I don’t feel comfortable, but neither does correspondent Buttonwood in the Economist (written two days ago):
Shares struggle again:
WHEN a canary stops singing, it is worth a sidelong glance. When whole flocks of birds keel over, it is time to be alarmed. The warning signs in the financial markets and the global economy are mounting. The early omens could perhaps be dismissed; falling commodity prices were a response to increased supply in oil or the equivalent of a tax cut for western consumers. Subdued inflation was just a consequence of lower commodity prices. Sluggish trade growth could be explained by a change in China’s manufacturing strategy; building more goods from scratch rather than assembling components made from abroad. Falling Chinese share prices in August were simply the bursting of an earlier bubble.
But it is nearly the end of September and more bad news seems to be announced every day. Chinese industrial profits dropped 8.8% year-on-year in August. Cheap Chinese steel was blamed for the closure of a steel plant in the north-east of England. Falling commodity prices are causing headaches for miners such as Glencore; S&P’s global mining index is down 64% since April 2011. Plunging mining shares are dragging down equity indices. Other sectors have been dragged into the slump; the US biotech sector, one of the hottest sectors of early 2015, has lost all its gains for the year. Analysts are downgrading their forecasts for US operating profits for the first time since 2009, according to SocGen; in the past, such downgrades have been associated with recessions.
In another bad sign, corporate bond spreads (the excess rate paid by companies to reflect the risk of default) have been rising again. Spreads are not back up to their levels of 2012, let alone 2008, but the direction is worrying. The problems are unsurprisingly concentrated in the mining and energy sectors; the distress ratio (the proportion of bonds with a spread of 10 percentage points over Treasuries) for US high-yield bonds has risen to 15.7%, the highest level in four years. Defaults haven’t risen significantly yet, but they seem likely to. A Japanese shipping group, Daiichi Chuo, has filed for bankruptcy today; its revenues have been hit by falling Chinese demand for raw materials.
Perhaps the global economy will recover; China may not be as weak as the bears fear and America had a great second quarter. But another sign of market distress is that inflation expectations five years out (from 2020 to 2025) have taken a recent hit. The markets are not expecting a return to normal even under the second term of the next American president. In India, the one BRIC that seemed to be escaping the downturn, the central bank has cut interest rates by half a percentage point, lowered its growth forecast and proclaimed that
It all seems to be a very odd time for the Fed to be thinking of pushing up rates.
It’s not easy. But to lose half in one month. Now there’s an achievement. Morals of this story (below):
+ Don’t believe back testing.
+ When it’s too good to be true, it isn’t.
+ ETFs can be dangerous, very dangerous. Not what we’ve all believed. We thought they were just baskets of stocks. They’re not always.
+ There’s desperation in the marketing of hedge funds. Beware.
From yesterday’s New York Times, excerpts:
Risky Strategy Sinks Small Hedge Fund
It was an upstart hedge fund that pitched large returns in periods of market turbulence by relying on a complex and controversial trading strategy.
At the height of the 2008 financial crisis, investors would have had a gain of more than 600 percent, according to projections in investor documents for the new hedge fund, Spruce Alpha.
But when markets again turned volatile this August, Spruce Alpha, which had started in April 2014, failed to turn the turmoil to its advantage. For that month — a particularly difficult period for many money managers — Spruce Alpha fared worse than most, losing investors 48 percent of their money, according to documents reviewed by The New York Times.
The under-$100 million fund, which was managed by the $1.5 billion Spruce Investment Advisors, has for now moved its positions into cash, said a person briefed on the fund. The fund has told investors that they can redeem what remains of their money.
The sudden reversal of fortune at Spruce Alpha sheds a spotlight not only on how managers market new hedge funds to investors, but also on the way some hedge funds rely heavily on exchange-traded funds and derivatives to profit from short-term turmoil in the stock markets. …
The Alpha fund was the asset management firm’s first foray into direct hedge fund trading. The firm said it had planned to raise as much as $500 million for the portfolio.
To sell the fledgling fund to investors, Spruce emphasized not only an outsize hypothetical performance going back as far as 2006 – but also that one of its top managers, Robert Stock, was a former researcher who had worked on simulations of laser defense missiles. …
The implosion in Spruce Alpha is unlikely to make waves in the more than $3 trillion hedge fund industry. For the investors who have lost nearly half of their investment, however, it is a cautionary tale of relying on glowing, but backdated, performance data.
Back-tested results in hedge fund marketing materials have long drawn scorn from some in the hedge fund world. The results are typically recreated with the benefit of hindsight, making it easier for a fund to post hypothetical good results.
Norman Kilarjian, a partner with Aksia, a hedge fund advisory firm to institutional investors, said individual investors should not put great credence into back-tested results in hedge fund marketing material because the results are derived assuming optimum trading conditions.
“I’ve never seen a back-test that didn’t look fantastic, but investors are often falling for it,” he said, not commenting on any specific hedge fund.
It is not clear exactly what caused the big losses in August. Spruce Alpha used a sophisticated strategy that involved derivatives to amplify returns from trading in exchange-traded funds, or E.T.F.s, of various strategies. The strategy seeks to make money off the volatility in the stock market.
E.T.F.s are securities that hold a portfolio of stocks and trade shares throughout the day. At first, these securities mostly just mirrored the holdings of major stock indexes, but they have since grown increasingly complex, with some relying on derivatives to amplify returns.
Trading in E.T.F.s has recently touched a nerve on Wall Street. Big-name investors like Carl C. Icahn and Leon Cooperman have blamed them for causing violent gyrations in the market. Laurence D. Fink, the chief executive of BlackRock, which is a big seller of more traditional E.T.F.s, has warned that leveraged E.T.F. strategies – those that rely on derivatives – could “blow up” the entire industry one day.
In 2009, both the Securities and Exchange Commission and the Financial Industry Regulatory Authority warned about the risks of investing in the strategy. “Investors should be aware that performance of these E.T.F.s over a period longer than one day can differ significantly from their stated performance objectives,” the regulators said in an investor alert.
The back-tested results for the Spruce Alpha fund may not have taken into account how markets and investors would react given the kind of circumstances that took place in August. The hypothetical results could have underestimated the fact that some E.T.F.s are used as trading instruments that big money managers move quickly in and out of in times of extreme market volatility.
In a disclaimer to its marketing materials, Spruce Alpha also noted some of the unreliability of back-tested returns. The hypothetical results “do not represent the results of actual trading” and “were achieved by means of the retroactive application of a hypothetical model that was designed with the benefit of hindsight and could be adjusted at will until desired or better performance results were achieved,” the disclaimer reads.
The tests had apparently not simulated a situation like Aug. 24, when some E.T.F.s seized up in the first few minutes at the start of trading. But a handful of nimble managers still managed to excel, some even maintaining double-digit returns for the year at the end of the month.
Todd Rosenbluth, director of E.T.F. research for Standard & Poor’s Capital IQ, said leveraged E.T.F.s were an inherently risky strategy that is more akin to “gambling than investing” and should be viewed as purely a trading strategy. …
The article does not explain how the hedge fund managed to lose 48% in one month. You can read the entire piece here.
Should you buy a Tesla X SUV?
The Tesla Model X does 0-60 in 3.2 seconds, a little faster than my Subaru Outback. But the Model X costs $130,000 — 4.33 times as much as my Subaru. Guess which is which?
Timely magazine renewals. I asked why Men’s Fitness magazine was sending me renewal notices?
Oops, they said, my subscription doesn’t expire until November 2017.
They were just being a little early. Other magazines are doing the same. Beware.
Putin is more than a little crazy. From various sources:
+ Putin is taking over Syria, with arms, guns, planes, military bases and soldiers.
+ He is bombing Assad’s enemies, our friends, but not ISIS, yet.
+ He says Syria’s dictator (and horrendous butcher) Assad will stay under the “protection” of the Russians.
+ If Assad stays, refugee Syrians will return to Syria and the European refugee problem will be solved. (And pigs will fly.)
Thank you, Vlad.
The one phone call strategy: From reader Lucky Marr,
COST CUTTING…Our ADT house alarm system was running $49. per month. A competing system offered same service for $33. I called ADT. They dropped to $34. per month. I stayed with ADT.
Favorite headline and favorite photo: Check out the expression.
Time for a hearing aid?
Harry Newton. My best shorts, so far, are WYNN, BHP, KMI, CAT, GS and IRDM. I’m not short Volkswagen. But, check, it out. Its chart is a thing of pure beauty:
The Blacklist starts up again tonight at 9 PM EST on NBC. The show is silly. But I do love its star, James Spader.
