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U.S. stock indices fed off of a surging U of M confidence index on Friday to close higher again (up 12 of the past 15 sessions). It was all cyclicals in charge as energy, industrials and financial (thanks David Tepper) led the charge. Safety languished as staples, telecoms and health care were the biggest laggards.
For the week, the S&P 500 gained 2.07% (for 2013 it’s 16 weeks up and just four down).
Treasurys sold off pretty hard, sending the 10-year yield back to the high end of the six-month range – settling up seven bps to 1.95%.
The commodity complex wasn’t playing along though as the precious metals got thumped again; OJ and cattle also sold off. Industrial metals and energy rallied on the high hopes of the confidence readong, but not enough to offset the decliners.
For the big name among those precious metals, gold is down seven days straight (good for $110/oz.). It’s now below the level it plunged to in April and is 12% below the support it had enjoyed during the late 2011 and mid 2012 sell offs (which was $1,540). One has to suspect that gold’s become the new asset to short.
In Europe another ugly day of data didn’t adversely affect equity prices (and why should it -- In Bernanke They Trust) as the continent’s major bourses shook off early-session declines to close nicely higher.
Over in the Pacific Rim, the Banzai Wonder Twins continue to activate as they sent the Nikkei up enough to more than recover from the prior-session’s decline. China ripped higher (although stuck at a level first hit 12 years ago). New Zealand and the Philippines didn’t get the memo to jolt higher, the only ones to close in negative territory.
U.S. stocks fell for the first session in five as Federal Reserve Bank of San Francisco President Williams gave a speech in which he talked about the “tapering” of QE. Tech, which has been the dog of 2013, was the only sector to close higher, helping to keep the S&P 500 from a deeper decline.
That Williams mentioned this even as the past two days of data have been especially ugly is not just strange, but uncompelling. There’s no way the big three on the FOMC (Bernanke, Yellen and Dudley) are going for this. Besides, this is just part of one of the Fed’s games that they play. That is, offer a façade that there’s some level of hawkishness residing within the Eccles Building. Nevertheless, the market didn’t appreciate the commentary. And frankly, since the major indices didn’t fall harder, I’m not sure they took the speech all that seriously anyway.
The Treasury market didn’t buy the comments whatsoever as the long end of the curve rallied to the tune of six basis points. That sent the 10-year yield down to 1.87%.
European equity bourses, which began their session higher, ended lower as they fell in sympathy with US stocks.
Over in Asia, the major indices ended mixed as China led the gainers, while the NICs (newly-industrialized countries) along with Japan led the losers.
And speaking of Asia, the Japanese economy expanded at the fastest pace in a year, and on an inflation-adjusted basis at a level that is rarely seen (+3.6% annualized rate) for an economy that’s dead in the water. But Japan doesn’t have inflation, which is why the Banzai brothers have taken monetary policy beyond extraordinary levels. Thus, most of the increase was due to the deflator (the GDP inflation gauge) collapsing at a 3% annual rate. The nominal rate increased just 1.2% annualized. Of course, anything with a positive sign in front of it gets economists all excited these days. Still, we shouldn’t get carried away, as the press has begun to do, with thinking Abenomics is working.
U.S. stock indices rallied from early-session weakness as traders couldn’t care that the day’s economic releases (both domestic and out of Europe) were broad-based ugly. Who needs economic growth when we’ve got central banks implementing a policy of whatever it takes, or so the thought process goes…for as long as that lasts.
Safety returned to the top-performers list as staples and utilities were among the winners; they were joined by the financials. Energy and tech (again) were the dogs.
The long end of the Treasury curve rallied along with stocks, sending the 10-year yield down four basis points to 1.94%. Still, that yield remains near the upper end of the six-month range (1.59% to 2.06%).
European equity indices rallied despite that fact that the euro zone’s recession extended to six quarters and shows not only zero sign of recovery but that the contraction is likely to deepen.
All major economies, with the exception of Germany (which just barely escaped consecutive negative GDP prints), remain in technical recession. And that elephant in the room I’ve been talking about (France) posted its third quarter of economic contraction out of the last four.
So with the euro-zone recession extending to six quarters (the longest in the euro era, but of course not as deep as the 2008-09 recession) this sets the stage for the ECB to engage in QE. Yes, they’ve pledged to backstop troubled-country debt but have never actually taken action (haven’t needed to as investors, or is it just their banks that continue to gorge on the toxicity, continue to lurch for yield with no regard for risk). Heretofore, the obstacle to Super Mario rolling out his version of QE has been the Berlin Wall of the German Bundesbank/Bundestag. But with Germany so close to recession, I suspect even they will cave.
Two weeks ago I had the pleasure of attending a presentation by Michael Pompian, author of Behavioral Finance and Wealth Management and several academic works that are incorporated in the behavioral finance curriculum for CFA Institute.
Pompian’s book linked above is an excellent read for anyone seeking to improve their investing. Listening to him speak inspired me to write about the important role psychology plays in finance decisions among investors.
Unlike traditional finance models, which assume that investors always make perfectly rational decisions based on all available information, behavioral finance recognizes that we as humans make mistakes. Generally these mistakes are a result of our limited cognitive abilities (cognitive biases) or emotional tendencies (emotional biases).
Cognitive biases stem from statistical, information processing, or memory errors. For example, investors may fail to update probabilities (especially within a Bayesian framework) or they may not gather and properly consider all relevant information. Instead, investors gather what they believe is sufficient information and apply heuristics to analyze and shape the information. The result is faulty reasoning and decisions that are not optimal from a traditional finance perspective.
Cognitive biases are grouped into two categories: belief perseverance and information processing. Belief perseverance bias occurs when an investors clings to their previously held beliefs despite contradictory information. One example would be an investor ignoring information that conflicts with their view or only remembering information that confirms existing beliefs. Information processing biases occur when an investors sorts and processes information illogically.
Unlike the deliberate nature of cognitive biases, emotional biases are more of a spontaneous reaction in attempt to satisfy basic human desires of avoiding pain and producing pleasure. The psychological predispositions that cause investors to irrationally frame information or a decision are harder to correct for than cognitive errors.
Mr. Pompian’s book thoroughly covers 20 different behavioral biases that fall into the cognitive or emotional bias categories. Below are brief descriptions of five biases I see frequently among individual investors. Read them carefully and try to identify the biases that you may experience in your own investing.
U.S. stocks advanced on Tuesday, making it 15 winning sessions out of the past 18 for the S&P 500, even as what had become the fulcrum security (the Italian 10-year) sold off (yield higher) for a fourth-straight day.
It was all cyclicals driving the market higher – an unusual situation thus far in 2013 – as financials, materials and energy led the move. Telecoms, tech (still a 2013 dog) and utilities were the biggest losers – although even these groups ended higher.
That which has been seen as the fulcrum security for some time now (as it has gone so has the rest of the risk asset world), looks to be relinquishing that position – the Italian 10-year is down four sessions straight, yet most developed-nation equity indices continue to run higher.
Also, while the Treasury market sold off (corroborating the risk-on move), credit did not as both investment grade and high-yield corporate bond indices declined.
Overseas, all major European equity indices rallied, about 0.50% on average, as Italy and the UK led the gains. In Asia it was a mixed scene as the Chinese indices led the decliners (Japan also pulled back), while the South Korean KOSPI led the winners.
U.S. stock indices ended mixed on Monday as the broad S&P 500 and NASDAQ managed fractional gains, while the Dow Industrials, mid and small caps lost ground.
After a two-session respite, safety returned to its 2013 role of sneaking into the top-performers list as health care and consumer staples joined financials as the only sector to gain ground yesterday. Telecoms and basic materials were the biggest losers.
The Treasury market sold off for a sixth day in seven, resulting in a yield back-up good for 30 basis points over this stretch. It appears the talk of the Fed “tapering” 2013 QE is the culprit – I think we’ll all look back in a couple weeks and laugh at such musings. Bernanke & Co. aren’t slowing the scheduled $85 billion/month in bond purchases during 2013 any more than European governments are engaging in the austerity they continue to blame their now 18-month long recession upon. (And speaking of which, I’ve noticed the financial press finally beginning to acknowledge that European austerity is more a perception than a reality. So for those who have relied on media reporting rather than seeking out the facts themselves, they’ve been tricked into thinking European governments have made progress in reforming the social model that currently buries the continent.)
The commodity complex sold off for a second day as the prices of crude, wholesale gasoline, cotton and aluminum pressured. Gasoline is down to about 10% since March -- although, still 20% above the five-year average. It settled at $2.82/gal. on Monday (add roughly 65 cents and you get the price at the pump). Crude declined $1.22 to $94.82/bbl.
The prices of corn (back near its all-time high), OJ (still 30% off the all-time peak hit in 2012) and wheat (just a touch above the five-year average) kept the complex from a deeper decline.
Most European equity indices lost ground, with the exception of the UK and German bourses that managed slight gains.
Over in Asia, indices were mixed as China, India and Indonesia got clocked. Japanese indices led the gainers, which as I’ve been noting has been the case for several months. Malaysia and the Philippines came along for the ride. It is getting quite interesting for Japan’s Nikkei – and the Banzai brothers that juice it higher. Not only does the index trade at 28 times earnings, even as the country remains mired in a two-year recession. But it has also hit a technical resistance level that’s summarily resulted in 40%-60% plunges three times now since 1996.
U.S. stock indices bounced, and fairly substantially, between gain and loss on several occasions Friday, but a late-session rampfest sent most to close at the highs of the session. For the week, the S&P 500 gained 1.1%, marking the third-straight week of gains – and up 14 of the past 18 weeks.
Health care, consumer discretionary and financials led the rally. Energy and materials were the biggest losers; telecoms and utilities also underperformed.
The Treasury market is back to sending yields higher from the low-end of the six-month range as the 10-year yield has backed up 27 basis points over the past week – up eight basis points on Friday to settle at 1.90%. (The six-month range is 1.58%-2.05%.)
Over in Asia, Japan’s Nikkei returned to the leadership position, jumping 2.9%. You may recall, when expressing surprise that the Japanese market led the Pacific Rim’s equity declines in the prior session, that I mentioned someone better get the Banzai brothers on the phone, pronto. Well, they did. The new dynamic duo (Japanese PM Abe and BoJ Governor Kuroda) came out with yet more talk of doubling their monetary base in a matter of two years (maybe people who don’t study this stuff know what that means – suffice it to say they’ll leave behind an epic lesson regarding the political micromanagement of an economy). That sent stocks higher and the yen crashing down to 101 to the US dollar.
Will the Banzai brothers successfully resurrect the Japanese economy? Of course not. They continue to do the same things their predecessors have been doing for 15 years now, only vastly more aggressive. Hence, a zombie they’ll remain.
And the sad thing is a zombie may be the best scenario for which one can hope – outside of the more sensible solution of forcing their banks to unload the non-performing assets on their books, implementing a tax-rate policy that jumpstarts capital formation and embracing the immigration a society that get trampled by age demographics desperately needs. Because if the Banzai brothers are successful in inciting inflation, the market will overwhelm any ability the central bank has to keep those rates floored and they’ll be crushed by the debt service costs that accompany a 235% government debt-to-GDP ratio.
U.S. stocks looked ready to rally again from early-session losses yesterday, but a Twitter-based rumor regarding the possibility the Fed may pull back on QE killed the rebound; the declines ended the latest winning streak at five sessions.
Consumer discretionary, health care and industrials outperformed. Telecoms and utilities were among the hardest hit.
The midday rebound in stock prices brought the commodity complex along for the ride, and it remained up for the session even as stock sold off. Components corn, wheat, nickel and wholesale gasoline fueled the advance. Not the precious metals though, selling off for third day in five. Crude also slipped, down 23 cents to $96.39/bbl.
Europe ended yesterday mixed with the Swiss market leading the gainers; the Italian and French indices took the brunt of the damage.
Over in the Pacific, the Korean KOSPI was the outperforming index. The Japanese Nikkei and JASDAQ indices lost the most (wait, that’s not supposed to happen – get the Banzai brothers on the phone, pronto).
Although inflation has remained very tame since the great recession, TIPS have performed well. How is that so? While TIPS are often spoken of as a “hedge” against inflation they share more in common with traditional bonds that you might think. The overall performance of TIPS does benefit from higher inflation, but there are more factors at work than just inflation alone.
It’s been a while since I’ve written on this subject, so perhaps it’s time to review the basics of TIPS. Treasury Inflation Protected Securities, or TIPS for short, are fixed coupon bonds issued by the US Treasury with principal value that is indexed to the Consumer Price Index (CPI). Although the semi-annual interest payments do get somewhat larger as the fixed coupon is multiplied by a principal balance that grows with inflation, most of the inflation compensation is realized either when the bond is sold or matures.
It’s important to understand that TIPS do not provide extra compensation over nominal Treasurys, they only remove one unknown factor (inflation) from the risk evaluation. Think about it - real inflation adjusted return is all that matters to consumption based investors. For nominal bonds, the market must first arrive at a level of real return to compensate for risk and then expectations for inflation are added to that. In the TIPS market, bonds are priced at a real yield but there is no need to add their expectations of inflation due to the CPI adjustments going forward.
It isn’t news to anyone that interest rates are extremely low across the entire bond market. Ultra-accommodative monetary policy and quantitative easing have driven interest rates far below where they would naturally be. The yield on the 10-yr Treasury is 1.75% as of this writing. Keep in mind that 1.75% includes compensation for expected inflation over the ten years that bond will be outstanding. What if investors need not worry about inflation over the life of the investment? I’m talking about TIPS.
The yield on the 10-year inflation protected Treasury is currently around -.50%. Remember that rate is quoted in real terms. If inflation averages 2.25% over the next ten years the total return on the TIP will be about 1.75%, matching the current yield of the nominal 10-year Treasury. But what will inflation be over the next ten years?
Actual inflation is unknown and has a huge impact on the real return of nominal bonds. Theoretically, TIPS should have lower risk than nominal Treasurys of the same maturity, considering the inflation adjusted performance of TIPS is known at purchase. And historical return data supports that theory as 10-year TIPS performance has been about as volatile at the performance of 5-year nominal Treasurys.
So at yields of -.50% TIPS seem like an awful deal in this environment right? Don’t be so quick to judge. In slightly simplified terms, the difference between the real yield on TIPS and the nominal yield on “normal” Treasurys is the market’s expectation for inflation – about 2.25%. Over the next ten years if inflation averages more than 2.25% TIPS will have a higher total return, and if inflation averages less than 2.25% nominal Treasurys will have a higher total return. Seems a bit more evenly matched when it’s laid out like that right?
Our recommendation is to hold both nominal and inflation protected securities in a bond portfolio. Both sectors work to dampen volatility of a balanced portfolio of stocks and bonds, but having a the diversification within the fixed income assets class helps improve expected risk adjusted returns as well.
Have a great day!
Cliff J. Reynolds Jr., CFA