Research Watch

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

As the great central bank rally powers along, some analysts are beginning to wonder what happened to risk. John Hussman says the risk/return profile of equities is now at its worst level in a century, in contrast to Citigroup’s Macro Risk Index, which suggests investors believe the ECB and Fed have essentially beaten their respective crises. If there’s anything investors have learned since Lehamn, it’s that recent rallies have been anything but risk-free — volatility insurance, trading at pre-crisis lows, is starting to look like a good buy. Then again, Bank of America Merrill Lynch analysts show just how effective central banks have been at crushing volatility in the past, and even the bearish David Rosenberg is amazed at the Fed’s control over stocks. By his calculations, equities are now at least as correlated with the size of the US central bank’s balance sheet as they are with earnings results. The good times may well roll on. Elsewhere, the real reason the Middle East is protesting, the future according to dividends, and meet the Survivor contestant who was booted off Wall Street. On video, Mitt Romney, or Mr Burns?

The worst buying conditions in 100 years...

“Our estimates of prospective return/risk for the S&P 500 have dropped to the single lowest point we’ve observed in a century of data. There is no way to view this as something other than a warning, but it’s also a warning that I don’t want to overstate. This is an extreme data point, but there has been no abrupt change; no sudden event; no major catalyst. We are no more defensive today than we were a week ago, because conditions have been in the most negative 0.5% of the data for months.

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The chart shows the S&P 500 since 1928, with blue bars identifying points where 1) the Shiller P/E exceeded 18; 2) the S&P 500 was above its upper Bollinger bands on daily, weekly and monthly resolutions; 3) the percentage of advisory bulls exceeded 45%, with bears less than 27%... and; 4) the 10-year Treasury yield exceeded its average over the prior 6-month period. This set of criteria is one of many observationally equivalent ways to define an ‘overvalued, overbought, overbullish, rising-yields’ environment.” (John Hussman of Hussman Funds, September 17)

And investors have forgotten about risk...

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“The Citi Macro Risk Index measures risk aversion in global financial markets. It is an equally weighted index of emerging market sovereign spreads, US credit spreads, US swap spreads and implied FX, equity and swap rate volatility. The index is expressed in a rolling historical percentile and ranges between 0 (low risk aversion) and 1 (high risk aversion). Based on this third risk measure, the perception of risk in the system is now the lowest since early 2010, before the Greek sovereign debt issue first moved the markets in a material way.” (Sober Look, September 17)

It might be time to buy volatility insurance...

“The occasional market downdraft... acts as a reminder of how much risk perception has drained out of the financial system these days. Making risk a decent buy these days. The VIX, which measures the expected volatility of the S&P 500 and thus its riskiness, is down to 14.6, up a little on last month’s low of 13.3, but still broadly back to the range that prevailed in the years before the financial crisis — at its worst, the VIX rocketed to the high 70s. … No doubt, much of this is down to central bank policy. For example, the European Central Bank’s promise to save the euro has caused Spanish credit default swaps, in effect the cost of insuring its bonds against default, to collapse. … Yet, overvalued or fairly valued, the price of risk is so low that it makes sense for investors to buy themselves some insurance against bad things happening. Because if the past five years have shown us anything, it’s that bad things happen.” (MarketBeat, September 18)

Then again, the Fed appears to be in control...

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And even Rosenberg sees a case for stocks...

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“In what he labels a ‘Houdini act of epic proportions,’ David Rosenberg says the US Federal Reserve has managed to broker a divorce between the stock market and the economy. … ‘The economy and earnings are weak, and getting weaker, but the interest rate used to discount the future earnings stream keeps getting more and more negative, and that in turn raises future profit expectations,’ Mr. Rosenberg said in his daily Breakfast with Dave report. He also noted that with the S&P 500′s dividend yield triple that of the belly of the treasury curve, investors are further enticed by equities, or at least those with attractive dividends and growth. Mr. Rosenberg’s analysis of the Fed’s balance sheet showed its high correlation with equities since QE1 was first hinted at in November 2008. He found that nearly 74% of the stock market’s movement can be explained by the level of Fed assets alone since QE1 was announced. ‘Until 2009, there was absolutely no correlation between the Fed’s balance sheet and the equity market,’ Mr. Rosenberg said. ‘Now the correlation is at least as deep as it is with corporate earning and the stock market.’ (Financial Post, September 19)

The real reason the Middle East is rioting...

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“A study released by the team under the direction of professor Yaneer Bar-Yam in September 2011 charted fluctuations in global food price since the financial crisis of 2007-8 and showed that, with each successive peak, citizens in food-importing countries reliably destabilise the political leadership. ‘When food prices go up,’ Bar-Yam told me this spring, ‘when food becomes unavailable, people don’t have anything to lose. That’s when social order is itself affected.’ The most recent such peak came in late 2010-early 2011 and yielded what is commonly called the Arab Spring. Bar-Yam also told me that the team’s model predicted another massive food price spike this fall/winter, even bigger than the last. This foreseeable crest was only exacerbated and expedited by this summer’s drought- and heatwave-bred corn disaster. And, indeed, the World Bank recently announced that food prices have reached record highs worldwide. As predicted, we have begun to see the concomitant rise in political instability in various forms, including riots and strikes.” (Pacific Standard, September 13)

The future according to dividends...

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“Here, instead of increasing at a year-over-year rate of anywhere from $0.84 to $1.49 per share as they have since mid-2010, the S&P 500’s dividends from the third quarter of 2012 to the third quarter of 2013 would appear to be set to rise by just $0.56 per share. That low figure indicates that investors expect a rather dramatic slowdown in the economy to take place by the third quarter of 2013. To put that observation into a larger context, our next chart shows the S&P 500’s quarterly cash dividends per share going back for each quarter since 1988-Q1.

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Here, we see that what happens with the S&P 500’s quarterly dividends provides a pretty good indication of what’s going on with the U.S. economy, and in particular the U.S.’ employment situation, as growing levels of dividends generally correspond with a growing job market, while falling or flat dividend levels correspond with a poor job market.” (Political Calculations, September 18)

Facebook for investors...

“[The Winklevoss twins’] first investment in June was SumZero, which brings together investors to share trading ideas and research. … [Founder Divya] Narendra believes the key to ensuring high-quality ideas was exclusivity. The site allows investors to become members only if they work on the ‘buy side.’ SumZero defines that group as investment professionals at hedge funds, mutual funds, and private-equity firms. Analysts from the ‘sell side’ such as Wall Street banks aren’t allowed. ‘We’re offering the site as an alternative to sell-side research,’ Mr. Narendra said. The site offers a weekly newsletter available to anyone but asks users for permission before placing their material in it. The appeal for members is the chance to read ideas from other investors, but also to spread the word about investments they already have. The four-year-old site has about 7,500 members, and Mr. Narendra says he continues to review each application personally, rejecting about 75% of them. Even the Winklevoss twins weren’t given access to the site before they become part owners of it. … The site also requires that members regularly submit trading ideas to maintain access to material posted by others. Members who don’t submit an idea for six months lose access to the database, but can get it back if they post a new one. The site also lets users follow one another and set up alerts for material posted about stocks they track.” (Wall Street Journal, September 17)

Surviving on Wall Street...

“Roberta ‘RC’ Saint Amour is a Bear Stearns alum, winner of the 112th Wellesley College ‘Hoop Rolling’ Competition, honorary member of the first inaugural Ladies of Investor Relations list, and a girl with a dream. That dream? Winning the new season of ‘Survivor: The Philippines’. Starting tomorrow, viewers can watch her go head to head with former San Francisco Giants second baseman Jeff Kent and the actress who played Blair on ‘Facts’ of Life, and while RC believes her time on Wall Street has prepared her well... the $1 million prize is not necessarily in the bag. And on the off chance she doesn’t emerge victorious, she’ll be looking to one of you for gainful employment, as the management at Landmark Ventures was apparently not interested in coming along for the ride: ... ‘They replaced me while I was gone, and I came back to no job, which was a little devastating — that’s the hardest part you go through with this wonderful experience. The sacrifices you make in order to have your dream come true. It’s tough sometimes, but I try not to think about it.’” (Deal Breaker, September 18)

Video of the Week: You've been 'Einhorned'...

A Wall Street Journal analysis shows just how much influence hedge-fund manager David Einhorn's words have on investors.

(Wall Street Journal, September 18)