Submerging Markets

Emerging market equities put in their 2013 highs (absolute and relative) on the very first day of trading. Since then, it has been all down hill.  By early July, large cap stocks had outperformed EM stocks by 30% YTD!  Anyone who was exposed to these markets lagged domestic benchmarks, diversification was punished.

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What happens with asset classes is that price tends to change before the news is apparent to most market participants. By the time people like me start tweeting about it, most of the damage has already been done.

May 22nd started the recent bout of heavy selling of. The faint smell of Taper was in the air and Mr. Market said “wait a minute, I can get 5% in The Bazvoo Republic or 3.5% at home?” Money got ripped out fast with some countries losing 20+% in only a few weeks. Currency and bond investors also got crushed. God forbid said country was running a current account deficit? Fuhgeddabout it.

Then one day with no warning, they stopped going down.  Anybody who owned these stocks had already screamed uncle. It just became a given that you would wake up and India got killed overnight. One thing social media is good at is amplifying sentiment extremes. People tweeting about Vietnam and Indonesia day after day screams low risk entry point.

I’m not saying that this is anything more than a dead-cat bounce.  What I am saying is that when everybody has given up on an ASSET CLASS, the risk reward sets up very nicely.

It would be very apropos if this marks some sort of short term top ;)

No country is safe from emerging market meltdown (MarketWatch)

Adviser cuts back on Emerging market stocks (WSJ)

The next emerging market crisis (NYT)

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How don’t you love bonds here?

I like bonds, I would certainly be a buyer here. Tapering is a foregone conclusion, so lets go with the assumption that come September the Fed will slow down its pace of asset purchasing.

My friend who is an anesthesiologist called me yesterday and asked how he should be duct-tapering his portfolio. This should give you an idea as to how negative the sentiment is in fixed income land. Bonds (TLT) have gotten absolutely destroyed, off ~17% since the beginning of May. I’m guessing they have seen the worst of this carnage, for now anyways.

I more than understand being under-weight bonds in a diversified portfolio, but as a trade, I think there is a short-term opportunity here. I know we shouldn’t catch a falling knife, but shouldn’t we buy when blood is in the street?

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Looking under the minutes

Let’s take a look at some of the intraday price action. Bonds rallied to intraday highs going into the minutes. After the release, rates spiked and bonds got crushed. Although sentiment is as bearish on bonds as I can ever remember, buying bonds here is catching a falling knife, they closed at fresh 52-week lows.tlt

Emerging markets were down 13.2% going into today. As domestic rates have risen, money has been sucked out of EM’s. They rallied to intraday highs after the minutes but that faded fast as they closed down 234 bps today, ugly.em

The large caps moved sideways all day in anticipation of the minutes. They moved swiftly to intraday lows only to rip 100+bps, chopping the genitalia off any shorts leaning too hard. That rally faded fast as they closed near the lows of the day. The SPY is now 3.7% off its all time-high.
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An interesting note is that although GLD was only down 29 bps today, the miners got hit 4.6%. This could be a change in character, or simply a pause as GDX is 21% higher than it was 10 days ago.

The Dow is now down 6 days in a row. The Blue Chips had 3 separate losing streaks in ’12 and was higher on the 7th day all three times.

I have no idea where we go from here but the price action certainly favors the bulls, at least in the very short term. Tomorrow is another day.

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Technically Rising Rates

Technology has a strong tendency to outperform when interest rates rise.  These companies typically aren’t heavily reliant on debt. With negligible borrowing, rising rates tend to hurt little, if at all.

Unlike investors who buy Utilities, tech investors are seeking growth.  They don’t have to weigh the risk of a 3.5% Utility yield vs collecting the 2.8% yield on the ten-year treasury.

What is interesting to note is that the weakest sectors when rates rise, are the very sectors that led us higher, and even went vertical in the first few months of 2013 (Utilities, staples, healthcare).

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Let’s take a look at the performance of Technology, Utilities and the S&P since the market peaked on August 2.

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Technology has outperformed Utes and Large Caps by 4.3% and 2.1% respectively. Lets see if this trend persists over the second half of the year.

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Discounting the Taper

Mr. Market discounts harder than the artist formerly known as J.C. Penney. Prices change well in advance of fundamentals, allowing markets to bottom midway through a recession. By the time the NBER declared the recession over in September 2010, the S&P 500 had advanced 70%.

Over the last 16 weeks, the yield on the ten-year treasury has risen 75%. We haven’t witnessed such a move in over 50 years. The spike is the market discounting Bernanke’s eventual taper. What’s remarkable is that consensus has the fed tapering it’s asset purchases by 23%. It’s hardly as if they are pulling the E-brake on this locomotive, Ben is merely taking his foot off the pedal,  slowing from 85 to 65.

I wonder is this is setting up for a sell the news event. With most bonds and bond proxies getting slammed over the past few weeks, have said assets already discounted the taper?

Performance since May 1

TLT -16.6%

PFF -7.6%

JNK -5.5%

LQD -8.7%

IYR -15.9%

REM -25.3%

MUB -8.9%

XLU -9.4%

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S&P 500 Global Sales

S&P Dow Jones is out with their “S&P 500 2012: Global Sales” piece which shows the percentage of sales of S&P 500 companies broken down by geography and sector.

We are always looking at these sort of numbers, i.e if we’re bullish on Europe, what sectors are most exposed to that region of the world? Knowing what’s under the hood is vital to asset allocation.  I am pulling a few nuggets that stood out to me the most.

  •  46.59% of S&P 500 sales came from overseas, the first increase after 3 consecutive years of decline (still down from 47.94% in 2008).
  • The largest percentage of overall S&P 500 foreign sales came from energy (20.61%), which is not surprising when you consider that the 2nd biggest company in the world, Exxon Mobil, generates 71.74% of its revenue from outside the U.S.
  • Information technology saw 58.3% of its sales come from abroad, the highest percentage of any sector (16.2% of all declared foreign sales).
  • Qualcomm generates 95% of its revenue outside the United States (did I read this wrong)
  • 39.7% of declared sales were classified as coming from “foreign countries”, in other words, no real breakdown was given.

Head over to S&P Dow Jones Indices for the full report.

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Model this

“I can calculate the motions of the heavenly bodies but not the madness of the people”

Isaac Newton’s response when asked to comment about the South Sea Bubble (~1720).

Throughout the history of the stock market,  the hundred year flood has occurred much more frequently than its name would suggest.  Recently, blame has been placed at the feet of HFT, TBTF banks, Paula Deen, Obama and economists whose models often try and jam square pegs into round holes.

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Jim Picerno’s book Dynamic Asset Allocation takes an interesting look at normal distributions in the equity market, or lack thereof.

“In fact, the bell curve fits reality very poorly.  From 1916 to 2003, the daily index movements of the Dow Jones Industrial Average do not spread out on graph paper like a simple bell curve.  The far edges flare too high: too many big changes.  Theory suggests that over time, there should be fifty-eight days when the Dow moved more than 3.4 percent; in fact there were 1001.  Theory predicts six days of index swings beyond 4.5 percent; in fact there were 336.  And index swings of more than 7 percent should come once every 300,000 years; in fact, the twentieth century saw forty-eight such days.

These statistics are staggering.  How can so many nobel laureates have base assumptions so wildly divorced from reality?  The answer of course, is that modeling human behavior is impossible.  I googled “modeling human behavior” and found 10,800,000 results (0.22 seconds).  Yea, good luck with that.

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