NEW$ & VIEW$ (21 AUGUST 2013)


Asian Shares Mixed After Sell-Off Asian stocks traded mixed following a dramatic two-day selloff across the region that sent governments in some markets rushing to stem further declines.

Emerging-Market Currencies Fall

Emerging-market currencies seen as most vulnerable to shifts in U.S. monetary policy slumped once again Wednesday, hours before the U.S. Federal Reserve is set to release minutes from its most recent policy meeting.

With traders and investors bracing for the possibility that the Fed will signal greater confidence that it will start peeling back, or tapering, stimulus measures from as soon as next month, some of the currencies that have been the biggest beneficiaries of the easy-money era fell hard. (…)

Malaysia Cuts 2013 Growth Forecast as Expansion Misses Estimates

The economy may expand 4.5 percent to 5 percent in 2013, from a previous prediction of as much as 6 percent, the central bank said in Kuala Lumpur today. Gross domestic product rose 4.3 percent last quarter from a year earlier, after gaining 4.1 percent in the previous period, it said.

Net exports of goods and services slumped 41.6 percent in the second quarter from a year earlier, after falling 36.4 percent in the first quarter of 2013, today’s report showed.

Total consumption rose 8 percent in the April-to-June period from a year ago after climbing 6.1 percent in the earlier quarter. Gross fixed capital formation gained 6 percent, after an increase of 13.1 percent in the previous period.

For Asia, Shades of 1997

The same toxic combination of U.S. and Japanese tightening that sparked the Asian financial crisis in 1997 is looming now. Time to freak out? Watch the dollar and yen, writes Vince Cignarella.

(…) Rewind to March 1997. Then, the Fed’s communications policy bore little resemblance to the current era of transparency, so inevitably some investors were taken aback when the central bank raised the discount rate, the rate at which the Fed lends money to commercial banks, to 5.5% from 5.25% after two years of trimming rates. (Remember, this was before fed funds targeting was in vogue.)

One month later, in April 1997, the Japanese government raised a nationwide consumption tax to 5% from 3%. This was seen at the time as a major contributing factor to Japan’s economy falling into a recession in Q41997.

Fast forward to today. The Fed is expected to usher in the beginning of the end of its bond-buying program, put in place after the financial crisis to stimulate growth. Whether the Fed makes a move in September or December will ultimately become a footnote in history. What’s important is that this tapering right now looks inevitable.

Meanwhile, Prime Minister Shinzo Abe is weighing an increase in the same exact consumption tax, to 8% starting April 2014 from the current 5%.

No wonder emerging markets in Asia are freaking out. By any measure, that’s a lot of money that’s going to stop making its way into the financial system. Say bye-bye to the search for yield and those “hot money” flows that propelled those markets higher. (…)

The question remains: Is this 1997 all over again?

So far, the market moves have been milder. A big reason: Many currencies back then were set at a fixed exchange rate against the dollar. Unmoored, the baht plunged 40% in four months after the central bank was forced to let it float in July 1997. A similar fate met the Indonesian rupiah when the crisis made the managed float rate impossible.

There are other differences this time around, as well. Before the Asian financial crisis, Japan helped drive the growth of the developing countries that neighbored it. This time around, China plays that role. And for all the hand-wringing about China’s growth outlook, no one is making any comparisons between China today and Japan in 1997.

So what’s an investor to do?

My approach: Keep close tabs on the dollar, especially how it trades against the yen. During the Asian financial crisis, investors looking for a safe place to camp out piled into the dollar. In April 1997, one dollar bought about 106 yen. By August 1998–at which point the crisis had spread to Russia and was causing U.S. stocks to reel–one dollar was fetching about 147 yen.

If the dollar begins to gain rapid ground against the yen, the Asian cold may turn into the Asian flu–a bug we’re all likely to catch.

Fingers crossed  Bloomberg offers hope thanks to Japan

The Fed’s surprise signal in May of the approaching tapering of asset purchases has unsettled emerging markets. Economies such as India and Indonesia, which are more reliant on foreign investment for growth and the funding of current account deficits, have been hit the hardest. The anxiety may not be justified, using past phases of Fed tightening as a guideline.

During 1999 and 2004-06, Asian GDP growth averaged 5.9 percent and currencies, after an initial bout of selling pressure, gained an average 5 percent against the U.S. dollar. The key this time will be the Fed’s ability to preserve risk appetite amid a leadership transition.





Chicago Fed Index Remains in Negative Territory

The Federal Reserve Bank of Chicago said Tuesday that its National Activity Index rose to -0.15 in July from -0.23 in June, while the less-volatile three-month moving average improved to -0.15 from -0.24.

It was the fifth straight month the two measures have remained in negative territory, indicating below-trend growth.

Doug Short adds this:

The next chart highlights the -0.70 level and the value of the CFNAI-MA3 at the start of the seven recession that during the timeframe of this indicator. The 1973-75 event was an outlier because of the rapid rise of inflation following the 1973 Oil Embargo. As for the other six, we see that all but one started when the CFNAI-MA3 was above the -0.70 level.

Click to View

The next chart includes an overlay of GDP, which reinforces the accuracy of the CFNAI as an indicator of coincident economic activity.

Click to View

Summer Jobs Elude Many Teenagers

The job-market recovery is leaving teenagers behind—especially those from low-income and minority backgrounds.

Less than a third of 16- to 19-year-olds had jobs this summer, essentially unchanged from a year ago, according to Labor Department data released Tuesday. Before the recession, more than 40% of teens had summer jobs. One in four teens who tried to find work failed to get a job, far above the 7.4% unemployment rate for the broader population.

Retailers, fast-food restaurants and other traditional employers of this cohort have stepped up hiring in recent months. But with the ranks of unemployed including many better-qualified candidates, companies have little incentive to hire inexperienced teenagers. With work still scarce, college students and even college graduates are settling for jobs once done mostly by teens, while at the same time more retirees are taking part-time jobs.



More on Job Growth Quality

(…) In short, yes, the U.S. economy is adding a large number of low-paying jobs, however we are also seeing relatively strong growth at the top end of the employment scale as well. We are missing the growth in jobs at the middle of the income distribution.



In short, the middle class is holed out.

Home Depot’s Earnings Rise 17%

For the first time since 1999, quarterly sales at Home Depot Inc.’s stores open at least a year rose at a double-digit rate, as the home-improvement retailer benefited from an improving housing market that has shoppers spending more freely on bigger ticket items like appliances and lawn mowers.

Amazing: Comps at Home Depot’s U.S. stores increased 11.4%. In F2Q, total transactions (traffic) increased 4.9% YoY to 393 million and average ticket increased 4.3% to $57.39.

Pointing up  Also note the following:

The Atlanta-based retailer has benefited from looser credit standards, as customers with lower credit scores were able to get approved for private-label credit cards, whose usage increased by 0.44%. The company’s professional customers, who represent 36% of its sales, also were able to attain increased lines of credit, which rose by an average $200 from a year earlier to $68,000. The company has been working with underwriters to help professional customers get extended credit lines.

Lowe’s Profit Up 26%, Boosts Outlook

Lowe’s Cos. fiscal second-quarter earnings jumped 26%, beating analyst expectations, and the home improvement retailer raised its outlook after logging double-digit percentage growth in revenue, buoyed by an improving housing market.

Net sales were up 10% to $15.71 billion, while same-store sales were up 9.6%. Gross margin widened to 34.4% from 33.9%.

The company also raised its financial outlook for the year, now expecting per-share earnings of $2.10 on sales growth of 5% and same-store sales growth of 4.5%. Its previous expectation was for share earnings of $2.05 on sales growth of 4% and same-store sales growth of 3.5%.

But the recent rise in mortgage rates seems to be biting as this chart from CalculatedRisk shows:



Iran Fills Rhetoric Void With Bullish Words on Oil Iran is willing to start an oil-price war to win back the market share lost through sanctions.

Iran is willing to start an oil-price war to win back the market share lost through sanctions, Bloomberg reports.

The country’s new, old oil minister Bijan Zanganeh says Iran wants to increase production by 70% in an effort to retake its place as OPEC’s second-largest producer.

“We only ask those who have replaced us in the world’s oil markets to know that when we are re-entering these markets they will have to accept that the oil prices decline or they should reduce their production to create enough space for Iran’s oil,” Mr. Zanganeh said.

It is the use of “only” in that sentence that stands out. There may or may not be a transliteration error, but the minister isn’t asking a small favor here. Internal OPEC politics mean the group’s other members won’t roll out the red carpet for the return of Iranian oil.

Iran already needs oil to trade way above where it now is in order to break even. A price war would be in nobody’s interests.

Can Iran even manage to increase its production? Bullish noises come from the state oil company, and Mr. Zanganeh, who was an oil minister from 1997 to 2005, has been welcomed as an authoritative, knowledgeable figure who will remove the politics from domestic oil production.

Raising production will likely require the return of those foreign, western oil majors — Norway’s Statoil ASA, France’s Total or Italy’s Eni – that quit Iran when sanctions hit. Getting them back will likely require the lifting of sanctions.


News of violent unrest in Libya has been flying under the radar somewhat in the face of the ructions in Egypt, but for the oil market the former situation is easily the one that is more interesting.

Libya last year was the fourth-largest oil supplier to Europe.

Clashes erupted Tuesday at oil terminals that had been closed in eastern Libya, The Wall Street Journal’s Benoit Faucon reports, with more peaceful protests at other terminals helping to cut the North African country’s oil production to levels not seen since the 2011 civil war that toppled strongman Moammar Gadhafi.

Remarks made to the Journal by Libya’s deputy oil minister this week suggest the government is running out of patience with the situation. This isn’t surprising — the disruption has cost the country over $1 billion in lost revenue to date.

Conflicting reports are only adding to an already-confusing situation. One day Libya invokesa legal clause known as force majeure, which excuses a seller from making deliveries because of events beyond its control; the next, ports are being prepared for reopening.

There is no certainty about anything in the world of Libyan oil.



Leveraged ETFs, the Flash Crash, and 1987

(…) You could be forgiven if you’ve never heard of leveraged ETFs. But this smallish corner of the investing universe could, under the right circumstances, do to the market what portfolio insurance did to the market in 1987: that is, force a liquidation that sparks a big selloff.

At least, that’s the suggestion of a new paper from the Federal Reserve Board, written by staffer Tugkan Tuzun. He likens leveraged ETFs to the portfolio insurance schemes of the 1980s, which are believed to have either contributed to or even caused the great crash of October 1987, when the Dow Jones Industrial Average dropped 22% in one day.

Portfolio insurance was a popular hedging strategy in the ’80s that used options, and “synthetic options,” to protect against losses. But it involved a daily rebalancing that, in October 1987, led to a “cascade” of sell orders that exacerbated what happened on Oct. 19, 1987.

That kind of one-day drop would be much harder to produce today, given the circuit breakers that were installed specifically in response to the ’87 crash. But the point of the Fed paper is that leveraged ETFs could, under the right conditions, produce a similar cascade of sell orders, amplifying the severity of any market drop.

Leveraged ETFs date back only to 2006, and have only about $20 billion in total assets. The key here, though, is what’s called rebalancing, which these funds typically do on a daily basis. Because these funds promise a certain multiple over the underlying exchange it’s tracking, the funds use derivatives and borrowed money to amplify their returns. Also, to maintain those returns, the fund managers must buy when the market is going up, and sell when it’s going down.

That’s where the 1987 connection comes in. What is generally believed to have happened in 1987 – it is still a debated subject – was that once the selling started, the portfolio insurance strategies demanded investors sell, resulting in a massive wave of sell orders.

Leveraged ETFs could bring about the same dynamic, Tuzun writes. Imagine a situation where the market is selling off. “LETF rebalancing in response to a large market move could amplify the move and force them to further rebalance, which may trigger a ‘cascade’ reaction.” If the fund is using swaps, counterparties are likely hedging their positions in equities or futures markets. Thus, a forced selloff of leveraged ETFs could, through derivatives and counterparties, wind up moving the cash stock markets.

Moreover, because most of this daily rebalancing occurs in the last hour or so of trading, a cascade of selling could amplify late volatility and drive indexes down near the close, leading to “disproportionate” price changes. (…)

I was managing equities in 1987 and Black Monday is still very much present in my mind. That was a scary day!

It was not caused by portfolio insurance, rather by a total loss of confidence in the willingness of world central bankers to cooperate and coordinate their actions in order to correct the imbalances in world currency markets.

This happened as U.S. equities were selling at very risky levels as per the Rule of 20. As portfolio insurance kicked in after the first down draft (whew!), markets sank further. The overvaluation quickly changed into a deep undervaluation creating a terrific buying opportunity for those who understood that this was not the end of the world.



Just kidding Mohamed El-Erian
Don’t wait for autumn to reposition portfolios


The next few months promise to be particularly tricky and volatile for markets, with uncertainty coming from the US, Europe, Japan and the Middle East. (…)

In the US, the Federal Reserve is expected to signal at its September policy meeting its appetite for tapering its exceptional support for markets and the economy. (…)

September may also bring news of the next chairman of the Federal Reserve. (…)

Then there is America’s highly polarised Congress. When they return from their summer recess, lawmakers will be unable to avoid for long two important pieces of legislation: the immediate one required for the continued functioning of the government; and that needed to avoid a technical sovereign default a few months down the road. (…)

The situation across the Atlantic is also quite uncertain. With German elections in September, and with few wishing to undermine Chancellor Angela Merkel’s likely victory, several national and regional initiatives have been placed on hold. This summer pause has reduced policy disagreements; but at the cost of heavily burdening the autumn policy agenda facing officials who have repeatedly proven reluctant to take prompt decisions absent crisis-like conditions. (…)

In Japan, delays in unveiling the “third policy arrow” are undermining the policy pivot implemented by the Bank of Japan at the behest of Prime Minister Shinzo Abe. Judging from the recent sell-off in Japanese equities and the behaviour of the currency, markets are already signalling that Japan’s policy experiment will falter if exceptional monetary and fiscal stimulus is not accompanied quickly by structural reforms. (…)

Then there is the Middle East. (…)

Rising Stocks Hit Short Sellers  Short sellers are facing their worst losses in at least a decade, a Wall Street Journal analysis has found, as many of the rising stocks they bet against have only continued to soar.

(…) [image]In the Russell 3000 index, the 100 most heavily shorted stocks are sharply outperforming the average returns of stocks in the index, according to a Journal analysis of data provided by S&P Capital IQ. The shorted stocks are up by an average of 33.8% through Aug. 16, versus 18.3% for all stocks in the index.

The gap between the performance of the most-shorted shares—as measured by percent of total shares outstanding at the beginning of the years—and the market as a whole is wider than it has been in at least a decade. (…)

Stock hedge funds are expected to outperform when markets fall but underperform during bull runs, since they generally hedge their bets by betting against stocks. But the gap is wider than usual. Through July, stock hedge funds returned 7.7% on average, compared with 19.6% by the Standard & Poor’s 500-stock index, including dividends. (…)


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