Tag Archives: stock market

That’s the question I see popping up frequently of late. The argument is a fundamental one focused primarily on the debt crisis going on in Europe at the moment and the seeming lack of ability of anyone in power to deal with it. Even Federal Reserve member Bullard expressed pessimism about the prospects on a recent CNBC stint. So why isn’t the euro coming unglued?

First of all, as the following charts show, the single currency has been weakening pretty steadily against all the major currencies over the last year.

EUR/JPY is down about 20%. EUR/USD is currently down about 15% from its high, and the other pairs are down a comparable amount. That’s a sizeable devaluation for a major currency in that period of time. So to say the euro hasn’t fallen apart is a bit off.

Could it be worse off? Sure. There are reasons why it isn’t, though.

The biggest reason is what we saw on Wednesday after the release of the minutes of the last FOMC meeting. It indicated the prospect for further QE, or at least further monetary accommodation. This potentiality is present in many of the major economies, while the ECB has dragged its feet being as aggressive as the likes of the Fed and Bank of Japan. We always have to remember that exchange rates are reflections of relative value, not absolute. If the Fed is acting in a fashion which weakens the dollar, then issues with the euro will not be reflected so sharply in EUR/USD.

Those looking at currency valuations also need to realize that unlike stocks and bonds, which are mainly priced in terms of the value of future events, currencies themselves cannot be priced that way. With a stock we look at future earnings and whatnot to figure out what it’s worth today. With bonds we discount back all the future cash flows. In both cases expected future inflation is a factor. Inflation is also a factor in currency valuation, but unto itself a currency has no cash flows to be discounted. As a result, a currency – in spot terms – is a more immediate asset.

The immediacy element means we need to look at the euro more in terms of what it’s being used to buy and sell. The Eurozone as a whole has been running a strong positive current account balance of late, meaning more money coming in than going out. That indicates increased demand for euros, with both trade and investment flows a factor. This is supportive for the euro.

Lastly, also keep in mind the so-called risk trade. The euro has been a primary beneficiary of periods when the markets were more positive about things like economic prospects. As the chart below shows, EUR/USD has been largely well-correlated to the S&P 500.

You may not buy into the euro rallying with stocks, but if that’s what the market does then it’s the reality we have to face at the moment. Regardless, it comes down to making sure we factor in all aspects of the multidimensional forex puzzle, and don’t get caught just looking at one side of any exchange rate equation.

It’s always reassuring when an industry leader releases information shedding positive light on the future of an alternative investment. Today, it was derivatives marketplace Chicago Mercantile Exchange, or CME Group, discussing the promising outlook of foreign currency futures.

Since the CME is arguably the biggest futures exchange out there, is it any surprise they’re touting FX futures contracts? No, not really, but the whole concept of currency futures is still pretty interesting nonetheless. I decided this fit as a nice follow-up to a post I wrote the other day on managed futures and risk mitigation in general, since these particular investments can get a little complex.

For anyone who’s unfamiliar with them, currency futures allow investors to exchange one currency for another on a future date at a specified price that is set at the time of the agreement.  This allows investors the ability to make a purchase that will be executed sometime in the future for the price it would cost them today. In turn, they’re granted protection against exchange rate fluctuations, which could end up working for or against them depending on where the currency pair moves.

Derek Sammann, global head of foreign exchange and interest rates at CME Group, explains how, due to rapid economic globalization, cross-boarder asset flows show no sign of slowing down anytime soon. This provides both a growing opportunity for potential prosperity, as well as risk, for investors interested in tapping the $4 trillion a day foreign currency market.

As Forex continues to become a more mainstream alternative investment option, the need for a supplementary vehicle for hedging risk will inevitably rise. Currency futures are just one avenue investors can take to fill that need. Others come in the form of continuously developing advanced software controls within the realm of spot Forex trading. As various up and coming forms of alternative investments popularize, it is interesting to note what types of risk controls they will inspire and bring with them.

 

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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.

One of the subject that’s come up in market discussion of late is the low level of the VIX, the so-called “fear index”. It has reached its lowest levels since back in the early days of the Financial Crisis in 2007. The chart below shows how the VIX has moved up and down since 1992.

The question which comes to my mind is whether we’re seeing a pattern similar to the one following the 1998-2003 period of elevated VIX value where the index retraces back to a lower level for a while as it did in the middle 1990s. The action in the markets in the early 2000s and the likes of Enron knocked a lot of individual investors out of stocks, just as recent developments have done. That makes a case for a similar kind of shift in volatility.

Just for the sake of comparison, I think it’s worth looking at volatility in other ways as well to see how things are playing out. The chart below shows the S&P 500 over the same time frame as the VIX chart. The two subplots show the relative width of the monthly Bollinger Bands (BWI) and a normalized 14-month reading of Average True Range (N-ATR). These give us a reading on how much movement there is in monthly closing prices and how wide the monthly ranges are respectively.

It is interesting to note that the Bollingers are back to being nearly as narrow as they were in the middle 2000s after working back from getting very wide back in 2009. As with the VIX, there is still some room to work lower to match prior lows, but we’re back into roughly the same range.

The N-ADR reading is a different story, though. In this case we’re nowhere near back to the lows of the middle 2000s and middle 1990s. In fact, N-ADR has been rising the last year! This tells us that while price changes from month to month may be getting smaller, the inter-month volatility remains elevated. Could this be a tip-off?

As a technical analyst I have a major concern with the way the S&P 500 made a lower low on the monthly chart back in 2009. That’s a big negative. Add to that the fact that momentum in the rally since then has backed off, as indicated by the lessening beats of prior highs for recent new highs, and you get reason for concern. If the market cannot overcome the 2007 highs on this rally, we could be in for quite a bit of a tumble. And when stocks tumble, volatility tends to rise quite dramatically. Generally speaking, before the top is put in the N-ATR reading is already on the rise. We’re seeing that now, so it’s definitely worth keeping that in mind, though given that we’re looking at monthly charts here, it may be a while yet before any sort of roll-over takes place.

In terms of making an investment that’s not in sync with the stock market while still battling market volatility, managed futures are looking like one of the diversified investor’s weapons of choice. Their biggest strengths come from an ability to thrive in all sorts of market conditions, divergence from the performance of more traditional investments, and the management of Commodity Trade Advisor’s whose strategies hedge risk.

As equities continuously suffer the wrath of unfortunate global economic health, we find ourselves in the optimum environment for alternative investing. Alan Reid, CEO of investment advisory firm Forward, says it best (and simplest) with, “managed futures strategies have a record of zigging when equity markets zag”. And he has the data to back it up.

A recent report produced by Forward plainly demonstrates managed futures immense lack of correlation by looking at the performance of the Barclay’s CTA, an index measuring the performance of Commodity Trading Advisors (managed futures specialists). During the first few years of the new millennium while the dot-com bust wrought devastation upon the stock markets, the Barclay CTA continued to deliver positive returns.

 

 

According to Forward’s report, over a 32-year period ending December 31, 2011, the CTA Index gained 5.21 percent annually, while the S&P 500 saw average gains of only 0.31 percent. During the last two major financial crises, the gains of the CTA Index remained in the double-digits, while those of the S&P hit negatives. How’s that for all weather investment?

Now more than ever, with global economic growth in question and strong market volatility threatening confidence in stocks, investors should be focusing on playing defense. And what better way to do that than with an alternative investment that’s past performance has demonstrated it clearly zigging when the equities markets zag?

 

 

 

 

 

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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.

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.

Today’s roster of top tier bulge banks holds some of the most colossal and well-known institutions in finance. JPMorgan Chase & Co., Deutsche Bank, Citigroup Inc., Morgan Stanley and Goldman Sachs; a few names that everyone’s heard, and almost everyone has an opinion about (usually in regards to their size). Of late, JPMorgan and Morgan Stanley have been receiving the majority of media flack with the whole $2B trade loss and Facebook equity underwriting investigation.

Though one bank has been doing a very good job at laying low for the past few months, and it wasn’t long ago that Goldman Sachs could hardly keep itself out of the news for more than five minutes. So one must wonder now, without the media blowing them up left and right, what has this large investment bank been up to?

A CNBC article answered this question by revealing that the bank has been doing a good job of being well, not so large. This fall, the firm is said to name less than 100 new partners; a group of higher ups at the firm that's shrinking steadily. After scrupulous vetting of these potential hires, the selected few are compensated handsomely (senior partner and CEO Blankfein pulled in an annual salary of $12 million in 2011) while gaining access to prestigious jobs at the firm. This alone would make one question why over the past year Goldman has seen a steady exodus of those employees fortunate enough to hold partner positions at the bank.

After reducing its total employee count by about 8 percent in the last year, as well as laying off about 50 last week, it’s clear that something is amiss with the firms growth pattern. As Goldman deflates as a whole in size, the heft of its partnership base usually lessens in congruence.

So where is this drastic size reduction coming from? Greece.

A few weeks ago, I wrote a post about how a potential Greek euro exit would likely affect the US. One of the main concerns was that it could set in motion a widespread panic amongst investors, who would then impulsively retract their allocated capital. Today, a Bloomberg article showed evidence of this theory starting to make its presence known.

The piece provided insight about how European turmoil is directly correlated to success amongst the investment banking industry. More specifically, the article looks at Greece and their potential abandonment of the euro for a return back to the drachma.

A Goldman analyst showed last week that for a third year straight, revenue from investment banking and trading is in danger of dropping at least 30 percent from the first quarter. The deadly combination of deal volume slowing, wider credit spreads, heightened volatility, and equity and credit markets falling, can all be traced back to fears of a Greek euro exit, followed by the spread of the European sovereign-debt crisis. These ingredients are the direct result of investors putting themselves into a defensive monetary state over the aforementioned euro woes.

This tension is taking its toll on the paychecks of investment bank employees, as 11 analysts reduced earnings estimates for the New York based Goldman Sachs in the past four weeks. The question now is whether these declines are cyclical, or indicative of a general phasing out of the investment banking industry. Boston Consulting Group, Inc. stated in late April that banks of this kind will see very little revenue growth during the next few years and will be forced to cut up to 30 percent of their managers.

Jamie Dimon and Lloyed C. Blankfein, CEOs of JPMorgan and Goldman Sachs respectively, are in adamant agreeance that this is, of course, is nothing more than a phase and the industry will undoubtedly bounce back. David Konrad, an analyst at KBW Inc. in New York, gives a bit of hope to the fighting back of these banks by pointing out that due to their large amounts of capital and strong liquidity, any program coming out of Europe that the market responds positively to will inevitably have a bold impact on valuations. He recalls how stocks have been known to jump up to 30 percent on just a bit of breathing room.

So could all of this drastic shrinking represent the end of the age where grand investment banks rule the financial industry?  Or is it in fact no more than a shock absorption effect occurring as they bend to accommodate European turmoil? As we all know, yes, they are big. But are they really too big to fail?

 

 

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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.

It seems as though Facebook has finally had the chance to regain a bit of its composure over the past few days as the snarling three-headed media monster’s attention has wandered a bit (for now, at least). I, like many others, admittedly do partake in this particular “guilty pleasure” of the investing world by keeping tabs on how the social network is faring in the market. Yesterday, I observed they closed at around $27 a share ($26.96, to be exact). So naturally, what was the first thing to come to mind? Shorting.

If only we could have foreseen the dramatic and untimely demise Facebook's stock would inevitably meet over the course of just two weeks; a sizable gain could have been generated by shorting. For those who aren’t familiar with this practice, it is a strategy based heavily on speculation. Basically, if there is a company who’s stock you feel is grossly overpriced, and you are quite certain that it will in fact depreciate in value, you go ahead and “borrow” shares of that stock from a person or establishment who has purchased them prior. So, let’s say you borrow 100 of company “Xs” shares at $20 a share. Right away, you sell them off at face value for a total of $2,000 - then you wait.

A few weeks later, wouldn’t you know it, Xs stock does end up taking a tumble and is now worth a paltry $10 a share. So, you buy back your 100 borrowed shares and return them to who, or what, you originally obtained them from. You have now made a profit of $1,000. This is clearly an exaggerated layman's version of the practice, but it demonstrates the basic principle.

So, if on Friday, May 18th as I scoffed at Facebook’s $38 opening price, I’d also simultaneously decided to borrow some 1,000 shares of it with plans to short the stock, I would have made a few dollars had I chosen to buy back and return them today (there are various fees that can be tied to shorting stocks that should also be factored in.)

But before you start kicking yourself for not doing this, there was so much hype, who could have really ever known for sure? And, there is always the notion that unlike formal stock investing where you can only lose as much as you put in, theoretically with shorting, you can lose drastic amounts of capital if the stock behaves opposite what you’d predicted and shoots up in value. Shorting is a risky business – is it worth it?

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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.

It has been a challenging month for bull market cheerleaders, as renewed tensions in the euro-zone and the growing possibility of a Greek exit, has erased almost all of the current calendar year price gains in global equity markets.  Much has been written on the topic, but should the unthinkable happen, it is safe to conclude that the uber bulls will argue that the accompanying carnage was not foreseeable in advance, just as they did following both the demise of the dot.com frenzy in 2001, and more recently, the mind-numbing deflation of the credit bubble.

In truth, the poor stock market performance that accompanied both episodes was not entirely a bolt from the blue, since reliable credit market indicators warned of an impending economic downturn well in advance on each occasion – an outcome that is virtually assured to precipitate a gut-wrenching slide in equity prices.

Meanwhile, and more importantly, the high valuations attached to equity markets at the market peaks registered during the summer of 2000 and the autumn of 2007 respectively, meant that stock prices embodied no margin of safety whatsoever, and as a result, astute investors could reasonably expect a cyclical decline in the major market averages to exceed typical historical experience.

The bottom line is that the actual sequence of events following both market tops was not foreseeable ahead of time, since the future is unknowable, but the potential downside risk implied by the lofty valuations, alongside the warning flags raised by a variety of reliable real-time indicators, gave investors ample time to prepare and adjust asset allocation appropriately.

The idea that the poor stock market returns over the past decade – and more – stems from so-called ‘black swan’ events does not stand up to serious scrutiny.  Fundamentals matter of course, but only insofar as they are not reflected in market expectations. Consensus opinion can be discovered in the number of dollars that investors are willing to pay for one dollar of trend earnings, and not in the research reports that the professionals periodically unleash on their clients – and almost always with a bullish tilt.

Successful long-term investing is an exercise that measures probabilities against potential outcomes, but quantifying the likelihood of loss over any time period is hardly an easy task. Nevertheless, it is far from difficult to reach any other conclusion, but the idea that a viable investment process begins – and perhaps even ends – with a plausible estimate of fair value.

The road to superior returns over extended horizons is always a question of value.  It may seem unsexy to some, but the verdict of history demonstrates that value matters – and undermines the thesis that so-called ‘black swans’ are to blame for the poor returns generated by the investment professionals since the turn of the new Millennium.

Turn the clock back and the truth is plain to see.  The halcyon days of the dot.com boom in the late 1990s saw almost 200 new issues more than double on their first day of trading in 1998 and 1999 as compared with less than 40 over the previous quarter century.  The manic nature of the market was captured by former Fed chairman, Paul Volcker, who commented in 1999 that “The fate of the world economy is now totally dependent…. on about 50 stocks, half of which have never reported any earnings.”

The number of dollars that investors were willing to pay for a unit of trend earnings vaulted to more than forty during the spring of 2000 – almost ten dollars more than the peak multiple registered during the autumn of 1929.  Absent a pronounced upward shift in the growth rate of trend earnings, the major stock market averages were actually priced to deliver an inferior long-term real return than that available on default-free Treasury inflation-protected securities.

Needless to say, it didn’t take much to precipitate the unwinding of such excess, but more insanity was to follow, as Alan Greenspan re-inflated the asset-based economy.  His actions precipitated a dangerous real estate bubble, as the ratio of median prices to median income jumped to three standard deviations above the historic norm.

Meanwhile, investors’ renewed appetite for risk saw stock market values jump to levels by 2007 that were close to the peaks observed at the heights of previous secular market bulls in 1901 and 1966.  In other words, stock markets were priced for perfection and provided no margin of safety to withstand any deterioration in the underlying fundamentals.

The near-doubling in stock market averages from the lows registered during the spring of 2009 has pushed valuations back into nosebleed territory once again, with the likelihood that prices decline in real terms over the next ten years increasing to as much as three-in-four based on historical data.  Needless to say, a possible Greek euro exit is not reflected in current valuations, and comments that such a development would prove containable, seems eerily similar to the rhetoric that accompanied the sub-prime meltdown.

Risk is running high, as reflected in low expected returns.  More astute investors will recognize that successful long-term investment is always a question of value.

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.

World stock markets enjoyed an almost 25 per cent gain from the cyclical low registered last October through mid-March, as the myriad of concerns weighing on investor sentiment slipped into the background.  Investor enthusiasm for risk assets returned, as the previously growing concern that the global economic expansion was set to falter all but vanished, as a steady stream of data surpassed market expectations.

The resilience has contributed to a general air of complacency amongst investors, who would do well to remember the old stock market maxim, “Sell in May and go away, come back on St. Leger day.”  The simple trading rule posits that investors would earn better returns if they sold their stock holdings at the beginning of May and remained on the sidelines until St. Leger’s day – the date of the world’s oldest classic horse race that is run at Doncaster on the second Saturday in September and has been run each year since it was founded by Colonel Anthony St. Leger in 1776.

The maxim has been part of stock market lore since at least the 1960s, though the rule has been modified in recent years and popularised as the ‘Halloween indicator’, whereby investors exit the stock market at the end of April as before, but remain in cash until the beginning of November.  Despite the modification, the trading strategy remains remarkably simple to execute and readers would be right to question whether the rule could truly be relied upon to produce superior risk-adjusted returns net of transaction costs and taxes in today’s competitive markets.

The first comprehensive study of the ‘Halloween indicator’ was performed by Sven Bouman of AEGON and Ben Jacobsen of Erasmus University who demonstrated in an article published in the American Economic Review in 2002 that holding cash from the beginning of May to the end of October and being fully-invested in the equity market for the other six months performed better than a simple buy-and-hold strategy in 36 of the 37 stock markets examined.

Bouman and Jacobsen analysed stock market data from January 1970 through August 2008 across the various country indices and discovered that mean monthly returns were higher over the half-year period to end-April than over the other six months to end-October.  Furthermore, the returns over the May-October period were often negative or less than the short-term interest rate available on cash.

The results of the study imply that all of the annual excess return generated by stocks relative to cash as compensation for risk has historically been earned in just six months of the year, and since the authors also found that the standard deviation of returns was similar in both six-month periods, a simple ‘Halloween’ switching-strategy can be employed by investors to significantly reduce risk and simultaneously enhance returns.

The authors demonstrated that the trading rule worked not only in developed markets such as Germany, Japan and the U.S., but also emerging bourses such as Brazil, Russia and Turkey.  The effect was particularly pronounced across European markets including Ireland, while New Zealand proved to be the only exception of the 37 markets studied.

Furthermore, the article traced the existence of a ‘Sell in May’ effect in the U.K. market as far back as 1694, while Jacobsen alongside Cherry Zhang of Massey University revealed in a separate but related paper published in 2010, that over the past three centuries, the strategy has worked in the U.K. almost 63 per cent of the time over one-year horizons, roughly 70 per cent of the time over-two year horizons, and more than 80 per cent of the time over five-year horizons.  Importantly, the same paper shows that the effect has not diminished through time and that the results remain both economically and statistically significant.

Investors may well dismiss the ‘Halloween’ indicator and argue that they have no option but to invest in stocks given the dearth of low-risk assets offering a reasonable return in today’s ultra-accommodative monetary environment.  However, development of the optimism-cycle hypothesis by Ronald Doeswijk of Robeco Asset Management reveals that the seasonal pattern in stock market returns can be exploited through a simple sector-rotation strategy.

Doeswijk’s optimism-cycle hypothesis assumes that investors “think in calendar years instead of twelve-month rolling forward periods.”  He argues that investors begin to look towards a new calendar year with excessively optimistic expectations as winter approaches, and adjust their calendar-year estimates slowly through the early months of the New Year as reality fails to match their high expectations.

Doeswijk notes that global earnings growth revisions correspond closely to the seasonal pattern in stock prices and posits that “cyclical stocks with their high sensitivity to the economic cycle” should benefit from the overly optimistic expectations during the winter months, while defensives should perform relatively well in the summer months given “worsening economic expectations.”

The strategist at Robeco examined a “global zero-investment strategy” from 1970 through 2003 “that is long in cyclical stocks and short in defensive stocks during the winter period, and short cyclicals and long defensives during the summer.”  The results were impressive as the strategy generated an annualised simple return of seven per cent and worked in “both up and down and low and high volatility markets.

The cyclical bull market in stocks appears to have struck a speed-bump, as the ‘stop/go’ nature of US recovery, a resumption of euro-zone crisis, and continued softness in Chinese economic data, tests investors’ nerve.  The old maxim ‘Sell in May and go away’ will be dismissed by most investors, but a reduction in equity allocations combined with a switch from overpriced cyclical stocks to defensives would appear to be the order of the day.

Previously posted on 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.

In an optimistic article published by Bloomberg Businessweek, it is predicted that despite March’s minor employment setback, the US job market will continue to grow throughout April. Predictions by Deutsche Bank economists Joseph LaVorgna and Carl Riccadonna illustrate that due to increased consumer confidence, the hiring world will expand at a rate of about 200,000 new positions per month during 2012.

As companies sales increase, investing in new workers becomes an attractive prospect for upping productivity. Thanks to strong consumer spending up climbs, the jobless rate appears to be doing the opposite. This is clearly demonstrated in March’s numbers, where it fell to 8.2 percent – the lowest it’s been in three years. In a recent Bloomberg survey of 70 economists, it was determined that the US economy is healing at an estimated median of 2.2 percent; a bit heftier than last years 1.7 percent.

With all the positive outlooks swirling around the US job market, inevitably a balance must be struck meaning someone’s gotta suffer. The stocks are assuming that role as they fell, bringing with them the S&P 500 Index to 1.2 percent. Asian stocks also declined for a fourth day, while China’s recent inflation increase killed hopes of the government easing monetary policy.

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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.