April 11, 2014
By Steve Blumenthal
The Fed owns 30% of all mortgage backed securities and nearly 25% of all the Treasury bonds. Wow! Unimaginable, but real.
I find myself frequently visiting the Fed’s website. I particularly like Dallas Fed President Richard Fisher. As a former fund manager, maybe it is his real life investment experience I favor most. I do certainly appreciate his direct and candid way.
Fisher presented in Asia last week and his speech was particularly insightful. Below, I highlight several bullets and provide the link to his speech. Also interesting was the wisdom that poured from Oaktree’s Howard Marks in a memo he wrote titled, Dare To Be Great.
Included in this week’s On My Radar:
- Richard Fisher – Adieu Quantitative Easing
- Dare To Be Great – Oaktree Capital Management’s Howard Marks
- Trade Signals – Seasonal Tendencies
Richard Fisher – Adieu Quantitative Easing
- Thus far, much of the money we have pushed out into the economy has been stored away rather than expended to the desired degree. For example, we have seen a huge buildup in the reserves of the depository institutions of the United States. Less than a fifth of commercial credit in the highly developed U.S. capital markets is extended through depository institutions. Yet depository institutions alone have accumulated a total of $2.57 trillion in excess reserves—money that is sitting on the sidelines rather than being loaned out into the economy. That’s up from a norm of around $2 billion before the crisis.
- As of March 14, our par holdings of fixed-rate MBS exceeded 30 percent of the outstanding stock of mortgage backed securities. Through these purchases, we have driven down mortgage rates and helped rekindle the U.S. housing market.
- We now own just shy of 24 percent of the stock of Treasury coupon securities. Having concentrated our purchases of Treasuries further out on the yield curve, and done so in size, we have driven nominal interest rates across the credit spectrum to lows not seen in over a half century.
Keep in mind that if the outstanding supply of mortgage backed bonds is dismissed, even if taper is reduced, the smaller size of the continued purchases can have a proportionately greater impact on that market.
As Fisher states, “Even with the taper, the recent decline of mortgage supply has driven our absorption of the MBS market to 85 percent of fixed-rate MBS issuance. The fall in net MBS supply is outpacing the taper.”
Though the Fed has reduced its monthly buying, they are buying a greater proportion of a reduced pool of available bonds. The current amount equates to 85% of all fixed-rate mortgage back securities’ new issuance. (Bold emphasis mine.)
I reflect back on a significantly imperfect Fed track record and my concern grows. Do you remember watching Laurel and Hardy as a kid? Their often misquoted line comes to mind:
“Well, here’s another fine mess you’ve gotten us into.”
So the banks have taken much of the cash created from Fed QE and deposited the excess cash right back – held on reserve at the Fed. The banks have accumulated $2.57 trillion in cash, up from just $2 billion before the crisis. The Fed, by buying massive amounts of longer-term U.S. Treasury bonds and mortgage-backed securities, has expanded their balance sheet from less than $900 billion (pre-crisis) to $4.3 trillion today. (Reread the last two sentences.)
Of immediate issue is a Fed exit. A coming issue is the potential inflationary impact of the $2.57 trillion in cash finding its way into the system.
More from Fisher’s speech:
“The Fed’s large-scale asset purchases dramatically and more broadly impacted credit markets. The U.S. credit markets are awash in liquidity. This has allowed U.S. businesses to restructure their balance sheets, manage their earnings per share through share buybacks financed with bargain-basement debt issuance, bolster stock prices through enhanced dividend payouts and position themselves for financing growth once they see the whites of the eyes of greater certainty about their economic future. By driving nominal interest rates to half-century lows, we have also reduced the hurdle rate by which future cash flows of publicly traded businesses are discounted. Thus, through financial engineering, we have helped bolster a roaring bull market for equities: The indexes for stocks have nearly tripled from the lows reached in March 2009.
Alongside these signs of rebound have been some developments that give rise to caution. I have spoken of these in recent speeches, echoing concerns I have raised in FOMC discussions:
- The price-to-earnings (PE) ratio of stocks is among the highest decile of reported values since 1881. Bob Shiller’s inflation-adjusted PE ratio reached 26 this week as the Standard & Poor’s 500 hit yet another record high. For context, the measure hit 30 before Black Tuesday in 1929 and reached an all-time high of 44 before the dot-com implosion at the end of 1999.
- Since bottoming out five years ago, the market capitalization of the U.S. stock market as a percentage of the country’s economic output has more than doubled to 145 percent—the highest reading since the record was set in March 2000.
- Margin debt has been setting historic highs for several months running and, according to data released by the New York Stock Exchange on Monday, now stands at $466 billion.
- Junk-bond yields have declined below 5.5 percent, nearing record lows.
- Covenant-lite lending is becoming more widespread. In my Federal Reserve District, 96 percent of which is the booming economy of Texas, bankers are reporting that money center banks are lending on terms that are increasingly imprudent.”
He continues, “The former fund manager in me sees these as yellow lights. The central banker in me is reminded of the mandate to safeguard financial stability. As I said recently in a speech in Mexico, we must watch these developments carefully lest we become responsible for raising the ghost of irrational exuberance.
It is clear to me that we have a liquidity pool that is more than sufficiently deep and wide enough nationwide to finance job-creating capital expansion and reduce labor market “slack”. But that will happen only if and when our fiscal authorities—the Congress and the President—are able to muster the courage to craft tax, spending and regulatory incentives for job-creating enterprises to mobilize liquidity for expansion and payroll growth.
Thus far, inflation has yet to raise its ugly head and inflation expectations as measured by consumer surveys and market-traded instruments have remained stolid. However, with each passing day, constantly adding massive amounts to the monetary base will inevitably present a significant challenge to the FOMC, which must ultimately manage this high-power money so that it does not become fuel for sustained inflation above the committee’s two percent target once it is activated and flows into the economy.” (Again, emphasis mine.)
Fisher specifically used the word inevitably. Inevitable assumes some point in the future. It is my two cents that the future may be closer than the Fed is leading us to believe. Here is the link to the full piece.
Dare To Be Great – Oaktree Capital Management’s Howard Marks
Here are three extracts from the memo:
- The goal in investing is asymmetry: to expose yourself to return in a way that doesn’t expose you commensurately to risk, and to participate in gains when the market rises to a greater extent than you participate in losses when it falls. But that doesn’t mean the avoidance of all losses is a reasonable objective.
- To succeed at any activity involving the pursuit of gain, we have to be able to withstand the possibility of loss. A goal of avoiding all losses can render success unachievable almost as readily as can the occurrence of too many losses.
- It’s important to play judiciously, to have more successes than failures, and to make more on your successes than you lose on your failures. But it’s crippling to have to avoid all failures, and insisting on doing so can’t be a winning strategy. It may guarantee you against losses, but it’s likely to guarantee you against gains as well.
Click here for the full piece. It is a wealth of investment wisdom and a great read.
Trade Signals – Seasonal Tendencies
Following is one of the charts I highlighted in this week’s Trade Signals. Sentiment again reached Extreme Optimism (Bearish). I continue to recommend a hedged equity position and expect a 5% to 20% correction.
My best guess is a more aggressive Fed exit in 2015. I believe rates will then rise faster than consensus believes, leading to a 2008-like crisis period.
It is with this thinking that opportunity exists. Please – don’t get depressed! That is not my intent. See it as a coming opportunity and use the readily available tools to protect your risk exposure today. It will be important to be in a healthy position to take advantage of the coming opportunity. If you are a far more aggressive investor, you may see opportunity just a select few did in 2007/08.
Until then, prudently hedge long equity exposure from time to time. I favor investor sentiment as a tool to use to help better identify market extremes. I talk about hedging in Trade Signals.
Something else you can consider is to: Overweight tactical investment strategies – make sure the managers have experience and discipline. Make sure those strategies have the ability to move to more defensive positions. I favor tactical relative strength that is based on price momentum (click here for my white paper – Understanding Tactical Investment Strategies).
As for bonds, shorten maturities and invest in flexible tactical bond strategies and flexible bond funds.
Click here for a link to Wednesday’s Trade Signals.
Conclusion
Smart beta is all the rage and much debate surrounds just what smart beta is. I presented early Tuesday morning to a packed room at the New York Society of Securities Analysts (NYSSA) Conference Center. There was disagreement on our panel (a good thing) as to just what qualifies as smart beta or whether enhanced indexing, intelligent indexing or smart indexing are better choices.
There are now fundamental indices, low volatility indices, factor based indices, revenue based indices and equal weighted indices.
To me, I see merit in any index approach that enhances the performance of a cap weighted index. For example, I see equal weight as a better alternative to cap weight. In cap weighted indices like the S&P 500 Index, the momentum of just a few stocks (AAPL for example) can cause an overweighting to any one stock or one sector (like Tech in 1999 and Financials in 2007). Mean reversion is painful when momentum peaks. That same degree of pain is lessoned in a better weighted index portfolio.
Inspired by the debate, I’m working on a future piece that sets out to define this important space. The good news is that there are a number of funds and ETFs in the intelligent beta (my favored name) space that can add return over cap weighted indices – all while owning the same constituents that make up the index. More on this topic soon.
It is going to be 70 degrees in Philadelphia and it’s Masters weekend. The thought of my father fills my heart. There were so many days we spent golfing together. When Masters weekend came around, we’d golf in the morning and huddle up on the couch together to watch the tournament in the afternoon.
While I certainly dared to be great at golf as a young man (still daring I’m afraid), it was my dad’s lessons of honesty and integrity that I remember most. One of his teaching tools was the game of golf. On that last Sunday together, we ate pizza and shared a good beer. His hospital room was filled with family and he was happy. He really did have some beer. He passed two days later.
So, this weekend, it is golf with my boys and a wonderful afternoon huddled up together on the couch watching the Masters. With a happy smile, I’ll be thinking of my father and inviting him to sit with me, Susan and the boys. We’ll have pizza and Susan and I will have a good IPA. I’m sure my dad will be with us in spirit.
Here is a Philadelphia Phillies hat tip to my old man!
Here is to the wonderful memories you share with your “old man” and, of course, your beautiful mother as well.
Dare to be great will be the message to my boys this weekend.
Wishing you the very best! I’m rooting for Phil!
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc. (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods.
CMG SR Tactical Bond FundTM, CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM: Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG SR Tactical Bond FundTM, CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456. Please read the prospectus carefully before investing. The CMG SR Tactical Bond FundTM, CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA. NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually mange client assets; and, (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Standard & Poor’s chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.
Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).