Macro Tsimmis

intelligently hedged investment

Archive for July, 2010

Market volatility heats up in 2Q10…but still signals “No worries!”

Posted by intelledgement on Sun, 25 Jul 10

All good things—and, presumably, bad things, too—come to an end. And the string of five consecutive quarters with declines in market volatility was decisively consigned to the history books in in 2Q10, as the average daily change (up or down) in the value of the S&P 500 index spiked 88% from ±0.59% in 1Q10—which is just about normal—to ±1.11% in 2Q10. Despite this 2Q10 surge, overall volatility in 2010 remains materially below the abnormally high levels of 2009, to say nothing of the all-time record volatility in 2008:

We track market volatility because it is a reasonably reliable gauge of risk levels. 80% of the time from 1950 to 2010, when volatility in the S&P 500 goes up—that is, the average annual 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.

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 2008-10 with 1929-31, 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 (-30%) was almost a repeat of 1929 (-34%) and 1931 (-72%) was more than twice as bad—while 2008 (-38%) was followed by a mere recession (albeit a really bad one) and the market was up in 2009 (+23%) and is only down moderately (so far) in 2010 (-8% as of 30 Jun 10). Here is chart that compares market volatility for the two crashes:

As is evident, measured in terms of volatility, the 2008 crash—apart from the spike—looks less and less like 1929 with each passing quarter. An 88% spike is notable, but never-the-less 2Q10 constituted the fifth consecutive post-crash quarter where present-day volatility was lower—for the last year, substantially so—than it was in the equivalent 1930s quarter.

Despite a panoply of potential black swan events hanging over our heads—Euro sovereign debt crisis, the Chinese real estate bubble and concomitant bad bank loans, the interplay of aging populations and structural deficits in the developed nations, the risk of a political, economic, and/or social dispute escalating into disruptive violence, ecological disasters, peak oil, pandemics, sunspots, space invaders, etcetera—the collective wisdom of The Market appears to be that we have succeeded (at least) in kicking the can down the road. That road had a sinkhole, which looked unsettlingly like the one we came upon in 1929—and promptly fell into! But this time—the market appears to telling us—we’ve leaped over the sinkhole, and while we teetered on the far edge for a spell, we have now successfully moved a few steps past it.

True, this is the same market that 15 months ago valued the S&P 500 at 683—and 15 months before that at 1468. But we also have 80 years of pricing data that tell us that we don’t have proximate systemic risk without extremely high volatility levels…like close to triple the ±1% we experienced in 2Q10.

Not to say a new chasm couldn’t open up tomorrow. But right now, we don’t see it.

Previous volatility-related articles:

Posted in General | Tagged: , , , | Leave a Comment »

SELL iShares Dow Jones US Technology ETF (IYW)

Posted by intelledgement on Mon, 19 Jul 10

OK, last September we got into this position—US high tech—holding our noses. At that point, the NASDAQ was up 38% in the previous six months. We felt that the rise was unjustified and unsustainable, but that [a] there was some risk we were wrong and [b] given the forward inertia the market had built up, we felt it was prudent to protect against “upside” risk even presuming our analysis was correct.

Well, by April of this year, the NASDAQ was up another 19%…but since then it has been falling back and is now just +5% from were we bought in last September. So, what’s the story here? Last September, we listed five ways we could tell if we were wrong, and the rally—and economic recovery that underlay it—were actually legitimate:

1. The economy ceased to contract and started expanding
2. The consumer continued spending money at a gradually expanding rate
3. Emerging markets continued growing faster; demand for commodities rose
4. Most countries continued to gain more from free trade than they lose
5. Inflation resurfaced

We have had modest economic growth but the jury is still out as to whether there is any substantial “organic” component to it or whether it mostly—if not completely—reflects government stimulus. Consumer spending has not appreciably improved. Emerging markets have continued to grow faster, but if Europe slides into recession and the USA is barely north of neutral, this is not much of an achievement; commodity demand growth is a mixed bag at best. There has not been a surge of protectionism, so condition four has clearly been fulfilled (and this criterion was relevant to the IYW ETF because US high tech sells so much to the emerging market countries). Inflation, on the other hand, remains dormant outside of China.

So, generously, we have two-and-a-half out of five. Not very persuasive. Thus, as we never believed in this rally in the first place, we are cashing in our chips here, booking our modest profit, and reducing our exposure to downside risk.

Previous IYW-related post:

Posted in A.1 Investment Recs | Tagged: | Leave a Comment »

2Q10 Intelledgement Macro Strategy Investment Portfolio Report

Posted by intelledgement on Wed, 14 Jul 10

Summary of Intelledgement’s model macro strategy model investment portfolio performance as of 30 June 2010:

Position   Bought   Shares Paid Cost Now Value   Change       YTD         ROI       CAGR  
FXI 03-Jan-07 243 37.15 9,035.45 39.13 10,109.63 -5.69% -6.03% 11.89% 3.26%
IFN 03-Jan-07 196 45.90 9,004.40 30.25 8927.80 -2.75% -0.98% -0.85% -0.24%
DBA 13-Mar-08 235 42.50 9,995.50 23.99 5,637.65 -0.95% -9.27% -43.60% -22.07%
TBT 21-Jan-09 233 42.84 9,989.72 35.48 8,266.84 -27.13% -28.87% -17.25% -12.34%
EWZ 3-Aug-09 165 60.39 9,972.35 61.83 10,628.21 -15.19% -17.13% 6.58% 7.28%
IYW 29-Sep-09 208 51.86 10,794.88 51.60 10,771.70 -11.48% -10.32% -0.21% -0.29%
GLD 21-May-10 95 115.22 10,953.90 121.68 11,564.54 n/a 13.39% 5.57% 64.11%
SLV 21-May-10 636 17.29 11,004.44 18.21 11,614.63 n/a 10.10% 5.54% 63.69%
DOG 25-May-10 204 54.01 11,026.04 54.01 11,018.04 n/a 3.21% -0.07% -0.73%
PSQ 25-May-10 246 44.74 11,014.04 45.26 11,133.96 n/a 3.64% 1.09% 11.61%
SH 25-May-10 201 9.41 10,978.58 55.01 11,057.01 n/a 4.66% 0.71% 7.49%
cash -13,769.30 10,174.48
Overall 31-Dec-06 100,000.00 120,904.29 -4.01% -4.56% 20.90% 5.58%
Macro HF 31-Dec-06 100,000.00 120,194.43 0.70% 2.39% 20.19% 5.40%
S&P 500 31-Dec-06 1,418.30 1,030.71 -11.86% -7.57% -27.33% -10.09%

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: The sudden return of volatility in 2Q10 had us jumping through hoops with not only more transactions than usual but some hard zigging and zagging…but in the end, all profitable (at least the closed trades):

Performance Review: Normally you’d have no difficulty characterizing a 4% loss as a bad quarter, but when you still beat the market (-12%) by eight points, the waters get a bit muddy. We did lose to the hedgies (±0%) by five points. Tactically, reflecting the schizoid market we are close to neutral here, with our three BRIC country funds plus our high tech fund bullish, our four short funds bearish, plus three commodity plays including two flight-to-safety/inflation insurance precious metal funds. Our BRIC ETFs overall were down—as one would expect in a -12% market: India (IFN, -3%), China (FXI, -6%), and Brazil (EWZ, -15%); plus the emerging markets-oriented US Technology ETF (IWY) tracked the market (-11%, which BTW did edge out the NASDAQ for the quarter by one point, for those keeping score at home). Our repurchase of the precious metal EFTs looks good so far with GLD +13% and SLV +10%; the agriculture commodities ETF (DBA) held its own (-1%). Our 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, had a disastrous quarter (-27%), as the European sovereign debt crisis sparked a flight-to-safety run on US government bonds, and interest rates consequently plummeted. Some of those losses were offset by profits on the purchase and sale of the three index short ETFs for the DOW (DOG), NASDAQ (PSQ), and S&P 500 (SH) during the quarter; we purchased them again towards the end of the quarter and were slightly ahead. We also made a profit on our sale of the Malaysia ETF (EWM), although the sale price was a tad lower than the close at the end of last quarter.

Overall, we are now 48 points ahead of the market in terms of total return-on-investment: +21% for us and -27% for the S&P 500 in the three-and-a-half years since the inception of the IMSIP at the end of 2006. We are one point ahead of our benchmark, the GAI Global Macro Hedge Fund Index, +21% to +20%. In terms of compounded annual growth rate, after three years IMSIP is +6%, the GAI hedgies are at +5%, and the S&P 500 is -10%.

Analysis: After five straight quarters of declining volatility, things got interesting—as in, “may you live in interesting times”—in 2Q10. A combination of continued slower-than-expected economic growth and the specter of sovereign debt defaults among European countries combined to spook the markets big time. The potential threat of defaults by any of the PIIGS (Portugual-Ireland-Italy-Greece-Spain) is considered to be extremely serious because it could engender a cascade of bank collapses—all over Europe and beyond—similar to the danger in 2008 attendant to a collapse of AIG, Bear Stearns, Citibank, Freddie, Fannie, Merrill Lynch, and/or Wachovia (all of whom were eventually bailed out by the US government). The powers-that-be most definitely consider that this would be a catastrophic eventuality, to be avoided at all costs. Thus the likelihood that central banks will once again deploy taxpayer dollars to bailout the moneyed elites, this time for their fecklessness in loaning money to over-extended governments instead of for their foolishness being lured into ludicrous spectulative bets by Goldman Sachs and their ilk.

Our perspective is that this is yet another swerve in the extended oscillating skid which we have written of before. The combination of intrinsically short-sighted democratically elected—and, more to the point, re-elected—politicians and a culture that increasingly craves instant gratification has done us in. We got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. The U. S. government’s attempts to address our problems have generally been short on addressing systemic issues and long on creating the temporary illusion that things are getting better.

The proper way to defeat an oscillating skid is to turn into it, thus affording your tires traction and enabling you to regain control. In our case, we could do this by allowing the insolvent financial institutions to go out of business, as they so richly deserve to. We could require more stringent capital requirements for both lenders and borrowers doing business in the USA. We could clean house at the regulatory agencies so they will actually enforce the rules already on the books (e.g., not allowing naked short selling). We could make it illegal for ratings agencies to accept payment from any company they rate. We could create an exchange for the trading of derivatives. We could encourage good corporate governance practices (e.g., favoring for government contracts companies that reward management with long-term stock options rather than instant cash bonuses so that corporate leaders’ interests were better aligned with the long-term interest of shareholders). We could reduce social welfare spending commitments to sustainable levels going forward.

But instead, we are fighting the skid at every turn. We are throwing good taxpayer money after bad propping up the “too big to fail” banks. We are debasing our currency in futile attempts to reinflate the housing and credit bubbles that got us into this latest fix in the first place. Instead of addressing the systemic problem of overcommitted government largesse, we are expanding the role of government and increasing our commitments.

Conclusion: There is no such thing as a free lunch. Someone always pays, sooner or later. For decades, we—through our elected leadership—have relentlessly whipped out our national credit card to, in effect, pass the debt on to future suckers. Well, if you have a mirror handy, you can meet one of those future suckers right now. The government is still flashing plastic, but now it is a debit card, and the account being charged is the one that’s comprised of your life savings.

In our best effort to avoid those charges, as of 1 July, we continue to hold four long emerging market ETFs in the portfolio: China (FXI), India (IFN), Brasil (EWX), 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). We believe that in a deleveraging environment, the economies that are still growing will fare far better than those that are not; thus these long positions will be the last we will surrender if and when things get really dicey. Already, things are somewhat dicey…enough so that we now have four inverse ETFs (that go up when whatever they are tied to goes down) to serve as insurance against a sudden worsening of the sovereign debt crisis (which could be either European- or domestic state/local government-based): the short DOW index ETF (DOG), the short NASDAQ index ETF (PSQ), the short S&P 500 index ETF (SH), and the inverse long-term Treasury bonds ETF (TBT). We are considering unloading this last because the (up-to-now) European sovereign debt crisis has engendered a perverse flight-to-safety that is driving U.S. bond rates down (and the values of the bonds up), even though in the long run the USA is no more solvent than Greece. We believe the value of those bonds will eventually plummet but we have held TBT for over a year now with no joy and it could be we can do better with the funds between now and a more opportune time to be short treasuries.

We also still have three long commodity plays: the agriculture ETF (DBA) and precious metals ETFs for gold (GLD) and silver (SLV). The dollar actually stronger again last quarter, the flight-to-safety reaction to the European sovereign debt crisis resulted in increased gold and silver prices anyway. In the longer run, we expect another massive round of central bank quantitative easing in response to the next crisis—or the one after that—and in the deluge of dollars that results, the commodities positions should provide some dry shelter for our assets.

Posted in A.2 Investment Reports | Tagged: , , , , , , , , , , , , , , , , , , | 1 Comment »