Research Watch

A bear call to rival the bulls. The value of ‘boring’. On video: Steve Keen responds to Paul Krugman (again).

PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.

After big bull calls from Goldman Sachs and JPMorgan before the Easter break, Nomura's resident uber-bear, Bob Janjuah, is out with a more sober assessment of where world markets are going. But as it turns out, that 'once in a lifetime' buying opportunity mightn't be so far away. Over at Societe Generale, Dylan Grice presents an excellent essay on the secret pleasures of 'boring' investing, concluding that high risk offers high excitement, not high returns. Meanwhile, GMO explains how to invest in a world with no cheap assets and, for all that's been said about America's sub-par recovery, the St Louis Fed demonstrates that the economy is actually chugging along OK compared to other post-bust periods. UBS looks to its commodity investment clock, which just struck 'sell', and researchers at J Capital list eight reasons not to trust Chinese economic data. Also, the best currency in the world, dinner at Buffett's childhood home, and how to invest based on CEO holidays. Finally, on video, Steve Keen keeps his debate with high-profile US economist and Nobel prize winner Paul Krugman alive.

Bob's not buying (yet) ... “ '¦ I continue to believe that while equity prices may surprise on the upside in Q3/into the US elections, late Q4/early 2013 and the (lack of) growth and US fiscal stories could herald the next stage of the post-2008/09 'M’ bubble, i.e., the next major equity bear market. '¦ Ultimately I still fear and expect the S&P500 – as the global risk-on/risk-off proxy – to trade at 800, and the Dow/Gold ratio to hit parity (currently at 8, down from an all-time high of 45 in late 1999) before we can begin the next multi-decade bull cycle. I think the battle between central bank inflationist policies and the natural cycle of deflationary debt deleveraging will continue to be attritional, and it may drag well into 2013 and 2014. I do however remain hopeful that in the next 12-24 months we will see both the basis form for the next major multi-year cycle of global economic development and we will see risk asset valuations at truly 'once in a lifetime’ cheap levels. We are not yet at this point.” (Bob Janjuah of Nomura, April 10)

But Hulbert might be '¦ “Might the stock market be embarking on a 10% or more correction, just as it did in April of each of the last two years? I doubt it. The sentiment data suggest that the correction that began earlier this month is going to be more modest. Consider the average recommended stock market exposure among a subset of short-term stock market timers tracked by the Hulbert Financial Digest. On April 2, the day of the bull market high, this average stood at 42.1% '” which is nowhere near as high as where it stood at the stock market’s peaks in either of the previous two Aprils.

In fact, as you can see from the accompanying table, the HSNSI at the April 2010 bull market peak was 23 percentage points higher than where it stood on April 2. And at the April 2011 peak this average was 25 percentage points higher. This contrast is significant, according to contrarian analysis, as it suggests that the recent bull market peak was not accompanied by the excessive levels of enthusiasm and euphoria that were seen as the market began its major corrections in each of the two previous Aprils. The accompanying table also shows where the HSNSI stood on the fifth day of each of these three corrections. Notice that the HSNSI has dropped far more over the last week than it did on the occasion of each of those prior two corrections. This is also telling, according to contrarians, because a hallmark of more major market tops is stubbornly-held bullishness. There would appear to be a lot less of that stubbornness in the current situation than in either of the previous two Aprils.” (Mark Hulbert in Market Watch, April 11)

'Boring' is undervalued '¦

“High risk doesn’t always equal higher return. Indeed, although higher quality stocks carry the sort of lower risk which is supposed to attract a low return, we’ve consistently found them to be higher return. Quality stocks, in other words, seems to possess that attribute most desirable to the long-term investor: systematic undervaluation. The easiest way to show this is to compare the returns of stock portfolios constructed by their market betas (see chart). It seems compelling enough: the outperformance has persisted over a lengthy period of time after all. '¦ We think Antti Ilmanen’s idea that 'high risk' securities attract a 'lottery ticket' premium is closer to being right than wrong. We also think that the same psychological tendency that overvalues lottery tickets undervalues quality stocks, as their robust business models and solid balance sheets do tend to be quite boring. So our best guess at the moment is that the mispricing of quality is indeed systematic. It reflects something permanent (our psychological hardwiring) rather than something transient (the fads of macroeconomic theory).” (Dylan Grice of Societe Generale, April 4)

How to invest in a world with no cheap assets '¦ “GMO's outlook for both stocks and bonds is that returns will be disappointing for years to come. Given these assumptions, Ben Inker, GMO's head of asset allocation, tackles two very difficult questions: 1) What role should bonds play in a portfolio? Diversification: Inker said that investors are overestimating the value of bonds’ risk reduction. In the past several years, he said, the correlation between stocks and bonds has been starkly negative. GMO thinks that extreme lack of correlation is unlikely to persist. Hedge Against Deflation: The problem, Inker said, is that yields these days are too low. The potential return from, for example, a 10-year bond going from 2% to 1% is not offset by the risk of loss of capital if yields increase from 2% to 3%. With GMO foreseeing more correlation between stocks and bonds, along with how bonds are not perfect hedges against deflation, the question regarding what role bonds should play in a portfolio does not seem unanswerable. Rather, we just need to rethink what we already assume about bonds. 2) Should investors be overweight stocks just because bonds are unattractive? The danger, Inker said, is that stocks might quickly go from modestly overvalued to fair value, in which case investors would suffer a permanent impairment of capital. 'That scares us,' he said – unlike the situation in the winter of 2009, when bonds were priced similarly to how they are today, but stocks were clearly undervalued. Inker said his discomfort lies with the notion that investors should increase their overall portfolio risk simply because they are being offered a bad opportunity set. '¦ GMO's position is that you shouldn't just jump from one conclusion to another without considering the risks. In Inker's mind, equities are indeed the best asset class available, but the high risk nature of the market worries him. Meanwhile, bonds are unattractive, but should you buy stocks just because of that? GMO cannot seem to find an accurate answer to this difficult question. For now, their way of addressing these risks is to hold more cash.” (Advisor Perspectives, March 27)

The US recovery's not that bad '¦
(St Louis Fed via Econbrowser, April 9)

The commodity clock ticks over '¦

“There are three elements to our cautious call on industrial commodities and miners. On all three points, we are more cautious than our global macro and asset allocation colleagues: 1) The end of Federal Reserve and European Central Bank (ECB) stimuli will cause an acceleration of capital flows out of emerging markets, hitting commodity demand. 2) China is undergoing a difficult transition away from the powerful labour and capital mobilisation of the past 25 years. As the authorities refuse to stimulate private construction and infrastructure in the face of a slowdown, commodity intensity will fall. 3) The US may see credit conditions deteriorate, post the ECB’s LTRO2 (longterm refinancing operation 2) and with a cyclical slowdown going into the middle of 2012. This would likely trigger a broader risk-off event and a further acceleration of capital flows out of emerging markets. Of the three elements of our call, we are seeing gathering evidence that the first two themes are working. However, there is no conclusive evidence of an increase in US credit stress, nor consistent signs of a US slowdown. On our investment clock that leaves us firmly in zone four: The disinflationary boom.” (UBS via Pragmatic Capitalism, April 10)

The Chinese data choose-your-own-adventure '¦ “The great thing about Chinese economic data is that you can read whatever you like into it. Anne Stevenson-Yang of J Capital Research put together this list of some of the recent, contradictory signals coming from China: 1) The HSBC PMI for March shows significant contraction (48.3) while the official PMI shows robust expansion (53.1). Yes, they rely on different data samples, but a 5-point spread is too large to reconcile with ideas about sampling. 2) Industrial enterprise profit dropped 5.2%, and SOE profit dropped 20%, yet corporate income tax revenue rose 29%. 3) Imports of raw materials surged'”copper imports rose 76%. 4) YoY and iron ore imports were up 29%–but prices continue dropping. 5) Industrial production grew but inventories grew more. 6) Property investment was up 27.8%, while the 'property prosperity index' (comprising eight property market statistics) was negative. Cement output was up 4.8% but prices are down 8% 7) Retail sales growth fell while household consumption grew. 8) Inflation slowed to 3.2%, and GDP growth slowed, while overall tax revenue rose 35%.” (Anne Stevenson-Yang of J Capital Research, via FT Alphaville, April 11)

The best currency in the world to own is '¦ the Norwegian Krone.
(ING via Business Insider, April 11)

Eat dinner in Buffett's childhood home '¦ “Adding yet another level to Buffett-mania, dinner at his childhood home will be auctioned off starting at $6,000. The catch: Warren Buffett won’t actually be there. But he’ll tape a personal video for the dinner party, assuredly complete with plenty of Aw-Shucks memories of growing up in the very home! The guests will also get a personally autographed photo of Buffett in front of the home. The dinner, to be held May 5 during Berkshire Hathaway’s annual meeting, will be auctioned off on eBay to benefit Girls Inc., an Omaha charity where Buffett’s daughter Susie Buffett sits on the board.” (Wall Street Journal, April 10)

Willing banks find profits in Iran '¦ “As Western sanctions on Iran have grown tighter, some small banks have found a lucrative niche financing what remains of the legal trade with the Islamic Republic. Top-tier financial institutions including Société Générale and Rabobank Group have stepped back from business with Iran in recent months, citing increased political risk and logistical hassles that attend even legal trade with the country. As a result, the remaining players are commanding higher fees and offering increasingly complicated services. Like Russia’s First Czech-Russian Bank LLC and China’s Bank of Kunlun Co. Ltd, they are typically small, obscure financial institutions often based in countries historically friendly to Iran. The firms and other intermediaries still brokering these trades are charging more than 6% per transaction for legitimate trade deals with Iran, on top of traditional banking fees, according to traders and bankers knowledgeable with the process. That is as much as triple the fees typically charged by Arab Gulf banks two years ago, before the United States and European Union significantly stiffened sanctions, according to Iranian businessmen.” (Wall Street Journal, April 8)

Keep an eye on the CEO's schedule '¦ “Companies announce good news before and after a CEO goes on vacation, and they stay quiet while he or she is gone. A new study by David Yermack at Stern School of Business identified this trend in a study of 66 big companies '¦ Abnormal stock returns are about 16 basis points higher than usual for each of the three days just before the CEO leaves for vacation, and about 17 basis points higher than usual for each of the three days after he returns... Realised volatility during long CEO vacations, 0.378, is about 15.6% below work-day volatility. It's not hard to suppose why this trend exists. CEOs like to leave on a good note; they want to have a restful vacation; and they want to take credit for any good news that happened while they were gone. The paper uses Boeing as a case study. This chart of W. James McNerney Jr.'s vacation days is typical of the trend.”

(Money Game, April 10)

Video of the week: Keen responds to Krugman '¦ (from 2.00 min onwards)

(EconoMonitor, April 9)

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