Monday, April 30, 2012

Personal Income and Outlays... A Few Charts

The Economic Populist notes:

While disposable income increased by 0.4%, when adjusted for inflation, disposable income was actually a 0.2% increase.
Over the longer term and on a real per capita basis, March marked the third month in a row in which disposable personal income printed a negative year over year figure, which shows just how how weak the employment recovery has been.

On the flip side of the income / consumption equation, has been solid spending (both in nominal and real terms), as consumers have reduced their savings rate below 4% (the savings rate had moved above 6% during the beginning of the crisis).

One area of real consumption weakness... energy in real terms. I am no expert as to specifics of what is making up the decreased demand (clean technology, less people driving to work, more people taking public transportation, etc...), but I will say that demand does tend to decrease when the price of good or service quadruples like energy has in recent years.

Source: BEA

April ETF Performance Recap

In a month where market pundits made it seem like we were experiencing a sell-off we have never seen before, markets were only slightly in risk-off mode, while EVERYTHING (except long treasuries) is now up for the year.

The question for investors is whether the risk-off environment was simply a pause following a sharp rise in risk assets in Q1 (i.e. just the temporary mean reversion seen below).

Or the beginning of a European crisis induced broader sell-off that is a continuation of Q3 2011 (as seen below).

Friday, April 27, 2012

GDP Breakdown

Bloomberg details:

The U.S. economy expanded less than forecast in the first quarter as a smaller contribution from inventories overshadowed the biggest gain in consumer spending in more than a year.
Gross domestic product, the value of all goods and services produced in the U.S., rose at a 2.2 percent annual rate after a 3 percent pace, Commerce Department figures showed today in Washington. The median forecast of economists surveyed by Bloomberg News called for a 2.5 percent rise. Household purchases increased 2.9 percent, exceeding the most optimistic projection. Homebuilding grew the fastest in almost two years
So there you have it... a VERY strong (perhaps unsustainable?) contribution from consumption, reduced impact from inventories, the beginning of contribution from residential investment for years to come (after years of decline), mixed trade, and what is likely to be negative impact from the government sector for years.

Source: BEA

Thursday, April 26, 2012

More on that Treasury Blood Bath

Just about a month ago when everyone was calling the end of the 30 year bond rally, I noted.
While any sell-off has the potential to become the large sell-off EVERYONE has been waiting for (economic data is improving, yields are very low, inflation is ticking higher), I am not yet convinced it's the sure thing these "experts" want you to believe.

But, I guess if you keep making the same prediction, eventually it will come true.
Apparently, we need to keep waiting.

A weak (and deteriorating) Europe, low inflation, low growth, an uptick in risk-asset volatility, and continued piling into the asset class by investors (mutual fund flows remain positive), businesses (looking for yield on cash), and government entities (QE) have not only supported the asset class, but made it one of the top performing asset classes month-to-date.

Source: Barclays Capital

Tuesday, April 24, 2012

The Power of Momentum

Gary Antonacci of Optimal Momentum blog has a great white paper out titled 'Risk Premia Harvesting Through Momentum' that details...

Momentum is the premier market anomaly. It is nearly universal in its applicability.
Gary then outlines how an investor can easily apply momentum through the use of asset pair modules to "effectively harvest risk premium profits". I highly recommend anyone interested in momentum or learning more about momentum to check out the (easy to understand) white paper that you can download here.

Reading the paper gave me an idea for a test that I felt would further show how universal momentum truly is. The test? How well would an investor have done applying momentum to the various cities that make up the Case Shiller Home Price Index, pretending (of course) that each city index was investable and liquid (i.e. things they aren't).

First, a quick update on the Case Shiller Home Price Index. To the Huffington Post:
The Standard & Poor's/Case-Shiller home-price index shows that prices dropped in February from January in 16 of the 20 cities it tracks.

The steady price declines have brought the nationwide index to its late 2002 level. Home prices have fallen 35 percent since the housing bust.

Prices in nine cities fell to their lowest levels since the housing bust. The average price in Atlanta fell 17.3 percent in February compared with a year earlier. That's the biggest annual drop in the history of the index for any city.
Yikes... let's see what momentum can do with this mess.


1) Take the 6-month rolling return for each city
2) Allocate the next month to the city that had the highest six month return

How well would we have done?

The chart below outlines the performance of this relative strength allocation, the composite-10, and Portland (which happened to be the best performing city over this time frame... who knew).

For those keeping track at home, that's a 12.7% annualized return for the relative strength index vs. 3.3% for the composite-10 and 4.8% for Portland, despite there being no rule that allowed an investor to get out of the market.

Not too bad.

Source: Case Shiller

One reason I was drawn to Gary's paper is that it is remarkably similar to something I've been working on for the better part of the past year, which itself is based on conversations that I've had with Meb Faber from World Beta over the past few years. If you haven't read Meb's paper A Quantitative Approach to Tactical Asset Allocation, another strong recommendation.

Monday, April 23, 2012

How's That Austerity Working?

Bloomberg details:

The debt of the euro region rose last year to the highest since the start of the single currency as governments increased borrowing to plug budget deficits and fund bailouts of fellow nations crippled by the fiscal crisis.
The debt of the 17 euro nations climbed to 87.2 percent of gross domestic product in 2011 from 85.3 percent the previous year, official European Union figures showed today. That’s the highest since the euro was introduced in 1999. Greece topped the list with debt at 165.3 percent of GDP, while Estonia had the least at 6 percent of GDP.
Bloomberg continues...
Italy ended last year with the second-highest debt at 120.1 percent of GDP. Spain’s rose to 68.5 percent from 61.2 percent. Germany posted one of the only declines, with its debt shrinking to 81.2 percent from 83 percent, Eurostat said in the report. Only five euro-region nations -- Estonia, Luxembourg, Slovenia, Slovakia and Finland -- had debt within the euro- region’s limit of 60 percent of GDP.

This leaves indebted European countries in an awfully precarious situation.

On one hand they have limited firepower left with debt levels increasing relative to nominal GDP even as they push austerity measure (always important to remember the debt to GDP ratio will rise as long as debt increases more than GDP and that can be in the form of flat debt and declining GDP). On the other, even if the citizens throw out leaders that favor austerity, for those pro-growth, it is unlikely to help as it doesn't address the cause of the problem... the imbalances between countries with vastly different production capabilities, demographics, beliefs, yet a shared currency.

Source: Eurostat

Thursday, April 19, 2012

Leading Economic Indicators (less Fed Control) Negative

Excluding the components the Fed impacts, the index is negative for the second time in three months, dragged down by the decline in the average work week.

Tuesday, April 17, 2012

Why Investors are Reaching for Yield?

Because high yield is just about the only place you can get yield within the U.S. without taking on interest rate risk. The question is whether investors know / are comfortable with the credit risk they are taking.

Source: Barclays

Chinese Treasury Holdings Back to 2010 Levels

For years, the mainstream media reported that China was unloading Treasuries when in fact they weren't (Treasuries were purchased and listed as being held by the U.K., then regularly revised to China). BUT, recent revisions to the TIC Data shows that the slow down we witnessed in late 2011, was actually a rather significant decline.

The rise in holdings comes after China reduced its position in U.S. government debt in 2011 for the first time since the Treasury started releasing the data in 2001, as yields fell to record lows.

* Chinese + United Kingdom Holdings as some purchases flow through the U.K.

Some of this was simply a reallocation to higher yielding agency bonds, but it doesn't seem to account for that much of it. We'll see in coming months (data will now be revised by the Treasury on a monthly, rather than yearly basis) if the bottom holds at spring 2010 levels or if things are taking a much different turn in China than most market participants believe.

Source: Treasury

Monday, April 16, 2012

Retail Sales Continue to Show Strength

The Washington Post details:

Americans bought more electronics, started home improvement projects and updated their wardrobes last month, inspired by warmer weather and a healthier job market.

The increase capped a strong quarter of gains and contributed to a brighter outlook among economists for growth in the January-March quarter. Businesses are responding by restocking their shelves at a steady pace, a sign that they expect the trend to carry over into the spring.

More retail spending also helped offset a decline in confidence among homebuilders. And it could ease concerns about March hiring, which slowed to half the pace of the previous three months.

Source: Census / BLS

Sunday, April 8, 2012

Employment Report: Not as Bad as I First Thought

Upon first glance, Friday's employment release was disappointing, but Scott Grannis pointed to something that does provide optimism.
In the past two months the household survey has made up for that lagging performance by posting growth of 740K jobs.
Below is a breakdown of the household survey broken down by the public (government) and private (business) sectors. The huge divergence accounts for how the household survey could show a net negative growth print for March, while the private sector grew by 336,000.

The private sector recovery over the last twelve months is now the same as the peak we saw last cycle (though that in itself was the "jobless" recovery). The main concern I see is whether the drag from the public sector will in itself cause the aggregate economy to stall, but this makes me much more optimistic than I was on Friday about a continued (albeit slow) recovery.

Source: BLS

Saturday, April 7, 2012

The VIX as an Equity Hedge

Back in January I posted a pair of VIX / S&P 500 tables that outlined the performance of the VIX and the S&P 500 given recent changes in the VIX, as well as the current level of the VIX. In response, reader Nazumo asked:

In service of the perpetual quest to find cheap and reliable hedging vehicles, I'd be curious to see a third table: (change in SPX / change in VIX) against VIX.
That table is below, but first I'll try to explain in a simple manner exactly what we're looking at.

The x-axis shows how much the VIX has changed over the last month (as of Thursday, this would read a '0 to 2.5 point drop' as the VIX reads 16.70 vs 18.05 a month back), while the y-axis shows how much the S&P 500 has changed over the last month in percent terms (as of Thursday, the S&P 500 would read '2.5% to 5%' as the S&P 500 was up around 2.6%).

That gets us to the 8.4% average rise in the VIX over the next month based on these two historical factors (note that I am not saying this will happen going forward); certainly a nice hedge if you can get it should equity markets sell-off.

So, is the VIX a good S&P 500 hedge? Based on the above table and the previous tables which incorporate starting levels the VIX may be a good hedge when:
  • Markets are calm
  • The price of volatility, as a form of insurance, is cheap
In other words, the VIX may be a nice equity hedge.... when you don't think you need it. By the time you KNOW you need(ed) it, after markets sell-off or when the VIX index is rising, it is likely too expensive to be of value.

Friday, April 6, 2012

A Weak Jobs Report

While the payroll (i.e. business) survey showed a net gain of 120,000 jobs in March (which in itself was weak), the household survey (the survey used to calculate the unemployment rate) actually showed a decline. Note that while this may just be noise after a warm winter that may have pulled hiring forward, the net result is most likely a (much) weaker employment situation than previously thought.

The Washington Post details how the unemployment rate can fall in the face of lost jobs:
In March, the household survey showed that the number of people who say they have a job fell by 31,000 and the number of people looking for a job fell by 79,000. That lowered the unemployment rate to 8.2 percent.
As the chart below shows, both the headline unemployment rate and broader measure of unemployment dropped as people left the workforce.

Breaking this down further, we see a continued split in terms of the male and female population. Men continue to find work (though the number of men dropping out rose in March), while women continue to run into difficult times, losing jobs and dropping out of the workforce in sizable numbers (more than 300,000 left in March alone).

Which all adds up to a stalling (perhaps temporarily) in the number of hours worked per person (on average), while remaining at a level WAY below historically norms.

Source: BLS

Monday, April 2, 2012

Baby's Got Sauce... Checking in on the World's Greatest Rotation Strategy

Definitely not the world's best strategy, but I thought I'd try out a headline grabber. In fact, there is no legit reason I can think of that explains why this seasonal pattern should outperform going forward, BUT the results (both in and out of sample) are good enough that I won't be ignoring them.

I planned to provide an update on the "Secret Sauce" allocation strategy as soon as I started seeing all the "sell in may, go away" articles that always come this time of year. I didn't have to wait long.

To Marketwatch:
Those interested in doing some spring cleaning in their portfolios this month might be tempted to do the most radical spring cleaning of all: Sell everything and go to cash.

That’s because April represents the end of the seasonally favorable six-month period that began last Halloween, and the fast approach of the time when many will “Sell in May and Go Away.”
Which brings me to the Secret Sauce, amazingly now in its 5th year of in sample testing.

What is the Secret Sauce?

An alternative to the "sell in May, go away" strategy, Secret Sauce is sell the S&P 500 in May and then invest in the Long Government / Credit bond index (rather than sit in cash). The "strategy" takes advantage of data mining that showed the Long Government / Credit index outperformed the equity market for the May through October time frame over the 34 years between 1974 and 2008.

The amazing thing is that since I first revealed the Secret Sauce back in July 2008, the results keep getting better. The massive outperformance since 1974 (14.7% vs 10.6% annualized returns) with lower volatility (12.4% vs 15.8% monthly standard deviation) was met by even larger outperformance over the past few years (35.6% vs 8.5% returns over the last 12 months, 11% vs 2% annualized over the last five) resulting in $1 invested in the Secret Sauce in January 1974 now being worth $188 vs. $1 in the S&P 500 being worth $47.5 (assuming no fees, transaction costs, or taxes).

And the strategy's theme song... G Love & Special Sauce with 'Baby's Got Sauce'

Source: S&P / Barclays Capital

Sunday, April 1, 2012

"Risk On" in Q1

Source: Bespoke