Right in Two…
Blackadder: I was under the impression that it’s common maritime practice for a ship to have a crew?Captain Rum: Opinion is divided on the subject. Everyone else says you should-I say you shouldn’t. Blackadder. “Potato” 1986.
Evidence Based Investing
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Watch out for the Traps
“Bankers are just like everybody else – except richer. Ogden Nash (US Poet 1902-71).(This post is going to be a little formula heavy. Sorry, I shall return to my usual inanity next week). Since 2009 Central Bankers (via QE etc.) have created a situation whereby all asset prices now have more or less the same expected long-term returns, such that Investors are now indifferent between them. So, Investors have (as was intended), been forced to look for alternative strategies to improve their return outlook. Two such strategies have emerged: the “reach for yield”, namely the buying of High Yield equities on the one hand, whilst others have focused on “Value”, to wit, the purchase of assets that are relatively cheap compared to their respective alternatives. Both contain some assumption flaws, which we will look at in turn.
Europe- the Final Countdown?
“Once a barrel of lit matches rolls into a field of dynamite sticks, you don’t try to predict which one will explode; you just get the heck out of there”- John Hussman (US Portfolio Manager). Sterling’s immolation has taken centre stage again this week, but behind the scenes, after a long lull, problems in Europe are starting to re-appear. Both political and economic issues, long avoided, have come home to roost, putting the prospect of full-scale crisis back on the agenda. Let us count the ways…
Structured to Fail…
The hypocrisy of some is that we like to think of ourselves as sophisticated and evolved, but we’re still also driven by primal urges like greed and power- Michael Leunig (Australian Cartoonist and Poet). [This posting serves as an adjunct to the latest Wendy Cook article, posted on Tuesday, regarding Structured CD’s in the US. What follows is a more UK-centric version of same].—Last week an adviser asked me about a new Structured Product a client had shown him. My first reaction was to rubbish it. However, I felt duty-bound to delve deeper into it. What I found made me wonder whether I had under-reacted! What I want to show today is not only how bad these sorts of things are for Investors, but how these firms make money on them (at the investor’s expense). Indeed, given access to these markets, investors could actually construct these products for themselves.
Timing is(n’t) everything
“Stocks have reached what looks like a permanently high plateau.” – Irving Fisher, (economist), 3 days before the 1929 market crash. We have covered this subject before (here, and in our Quarterly Review of Q2 2015), but it is always worth returning to, as Investors appear unable to shake off the conviction that they can “beat” the market. Passive inflows (and Active outflows) suggest the tide is turning, but as all politicians feel obliged to say nowadays, there is still much to do. It is gratifying to know that the ranks of Index investors are rising (through EBI, but others too), and that we are no longer the geeks at the party that no-one wants to talk to.
What can we expect in return?
“Blessed is he who expects nothing, for he shall never be disappointed.” ― Alexander Pope [We have recently been asked to explain in more detail how we arrived at our Expected Rate of Return numbers used as our return assumptions. What follows is an attempt to rationalise the output numbers, in a way that can hopefully be understood as the basis for our investment philosophy]. Below is a copy of the latest ERR breakdown, (from our Turnkey Workbook), showing the sources of the Equity and Bond Risk Premium (ERP) we expect to achieve over time. We shall attempt to dis-aggregate them and look at the internal logic of the results. The Bond premium has 3 constituent parts:1) The Risk-Free Rate (RFR) – the interest payable on a risk-free investment.2) A Maturity Premium – as the maturity of a bond rises, so does the risks associated with that investment.…
The Reach for Yield Goes Global
“The Fed is now hostage to Wall Street. If the stock market pulls back a few percent the Fed becomes frightened. In a way I suppose, the Fed is justified in that belief because it is responsible to a great degree for the elevation of financial asset values”. Jim Grant (Grant’s Interest Rate Observer). On Friday, Janet Yellen, the Head of the US Federal Reserve, will speak at their annual Jackson Hole Conference, (in Wyoming), and is widely expected to comment on US Interest Rate policy. With an election in November, September may be the last chance to raise rates before the traditional pre-election purdah, as the Fed tries to maintain the illusion of political neutrality. But will they take it? Opinion is divided on the subject, despite what some Fed officials say.
Looking over the hedge
“All markets look liquid during the bubble (massive uptrend), but it’s the liquidity after the bubble ends that matters.” J. Schwager, Market Wizards. Anyone who is looking at Global Investing is now (post Brexit) having to confront the currency issue. To hedge or not to hedge? Let’s see if we can make any sense of the issue…The purpose of hedging currency risk is to isolate returns on the asset class from that of the currency in which they are denominated. It is vital to ensure that asset returns are not overwhelmed by adverse currency movements. The charts below show the Implied Volatility for the (U.S.) Bond and Equity markets respectively (both are annualised figures).
On Shaky Foundations
Wendell: [Viewing the desert crime scene] It’s a mess, ain’t it, Sheriff?Ed Tom Bell: If it ain’t, it’ll do till the mess gets here. from No Country for Old Men (2007)
