the February 2015 ADP employment report

Market commentators blamed the early decline in the S&P 500 yesterday on a “disappointing” ADP monthly employment report.  I don;’t think this is right, in two respects:

–it doesn’t appear to me that, given horrible weather which can’t have been captured in any seasonal adjustment,  the report was disappointing, and

–even if it were, I don’t think the report itself was a cause of yesterday’s market decline.

As to the report,

according to ADP the US economy added 212,000 new jobs last month.  That’s not the explosive growth that the Bureau of Labor Statistics has been reporting recently.  But 200,000+ is still way above what’s needed to absorb new market entrants.  So it implies that unemployment is still being steadily whittled down.  Also,

the ADP numbers have been coming in substantially below the BLS ones recently, so there’s no good reason to believe that they are predictors of the official government figures being released tomorrow.  Even if they were, February would still be a continuation of the string of hefty job gains the economy has ben cranking out for over a year.

Yes, maybe there are computer-driven traders whose machine quickly scan important press releases and trade based on what they find.  But I don’t think they’re enough to keep the market down.

About the market,

it seems to me that yesterday’s decline is purely technical.  That is, traders believe that we’re at the upper bound of potential short-term upside (another way of saying that we’ve reached pretty close to the total gain investors believe the S&P 500 has in it for 2015).  They see little potential for quick profit, so they shift to selling, for two reasons:  they want to see how far they can push the market down before they meet resistance, and they want to establish more profit potential (say, +5%) before going long again.

Put another way, they’re trying to establish the boundaries of the trading range, or channel, they (me, too) think the market will be trading in until either better earnings news is in the offing or we understand more about what effect any Fed interest rate hikes will have on stocks.

paradox of thrift; paradox of indexing?

The paradox of thrift is the idea that the common sensical approach individuals take in bad economic times–that is, to save a lot more–actually reduces overall consumption and ends up making a bad situation worse.


People are beginning to talk about the same sort of situation happening with investing and index funds.

The idea of indexing was initially popularized by Charles Ellis, who argued that large numbers of well-trained, well-educated, highly motivated, highly compensated portfolio managers were battling it out with one another every day in the active management world.  Therefore, he argued, none would be able to maintain a clear competitive advantage over any of the others.  And they would all be running up costs in their (futile) attempts to do so.  Therefore, the wisest course for anyone would be to take the lowest-cost route–simply buying the index.

Of course, it took Vanguard to provide the means and many years for the idea to be accepted.

Today, in contrast, it’s accepted that the lowest risk course of action, and likely the highest return one as well, is to buy an index ETF or mutual fund.

Over recent years, there has been a steady flow of assets away from traditional active managers in the US and into index products–meaning less money from management fees to fund active manager research.  In addition, the recent recession has triggered the mass layoff of seasoned brokerage house equity analysts.  (This is due to the contraction in assets under active management, regulatory constraints on the use of “soft dollar” commissions and the dominance of trading over research in brokerage firm office politics.)

Are we at the point where indexing has culled the herd of active managers enough that the fierce competition which has made the US stock market super efficient over the past generation is no longer functioning?

No, not yet.  2014 was the worst year in a long time for active managers, as far as outperformance is concerned.  And we know that hedge funds have rarely been able to keep up with the S&P.

However, today’s Wall Street seems to me to be much more reactive than proactive when it comes to company news.  That is to say, the market seems to react more strongly to company announcements of good or bad news, rather to have anticipated them from leading indicators.  Take, for example, the shock Wall Street showed when firms had weak 4Q14 results because of euro weakness–even though the size of the firms’ EU business was well-known and the change in value of the euro is shown in currency trading every day.

So something has changed.  It may simply be that brokerage research departments were much more important to the smooth functioning of the equity market than has been commonly perceived.

My question:  will individual investors take the place of active managers in keeping markets efficient?


Nasdaq at 5000: significance?

Yesterday, almost 15 years (!!!) after peaking at the height of the Internet bubble in March 2000, the NASDAQ closed above 5000, and traded within a percent of its old high of 5048.


We should first note that this is not your older brother’s NASDAQ.  Many former stars have flamed out;  healthcare and services companies, which were a footnote back in the last century now make up about 40% of the index.  So the rebound hasn’t been achieved by the same group of companies that sagged in 2000.

Typically, reaching an old high brings out a rush of selling, as disgruntled holders “trapped” in losses finally break even and cash out.  Yes, looking in the rearview mirror and waiting for breakeven is a little crazy.  But the tendency is cemented deep in the modern psyche–in fact, it’s the first thought habit I tried to break when training analysts and PMs–and everyone has it.

Still, I can’t imagine that many people hanging on this long.  After all,  emotional buyers/sellers had the excuse  of a lifetime in 2009 to dump out losing holdings.

Because of this, I don’t expect the typical breakeven purge.

Nevertheless, reaching a significant milestone almost always induces the market to pause and reflect.  It’s like having a clean canvas and hesitating to place the first brush stroke   …or like knowing you have to set out in a new direction but not wanting to take the first step.  A certain amount of milling about takes place before the eventual break above the old high.

Because of this, I expect NASDAQ will have some initial trouble establishing new high ground, for this reason.

Two points to remember:

–in 2000, NASDAQ stocks were priced in the stratosphere.  They collapsed after spending on tech stuff came to a screeching halt.  that happened in large part because the feared Y2K worldwide computer meltdown didn’t happen.

Today, prices are reasonable, the index is much more diversified and economic growth appears steady, albeit slow. So I think a repeat of the 2000 swoon is highly unlikely.

–once any price breaks through all the old highs, investors eventually realize that, from a market technician’s point of view, there’s no more resistance to upward movement anywhere.  It’s all blue sky.  So prices begin to motor strongly ahead.

the move to Europe

Increasing numbers of US-oriented equity investors are announcing that they’re shifting assets away from the US toward the EU.  Actually, while managers may phrase their statements as intentions, no one is going to reveal plans they have yet to carry out, so we should figure that the announcer have already done the lion’s share of their buying.  Now they wouldn’t mind if other follow their lead.

The rationale for doing so is clear:  US stocks are pricy, the EU is not; and the EU is arguably following on the same general economic trajectory as North America, only with a two-year lag.  If so, buyers get the equivalent of 2013 prices.

The move isn’t without risks, however.  While it does appear that Grexit is already in the rear view mirror–and, admittedly, I’ve been arguing that losing Greece as a member would be a speed bump for the EU, not a catastrophe–there’s some chance worries will resurface later in the year.

The main issue for investors as I see it, however, is a tactical one–how to play the euro.  Here’s where I genuinely don’t know–and why I hesitate to make the load-up-on-the-EU move myself.

Two choices:

–figure that the EU will remain in economic intensive care and that the euro will therefore remain weak.  This implies buying EU-based multinationals with hefty US exposure.  In euros their earnings will look great   …and EU portfolio managers will tilt their portfolios in this direction.  Multinationals have clearly been the way to go since the EU began to slow down last summer.   The problem with this is that the idea may be getting pretty long in the tooth

–figure that the dollar-earners are all played out and buy the next logical development–the revival of the domestic EU economy.  This would mean buying purely domestic firms.  They will do well if the euro begins to strengthen against the greenback and/or if the EU starts to show relative economic strength.

I’m still on the fence.

I have 5%-10% of my IRA/401k money in actively managed Vanguard Europe mutual funds.  That’s a more or less permanent position–meaning I haven’t changed the allocation in years.  A month or two ago I added shares of IHG to my actively managed taxable account.  I’d held IHG for a long while and sold in the middle of last year.  I’ve recently become more enthusiastic about hotels–I added MAR at the same time–and also wanted to added dollar earners based in Europe.

That’s it.

Intellectually, I think adding domestic EU exposure is the right step.  I just can’t bring myself to pull the trigger.

Instead, I’ve stuck with looking for tech/Millennial exposure in the US.  I guess I think it’s too soon.

Any thoughts?

science and math vs. academic finance (pension consultants, too)

“Evaluating Trading Strategies”

The Buttonwood column in the February 21st issue of The Economist talks about a recent article published in the Journal of Portfolio Management, titled “Evaluating Trading Strategies,” authored by Profs. Campbell Harvey of Duke and Yan Liu of Texas A&M.

Long ago, I’d come to think of the difference between academic financial theorists and portfolio managers as somewhat like that between teachers of academic literary theory and actual authors.  That is to say, the two sets of people live in very different worlds, with little in common    …and without that much relevance for each other.

Three exceptions with finance:

–academics are often used as front men for various investment schemes, such as in the case of the ill-fated Long-Term Capital Management, which raised a huge amount of money to implement a strategy of buying illiquid bonds and collapsed shortly thereafter–destabilizing the world financial system in the process

–they often sit as window dressing on the boards of directors of financial companies, and

–their theories inform much of the methodology of the investment consultants on whose advice pension fund managers rely heavily.

its conclusion

The article has an emperor’s new clothes aspect to it.

Simply put, it says that academic finance researchers routinely use a standard for testing for the statistical significance of their findings that is much too weak and alrady discredited in mainstream scienticif research.  Because of this failing, in statistical work in finance large numbers of false.  This is through ignorance, not malice.

As the authors put it:

“So where does this leave us? …Most of the empirical research in finance, whether published in academic journals or put into production as an active trading strategy by an investment manager, is likely false.  …half the financial products (promising outperformance) that companies are selling to clients are false”

Who knows whether this article will have any long-term effects?

In the real world, very few people take academic finance theories seriously–except for pension funds, which rely heavily on consultants who use it to legitimize their advice.  The conclusion that the “advice” is little more than picking numbers out of a hat (arguably even less reliable than that method) has the potential to really shake up this chronically poor-performing sector.

Macau casinos, February 25, 2015

Macau casino stocks in Hong Kong took a drubbing overnight, continuing weakness shown by US parents in Wall Street trading yesterday.  The US stocks are down again as I’m writing this.


Analysts had been estimating (guessing/hoping is probably a more accurate description) that the amount lost by gamblers during the current Lunar New Year month would come in at slightly more than half what they left at the tables during the comparable period last year.  With the month nearly gone, data so far indicate that the actuals will come in at somewhat less than half the 2014 take.  Hence the selloff.

If there’s a positive story for the Macau casinos–and I think there is a strong one–it has little to do with whether this month is good or not.

Current weakness is the result of  a campaign by Beijing that’s now deep in its second year.  The idea is to restore faith in the Communist Party by discouraging flashy over-the-top consumption by the politically well-connected.  It’s also aimed at quashing corrupt local government get-rich-quick schemes involving crazy real estate developments and unneeded, heavily polluting basic industry projects.  This two-pronged attack, which has had a negative effect on high-roller gambling in Macau, has lasted much longer than anyone, myself included, had predicted.  The February-to-date casino results seem to indicate that Beijing has not yet taken its foot off the regulatory accelerator.

The positive case has three parts:

–the development of the Cotai Strip along Las Vegas lines is creating a new, more lucrative, less volatile gambling market in Macau.  It’s for middle-class Chinese visitors who want a gambling vacation that also includes resort dining and entertainment.  This business has been expanding very rapidly.  It now accounts for about three-quarters of the SAR’s gambling profits.  Non-gambling attractions in Macau are still in their profit childhood.  In pre-recession Las Vegas, however, resort profit equaled that of the casinos.  So there’s plenty of room for expansion

–at some point–who know when–the current anti-corruption campaign will abate and high-roller business in Macau will begin to stabilize and then gradually expand again.  Beijing’s crackdown began in 2013 but only started to cause serious high-roller attrition in Macau in late spring last year.  So positive year-on-year earnings comparisons are unlikely before autumn.

–the stocks are reasonably priced–cheap, if you believe the first two points.

The Macau casino stocks are now what I would call a value idea–meaning that we have a good sense of what will happen but are pretty much at sea about when.  High dividend yields argue that we’re gin paid to wait.

One technical note:  the stocks hit relative low points about a month ago and have come back to those lows over the past few days.  It would be a sign that they may be finally bottoming if they can stay above the month-ago lows as the weak February results are officially announced.   Technicians would regard a breakdown below these lows would be a good thing in the US, but bad news in Hong Kong.


Get every new post delivered to your Inbox.

Join 345 other followers