Take some chips off the table


Author Cam Hui

Posted: 22 Feb 2012

I wrote that I had been watching the behavior of cyclical stocks for a signal that a correction may be starting (see Correction? Watch the cyclicals!) and we may have seen that signal yesterday.

Is the consumer getting into trouble?
Consider, for example, the relative performance of Consumer Discretionary stocks against the market as a measure of risk appetite. This sector began a relative uptrend against the market last August but declined through a relative uptrend yesterday. This move, in conjunction with the behavior of other key sectors, may signal the end of the risk-on trade for the time being.

I would also point out that we have seen two consecutive housing related releases come in below expectations (homebuilder sentiment and housing starts). The housing sector, which recently turned from a train wreck into a recovery, has been a mild economic tailwind for the economy and consumer. Cullen Roche at Pragmatic Capitalism is not as sanguine about the housing recovery as many other analysts:

I still don’t see the recovery in the various housing indices that many are raving about. To me, this looks almost exactly like what I’ve been predicting all along. A sideways market that is consistent with past bubble experiences. Think Nasdaq, Shanghai, Gold in the 80s, etc. In essence, it looks like a big L.

CNBC reported that Americans are tapping home equity again as home prices have bottomed and started to appreciate again. I believe that HELOCs have been one reason why consumer spending has held up well despite the increase in payroll taxes this year.

So what happens to the consumer if the housing price recovery were to pause here?

Cyclical stocks rolling over
Another measure of the risk trade is the behavior of cyclical stocks. Business Insider highlighted the fact that CAT, which is highly cyclically sensitive on a global basis, just posted some disappointing sales statistics:

Caterpillar, the industrial behemoth that makes earthmovers, regularly publishes its rolling 3-month dealer sales statistics.

This gives us a sense of capital equipment sales in various global regions, which in turn serves as a proxy for economic activity.

And the latest numbers aren’t good. Worldwide dealer sales accelerated in the three months ending in January. The North America and Asia/Pacific regions posted double-digit declines.

The chart below of the Morgan Stanley Cyclical Index against the market shows a pattern that is very similar to the Consumer Discretionary sector. Cyclical stocks have also violated a relative uptrend yesterday, which is another bad sign for the bulls:

I also don’t like how Dr. Copper is behaving:

Note that this is not a “dive in the bunker” bearish call, but a warning that it may be time to take some chips off the table and to re-balance portfolios toward a greater emphasis on risk control.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Time to buy gold and commodity stocks?


Author Cam Hui

Posted: 20 Feb 2013

Last week, I wrote that traders looking for a correction should closely monitor the behavior of cyclical stocks (see Correction? Watch the cyclicals!). So far, cyclical stocks remain in a relative uptrend when compared to the market and their relative uptrend remains intact. There is no hint that a correction has begun.

What I do find unusual is that while the relative performance of cyclical stocks remain robust, the shares of commodity producers continue to lag. This is curious when resource stocks represent the most cyclically sensitive sectors of the stock market.

In addition, the price of gold is deflating despite the talk of currency wars. Gold is an alternate currency and should be a beneficiary under a scenario where global central banks engage in competitive devaluation. However, the price of gold is fallen so much that a dark cross, or death cross, is rapidly approaching.

Commodity producers washed out
In the past few months, gold stock investors have fared worse than holders of bullion. I have been a long advocate that gold bulls should hold bullion rather than the shares (see Where is the leverage to gold? as one of many examples of previous posts on this topic). However, we may be approaching a point where traders could tactically favor gold stocks over bullion.

The graph below show the ratio of the Amex Gold Bugs Index (HUI) against the price of gold charted on a weekly basis. I have further overlaid a 14-week RSI on the top panel. Note that weekly RSI is now below 30 indicating an oversold reading. Past oversold readings have marked points where gold stocks have outperformed gold. In addition, the HUI/gold ratio is nearing the bottom of 2008, when investors dumped gold stocks in a bout of panic selling.

An analysis of the relative performance mining stocks show a similar pattern. Mining stocks are also approaching a key relative support level marked by the 2008 panic bottom.

These charts suggest to me that mining stocks are getting washed out and they are poised for a reversal in the months ahead.

Within the resource and commodity producing sector, energy stocks show a more constructive relative performance pattern. The chart below of the relative performance of this sector indicate that energy stocks have rallied through a relative downtrend line, i.e. they’ve stopped underperforming and a reversal may be close at hand.

Based on this analysis, my inner investor tells me that it is time to start accumulating positions in energy and mining. My inner trader, on the other hand, wants to dip his toe in the energy sector, play the golds for a bounce and wait for the relative reversal in mining before committing funds.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

A reply to the Ritholz secular bear question


Author Cam Hui

Posted: 19 Feb 2013

I haven’t had the time, but I had been meaning to write a reply to Barry Ritholz’s posts last week where he indicated that he believed that the secular bear market that began in 2000 was in the process of ending (see Explaining My Position on Secular Bear Markets). His caveat was:

I DO NOT KNOW IF ITS OVER. It could be, but I suspect it is not. I do think that it is in the process of coming to an end, and that’s why I used the baseball metaphor of in the 7th inning.

Note: “Coming to an end” does not mean over. I erroneously assumed most people would understand what “in the 7th inning” meant — to those folks overseas, an American game of baseball has 9 innings. The 7th inning means its late in the game, but there are still a few innings left to be played.

I would tend to agree with his assertion that we are much closer to the end than the beginning of this secular bear, but I don’t think that it’s over for a couple of reasons:

  1. Valuations: Stock market valuations have not declined sufficiently to levels where secular bulls have historically begun; and
  2. Demographic effects on fund flows: The Baby Boomers are just starting to retire and take money out of stocks. Who are they going to sell to?

A long term look at stock market valuation
My favorite long-term valuation metric is Market Cap to GDP (via VectorGrader) as a rough proxy for the aggregate Price to Sales for the stock market. Market Cap to GDP, shown on the top panel, remains elevated relative to its own history. Secular bulls have historically begun when this measure has been depressed. In addition, note how falling Market Cap to GDP ratios have corresponded to secular bear markets, which have shown up as sideways markets.

The above chart of Market Cap to GDP only goes back to 1950, in which we have only had one episode of a secular bear, or sideways market. Barry Ritholz also showed, in a separate post from his secular bear post, a much longer history of this ratio that goes back to 1925 from Bianco Research. Market Cap to GDP remains highly elevated relative to its own history. That’s one reason why I don’t believe that a secular bull can start from current levels.

Indeed, Warren Buffett uses a similar ratio of Market Cap to GNP as a valuation measure for stocks. Cullen Roche at Pragmatic Capitalism pointed out that this metric has risen to levels that could only be called  overvalued:

For the first time since the recovery began, Warren Buffett’s favorite valuation metric has breached the 100% level. That, of course, is the Wilshire 5,000 total market cap index relative to GNP. See the chart below for historical reference.

I only point this out because it’s a rather unusual occurrence and the recent move has been fairly sizable. It happened during the stock market bubble of the late 90′s, but then occurred again just briefly during the 2006-2007 period when the valuation broke the 100% range in Q3 2006 and stayed above that range for about a year. We all know what followed the 2007 peak in stock prices.

Demographic headwinds for stocks
Another reason for the continuation of a secular bear, or sideways stock market, is the outlook for fund flows. Simply put, stock prices rise when there are more buyers than sellers. So what happens when Baby Boomers in retirement or nearing retirement withdraw money from stocks? Can their children and grandchildren support stock prices at these price and valuation levels?

I wrote about this topic in 2011 (see A stock market bottom at the end of this decade) and cited two demographic studies by the San Francisco Fed and by Geanakoplos et al.  The conclusions of these studies were that the projected inflection point where the fund flows of the Echo Boomers into stocks start to overwhelm the fund flows of their parents the Baby Boomers is somewhere between 2017 and 2021.

Until then, we will have to live with the ups and downs of a sideways and range bound stock market. Investors should therefore expect that the risk-on/risk-off environment should continue until the end of this decade.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

How tail-risk has fallen


Author Cam Hui

Posted: 18 Feb 2012

There is no doubt that tail-risk, or the risk of a catastrophic meltdown of the financial system, has fallen dramatically in the last couple of years. Consider that two years ago, Europe was mired in one summit after another over the eurozone financial crisis. In 2013, EU ministers are holding a crisis summit meeting over *gasp* horse meat (via The Telegraph):

The summit comes as supermarkets in Britain were urged by the Food Standards Agency to test pork, chicken and other meats for cross-contamination.

Meanwhile, Tesco has admitted that it had been selling frozen spaghetti bolognese ready meals which were between 60% and 100% horse meat.

Tomorrow’s meeting has been called by Ireland, which holds the EU presidency, and where the scandal began after horse meat was discovered in frozen beef burgers.

The country’s agriculture minister Simon Coveney said the summit was being held to discuss “whatever steps may be necessary at EU level to comprehensively address this matter”.

Measures on the agenda will reportedly include labelling processed meat for its origin. Meanwhile processed meat manufacturers in Ireland have been asked to carry out DNA testing in a bid to reassure consumers and export markets.

How times have changed.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

More signs of froth


Author Cam Hui

Posted: 18 Feb 2012

As a follow-up to yesterday’s post (see Is the credit market cruisin’ for a bruisin’?) where I detailed signs of froth in the credit market. I offer the following anecdotes of rising risk appetite.

Everyone’s bullish
Firstly, Joe Wiesenthal at Business Insider wrote that Nomura strategist George Goncalves found that when he went around the world on a marketing trip, virtually all institutional accounts were bullish:

Uniformly, he found that the view was this: The Fed had its hand on the till, and there was almost no way for risk assets to go down in light of the Fed stimulus. Virtually everyone was bullish. Even the bond managers aren’t worried about a great-rotation inspired selloff (they’re not really that worried about a shift from bonds to equities) though it is in the back of their minds.

The next frontier is…
In addition, I received the following unsolicited email last week, which I reproduced with the names blanked out:

Many analysts have called this week’s Asiacell IPO the first test of the Iraqi stock market. Would foreign investors flock to a region that has been viewed as volatile with no stability?

I wanted to see if you would be interested in speaking with the portfolio manager for one of the largest equity funds in Iraq, _______. He says the Iraqi market is primed to become the best performing international investment and it’s no longer just about oil, as Asiacell proved on Sunday.

_______ says infrastructure, telecommunications, transportation are all positioned for growth. He says the big picture of Iraq has changed dramatically since the US forces and media pulled out of the country.

_______ understands the Iraqi markets better than most traders, entrepreneurs and investors. He has visited Iraq many times, meeting with the country’s biggest business leaders. He brings an unfiltered perspective on how the Iraqi market is evolving, and has said the market is ripe with potential.

If you’re interested in speaking with _______, he can discuss:

* Why telecommunications in Iraq is igniting a productivity surge similar to what the US saw in the 1990s.
* What the Asiacell IPO means to the international market.
* Why many American investors may not be seeing the big investment picture in Iraq.
* Why many companies in Iraq have PE ratios below 4.
* Why _______ believes the Iraqi market is poised to become one of the best performing markets over the next decade.

Hmmm,the Iraqi stock market as the next *ahem* frontier. How special!

Then I saw this commentary last Friday from David Rosenberg:

Yesterday, I mentioned several parts of Latin America as being hidden investment gems for our international strategy. Another sleeper out there is segments of Africa where private equity is finding a home and even more liquid capital inflows into equities are rising to levels not seen in two years – to little fanfare, the frontier markets are up 8% so far this year, outpacing both the developed world and the traditional emerging market universe. See Investors Scramble for Africa on page 19 of the FT.

Is it well known that the Nigerian stock market is up 63% over the past year or that Kenya is up 46% (in USD terms)? Does anyone even know where these countries are on a map? Ghana has been a real hotspot for money inflows and its market has rallied 18%. Of course, liquidity is low in these markets and volatility high, but by all accounts, forward and trailing P/E ratios are among the lowest in the world and the FT article cites a nice 6% dividend yield to boost.

I could write about how 16 year-old Desperate Housewives actor Rachel Fox became a minor celebrity for her day trading activities or the WSJ article about how individual investors are funding currency trading with credit cards as examples of froth, but that would be too easy. But when the perennially bearish David Rosenberg starts to tout frontier markets like Nigeria, Kenya and Ghana, be afraid, be very, very afraid.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Is the credit market cruisin’ for a brusin’?


Author Cam Hui

Posted: 18 Feb 2013

A couple of weeks ago, I wrote a post entitled Stocks cruisin’ for a brusin’. Now it appears that the corporate bond market has fault lines of its own that may crack soon. Citi strategist Stephen Antczak (via Business Insider) explained that were enormous flows into corporate credit in search of yield over the years:

The first thing to remember, writes Antczak, is that mutual funds and ETFs together are responsible for a big portion of the marginal flows into corporate credit markets in recent years. Mutual funds now account for $1.7 trillion of the market, up 69 percent from the first quarter of 2009, and ETFs are responsible for $200 billion – up 328 percent in the same time period.

If interest rates were to rise, it would create forced selling by funds as investors redeemed:

The problem is that these investors tend to be backward-looking and sensitive to total returns, particularly negative total returns. And if 10-year Treasury rates were to rise anywhere near what our economists expect (again, 2.5% by year end) total returns in the corporate market may very well be negative. And if returns do in fact turn negative, we would expect investors to scale back mutual fund investments, creating forced sellers.

Illiquid market + stampede = Rout
Corporate bonds are notoriously illiquid, who would take the other side of the trade? David Merkel of Aleph Blog explained corporate bond liquidity this way:

In any vanilla corporate bond deal, when it comes to market for its public offering, there is a period of information dissemination, followed by taking orders, followed by cutoff, followed by allocation, then the grey market, then the bonds are free to trade, then a flurry of trading, after which little trading occurs in the bonds.

Why is it this way? Let me take each point:

  1. period of information dissemination — depending on how hot the market is, and deal complexity, this can vary from a several weeks to seven minutes.
  2. taking orders — you place your orders, and the syndicate desks scale back your orders on hot deals to reflect what you ordinarily buy and even then reduce it further when deals are massively oversubscribed. When deals are barely subscribed, odd dynamics take place — you get your full order, and then you wonder, “Why am I the lucky one?” After that, you panic.
  3. cutoff — it is exceedingly difficult to get an order in after the cutoff. You have to have a really good reason, and a sterling reputation, and even that is likely not enough.
  4. allocation — I’ve gone through this mostly in point 2.
  5. grey market — you have received your allocation but formal trading has not begun with the manager running the books. Other brokers may approach you with offers to buy. Usually good to avoid this, because if they want to buy, it is probably a good deal.
  6. bonds are free to trade — the manager running the books announces his initial yield spreads for buying and selling the bonds. If you really like the deal at those spreads and buy more, you can become a favorite of the syndicate, because it indicates real demand. They might allocate more to you in the future.
  7. flurry of trading — many brokers will post bids and offers, and buying and selling will be active that day, and there might be some trades the next day, but…
  8. after which little trading occurs in the bonds — yeh, after that, few trades occur. Why?

Corporate bonds are not like stocks; they tend to get salted away by institutions wanting income in order to pay off liabilities; they mature or default, but they are not often traded.

Signs of froth in credit
What’s more, investors have been raising their own risk levels to chase yield, such as maturity extension (i.e. going out longer along the curve) and buying lower credits. Antczak indicated that bond duration of new issuance is way up, indicating rising price risk as investors extended maturity.

Surly Trader illustrated this example of how issuers are responding to investor demand with low quality credit issues:

Jump into the news from WSJ:

The consumer-lending joint venture of private-equity firm Fortress Investment Group and insurer American International Group is planning a rare securitization of subprime personal loans as early as this week, in the latest test of risk appetite for asset-backed bonds, where soaring demand has pushed yields to record lows.

The $604 million issue from consumer lender Springleaf Financial, the former American General Finance, will bundle together about $662 million of loans secured by assets such as cars, boats, furniture and jewelry into ABS, according to a term sheet.

Are you kidding me? Furniture? Do I get a personal loan and show them a picture of my couch? Do you think when I figure out that I won’t be able to pay back my personal loan that I might take my couch with me? Are they going to hold the items in a massive pawn shop?

It gets better:

The 190,627 loans in the Springleaf deal have an average FICO credit score of 602, in line with many subprime auto ABS. But the average coupon of 25% on Springleaf’s personal loans is above that on even “deep subprime” auto loans, probably because there is no collateral for 10% of the issue, an analyst said.

The “A” rated slice of the debt may yield near 2.5%, or two percentage points over an interest-rate benchmark, according to price talk circulated to investors.

Holy s*#t.

With 190,627 loans, that implies that the average loan size is about $3,000. How exactly do you think you will collect on any of those loans if there is a default? Do you think it might cost more than that to even get one guy to pay it back? Average FICO of 602? If you know a bit about credit scores, you know how trustworthy this group has been in the past. There is just 10% of subordination protecting this bond and for putting your head in the guillotine you get a sexy 2.5% interest rate every year…thats $2.50 for every $100 you put on the roulette table…

If you hurry, there might be a few units left for you…

Trouble ahead for the risk trade?
The Business Insider article I mentioned also cited the linkages between the credit market and the stock market:

The chart below, via BofA Merrill Lynch, shows the size of the rally in credit – and how it has mostly tracked that in other risky assets like the S+P 500 that began in November.

The big spread tightening in the credit space that occurred when a deal was reached on the “fiscal cliff” is what caused so many Wall Street strategists to blow through their year-end targets only a few days into January.

However, that uptick circled in the chart above – a significant sell-off in corporate debt at the end of the month – has people talking.

Should we see a selloff in the increasingly fragile credit market, it could turn into a rout whose contagion could spread into other risky assets like stocks. I have no idea what the trigger might be, but stock bulls should be aware of this risk.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

ECB Chief Mario Draghi Gets It, Does Merkel?


Author Larry Berman

Posted: 30 July 2012

Prior to Draghi’s comments today at 6:10 ET, risk assets were weaker, European stocks were soft, US futures were slightly lower and the euro was flat. It is clear we initially saw a wave of short covering and some long speculation. Stressed European bond yields have moved lower, but remain elevated (Spanish 10s still north of 7%). It would seem, by the strength of his words, that he gets it—yet to be determined if Merkel gets it. But in the interim, he likely took away the marginal seller until the dust settles or until we here from Merkel one way or the other.

If it is just back to US earnings and not having to worry about Europe for a while, then the markets could resume their upward grind. For those willing to speculate that this could be the European liquidity bazooka, stops under yesterday’s low are recommended. We are not certain here, but we do know monetizing the debt will not fix the problems—it will help psychology for a while as it has done in Japan for 17 years, but their stock markets remain 70%+ below the 1989 peak so who is kidding who.

Time for one step back?


Author Cam Hui

Posted: 25 July 2012

Last Monday, I wrote that markets were choppy, volatile and lacking in direction (see Waiting for direction) and I was waiting for a technical breakout, either to the upside or downside. Despite the upward bias shown by the stock market last week, I remain convinced that equities remain in a trading range. In that case, the coming week might be a opportunity for stocks to take one step back.

These days, the way to think about global markets is to think about how the Big Three are behaving, namely the US, Europe and China. In the US, a glance of the chart of the SPX tells the story. The market remains in an ascending triangle pattern, but was rejected at resistance on Friday. This suggests to me to expect some weakness, with downside support appearing at about the 1350 level.

Across the Atlantic, the Euro STOXX 50 is showing a similar pattern of a rising wedge and ascending triangle. We have been seeing relatively good, or at least benign, headlines out of Europe. My instincts tell me that Friday’s carnage may be the start of a negative news cycle.

Then there is China. When I think about China, I could point to the bullish pattern formed by commodity indices, but they have been distorted by the weather driven rally in the grains. Instead, consider the price of Dr. Copper, which is displaying a pattern that is eerily similar to the previous two charts.

I am also watching the AUDCAD currency pair. While the Australian and Canadian economies are similar in character in their resource exposure, Australia is more sensitive to Chinese demand while Canada is more sensitive to American demand. The AUDCAD staged a minor breakout last week. Will the breakout hold?

In short, the risk-on trade appeared to have hit some kind of collective resistance level and may be in the process of pulling back. How it performs in the coming week will give further clues of whether the bulls can make a stand or if we are back to the same-old-same-old of choppy and direction-less markets.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

How big a bazooka does the Fed need?


Author Cam Hui

Posted: 25 June 2012

Ben smiled and unveiled it with a flourish, “Let me show you my bazooka.”

“Oh!”  _______________  (fill in the blanks)

  1. Her eyes widened, “It’s enormous!”
  2. She wrinkled her nose, “Are you sure it’s going to do the job?”
  3. She stifled a smile, “Well, it’s the thought that counts.”

Notwithstanding my bad writing (in the style of other parodies), questions remains ahead of the FOMC announcement. What will the Fed do? Will it be enough?

Coincidentally, Bank of Canada researchers published a paper entitled Unconventional Monetary Policy: The International Experience with Central Bank Asset Purchases that assessed the effectiveness of “unconventional monetary policy measures”, or quantitative easing. Here are their conclusions:

  • Evidence suggests that the implementation of unconventional monetary policy during the recent financial crisis, via credit easing and asset purchases, succeeded in reducing credit spreads and yields, thereby providing further easing of financial and monetary conditions and fostering aggregate demand.
  • These policy measures are most effective when targeted to specific market failures, sufficiently large relative to the targeted market, and clearly communicated.
  • The evidence must be treated with appropriate caution, since the evaluation of the effectiveness of unconventional monetary policy is subject to problems of identification.
  • The ongoing fiscal retrenchment will affect the outlook and therefore the timing of the withdrawal of monetary stimulus.
  • Central banks should account for the potential negative externalities of unconventional monetary policies, which are often neglected in the analysis of their effectivness.

Dave Altig and John Robertson of the Atlanta Fed’s macroblog referenced the paper in a post and highlighted what they considered the salient points [emphasis theirs, not mine]:

The effectiveness of unconventional monetary policy measures depends on several factors. Measures appear to have been effective (i) when targeted to address a specific market failure, focusing on market segments that were important to the overall economy; (ii) when they were large in terms of total stock purchased relative to the size of the target market; and (iii) when enhanced by clear communication regarding the objectives of the facility

In other words, you need to adjust the size of the bazooka to the size of the market. If the Fed were to choose to start buying MBS securities, the size of the intervention needs to sufficiently large to push MBS prices up (and yields down). On the other hand, an extension of Operation Twist will likely have limited effect, other than on market psychology, because it only has a limited amount of short-dated securities it can sell in order to extend the maturity of its holdings. Altig and Roberson went on to say:

[T]he accumulated evidence suggests to us that we should be really thinking in terms of something like the stock or accumulated total of Fed purchases relative to the size of publicly held Treasury debt, as the passage from Kozicki and coauthors indicates. That calculation produces a Federal Reserve share of about 16 percent of publicly held Treasury securities for fiscal year 2011, which is up sharply from the 8–10 percent levels seen during the 2008–10 period but very similar to the share of Treasury securities held by the Federal Reserve during the years 2000 through 2007.

They went on to say that the Fed should also consider not how much Treasury securities the Fed holds, but the composition of the supply:

In the shorter term, changes in the magnitude of federal government may not have too large of an independent impact on the stance of monetary policy, although it is noteworthy that current projections indicate the Treasury will sell about $1,450 billion of debt to the public in fiscal year 2012, and $1,060 billion in 2013. In addition there is this, from today’s edition of The Wall Street Journal’s Real Time Economics:

“The U.S. Treasury intends to continue to gradually extend the average maturity of the securities it issues—a tactic that locks in borrowing costs but potentially dilutes the impact of a Federal Reserve policy intended to boost the economy.”

In such an environment, it is probably good to remember that standing pat with central bank asset purchases does not necessarily mean standing still with monetary policy.

Monday’s market reaction to the Greek election, where it more or less got what it wanted, is telling. The consensus seems to be for more Twist, but not much else (see one example here). Just keep this in mind as you assess the Fed’s announcement Wednesday.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

It DOES take a village…


Author Cam Hui

Posted: 15 Apr 2012

I have written extensively about bringing back the partnership investment bank (also see previous posts here, here and here). Now consider this NY Mag account of John Mack’s of when he first began working at Morgan Stanley [emphasis added]:

Back when Mack started as a bond trader at Morgan Stanley, in 1972, things were a little different. “There were only 350 people,” he says. “They had $6 million in capital. Any time we priced a deal, every partner at the firm came to the meeting.” is first brush with disaster came during the 1987 stock-market crash.

The key quote is every partner came to the meeting when they priced the deal because the partners’ money was on the line. Do you think that today’s Morgan Stanley behaves in the same way when the senior directors are playing with Other Peoples’ Money?

I see two problem in the structure of today’s financial services firms. First, rewards are asymmetric. Today, if they win, bankers make out like bandits, but if they lose, someone else takes the hit. If a partnership investment bank loses, the partners lose their houses, their cars, their kids education, etc. That kind of double-edged incentive system makes people far more sensitive about risk control.

The second is this underlying belief of the superstar who can do it all and thus needs to be rewarded. Yet, as Tom Brakke wrote, the myth of the superstar is largely a myth:

When Chesley Sullenberger landed Flight 1549 in the Hudson, he was hailed as a hero, but bringing the plane down and getting the passengers off safely was a team effort. Co-pilot Jeffery Skiles somehow had completed restart attempts on both engines and was also able to run through most of the procedures to ditch the airplane — “something [the crash investigators] found difficult to replicate in simulation.” And the flight attendants (Shelia Dail, Donna Dent, and Doreen Welsh) ensured that 150 people were able to get out of the two of four exits that were viable, within three minutes.

A organization that has a superstar has to bear the cost to its corporate culture:

As anyone who has spent time around investment stars knows, the kind of culture that is created to support them usually doesn’t lend itself very well to the investment equivalent of landing in the Hudson. Instead, the environment can be much like that which Gawande has seen in operating rooms, where a head surgeon rules the day and is rarely challenged. Few are willing to speak up, leading to “a kind of a silent disengagement, the consequence of specialized technicians sticking narrowly to their domains. ‘That’s not my problem’ is possibly the worst thing people can think,” but it happens all the time (even in the investment world where people tend to be smart and opinionated).

I wholeheartedly agree with that characterization. Early in my career, I personally witnessed a “star” investment banker who was allowed to run wild blow up a major investment bank, much to the detriment of his partners.

Brakke wrote that, most often, there is a team around the star:

The star system isn’t universal in the business, but it is dominant. And often one of the stars is also given the title of chief investment officer at some point along the way, a further acknowledgment of their track record — and a position for which most are wholly unprepared. Oh, the part of it where they are supposed to opine about the market? That they can do and do well. But the real work, of creating an organization that builds on an array of talent and a confluence of ideas to meet the needs of clients? Not so much.

This study published in the Harvard Business Review shows that, in the business of investment management, the top firms are built around teams:

Success if predicated on teamwork, built on trust and the right incentive structures. In investment banking, that also means creating the right incentive structures, not only to make money for the bankers, but to put the right risk controls in place so that society doesn’t bear the cost of failures.

Dare I say it? In investment management and banking, it does take a village to succeed.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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