Posts filed under “Think Tank”
David R. Kotok
October 5, 2014
An era is ending: for over half a decade, nearly worldwide, zero interest rates suppressed volatilities. That is over. The first sign of this evolution came over a year ago when the bond market experienced the “taper tantrum” as then Fed Chairman Ben Bernanke alluded to forthcoming rising interest rates. Since then, the re-volitization process has morphed to currencies, commodities, and stock prices.
More and exciting volatilities lie ahead.
We are likely to see the Dow Jones Industrial Average move precipitously up or down 200 points with greater frequency. Why not? Two hundred points is only about 1%. Contrast that with the Russell 2000 index which lost 10% since its summer peak.
As the global zero-interest-rate era draws to a close, previously comforting, steady trends with smaller deviations are about to be replaced. That was the old normal of the past half-decade. In the stock market we are beginning to see the newer normal. We had some of it this week.
In bonds, we have already seen the changes in volatility, first with the taper tantrum last year and now with the widening of the high-yield spread to Treasurys. Bond volatility shows up in spreads.
It also shows up in large market moves when momentous news like Bill Gross’s exit from PIMCO shocks markets and alters pricing. Sequential leadership changes at a two-trillion-dollar asset manager act to trigger market responses. Many know the existing holdings. They come to expect that large liquidations will occur. They know that, in a mutual fund, forced selling to raise cash may provide opportunity for the buyers who stand aside and wait for the seller to disgorge. The buyer gets the bargains, while the shareholders of the selling fund must accept the results of their redemptions.
We saw some signs of that in the past week. Cumberland is ONLY a separate account manager. We do NOT manage any mutual fund. ETFs aside, we do NOT use traditional bond mutual funds in most cases. All of our clients have 100% transparency regarding their own accounts. All client accounts are private when it comes to any information about their holdings. We wouldn’t have it any other way.
Let’s get back to market volatility.
There is no central bank role in this gyration. Market agents must not and should not expect there to be. The Federal Reserve has reaches neutrality this month and is calculating a policy shift to raise interest rates. The Fed is not engaged in saving the skin of any money manager, regardless of size. That would change only if the entire system were threatened. Two trillion is a lot, but it is not enough to threaten the entire system. It is, however, big enough to produce jagged lines on volatility charts.
Differentials in policy also cause higher volatility. The US is at neutral and has stopped QE. Market-based options pricing suggests that the policy-oriented Fed Funds rate will be somewhere between 0.50% and 0.75% by the end of next year. So we see volatility changes to anticipate that the US will nudge rates up from the zero boundary soon.
Meanwhile, the European Central Bank is below zero and trying to figure out how to do more QE. The Bank of Japan continues its 20-year policy of zero interest rates. And the Bank of England looks to be directed toward normalizing and eventual tightening. All of that maneuvering adds to volatility in currencies. The big-four currencies used to be on the same zero-boundary path. No more. Currencies are the basic substance by which financial assets are priced. Markets clear all transactions in money. And though money was priced at zero rates, that is now changing.
The dollar is getting stronger; the euro and yen are getting weaker; and the pound may be getting stronger. These are shifts from an era when the dollar remained weak for years and our QE was the leadership policy of central bank expansion. That situation has changed. Markets have changed. We have entered a new era. We may as well get used to it.
Some market agents want the old regime to go on forever. Last week was a good example. Consultants contacted me over the course of the downdraft day. They expressed their relief about having a cash reserve. But Friday’s surge after the labor report reversed the emails, texts, and messages to comments like, “Why didn’t we spend the cash at the bottom of the down day, 24 hours preceding the up day?” C’mon. That actually came from a professional. Really!
Back away from the day-to-day volatility and look at the week. Cumberland’s largest overweight position in the US exchange-traded fund (ETF) portfolios is defensive. It is the Utilities sector. Last week, it was up 1.6% according to Barron’s. The Telecommunications sector broke even last week. It, too, is usually characterized as a defensive choice. By the way, last week all the rest of the sectors were negative.
Our most underweight positions are in Energy and Materials. Because of the relative size of the Energy sector, that sector is extremely underweight. Oil and gas sectors were down 4% last week. Energy sector ETFs do not do well when the commodity price of the substance they deal in is falling. We are watching the oil price fall. How far it falls, at what velocity, and for how long – all are yet to be revealed.
Transition in monetary policy coincides with continuing heightened geopolitical risk, whether with regard to Ukraine or ISIL or Asian hotspots. Keep an eye on the developing China-Russia rapprochement. Each sees a weakened America as an opening and therefore sees alignment with the other as an advantage.
All this says volatility will rise. Risks and uncertainty premiums are rising. They all go together.
At Cumberland Advisors, we are maintaining a cash reserve in our US ETF accounts. We also have some cash reserve in our momentum ETF strategy and our international ETF strategy. We may change this allocation at any time. Only the sector-rotation ETF strategy is fully invested. Why? Because it never uses cash and is always fully invested.
We use all four strategies at Cumberland. They serve different purposes depending on the allocation mechanism and the preferences of the client.
David R. Kotok, Chairman and Chief Investment Officer
The Wayback Machine Birthday Tour
By John Mauldin
October 3, 2014
“Would you tell me, please, which way I ought to go from here?”
“That depends a good deal on where you want to get to,” said the Cat.
“I don’t much care where –” said Alice.
“Then it doesn’t matter which way you go,” said the Cat.
“– so long as I get somewhere,” Alice added as an explanation.
“Oh, you’re sure to do that,” said the Cat, “if you only walk long enough.”
– Lewis Carroll, Alice in Wonderland, 1865
Today, in the spirit of the wisdom the Cheshire Cat offers Alice, I would ask how you can know where you are now and where you’re going if you don’t know where you came from. You and I have lived through the first nearly 14 years of this topsy-turvy new century together, and many of its details as well as its overarching themes deserve to be recalled. But rather than offering you a dry, plodding recap of recent history, I’ve come up with a different and hopefully more fun way to revisit the past decade and a half.
I’ve been writing this letter for some 15 birthdays now, well over 10,000 pages of collected work. Every word is still at my website – a history, if you will, of what I was thinking at the time. I asked my longtime (and long-suffering) editor, Charley Sweet, to go back over this past decade and a half and give us a review of what I was saying my birthday week. When I perused what he came up with, a few things leapt out at me.
First, it turns out to be quite lucky that I was born in October, because when we assembled all the letters for the first week of that month, it turned out we hit on most of the big issues that came along in the first 15 years of the century: the tech-bubble collapse and ensuing recession; the actions of the Fed in the early ’00s, especially with regard to the housing bubble; the fundamental challenge – and promise – of accelerating change; the subprime collapse and Great Recession (including “the bailout”); the problems with Keynesian excesses at the Fed and other major central banks; the crisis in the Eurozone; and the healthcare crisis (and Obamacare).
Second, I could see my own thought process evolving and realized again how truly important it is to continually test your ideas in the marketplace.
The plan was to take a short stroll through the history of my letters to get a feel for how our world and my thinking about it have changed over time. As it developed, Charley presented me with a rather voluminous package of excerpts, one far too long to send out as a Thoughts from the Frontline letter. So I will have to viciously edit myself to make the retrospective more consumer-friendly for TFTF readers. But for those who are interested, we are posting the entire summary here (and it will remain available there).
As you read the entry for each year, think back on your own thought process and actions at the time. Surprisingly, as I did the same, it appeared to me that, more often than not, I “got it right” (even if I got it early). So let’s climb into the Wayback Machine and take a spin through the last 15 tumultuous years. We will begin with my call in October 2000 for a recession in 2001.
[Note: comments in brackets were written as we edited this. Everything else is verbatim from the original letters.]
The Probability of a Recession Grows
October 20, 2000
I get lots of mail from readers asking me to tell them if I think we will have a recession next year. I think I can say with some authority that making predictions can get you out on a limb. There are scores of variables that affect our economy. At any given time you can find trends that will seem to be pointing us to one conclusion, and other trends that might yield the opposite conclusion. It is only in hindsight that the pundits will tell us that we should have seen the most important trend all along. So instead of predicting a flat yes or no, I am going to assign some probability to the potential for a recession, and then as we go along I will either increase the probability or decrease it….
[If the yield curve is functioning as an accurate predictor of recession] we should be looking to see a recession next summer at the earliest and probably next fall. As I think back over the last few recessions, there were very few signs one year ahead that a recession was coming. For most economists and analysts, the recession was a surprise even one quarter out!…
Category: Think Tank
AMATEURS Ask permission. PROFESSIONALS Do. Amateurs are afraid they’re going to ruffle feathers, they’re afraid they won’t have success, they want everyone to feel good about them. Professionals know this is an impossibility. Sure, there are amateurs who don’t ask and do heinous things, but they usually don’t even see the landscape to begin with….Read More
The outlook components of the Japanese Tankan survey declined materially and may imply that the economy contracted in Q3 this year. Furthermore, the weak August output data also suggests that Japan could be facing a recession. As the data continues to worsen, further monetary and fiscal stimulus becomes more likely, which will result in a…Read More
Category: Think Tank
Why the Fed Is So Wimpy John Mauldin October 1, 2014 Another in what seems to be a small parade of scandals involving secretly recorded tapes of Federal Reserve regulators emerged last week. What a number of writers (including me) have written about regulatory capture over the past decade was brought out into…Read More
Schizophrenic Financial Markets & Policy David R. Kotok Cumberland Advisors, September 27, 2014 We will start this weekend missive with three serious quotes and references. They are from thoughtful work by professional and personal friends. And they offer diverse views. QUOTE # 1. “We offer new analyses in this working paper of the impact…Read More
Category: Think Tank
Derivatives Are Manipulated Runaway derivatives – especially credit default swaps (CDS) – were one of the main causes of the 2008 financial crisis. Congress never fixed the problem, and actually made it worse. The big banks have long manipulated derivatives … a $1,200 Trillion Dollar market. Indeed, many trillions of dollars of derivatives are…Read More