Posts filed under “Trading”
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
> My Sunday Washington Post Business Section column is out. This morning, we look at The world’s greatest stock picker? Bet you sold Apple and Google a long time ago. (Thats the print headline; online it was Why the world’s greatest stock picker would’ve ditched Apple). This is the third (and likely final) installment of…Read More
This week’s Masters in Business Radio show at 10:00 am and 6:00 pm on Bloomberg Radio 1130AM and Siriux XM 119 (it also repeats all weekend).
Our guest this week is Jack Schwager, best known as the author of the seminal and popular Market Wizards books, first published in 1988.
All of the past Podcasts are here (and coming soon to Apple iTunes).
Next week, we speak with Larry Swedroe, Buckingham Asset Management’s Director of Research.
Books by Jack Schwager:
• Market Sense and Nonsense: How the Markets Really Work
• Getting Started in Technical Analysis
• A Complete Guide to the Futures Markets: Fundamental Analysis, Technical Analysis, Trading, Spreads, and Options
Streaming audio after the jump
One of my favorite pastimes is dissecting accepted Wall Street wisdom to see if it contains any value for investors or traders. Often, upon examination, the widely held beliefs turn out to be closer to magical thinking than financial acumen. One of the more recent examples is the way some analysts use data on sentiment…Read More
China is on the verge of breaking out from its pattern of consolidation, at least according to the monthly chart book from the analytics team at Bank of America Merrill Lynch. If you look at the chart above you can see that the Shanghai Composite Index is in the midst of transitioning into an…Read More
Nice graphic showing the 10 greatest — and worst — trades of all time. The lure of these outsized billion dollar wins seems to affect the psychology of many investors and traders, looking for that one giant score.
click for full infographic
Source: 888 Markets
No matter what, the long-term investor comes out ahead of the short-term trader Barry Ritholtz Washington Post, August 10, 2014 Last time, we looked at why traders are at an almost insurmountable disadvantage against investors due to short-term capital gains taxes. Many of you wrote in to note several factors that would have allowed…Read More
My Sunday Washington Post Business Section column is out. This morning, we revisit the advantages the long term passive indexer has versus short term active traders. The print version had the full headline The trader can narrow the gap but won’t win, while online, it was called No matter what, the long-term investor comes out ahead…Read More
Last month, I spilled a considerable number of pixels explaining why Rupert Murdoch’s Time Warner bid had no significance to whether or not this is a market top. My short list included complaints of cherry picked data that somehow ignored most of Murdoch’s M&A activity over the past half century; a laughably small sample size…Read More