Tag Archives: economy

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

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.

US stock prices have made little headway in more than thirteen years, and the cumulative real returns generated by the major market averages have lagged Treasury bonds by a substantial margin over the period.  The uber-bulls are confident however, that the more than decade-long stagnation has led to attractive valuations that should pave the way for strong returns in the years ahead, and some investment practitioners have gone as far as to predict a doubling in equity values by 2022.  Is the optimism justified?

It is important to appreciate the sources of historical real stock market returns, which can be decomposed into three building blocks – the dividend yield, real growth in earnings-per-share, and changes in valuation.  Since 1871, US stocks have delivered annualised real returns of 6.5 per cent, of which more than seventy per cent is attributable to the dividend yield, roughly one quarter to real growth in earnings-per-share, and the remainder to an increase in the valuation multiple attached to current per share profits.

Looking forward, future returns seem virtually certain to fall short of the historical experience, simply because the dividend yield is little more than two per cent today or less than half its long-term mean.  The uber-bulls will undoubtedly argue that the dividend yield understates the total payout to shareholders, due to sizable increase in share repurchase activity in recent decades.

However, share buybacks are already included in per share numbers, and adjusting the payout ratio upwards would be double-counting.  In other words, an existing shareholder can either participate in the buyback and miss out on the earnings-per-share accretion, or forego the cash distribution and benefit from the capital gain.  Thus, forecasting future returns on a per-share requires no adjustment to the dividend yield.

The second building block in estimating future returns is the real growth in earnings-per-share, which is linked to the economy’s long-term growth rate.  However, existing shareholders have a claim on publicly-quoted per share earnings and not economy-wide profits.

Initial public offerings and secondary issues account for a considerable portion of the growth in aggregate earnings through time, and as a result, the growth in per share numbers falls well short of the cumulative increase in total profits.  Indeed, real earnings-per-share have increased at an annual rate of just 1.7 per cent since 1871, or roughly half the pace of economic growth.

The optimists put forward a variety of reasons as to why earnings-per-share growth will be higher in the future, but none stands up to serious scrutiny.  It is argued that share repurchases will provide a boost to earnings, which conveniently ignores the fact that the reduction in share count through time is largely a myth.  Indeed, new share issuance in excess of buybacks has averaged 1.25 per cent a year over the past half century, and repurchases have exceeded new issuance in just eight years.

The second argument relates to the growing share of profits generated overseas in high-growth markets.  The share of revenues sourced in foreign markets has increased from about thirty per cent more than a decade ago to almost fifty per cent today.  However, roughly sixty per cent of overseas revenues come from mature European economies, with a further ten per cent coming from Canada.  All told, just one in every eight sales dollars is generated in high-growth economies, which is simply not large enough to provide a meaningful boost to earnings growth.

The bulls also fail to appreciate that globalisation is a two-way process, and just as American multinationals have made impressive share gains in overseas markets, the same is true of foreign companies in the US.  Indeed, foreign subsidiaries have captured an increasing slice of economy-wide profits over the past two decades, with the share rising from just five per cent in the early-1990s to about fifteen per cent today.

Finally, the global financial crisis and the calamitous drop in economic activity have had a lasting impact on corporate sector behaviour with elevated unemployment levels and a relatively low business investment rate threatening to lower potential future growth rates in the developed world.  All told, there is no reason to believe that long-term growth in real earnings-per-share will stray too far from its historical trend.

The final input to the return estimation process is valuation change.  The market looks reasonable value on current earnings, but the greater than twenty multiple on cycle-adjusted profits is closer to previous secular bull market peaks than bargain basement levels seen in the past.

The bulls argue that the multiple is inflated due to the collapse in corporate profitability during the crisis, but using median earnings over the past decade or a denominator based on twenty-year average earnings to correct for the recession does not paint a different picture; the stock market is expensive.

The best the bulls can really hope for is no change in valuation multiples, which could prevail if macroeconomic volatility drops from its currently elevated levels.  However, should macroeconomic volatility remain high, it is far more likely that valuation multiples will contract, and at the very least, return to their historical mean.

Careful analysis suggests that equity investors can reasonably expect annual real stock market returns of 3.5 to 4 per cent at best in the decade ahead – well below the historical experience, and could deliver far worse should valuation multiples contract.  The bullish optimism is unfounded.

 

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.

The prospect of having an investment industry genius strategically (and often aggressively) managing your asset allocations in an attempt to kill risk and crank out returns can be alluring. Add to that the current upsets throughout the global economy, and despite their stigmatic volatility, hedge funds are looking pretty tempting.

Unfortunately for many retail investors, the restrictions that determine who can access a hedge fund don't leave much in terms of acceptance. In order to invest in these managed funds, one must either be an accredited investor with $1 million plus in liquid assets and a $200,000+/year paycheck, or a qualified purchaser, who owns at least $5 million in investments already. This clearly narrows the investor diversity scope down a bit.

But, the shell of the hedge fund industry looks like it’s finally starting to crack. Recent findings of financial research firm Cerfulli Associates published in an InvestmentNews article last week demonstrated that money managers expect their allocations into alternative investments to increase by at least 50% over the next three years. Investors and financial advisors also have a growing desire to increase alternative investments to negate market downturns and create a divergence from the stock and bond market.

But what does this have to do with making the elusive world of hedge funds more mainstream? It seems the ripples caused by an overall increase in demand for alternative investments have reached the mutual fund industry in the form of something known as ‘alternative mutual funds’.

Funds of this sort fall into alternative sectors such as long-short equity (one of the more popular), currencies, precious metals, and commodities. Taking it to the next level, alternative mutual funds twisted and evolved a bit further into something very similar, known as hedge-like mutual funds (the two names are often even interchanged.) These funds have the potential to hedge risk and generate stronger returns using some of the same strategies and tools that hedge fund managers use.

The most attractive characteristic of investing in a hedge-like mutual fund is that now, average-income investors can access the advantages of hedge fund investing previously available only to those qualified to invest in a hedge fund. Because the SEC regulates them, hedge-like mutual funds preserve some amount of the conservatism and transparency that is demonstrated within traditional mutual funds. Unfortunately, this can also impact these funds negatively in that it restricts their flexibility and requires a greater level of liquidity.

Though these crossbreed mutual funds aren’t anything new and earth shattering, Cerulli predicts that within the next five years, their presence will increase to the point of comprising 10 percent of mutual fund assets - a 245+ percent surge. The fueling of their growth really comes down to one thing: education. Money managers who strive to educate financial advisers on their investment products are the ones seeing positive results. This is due simply to the fact that many advisers are not yet familiar with all of their options in alternatives available to them. And we all know how easy it is to fear the unknown.

The theme of taking an investment that was once unavailable to traditional investors and making it available to them is common across the alternative investing landscape. Hedge-like mutual funds have successfully done what Currensee is striving to accomplish by carrying out this theme. Just the way hedge fund management, tools, and strategies were only available to high net-worth investors at one time, not long ago the world currency market experienced the same inaccessibility. However, with the emergence of various types of trade replication software and autotrading, even those with no prior knowledge of currency trading can allocate a portion of their investments to this type of alternative.

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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.

India has been viewed as a tiger economy – rather than a lumbering elephant – ever since it embraced outward-looking, market-friendly policies in 1991.  Income-per-capita has increased from just $300 three decades ago to $1,700 today, and the economy has not experienced a single year of contraction since the Iranian oil shock and a bad monsoon struck in 1979.

A poor growth mix in recent years however, has undermined the sub-continent’s status as emerging-market darling.  Persistently large fiscal deficits, a deteriorating external position, and stubbornly high inflation have led to a change in concerns over India’s ability to sustain its high-growth performance to whether it can simply maintain overall stability.  Corrective measures are required urgently if the country wishes to avoid a return to the status of lumbering elephant.

The Indian economy endured centuries of sub-par performance until recently.  Indeed, income per capita stagnated for almost 350 years following the arrival of the British at Madras in 1602.  The economy fared little better in the decades that immediately followed independence in 1947, as the subcontinent withdrew into autarky and socialism.

Economic growth averaged 3.5 per cent a year – the so-called ‘Hindu’ rate of growth – from the late-1940s through the 1970s, or roughly half the rate achieved by Asian tigers with outward-looking, market-friendly policies.  The economy’s performance was particularly disappointing over this period, given that the population grew at 2.2 per cent a year.  Indeed, the modest annual increase in income-per-capita meant that India made little headway in reducing mass poverty.

The first efforts to dismantle socialism and reform the domestic economy were introduced following the election of the Janata Party in 1977, and further economic liberalisation took place in the 1980s under Prime Ministers Indira Gandhi and Rajiv Gandhi.  The reforms alongside profligate public spending helped to accelerate the rate of GDP growth to 5.5 per cent in the 1980s, but the expansion was based on unsustainable borrowing, and a crisis erupted in 1991 when the country ran out of foreign exchange.

The foreign exchange crisis induced India to abandon its inward-looking policies and embrace the economic reforms recommended by the International Monetary Fund (IMF).  The new direction was not without its critics, and opposition parties argued that the new policies would result in a ‘lost decade’ of economic growth, as had been seen in other lesser-developed countries that supposedly adopted the IMF-model in the 1980s.  The critics vowed that they would reverse the reforms when they came to power.

The pessimism proved misplaced, as the country’s finances were restored within two years of the reforms, and the annual rate of GDP increase accelerated to a new record of 7.5 per cent from 1994 to 1997.  The outward-looking, market-friendly policies proved too successful to be reversed, and reform continued even when other political combinations came to power.

The Indian economy has continued to move forward at a robust pace, and weathered numerous tests of its resilience relatively well.  Economic growth slipped to 5.5 per cent a year from 1997 to 2002, a favourable outcome given that the Asian financial crisis, two severe droughts, and a global recession all struck over this period.

The economy’s performance improved sharply after 2003, and annual growth accelerated sharply to an average of almost 9.5 per cent in the three years that preceded the global financial crisis.  The ‘Great Recession’ took its toll on the economy, but growth was still almost seven per cent in 2008, and rapidly recovered to an average of more than eight per cent a year in 2009 and 2010.

The recent growth performance however, was propped up by unsustainable aggregate demand policies.  The overall fiscal deficit has averaged close to ten per cent of GDP over the past three years, and the budget released in February does not display any serious ambition to restrain public spending.  The government’s profligacy has been driven primarily by populist spending policies, and with national elections due by 2014, next year’s budget is unlikely to be much better.

The public debt-to-GDP ratio is already close to 70 per cent or 30 percentage points higher than similarly-rated sovereigns, and further increases in the ratio are virtually certain to lead to rating downgrades.  Further, current fiscal policy has contributed to a widening current account deficit and rising net external indebtedness.

The level of net external debt to GDP is already above ten per cent or three times greater than similarly-rated peers, and the more than ten per cent drop in foreign exchange reserves since last autumn limits its ability to absorb sustained capital outflows.

The profligate public spending policies helped push the rate of headline inflation up to the eight-to-ten per cent range over the past two years, and though the inflation rate has since decelerated to seven per cent, it remains above the central bank’s comfort zone.  The stubbornly high rate combined with a sharp drop in the Rupee, limits the central bank’s ability to stimulate the economy, which has seen its quarterly growth rate plunge to the lowest level in seven years.

India is rapidly losing its lure as emerging market darling.  Persistently large fiscal deficits, a deteriorating external position, and stubbornly high inflation have seen foreign investors look elsewhere for growth opportunities.  The lumbering elephant stands at a crossroads.

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.

It's been almost four years since the global financial crisis reached its climax, and the world economy is still unable to reach escape velocity without ongoing life support from central banks and governments.  The perennial optimists remain unmoved by the unimpressive economic expansion, and continue to believe that reflation efforts will ultimately prove successful, and that growth will return to its historical trajectory in the not-too-distant future.

However, the level of long-term interest rates offered on government bonds across a number of markets including Canada, Germany, Japan, the Netherlands, the U.K. and the U.S., is at odds with this view.  Indeed, sub-two per cent yields in many of the world’s leading economies are simply not consistent with robust future growth.

The economic data reported during the current upturn to date confirms that something is fundamentally different about this cycle.  The U.S. economy for example, is currently experiencing the weakest recovery on record with growth running at less than half the pace that is typical for this stage in the cycle.  Meanwhile, the euro-zone’s economic performance since the ‘great recession’ struck is even less inspiring, and trails the Japanese experience following the deflation of its twin property and stock market bubbles more than two decades ago.

The hard evidence would appear to suggest that the deleveraging of balance sheets to correct for the excessive build-up of debt throughout the developed world, and across all sectors of the economy, in the years leading up to the financial crisis, will exert a heavy toll on growth for years to come.

The extent of the debt accumulation over a period spanning three decades is simply staggering.  The level of non-financial sector debt relative to GDP in the developed world increased from 170 per cent in 1980 to almost 310 per cent by 2010, well above the thresholds that have been shown empirically to retard growth.  In other words, the rate of debt increase outpaced economic growth by more than four percentage points a year on average for three decades.

The late American economist, Herbert Stein famously wrote in “What I Think: Essays on Economics, Politics & Life” that “If something cannot go on forever, it will stop.”  The unsustainable private sector borrowing spree duly came to an end with the arrival of the ‘great recession’ in 2008, but the upward trend in outstanding debt continued, as declining tax revenues and automatic stabilisers increased the pressure on government finances.

The bottom line is that deleveraging has barely begun, with combined public and private sector debt relative to GDP across the developed world still close to an all-time high.  It is important to recognise that never before in modern history has so many of the world’s leading economies been saddled with so much debt.

Indeed, an analysis of the U.S. experience post-1945 reveals that total non-financial sector debt rarely strayed far above 150 per cent of GDP until the 1980s.  Simply put, the negative growth impulse arising from balance sheet rightsizing in one sector of the economy was traditionally offset by an increasing debt-to-GDP ratio in another sector.

Academic research by Stephen Cecchetti and others at the Bank for International Settlements reveals that debt begins to hurt growth when it reaches 85 per cent of GDP for the public sector, 90 per cent of GDP for the non-financial corporate sector, and 85 per cent of GDP for the household sector.

In aggregate, each of these levels has been surpassed across the industrialised world or an area that accounts for two-thirds of global economic output.  In other words, there is simply no balance sheet slack available to counteract the effect of deleveraging, and as a result, growing out of the problem does not appear to be a feasible option.

Several commentators argue that the debt will ultimately be inflated away.  However, as repeated rounds of quantitative easing in the U.S. demonstrate, inflation is not that easy to generate in the presence of persistent economic slack, and when the credit channel of monetary transmission is impaired.  Further, high inflation rates relative to the emerging world could potentially harm the labour market, as production shifts overseas to exploit lower costs.

The developed world is drowning in debt, and near-zero interest rates and unconventional monetary policies have failed to ignite an economic recovery that is sufficiently robust to allow for a fall in aggregate debt levels to more sustainable levels.  Lacklustre economic growth should be expected for several years to come.  Welcome to the ‘new normal.’

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.

Oil hit an eight-month low in Asia, keeping consistent in its recent jumpy behavior that tends to mirror news coming out of Europe. This comes down from crude oil’s up position June 11 after a European pledge that the euro zone countries would lend Spain $125B to alleviate the pain in its struggling banks. This, combined with talk about how investors have been looking into commodities as a safe place to park their capital as they wait out this passing economic storm, made me want to take a closer look at what’s going on in energy today.

Right now, Chesapeake Energy, the world’s second largest natural gas company, is a pretty entertaining case to follow. For anyone who hasn’t been doing so, the Chesapeake story started picking up June 4 as their stock saw a sudden turnaround rising 6.03 percent to $16.52 a share (previously on a longtime downward spiral as their stock had dwindled around 55 percent from its peak performance). At that time, I couldn’t help but wonder what kind of an investment this company could potentially turn into.

The change was a direct result of some democratic cuts that took place amongst the company’s board of directors. It was actually billionaire Carl Icahn, with his sturdy 7.56-percent stake in the natural gas conglomerate, who set things in motion.

In a letter he wrote to the company last month, Icahn spoke on behalf of himself and a group of disgruntled fellow Chesapeake investors voicing dismay with how the board was operating the company. In it, he expressed that he felt it was these board members who were largely responsible for the dismal Chesapeake stock performance.

On June 11, the company responded to Icahn by announcing that they planned to remove four of their nine current board members. This seemed to be just the antidote investors were looking for, as many of them openly expressed their satisfaction with the decision.

Though the company’s June 11 stock performance demonstrated Chesapeake was starting to regain traction with investors, they were and are still nowhere near a comfortable monetary state. With $12.6 billion in long-term debt, they are looking to disperse $14 billion in assets in an attempt to alleviate their weighty debt burden.

On June 8, Chesapeake announced at an annual meeting that it would be selling its Midstream Partners pipelines and Chesapeake Midstream Development to Global Infrastructure Partners June 26 for a combined $4 billion dollars. This move came at a prime time, as the company is clearly strapped for cash under their hefty debt.

The question now is, given the mitigating circumstances with both the company and the global economy, how should investors approach the wounded (but slowly recovering) beast that is Chesapeake Energy? Engage in buying off their debt via corporate bonds? Bank on materialization of a positive rebranding turnaround as Carl Icahn takes matters into his own hands? Consider commodities as a safe place to stash their dough until European turmoil cools off? Decisions, decisions.

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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.

U.S. stock prices are no higher today than they were in 1999, and the purchasing power of the major market indices has made no progress in fifteen years.  Meanwhile, the yield available on ten-year Treasury bonds has dropped from close to seven per cent in the mid-1990s to below two per cent.  Not surprisingly, the superior investment performance generated by default-free Treasuries has severely dented the notion that equities are the safest asset for long-term investors.

The sub-par returns generated by stock markets over the past decade has been accompanied by a marked change in the asset allocation of defined-benefit pension plans, with many corporate sponsors electing to reduce their equity exposure and increase their fund’s weighting in fixed income securities.  The latest corporation to effect such a change and capture public attention was Ford Motor Company, who announced earlier this year that it intended to lift the proportion of its pension fund assets invested in bonds to 80 per cent, up from 45 per cent previously.

The trend towards the de-risking of defined-benefit pension schemes has sparked an avalanche of commentary from so-called investment experts, who argue that the asset allocation switch is misguided and could prove to be anything but riskless should the yield on Treasury bonds increase from generational lows to more normalized levels.

Of course, similar arguments were made more than a decade ago when Boots, the British pharmacy retailer, liquidated its entire equity portfolio and moved all of its pension fund assets into high-quality fixed income securities.  Importantly, then as now, the arguments are bogus and demonstrate a complete lack of schooling in elementary financial theory.

The decision to replace equities with bonds in a defined-benefit pension scheme is not a call on the long-term returns expected from either asset class, but a strategy to reduce financial risk, by investing pension plan assets in securities with a duration that better matches the duration of liabilities.  Minimizing the volatility of the value of pension plan assets relative to pension liabilities reduces the probability that a company will have to divert capital and make costly deficit contributions, most likely at a time when the firm can least afford them.

It is important to appreciate that holding equities in a defined-benefit pension scheme increases a firm’s overall leverage, and in turn, the expected costs of financial distress.  Although a defined-benefit pension fund and its corporate sponsor are legally separate entities, the economic reality is very different, and since the company is ultimately liable to meet the pension liabilities, the balance sheets should be consolidated to give a complete view of the firm’s capital structure.

Suppose a firm has $1,000 in operating assets financed by $250 in debt and $750 in equity, which gives a debt/equity ratio of one-to-three.  The capital structure appears to be relatively conservative, but suppose the company has pension liabilities of $500 and pension assets of $500, with $350 invested in stocks and $150 in bonds.  The stocks can be thought of as ‘negative firm equity,’ and the bonds can be regarded as ‘negative pension liabilities.’

A complete picture of the firm’s capital structure, which includes the pension plan in the calculation of leverage, shows that the debt/equity ratio increases from one-to-three to 600/400 or three-to-two.  The pension plan’s asset allocation seriously increases the firm’s overall financial risk, and the observation clearly matters, since academic research confirms that such information is impounded in stock prices.

Further, should the market determine the capital structure to be appropriate, it is still not suitable because the company is forgoing the opportunity to exploit the valuable tax shield that would arise from financial leverage on its own balance sheet.  The same capital structure could be achieved and the tax shield utilized by switching the pension plan’s stock holdings into bonds, while issuing the same amount of debt at the corporate level and using the proceeds to repurchase an equivalent amount of its own shares.  This is akin to the strategy adopted by Boots in 2001, which was so widely criticized at the time.

The de-risking of defined-benefit pension plans continues with Ford Motor Company recently announcing its decision to increase its bond allocation to 80 per cent.  The strategic move has been challenged by investment professionals, who fail to appreciate that just as there are two sides to every story, there are two sides to every balance sheet.

Perhaps the last word on this controversial issue should be left to the late Fischer Black, who wrote in 1980, “My message is simple.  Almost every corporate pension fund should be entirely in fixed dollar investments.”

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.

Our Two Cents – Week of 5/21/12

Even though the unofficial start of summer kicks off this Memorial Day weekend in Boston, flip flops and sunscreen were out in full force last weekend. What was the temperature of financial markets from the past week? Read on to find out.

In the U.S., the economy was picking up after an early spring slump. Data showed growth in the April-June quarter is off to a good start, thanks to falling gas prices and solid hiring gains. Manufacturing and housing continued to show signs of economic expansion as factory bookings for long-lasting goods rose 0.3 percent last month, according to a May 24 Commerce Department report. Other numbers showed purchases of existing and new houses also increased. In the business sector, about 72 percent of startup CEOs reported thoughts of economic optimism this year in a study conducted by Silicon Valley Bank.

For the eurozone, unfortunately, there haven’t been too many signs of economic confidence after fiscal turmoil continues in Greece. The country is facing a possible exit from the eurozone that could cost the region hundreds of billions of euros. Greece’s financial minister said he expects the financial disorder to last about 12-24 months, allowing time for Greece to decide if it wants to stay in the single eurozone currency. As Greece struggles with itself, European leaders have prepared crisis-fighting plans for discussion at an informal EU Summit this week. According to the European Central Bank, officials said the eurozone needs growth and austerity.

In April, hedge funds upped 0.12 percent, according to the HFRX Global Hedge Fund Index, which puts their year-to-date gain at 3.27 percent.

 

 

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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.

Last week’s webinar session featuring Currensee Trade Leader Taylor Growth delivered strong information on a “conservative” trading strategy and its pertinence to these current tempestuous market times. The concepts touched upon and insight provided could be quite useful to anyone involved in Forex, so I thought I would share some of what was revealed.

With a historical success rate in the high 90’s and currently up 1.5% this month, Taylor Growth seems to be doing something right. Tom Dawson, COO at Taylor Growth who spoke on the company’s behalf, attributes this success to a few key concepts: preparation is integral, you must consider multiple sources of influence like technology and the economy, and you need to have rules and systems you believe in.  Not long ago, the world of Forex was something new and uncharted – an environment he compared to the Wild West.

“There was a need for a conservative, careful, and productive company. One that was going to do a good job in producing real results that were accessible to people,” Dawson explained. He went on to say how it’s easy for someone with millions of dollars to achieve world-class results in Forex, but it’s a completely different story when you can only put 10K into the market, and that is why skilled traders are needed to help in attaining these results. Dawson finds solace in knowing that even though it may not seem it, there is in fact consistency in foreign exchange.

“One of the great things about Forex is that every month, companies all over the world have to move their money to do things like pay rent, etc. It’s the daily moving of this $4-5T that acts as a stabilizer bringing things back to equilibrium,” he explained.

By using range trading and understanding that over time, there will be various ebbs and flows in Forex, Dawson sees that no matter where a currency goes, it will usually always return back to its point of origin. This general paradigm of consistency is what inspired Taylor Growth’s goal of being able to achieve the highest risk adjusted return possible while producing smooth results – or, as Dawson put it, “taking the chop out”.

He explained how the use of Pattern Recognition when looking at what’s going on in the marketplace allows this consistency to actually be seen. It becomes apparent that there are repeatable, definitive patterns that occur, such as how the dollar is stronger and weaker at different times of the month. Taylor Growth has seen such a high success rate because they pay close attention to these patterns and base their decisions on them, which is something that’s hard for a computer to do.

Even with Taylor Growth’s scrupulous attention to macroeconomic detail, there will always be some degree of risk. Knowing this, he’s formulated a few ways he believes are the most secure for protecting investors from losses. Setting automated stops is not something Taylor Growth generally practices. Instead, when things start moving against them, they cut the trade themselves as a means of managing risk. By using a balanced combination of betting small, understanding which patterns are in confluence with them, and being comfortable with taking a loss when a trade moves within several hundred pips, Taylor Growth has achieved a historical success rate in the high 90’s. On larger trades, however, they do set hard stops to abstain from risking more than 1%.

One deterrent of automatic stop losses Dawson touched on was the way they can react to a Flash Crash.

“Problems can arise when a market is thinly traded at a particular time and if it moves up or down 200-300 pips, you run the risk of losing the trade because of the stop, even though you were correct. If the stop weren’t on, you would have eventually won the trade,” he explained.

The webinar was concluded with a Q&A session that touched on topics such as stop hunting, among others. Our next webinar will be taking place Wednesday, May 9th 2012, 12:00pm ET / 6:00pm CET where CEO Dave Lemont will reveal five secrets of investing in the growing Forex market - sign up here.

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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.

Our Two Cents – Week of 4/30/12

While we’re still recovering from the Boston Bruins’ devastating playoff loss against the Washington Capitals last week, we tossed the sports pages for the business section to see how the financial markets scored.

While the U.S. economy only grew 2.2 percent in Q1 2012, there were signs that the economy thrived in the right places, including consumer spending. Personal consumption rose by 2.9 percent, exceeding expectations for a 2.3-percent rise, and up from 2.2-percent growth in Q4 2011. Personal incomes in March increased by the most in three months, as the Commerce Department said consumer income rose 0.4 percent last month. Confidence in the global economy grew substantially, according to the Q1 2012 ACCA/IMA Global Economic Conditions Survey, the largest global study of professional accountants. Thirty-two percent of respondents said they saw an uptick in U.S. business confidence, versus 18 percent in Q4 2011.

While Americans are feeling more financially confident, many are still uneasy about investing in the stock market. According to a new poll from Bankrate.com, about three-fourths of respondents said they were less inclined to investing in the stock market than they were a year ago. Perhaps it’s because of the stock market’s volatility, and they should consider methods of alternative investing. Speaking of alternative investments, hedge funds have outperformed other asset classes during the last 17 years, according to new research from KPMG and a hedge fund lobby group.

In the eurozone, Greece held talks with its international creditors about delaying by one year its medium-term deficit goals, working to ease the ongoing austerity measures on the economy. Across Europe, British Prime Minister said the continent was not “anywhere near half-way through” the economic crisis, but the German government said they’re more optimistic than Cameron about Europe’s financial stability. Cameron’s commentary came at a time when his country fell into a double-dip recession.

 


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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.