling them to credible financial institutions, etcetera, etcetera. Just about everyone behaved short-sightedly with little if any regard for systemic risk; there is plenty of blame to go around.

Where we do agree with Mr. Ratigan is with respect to his criticism of what is happening—or, in some cases, not happening—now: the continued attempt to reflate values back up to tulip bulb mania levels, the continued assumption of the debts of so-called “too-big-to-fail” institutions by the government, the failure to pass meaningful reforms such as sundering the cozy relationship between ratings agencies and the institutions who create the equities to be rated—as insane as this sounds, currently the former are paid by the latter—and creating an exchange for credit default swaps and other esoteric financial instruments to ensure transparency and facilitate the self-governing influence of market forces—not to mention creating a mechanism for dismantling big failed financial institutions in an orderly way and holding their leadership personally accountable for their failures which would better align their interests with that of the owners and society as a whole.

For that matter, why are we bailing these failed institutions out by assuming their debts? And why are we undertaking additional obligations such as health care and dubious stimulus programs on top of the existing deficits plus the imminent demographic-driven shortfalls in entitlements funding? Why are we focused on heath insurance and cap-and-trade when the real threat to our way of life is our failure to understand and address our financial failings?

Conclusion: Sadly but surely, we remain confident that the worst is yet to come. However, we cheerfully admit we have no idea when. Perception is reality, and so long as the market perceives that things are hunky dory—as it manifestly does now—it is a greater risk to capital to fight it (go short) than to go with the flow.

Accordingly, as of 1 April, we continue to hold five long emerging market ETFs in the portfolio: China (FXI), India (IFN), Brasil (EWX), Malaysia (EWM), and US high tech (IYW which we consider an emerging market play as some two-thirds of the revenue of the companies comprising the ETF are ex-USA derived). Most of these would go—and be replaced by inverse index ETFs (that go up when the market goes down) if and when things get dicey again.

We also still have one long commodity play and a short on treasuries as hedges against the decline of the dollar: the agriculture ETF (DBA) and the inverse long-term Treasury bonds ETF (TBT). The dollar actually was stronger last quarter, and we sold our gold and silver ETFs in anticipation that a flight-to-safety reaction to the European sovereign debt crisis would buttress it even more, and deflate commodity prices. That did not happen and we are not likely to remain so unhedged against a dollar decline for a lengthy period because the longer we sit on a bench in the station, the greater that chance that train will leave without us.

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Market to investors: “Be cool, man…everything’s copacetic!”

Posted by intelledgement on Wed, 07 Apr 10

Real estate valuation and foreclosure shoes may still be dropping, the deficits may still be growing, credit may still be tight, and the PIIGS may be oinking louder than ever…but the market is telling us that the immediate danger of a 1930s-like meltdown has passed.

We have been tracking market volatility for a while now because it is a reasonably reliable gauge of risk. 80% of the time from 1950 to 2010, when volatility in the S&P 500 goes up—that is, the average daily change in the price of the index (up or down) is greater than it was in the prior year—market performance declines. And when volatility declines year-over-year, market performance improves 63% of the time.

Well, the results are in from 1Q10, and following an epic surge in volatility in 2008 to the highest levels ever, the tide has consistently receded. 1Q10 was the fifth consecutive quarter in which volatility has declined. And the level of volatility in the quarter was all the way down to average: just a ±0.59% daily change in the value of the S&P 500 index. This was the lowest reading in two-and-a-half years…since 2Q07—right before things started getting interesting—when volatility was ±0.44%. Here is a chart showing annual volatility levels for the past 60 years:

Note that the value for 2010 is preliminary, based on just 1Q10 data.

Normally we prefer to use the S&P 500 index for analysis in preference to the Dow Jones Industrial Average because it has a more robust data set: 500 stocks as opposed to just 30. In this case, however, the DJIA has one thing the S&P 500 lacks—historical data prior to 1950. Thus, when it comes to comparing 2008 with 1929, it’s the DJIA that carries the load.

There is a lot of debate about the validity of comparing these two crashes. Bears tend to point to the faltering economies, failing banks and businesses, high unemployment, foreclosures, deflationary pressures—and, of course, the peaks in volatility—as similarities. Bulls tend to brush these aside with the observation that the 1929 crash ushered in a catastrophic depression—the market decline in 1930 was twice as bad as 1929 and 1931 was again worse still—while 2008 was followed by a mere recession (albeit a really bad one) and the market was up in 2009 and is up again (so far) in 2010. Here is chart that compares market volatility for the two crashes:

Following the 1929 crash, there was one quarter of eerie calm, followed by years of “may you live in interesting times.” This time, however, we have calmed down more slowly, but inexorably back to normal volatility. Insofar as this reflects the collective wisdom of market participants, that appears to be that the crash of 2008 is not “the big one” in the same sense that the crash of 1929 was.

This isn’t to say that the common wisdom—that risk here has been reduced—is the be-all and the end-all. Anyhow, given that it more likely fear which engenders volatility than the other way round, using a measurement of volatility as a predictive mechanism would be, well, risky at best.

Be that as it may, while the market could be wrong here—and a lot of minds could change in a hurry should Toto pull the curtain aside—for now reality is that the market perception is, essentially, “Be cool, man…everything’s copacetic!”

Previous volatility-related articles:

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