Sales is a trap

Friday morning thoughts:

Think about your value add.

What not to be:

  • Collection of features: people don’t buy the iPhone because it’s a better product. They do it because of the image that Apple has created for itself. “Smart, rich people by iPhones, you peasant”
  • Self-Centered: If the majority of your sentences start with I, me, or we, switch it up.
  • Robotic: Do not sound rehearsed; people can smell bullshit a mile away.
  • Generic: Tailor you pitch to the client or whoever you’re talking to at the bar.

What you should be:

  • A touch emotional: find a personal connection with the prospect.
  • Courteous and Agressive: this is a constant negotiation. The amount of each is completely dependent on who’s on the other side of the conversation.
  • An experience: make it believable that you can solve literally every problem that your potential client has. That being said…

Don’t sell performance. If you sell performance once, you’ll always be selling performance.

Individuals choose advisors because (1) they know they aren’t experts in investing & (2) they don’t have the time to become experts.

Individual investors tend to underperform the market. They trade too frequently, causing unnecessary tax liabilities. They sell their winners and buy more of their losers. They’re exposed to their own cognitive biases and media influences. By they, I mean we, and by we, I mean me.

 

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Sales is a trap

Discretionary Recessionary Signals

Do you feel more optimistic than a year ago? Despite more negative headlines and political turmoil, bond markets are signaling more optimism surrounding future growth than a year ago.

 

Nominal yields around the world are much much lower than their historical averages. We actually see negative rates in some European nations. That being said, things are improving. Long-term growth expectations are heating up:

10to2

Since a year ago (See: Column “Delta One Year”), all yield curves have steepened, with the Italian yield curve steepening the most severely. In all cases, the 10-year yield rose/fell faster/slower than the 2-year yield. This signals more demand for short term bonds compared to a year ago. Since a month ago (See: “Delta One Month”), all yield curves, save for Italy, have flattened. This signifies more demand for long term debt than short term debt. See Table 1:

table1

It seems sentiment has changed since a year ago. Within the last month, more investors have loaded into longer-term fixed income securities. This is a yield-seeking activity. There has been a global flight to longer term, higher yielding fixed income securities within the last month. This point of view describes investors preference for more yield (less long-term risk).

As yields rise, the opportunity cost of owning stocks rises. More investors will flock to bonds as yields become more attractive. This dynamic causes equity markets to follow bond markets. This point of view describes investors preference for more return i.e. more yield.

 

Dueling Pianos:

As the yield curve steepens, expectations of future long-term growth have risen relative to short-term growth expectations. As investors become more optimistic on the economy, more money will pile into riskier assets, i.e. stocks. I call this the Future Expectations argument. Under this argument, a yield curve steepening results in higher stock prices. This argument describes an investors preference for risk. More expected growth = more willingness to accept risk. Under this argument, bonds and stocks are inversely correlated.

As the yield curve steepens, yields rise and prices fall on the long end of the curve. As yields rise, equity investors looking for yield will sell equities in favor of bonds. As long term yields rise, equities will fall. This is the Opportunity Cost argument. Under this argument, a steepening yield curve will result in lower stock prices. This argument describes an investors preference for yield. Under this argument, bonds and stocks are positively correlated. (For more on Stock/Bond Correlation, see PIMCO).

Given today’s nominal yields & equity values:

Investors are yield-seeking at current nominal yields, thus the Opportunity Cost argument dominates the Future Expectations argument. When the yield curve flattens today, equities will rise tomorrow and when the yield curve steepens today, equities will fall tomorrow. As nominal yields rise, I believe the relationship will flip, and the Future Expectations argument will dominate.

In 12 out of those same 12 markets, yield curves have steepened over the last year. In 11 out of 12 markets in our sample, yield curves have flattened within the last month. Should this change of sentiment continue, yield curves will flatten and equities will continue to rise. However, I expect the long-term trend to prevail, with yield curves continuing to steepen throughout the next year.

When the ECB and BoE decide to stop QE and raise short term rates, I expect yield curves to steepen. As yield curves steepen, equity markets will fall as investors switch to bonds from stocks. Investors will flock to safety, rallying bond markets.

Watch the ECB and BoE for signals on bond markets. See German Bund Yields.

Thanks for reading,

– Tommander-in-Chief

Sauce: http://www.wsj.com/mdc/public/page/2_3022-govtbonds.html

Further: “What the hell are you talking about?”

A common measure of bond market sentiment is the different between the yield on a 10-year government bond and a 2-year government bond. For example, the spread below is 1.25%. (Note: not the actual yield curve below.)

sampleYC

Review: There are two types of yield curve steepeners: Bull and Bear. A bull steepener short term rates are falling faster than long term rates. This means the 2-year fell faster than the 10-year (and both rates fell); recall, prices rise as yields fall. A bond bull market is one where yields fall. A bear steepener is one where the 2-year rises less than the 10-year, and both rates rise. Prices on bonds fall as yields rise.

 

Discretionary Recessionary Signals

Why are Markets so Calm?

Valuations are stretched and economic data is cooling, yet markets are complacent. Why? The following are rationalizations of current market values.

1.) Massive movement from active management into passive strategies. Why pay someone to under-perform the S&P 500? Passive investing implies no trading, which means less volatility.

2.) Increased regulation has permanently caused a decline in the riskiness of markets. Insurance companies and financial institutions no longer have autonomy over what they can invest in. With more oversight comes less risk…

3.) Lower interest rates globally have caused investors to flood into riskier assets. With more investors seeking risk, demand is high, creating inflated but stable asset prices. Argentina, who has defaulted on Government debt SEVEN TIMES, just issued a 100-year bond at a 7.9% yield. Demand for the high yielding asset was strong.

4.) JPMorgan estimates that stock pickers account for just 10% of trading volumes, with 60% done by quantitative trading strategies and passive investing. With more trading done by ’emotionless’ quantitative algorithms rather than hot-blooded traders, market risk has declined permanently. We’re in a “new normal” of low volatility and interest rates. Sounds firmiliar… *cough* Tech bubble in 2000 *cough*

5.) “Stocks always go up.” 😉

6.) Quantitative Easing in Europe and Japan cause inflows to higher yielding assets. The Bank of Japan (BOJ) or the European Central Bank (ECB) pumps liquidity into markets through open market operations (bond buying initiatives). Sellers of the bonds use the Yen or Euros to buy US Dollars. They use the Dollars to buy equities and debt. QE by foreign governments is inflating assets prices. As they continue to ease, i.e. flood markets with liquidity, we should see the trend continue. However, we have seen the USD decline since December ’16. Keep an eye on foreign monetary policy moves. A sudden move by the ECB or BOJ might cause fluctuation in US asset prices.

SAUCE: https://www.bloomberg.com/news/articles/2017-06-27/markets-may-have-nothing-left-to-fear-but-fearlessness-itself

Thanks for reading.

– Tommander-in-Chief

Why are Markets so Calm?

Trouble in Yellen-Land

Bond markets and the Fed aren’t making sense.

The Fed (“Yellen”) rose the Federal Funds Rate (FFR) last Wednesday, June 12th to a range of 1.00% to 1.25%.

The Fed has two mandates: (1) to keep prices stable (i.e. keep inflation around 2%) and (2) to minimize unemployment. In other words, stabilize the economy by cooling it off when growth gets too fast and heating the economy up when growth slows.

The mechanisms to do this are two fold. The Fed can raise the “Federal Funds Rate” (FFR), making short term credit less available. The FFR is the lowest rate at which a financial institution can borrow. If you raise the lowest rate available in US markets, everything else should follow. Right?

Wrong. The FFR is a very short term instrument. Changes in the FFR only change short term interest rates. (See: Term Structure of Interest Rates). This brings us to our second weapon in the Fed’s arsenal: the Balance Sheet. The Fed can buy and sell securitized mortgages and government debt. They can hold assets on their balance sheet to synthetically alter the supply of debt at longer tenors.

Quantitative Easing (QE) by the Fed flooded markets with cash by purchasing bonds in the open market in order to promote lending (i.e. liquidity). The Fed’s balance sheet exploded… I mean EXPLODED. Check this post for relativity. In the most recent Fed statement, the Committee agreed it would soon be time to bring the balance sheet back to “normal”. This means they will no longer buy new treasuries or redeem matured securities.

Once balance sheet normalization begins, there will be less demand for Treasuries and yields should rise, ceteris paribus. Right?

However, longer term treasury yields have fallen while short term rates rose. This results in a flatter yield curve. Growth in the US and the world remains tepid; and inflation in the US remains under the 2% target rate, but the Fed sees fit to continue tightening monetary policy.

So what gives Janet? 

This morning, Lisa Shalett, Head of Wealth Management Investment Resources at Morgan Stanley, wrote: “… we believe the Fed has embraced a new narrative that extends beyond its mandate of full employment and 2% target inflation.”

The Fed isn’t raising rates because our economy is heating up; they’re trying to combat the next recession proactively. They’re ‘normalizing’ the FFR and the balance sheet back to levels where they can reasonably combat the next recession.

OK, but why the flatter yield curve?

A colleague of mine introduced the idea of relative interest rates as an additive theory. The risk/reward profile of US debt is one of the best in the world. For example, the 10-year government debt yield in Singapore is comparable to the same rate in the US. Would you rather have Singaporean dollars or US dollars given current market conditions? That being said, we have seen a sell off in the US dollar since the beginning of the year. Take a look at what has happened to the US dollar since President Trump took office:

USDsinceTRUMP

The dollar has rallied and subsequently sold off since the election. In my colleague’s argument, the dollar should rise. If there is a high demand for Treasury bonds, we will see a rise in demand for dollars. You can’t buy US government debt with foreign currency; you have to convert it to US dollars first. More buying of USD pushes up the price.

The recent bond market rally on the long end of the yield curve has pushed rates lower. This could be from more demand as per my colleague’s point; or the bond market is calling bullsh*t on the Fed’s optimistic outlook for the economy because a movement from stocks into bonds signifies a move to safety. When the 10- to 2-year spread tightens, it signifies lower growth expectations in the future.

tenminustwosinceTRUMP

When Trump was elected, stock markets rallied. The so called “reflation trade” became all the buzz and a “risk-on” mentality became popular. Check out the pop in the 10 to 2 on November 8-10th. This was a spark of optimism that the US economy might see some fiscal stimulus. Since, the bond market has postulated that the current administration might not be able to meet goals in respect to healthcare and infrastructure stimulus, thus spreads have narrowed and expectations tempered.

To review:

The Fed says we’re growing at a healthy clip, with inflation rising. Their reflation narrative is weak, and the bond market isn’t buying it.The Fed is trying to stockpile ammo before the next recession.

What I’m watching:

An inverted (i.e. negative) 10- to 2-year spread has preceded EVERY recession in recent history. Check it out:

10two

Keep an eye on the 10 to 2.

What I’m Reading:

Thanks for reading,

– Tommander-in-Chief

 

Disclaimer: there are SO MANY moving parts in finance. It’s impossible to point to any one factor because it’s always a combination of several or many factors that affects markets.

Trouble in Yellen-Land

In the grand scheme of things, how big is Apple?

Apple, Inc., producer of the iPhone, announces quarterly earnings on Tuesday.

This WSJ article claims that the cash and cash equivalents on APPL’s balance sheet will exceed $250 billion dollars. I put this article together to give you some idea what that looks like.

Relative to the World:

$250 billion is about the same size as the nominal GDP of Venezuela, Pakistan, Chile, Bangladesh, or Finland. It’s about the same size as the combined GDP’s of the smallest 61 countries in the world. I repeat, Apple could afford to buy the smallest 61 countries in the world using ONLY CASH!!

Switching to revenue as a metric:

Apple, at $233.72b, would be the 47th largest country in the world, between Vietnam and Peru. For relativity, Toyota Motor produces $236.6 b in revenue each year. The largest company in the world is Walmart at $482.13 b in revenue. Walmart would sit between Poland and Belgium if you allow sales to be a metric compared with GDP. Walmart is bigger than Belgium, UAE, Norway, Hong Kong, South Africa, Denmark; the list goes on and on.

Of the top 15 largest corporations in the world (FORBES), six are commodity producers, two are automotive producers, two tech (Apple, Samsung), and two conglomerates, one is utilities, one pharma, and one financial. Apple makes up 6% of the revenue of the top 15 companies in the world.

top15

In terms of Geography:

Five are USA based, four Chinese, and one from each of the following: UK, Germany, Japan, S. Korea, Switzerland, and Netherlands.

bygeography

This is the world represented by the top 15 companies sorted by sales revenues. Note: Eight (8) countries represented.
percentsgeography

This is the world represented by the top 8 economies sorted by GDP. Strangely similar eh?

top8gdp

Grexit: Should we be worried?

Without another bailout, Greece is set to default in June on yet another debt payment of $7.0b.  If Apple agreed to pay instead of the Greek government, it would represent just 2.8% of the cash on Apple’s balance sheet.

The entirety of Greece’s nominal debt in dollars is $375.6 billion. Apple’s total debt is around $100 billion. Apple’s total cash is around $250 billion. Apple could afford to buy two-thirds of Greece’s debt using ONLY CASH. It would only need about $125 billion in nehw debt to completely refi te whole country.

Remind me, why are we worried about Greece again?

Food for thought. Thanks for reading.

– Tommander-in-Chief

Sauce:

1.) http://statisticstimes.com/economy/countries-by-projected-gdp.php

2.) http://fortune.com/global500/list

3.) https://www.wsj.com/articles/apples-250-billion-cash-pile-enlivens-hopes-fuels-expectations-1493566748

In the grand scheme of things, how big is Apple?

Relative Performance: Equal or Market Capitalization Weighted Index?

Using SCHA and SCHX as proxies for Small and Large cap equity markets, I attempt to measure cumulative relative performance over one (1), two (2), and three (3) year time periods.

The S&P 500 is a market capitalization weighted index, meaning the biggest companies have the biggest weights in the index. The Dow Jones Industrial Average (DJIA) is a price weighted index. So companies with large stock prices are weighted heavier. (Example: Goldman Sachs at $230 has much more weight than Intel at $34). There are also equal weight indexes (Ticker: RSP). These weight each stock in the index equally, regardless of price or market cap. (Ex: 60 stocks, each gets 1/60th weighting.)

Investing your money in a market cap weighted index leaves you relatively more exposed to larger companies, where equally weighted indexes leave you more exposed to smaller caps. Price weighted indexes have very little mathematical basis, other than they’re easy to understand. Price weighted indexes are not good representation of changes in value of the stock market, thus we ignore them in this exercise.

Small cap stocks tend to exhibit more price movement, i.e. more volatility. More risk, more reward. On average, small caps will outperform in a bull market, but under-perform in a bear market. The strategy goes, overweight small caps when times are good, overweight large cap value (Walmart, Walgreens) when times go sour.

Here’s the relative cumulative performance of Small/Large Cap equities. A number above one (1) means small cap is outperforming, while a number less than one (1) means Large Caps are outperforming.

rp_largesmall

 

The above graph shows relative cumulative performance starting in March of each year. Example, blue line shows 36 month relative cumulative returns, while the green line shows the 12 month relative cumulative returns.

Since Trump took office in November of last year, we’ve seen a bump in small caps, then a subsequent sell off, relative to large caps. Small caps popped first, then large caps followed. However, small caps have outperformed relatively since last year, while large caps have performed better since three (3) years ago.

We need to compare this to an average ratio for each time period (far right column). Note: these are weekly returns (March thru March).

smalllargetable

Large Cap have outperformed Small Cap over the last three years, pretty significantly, and under-performed over the last twelve (12) months.Thus, equal weight has outperformed over the past year as we see below. However, Large caps have made a *Huge* rally relative to small caps since February. Here we used RSP and SPY as proxies for equal and market weighted indexes.

rp_eq_mkt

Strategy: Large Caps were over valued last March, but Small cap valuations are catching back up. Buy equal weight for the 6-9 month time period, then re-evaluate relative performance. Note: Tax reform will help Small cap over Large cap, so watch for tax reform in late summer,early fall (LINK, Fortune).

Disclaimer: this article is designed to help you choose between Equal or Market cap weighted indexes; I’m not advocating specific securities. This is only one measure of relative valuation, do more research on your own before purchasing securities. I do own SCHA.

Relative Performance: Equal or Market Capitalization Weighted Index?

Supersize Me’s Effect on MCD’s Stock Price

Image result for mcd

I’ll save you the suspense: MCD’s stock price returns were affected by the release of Morgan Spurlock’s Supersize Me on May 7, 2004. However, MCD’s stock price returns were also unaffected by the release of Morgan Spurlock’s Supersize Me when measured differently.

If you just change how you measure the reaction, you can get the data to tell you what you want. In the business it’s called confirmation bias or data mining. The desire to produce a positive result incentivizes researchers to get the numbers to tell them what they want to hear.

In the example of McDonald’s stock price, we use an event study to gauge the average change in stock price before and after the ‘event’. Morgan Spurlock’s Supersize Me didn’t portray McDonald’s fares in the most appealing light, so I expected to find a negative change in the returns and volume of McDonalds stock, all else held constant.

Quick stats refresher:  A big t-stat implies rejection of the null hypothesis, in favor of the tested hypothesis. A small p-value implies significance. A p-value ranges from [0,1] with zero being the most significant and one being the least.

Using a simple t-test to compare average daily returns here’s my results:

Screen Shot 2017-03-08 at 4.51.39 PM.png

A small p-value, as we see above, implies significance. This means the average return on MCD’s stock was significantly different before and after the release of Supersize me! But check this out…

Screen Shot 2017-03-08 at 4.51.32 PM.png

Over the same time period, but at a weekly tenor, we see a different result. This p-value is huge, the average weekly returns were not significantly different from one another before and after the release of Supersize me.

 

Screen Shot 2017-03-08 at 4.49.49 PM.pngScreen Shot 2017-03-08 at 4.50.19 PM.png

This exercise goes to show you should be wary and inquisitive if a statistic doesn’t make sense or makes too much sense. The financial world is not a laboratory where everything works out the way it “should” according to the models. Statistical findings are useful tools to model and describe our world, but always take them with a grain of sand. (I’m never sure if its sand or salt…)

Challenge ideas, be inquisitive, and don’t get all your news in one place.

Thanks for reading,

-tommander-in-chief

Note 1: If you want the data, I’ll be happy to provide it.

Note 2: Time Period (Jan. 1, 2004 – Sept. 20, 2004)

Side note: Risk is a human made concept. If you can associate a probability with an uncertainty, you’ve created risk. If you can’t calculate a probability that an event will occur it remains an uncertainty, and is either over or underestimated depending on your past experiences. For example: you hear about a recent shark attack on the news and are planning a day at the beach. Because of immediately available information, you overestimate the probability that you’ll be attacked by the shark and spend the day building sandcastles rather than shredding the surf. The risks don’t match up.Your perceived risk and the probability that you’ll be gobbled up by a Great White are different.

 

Supersize Me’s Effect on MCD’s Stock Price