Tag Archives: asset allocation

A while back, motivated by persistent misinformation being presented in the media, I did a quick study of volatility in various markets. It was something I repeated here last year using weekly rather than daily data. Markets have had lots of different things happening recently, so I decided to re-run the daily data study, this time using 5 years of data rather than just the 1 year I went with the first time around. Also, rather than showing the figures in tabular format, I’ve decided to make things more visual and put the results in a pair of charts.

Here is the first one which compares four exchange rates, four major US stock indices, eight big cap common stocks, four major commodities, and four key US interest rate instruments (using futures for the latter two groups). It looks at volatility from the perspective of the standard deviation of daily % returns. This basically gives us an idea of how much of a change we see in each market on a given day.

The results are consistent which my prior analysis. The interest rate and exchange rate markets are noticeably lower in volatility than commodities, stocks, and stock indices. The major forex pairs move roughly about the same amount as longer maturity fixed income instruments like T-Bonds (using a price basis rather than an interest rate basis).

The second chart uses average daily ranges as the comparison point. The ranges are calculated as (High – Low)/Prior Day’s Close. This allows us to look at percentages for all markets so we’re comparing apples to apples.

There’s a bit of shuffling around in the order in which the markets rank when looking at ranges rather than returns, but generally the pattern is the same. Interest rate and exchange rate markets fall on the low end of the scale while individual stocks and commodities are on the high end.

The first reason for showing these images to you is so the next time someone tells you how risky the forex market is you can show them the comparison and ask them if they want to reconsider.

The other reason I bring this subject up is to provide a better understanding of volatility across markets , which factors into things like bid/ask spreads, margin requirements, and the like. This should help in your investment asset allocation process – or at least to have some insight into how different markets move if you’re just focusing on only one or two. Of course once you start applying leverage you can create a situation where any market can result in a very volatile account equity line.

The ‘dash for trash’ is on, as the near-record low yields available on safe assets has prompted investment professionals to move further out the risk spectrum in a desperate bid to earn nominal returns that satisfy client needs.  Cautious optimism persists among buy-side commentators, but actions speak louder than words, and market movements suggests investors are behaving quite differently than their rhetoric, as robust demand continues to outstrip supply and push the yields on lesser-quality bonds ever lower.  The resulting valuations confirm that a substantial part of the market for fixed income securities has entered the speculative phase of the credit market cycle.

It was all so different not so long ago, as the bullish complacency apparent at the height of the credit bubble, turned to all-embracing fear following the collapse of Lehman Bros.  The first tremors of what would soon become the worst financial crisis in seventy years erased the irrational exuberance evident in the prices of risky debt, but the failure of a major investment house proved lethal; the credit markets ceased to function, as forced selling – and the resulting illiquidity – pushed yields to unfathomable levels.

Extreme risk aversion prompted investors to flee the market for corporate credit en masse, which saw investment-grade bonds suffer double-digit losses in a matter of weeks.  The carnage in high-risk segments was far more punishing, as the spike in the yields of junk bonds to more than twenty per cent resulted in losses of some 45 per cent for their unfortunate holders.

All told, the default rates implied by the yields available on even the highest-quality credits moved to levels that were without modern precedent, and savvy investors could bank on equity-like returns with bond-like risk.  Of course, outsized rewards could be expected if, and only if, the Bernanke-led Fed’s unconventional monetary policies could unfreeze the markets, and return risk appetite to more normal levels.

Near-zero interest rates, in tandem with credit-easing policies proved successful, and the spread on lesser-quality credits versus default-free Treasuries dropped from a peak of more than six per cent at the end of 2008 to below three per cent just eight months later, as investors priced out an economic and financial apocalypse.  Fed policy ensured a quick return to ‘business-as-usual’ on Wall Street.

Corporate bond pricing may not seem excessive to many on first glance.  After all, the credit spreads on lesser-quality corporate bonds have made little progress in the past three years, hovering around three per cent for most of that time, while current spreads are more than one percentage point above the lows registered at the height of the credit bubble.  This observation has seen many buy-side commentators argue that the bull market has further to run.

However, vigorous demand for safe assets, in concert with aggressive central bank purchases, has pushed the yield on ten-year Treasury debt deep into negative territory, when adjusted for long-term inflation expectations implied by the yields available on Treasury inflation-protected securities (TIPS).  As a result, current spreads for lesser-quality corporate credit imply a real yield of just two per cent – a level of return that rewards investors for delaying consumption, but provides little to no compensation for default risk.

It is quite clear that risky corporate debt is dangerously overpriced, but identifying a trigger that changes the status quo is always difficult.  Nevertheless, the trigger could well be a peak in corporate profitability, which may not prove sufficient to derail the equity market, so long as aggregate earnings do not come in too far below expectations, but a wide dispersion of profit outcomes across the individual constituents that comprise stock market indices, could punish corporate bond investors.

To appreciate why, it is important to grasp the financial theory that explains the pricing of corporate credit.  The Nobel laureate, Robert Merton, increased our understanding of corporate debt pricing, when he applied contingent-claims analysis way back in 1974.  He argued that owning a corporate debt claim is analogous to owing a risk-free debt claim of the same maturity, and issuing an option to default to the company’s shareholders – an option to put the firm at the value of the risk-free claim.

The value of the put option is determined by total firm volatility – both firm-specific and market-related – unlike equity prices, which only incorporate the latter.  Thus, if firm-specific or idiosyncratic risk increases on the back of a wide dispersion of earnings outcomes among equity index constituents, the value of the put option will increase and benefit shareholders at the expense of bondholders.  In other words, if stock market volatility and firm value remain unchanged, wealth will simply be transferred from the holders of debt claims to the company’s shareholders.

The theory helps explain why the market for corporate debt typically leads the equity market at important turning points.  Indeed, credit spreads bottomed in the spring of 2007, or more than half a year before aggregate stock prices reached their apex.  A similar dynamic could well be in the offing today.

The Federal Reserve’s unconventional monetary policies may well underpin the excesses apparent in the pricing of lesser-quality corporate credit for now, but liquidity is a dubious concept at best, and can disappear in a heartbeat.  Stormy weather may not be far away.

www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Japanese asset prices have jumped onto investors’ radar screens of late; the return of the Liberal Democratic Party (LDP) to power late last year has sparked hopes that the new leadership might match their pre-election rhetoric with actions that help to bring years of economic stagnation to an end.

The Diet was dissolved last November, and the LDP, under Shinzo Abe, secured a landslide election victory four weeks later, as voters expressed their disillusionment with the Democratic Party of Japan and backed the LDP’s promises to wage a determined battle against deflation through aggressive monetary easing, alongside flexible fiscal management.

Mr Abe harangued the Bank of Japan (BOJ) during the election campaign, arguing that the monetary authority has been far too timid in its efforts to combat long-term deflation.  Further, he threatened to amend the 1998 Bank of Japan Act if the central bank does not soon accede to a two per cent inflation target, and after he assumed the post of Prime Minister, he taunted the monetary policymaker with the words, “There is no future for a country that abandons hope for growth.”

The need for bold action on both fiscal and monetary fronts is not difficult to understand in the context of an economy that has been in relative decline for more than two decades, and recently slipped into its fourth recession since 2000.  Real GDP growth averaged more than four per cent a year from 1974 to 1990, but has averaged barely half a per cent a year ever since, as the economy continues to languish in the aftermath of the bursting of a joint asset and credit bubble more than twenty years ago.

The damage inflicted upon private-sector balance sheets by the implosion of the bubble led to a pronounced and protracted deleveraging that saw private-sector savings surge relative to investment.  The resulting deflationary impulse has seen the GDP deflator drop almost 18 per cent from its 1994 peak, while nominal GDP is almost ten per cent below the peak registered during the fourth quarter of 1997.

The BOJ cut policy rates to near-zero by 1995, and shifted to a zero-interest-rate-policy (ZIRP) in the spring of 1999, which was followed by the adoption of a quantitative easing policy that persisted from 2001 to 2006.  However, the unconventional policy failed to prevent deflation from taking hold and the resulting strong demand for precautionary money balances ensured that the private-sector’s financial surplus persisted at high levels.

High private-sector savings relative to investment contributed to large fiscal deficits that have seen the public-sector debt ratio jump to close to 240 per cent of GDP, a level that is in a class of its own – even compared to the euro-zone’s troubled periphery.  Fortunately, the preference for low-risk assets in a deflationary environment ensured that the growing government debt could be financed by private-sector savings at a low interest cost.

Looking forward however, projections of future fiscal deficits and household savings rates as the population ages, suggests that it is only a matter of time before the Japanese is forced to tap foreign capital markets, which are far less likely to provide funding at today’s historically low rates.

An upturn in borrowing costs would have a large adverse impact on the financial sector’s health.  Indeed, the central bank estimates that a one percentage point increase in yields would wipe out roughly two years of banking sector profits.  Thus, the need to revitalise the Japanese economy is a matter of some urgency.

There is no doubt that the world’s third-largest economy is beset by many structural issues that need to be addressed if nominal economic growth is to be lifted to a level that will put the fiscal position on a more sustainable path.  Constructive government policies are required to raise real growth, but ending deflation is the purview of the central bank, and the time for credible action is now.

Sceptics will argue that increasing the inflation target to two per cent will have little durable impact, since the BOJ has already failed to meet its current target of one per cent.  However, the central bank has all too often been the architect of its own failings, and has snatched defeat from the jaws of victory on more than one occasion.

Indeed, Ben Bernanke, then a professor at Princeton, remarked as far back as 1999 that “Japanese monetary policy seems paralysed, with a paralysis that is largely self-induced.”  He noted “the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.”

Little has changed in the intervening years, as the BOJ consistently argues that deflation is not the result of timid monetary policy, but stems from structural issues that have lowered the economy’s potential growth rate.  The central bank’s rhetoric has signalled to economic agents that it cannot defeat deflation alone, which has almost certainly reduced the potency of its unconventional policies.

Central bank credibility may well be restored under a change of leadership orchestrated by Mr Abe, but deflationary expectations are deeply engrained and the battle will not be easily won.  Nevertheless, monetary developments in Japan merit close attention in 2013.

www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Since the Currensee marketing department is approximately 75% Crazy Cat Lady, you know we were excited by the Guardian headline, “Ginger moggy beats the professionals and a team of students in the Observer's share portfolio challenge” (Note to confused Americans: moggy means cat in British)

Here’s what happened: two investment professionals took on a roomful of schoolkids and an orange cat in a stock-picking contest set up by the Observer.  Each team invested 5,000 (fake) GBP for a year, and was allowed to reallocate quarterly.  The final ROI : Cat, 10.8%; professionals, 3.5%, and students, -3.2%.

Aha, you cry! It’s the triumph of the Random Walk!  After all, what’s more random than the behavior of a cat? Economist Burton Malkiel's book A Random Walk Down Wall Street is a popular one, and it pretty much says that share price moves, if not actually random, are sufficiently complex as to be practically random.

Hold on, put down the catnip, even if the market behaves randomly, does that mean that random picking is the best market strategy?

If you had bought and held the entire FTSE all-shares index (the universe from which the teams picked their stocks) for 2012, you’d have earned 8.2%.  That reduces the cat’s edge to just 2.6%, still nothing to sneeze at, and makes the professionals and kids look pretty bad.  Maybe “buy the market” is the way to go.

Let’s look at the rules of the Observer’s game.  Players were restricted to stocks in one index – not ideal diversification - and could buy or sell just once per quarter. It doesn’t say for sure, but I don’t think they could do any short selling or avail themselves of future or options on the stock in that one index.  Would you pay a money manager to apply those rules to your hard-earned nest egg?

Clearly the game has been simplified for the school children and perhaps the cat, too.  It’s a fun illustration of randomness, but it was like a poker tournament stopped after the first four cards were dealt.  Trading and money management are long-term full-time jobs, and real professionals need access to all the tools and markets they can get to create diversified portfolios for their clients.

Or, you could always just throw your favorite toy mouse at a grid of numbers and hope for the best.

 

 

 

 

 

Retail spot forex trading is financially zero sum for the market as a whole. That means any profits made by one individual must come at the expense of someone else (or multiple someones). Actually, when you factor in the costs of bid-ask spreads, commissions where charged, and the bid-ask spread in carry interest rates (yes, they have a bid-ask spread there too!) for positions held overnight, retail forex trading is actually negative sum for the market as a whole. This is something to keep in mind as you think about your participation in it. (Feel free to use the comment section below to voice your arguments against the above statements. I will happily refute them. J )

Why should you care?

Because it means retail forex is a game driven by skill. While just about anyone can make money in the stock market by holding a mutual fund or index ETF in a bull market (or even in an overall flat market when factoring in dividends), nothing can be further from the truth in forex. It’s a lot like poker where in the long-run the money will tend flow from the weak players to the strong ones. As a result, you want to be among the strong players to have any reasonable expectation of long-term success in the market.

Of course one of the things many folks have relied upon to keep the trading profits flowing is the constant influx of new traders into retail forex trading. They are weak players for the most part, and their losses feed the stronger ones. Of late, however, the growth in forex trading (retail and overall) has stalled out. We’ve even started to see contraction in places. That means those weak newbies aren’t flowing into the market the way they were, and they may even be leaving on net. That will tend to make the market more competitive if it continues, requiring a higher level of skill.

On top of that, social trading has gained a lot of traction recently. That effectively increases the portion of the market controlled by the better skilled traders as more accounts mirror their trades (assuming, of course, those traders being mirrored are in fact skilled).

Combine a market where the weak players may be leaving on net with an increasing proportion of the market under control of skilled players and you have the makings of rising competition among traders. This is something would could actually create a feedback loop whereby traders who don’t feel they can compete personally will allocate funds to programs like Trade Leaders. Furthermore, it will make increasingly clear those who really are highly skilled and those who are only pretenders.

Something to think about as you ponder you own involvement in the markets.

Hedging risk is an integral factor in any intelligent investment strategy. Since no one knows for sure exactly where the markets will move, who’s to say components of your equity portfolio won’t crash and burn when faced with market volatility?

In the game of beating the stock market, many will play and very few will win.

Speculating on potential gains you could achieve on certain investments really isn’t practical. What is practical, though, is assuming an opposite position in single stock futures against your current cash market security position to hedge risk you might encounter. This can be achieved in various ways, one of which is the writing or purchasing of options on single stock futures contracts.

If you’re bullish about single stocks, consider using a synthetic long call strategy. Here, the investor simultaneously assumes a long position and put option on a single stock futures position. Together, the two create a something comparable to a long call. The very attractive benefit of this move being that your maximum loss is limited to just commission plus the premium paid on the option, while your maximum gain is virtually unlimited.

Say you are very confident that the share prices of company X will rise. Instead of buying stock outright at $49 per share, which runs you the risk of loss should the market move against you, you purchase one single stock futures contract on company X. you then take it one step further by buying put options on your futures position. For the premium paid, a long put gives you the right to sell the underlying instrument (future) at the puts strike price, should you choose to exercise it.

Three months later, you learn that you were correct; company X’s share prices have gone up and are now trading at $54 per share. You can now sell your single stock futures contract, which has increased in value along with the underlying security, for a profit. The put you purchased will simply expire unexercised at no harm to your position.

But what if you were wrong? What if the whoopie pies that company X produces have recently been discovered contaminated by salmonella and the result of the news on stock prices is devastating? Well, here is where the put would come into play.

Since the value of the futures contract is correlated with the underlying security, it has also plummeted in price and is now virtually worthless. However, by exercising your put option, you may sell your worthless futures contract at the strike price previously establish when the stock was trading healthfully. Even though company X’s stock price crashed and burned, taking your single stock futures position with it, you can sell it for a loss of only the premium you paid for it along with commissions.

Below is a chart showing a protective long put for visualization of potential outcomes. The red line is the put, and the blue is the spot market, but we will assume it’s the futures position for purposes of the example described above (since spot and futures move together). As you can see, should the stock position continue on an upward trend, you will profit with your long futures position. However, should it take a bearish turn and drop past your purchased put strike price (red) you will have the right to exercise and sell your futures at the strike, which will be more than it is worth.

So why don’t more people establish synthetic long call positions? Is it too much effort? Or do they just not know they exist?

One possibility could tepid congestion. Suppose the cash market stock drops a just few points; enough to sink below your futures purchase price, but not to the point of permeating your puts strike. Then, should congestion ensue until both derivatives reach expiration, you’re stuck with a loss. Granted it would still be limited to 1) the scope of the futures minus the strike of the put and 2) the put premium plus commission, but still, a loss nonetheless.

If you’re bullish, a synthetic long call could possibly serve as a well-protected strategy. Rather than buying the stock outright and risking a hefty loss should the market move against you, for the price of a few fees, you could purchase a put, combine it with a long futures, and limit your losses. Knowledge is power – a well-educated investor has a far better chance of success than an overzealous better.

 

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

The dawn of a new millennium marked the end of the secular bull market in stocks that began almost two decades earlier in the autumn of 1982.  The magnitude of the subsequent decline in equity prices forced investors – albeit reluctantly – to accept that returns had been more than excessive during the heady days of the dot.com boom.

The verdict that stemmed from investors’ soul-searching soon became clear – the high valuations afforded to stocks meant that they could no longer be depended upon to deliver stellar returns year after year, while the notable increase in correlations among existing classes of risk assets amid the turbulence, confirmed that the diversification benefits of traditional asset allocation models had been eroded.  Not surprisingly, the hunt for non-traditional assets began in earnest.

The search for alternatives coincided with an end to the two-decade long downturn in commodity indices, as supply/demand dynamics converged to push prices higher.  Years of under-investment in the infrastructure of several raw materials combined with the emergence of China as a major source of demand, which led many savvy analysts to conclude that commodities had entered the expansionary phase of a super cycle that could be expected to last for several years, and perhaps, even decades.

The super cycle hypothesis took some time to capture investors’ attention, as two decades of ‘false dawns’ saw investable cash deployed elsewhere, but the game changed following a number of high-profile reports from respected analysts in 2005, including Alan Heap at Citi, not to mention the best-selling book, “Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market,” which was penned by Jim Rogers, co-founder of the Quantum Fund with George Soros in the early-1970s.

Academic papers soon followed, and demonstrated that changes in commodity prices and stock market fluctuations demonstrated a strong negative correlation through time.  Inviting returns alongside the potential for significant diversification benefits proved hard to resist, and the sheer size of the funds that poured into the non-traditional asset class helped underpin the most pervasive commodities boom in modern history.  Indeed, the cyclical upturns of the early-1950s and early-1970s fall well short of the most recent boom in both magnitude and duration.

The global financial crisis and the steep economic downturn that followed brought an end to the seemingly irrepressible rise in commodities, with indices of metal and mineral prices declining by more than thirty per cent from the peak in 2008 to the trough in 2009.  However, the setback proved to be temporary, as the world’s emerging economies soon returned to a high-growth trajectory, and the resource-intensive nature of their growth brought the expansionary phase of the commodity super cycle back to life.

The revived bull market has sputtered of late, and investors are questioning whether the commodities space is still an attractive home for investment funds.  To provide a satisfactory answer to this query, investors need to know whether super cycles actually exist, and, if so, can the supply/demand dynamics be depended upon to justify investment.

More than three decades ago, Walt Whitman Rostow identified a commodity super cycle that is roughly fifty years in length, with expansionary phases extending from 1790 to 1815, 1848 to 1873, and 1896 to 1920.  More recently, John T. Cuddington and Daniel Jerrett employed more sophisticated econometric techniques in two separate papers, and provided evidence that supports the existence of super cycles for both crude oil and metals.

It is clear that commodity super cycles – spanning anywhere from twenty years in length to seventy years – do exist, but that alone, is not sufficient to support the case for investment in basic materials.  Do supply/demand conditions point to a continuation of the expansionary phase, or is it running out of steam?

The demand-side enthusiasts cite the rapid industrialisation and urbanisation of China as reason to remain bullish.  The Middle Kingdom’s economy has doubled in size in just seven years, and the resource-intensive nature of its growth means that it has accounted for more than eighty per cent of the increase in global demand for nearly all energy and metals products over the same period.

However, per capita consumption of energy and most metals is already well above the figures apparent in economies with comparable levels of GDP per capita, while the high investment share of GDP – at more than forty per cent for a decade – calls for a rebalancing of the economy.  Consensus estimates look for economic growth of seven to eight per cent a year in the decade ahead, but simple arithmetic suggests that a successful rebalancing of the economy towards consumption would lead to a growth figure closer to five per cent.

The demand-side case is weakening, but the bulls believe that supply-side constraints will continue to support prices.  It is important to note that two decades of declining prices meant that producers did not commit to new investment projects until they could be sure that the price increases were permanent and not just one more false dawn.  Obviously, after ten years of rising prices, such caution is no longer evident.

The expansionary phase of the commodity super cycle is running out of steam, while investment flows have eroded the diversification benefits.  The motivation for commodity investment is questionable.

www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Equity investors have enjoyed a sustained advance in stock prices for several months, as expectations premised upon the belief that policymakers are miracle-workers, allowed the major market averages to move sharply higher.  An overdue reality-check was sure to arrive at some point, and so it has, as corporate America’s most disappointing quarterly earnings season in many years, reveals that ‘big business’ is not immune to the troubling deterioration in global economic momentum.

The third-quarter reporting season is well underway at this stage, and the latest numbers reveal that corporate America is set to post a year-on-year decline in quarterly earnings-per-share (EPS) for the first time since the autumn of 2009.  Consensus estimates forecast a two per cent drop in quarterly EPS, as a sharp slowdown in revenue growth alongside margin compression, has sent corporate profitability into reverse.

Corporate America has enjoyed an extraordinary earnings boom over the past three years, as an intense focus on costs allowed margins to surge to record levels – more than three percentage points above their long-term mean, while a strong contribution from global operations more than offset tepid revenue growth in the US.

However, the ability to tap further cost efficiencies is largely exploited at this juncture, while the economic malaise in the euro-zone, and a marked slowdown in the pace of economic growth in emerging markets including China, means that foreign operations are no longer bolstering bottom-line performance.

The recent trends are unsettling.  FactSet reports that the percentage of companies reporting earnings above expectations thus far is in-line with historical averages at close to seventy per cent, but the aggressive reduction in earnings estimates during the pre-reporting season means that this figure is not particularly impressive.

Further, the percentage of companies posting revenues above consensus estimates at about 35 per cent, is more than twenty percentage points below recent experience, and as low as the number seen in the first quarter of 2009, when the global economy was deep in the throes of the worst downturn in generations.

The top-line disappointment is almost exclusively an international affair, with a spate of companies including GE, Ingersoll Rand, and Microsoft attributing the shortfall in sales to weak economic conditions in Europe, and others including Caterpillar and Intel, citing soft activity in China.  Currency issues were mentioned in a number of earnings reports, but this was just a minor irritation, with sluggish revenue growth stemming primarily from soft demand.

The fourth-quarter earnings season is unlikely to prove any kinder than the current reporting period, as more than three-quarters of the companies that issued forward guidance, provided an earnings outlook below the Wall Street consensus. This the highest number since FactSet began collating the data in 2006.

The negative guidance appears to have had little impact on the bottom-up analyst community, who forecast a resumption of earnings growth during the fourth quarter, with an eight per cent increase in EPS pencilled in.  The optimism continues for 2013, with a four per cent increase in revenues expected to lead to EPS growth of ten per cent.

The numbers appear fanciful as the US economy continues grow at subpar rates, the euro-zone crisis is ongoing, while structural issues could well see growth rates in emerging markets such as Brazil, China, and India that are well below recent norms.  Further, it is difficult to see how low, single-digit sales growth will propel margins any higher than they already are.

Corporate America’s good fortunes in recent years have been premised upon a concerted effort to control variable costs, with incremental revenue increases dropping straight to the bottom line.  Costs have already been pared to the bone, which means that further margin expansion is not feasible without robust top-line growth.  Indeed, revenue increases in the three to four per cent range, at such an advanced stage of the earnings cycle, have typically been accompanied by margin contraction, and not expansion.

In this regard, it is instructive to observe that current earnings have reached levels – relative to their ten-year average – that have rarely been exceeded during the past half century and typically followed by poor growth outcomes in subsequent years.  Statistical analysis reveals that corporate earnings are roughly 25 per cent above trend, and given the soft global economic picture, it would be unduly optimistic to expect double-digit percentage point gains to continue.

The third-quarter reporting season has been notable for the sluggish revenue growth that has brought an end to corporate America’s winning streak.  Wall Street remains bullish on the outlook for the remainder of this year and beyond, but a more constructive analysis suggests the boom in corporate profits is at an end.

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

I believe it was New Jersey governor Chris Christy I saw saying to his constituents before Hurricane Sandy hit something to the effect of damage was going to happen despite their best efforts because they couldn’t prevent the storm barreling through.  This is a lesson for investors.

Markets do not always do what we want them to do. That’s a fact of life as an investor or trader. We can do all kinds of great analysis, pick just the right market or security or investment vehicle but still get hit by something unexpected or unavoidable. The investors who survive these sorts of events, and even thrive coming out of them, are the ones who are prepared, while those thinking only of how much they stand to make in the markets are the ones swept away.

It all comes down to risk management. And it has become clear in recent years that the old methods of diversification through spreading money around low-correlated markets are no longer sufficient. Markets which are largely uncorrelated during good times have a tendency to becoming strongly correlated during troubled times – exactly what the old diversification systems relied on them not doing. As I shared with my Twitter and Facebook followers, even just looking at stocks we have seen big swings in the correlation of individual securities with the overall market (which interestingly has gotten low recently). This requires a different type of thinking.

And even if we get the diversification side of things right, that doesn’t completely mitigate our big picture risk. There is always something that can come along and put our hard-earned money at risk. That is where worst case scenario type analysis has to take place. This is where many in the financial sector fell flat, leading to the financial crisis. They felt comfortable with the risk of their portfolios as indicated by the Value-at-Risk (VAR) models they were using, forgetting to account for what could happen beyond the 95% confidence level – events virtually inevitable in the long run. It’s the remaining 5% they should have been worried about, as it’s in that area where they lost their business and very nearly locked up the whole financial system.

The same goes for an individual. Identify the worst and prepare of it. The tools Currensee has put in place in the Trade Leaders program definitely help do just that. You won’t be able to avoid taking some losses along the way, but if you prepare properly you can avoid seeing your financial well-being get swept out to sea.

The world’s major stock price averages have registered robust double-digit gains, since early-summer, to within touching distance of multi-year highs, a somewhat puzzling development given that virtually all of the most recent data confirms that global economic growth has slowed to the most sluggish pace since the ‘Great Recession’ came to an end three years ago.

A troubling slowdown in economic activity is detectable almost everywhere, with stagnation or outright contraction evident across much of the developed world, while several emerging market economies have struck a nasty speed-bump.  The deterioration in the global economic outlook is beyond dispute, and reflected in rising unemployment, falling investment rates, as well as the volume of world trade, which has slowed to a standstill.

Hope continues to trump reason however, as investors continue to demonstrate blind faith in policymakers’ ability to deliver stimulus measures that will lift the global economy from its current soft patch.  It is staggering to observe that many seasoned market players persist with such a belief, given that all the evidence suggests that the various growth models responsible for the robust expansion in economic activity, in the years that preceded the global financial crisis, are now exhausted.

The debt-driven model that underpinned economic growth throughout most of the Western world, for at least the past two decades, is undoubtedly beyond rescue at this juncture.  The rate of increase in non-financial private sector debt outpaced GDP growth by more than three percentage points a year on average through the 1990s, and the gap widened to almost six percentage points a year in the early years of the new millennium, which inevitably pushed debt ratios to dangerous levels.

The unsustainable private sector borrowing spree duly came to an end once the ‘Great Recession’ struck in 2008, and the resulting plunge in economic activity required fiscal and monetary stimulus on an unprecedented scale to prevent a worldwide depression.  The unthinkable did not happen of course, but policymakers’ efforts to promote a self-sustaining economic expansion have been less than impressive.

The U.S. economy for example, is experiencing the weakest recovery in post-war history, with annualized economic growth, quarter-on-quarter, averaging little more than two per cent since the downturn ended, or less than half the pace recorded over a comparable time period, following the previous ten recessions.  Additionally, although real output has reached new highs, not one of the four indicators that the National Bureau of Economic Research employs to date business cycles, has exceeded their pre-recession peaks.

Meanwhile, European economic performance has been even less inspiring, with activity failing to recover its pre-recession peak in both the euro-zone and the U.K., such that GDP-per-capita is still roughly two per cent below its 2007 level in the former, and six per cent below in the latter.  Further, the post-recession experience in both economic regions trails the Japanese record following the deflation of its twin property and stock market bubbles more than two decades ago.

Three years have passed since the advanced economies of the Western world reached their nadir, and economic growth continues to disappoint, while aggregate debt ratios remain close to record levels, as the deleveraging of private sector balance sheets has been offset by the deterioration in public finances.  Further, persistently elevated unemployment rates, alongside relatively subdued investment in the productive capital stock, threatens to lower potential growth rates that are already pressured by an unfavorable demographic picture.

The debt-driven model apparent in most of the developed world is bankrupt, but troubling, the growth models applied in emerging market economies can no longer be relied upon to drive the global economy forward.  This is true not only in India, where persistently large fiscal deficits, a deteriorating external position, and stubbornly high inflation have undermined the sub-continent’s status as emerging-market darling, but also in China, where an unprecedented investment boom has limited the central government’s scope to offset the sharp slowdown in economic growth via a fiscal stimulus package centered on infrastructure spending.

The Middle Kingdom’s economy is already in desperate need of rebalancing towards household consumption, which at less than 35 per cent of GDP is well below that of countries at a similar level of in income.  Additional infrastructure spending at this juncture may well ease cyclical pressures, but would undoubtedly result in greater economic turbulence later.

China’s policy response to the global financial crisis precipitated a nine percentage point increase in the investment share of GDP to close to 50 per cent between 2007 and 2011.  However, the investment boom has been accompanied by an increase in the incremental capital/output ratio – the quantity of new capital required to generate an additional unit of growth – to levels comparable to its East Asian neighbors just before crisis struck in 1997.

Further, central government and corporate debt ratios are not far removed from Japanese levels just before its economic miracle came to an end in 1989.  Rebalancing, and not fiscal stimulus, is what the Chinese economy requires, and simple arithmetic suggests that this is not possible without a significant drop in the economy’s long-term growth rate.

Investors continue to push stock prices higher on hopes that stimulus measures will return the world economy to a more familiar growth trajectory.  Cyclical solutions cannot solve structural problems however, and it is troubling to note that there are no growth engines available to push the world economy forward.

www.charliefell.com

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