Posts filed under “Think Tank”
NIRP, ZIRP, PIRP & Paris
Cumberland March 10, 2015
We will soon travel to Paris for Global Interdependence Center’s “New Policies for the Post Crisis Era” conference. The conference and accompanying activities are being held at the Banque de France on March 23, and the GIC delegate’s roundtable will be held at Bistro de la Muette on March 24, 2015. Any readers who can make last-minute arrangements to join us are most welcome. For more information or to register for this event, click here. (www.interdependence.org)
What a time for a discussion of Eurozone monetary policy and economic outcomes.
We have posted a G7 chart on our website (http://www.cumber.com/content/misc/G7_Table.pdf) . The chart depicts the interest rates on the two-year benchmark sovereign note and 10-year benchmark sovereign bond (technically the US Treasury item is a note, not a bond) for the G7 countries (United States, Canada, United Kingdom, France, Germany, Italy, and Japan). The chart shows that the highest interest rates are in the US. Look at the rest of the G7 members, the countries that constitute the large, mature capital markets of the world. It is evident that the world is upside down and backwards. The interest rates in the countries and currency zones where quantitative easing (QE) is still underway or about to expand immensely are lower by substantial amounts than the interest rates where QE has stopped and policy may be heading toward tightening.
Contrast the highest-credit-quality sovereign instruments. The US has the world’s reserve currency, and the US dollar is strengthening. A recovering US economy yields two percentage points more on the benchmark 10-year sovereign instrument than does Japan, where QE is ongoing and the debt-to-GDP ratio is three times that of the US. And the US note yields about 2% more than Germany’s bund (the benchmark for the Eurozone, where the European Central Bank [ECB] is launching an 18-month expansion of QE that will total in excess of €1 trillion). Under normal circumstances the differential in those interest rates would suggest that the dollar will be weaker over the next decade by about 2% per year against the yen or the euro. Yet all activity in the markets suggests the opposite. All pricing of futures, foreign exchange markets, and other asset categories suggests that this differential of 2% per year is backwards.
Think about future decision-making in sovereign debt allocation jurisdictions outside of the G7. Put yourself in charge of the sovereign wealth fund in a Caribbean nation, the Persian Gulf, or an Asian country. You have an allocation to high-grade government debt. No matter how large or small it is, it is large in terms of presence. A piece of your total fund will be in the highest-credit-quality sovereign debt. In Europe, you will favor Germany but will not go near a credit like Greece. You will also favor the Japanese yen, the US dollar, and the British pound. When you have to select among them, where will you apply your heaviest weight? You’ll overweight the US dollar and holdings of US government obligations at the expense of all others.
Whether you sell the others or take new-money flows into the US dollar is a separate question. On the other hand, the ECB is a buyer of whatever you want to sell. The Bank of Japan (BoJ) will help you if you happen to have any yen-denominated instruments left to sell. This policy acts to bid for US government securities and, by definition, all other US securities that tier from the US Treasury curve or are directly or indirectly related to it. Large global buyers of US-dollar-denominated high-grade bonds, including US government bonds, will be prevalent and highly active for the next two years.
Next, we tip our hat to Dennis Gartman for his clever use of the acronyms NIRP (negative interest rate policy), PIRP (positive interest rate policy), and ZIRP (zero interest rate policy).
What does that mean as the Federal Reserve moves away from zero to some low but positive interest rate? In the US, we go from ZIRP to PIRP. In the Eurozone they have gone from ZIRP to NIRP. Japan continues at ZIRP, as it has for the past several years.
Conversations in Paris will deal with the policy implications of this extraordinary distribution of global policy and the important impacts of ZIRP. One-third of the high-grade sovereign debt in the Eurozone and nearby European countries, like Sweden or Switzerland, is now trading around NIRP. The number of countries and the amount of debt at NIRP are both likely to grow. What does that mean for the suppression of yields worldwide? How will it affect asset allocations with traditional compositions that have not had to change much for the last 50 years but must now change radically? What do these global policy moves mean for the US, its economy, financial markets, and asset pricing?
What we do know going into the Paris conference is that the single most enduring element in valuation of financial assets is the interest rate. The basic construction of asset pricing starts with the riskless interest rate. And now we have the greatest distortion in interest rates that the world has ever seen.
At Cumberland Advisors, we have taken the position that low interest rates mean rising asset prices on a sustained basis. That is true for stocks and all other related asset sectors and categories. We see the US using 2015 and 2016 to move from ZIRP to PIRP. That does not necessarily mean a large increase in rates. It does mean something above zero. In the context of the rest of the world at ZIRP or NIRP, it means that the higher the US goes with PIRP, the greater the inflows into the US currency, seeking higher yields.
In Paris, we will discuss NIRP, PIRP, and ZIRP. I hope you will join us. We will have lots to say upon our return to the US.
Meanwhile, we are repositioning and reallocating within portfolios and changing sector choices because of NIRP, PIRP, and ZIRP in global markets. Clients will see this activity in their accounts. Currently, cash in the US core model is 35%. It has been that way for about a week. This is a temporary change. In the broad-based US model it is about 16%. The idea is to rebalance and capture the dramatic effect of the abrupt currency changes and to be ahead of the J-curve effects.
In the global models we have raised our foreign weights, lowered the US, and are over half currency hedged in the international part. We will write more on J-curves but cannot take the time to do it now. Portfolios come first, writing is second.
David R. Kotok, Chairman and Chief Investment Officer
Category: Think Tank
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NASDAQ 5000 – Crash? Bubble? Fair Value?
March 4, 2015
Almost fifteen years ago, on April 1, 2000, we wrote and published a piece entitled “Will the NASDAQ sell-off become a crash?” We have now retrieved that piece from our archives and posted it on our website.
In preparing that piece we evaluated the stock market and made a theoretical calculation in which we merged two companies, Cisco and Microsoft. We assumed that their reported earnings were accurate. We found that the two companies merged together had earnings of $10 billion and their merged theoretical market valuation amounted to $1 trillion. Our conclusion at the time was fairly straightforward. There was nothing wrong with either company. Both Cisco and Microsoft were fine, large, developing, worldwide leaders in the Technology sector. The stock price, however, was wrong. At 100 times earnings, the price of the theoretically merged company’s shares was not justified by any valuation technique. The combined GDP of all countries in the world was estimated at $30 trillion.
We concluded in our piece that the NASDAQ at 5000 was setting up for a crash. The fourth page measures the value of Cisco against a list of companies (that list included Apple). 15 years ago, we forecast that NASDAQ 5000 would lose over two-thirds of its value before the crash and sell-off ran their full course. Never did we think that the result would be a loss of 80% of its value.
This week, Convergex published a piece including their discussions of NASDAQ 5000. Author Nicholas Cola titled the piece “NASDAQ 5000 – Don’t Call it a Comeback” (March 3, 2015).
(See below for full report)
Here is the summary, which tells most of the story:
With the NASDAQ Composite back to the magic 5,000 level, today we look at the “heavy hitters” in the index. The companies with the top 10 weightings comprise some 32% of the entire index, led by Apple (9.9%), Microsoft (4.8%) the two flavors of Google (4.6%). So where do NASDAQ Comp valuation levels sit at 5,000, and what do you get for your money? Forward P/E multiples based on analyst expectations are 19x earnings, a noticeable premium to the S&P 500 at 17x. In return for that markup, those top 10 names in the NASDAQ offer the promise of real revenue and earnings growth. Analyst estimates for top line growth in 2015 for the top 10 names average out at 13.7% and the 3-year CAGR through 2017 is 11.2%. That translates into 9.4% earnings growth for this year and 11.7% compounded growth through 2017. The real question behind NASDAQ 5,000 Version 2.0 is simple: what price do you pay for growth stocks versus the broader index.
Let’s take a look at the issue now compared with conditions when our NASDAQ 5000 piece was written 15 years ago. Microsoft is now 4.8% of the index, Cisco is 2%, and Apple is approximately 10% of the index and the largest weight. The Convergex research piece provides the remaining information in detail. For information about Convergex, visit www.convergex.com. If you want to send them a reply on their commentary or obtain a copy of Nicholas Colas’s March 3, 2015, piece, we suggest sending an email to Convergex at email@example.com. Note: Cumberland is a user of Convergex’s services and receives their research missive daily.
So what does it mean that the price/earnings ratio is no longer 100:1? It is now in the mid-teens. The stocks currently represented in the NASDAQ are still heavily focused within the Technology sector. Some of the companies, whose market prices may be high relative to past references, are supported by profits and robust estimates of future growth. What is the condition of those companies? Do they have large reserves of cash, or are they involved in heavily leveraged debt structures? Cash seems to be the answer in most cases.
What is the basic condition of the Technology industry? In the dot.com era 15 years ago, as the NASDAQ steamed toward 5000, there were many companies that had no product or earnings. They had only future prospects. Companies formed in garages and found themselves with overnight capitalizations in the billions. Technology sector fever gripped the stock market as a whole, with the Tech sector priced at nearly one-third of total market value at its peak. The price of stocks relative to America’s gross domestic product (GDP) reached all-time highs, based upon trillions of dollars in market value for companies that were little more than concepts. By some estimates, the US market cap was $7 trillion in excess at the top of the tech bubble.
Is the picture the same today with the NASDAQ at 5000? We think not. Could the NASDAQ go through a correction? Yes. We have had an extended bull market of six years’ duration. Corrections have been elusive but are inevitable. That includes the NASDAQ.
We wrote about the NASDAQ 5000 15 years ago as a bubble, the forerunner of a crash, and a valuation supported without earnings or momentum other than prices set by speculative fever. Now, 15 years later, the NASDAQ represents companies that have worldwide growth potential and are revealing once again the remarkable robustness of technology advancement as a business model. These companies are very American. Look at the NASDAQ list and note the nature and structure of these success stories that are rooted in the United States.
Is the NASDAQ 5000 a crash in the making? Fifteen years ago the answer was, without equivocation, yes. Today, the answer is no. It is 15 years later.
We are overweight the Technology sector in our US exchange-traded fund (ETF) managed accounts. Those ETFs contain the stocks mentioned in the Convergex report along with many others. We think the outlook for this sector’s evolution is strong and strategically long-term, with higher earnings, profits, dividends, and stock prices ahead.
We put together a short video on this NASDAQ 5000 phenomenon and how it figured into the creation of our ETF separate account management structure back in 1999. You can view the video here.
David R. Kotok, Chairman and Chief Investment Officer