FOFViewForm Object
(
    [form:protected] => FOFForm Object
        (
            [model:protected] => LegacyinterfaceModelCommentaries Object
                (
                    [default_behaviors:protected] => Array
                        (
                            [0] => filters
                            [1] => access
                        )

                    [__state_set:protected] => 1
                    [_db:protected] => JDatabaseDriverMysqli Object
                        (
                            [name] => mysqli
                            [nameQuote:protected] => `
                            [nullDate:protected] => 0000-00-00 00:00:00
                            [_database:JDatabaseDriver:private] => joomla
                            [connection:protected] => mysqli Object
                                (
                                    [affected_rows] => 1
                                    [client_info] => mysqlnd 5.0.11-dev - 20120503 - $Id: 15d5c781cfcad91193dceae1d2cdd127674ddb3e $
                                    [client_version] => 50011
                                    [connect_errno] => 0
                                    [connect_error] => 
                                    [errno] => 0
                                    [error] => 
                                    [error_list] => Array
                                        (
                                        )

                                    [field_count] => 1
                                    [host_info] => Localhost via UNIX socket
                                    [info] => 
                                    [insert_id] => 0
                                    [server_info] => 5.5.46
                                    [server_version] => 50546
                                    [stat] => Uptime: 5646915  Threads: 1  Questions: 2051469  Slow queries: 0  Opens: 100  Flush tables: 1  Open tables: 93  Queries per second avg: 0.363
                                    [sqlstate] => 00000
                                    [protocol_version] => 10
                                    [thread_id] => 192449
                                    [warning_count] => 0
                                )

                            [count:protected] => 23
                            [cursor:protected] => 
                            [debug:protected] => 
                            [limit:protected] => 0
                            [log:protected] => Array
                                (
                                )

                            [timings:protected] => Array
                                (
                                )

                            [callStacks:protected] => Array
                                (
                                )

                            [offset:protected] => 0
                            [options:protected] => Array
                                (
                                    [driver] => mysqli
                                    [host] => localhost
                                    [user] => joomlauser
                                    [password] => default
                                    [database] => joomla
                                    [prefix] => ap_
                                    [select] => 1
                                    [port] => 3306
                                    [socket] => 
                                )

                            [sql:protected] => 
SELECT COUNT(*)
FROM (
SELECT `#__legacyinterface_commentaries`.*
FROM `#__legacyinterface_commentaries`
WHERE (`access` IN ('1','1'))) AS a
                            [tablePrefix:protected] => ap_
                            [utf:protected] => 1
                            [errorNum:protected] => 0
                            [errorMsg:protected] => 
                            [transactionDepth:protected] => 0
                            [disconnectHandlers:protected] => Array
                                (
                                )

                        )

                    [event_after_delete:protected] => onContentAfterDelete
                    [event_after_save:protected] => onContentAfterSave
                    [event_before_delete:protected] => onContentBeforeDelete
                    [event_before_save:protected] => onContentBeforeSave
                    [event_change_state:protected] => onContentChangeState
                    [event_clean_cache:protected] => 
                    [id_list:protected] => Array
                        (
                            [0] => 0
                        )

                    [id:protected] => 0
                    [input:protected] => FOFInput Object
                        (
                            [options:protected] => Array
                                (
                                )

                            [filter:protected] => JFilterInput Object
                                (
                                    [tagsArray] => Array
                                        (
                                        )

                                    [attrArray] => Array
                                        (
                                        )

                                    [tagsMethod] => 0
                                    [attrMethod] => 0
                                    [xssAuto] => 1
                                    [tagBlacklist] => Array
                                        (
                                            [0] => applet
                                            [1] => body
                                            [2] => bgsound
                                            [3] => base
                                            [4] => basefont
                                            [5] => embed
                                            [6] => frame
                                            [7] => frameset
                                            [8] => head
                                            [9] => html
                                            [10] => id
                                            [11] => iframe
                                            [12] => ilayer
                                            [13] => layer
                                            [14] => link
                                            [15] => meta
                                            [16] => name
                                            [17] => object
                                            [18] => script
                                            [19] => style
                                            [20] => title
                                            [21] => xml
                                        )

                                    [attrBlacklist] => Array
                                        (
                                            [0] => action
                                            [1] => background
                                            [2] => codebase
                                            [3] => dynsrc
                                            [4] => lowsrc
                                        )

                                )

                            [data:protected] => Array
                                (
                                    [start] => 120
                                    [limitstart] => 120
                                    [option] => com_legacyinterface
                                    [view] => commentaries
                                    [Itemid] => 616
                                    [layout] => 
                                    [task] => browse
                                    [directionTable] => asc
                                    [sortTable] => published_on
                                    [filter_order] => published_on
                                    [filter_order_Dir] => desc
                                    [savestate] => 1
                                    [base_path] => /var/www/html/apcms/components/com_legacyinterface
                                )

                            [inputs:protected] => Array
                                (
                                    [get] => JInput Object
                                        (
                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

                                                    [attrBlacklist] => Array
                                                        (
                                                            [0] => action
                                                            [1] => background
                                                            [2] => codebase
                                                            [3] => dynsrc
                                                            [4] => lowsrc
                                                        )

                                                )

                                            [data:protected] => Array
                                                (
                                                    [start] => 120
                                                )

                                            [inputs:protected] => Array
                                                (
                                                    [get] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [start] => 120
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [post] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [cookie] => JInputCookie Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                    [get] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                    [start] => 120
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [post] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [cookie] => JInputCookie Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [files] => JInputFiles Object
                                                                        (
                                                                            [decodedData:protected] => Array
                                                                                (
                                                                                )

                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                    [get] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [start] => 120
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [post] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [cookie] => JInputCookie Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [files] => JInputFiles Object
                                                                                        (
                                                                                            [decodedData:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [env] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [request] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [start] => 120
                                                                                                    [limitstart] => 120
                                                                                                    [option] => com_legacyinterface
                                                                                                    [view] => commentaries
                                                                                                    [Itemid] => 616
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [server] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [HTTP_AUTHORIZATION] => 
                                                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                                                    [HTTP_ACCEPT_ENCODING] => gzip
                                                                                                    [HTTP_ACCEPT_CHARSET] => ISO-8859-1,utf-8;q=0.7,*;q=0.7
                                                                                                    [HTTP_ACCEPT_LANGUAGE] => en-us,en;q=0.5
                                                                                                    [HTTP_REFERER] => http://wordpress.hubtech.tv/?start=120
                                                                                                    [HTTP_USER_AGENT] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729)
                                                                                                    [HTTP_HOST] => wordpress.hubtech.tv
                                                                                                    [HTTP_CONNECTION] => Keep-Alive
                                                                                                    [PATH] => /sbin:/usr/sbin:/bin:/usr/bin
                                                                                                    [SERVER_SIGNATURE] => 
                                                                                                    [SERVER_SOFTWARE] => Apache/2.4.16 (Amazon) PHP/5.5.31
                                                                                                    [SERVER_NAME] => wordpress.hubtech.tv
                                                                                                    [SERVER_ADDR] => 10.28.13.29
                                                                                                    [SERVER_PORT] => 80
                                                                                                    [REMOTE_ADDR] => 186.89.97.165
                                                                                                    [DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                                    [REQUEST_SCHEME] => http
                                                                                                    [CONTEXT_PREFIX] => 
                                                                                                    [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                                    [SERVER_ADMIN] => ben@hubtech.tv
                                                                                                    [SCRIPT_FILENAME] => /var/www/html/apcms/index.php
                                                                                                    [REMOTE_PORT] => 64633
                                                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                                                    [SERVER_PROTOCOL] => HTTP/1.1
                                                                                                    [REQUEST_METHOD] => GET
                                                                                                    [QUERY_STRING] => start=120
                                                                                                    [REQUEST_URI] => /?start=120
                                                                                                    [SCRIPT_NAME] => /index.php
                                                                                                    [PHP_SELF] => /index.php
                                                                                                    [REQUEST_TIME_FLOAT] => 1524775397.572
                                                                                                    [REQUEST_TIME] => 1524775397
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [session] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [__default] => Array
                                                                                                        (
                                                                                                            [session.counter] => 1
                                                                                                            [session.timer.start] => 1524775398
                                                                                                            [session.timer.last] => 1524775398
                                                                                                            [session.timer.now] => 1524775398
                                                                                                            [session.client.browser] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729)
                                                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                                                (
                                                                                                                    [data:protected] => stdClass Object
                                                                                                                        (
                                                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                                                (
                                                                                                                                    [commentaries] => stdClass Object
                                                                                                                                        (
                                                                                                                                            [limitstart] => 120
                                                                                                                                            [filter_order] => published_on
                                                                                                                                            [filter_order_Dir] => desc
                                                                                                                                        )

                                                                                                                                )

                                                                                                                        )

                                                                                                                )

                                                                                                            [user] => JUser Object
                                                                                                                (
                                                                                                                    [isRoot:protected] => 
                                                                                                                    [id] => 0
                                                                                                                    [name] => 
                                                                                                                    [username] => 
                                                                                                                    [email] => 
                                                                                                                    [password] => 
                                                                                                                    [password_clear] => 
                                                                                                                    [block] => 
                                                                                                                    [sendEmail] => 0
                                                                                                                    [registerDate] => 
                                                                                                                    [lastvisitDate] => 
                                                                                                                    [activation] => 
                                                                                                                    [params] => 
                                                                                                                    [groups] => Array
                                                                                                                        (
                                                                                                                            [0] => 9
                                                                                                                        )

                                                                                                                    [guest] => 1
                                                                                                                    [lastResetTime] => 
                                                                                                                    [resetCount] => 
                                                                                                                    [requireReset] => 
                                                                                                                    [_params:protected] => Joomla\Registry\Registry Object
                                                                                                                        (
                                                                                                                            [data:protected] => stdClass Object
                                                                                                                                (
                                                                                                                                )

                                                                                                                        )

                                                                                                                    [_authGroups:protected] => Array
                                                                                                                        (
                                                                                                                            [0] => 1
                                                                                                                        )

                                                                                                                    [_authLevels:protected] => Array
                                                                                                                        (
                                                                                                                            [0] => 1
                                                                                                                            [1] => 1
                                                                                                                        )

                                                                                                                    [_authActions:protected] => 
                                                                                                                    [_errorMsg:protected] => 
                                                                                                                    [_errors:protected] => Array
                                                                                                                        (
                                                                                                                        )

                                                                                                                    [aid] => 0
                                                                                                                )

                                                                                                        )

                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [jrequest] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                )

                                                                        )

                                                                    [env] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [request] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                    [start] => 120
                                                                                    [limitstart] => 120
                                                                                    [option] => com_legacyinterface
                                                                                    [view] => commentaries
                                                                                    [Itemid] => 616
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [server] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                    [HTTP_AUTHORIZATION] => 
                                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                                    [HTTP_ACCEPT_ENCODING] => gzip
                                                                                    [HTTP_ACCEPT_CHARSET] => ISO-8859-1,utf-8;q=0.7,*;q=0.7
                                                                                    [HTTP_ACCEPT_LANGUAGE] => en-us,en;q=0.5
                                                                                    [HTTP_REFERER] => http://wordpress.hubtech.tv/?start=120
                                                                                    [HTTP_USER_AGENT] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729)
                                                                                    [HTTP_HOST] => wordpress.hubtech.tv
                                                                                    [HTTP_CONNECTION] => Keep-Alive
                                                                                    [PATH] => /sbin:/usr/sbin:/bin:/usr/bin
                                                                                    [SERVER_SIGNATURE] => 
                                                                                    [SERVER_SOFTWARE] => Apache/2.4.16 (Amazon) PHP/5.5.31
                                                                                    [SERVER_NAME] => wordpress.hubtech.tv
                                                                                    [SERVER_ADDR] => 10.28.13.29
                                                                                    [SERVER_PORT] => 80
                                                                                    [REMOTE_ADDR] => 186.89.97.165
                                                                                    [DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                    [REQUEST_SCHEME] => http
                                                                                    [CONTEXT_PREFIX] => 
                                                                                    [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                    [SERVER_ADMIN] => ben@hubtech.tv
                                                                                    [SCRIPT_FILENAME] => /var/www/html/apcms/index.php
                                                                                    [REMOTE_PORT] => 64633
                                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                                    [SERVER_PROTOCOL] => HTTP/1.1
                                                                                    [REQUEST_METHOD] => GET
                                                                                    [QUERY_STRING] => start=120
                                                                                    [REQUEST_URI] => /?start=120
                                                                                    [SCRIPT_NAME] => /index.php
                                                                                    [PHP_SELF] => /index.php
                                                                                    [REQUEST_TIME_FLOAT] => 1524775397.572
                                                                                    [REQUEST_TIME] => 1524775397
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [session] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                    [__default] => Array
                                                                                        (
                                                                                            [session.counter] => 1
                                                                                            [session.timer.start] => 1524775398
                                                                                            [session.timer.last] => 1524775398
                                                                                            [session.timer.now] => 1524775398
                                                                                            [session.client.browser] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729)
                                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                                (
                                                                                                    [data:protected] => stdClass Object
                                                                                                        (
                                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                                (
                                                                                                                    [commentaries] => stdClass Object
                                                                                                                        (
                                                                                                                            [limitstart] => 120
                                                                                                                            [filter_order] => published_on
                                                                                                                            [filter_order_Dir] => desc
                                                                                                                        )

                                                                                                                )

                                                                                                        )

                                                                                                )

                                                                                            [user] => JUser Object
                                                                                                (
                                                                                                    [isRoot:protected] => 
                                                                                                    [id] => 0
                                                                                                    [name] => 
                                                                                                    [username] => 
                                                                                                    [email] => 
                                                                                                    [password] => 
                                                                                                    [password_clear] => 
                                                                                                    [block] => 
                                                                                                    [sendEmail] => 0
                                                                                                    [registerDate] => 
                                                                                                    [lastvisitDate] => 
                                                                                                    [activation] => 
                                                                                                    [params] => 
                                                                                                    [groups] => Array
                                                                                                        (
                                                                                                            [0] => 9
                                                                                                        )

                                                                                                    [guest] => 1
                                                                                                    [lastResetTime] => 
                                                                                                    [resetCount] => 
                                                                                                    [requireReset] => 
                                                                                                    [_params:protected] => Joomla\Registry\Registry Object
                                                                                                        (
                                                                                                            [data:protected] => stdClass Object
                                                                                                                (
                                                                                                                )

                                                                                                        )

                                                                                                    [_authGroups:protected] => Array
                                                                                                        (
                                                                                                            [0] => 1
                                                                                                        )

                                                                                                    [_authLevels:protected] => Array
                                                                                                        (
                                                                                                            [0] => 1
                                                                                                            [1] => 1
                                                                                                        )

                                                                                                    [_authActions:protected] => 
                                                                                                    [_errorMsg:protected] => 
                                                                                                    [_errors:protected] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [aid] => 0
                                                                                                )

                                                                                        )

                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [jrequest] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                )

                                                        )

                                                    [files] => JInputFiles Object
                                                        (
                                                            [decodedData:protected] => Array
                                                                (
                                                                )

                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [env] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [request] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [start] => 120
                                                                    [limitstart] => 120
                                                                    [option] => com_legacyinterface
                                                                    [view] => commentaries
                                                                    [Itemid] => 616
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [server] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [HTTP_AUTHORIZATION] => 
                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                    [HTTP_ACCEPT_ENCODING] => gzip
                                                                    [HTTP_ACCEPT_CHARSET] => ISO-8859-1,utf-8;q=0.7,*;q=0.7
                                                                    [HTTP_ACCEPT_LANGUAGE] => en-us,en;q=0.5
                                                                    [HTTP_REFERER] => http://wordpress.hubtech.tv/?start=120
                                                                    [HTTP_USER_AGENT] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729)
                                                                    [HTTP_HOST] => wordpress.hubtech.tv
                                                                    [HTTP_CONNECTION] => Keep-Alive
                                                                    [PATH] => /sbin:/usr/sbin:/bin:/usr/bin
                                                                    [SERVER_SIGNATURE] => 
                                                                    [SERVER_SOFTWARE] => Apache/2.4.16 (Amazon) PHP/5.5.31
                                                                    [SERVER_NAME] => wordpress.hubtech.tv
                                                                    [SERVER_ADDR] => 10.28.13.29
                                                                    [SERVER_PORT] => 80
                                                                    [REMOTE_ADDR] => 186.89.97.165
                                                                    [DOCUMENT_ROOT] => /var/www/html/apcms
                                                                    [REQUEST_SCHEME] => http
                                                                    [CONTEXT_PREFIX] => 
                                                                    [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms
                                                                    [SERVER_ADMIN] => ben@hubtech.tv
                                                                    [SCRIPT_FILENAME] => /var/www/html/apcms/index.php
                                                                    [REMOTE_PORT] => 64633
                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                    [SERVER_PROTOCOL] => HTTP/1.1
                                                                    [REQUEST_METHOD] => GET
                                                                    [QUERY_STRING] => start=120
                                                                    [REQUEST_URI] => /?start=120
                                                                    [SCRIPT_NAME] => /index.php
                                                                    [PHP_SELF] => /index.php
                                                                    [REQUEST_TIME_FLOAT] => 1524775397.572
                                                                    [REQUEST_TIME] => 1524775397
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [session] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [__default] => Array
                                                                        (
                                                                            [session.counter] => 1
                                                                            [session.timer.start] => 1524775398
                                                                            [session.timer.last] => 1524775398
                                                                            [session.timer.now] => 1524775398
                                                                            [session.client.browser] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729)
                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                (
                                                                                    [data:protected] => stdClass Object
                                                                                        (
                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                (
                                                                                                    [commentaries] => stdClass Object
                                                                                                        (
                                                                                                            [limitstart] => 120
                                                                                                            [filter_order] => published_on
                                                                                                            [filter_order_Dir] => desc
                                                                                                        )

                                                                                                )

                                                                                        )

                                                                                )

                                                                            [user] => JUser Object
                                                                                (
                                                                                    [isRoot:protected] => 
                                                                                    [id] => 0
                                                                                    [name] => 
                                                                                    [username] => 
                                                                                    [email] => 
                                                                                    [password] => 
                                                                                    [password_clear] => 
                                                                                    [block] => 
                                                                                    [sendEmail] => 0
                                                                                    [registerDate] => 
                                                                                    [lastvisitDate] => 
                                                                                    [activation] => 
                                                                                    [params] => 
                                                                                    [groups] => Array
                                                                                        (
                                                                                            [0] => 9
                                                                                        )

                                                                                    [guest] => 1
                                                                                    [lastResetTime] => 
                                                                                    [resetCount] => 
                                                                                    [requireReset] => 
                                                                                    [_params:protected] => Joomla\Registry\Registry Object
                                                                                        (
                                                                                            [data:protected] => stdClass Object
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [_authGroups:protected] => Array
                                                                                        (
                                                                                            [0] => 1
                                                                                        )

                                                                                    [_authLevels:protected] => Array
                                                                                        (
                                                                                            [0] => 1
                                                                                            [1] => 1
                                                                                        )

                                                                                    [_authActions:protected] => 
                                                                                    [_errorMsg:protected] => 
                                                                                    [_errors:protected] => Array
                                                                                        (
                                                                                        )

                                                                                    [aid] => 0
                                                                                )

                                                                        )

                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [jrequest] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                )

                                        )

                                    [post] => JInput Object
                                        (
                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

                                                    [attrBlacklist] => Array
                                                        (
                                                            [0] => action
                                                            [1] => background
                                                            [2] => codebase
                                                            [3] => dynsrc
                                                            [4] => lowsrc
                                                        )

                                                )

                                            [data:protected] => Array
                                                (
                                                )

                                            [inputs:protected] => Array
                                                (
                                                )

                                        )

                                    [cookie] => JInputCookie Object
                                        (
                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

                                                    [attrBlacklist] => Array
                                                        (
                                                            [0] => action
                                                            [1] => background
                                                            [2] => codebase
                                                            [3] => dynsrc
                                                            [4] => lowsrc
                                                        )

                                                )

                                            [data:protected] => Array
                                                (
                                                )

                                            [inputs:protected] => Array
                                                (
                                                )

                                        )

                                    [files] => JInputFiles Object
                                        (
                                            [decodedData:protected] => Array
                                                (
                                                )

                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
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                                    [title] => IBM: When a Company Veers Off the Roadmap
                                    [slug] => diamondhill_012115
                                    [fulltext] => 

In 2010, International Business Machines’ (IBM) then-CEO Sam Palmisano unveiled the company’s 2015 Roadmap in which management detailed its plans to grow (non-GAAP) operating earnings to “at least $20” per share by 2015.  This plan was the successor to a 2010 Roadmap, originally unveiled in 2007, in which management outlined its plan to deliver “at least $10” in earnings per share by 2010.  Since the company ultimately exceeded its 2010 Roadmap expectations and delivered $11.52 in 2010 earnings per share, the 2015 Roadmap was generally met with enthusiasm by IBM shareholders.  However, the 2015 Roadmap has proven to be a bumpy ride.  On October 20, 2014, along with a disappointing third quarter earnings report, current CEO Ginni Rometty disclosed that the company will fail to achieve “at least $20” in (non-GAAP) operating earnings per share, the cornerstone of the much-publicized 2015 Roadmap.  This development provides a worthwhile context within which to assess some of the advantages and disadvantages of long-term earnings roadmaps, and provide an update on why we continue to view IBM as an attractive investment despite management’s acknowledgement that the 2015 Roadmap was overly optimistic.

Pros and Cons of Long-Term Earnings Roadmaps

While I am not a proponent of long-term earnings roadmaps, I can understand the appeal of such a tactic to the CEO of a business like IBM.  IBM’s core businesses are generally much less volatile and much more resilient than typical technology businesses, and a long-term earnings roadmap was one method of illustrating this.  In addition to conveying management’s view that the company’s operating earnings could nearly double between 2011 and 2015, the 2015 Roadmap detailed the favorable operating margin impact of operating leverage in the company’s software business, cost reductions in its services businesses, and a continuing business mix shift toward more profitable products and services.  Recognizing that technology companies’ capital allocation track records have been mixed at best, the 2015 Roadmap also included an expectation that the company would generate approximately $100 billion in free cash flow between the beginning of 2011 and the end of 2015.  Management committed that approximately 70% of that free cash flow would be returned to shareholders in the form of dividends ($20 billion) and share repurchases ($50 billion), and that an additional $20 billion would be used for acquisitions. 

Although these objectives seemed reasonable enough at the outset of IBM’s 2015 Roadmap, the long-term earnings roadmap inevitably became a short-term earnings roadmap as time passed and 2015 approached.  As revenue growth proved more challenging to achieve than management anticipated, the company also became more aggressive in its share repurchases.  At the end of the third quarter of 2014, with five quarters remaining in the timeframe covered by the 2015 Roadmap, the company had already exceeded the $50 billion total share repurchase commitment by $4 billion.  Some investors questioned whether these repurchases were the best use of capital, or were simply driven by management’s desire to reduce the share count in hopes of meeting the 2015 Roadmap operating earnings per share target.  While we were generally pleased that IBM was repurchasing shares at a discount to our estimate of intrinsic value, we would have been concerned had these share repurchases been funded by drastic reductions in research and development spending.  Because research and development is an important driver of product enhancement and innovation, and thus future revenue and profit, we believe it is important to monitor IBM’s commitment to research and development (R&D) spending despite a focus on cutting costs in other areas.  As illustrated in Table 1, during the years covered by the 2015 Roadmap, R&D spending remained approximately 6% of revenue, consistent with the years preceding the 2015 Roadmap.

 

 

IBM’s R&D spending provides an interesting contrast to Hewlett-Packard’s R&D spending between its fiscal years 2002 and 2010.  To be fair, Hewlett-Packard made large acquisitions of both Compaq and Electronic Data Systems that somewhat decreased the company’s necessary R&D spending as a percentage of revenue, but in my view, this only explains part of the significant reduction in the company’s R&D spending.

Underinvestment in R&D can have substantial negative impacts on a business, as was ultimately the case at Hewlett-Packard.  So while we generally view IBM’s share repurchases as an attractive use of capital, we believe it is imperative that the share repurchases be done in combination with a continued commitment to R&D spending. 

In my view, possibly the most significant downside of earnings roadmaps is the excessive focus placed on a single year’s earnings, which in the case of IBM was 2015.  I would much prefer that management focus on continuously growing the intrinsic value of the business rather than managing the expectations of employees, analysts, and the press with regard to any single year of earnings.  While we were disappointed that IBM failed to execute on portions of its 2015 Roadmap, the company’s 2015 earnings and free cash flow are a relatively small component of our estimate of intrinsic value, and we continue to believe that IBM shares are priced well below their intrinsic value.

Attractive Businesses at an Attractive Price

IBM’s software and services businesses account for the vast majority of the company’s profits, and each business has characteristics that make it fundamentally attractive and resilient.  IBM’s software, the largest contributor of profit, is integral to the functioning of customers’ IT environments, and customers rarely want to endure the complexity and cost associated with switching to another provider.  The services businesses give IBM an opportunity to solve substantial problems for customers in a mutually value-creating manner, and these service engagements often result in increased customer trust and dependence on IBM solutions.  In addition to software and services, IBM possesses what is essentially a monopoly in the mature but lucrative mainframe hardware market and also operates a non-mainframe hardware business and a relatively small but profitable financing business. 

We believe the combination of these businesses constitutes an attractive technology company that is well-positioned to grow intrinsic value per share over the long-term.  The disappointment associated with the company’s 2015 Roadmap, and uncertainty about future growth, has resulted in a market price that is well below our estimate of IBM’s per share intrinsic value.  If management is able to execute relative to fundamental expectations that are now lower than what was detailed in the 2015 Roadmap, we believe that IBM shares will provide attractive returns to shareholders.

 

The views expressed are those of the research analyst as of January 2015, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. DIAMOND HILL® is a registered trademark of Diamond Hill Investment Group, Inc.

© 2015 Diamond Hill Capital Management, Inc. All Rights Reserved.

[description] => In 2010, International Business Machines’ (IBM) then-CEO Sam Palmisano unveiled the company’s 2015 Roadmap in which management detailed its plans to grow (non-GAAP) operating earnings to “at least $20” per share by 2015. This plan was the successor to a 2010 Roadmap, originally unveiled in 2007, in which management outlined its plan to deliver “at least $10” in earnings per share by 2010. Since the company ultimately exceeded its 2010 Roadmap expectations and delivered $11.52 in 2010 earnings per share, the 2015 Roadmap was generally met with enthusiasm by IBM shareholders. [author] => Nate Palmer [legacyinterface_firm_id] => 113 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 15:45:22 [created_by] => 948 [modified_on] => 2015-01-21 15:45:32 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2390 [hits] => 0 ) [1] => stdClass Object ( [legacyinterface_commentary_id] => 2325 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15562 [apv_conversation_id] => 3240 [content_type] => market-commentary [title] => Switzerland Wins As Its Central Bank Surrenders [slug] => euro_012115 [fulltext] =>

If anyone had any doubt how severely the global economy has been distorted by the actions of central bankers, the "surprise" announcement last week by the Swiss National Bank (SNB) to no longer peg the Swiss franc to the euro should provide a moment of crystal clarity. The decision sent the franc up almost 30% in intraday trading, a scale of movement that is unprecedented for a major currency in the modern era. Although very few in the media or on Wall Street fully understand the ramifications, the situation that forced the Swiss to abandon the peg will soon be faced by bankers of much larger countries in the coming years, the implications of which can have more profound implications for global financial markets.      

Other than the immediate fluctuations in exchange rates, the primary reaction to the Swiss move has been indignation. The airwaves have been awash with officials and investors who have felt betrayed by an irresponsible bank that has not only squandered its own credibility but has also damaged the reputation of all central banks. Despite the complaints of now-ruined foreign-exchange speculators, who believed recent statements from the SNB that it would continue to enforce the peg, a blindsided policy reversal was its only viable option. Any hint that the policy was about to change, or could change, would have resulted in the same mass buying of Swiss francs.

But the only thing the SNB did wrong (other than initiating the peg in the first place) was to admit that the policy was unsustainable and have the courage to reverse course. In so doing, they violated the first rule of central banking, which appears to be: Never admit to making a mistake.   

Although the move is not as dramatic a change as the recently defeated gold reserve referendum would have likely produced (see my prior commentary), the abandonment of the peg makes Switzerland the first major economy to surrender in the international currency war. It has decided not to race to the bottom, and it has understood that a cheap currency does not solve economic problems. The decision gives a long-delayed victory to the Swiss people. 

With a centuries-old legacy of economic independence, the Swiss initially had the good sense to avoid joining the monetary quagmire that became the Eurozone. But with the 2011 euro peg, the country de facto joined the currency union. This tasked a country with a population of just over 8 million people to support the euro, a falling currency used by 335 million people locked in a dysfunctional political union, with governments that have been serially unable to deal with horrific debt profiles. According to tradingeconomics.com, 2013 figures show Switzerland has a debt-to-GDP ratio of just 35.4%. In contrast, the Eurozone has an extremely high ratio of 90.9%. Taking on that kind of dead weight was a very big job for a very small country.

Predictably, the numbers got very silly very fast. In 2009, Switzerland's foreign exchange was $92 billion (SNB Annual Report), representing just 17.5% of its annual GDP. This was high by national standards, but well within the range of most developed countries (The U.S. now has almost no foreign exchange reserves - just .9% of GDP). But in order to maintain the peg, the SNB had to buy hundreds of billions of euros annually. Over the past six years, the tab came to almost $10,000 per year per Swiss citizen. These are enormous sums, even for a rich country. As a result, by the end of 2013 Switzerland's foreign exchange reserves had swelled to $488 billion (SNB Monthly Statistical Bulletin, Dec. 2014) or 71% of its annual GDP. This dwarfs the reserves-to-GDP levels held by the globe's two primary foreign exchange depositories, China (41.3%) and Japan (24.4%).

In retrospect the task was absurd. It was like asking a 100 lb. jockey to perpetually piggyback a 600 lb. sumo wrestler. But the real problem came in recent months when the European Central Bank came closer to announcing a program of quantitative easing, which would have brought even more downward pressure on the euro, requiring the SNB to pick up the buying pace even further. Asking the Swiss to shoulder the QE burden was like asking the jockey to carry the Sumo wrestler into an all-you-can-eat sushi bar. Given that grim reality, the SNB had no choice but to lay down its burden.

Despite this prospect of an open-ended euro buying cul-de-sac, mainstream economists have argued that the move will decimate Switzerland's finances and ruin its economy. They argue that by letting the euro fall, the SNB will suffer immediate losses on the hundreds of billions of euros it now holds in reserve. While this is true, it ignores all the hundreds of billions, if not trillions, of francs that the Swiss would have had to spend (to buy euros) in coming years to maintain the peg. Modern economists believe that the money needed could have been printed out of thin air with no cost to the Swiss economy. But to believe that is to believe in fairy tales.

But when you look at it clearly, Japan, China, and many emerging economies find themselves in roughly the same boat as Switzerland. They are continually inflating their own foreign exchange reserves in order to enforce an unofficial peg against the U.S. dollar. However, in no othercountry has the relative scale of foreign exchange purchases been as dramatic as in Switzerland. But if the Fed unexpectedly launches another round of QE, which I believe it will, then the rest of the world will have to face the same decision as Switzerland had; whether to continue to throw good money after bad, or to cut and run and take the pain now.

Those still in shock by what they see in the rear view mirror had better focus their attention on what lies ahead. To me, the mother of all pegs is the one provided by China to the U.S. dollar. Both the yuan and the Hong Kong dollar are pegged to the U.S. dollar, and China has spent far more money than Switzerland defending its peg. Should China pull the plug on the dollar, our economy has a much larger drain to go down. The Europeans had only recently begun to rely on Switzerland, yet America has been limping on China's crutch for decades. Since our reliance is much greater, so too is the potential impact once it's removed.

Another difference is that while the Swiss are few in number relative to the population of the Eurozone, per capita income in Switzerland is higher. In contrast, China has a larger population than the United States, but its people subsist on much lower incomes. So it's not the rich subsidizing the less well off, but the Chinese poor subsidizing America's middle class. As a result, the immediate gain to China and loss to America will be that much greater than is the case with Switzerland and Europe.

In the future the Swiss surrender may be looked at as the first significant counter-attack against our current global system of monetary insanity. The mistake was not ending this peg, but in adopting it in the first place. The Swiss once again have a strong currency with expanded purchasing power. Yes, Swiss exporters may lose market share to international rivals. But the amount of Swiss francs they will actually earn from each unit sold will likely increase. So the Swiss may be able to export less and still earn the same money. In addition, the cost of imports will fall, allowing the Swiss to buy more with less. 

Contrary to the common current belief, the goal of an economy is not to manufacture more products for others to buy, but to be able to buy more products yourself.  In that respect, exports are merely the means to achieving that end. The less you need to export to pay for your imports the better. In other words, the goal of an economy is to consume, not to work. If we could consume without working we would happily do so. Working without consuming, not so much. In the past, the Swiss prospered with one of the world's strongest currencies. It will do so again.

Ironically, without the support of the SNB in propping up the euro, full-blown European QE may now be a more remote possibility, and a euro rally against the dollar may not be too far off. Goldman Sachs noted the Swiss' message is that QE is going to be done and perhaps even larger than previously thought. But, with tough love from Switzerland perhaps the European Union may choose to consider real economic reforms rather than risk QE without a Swiss safety net to catch the euro if it starts to tumble uncontrollably. In fact, the forces now in motion, accelerated by the SNB's move, may push the Fed that much closer to launching QE4. Since the "long dollar, short euro" trade is predicated on the expectation of QE in Europe and rate hikes in the U.S., if we end up with QE4 in the U.S. and no QE at all in Europe, the fireworks in the foreign exchange market are just getting started.

© Euro Pacific Capital

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  • Amid lower forward-looking returns, investors are focusing on multi-asset solutions, enhanced beta, income and alternatives in Asia-Pacific.
  • PIMCO is prepared to address these themes, drawing upon our time-tested investment process that combines high-level macroeconomic views with thorough on-the-ground research. 
Over the past several months, it has been my privilege to visit many of PIMCO’s clients throughout the Asia-Pacific region. Japan, Asia ex Japan, Australia and New Zealand together compose a large and diverse set of economies; still, we have observed five important common themes that have emerged among the region’s investors:
1. A recognition of lower forward-looking returns,2. A focus on multi-asset solutions,3. A desire to look beyond traditional betas in both fixed income and equities,4. A preference for income-oriented investment solutions and5. An increased interest in harnessing the potential value of alternative investments.
 
As we head into 2015, PIMCO is prepared to address these themes, drawing upon our time-tested investment process that combines high-level macroeconomic views with thorough on-the-ground research.Theme 1: Recognition of lower forward-looking returns 
As noted in PIMCO’s December Cyclical Outlook, the markets have largely priced in the New Neutral reality of lower secular policy rates and lower market returns. The drop in oil prices may temporarily buoy some markets and hurt oil-producing economies, with an overall neutral to modestly positive impact on global growth. However, while this cyclical phenomenon plays out, the secular horizon still portends an environment where lower returns will be the rule rather than the exception.

We were privileged at our December Cyclical Forum to be joined by former U.S. Federal Reserve Chairman Dr. Ben Bernanke, who suggested that global central bankers are likely to remain focused on growth in the real economy in determining the course of monetary policy. Considering that growth is likely to remain measured and that therefore policy rates are likely to remain low, market returns are unlikely to be as ebullient as we have seen in recent years. In turn, this reduces the ability of traditional stock and bond returns to suffice as the engines of a modern investment portfolio.

Theme 2: A focus on multi-asset solutions 
We continue to see strong client interest in multi-asset solutions that transcend single asset classes to capitalize on a broad range of potential return drivers. Here in Asia-Pacific, these strategies may be particularly appealing to clients as first steps in deploying assets offshore, given the diversification and multi-sector accessibility they confer, as well as for clients seeking to move into higher-discretion, higher-return target strategies while limiting downside risk.

PIMCO offers a broad array of multi-asset solutions with long-term track records, including strategies with a real return orientation, strategies that express PIMCO’s broad “best ideas” and strategies that integrate our absolute return offerings while explicitly managing downside risk.

Theme 3: Looking beyond traditional betas 
For decades, PIMCO has provided innovative solutions for enhancing traditional bond and stock betas. Client demand for these solutions has burgeoned in recent years, in light of both the limitations to traditional betas and the abilities of these “smart beta” and “liquid alternatives” solutions to help clients meet investment objectives.

In fixed income, PIMCO’s unconstrained strategies seek to move beyond traditional fixed income returns and source alpha opportunities without the limitations of a benchmark. With the ability to modulate interest rate sensitivity and harness a global opportunity set, these strategies provide investors with valuable flexibility in the face of a lower return environment. Similarly, strategies that seek to opportunistically isolate alpha sources in credit, mortgages and commodities can be powerful additions to a portfolio.

In equity space, PIMCO’s StocksPLUS strategies, including the four-time winner of the U.S. Lipper Best Funds Group Large Company Equity award (2010, 2011, 2012, 2013), have been joined by a robust set of offerings in our Fundamental Index-based product suite. The latter strategies have grown from a collaboration with our partners at Research Affiliates, a pioneer in fundamental indexing. Because traditional market-capitalization-weighted indexes tend to overweight overpriced securities, fundamental indexes seek to structurally outperform traditional indexes by investing in securities that are underpriced relative to fundamentals and selling securities that are overpriced relative to fundamentals. PIMCO portfolio managers then add a layer of active fixed income management to this “smart beta” approach, presenting a compelling investment solution.

Theme 4: Income-oriented solutions 
Our clients’ increasing focus on income-oriented solutions is supported by both demographic trends and market realities. An aging global population naturally focuses on steady sources of income, and uncertainty about long-term market returns augments investor focus on income generation in the near term.

PIMCO’s Income strategy is managed by our Group CIO, Dan Ivascyn, and managing director Alfred Murata. Last year, Dan and Alfred were jointly recognized as 2013 Morningstar Fixed-Income Fund Managers of the Year (U.S.). Investors continue to utilize this strategy in pursuit of income without sacrificing a strong risk management focus.

Another income-generation-focused strategy that has attracted interest from investors in Asia-Pacific is the Capital Securities strategy. This strategy blends macroeconomic analysis with rigorous credit research to identify securities that may outperform bank equities and traditional high yield bonds.

Theme 5: Exploring alternatives 
PIMCO’s alternatives strategies target high returns while aiming to reduce portfolio volatility by focusing on uncorrelated sources of alpha.

We have seen a broad array of approaches to alternatives in Asia-Pacific: Some investors favor direct investments in hedge funds and/or private equity strategies, some prefer fund-of-funds approaches and some primarily seek co-investment opportunities. PIMCO currently offers hedge fund strategies (global macro, relative value, commodity) and private equity strategies (opportunistic real estate and opportunistic credit). We plan to grow this important business to target opportunities that our alternatives portfolio management team identifies, and serve increasing client demand for these solutions. We look forward to continuing the dialogue on this important opportunity set in the coming months.

The above list is by no means exhaustive, but it does represent what many Asia-Pacific investors are prioritizing in 2015.

In closing, let me express my gratitude for the time our clients have taken to share their investment needs and priorities; these exchanges enable PIMCO to serve investors more effectively. We stand ready to support our clients however we can, and we wish you a happy, healthy and prosperous 2015.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Absolute return portfolios may not fully participate in strong positive market rallies. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

Smart beta refers to a benchmark designed to deliver a better risk and return trade-off than conventional market cap weighted indices. PIMCO’s liquid alternative strategies are without the principal lock-ups of traditional private equity funds and hedge funds and include separate accounts whose holdings can be liquidated at a client’s request subject to current market conditions, mutual funds that can be liquidated at NAV on a daily basis and ETFs that can be liquidated on the secondary market under normal market conditions. There is no guarantee that a security will be able to be liquidated in a timely fashion or when it would be most advantageous to do so.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors. Investors should consult their investment professional prior to making an investment decision.

The Morningstar Fixed Income Fund Manager of the Year award (2013) is based on the strength of the manager, performance, strategy and firm's stewardship. Morningstar named Dan Ivascyn and Alfred Murata the 2013 Fixed Income Manager of the Year (US). The Lipper Fund Best Group over 3 Years Large Equity award (2013) recognizes funds that have delivered consistently strong risk-adjusted performance, relative to peers

This material contains the opinions of the authors but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark or registered trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. THE NEW NEUTRAL and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Pacific Investment Management Company LLC in the United States and throughout the world.

©2015, PIMCO.

[description] => Amid lower forward-looking returns, investors are focusing on multi-asset solutions, enhanced beta, income and alternatives in Asia-Pacific. PIMCO is prepared to address these themes, drawing upon our time-tested investment process that combines high-level macroeconomic views with thorough on-the-ground research. [author] => Eric Mogelof [legacyinterface_firm_id] => 335 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 15:49:12 [created_by] => 948 [modified_on] => 2015-01-21 15:49:28 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2392 [hits] => 0 ) [3] => stdClass Object ( [legacyinterface_commentary_id] => 2327 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15564 [apv_conversation_id] => 3242 [content_type] => market-commentary [title] => Saudi Succession [slug] => confluence_012115 [fulltext] =>

On New Year’s Eve, King Abdullah of Saudi Arabia was hospitalized with pneumonia.  According to reports, he is taking visitors and will probably survive this illness.  On the other hand, the king is at least 90 years old and is becoming increasingly frail.  

In light of his advanced age and declining health, an analysis of royal succession in Saudi Arabia is in order.  This process is becoming increasingly uncertain.  Unlike many European royal families, Saudi successions are not based on primogeniture; instead of passing from the king to his eldest son, it passes to a brother.  Due to the advancing age of the second generation of princes, this process is becoming increasingly problematic. 

We will begin this report with a history of Saudi kings.  Following this history is an examination of the current Saudi succession, focusing on the Crown Prince and who remains as potential kings among the “second generation” of the Saudi Royal Family.  In this context, we will analyze the challenges facing the kingdom and how the succession issue will likely complicate the manner in which these issues are resolved.  As always, we will conclude with potential market ramifications. 

History

Saudi Arabia was founded by Ibn Saud, a charismatic sheik who created the modern kingdom.  Through military campaigns and intermarriage, Ibn Saud gradually unified the territory on the Arabian Peninsula to create the modern Saudi state.  During this process, he had at least 22 wives and 45 sons, 36 who survived to adulthood.  He ruled Saudi Arabia from its founding in 1932 to 1953.  

Due the large number of sons, Ibn Saud created a succession plan that would shift from brother to brother rather than from the eldest brother to his eldest son (the aforementioned primogeniture).  

The first successor was King Saud, the oldest son of Ibn Saud who survived into adulthood.  He was a favorite of the founder.  Unfortunately, he proved to be a problematic king.  Saud ruled as if the country were his personal fiefdom, instead of a country.  His policies were mercurial; sometimes, he would support Arab nationalist movements, only to later support American policy in the region which opposed nationalist programs.  His personal habits were extravagant; he took on huge debts that the kingdom struggled to service.  Increasingly at odds with his younger brother Faisal, it appeared a civil conflict might develop.  However, the family and clergy were able to pressure Saud to abdicate in favor of Faisal in 1964. 

Unlike Saud, Faisal, the third son of Ibn Saud, was a cautious, sober man who did not share the extravagant habits of his older brother.  He became King in 1964 after being Saud’s prime minister.  Known for personal piety and thrifty habits, Faisal put the kingdom’s fiscal house in order.  

He also introduced public education in the kingdom (for both genders) and ended slavery.  His foreign policy was anti-communist and pan-Islamic.  Opposing the Arab nationalist movements of Hafez Assad and Gamal Nasser, Faisal wanted to build a pan-Islamic movement that would unify the region based on religion and monarchy.  Unlike many of his successors, he preferred a more inclusive position on Islam, embracing both Sunni and Shia. This position actually undermined the influence of clergy in Saudi Arabia, who tended to support a rather strict form of Sunni Islam.  During his reign, relations with the U.S. were generally positive due to his opposition to communism.  However, Faisal was anti-Zionist and U.S. support for Israel in the 1973 Yom Kippur War led Faisal to order the OPEC oil embargo on the U.S., which led to a quadrupling of oil prices.  

Faisal was assassinated by a half-nephew, Faisal bin Musaid, in 1975.  It is unclear why Musaid murdered his uncle; Musaid’s brother had been killed by Saudi security forces when he attacked a television station Faisal had commissioned.  Some sources argue that the assassination was to avenge his brother’s death.  Musaid did study in the U.S. at the University of Colorado and was arrested in Boulder for possession of LSD and hashish.  Some speculate that drug use may have caused insanity.  Regardless, he was executed in June 1975 on the charge of regicide. 

Khalid, the fourth oldest son (who survived to adulthood) became the fourth king of Saudi Arabia.  Interestingly enough, Khalid’s older brother, Muhammad, renounced any claim to the throne, paving the way for his younger brother to become king.  Muhammad was a close confidante of both King Khalid and his successor, Fahd, discussed below.  However, due to his very conservative views, Muhammad was not considered flexible enough to be king, a flaw he seemed to recognize. 

Khalid was seen as a caretaker monarch.  He had only a passing interest in politics, although he did ensure that all major decisions required his approval.  His disinterest was part of the reason he was popular among the princes.  Khalid’s reign was characterized by significant economic development.  The combination of his predecessor’s austerity and the massive revenue infusion that followed the spike in oil prices after the Arab Oil Embargo funded this expansion.  He also was less tolerant of religious diversity than Faisal, which boosted the status of the local clerics. Khalid had the unfortunate job of dealing with the 1979 seizure of the Grand Mosque in Mecca.  This led to military operations against the militants.  It also led Khalid to become even more supportive of religious conservativism.  

Khalid suffered from heart disease and had a series of heart attacks and major cardiac surgeries.  In 1982, he suffered a fatal heart attack and was succeeded by the prime minister and Crown Prince Fahd.  

Fahd was the eighth son of Ibn Saud (seventh oldest son to achieve adulthood).  He was also the eldest son of Saud and Hassa al-Sudairi,1 one of the favorite wives of the founder.  Two older sons of Saud, Prince Nasser and Prince Saad, were passed over when Fahd was crowned as king.  Prince Nasser, who was born to a lower ranked wife, was considered unfit due to a scandal that occurred when he was governor of the Riyadh province.  Prince Saad was believed to be of weak character and not deemed to have the qualities for leadership. 

King Fahd was considered worldly in his personal behavior, known for lavish trips to Europe.  He made several significant foreign policy decisions during his reign.  Fearing the Iranian Revolution, he actively supported Saddam Hussein’s Iraq during the Iran-Iraq War.  His oil minister, Zaki Yamani, abandoned the kingdom’s OPEC role of swing producer in 1986; this led to a collapse in oil prices and was partly responsible for the downfall of the Soviet Union.  Eventually, Fahd, not a fan of the influential Yamani, unceremoniously fired him.2 King Fahd also invited the U.S. military to Saudi Arabia in the autumn of 1990 after Saddam Hussein invaded and annexed Kuwait.  President Bush and Secretary of State Jim Baker built a large coalition to oust Iraq from Kuwait, using Saudi Arabia as a base of operations.  Although the execution of the war was impressive, anger at the king for allowing “infidels” to operate in the land of Mecca and Medina spawned al Qaeda, led by Osama bin Laden. 

Fahd opposed social reform and spent heavily on military hardware, most likely due to fears caused by the Iran-Iraq War and the First Gulf War.  Spending on defense cut expenditures on infrastructure, which weakened economic growth outside the energy sector.

In 1992, Fahd tried to create a more formal system of succession, allowing the current king to name his successor instead of relying on informal decisions by the sons of Ibn Saud.  The edict allowed the sitting king to select by his own criteria, permitting him to pass over those with seniority and setting the stage for moving to the grandsons of Ibn Saud. 

Already in poor health due to smoking, diabetes and obesity, Fahd suffered a major stroke in 1995.  Crown Prince Abdullah began to run the kingdom on a regular basis following King Fahd’s stroke. 

King Abdullah took control of the kingdom after Fahd’s death on May 27, 2005.  He is the 10th son of Ibn Saud; despite the power of the sons of Sudairi, Abdullah became king due to his role as de facto regent for 10 years before King Fahd died.  Abdullah has been a popular king.  In contrast to Fahd, his personal piety and demeanor have improved the standing of the royal family among Saudis.  He has promoted some reforms to the Saudi economy, including joining the World Trade Organization, and has made modest moves to ease religious restrictions and support religious diversity.  For example, in 2012, he replaced the head of the religious police with a more moderate figure.  This isn’t to say Abdullah is democratizing the kingdom, but he is attempting to ease internal tensions.  

Current Issues

In foreign policy, Saudi Arabia maintains relations with the U.S., although tensions have been rising over the Obama administration’s detente with Iran.  The kingdom also opposed America’s policy to allow Egyptian leader Hosni Mubarak’s removal from power.  Saudi leaders were concerned about the U.S. ouster of Saddam Hussein, and given the chaos that has developed in Iraq, these concerns were warranted.  Abdullah approved the Saudi military incursion in Bahrain to quell Shia unrest.  The Saudi government dramatically increased social spending in light of the “Arab Spring” to quell domestic calls for democracy.  

Although Saudi Arabia has opposed Islamic democracy movements, like the Muslim Brotherhood, recently, there is evidence that policy may be changing.  In general, Saudi Arabia was uncomfortable with the Islamic parties in Turkey on fears that an Islamic alternative to monarchy would encourage similar movements in the kingdom.  However, that posture is coming under scrutiny.  If the alternatives to Islamic monarchy are secular dictators, jihadist insurgencies or Shiite theocracy, perhaps the Muslim Brotherhood or similar groups are a better substitute.  We will be watching to see if the Saudis try to support such an alternative to the Islamic State in Syria and Iraq.  

The other major issue is Saudi Arabia’s decision to let oil prices fall.  The situation is somewhat similar to 1986.  At this point, we believe Abdullah supports Oil Minister Ali Naimi’s decision to allow prices to fall, but given the king’s health issues and advanced age, royal influence on this policy may be lacking.  As we will discuss below, Abdullah does not have an effective regent and so oil policy may be operating somewhat independently of the monarchy.  If so, there may be less than a thorough understanding of the geopolitical risks the oil policy may be creating. 

The Succession Issue

King Abdullah has outlived two crown princes, Prince Sultan and Prince Nayef.  Both deceased crown princes were members of the Sudairi Seven.  The current heir apparent, Crown Prince Salman, also a Sudairi, has serious medical issues.  He has suffered a stroke, has had back surgery and is reportedly suffering from Alzheimer’s disease.  Although there are 10 remaining princes who, in theory, could be king, most have health, experience or personality issues that all but eliminate them as candidates.  Abdullah has probably appointed the last “king eligible” prince, Muqrin, to the post of deputy crown prince.  He is the youngest surviving prince of Ibn Saud.  This would suggest he is next in line if Salman cannot take office; however, if Abdullah dies and Salman becomes king, it is unclear if Abdullah’s appointment will remain in force or if Salman will appoint his own successor.  

Essentially, it is highly likely that within the next decade the third generation of the House of Saud will take power in the kingdom.  To facilitate succession to the third generation, King Abdullah created the Allegiance Council in 2006.  The council, comprised of senior members of the royal family, in theory, would approve Abdullah’s successor’s crown prince.  As we move to the third generation, the council would face the unenviable task of selecting from a large number of princes with a wide dispersion of talents and support within the family.  There is no clear line of succession in the third generation.  This increases the risks to the oil markets and the region. 

Ramifications

The issue of Saudi succession is probably not imminent.  Even if King Abdullah does not outlive his third crown prince, it isn’t obvious that his designated successor, Salman, could take power or actually run the kingdom given his health issues.  Although there are concerns about the viability of a Muqrin administration, we suspect the royal family will accept him as king simply to avoid the looming problems that shifting to the next generation will certainly bring.  

Deputy Crown Prince Muqrin is young by second generation standards; he will turn 70 in September.  As noted above, there are other living sons of Ibn Saud, but none are generally considered strong candidates for king, due to personality, age, experience or health issues.  Even Muqrin wasn’t considered a strong candidate until he was named deputy crown prince by King Abdullah.  Given Muqrin’s age and health, his ascension to king would likely give the royal family perhaps a decade before power shifts to the next generation.  However, as the above history shows, kings can abdicate, be assassinated or face deteriorating health.  It is certain that, at some point, the royal family will need to prepare for a new generation to run the kingdom and create a more set line of succession to avoid the current uncertainty.

For now, the greatest immediate risks to the region and markets from this issue are if (a) Abdullah were to become incapacitated or die, and (b) Crown Prince Salman simply isn’t capable of ruling.  Since it isn’t clear that Prince Muqrin would take power, a succession battle could develop sooner than expected.  Given the challenges Saudi Arabia faces, from dwindling American power in the region to a stronger Iran and the breakdown of nation states in the area, a power vacuum in Saudi Arabia would be profoundly dangerous.  If conditions deteriorate, it would likely end the current bear market in oil and lead to higher overall inflation in the developed world.  

Bill O’Grady

January 20, 2015

 

This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinion of the author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

 


1 Hassa al-Sudairi bore seven sons who survived to adulthood.  They are considered perhaps the most influential of Ibn Saud’s sons and are nicknamed “the Sudairi Seven.”

According to Daniel Yergin, Yamani learned of his sacking by hearing it on television. 

Yergin, D. (1991). The Prize: The Epic Quest for Oil, Money, and Power (p. 763). New York: Simon & Schuster.

Confluence Investment Management LLC

Confluence Investment Management LLC is an independent, SEC Registered Investment Advisor located in St. Louis, Missouri.  The firm provides professional portfolio management and advisory services to institutional and individual clients.  Confluence’s investment philosophy is based upon independent, fundamental research that integrates the firm’s evaluation of market cycles, macroeconomics and geopolitical analysis with a value-driven, fundamental company-specific approach.  The firm’s portfolio management philosophy begins by assessing risk, and follows through by positioning client portfolios to achieve stated income and growth objectives.  The Confluence team is comprised of experienced investment professionals who are dedicated to an exceptional level of client service and communication.  

© Confluence Investment Management

[description] => King Abdullah of Saudi Arabia was recently hospitalized with pneumonia. In light of his advanced age and declining health, an analysis of royal succession in Saudi Arabia is in order. We will begin with a history of Saudi kings and follow with an examination of the current Saudi succession, focusing on the Crown Prince and who remains as potential kings among the “second generation” of the Saudi Royal Family. We will analyze the challenges facing the kingdom and how the succession issue will likely complicate the way these issues are resolved, and conclude with potential market ramifications. [author] => Bill O'Grady [legacyinterface_firm_id] => 98 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 15:54:29 [created_by] => 948 [modified_on] => 2015-01-21 15:55:25 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2393 [hits] => 0 ) [4] => stdClass Object ( [legacyinterface_commentary_id] => 2328 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15565 [apv_conversation_id] => 3243 [content_type] => market-commentary [title] => Greece's Perilous Odyssey [slug] => abbett_012115 [fulltext] =>

Greeks will go to the polls on January 25. The outcome may lead to debt repudiation, other severe losses on assets, and the beginning of the end of the common currency. Even if Europe avoids the worst, the best anyone can hope for is heightened levels of uncertainty. It is not a pretty picture, and the blame for this mess is so widespread that it would take a book just to name the people and institutions responsible.

The Story So Far
Greece has for some time occupied the epicenter of Europe’s troubles. It was, after all, Athens that in 2009 triggered the Continent’s still-raging fiscal-financial crisis by admitting that it had misled about its financial health. Since then, Greece has received two European Union (EU) bailouts, totaling €240 billion, each conditioned on budget austerity and other economic reforms pressed by the EU, the European Central Bank (ECB), and the International Monetary Fund (IMF), the so-called troika. These reforms included measures to privatize government assets and steps to make the economy more dynamic and competitive through labor market and regulatory reforms. Greece has stuck to its promised budget austerity, though not without considerable angst and political close calls. Though troika monitors remain disappointed about other reform efforts, they had pretty much concluded that Athens had come far enough to emerge from bailout strictures. The country’s budget had balanced, they noted, and the economy was beginning to grow, albeit haltingly and from a deep recession.1

But crisis has found Greece again. This latest phase arises from a quirk in Greece’s political process. The largely ceremonial position of president is vacant. Prime Minister Antonis Samaras of the new Democracy party—center-right, pro-austerity, pro-cooperation with the troika—put forward Stavros Dimas for the post. Normally, this would have been a political non-event. Dimas ran unopposed. But the left-leaning, anti-austerity Syriza party, then leading in the polls, realized that a failure to get sufficient votes would trigger a general election. It worked with other opposition parties, including the far-right and actively anti-Europe Golden Dawn party, to vote down Dimas. Prime Minister Samaras had to call an election. Perhaps because Syriza’s lead in the polls had by then narrowed, he decided on an earlier rather than a later date. Now this quirk has raised the chance of an anti-austerity coalition coming into power in Athens and with it possibly an end to Greek cooperation with the troika, even an end to Greek membership in the common currency.2   

Uncertainties Inside Uncertainties
It is entirely possible that Samaras will return to office. Syriza’s lead has already shrunk from double-digits not too long ago to only three percentage points, according to some polls, well within their statistical margin of error. But even with a Samaras victory, uncertainties would remain. No doubt chastened by his defeat in the presidential poll and by the need to have called an election, he could easily show a greater willingness to soften austerity policies and delay other reforms still longer. Europe in time might find him and his new coalition much less cooperative than he or it once were. And this is the most stable and predictable of the potential environments that could emerge from the Greek vote.3    

A Syriza victory, with its volatile leader, Alexis Tsipras, as prime minister, would open a myriad of possibilities, one more destabilizing than the other. Actually, there is no way to know what sort of agenda he might put in place. He has over the last couple of years talked out of so many sides of his mouth that Greeks going to the polls later this month really cannot know for what or against what they are voting. When Syriza first gained popularity, Tsipras expressed unrestrained hostility to Greece’s membership in the euro and argued that Athens should repudiate much of its debt. More recently, he has softened his resistance to euro membership, though he still espouses a determination to tear up the austerity conditions imposed by the troika. His current position on debt repudiation remains ambiguous. All this could, of course, change again after a newly elected Prime Minister Tsipras had time to meet with German chancellor Angela Merkel, ECB president Mario Draghi, and the IMF.4     

Against such a backdrop, the election promises anything from an ambiguous moderation in Greece’s playbook all the way to an exit from the common currency, what journalists in the early days of the current crisis referred to as “Grexit.” It is little wonder, then, that markets quickly upped the interest rate charged on Greek borrowing, from about 5.5% a few weeks ago to 9.5% right after the election was called.5

Possibilities—Some Helpful, Most Destructive       
For the Greeks, these more extreme possibilities could cut two ways. On the positive side, an exit from the euro and a return to a depreciated drachma would aid growth by making Greek goods and services cheaper to the rest of the world and, accordingly, more competitive. Debtors within Greece would benefit, too, having the ability to discharge their obligations in a currency much depreciated against the euro. On the negative side, such a prospect would destroy wealth. Greek savers would see the global purchasing power of their assets drop with a drachma depreciation, whatever initial conversion rate the government determined.

For those holding the outstanding overhang of euro-denominated Greek debt, the matter could get even more complex. An outright repudiation would, of course, bring complete losses to lenders, most directly to banks elsewhere in Europe and indirectly to anyone who holds equity in or the debt obligations of these European banks. That would include many American financial institutions and investors. A rescheduling of the debt, perhaps by lengthening maturities or arbitrarily reducing the stated interest payments, would cause less drastic immediate losses, but losses nonetheless. These hardships would occur whether Greece stayed in the euro or exited, though it is an open question whether the rest of the eurozone would allow Greece to remain in the common currency after repudiating its debt or unilaterally rescheduling it.

An exit from the euro would add still more complications. Greece could return to the drachma and still honor its euro debt, though the government would face a great burden in doing so, since it would take a lot of depreciated drachmas to meet those euro obligations. It is possible, if not especially likely, that Greece could exit the euro and insist on rescheduling the outstanding debt in drachma, imposing a huge loss on lenders, though not as much as with outright repudiation. No doubt such a move would create international lawsuits and take years to resolve. In any of these possibilities, Greece would find it much more difficult and expensive to borrow on international financial markets, especially with a return to the drachma, for then lenders would insist on a special premium to protect them against possible future currency losses, certainly a greater premium than they would demand with euro-denominated debt.

In one respect, Greece can matter only little to Europe or the eurozone. It is too small to threaten the basics of either European economics or finance. Its gross domestic product (GDP), at the equivalent of $243 billion in 2013, is not even a fifth the size of Spain’s, only slightly more than one-tenth the size of Italy’s, and barely more than one-twentieth the size of Germany’s economy. Greece’s outstanding debts amount to only 1.0% of all European bank assets. It would not be a happy day if those Greek assets were to become worthless, but it would hardly become the stuff of a financial catastrophe. The financial system would remain no less sound than it is presently, and Europe’s economy might even look marginally stronger with Greece gone.6

But in another respect, a Greek exit or debt rescheduling could have serious ramifications by pointing up alternatives for other beleaguered members of Europe’s periphery. Any debt repudiation, with or without an exit from the common currency, could tempt other heavily indebted nations to fellow suit, entirely or partially, as a way to ease their immediate burdens. Even if Greece were to take no more drastic a step than to renegotiate the austerity strictures of its bailout, others might ask for similar concessions. Granting them would undermine EU efforts at control and delay the continent’s return to overall financial health. It also could erode critical German support by putting the lie to the promises Berlin gave to convince German taxpayers to bankroll the bailout. And if Athens were to withdraw from the euro, questions about the ultimate viability of the common currency would grow, complicating any efforts at financial healing and making it that much more difficult to hold this experiment together. 

Likelihoods    
To assess which of these directions is likely, however, is clearly impossible at this juncture. What is clear, though, is that for the foreseeable future, Europe will labor under more uncertainty than previously, and with three prospects: 1) Greece will continue for some time to pay considerably higher borrowing rates than it did just a few weeks ago, which could in time undermine some of the budget gains the country has made even if in the interim Athens holds to its austerity promises; 2) to the extent that Greek intransigence grows, fears over a general turn in this direction elsewhere in Europe’s periphery will tend to raise borrowing costs there, even if these governments make no overt statements or actions to step away from austerity; and 3) prospects for the eurozone will remain ever more doubtful than in the past, weighing further on the euro’s value and making it still more difficult than it already is for the zone’s leadership, particularly at the ECB, to plan or otherwise conduct its business effectively.  

1 See, “Greece Crisis: Schaeuble Warns Over Reform,” BBC News, December 30, 2014.
2 See, Renee Maltezou and Deepa Babington, “Small Parties to Play Outsized Role in Greek Election,” Reuters, December 30, 2014.
3 See, “First Round Failure,” The Economist, December 18, 2014.
4 See, “The Euro’s Next Crisis,” The Economist, January 3, 2015.
5 Data from Bloomberg.
6 Data from Eurostat.

© Lord Abbett

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The European Central Bank (ECB) is likely to announce a quantitative easing (QE) program involving European sovereign bond purchases at its upcoming policy meeting on January 22, 2015. Recall back in September of 2014, in our two-part Weekly Market Commentary “Don’t Fight the ECB?” we highlighted several reasons for favoring U.S. equities and largely avoiding European equities, despite the ECB’s prior stimulus efforts and potential for outright QE. With QE likely forthcoming, we revisit the opportunity in Europe, which we believe may be setting the stage for a head fake.

WHAT WE ARE WATCHING

As we evaluate the opportunity in European equities, here is what we
are watching:

·        Economic growth

·        Inflation

·        Earnings

·        Valuations

·        Loan growth

·        Relative strength

Economic growth gap between the U.S. and Europe is widening. The U.S. economy has been growing faster than Europe in recent years based on real gross domestic product (GDP). Based on the Bloomberg-tracked consensus of economists’ forecasts for the fourth quarter, Eurozone GDP grew 0.9% during 2014, compared with 2.3% for the U.S. We expect that gap may widen in 2015, as our forecast for U.S. GDP growth (discussed in our Outlook 2015: In Transit publication) is at least 3%.* Even with QE, we do not expect growth in Europe to accelerate in the near term, and as a result we expect this growth gap may widen — although the gap in the third quarter of 2014 of more than 4% (5.0% in the U.S. versus 0.6% in the Eurozone) is not expected to be sustained.

*As noted in the Outlook 2015, LPL Financial Research expects GDP to expand at a rate of 3% or higher, which matches the average growth rate of the past 50 years. This is based on contributions from consumer spending, business capital spending, and housing, which are poised to advance at historically average or better growth rates in 2015. Net exports and the government sector should trail behind.

Deflation risk remains high. Sluggish growth and structural challenges (more on that to come) have led to deflation in Europe, which could result in delayed purchases and investment, further slowing the economy. December 2014 annual inflation in the Eurozone was just -0.2%, or 0.8% excluding food and energy (Eurostat data), not anywhere close to the ECB’s 2% target. Meanwhile, inflation expectations have continued to fall. QE could help a bit in this regard, but we do not expect it to be enough to drive a sustained gain in prices, especially when considering the lack of economic growth.

Earnings mirage. Earnings are expected to increase by 25% in Europe, year over year, in the fourth quarter of 2014. But the gain is all due to depressed financial sector earnings a year ago, which are propping up earnings growth for that sector, while revenue growth is nonexistent. Just three Euro Stoxx 600 sectors are expected to grow earnings based on Thomson Reuters estimates, while eight S&P 500 sectors are expected to grow earnings year over year (for an overall expected mid-single-digit gain). Although S&P 500 revenue is only expected to grow about 1% during the fourth quarter of 2014 (despite the 15% expected drop in energy revenue), that looks good compared with the 2.1% revenue drop expected for Europe. We expect slow growth and extremely low inflation to continue to weigh on European earnings, despite the export benefit of the weak euro.

European valuations look cheaper than they are. European stock valuations (excluding the United Kingdom) are lower than those in the United States based on price-to-earnings ratios (PE) [Figure 1], and they have gotten cheaper since we last wrote on the subject. The discount is currently 12% on a trailing PE basis and 17% on a forward basis. Adjusting for sector mix (the S&P 500 is much more growth oriented, which carries higher valuations), these discounts close significantly. For example, technology makes up about 17% of the S&P 500, compared with just 4% of the MSCI Europe Index, while the MSCI Europe has about triple the weight of the S&P 500 in telecoms and utilities (11% versus 4%). Given the economic growth gap and sector mix, we currently do not find the valuation discount to the U.S. particularly attractive.

Credit still not flowing. The fractured banking system may mute the effectiveness of QE, because increases in the money supply have not translated into loan growth [Figure 2]. Banks are still undercapitalized and some of the region’s banks still have problems with bad loans, which, when combined with economic uncertainty, is constraining lending. Credit is the fuel for economic growth and European private sector lending — though falling more slowly — is still down 1.1%, year over year, in the latest reported period (November 2014).

Relative strength trend still negative. Since the start of the current bull market in March 2009, European stocks have struggled mightily, relative to the U.S. In 2014, Europe’s loss (based on the MSCI Europe Index) trailed the S&P 500’s 13.7% gain (total return) by more than 19 percentage points, and Europe has slightly underperformed the U.S. so far this year through January 15, 2015 [Figure 3]. From a technical perspective, we have not yet seen enough sustained relative momentum to signal an attractive opportunity relative to the U.S (we should note we are getting closer in emerging markets [EM]).

CONCLUSION

Although we would view a potentially bold QE program from the ECB as an incremental positive, the ongoing growth and deflation challenges in Europe leave us still with a strong preference for the U.S. and a belief that any short-term rally may be short lived. For overseas opportunities, we would first look to EM with a focus on Asia. European valuations have become a bit more attractive and the weak euro may help drive more exports, but we would like to see more fundamental and technical improvement — and get past the risk that the ECB disappoints — before considering a possible Europe trade. 

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not ensure against market risk.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

All investing involves risk including loss of principal.

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The MSCI Europe Index captures large and mid cap representation across 15 developed markets (DM) countries in Europe.

The STOXX Europe 600 Index is derived from the STOXX Europe Total Market Index and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid, and small capitalization companies across 18 countries of the European region.

DEFINITIONS

Eurostat is the statistical office of the European Union situated in Luxembourg. Its task is to provide the European Union with statistics at European level that enable comparisons between countries and regions.

The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio.

The money supply is an economic term for the total amount of currency and other liquid assets available in an economy at a point in time. There are several ways to define this number. M1 includes physical money such as coins and currency, checking accounts (demand deposits), and Negotiable Order of Withdrawal (NOW) accounts. M2 includes all of M1, plus time-related deposits, savings deposits, and non-institutional money-market funds. M3 includes all of M2, as well as large time deposits, institutional money-market funds, short-term repurchase agreements and other larger liquid assets. M3 is considered the broadest measure of an economy’s money supply.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

Tracking #1-346125 (Exp. 01/16)

© LPL Financial

[description] => The much anticipated European Central Bank (ECB) policy meeting this week may include a quantitative easing (QE) program announcement. Although we would view a potentially bold QE program from the ECB as an incremental positive, the ongoing growth and deflation challenges in Europe leave us still with a strong preference for the U.S. [author] => Burt White [legacyinterface_firm_id] => 490 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 16:12:36 [created_by] => 948 [modified_on] => 2015-01-21 16:12:48 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2395 [hits] => 0 ) [6] => stdClass Object ( [legacyinterface_commentary_id] => 2330 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15567 [apv_conversation_id] => 3245 [content_type] => market-commentary [title] => Investor implications of QE by the ECB [slug] => merk_012115 [fulltext] =>

cartoon

Background

First some background: Draghi argues that the law requires the ECB to pursue an inflation target of close to 2%. To achieve this, he says the ECB will alter the “size, pace, and composition” of its balance sheet. A couple of months ago, he further indicated he would like to get back to the 2012 size of the ECB balance sheet.

The size of a central bank’s balance sheet is colloquially referred to as the amount of money “printed,” even if no physical currency is printed. Most central banks “print” money by buying bonds (also referred to as quantitative easing, or QE). When they buy securities from a bank, they literally create the money out of thin air, as they simply provide a credit to the bank with the stroke of a keyboard. That’s what the Federal Reserve and Bank of England have done. That’s what the Bank of Japan is currently doing. When pursuing QE, central banks dictate how much money is being “printed.” The general idea behind QE is that it eases credit conditions and encourages banks to lend more. In the U.S., QE caused excess liquidity (i.e., unneeded cash) to build up in the banking system. Fortunately for the banks, they can earn some small amount of interest on that excess US dollar cash from the Fed through interest paid on excess reserves.

The ECB balance sheet has historically been demand based. In other words, rather than ‘printing’ money, the ECB has provided liquidity against collateral. In 2012, banks extensively accessed the ECB’s facilities. As there has been little demand for borrowing in the real economy, banks first parked the excess cash with the ECB, then started to return the liquidity once they were allowed to do so, causing the ECB balance sheet to shrink once again:

graph 1

A couple of things have changed since 2012:

The ECB all but promises to keep rates low for an extended period;

Rather than earning interest, banks are now charged for parking cash at the ECB in the form of a negative deposit rate.

If you put yourself into the shoes of a bank: why would you sell your securities for cash, unless you have a project to fund? Holding cash has become expensive because of negative deposit rates. Furthermore, because the ECB promises to keep rates low, why not hold off in accessing liquidity until there is real demand from borrowers?

It should be clear, though, that the negative deposit rate at the ECB makes comparing today’s balance sheet to that of 2012 akin to comparing apples to oranges. Not content with low inflation expectations, Draghi is expected to announce a QE program this Thursday. Let’s keep in mind that anyone selling bonds to the ECB must do something with the cash. QE programs in other countries allowed banks to earn some interest on their excess cash. At the ECB, sellers will have to pay the ECB to in order to hold excess cash. As a result, sellers will think twice before selling. Having said that, at the right price, there will be sellers. However, we are now moving from apples and oranges to bananas – pardon the pun: any amount of buying by the ECB will be more potent with negative interest rates on cash deposits at the ECB, casting serious doubts over whether it is appropriate to state that the 2012 size of the balance sheet is the appropriate size.

Given publicly available comments, odds are that the ECB intends to “print” approximately €600 billion trough QE, although estimates range from €500 billion to substantially higher. More likely is an open-end program where Draghi will announce a pace of purchases, then indicate the ECB will adjust the “size, pace and composition” of the balance sheet, as needed.

Draghi’s excuse

So what’s going on? Here’s what spooks Draghi:

graph 2

Without becoming too technical, the cryptically titled “5y5y inflation expectations” are longer-term inflation expectations in the Eurozone. Basically: the fear is that the ECB misses out on its mandated target of close to 2% inflation. As central banks control the printing press, the theory goes, they should be able to control inflation. For comparison, please see the chart below that shows a similar trend in the U.S.:

chart

In the past, former Fed Chair Bernanke announced new rounds of QE when inflation expectations were falling as they are today. Not now. The U.S. recovery is said to be on track; and those pesky low inflation expectations are merely a distortion in the data based on falling oil prices.

In contrast, Draghi shrugs off the benefit of low oil prices and clings to the ECB’s legal mandate to boost inflation. Never mind that the ECB has said many times that a key problem preventing growth in the Eurozone is its “broken transmission mechanism,” i.e. impaired banks. While banks in the Eurozone are gradually getting healthier, the emphasis is on gradual: it takes time. With a more well-functioning transmission mechanism in the U.S., our analysis shows, should demand for borrowing pick up, inflation has a much easier time gaining foot in the U.S. In contrast, it’s very difficult to induce inflation in the Eurozone with banks unwilling and/or unable to lend.

Never mind that sanctions against Russia are a significant headwind to growth. Never mind that Germany has engaged in structural reform and as a result is doing just fine and doesn’t need QE. German economic sentiment is picking up. In contrast, the laggards in the Eurozone may sorely need structural reform, but are getting QE instead.

We have to conclude that Draghi is using falling inflation expectation as an excuse to pursue QE.

Draghi’s real motivation

Draghi gave what we believe is his real motivation in a press conference last summer: structural reform with a high exchange rate is politically very difficult. Namely, with a strong euro, workers have to accept lower wages to become more competitive. The alternative is to increase competitiveness through a weaker exchange rate, avoiding the difficult process of telling workers that their wages need to be cut. The backlash against structural reform has shown to Draghi – and this is our interpretation – that pain thresholds have been reached. As such, Draghi clings to the ECB’s inflation target to come to the rescue of governments.

Except, of course, that the will for structural reform might evaporate when the ECB takes away the pressure for reform. While not perfect, amazing steps towards reform were taken when bond markets forced policy makers to their knees. None of that anymore, so it seems.

Draghi has argued that a weaker euro would be inflationary. An implicit goal of QE appears to be to weaken the euro. Indeed, the euro has weakened from a high of 1.3993 versus the greenback last May to 1.1547 as of this writing.

Hurdles

It should also be noted that Draghi has earned himself a reputation that he is not afraid of over-delivering. However, he faces the practical problem that European debt markets aren’t as liquid as U.S. markets. Draghi has indicated he wants to foster rather than inhibit trading; however, the Bank of Japan has all but destroyed liquidity in Japanese Government Bonds as that central bank gobbles up securities. Odds are that a quarter of the securities the ECB is going to buy are German bonds. With yields already negative for German 5 year notes, it will be interesting to see how far Draghi is willing to push them down. In some cases the ECB may be buying bonds with negative yields, thus guaranteeing a loss to the ECB. Various news stories have indicated that the ECB will also buy securities of supra-national agencies, such as the European Investment Bank. The ECB can implement a €600 billion bond purchase program; many observers –including us – doubt, however, that the ECB could dramatically ramp up that program. And when it comes to managing inflation expectations, the unlimited bazooka is what matters.

The other practical problem is the potential political backlash against QE. On Tuesday, German Chancellor Angela Merkel spoke at an event with Draghi in the audience: "I have only one plea ... and that is aimed at all the representatives of the ECB: it must be avoided that any action taken by the ECB in any respect whatsoever could result in the impression that what needs to be done in the fiscal and competitive spheres could be pushed into the background."

Investor implications

When it comes to QE, expectations matter. In fact, in the U.S., the announcement of QE might have had a bigger impact than its implementation. In Japan, both announcement and implementation have had an impact, although it needs to be said that the program at the BOJ is of a much bigger scale than the Fed’s program ever was. If we look at the Eurozone, the above chart says it all: the market is not impressed, inflation expectations in the Eurozone continue to fall. The hurdles listed above appear to be meaningful.

In the meantime, “everyone” says the euro has to weaken. Even the Swiss National Bank has thrown in the towel. Speculative positions on the U.S. dollar show an extremely bullish sentiment. What could possibly go wrong?

When exchange rates move, they do so in anticipation that a central bank “will do the right thing” – or at least the thing that’s expected of them. So if inflation ticks up, for example, a country’s currency often rises as a central bank is expected to raise rates. It’s then months later that reality kicks in and the currency adjusts downward again if the central bank is not living up to expectations. In case of the U.S. dollar, investors appear to be counting on a hawkish Fed. We call the Fed’s posturing one of wishful thinking, doubting they can be so tough in light of falling inflation expectations. The Fed’s promise to be patient in raising rates appears to signal that they indeed want to be, well, late.

Not surprisingly, gold has done quite well in this environment: with real interest rates firmly in negative territory in much of the world – including the U.S., this shiny brick that pays no interest appears to be a formidable competitor.

Implications for investors go much further, though: central banks may be becoming a destabilizing force. The Swiss example shows how imbalances can correct violently as policies are reversed. What happened to the Swiss franc can happen to stocks and bonds. For more details on this, please read my OpEd in the Financial Times.

Axel Merk

Axel Merk is President & CIO of Merk Investments
Manager of the Merk Funds

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Merk Investments LLC makes no representation regarding the advisability of investing in the products herein. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice and is not intended as an endorsement of any specific investment. The information contained herein is general in nature and is provided solely for educational and informational purposes. The information provided does not constitute legal, financial or tax advice. You should obtain advice specific to your circumstances from your own legal, financial and tax advisors. As with any investment, past performance is no guarantee of future performance.

© Merk Investments

 

[description] => Is European Central Bank (ECB) head Draghi’s determination to purchase government bonds turning Europe into a banana republic? What are the implications not only for the euro and U.S. dollar, but gold, stocks and bonds? Our analysis shows that conventional wisdom may be proven wrong in more than one way. [author] => Axel Merk [legacyinterface_firm_id] => 292 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 16:22:45 [created_by] => 948 [modified_on] => 2015-01-21 16:23:14 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2396 [hits] => 0 ) [7] => stdClass Object ( [legacyinterface_commentary_id] => 2331 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15568 [apv_conversation_id] => 0 [content_type] => market-commentary [title] => Tocqueville Gold Strategy Investor Letter: Year End 2014 [slug] => tocqueville_012115 [fulltext] =>

It is a little-known fact that gold outperformed all currencies in 2014, except for the US dollar. In dollar terms gold declined 1.7 percent, but as the table below shows, it posted solid gains against all other currencies. While the dollar price of gold was essentially flat in 2014, highly negative media coverage created the impression that gold was a disaster. Negative sentiment weighed heavily on the performance of gold-mining shares, with our benchmark XAU index down 17.3 percent. Meanwhile, dollar bulls appear dangerously overcommitted to the greenback, with open interest at an all-time high. The dollar’s strength relative to other currencies has camouflaged the strength of gold. Both dollar and gold strength in our opinion portend trouble ahead for financial assets (click here). It seems to us that with financial assets at all-time highs and red flags proliferating, this is an opportune moment to acquire cheap wealth insurance in the form of physical metal and precious-metal mining shares.
 


 

We share the view of many contrarians that the six-year bull market in equities has been powered in large part by the Fed’s policy of zero-interest rates and quantitative easing, which has driven investors into risky assets. As noted by Fred Hickey in his January 4, 2015, newsletter (High Tech Strategist), “The market’s price to sales ratio is at an all-time high, the market capitalization to GDP ratio (Warren Buffett’s favorite indicator) is the second highest in history…. The Shiller Cyclically Adjusted P/E Ratio for the S&P is 27. That level has been exceeded only two times before – in 1929 and 2000.”
 

It seems to be the consensus view, and it is certainly the party line of the Fed, that the money printing of the past six years is history. As Hickey points out, if the fuel for the market advance has been spent, what is there left to support lofty equity valuations? Numerous factors point to spreading economic weakness for the global economy. These include the weakness of foreign currencies relative to the US dollar (which increases the debt load of dollar-denominated debt, fueling the growth of emerging market economies), falling commodity prices, widening credit spreads, and a broad assortment of feeble economic reports that market bulls choose to ignore. If we are correct in our view, corporate earnings are set to decline, undercutting a key pillar of the bullish case for equities.
 

We believe that a serious market correction, or the onset of a bear market, would exert extreme pressure on the Fed to reverse course and resume money printing. The Fed, most likely aware that their credibility is at stake, would probably resist this option at all costs. Capitulation to market weakness by the Fed at this juncture would in our opinion lead to the evaporation of confidence in all central banks, since investors would be forced to accept the proposition that money printing, once started, can never be stopped.
 

A return to quantitative easing would be transformational for the perception of gold. We believe the transformation would happen suddenly. As noted by investment luminary Paul Singer in a letter to his clients, confidence, especially when it is not deserved, is a thin veneer. When confidence falls apart, the consequences can be quite severe. In a recent interview, Jeffrey Gundlach, CEO of investment giant DoubleLine, commented, “It is interesting how you have been beginning to see signs of investor concern around the edges about the health of the economy and about the financial system. Historically, when junk bonds give up the ghost and treasuries remain firm, it is a signal that something is not right.” In our view, the hidden strength of gold during 2014 is another sign that investors are starting to sense that something is not right.
 

We believe that capital is beginning to scramble towards higher ground in anticipation of a monetary crisis. To us, this explains the relative strength of the US dollar. The same concern is reflected in the less obvious strength of gold. As of this writing, the euro price of gold has surpassed the 1,000 level. The downtrend of the past three years seems to have been broken in euro terms. Investment flows from Asia continue strong. China and India now buy as much gold as the mining industry produces. While the Chinese central bank remains secretive, not having updated gold reserves reporting since 2009, the sharp decline in purchases of US Treasuries (see below) implies a step up in gold purchases.
 

Central bank buying, led by Russia, is robust; central banks have added gold bullion to reserves for 14 straight quarters. Political pressure to repatriate gold bullion has also been on the rise. Countries considering or successfully repatriating gold include the Netherlands, France, Belgium, Austria, and Germany. As noted by Casey Research, repatriation has led to the biggest drawdown in gold held at the NY Fed in more than 100 years.
 

Source: MeridianMacro
 

We believe that a breakdown of trust in financial intermediaries – including bullion banks, “synthetic” gold substitutes such as ETFs, and derivatives, as well as the integrity of central-bank custodial relationships – is behind the growing clamor to repatriate physical gold bars owned by sovereign states. Ebbing confidence is not limited to the official sector. Gunvor, the world’s fifth-largest commodity trader, decided to discontinue gold trading in part “because of difficulties in finding steady supplies of gold where the origin could be well documented” (Bloomberg, 12/12/14). Grant Williams, of Vulpes Investment Management, explains, “Because of the mass leasing and rehypothecation programs [the use by financial institutions of clients’ assets, posted as collateral] by central banks, there are multiple claims on thousands of bars of gold. The movement to repatriate gold supplies runs the risk of causing a panic by central banks.”
 

Loss of trust is the genesis of bank runs. Bullion banking is a fractional reserve system in which large amounts of credit are extended based on a relatively small quantity of physical metal. Sovereign gold bars are a major component of the credit base. We believe this is a story to watch very closely in the coming year.
 

It seems to us that that the circle of those disparaging gold has dwindled to a rear guard of hard-core, dollar-centric addicts still hooked on a monetary policy designed to herd investors into risky assets. In a truly Orwellian transposition, gold, the safest asset in history, is maligned by the financial media as risky, while financial assets at near-record valuations are viewed as compelling. In the simplistic logic that passes for financial wisdom, if equities are good, then gold must be bad. If there has been a Greenspan/Bernanke put for equities, why not a Yellen cap for gold?
 

Such a notion might explain the fearless manner in which gold has been periodically trashed. A skidding $US gold price confirms that all is well. “Synthetic” gold, created by bullion banks for propriety-trading desks, high-frequency traders, and commodity traders, is dumped (often following Fed policy pronouncements) onto thin markets during non-trading hours to trigger stops and spread panic. No physical gold changes hands during such raids. Sellers abandon any pretext of “best execution,” the usual standard for discrete distribution of positions. Instead, the raids are crafted to smash the price with as much noise as possible.
 

We believe that the gold market has been manipulated, which to us is no surprise. Rigging has become a central feature of financial markets since the onset of quantitative easing. Too-big-to-fail banks, US and European, have admitted to manipulating Libor, energy, and currencies. Zero-interest rates and quantitative easing are to us blatant manipulations of bonds, interest rates, and equities. Why should gold be exempt? On December 15, 2014, a class-action lawsuit filed in the United States District Court, Southern District of New York (In Re: Commodity Exchange, Inc., Gold Futures and Options Trading Litigation) named the Bank of Nova Scotia, Barclays plc, Deutsche Bank AG, HSBC plc, and Société Générale SA as defendants on allegations of price fixing in the gold market. The various allegations in the Complaint include the following:
 

The PM Fixing aligns with the opening of the New York market, and specifically the Commodity Exchange, Inc. (COMEX) market on which gold futures and other derivative contracts are traded…. The economic and other evidence overwhelmingly shows that Defendants sought to avoid the uncertainties and risks associated with the gold derivatives market – i.e., that the market would move against a Defendant’s short position – by agreeing to manipulate the PM Fixing through repeated conduct to artificially suppress the price of gold.
 

The Complaint is now in the hands of the district judge. The allegations are supported by exhaustive statistical data, similar to those produced in the previous successful action against Libor manipulation. The defendants have filed a motion to dismiss; the judge will decide in the coming months whether to allow the case to proceed. If the case proceeds, we would hope it results in placing important participants on the witness stand. However, should it get to that point, there is a possibility that the defendants could propose a settlement to avoid discovery, which in our opinion would be disappointing.
 

Regardless of how the litigation is resolved, we believe that the scrutiny from regulators in Germany, Switzerland, and the UK (FCA), along with these legal actions, has already caused a change in behavior by bullion banks and other institutions involved in price manipulation. Deutsche Bank, for example, has withdrawn from precious-metals trading. In other cases, internal and external legal scrutiny of precious-metals trading activity will most likely lead to reduced participation by many of these institutions.
 

For investors, the overriding question is what these changes might imply for future gold prices. In the short run, we believe that price raids mounted by synthetic supply will become less frequent and less intense. We believe that in time, should our expectation prove correct, the gold market may come to seem less dangerous and perhaps less mysterious to those who wish to initiate long exposure. Over the longer term, we believe that the diminished presence of Western institutions in precious metals markets, and the supplies of synthetic gold in which they specialize, will allow the very bullish supply and demand equation for physical metal to be reflected in the price. Should this shift occur in concert with a diminished role for the US dollar as a reserve currency – a prospect most certainly desired by the BRICs and other developing economies – gold will play an expanded role and the dollar gold price will benefit. The perfect storm for gold would be for these structural changes in the gold market to occur in conjunction with a loss of confidence in central bankers.
 

Mining Stocks
 

While gold held its own during 2014, mining stocks did not. Even though our benchmark XAU index rose 20.60 percent through the first half of the year, those gains were more than erased during the second half; on the year the index declined 17.29 percent. However, the index does not tell the entire story. Many of our holdings showed decent gains during the year, and on the whole our clients’ portfolios outperformed the index by a substantial amount.
 

Positive factors for the mining industry include declining costs (oil being a major input) and better discipline applied to capital allocations. Scotiabank estimates that each $1/barrel decline in the oil price translates into a $1/ounce reduction in cash costs. The impact of oil alone therefore would amount to a roughly 7-percent reduction in production costs globally. In addition, the strength of the US dollar also impacts costs favorably, as most of the world’s gold is produced outside the US. These two factors alone, in our estimation, would result in a 10-percent decline in global cash costs for the coming year. The benefits of cost-cutting initiatives, including significant workforce reductions launched in 2013 and 2014, are likely to become more visible in 2015 and beyond.
 

For the intermediate term, mine supply seems likely to decline (assuming flat gold prices), which should ultimately be constructive for gold prices. The industry is in the midst of a period of reassessment and restructuring that began at the end of 2013. There are many new CEOs whose principal mandate is to improve returns on capital. Obviously, some companies will be more successful than others in achieving those returns. Overall, we expect to see divestitures, balance-sheet improvement, and M&As.
 

A good part of our success last year arose from our exposure to the royalty companies. Their business thrives during periods of capital scarcity for gold miners. In addition, several of our important holdings were able to add value through the advancement of mine construction or astute acquisitions. Lastly, one of our largest holdings, Osisko Mining, was taken over by Agnico Eagle and Yamana. The residual piece of the original company has been reconfigured as a royalty company and remains an important holding.
 

It is essential to remember that the gold-mining industry is not monolithic. There are some companies that are well managed and are able to create value despite the difficult gold market of the past few years. Of course, there are other companies that seem to destroy value year in and year out. Clearly, our strategy is to concentrate our holdings in those companies that add value for shareholders during difficult periods, independent of the gold price. When the gold market improves, we believe that our core holdings will perform consistent with the gold price and our relevant benchmarks.
 

With all best wishes for a prosperous 2015!

John Hathaway
Senior Portfolio Manager
© Tocqueville Asset Management L.P.
January 15, 2015
 

This article reflects the views of the author as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast or opinion will be realized.
 

References to stocks, securities or investments should not be considered recommendations to buy or sell. Past performance is not a guide to future performance. Securities that are referenced may be held in portfolios managed by Tocqueville or by principals, employees and associates of Tocqueville, and such references should not be deemed as an understanding of any future position, buying or selling, that may be taken by Tocqueville. We will periodically reprint charts or quote extensively from articles published by other sources. When we do, we will provide appropriate source information. The quotes and material that we reproduce are selected because, in our view, they provide an interesting, provocative or enlightening perspective on current events. Their reproduction in no way implies that we endorse any part of the material or investment recommendations published on those sites.
 

Source:  Tocqueville
Author:  John Hathaway
[description] => John Hathaway, manager of the Tocqueville Gold Fund (TGLDX), looks back at the performance of gold over 2014, noting that: "in dollar terms gold declined 1.7 percent, but…it posted solid gains against all other currencies," and that "the dollar’s strength relative to other currencies has camouflaged the strength of gold." [author] => John Hathaway [legacyinterface_firm_id] => 431 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 16:27:24 [created_by] => 948 [modified_on] => 2015-01-21 16:27:49 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2397 [hits] => 0 ) [8] => stdClass Object ( [legacyinterface_commentary_id] => 2312 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15548 [apv_conversation_id] => 3226 [content_type] => market-commentary [title] => The Swiss Release the Kraken! [slug] => mauldin_012015 [fulltext] =>

“Below the thunders of the upper deep,
Far far beneath in the abysmal sea,
His ancient, dreamless, uninvaded sleep
The Kraken sleepeth: faintest sunlights flee….

“There hath he lain for ages, and will lie
Battening upon huge sea-worms in his sleep,
Until the latter fire shall heat the deep;
Then once by man and angels to be seen,
In roaring he shall rise and on the surface die.”

– Alfred, Lord Tennyson, “The Kraken

"The exact contrary of what is generally believed is often the truth."

– Jean De La Bruyère

“Cry ‘Havoc!’ And let slip the dogs of war!”

– William Shakespeare, Julius Caesar, Act III, Scene I

“No mas!”

 – Roberto Duran to the referee at the end of his fight with Sugar Ray Leonard, 1980

If you want evidence that central bankers play by their own rules, regardless of what they say or what conventional wisdom tells us, last week’s action by the Swiss National Bank should pretty much fill the bill. My friend Anatole Kaletsky, in a CNBC interview not long after the announcement, quipped (with a completely straight face) that just as James Bond has a license to kill, central bankers have a license to lie.

Swiss National Bank Chairman Thomas Jordan had assured us just the week before that the Swiss would continue to “hold the peg” whereby the SNB kept the value of the Swiss franc from rising higher than €1.22. “The cap is absolutely central,” he said. And SNB Vice Chairman Jean-Pierre Danthine said publicly only last Monday that the peg would remain a cornerstone of Swiss banking policy.

Early Thursday morning the Swiss abandoned that policy. Much of the press coverage in the (largish) wake of their surprise move has focused on the costs to banks and hedge funds around the world, but you have to realize that serious pain is being felt in Switzerland itself. Every bank and business that held non-Swiss-franc debt or investments took an immediate 15–20%+ haircut on its holdings. Swiss investors lost at least 10% on investments in their own stock market and more on shares they held in other stock markets. Forty percent of Swiss exports go to the Eurozone, and the Swiss franc is now over 30% higher than it was five years ago – with almost half that movement coming in one day. Those exporters just got hammered.

And this was not a painless policy decision for the SNB. Citibank estimates the SNB’s losses to be close to 60 billion Swiss francs. Let’s try to add a little perspective on that. The US is (very) roughly 40 times the size of Switzerland in both GDP and population. At today’s conversion rate, the Swiss lost something like $70 billion if Citibank is right. That’s like the US Federal Reserve’s losing $2.8 trillion. That, my friends, will leave a red mark on any central bank’s balance sheet. Not that the Swiss can’t afford it or that they’re going to be out on the corner with a tin cup, but they do have a considerable quantity of euros that are now much less valuable. And dollars and yen and pounds and renminbi. But then again, they are in the privileged position of having a currency that the rest of the world wants, so much that in order to hold it you will have to take a haircut on your deposits at the SNB, a haircut that is going to increase (more on that later).

There are also serious losses in the international banking community. We are just now beginning to learn how many funds and brokerages will have to close.

Do you think that SNB Chairman Thomas Jordan will be going into the local restaurants and getting high-fives and fist bumps? Exactly what do you think his reception will be in Davos (where he is scheduled to appear)? Christine Lagarde, the managing director of the IMF, gave a somewhat frosty reply to my friend Steve Liesman at CNBC when he asked her only a few hours after Jordan’s move (in what was clearly an already-scheduled interview) about her thoughts on the surprise announcement. She was not amused, but she kept her professional stage smile in place. (It was a very good interview.)

In Norse mythology, the Kraken was a sea monster that attacked ships unaware. In Greek mythology, it was a pet sea monster (of either Hades or Zeus) that would be released upon enemies that annoyed its master. It has been an iconic figure in comics and movies for the last 30 years. “Release the Kraken!” is the standard line prior all hell breaking loose.

In an era when central bankers are supposed to be more open, collaborative, and communicative, what would make the Swiss National Bank decide to turn on a dime and shock the markets – to release the Kraken, as it were? Note that in fact all hell did break loose. Rather than delivering hints accompanied by a few well-placed leaks, the Swiss decided it would be best to completely surprise the markets. It will be a long time before we get the full story on what must have been going through their heads as they reached the decision.

I have spent the last few days reading a great deal and talking with friends, trying to understand the “why” of the suddenness of the Swiss action. If we can get some insight into this question, perhaps it will give us a few clues as to upcoming global central bank policy changes in general and the problems facing Europe in particular.

While I do fully intend to try to reduce the length of my letters this year, this one is going to be longer because it will contain a significant number of charts. We’ll look at the data that made Thomas Jordan and his team at the SNB throw in the towel on their peg policy, and I think we should look at it in depth. Just as Roberto Duran walked away from Sugar Ray Leonard at the end of the eighth round of their famous fight in 1980, telling the referee “No mas,” the SNB signaled that it had had all the pain it could deal with.

The First Casualty of the Currency Wars

My last book, Code Red, was all about the currency wars that I expect to dominate the latter part of this decade, triggered by Japan’s massive quantitative easing. Jonathan Tepper and I pointed out that, going forward, it is every central banker for himself. While the world’s central bankers typically matriculated at the same schools and espouse the same beliefs, and while they regularly meet each other at conferences and BIS meetings and freely employ words like cooperation and collaboration in their dealings with one another, the reality is that they are all politically captive to the countries they serve.

While central bankers may espouse independence from their governments, they do live and work in their particular countries and are largely responsible for those countries’ economic well-being. They are going to do whatever they feel is necessary to help their governments and domestic businesses perform as well as they can, while trying to maintain the stability of their local currencies.

Japan is not going to cater to Korea with its monetary policy; neither is Indonesia really interested in helping Singapore or Malaysia; and countries like Switzerland and Sweden carve out their own paths on the flanks of the Eurozone. The US Federal Reserve has made clear on many occasions that it is not responsible for the policy decisions and outcomes of any other country. If you were the Swiss National Bank and looked at the following data, what would you do? The simple fact is that Europe and the Eurozone just don’t make sense; nor, given the recent Swiss action, do they seem to be pursuing the sorts of policies that would improve their condition.

It’s not just about deflation. Switzerland is experiencing deflation and yet has full employment, a balanced budget, and a positive trade balance. Germany, France, Austria, Belgium, the Netherlands, Finland, Sweden, and Denmark are all either in deflation or close to it.

Recent central bank policy has led to the anomaly of negative interest rates. Negative rates began to show up a few years ago and are now pervasive. I’m going to post close to a dozen charts from Bloomberg. You might want to save this letter so you can show it to your grandkids in 30 years when they complain about aberrant economic conditions and volatility. “Kids, you have no idea what we went through back in the mid-teens! It was way wacko back then.”

Each chart for a European country compares the yield curve from a month ago to today’s. As you can see, rates have moved strongly downward.

Note in the first chart that Switzerland’s 10-year yield is NEGATIVE (-0.08%).

Germany’s yield curve is negative through six years! Which almost forces you out the yield curve, bringing 10-year rates down to below 50 basis points!

Seriously, can you understand a world where French four-year bonds have a negative yield? Or where their 10-year bonds yield about a third of the US rate?

Netherlands rates turn positive four years out – whoopee.

Belgium, with debt-to-GDP of 101%, has negative rates. Go figure.

Meanwhile, Italy has debt-to-GDP of 133% and growing by 4-5% a year and a 10-year bond yielding less than that of the US 10-year.

Spain – all positive, but with a 10-year that pays less than Italy’s.

Gotta love the Portuguese 10-year at 2.97.

Ireland has debt-to-GDP close to 125% and lower rates throughout the yield curve than the US rates.

Rates are even falling in Greece … if you want to go out 17 years.

And here are the US and Japan, for reference.

Japan’s 7-year is almost negative (+0.1%).

Not only are the Swiss not holding the peg, they have put out the “Not Welcome” mat, lowering their negative interest rates to -0.75%, with the implication that if that isn’t enough, they will drop them to -1.5%. You want a Swiss safe haven? It will cost you. And the irony is that many will pay it. Losing only 0.75% a year sounds really good if you are Russian. (The Danes moved their negative rates to -0.2% this morning just to make sure no one starts to see them as a rent-free safe haven.)

Then you look around at the rest of Europe, and what you see, mostly, are problems. Where is the growth going to come from? Russian corporations and oligarchs have taken out massive Swiss-denominated loans, as has much of Eastern Europe. More than one million Hungarians are in dire straits. Nearly 65% of the country's household mortgages are denominated in foreign currencies – mostly Swiss francs, according to the National Bank of Hungary. And according to Bloomberg News, more than 40% of mortgages on the books of Poland’s banks are denominated in Swiss francs. When the borrowed currency surges against the borrower’s home currency, the effective cost of that debt balloons.

Pity the Poor Swiss

To help us understand the mindset of the Swiss central banker, let’s turn to a tongue-in-cheek analysis of the problems of the SNB by my friend Charles Gave. (Charles has a wicked-sharp sense of humor at all times, but he’s at his best when skewering economists.)

They [the SNB] didn’t mind pegging the Swiss franc to the Deutsche mark, but it is becoming more and more obvious that the euro is more a lira than a mark. A clear sign is the decline of the euro against the US dollar.

Mr. Draghi has been trying to talk the euro down for at least a year. This should not come as a surprise. After all, in the old pre-euro days, every time Italy had a problem, the solution was always to devalue.

But the Swiss, not being as smart as the Italians, do not believe in devaluations. You see, in Switzerland they have never believed in the ‘euthanasia of the rentier’, nor have they believed in the Keynesian multiplier of government spending, nor have they accepted that the permanent growth of government spending as a proportion of gross domestic product is a social necessity. The benighted Swiss, just down from their mountains where it was difficult to survive the winters, have a strong Neanderthal bias and have never paid any attention to the luminaries teaching economics in Princeton or Cambridge. Strange as it may seem, they still believe in such queer, outdated notions as sound money, balanced budgets, local democracy, and the need for savings to finance investments. How quaint!

Of course, the Swiss are paying a huge price for their lack of enlightenment. For  example, since the move to floating exchange rates in 1971, the Swiss franc has risen from CHF4.3 to the US dollar to CHF0.85 and appreciated from CHF10.5 to the British pound to CHF1.5. Naturally, such a protracted revaluation has destroyed the Swiss industrial base and greatly benefited British producers [not!]. Since 1971, the bilateral ratio of industrial production has gone from 100 to 175... in favor of Switzerland.

And for most of that time Switzerland ran a current account surplus, a balanced budget, and suffered almost no unemployment, all despite the fact that nobody knows the name of a single Swiss politician or central banker (or perhaps because nobody knows a single Swiss politician or central banker, since they have such limited power? And that all these marvelous results come from that one simple fact: their lack of power.)

The last time I looked, the Swiss population had the highest standard of living in the world – another disastrous long-term consequence of not having properly trained economists of the true faith.

Draghi: Quantitative Teasing

“Whatever it takes!” was Draghi’s mantra just a few years ago. He has been promising action for all that time and has basically delivered nothing. As I noted a few weeks ago, he has pushed his “street cred” to the limit. He really has to deliver something at the January 22 ECB meeting, or the markets will simply no longer believe him. If he doesn’t do something significant, I think the euro could rip higher, applying even more deflationary pressure throughout Europe.

(Note that there is really nothing all that bad about deflation unless you have a high level of debt and your budget isn’t balanced. Then you get caught in a debt spiral, which forces you into something that has come to be universally abhorred, called austerity, which in other days and times was simply called living within your means.)

Draghi is not lacking in the desire to be more like Bernanke and Yellen. The problem is that he must win consensus among the board of governors of the ECB. To do any serious quantitative easing without the approval of Germany and its Bundesbankers would create very serious problems for him in Europe.

It now appears that what the ECB will do is compromise. They will go ahead to do QE, but each country will assume responsibility for its own bonds. Under that plan, Germany will not be responsible for French or Italian or Spanish bonds bought by the ECB. The ultimate responsibility will be with the national central banks of the individual countries.

This would create a “silo effect” and have long-term implications. To take one example, as noted above, Italy has 133% debt-to-GDP, and its debt is growing at 3 to 4% a year. Now, if the ECB began to purchase Italian debt, the cost of that debt would fall. Since Italy has to refinance (and purchase new) at least 10% of its debt this year with an average cost of well over 3.5%, it could lower its overall interest cost. But given that the country is in deflation and will likely be in its third straight year of recession, deficits will be higher than forecast, and debt-to-GDP will increase.

As we have noted on numerous occasions, Japan no longer has a functioning bond market without the Bank of Japan. What happens when Italian debt rises in cost to the point that individuals no longer want to buy that debt and the market essentially becomes the European Central Bank? Crazy? I think not. It won’t happen this year or the next or even for a few years after that; but unless Italy gets its budgetary house in order – something that will be difficult given its huge pension and healthcare obligations and poor demographics, debt-to-GDP of 150% or 160% is possible by the end of the decade. That is the level at which Greece became a problem a few years ago.

Now, I understand that all my Italian readers will point out that Italy is not Greece, but they both have to coddle the bond market with a reassurance that those who bought will get paid. And given the track record of Italy over the last century, it is not altogether clear to me that you can approach Italian debt with 100% confidence. I know, it’s different this time; but bond buyers are a fickle lot. You buy government bonds because you want to avoid risk.

Draghi is going to have to fight the perception that he is enabling countries to avoid dealing with their imbalances, even as he tries to improve the terms of trade by forcing the euro down.

The common wisdom is that now the Germans are fighting against assuming Italian debt by putting it on the books of the ECB. But Will Denyer points out this morning that there is reason to think that the various countries might actually want that debt for a time, until it can indeed be mutualized in some distant future. Writing for GaveKal, he says:

The US has just provided a remarkable example of the third option at work. Last year, the US Treasury paid a record amount of interest, roughly US$430bn. But over the same period the Fed remitted almost US$100bn to the Treasury, thanks to a balance sheet bloated by QE operations. If we net out remittances from the Fed, the Treasury’s interest payments fall by almost a quarter. Or, to put it another way, with US$17.6trn in debt outstanding in 2014, this effectively lowered the Treasury’s interest cost by around 50bp. And that is before we factor in any effect on market rates.

But what about the eurozone, where many governments are involved? Normally, any profits made by the ECB are pooled and distributed to member countries in proportion to the central bank’s capital subscription weightings, which are based on population and gross domestic product. That means Germany gets the most, then France, and so on... These outflows pay no attention to where the profits came from. In a QE program today, most of the profits are not going to come from German or French bonds, which yield next to nothing. Most are going to come from the smaller peripheral governments that are currently paying more interest on their debt. We don’t need to do any math to figure out that QE done by the ECB would result in a massive transfer of wealth from the periphery to Germany and France. This is true almost regardless of how purchases are apportioned.

What would make a big difference is if the ECB made an exception to its normal profit-sharing practices, and said that all profits on Portuguese bonds will go back to the Portuguese government, all profits on Italian bonds go back to the Italian government, and so on…. In this structure, all eurozone governments would benefit from QE, at the expense of anyone holding the currency (just as happened in the US, UK, Japan…). The German government would also benefit from any central bank purchases of its debt, but it will no longer also receive a massive transfer of wealth from the periphery.

While everyone is talking about how Germany may demand that credit risk be isolated within each country, that may be a mirage. It may well be the peripheral governments that want the profits from QE to stay within each country – so they can reap all of the regular benefits of currency debasement.

What does this mean for markets? However it is structured, QE is likely to weigh on the euro (that is, if the ECB actually debases its currency on a scale that lives up to lofty expectations). A big QE announcement would also probably lift equity prices, at least initially.

So what caused the Swiss to act? I think it was in part that they looked at the general weakness of Europe and its seeming inability to pursue reforms or to address its imbalances in any realistic manner. Many Eurozone leaders seem to think the European Central Bank has magic in its vaults and simply hope that the Germans can be persuaded to release some of that growth pixie dust. The Swiss look at their own experience and see the continued growth of debt and unfunded obligations in Europe as a real problem.

On top of all the other developments, the European Court of Justice issued a preliminary ruling on Wednesday that allows the ECB to employ quantitative easing. There are rumors that the ECB is going to propose a package that may run as high as €2 trillion – countered by “leaks” that suggest the total will be a fraction of that amount. Frankly, the market has priced in €500 billion already. If Draghi doesn’t deliver a multiple of that, I think we will see a disappointed market.

Was the Swiss banking and business community given a heads-up? Were there phone calls from one desk to another? Clearly, there are communication channels. And the timing of the ECJ ruling and the announcement by the SNB the next day is more than suspicious. (Yes, I know it’s a preliminary ruling, but do you really think it will get changed?)

I think the SNB looked down the road and saw the euro at parity to the dollar (which is where Draghi and the rest of Europe would like to have it), realized how much they would have to spend and ultimately lose to maintain the euro peg, and decided it simply wasn’t worth the cost. That $70 billion loss could turn into a $150 billion loss before you knew it.

Simply removing the peg and taking that much buying off the table will in itself begin to reduce the value of the euro. Will the Swiss begin to move some of their rather large euro holdings to US dollars and other currencies? That move would seem the logical follow-on, and it would push the euro down even farther.

In 2002 I said the euro would rise to $1.50 and then fall back to parity. We do seem to be on that journey. This is not, of course, a one-way trip; and I would expect the euro to correct upwards at some point before resuming its downward journey.

The interesting question will be, if the ECB starts down the path of QE, at what point will it feel it can stop? Will it depend on an inflation-target number? It doesn’t seem likely that QE can actually deliver inflation in a deleveraging world – and Europe must at some point deleverage. Thus, we could see QE in the Europe for a rather long time.

The Eurozone is simply unbalanced, and a monetary policy appropriate for Italy or Spain is not appropriate for Finland or Germany.

Unless and until its members create a fiscal union and come up with some formula to mutualize their debt, the Eurozone will remain imbalanced and will become increasingly likely to break up. Ironically, if they fail to pursue QE, there will be a crisis sooner rather than later; but a crisis is precisely what they need in order to address the present imbalances. They are not going to substantially reform their labor and budgetary processes except in the act of crisis resolution.

A significant QE package (on the order of €1 trillion or more per year) may be enough to postpone the crisis for at least several years. And perhaps that is all they intend to do, thinking that somehow they can all get a handle on their budgets and that growth will magically ensue in a world where debt has already overwhelmed the markets and governments have grown too large relative to the private sector that is necessary to support those governments. Stir into that mix healthcare and pension obligations that are even larger than those in the United States, and you have a surefire formula for a major crisis at some point in the future.

Traders tend to act as if the current trend will never end. For some odd reason, they trust central bankers, when the truth is that central bankers will lie when they feel it is necessary. As Anatole said, they believe they have a license to lie. But one way and another, the current relative quiet in Europe will not hold indefinitely.

My friend Mohamed El-Erian has this to say about the Swiss National Bank decision:

Following the abrupt removal of the currency peg, Switzerland is now looking at a period of bumpy economic and financial adjustment. Being a relatively “open economy”, in which trade and tourism play an important role, Swiss companies face a considerable competitiveness challenge ahead. The country will also have to deal with issues of currency mismatches, as well as having to battle larger, externally induced deflationary forces.

But the implications extend far beyond Switzerland. Countries with Swiss franc denominated liabilities, such as Hungary, now have to deal with a major adverse valuation shock.

More importantly in terms of global systemic effects, politicians in the core economies within the eurozone – including Germany, Austria, Finland and the Netherlands – will see the SNB’s move as a reaffirmation of the dangers of substituting financial engineering for real economic reform. As such, they will be less willing to accommodate the hyperactivism of the ECB. And while this is unlikely to stop the ECB from doing more, it may increase the legal, reputational and unity risks it takes in doing so.

Then there are the consequences for a global economy which, in the absence of a comprehensive policy response in the advanced world, has ended up overly reliant on central bank interventions. Given that their tools cannot reach directly and sufficiently at what holds back growth and jobs, these central banks have been forced to use the partial channel of financial asset prices to influence real economic outcomes.

To this end, central banks have sought to repress market volatility as a means of encouraging risk taking that would then boost asset prices and thus encourage greater household consumption (via the wealth effect) and corporate investment (via animal spirits).

We are already in a currency war, where Japan and China feel the need to protect their competitiveness. Europe now feels compelled to follow. The furthering of various country’s campaigns in this war is creating massive divergence among the major central banks and an environment in which the dollar is likely to become much stronger than it otherwise would.

If the ECB does deliver massive QE, that course has the potential to set off an even uglier set of events than followed on Japan’s Halloween surprise. We could see a series of emerging-market crises, a rush to global risk aversion on top of divergence, and the USD carry trade might unwind quite forcefully, creating a very ugly feedback loop. The risk of financial shocks to the rest of the world – particularly to Europe’s thinly capitalized banking system and China’s questionably solvent financials – is enormous.

Trouble is, the “appropriate” measures needed to keep Eurozone risks at bay may be toxic for the rest of the world, and the “appropriate” policy for the rest of the world may be toxic for the Eurozone. Europe’s grinding further into deflation until the EMU collapses – by the ballot or by the bullet – is an ugly scenario for the world, but a far less immediate risk than that of a violent unwind in the USD carry trade.

It’s every central bank for itself, and I imagine Draghi, too, intends to surprise. Stay tuned.

The Cayman Islands, Zurich, Florida, and New York

I see Grand Cayman, Zurich, and Florida on my schedule, and New York is also looking likely in March. I am “entertaining” the Mauldin Economics writing and management team starting this weekend here in Dallas. Then in February it’s on to the Caymans. It has been awhile since I was in the Cayman Islands, and this time I’ll take a short hop over to Little Cayman to visit my friend Raoul Pal for a few days. A brilliant macroeconomist and trader, Raoul has now based himself in Little Cayman, although he frequently flies to visit clients. In March I’ll be in Zurich (and maybe some other parts of Europe) and then hop back over the pond to Orlando. I will be in NYC later that month, and DC is calling. Not to mention La Jolla. The present wonderful period of reduced travel is coming to an end.

The quote at the beginning of the letter from Jean de la Bruyère, the 17th century French philosopher, is one of my favorites and got me to wondering what else he might have written. Since research no longer requires a trip to the library but merely a few clicks, I was able to spend a good bit of time with the gentleman, even though he shuffled off this mortal coil some 320 years ago. Besides the usual French Enlightenment thoughts, he had a great deal to say about friendship and other personal relationships. Here’s a nice one: “Two persons cannot long be friends if they cannot forgive each other's little failings.”

But my favorite is: “To be among people one loves, that's sufficient; to dream, to speak to them, to be silent among them, to think of indifferent things; but among them, everything is equal.” (Here are more quotes from him.)

My own happiest times are when I am with family and friends. And I am particularly lucky in the number of friends I have. Old friends are the best, but new friends are wonderful, too, as there is so much to learn and share.

This weekend my fellow writers at Mauldin Economics begin to show up from around the world. Jawad Mian, whom you will get to know more about, comes Saturday evening, then Jared Dillian on Sunday, along with Olivier Garret and Ed D’Agostino. Tony Sagami shows up Monday from Bangkok via Montana. I think Worth Wray will be here Sunday as well. Later in the week I’ll be joined by my new partners (yet to be announced) in what will become Mauldin Portfolios, a portfolio design and management firm geared to helping you create portfolios for your clients that work in the present challenging environment. We’ll do our best to understand the opportunities and risks in front of us, both those the market presents and the more direct business challenges. Long days, but the cameraderie will be sufficient, as de la Bruyère might say.

He also gave us a thought on book writing: “Making a book is a craft, like making a clock; it needs more than native wit to be an author.” And while that is a feel-good line for those who are published, the truth is closer to this pithy observation from Winston Churchill:

Writing is an adventure. To begin with, it is a toy and an amusement. Then it becomes a mistress, then it becomes a master, then it becomes a tyrant. The last phase is that just as you are about to be reconciled to your servitude, you kill the monster and fling him to the public.

Your hoping to slay a few monsters and fling a few books at you this year analyst,

John Mauldin

 

© Mauldin Economics

www.mauldineconomics.com

[description] => In an era when central bankers are supposed to be more open, collaborative, and communicative, what would make the Swiss National Bank decide to turn on a dime and shock the markets – to release the Kraken, as it were? Note that in fact all hell did break loose. Rather than delivering hints accompanied by a few well-placed leaks, the Swiss decided it would be best to completely surprise the markets. It will be a long time before we get the full story on what must have been going through their heads as they reached the decision. [author] => John Mauldin [legacyinterface_firm_id] => 287 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 05:29:56 [created_by] => 945 [modified_on] => 2015-01-20 05:30:42 [modified_by] => 945 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2378 [hits] => 0 ) [9] => stdClass Object ( [legacyinterface_commentary_id] => 2313 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15549 [apv_conversation_id] => 3227 [content_type] => market-commentary [title] => 5 Things To Ponder: A View Of A Correction [slug] => streettalk_012015 [fulltext] =>

It has been a rough start to a new year as all of the gains following the end of the Federal Reserve's flagship "QE-3"campaign have been erased.

 SP500-MonthlyGains-011515

As I discussed yesterday, there is currently little concern by the majority of Wall Street analysts that anything is currently wrong with the markets. While earnings estimates are rapidly being guided down, it is likely only a temporary issue due to plunging oil prices. However, not to worry, the economy is set to continue its upward growth trajectory.

Maybe that is the case. But as investors we should always have a watchful eye on the things that could possibly go wrong that could lead to a rapid decline in investment capital. As I stated last week:

"What I find most interesting is that there is very little concern that something could negatively impact the markets. In fact, if anything would actually happen, it will just be a mild 10-15% correction. The problem is that historically, such outcomes have only been found in "rarified air." Could this time be different? Sure, anything is possible. However, as an investor my primary concern should be the protection of my limited investment capital against unmitigated destruction."

This week's reading list is a variety of opinions on the state of the markets and the risk that currently prevail. This is of keen interest to me as an "almost fully invested bear."


1) Market Madness Started With End Of QE by Jeff Cox via CNBC

"For nearly six years running, the U.S. stock market has withstood a myriad of body blows, from a stuttering economic recovery to a debt crisis in Europe to massive political instability in Washington.

Underpinning each move higher was the knowledge that the Federal Reserve would keep the printing presses running, with aggressive quantitative easing programs that sent market confidence high and asset prices soaring.

Now, though, comes a shock that has Wall Street reeling: The Black Swan-like collapse in oil prices that has provided a stern test of whether equity markets can survive nearly free of Fed hand-holding."

Read Also:  Bullish For The Right Reasons by First Trust

2) Markets Are Freaking Out For No Good Reason by Matt O'Brien via The Washington Post

"Markets might be efficient, but, boy, can they be stupid sometimes.

The latest brouhaha came, like it did a few months ago, over a surprisingly bad retail number. Markets expected it to fall 0.2 percent in December, but in reality it fell 0.9 percent.

Cue the freakout: The Dow was down 300 points at 1:30, falling about 1.75 percent. Bond yields on U.S. Treasury debt are falling, too, a sign that people are hunting for safety."

Retail-Treasuries

Read Also: These 6 Gurus Are (Mostly) Bullish For 2015 by Howard Gold via MarketWatch

 3) Navigating High Stock Valuations In A Deflationary World by GaveKal Capital Blog

"As we highlighted yesterday, stock valuations jumped again in December to another cycle high. As the first two charts show, the cyclically adjusted P/E multiple has only been higher on several occasions and the median stock is trading at a record price to cash flow multiple as far back as we have data. These high valuation levels leave stocks at risk.

High stock valuations and growing signs of deflation pose all sorts of risks to portfolios, so an important question is what kind of asset allocation is likely to mitigate some of those risks?"

GaveKal-Valuation-011515

Read Also: The Most NOT Hated Bull Market by Meb Faber via Meb Faber Research

Sentiment-Faber

4) How To Defend Your Money From A Bear Market by Michael Sincere via MarketWatch

"Skeptics are ridiculed as “naysayers,” “permabears” or “doom and gloomers.” As the bull market goes higher, many investors think that maybe it really is different this time. Maybe central banks have the power to keep markets levitated indefinitely.

Meanwhile, the bubble gets bigger and bigger, until complacent investors accept the bubble as the “new norm.” Nowadays, uber-bulls believe this market is unstoppable, while some experts have made predictions of Dow 20,000 in 2015."

Read Also: The Stock Markets Dilemma by Jeffrey Snider via Alhambra Partners

5) The One Chart Bear Case For US Stocks by Dan McCrum via Financial Times

"Tuesday’s presentation was a variation on that theme, with the investor warning that while lower oil prices help the US economy, watch out for the impact of the shale boom deflating. A few choice slides below, starting with one to keep in mind on the US stock market.

We always hesitate to use the word unprecedented. Still, another year of gains for US stocks would be the seventh in a row and, well…"

Gundlach-Stocks-BearCase-011515

Read Also: Jeff Gundlach Presentation via Business Insider


Bonus Read:  Perma Bull Throws In The Towel by Zerohedge


"As the bull market goes on, people who take great risks achieve great rewards, seemingly without punishment. It's like crime without punishment or sex without sin." - Ron Chernow

Lance Roberts

Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of "Street Talk with Lance Roberts", Chief Editor of "The X-Factor" Investment Newsletter and the Streettalklive daily blog. Follow Lance on Facebook, Twitter and Linked-In.

© Streettalk Live

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US equities have now fallen three weeks in a row. At its low on Friday, SPX was 5% off its high on December 29.

The lows a week ago pierced the 20-weekly ma. Strong uptrends remain above this line (arrows).  This week, the market fell through again and then recovered, again. In the past, a close below the 20-wma has often led to a touch of the weekly Bollinger band bottom, currently at 189 (yellow). The key 20-wma level is now 200.5.


That SPY has fallen to its 20-wma on consecutive weeks is a sign of weakness. It's impressive that it keeps recovering but repeated touches normally leads to failure.

In the last 2 years, a 3 week decline of 5% has been the extent of most pullbacks in US equities. November 2012 was the last time a pullback lasted much longer. Expecting much more has been a losing proposition.



There are a few factors in equity's favor heading into this week.

Probably the most important is that the ECB has a policy meeting on Thursday, at which it may well provide details on its version of quantitative easing in order to combat the slump in European demand. Announcements to this effect have been greeted with enthusiasm in the past. It is not hard to imagine equities rising the next few days in anticipation. This was probably the catalyst for Friday's gain of 1.3%.

There was probably a short term low in equity bullishness this week. DSI (daily sentiment) was at a level consistent with recent lows in SPX (data from Chad Gassaway).



Similarly, equity put/call has also been elevated over the past month; when this rolls over, SPX has usually moved higher (data from Larry McMillan).



What is worrisome about put/call is the ratio started to roll lower a week ago, during which time equities have fallen. That has not been the pattern in the past; the rollover has lagged the lows in equities. To that end, note that there were no spikes higher in put/call this week, despite a strong sell off.

Likewise, although these surveys can lag, it must be noted that both AAII (individual investors) and NAAIM (active managers) saw anincrease in bullishness this week. NAAIM respondents are 87% net long equities, an increase from 71% the week before. Both of these are consistent with put/call rolling lower.

It's rarely a positive when investors become more bullish as price heads lower, and that seems to be the case now. This makes us skeptical of how significant equities will rise before heading lower.

The Vix term structure also inverted this week. Vix has been elevated for most of the past month. Lows in SPX have mostly corresponded to times when the term structure has inverted. The watch out is that the early January inversion quickly reversed.



Finally, US treasuries might have experienced a blow off top, at least short term. Treasury investors' optimism (lower panel) has spiked higher, and these spikes usually correspond to at least a plateau in appreciation (data from Sentimentrader).



This happens to correspond to 30-year treasuries nearing a 20 year channel top; monthly RSI (5) is 90, which has also been consistent with a near term price plateau or top. Money moving out of treasuries would normally (but not always) benefit equities.



On balance, a rise in equities this week seems likely but, again, we are skeptical how far a bounce will go.

SPY has now fallen three weeks in a row. Excluding the 2008 bear market, SPY has fallen three weeks in a row 16 other times since 2003. In 15 of those, the index at least retested its low of the third week within the next three weeks. The one exception was in March 2004; price rose one week, but was lower 7 weeks later.



The same is true with RUT. It has been down three weeks in a row 14 other times since 2003, 13 of which were at the low again within three weeks. The one exception was last February; price rose the next 4 weeks, but was lower after 10 weeks.



The key watch out from the start of the year has been NDX. It was the only US index to peak in November and then make a lower high in December. NDX continues to lead to the downside; it slightly undercut its December lows this week. There are now two low highs and a lower low in NDX. That constitutes a downtrend. The pattern is a descending triangle (flat bottom, lower tops); these break lower 64% of the time according to Tom Bulkowski.


A potential positive for NDX is a trend line (dashed) from November 2013 that comes in near 4050, about 1% below Friday's low. There is also a 6 week supply of trading volume between 4000 and 4090 from August to October (yellow) that might provide support on further weakness. For now, the near term trend is down.

A week ago, SPX, RUT and DJIA did not have a lower high like NDX; now, all do. And all three are now also under their 50-dma. On weakness, the next obvious target is the December low. For DJIA, that happens to be near its 200-dma as well. On strength, look for resistance at last weeks high near 17,900 (dashed red line).



SPY now has a lower high. It is under a declining 5-dma and 13-ema; the 50-dma is flat. At best, this is a weak price trend. Regaining 203 would turn the slope of the 13-ema positive but 205 looks more formidable; that is the location of the line from the lower highs and its also weekly R1 next week and the pivot for the month of January. Regaining that level would be very positive. Like DJIA, the December low and the 200-dma are the obvious targets on weakness.



Since the start of the year, SPY has now gapped up 8 of 11 days, yet the price has moved lower 8 out of 11 days. In other words, the market drifts up over night and then mostly sells off during the day. The overnight gaps have netted a gain of $3.20, but SPY is lower YTD by $3.90. There has been more distribution than price is showing. It's not healthy.

Many sectors have retraced to their December lows. Banks have now lost that level. The same is true for transports. All the cyclical sectors are below their 50-dma; what are considered defensives (healthcare, utilities and staples) are all above their 50-dma. This pattern, too, is not healthy.



At its low this week, SPY was back at levels it traded at in August. There has been a lot of movement but not a lot of net progress.

What's going on? In early December, SPX completed a period of 7 weeks higher in a row. We looked at prior instances since the 1980s (here). There were 10 others; in 8 of these, SPX struggled to move higher for two months or longer. Some of these corresponded to major tops. In two instances, SPX largely continued higher. We seem to be repeating what has happened in the majority of cases; choppy, sideways action. US equities might be digesting the large gains made over the past 3 years; this has happened many times before and may well continue for several more months.



Lastly, outside the US, the highly disliked emerging markets are setting up an ascending triangle under 39.5. You can see it has formed this same pattern at lows before. Recall that fund managers are very underweight this region; a set up for outperformance in the past. Emerging markets correlate with commodities, so stabilization in oil and copper are likely to be necessary.



Monday is a market holiday to commemorate MLK. The days following are seasonally weak.

Our weekly summary table follows.

© The Fat Pitch

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The economy

Drop in energy  prices  dominates global headlines

As we enter the holiday season and consumers look for a little extra cash to spend, they shouldn’t have to look too far. The price of oil has fallen nearly 40% since its annual peak in mid- June.  This has helped drive down the national price of gasoline to an average of roughly $2.75 per gallon.  The economic implications on a global scale are somewhat mixed, with major oil importers benefiting the most.  The U.S. continues to consume more oil than it produces, but advances in technology and domestic production have been increasing at a rapid pace.  Beyond energy, the backdrop for the U.S. economy continues to be strong, with a third quarter GDP estimate of 3.9% and a labor market that continues to plod along; although improvements are still needed.  The strong close to 2014 is providing a robust tailwind for the domestic economy entering the New Year, whereas many countries overseas continue to cope with slower growth and potential deflation.

The bond market

Treasury  rates  drop across all maturities

Contrary to the trend for much of this year, interest rates dropped across the yield curve in November, providing a positive boost for bond prices.  The flattening of the U.S. Treasury yield curve has been a point of interest in 2014, with rates on shorter-term bonds rising and longer-term bonds continuing to fall. A flattening and potentially inverted yield curve can be a signal of slow growth on the horizon.  However, with the Federal Reserve manipulating rates to a greater extent than seen historically, this is not necessarily a foregone conclusion.  Their bond purchase program, although now completed, has had the biggest impact on the long end of the curve, while the prospect of a higher federal funds rate in 2015 is placing upward pressure on short-term rates. With this scenario in play, it remains prudent to be well-diversified along the short and intermediate portion of the yield curve.

The stock market

Stocks push higher  in November

The Dow Jones Industrial Average reached record highs yet again in November after fully working its way back from a sell-off in September / October.  Large and mid-cap domestic stocks continue to lead the way, with small caps and foreign equities trailing well behind.   Central banks around the world continue to look for new ways to stimulate economic growth, but these measures have not necessarily translated into strong stock returns.  The European Central Bank is delaying until early 2015 for additional stimulus measures, causing markets in Germany and France to drop more than 5% year to date.  On a positive note, a recent surprise interest rate cut in China did have a constructive impact on their stock returns, and U.S. markets are capitalizing on strong corporate earnings and a stable economy.  While numerous record highs are a cause for worry amongst some investors, we still believe fundamentals justify the current trend.

Economic Trends

Headlines

U.S. grows continues to be strong,  while  energy  market sells off.

Large  cap stocks once again lead markets higher in November.

Emerging markets lag, but see new measures put in place to help growth.

Energy  stocks take major hit in November as oil prices approach the $60 / barrel level.

Fixed income markets

China  steps into easing measures with a surprise rate cut.

Survey  shows investors now betting on  run for Treasuries (meaning interest rates will fall).

Bronfman E.L. Rothschild, LP is a registered investment advisor. Securities, when offered, are offered through Baker Tilly Capital, LLC, member of FINRA and SIPC; Office of

Supervisory Jurisdiction located at 10 Terrace Court, Madison, WI 53718, phone 800.362.7301. Bronfman E.L. Rothschild, LP and Baker Tilly Capital, LLC are not affiliated.

This publication should not be viewed as a recommendation, an offer to sell, or a solicitation of an offer to buy a particular security or service. The commentary provided is for informational purposes only and should not be relied on for accounting, legal, tax, or investment advice. Financial information is from third-party sources. While such information is believed to be reliable, it is not verified or guaranteed. Performance of any indexes is provided for reference and competitive purposes only without factoring any fees, commissions, and other charges. Individual results achieved by investors will be different from those of the indexes. Indexes are unmanaged; one cannot invest directly into an index. The views and opinions expressed are those of Bronfman E.L. Rothschild, LP, and they are subject to change at any time. Past performance does not imply or guarantee future results. Investing in securities involves risks, including possible loss of principal. Diversification cannot assure a profit or guarantee against a loss. Investing involves other forms of risk that are not described here. For that reason, you should contact an investment professional before acting on any information in this publication. 

© Bronfman E.L. Rothschild

[description] => The drop in energy prices dominates global headlines and the economic implications on a global scale are somewhat mixed, with major oil importers benefiting the most. Beyond energy, the backdrop for the U.S. economy continues to be strong, with a third quarter GDP estimate of 3.9% and a labor market that continues to plod along; although improvements are still needed. The strong close to 2014 is providing a robust tailwind for the domestic economy entering the New Year, whereas many countries overseas continue to cope with slower growth and potential deflation. [author] => Kevin Moloney [legacyinterface_firm_id] => 502 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 16:55:27 [created_by] => 948 [modified_on] => 2015-01-20 17:00:00 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2381 [hits] => 0 ) [12] => stdClass Object ( [legacyinterface_commentary_id] => 2316 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15555 [apv_conversation_id] => 3232 [content_type] => market-commentary [title] => Swiss Surprise: National Bank Ends Currency Cap [slug] => invesco_012015 [fulltext] =>

On Jan. 15, the Swiss National Bank (SNB) unexpectedly abandoned its policy to cap the value of the franc at 1.2 euros.1 Over the past few years, the SNB has had to sell billions of francs to buy euros to prevent an excessive appreciation of the domestic currency ― a too-strong currency could dent the country’s export business. The prospect of quantitative easing (QE) in Europe raised the prospect of more franc sales, more euro purchases, and the significant risk of potentially large foreign exchange losses for the SNB. It therefore changed tack by abandoning the cap but cutting official interest rates further to -0.75% from -0.25%.1 As a result, the franc has appreciated 17.5% versus the euro and 16.5% versus the US dollar,2 although we believe there could be further volatility ahead.

What are the implications? 

Interest rate markets:

Overall, we believe the move should have a positive impact on European rates markets. After the SNB printed francs and bought euros, it would recycle the euros into short-dated government bonds. Although the SNB is now stepping away from that process, negative interest rates in Switzerland could lead money to leave the Swiss banking system and find its way into other bond markets with positive nominal yields (and probably longer duration than the markets where the SNB was buying). Moreover, foreign assets have suddenly become much cheaper in Swiss franc terms.

Currency markets:

On the currency side, the SNB was one of the biggest buyers of euros in the market, so the euro has weakened. The market has also assumed that the SNB caught wind of what the ECB is planning in terms of QE and sold euros on the back of this. The trend for a weaker trade-weighted euro was already in place, and this could exacerbate those selling pressures. The euro appears to be the key funding currency (i.e., the best currency to sell to fund long currency positions) and we believe this is a clear negative for the euro.

Swiss economy:

We expect the largest negative impact will be on Switzerland itself. Inflation is already running at -0.3%3 year over year, and a strong currency could push it deeper into negative territory. The central bank has lost credibility in its battle against deflation, so it will probably need to take deposit rates even lower, and Swiss bonds could soon have negative yields out to 10-year maturities. Meanwhile, we expect Swiss companies with large foreign earnings to see Swiss franc profits reduced, and Swiss stocks were down sharply on the announcement (in Swiss franc terms).2 It will also be important to watch for any idiosyncratic risks, such as the collateral impacts of Swiss franc carry trades being unwound.

1 Source: Swiss National Bank

2 Source: Bloomberg LP, Jan. 15, 2015

3 Source: Swiss Federal Statistical Office

Important Information

Idiosyncratic risk is specific to an asset or a small group of assets and has little or no correlation with market risk.

Carry trade is a strategy in which traders borrow a currency that has a low interest rate and use the funds to buy a different currency that is paying a higher interest rate.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.

©2015 Invesco Ltd. All rights reserved.

[description] => On Jan. 15, the Swiss National Bank (SNB) unexpectedly abandoned its policy to cap the value of the franc at 1.2 euros.1 Over the past few years, the SNB has had to sell billions of francs to buy euros to prevent an excessive appreciation of the domestic currency - a too-strong currency could dent the country’s export business. [author] => Rob Waldner, Nicholas Wall, Ray Uy [legacyinterface_firm_id] => 225 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 17:01:50 [created_by] => 948 [modified_on] => 2015-01-20 17:26:04 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2382 [hits] => 0 ) [13] => stdClass Object ( [legacyinterface_commentary_id] => 2317 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15553 [apv_conversation_id] => 3230 [content_type] => market-commentary [title] => The Politics of Economic Stupidity [slug] => prosyn_012015 [fulltext] =>

NEW YORK – In 2014, the world economy remained stuck in the same rut that it has been in since emerging from the 2008 global financial crisis. Despite seemingly strong government action in Europe and the United States, both economies suffered deep and prolonged downturns. The gap between where they are and where they most likely would have been had the crisis not erupted is huge. In Europe, it increased over the course of the year.

Developing countries fared better, but even there the news was grim. The most successful of these economies, having based their growth on exports, continued to expand in the wake of the financial crisis, even as their export markets struggled. But their performance, too, began to diminish significantly in 2014.

In 1992, Bill Clinton based his successful campaign for the US presidency on a simple slogan: “It’s the economy, stupid.” From today’s perspective, things then do not seem so bad; the typical American household’s income is now lower. But we can take inspiration from Clinton’s effort. The malaise afflicting today’s global economy might be best reflected in two simple slogans: “It’s the politics, stupid” and “Demand, demand, demand.”

Click here to read more

© Project Syndicate

[description] => In 2014, the world economy remained stuck in the same rut that it has been in since emerging from the 2008 global financial crisis. But we know how to escape our current malaise, which suggests that the big problem facing the world in 2015 is political, not economic. [author] => Joseph Stiglitz [legacyinterface_firm_id] => 345 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 17:16:00 [created_by] => 948 [modified_on] => 2015-01-20 17:16:11 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2383 [hits] => 0 ) [14] => stdClass Object ( [legacyinterface_commentary_id] => 2318 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15554 [apv_conversation_id] => 3231 [content_type] => market-commentary [title] => Despite Escalating Volatility, U.S. Fundamentals Remain Sound [slug] => nuveen_012015 [fulltext] =>

U.S. equities declined for a third straight week, with the S&P 500 Index dropping 1.2%.1 Defensive areas such as utilities and telecommunications were the best-performing sectors, while the financial sector was hit the hardest.1 Notwithstanding last week’s decision by the Swiss National Bank to remove its currency peg, the fundamental backdrop has not changed much in recent weeks. We attribute the fall in equity prices to ongoing worries about the collapse in oil prices and the ripple effect on the global financial system.

Weekly Top Themes

1. Retail sales levels fell in December, but longer-term trends remain positive. Sales excluding gasoline dropped 0.4% last month,2 but we think it would be an overreaction to suggest that the retail sector is in trouble. Over the past six and twelve months, sales ex-gas were up 4.4% and 5.3%, respectively.2

2. Inflation looks steady, but may be due to fall. The headline Consumer Price Index (CPI) fell 0.4% in December and core CPI was unchanged.3 Core CPI was up 0.8% year-over-year.3 Given the sharp decline in energy prices, we expect core CPI may turn negative in February or March.

3. We believe lower oil prices produce a net benefit to the U.S. economy. Declining oil prices help consumers and users of energy. Oil producers are hurt by this trend, but this group is relatively small. Nonfarm payrolls show 140 million people are employed in the United States, with 931,000 working in the oil and gas industry.4 In other words, less than 1% of total U.S. employment is based in the energy sector.

4. Near-term earnings trends may be disappointing, but we remain optimistic about the coming year. As the fourth quarter earnings season begins, current S&P 500 estimates are for a paltry 1% year-over-year gain, with weakness centered in the energy sector.5 Looking ahead, we believe an improving economy and healthy profit margins should help corporate earnings to rebound.

5. The U.S. dollar may be overdue for a pullback. The dollar has rallied substantially over the past few months, due to falling oil prices plus diverging economic growth and monetary policies between the United States and other countries. We think these long-term trends will persist, but some sort of nearterm consolidation or counter-rally in the dollar may occur.6. European growth remains under pressure. We expect the eurozone to continue to struggle as long as bank lending remains depressed, inflation remains close to zero and governments remain unwilling to increase spending. The growing possibility of additional easing action by the European Central Bank (ECB) will help, but likely won’t be enough to pull Europe out of its doldrums.

7. Investors have a long list of events and data to react to this week. Earnings results will get their share of attention, and this week also features a rash of Chinese economic data, the President’s State of the Union address, an ECB meeting and elections in Greece.

Sentiment Falters, Yet Equities Still Look Attractive

The sharp decline in oil has contributed to a fall in equity prices and in bond yields, as it has sparked global deflation fears and undermined confidence in the global economy. The fundamental supply and demand factors behind falling prices are real, but we believe prices may have overshot and the current turmoil should diminish. The souring of investment sentiment seems out of sync with increasing evidence of economic acceleration.

The pickup in volatility is unnerving, but we encourage investors to ride out the equity market turbulence. Those with longer-term horizons may want to consider using periods of weakness to add to positions as well. We expect the coming year to be a positive one for global equities in both absolute terms and relative to Treasuries. We think both the economy and corporate earnings are strengthening, and global monetary policy remains supportive. Commodity price volatility remains a risk, and equities are likely to remain vulnerable until oil prices stabilize. We think equities will be able to overcome this risk.

1 Source: Morningstar Direct, as of 1/16/15 2 Source: U.S. Department of Commerce 3 Source: Bureau of Labor Statistics 4 Source: Deutsche Bank Research 5 Source: MRB Partners 

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

RISKS AND OTHER IMPORTANT CONSIDERATIONS

The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.

Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.

©2015 Nuveen Investments, Inc. All rights reserved.

GPE-BDCOMM3-0115P 5418-INV-W01/16

[description] => U.S. equities declined for a third straight week, with the S&P 500 Index dropping 1.2%. Defensive areas such as utilities and telecommunications were the best-performing sectors, while the financial sector was hit the hardest. Notwithstanding last week’s decision by the Swiss National Bank to remove its currency peg, the fundamental backdrop has not changed much in recent weeks. We attribute the fall in equity prices to ongoing worries about the collapse in oil prices and the ripple effect on the global financial system. [author] => Robert Doll [legacyinterface_firm_id] => 320 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 17:24:28 [created_by] => 948 [modified_on] => 2015-01-20 17:25:06 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2384 [hits] => 0 ) [15] => stdClass Object ( [legacyinterface_commentary_id] => 2319 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15556 [apv_conversation_id] => 3233 [content_type] => market-commentary [title] => Navigating the Oil Slick [slug] => calamos_012015 [fulltext] =>

Markets have begun 2015 on a volatile note, as plummeting commodity prices exacerbate fears of slowing global growth. We remain bullish on U.S. equities for 2015 and expect U.S. GDP growth of 2.5%–3.0%. Global GDP will likely be slower, expanding 2.0%–2.5% in 2015, reflecting euro zone weakness as well as more measured and bifurcated growth in the emerging markets.

Investors should be prepared for elevated volatility as markets work through the impact of slowing global growth and price declines in oil and other commodities. Political uncertainties will likely foment turmoil in the markets—including continued debate between the European Central Bank (ECB) and German finance ministers, renewed concerns about Greece, squabbles within OPEC, and economic deterioration in Russia. Given economic weakness outside the U.S., a strong dollar and weak oil prices, the Federal Reserve is likely to forestall interest rate increases until late in the year, which should keep the yield of the 10-year Treasury bond in the 1.50%–2.25% range for 2015.

The good news? Deflationary pressures caused by plunging commodity prices will likely allow the Fed to “be patient” in pushing up short-term rates. This, combined with weak growth in Europe, has caused the 10-year Treasury to fall back below 2%, pushing spreads between equities and bonds close to historic high. As U.S. companies regain confidence that U.S. economic growth will strengthen, we believe M&A and share buyback activity will put a floor on valuations, allowing markets to move still higher (Figure 1). Our outlook is for the S&P 500 Index to hit 2,250 by year-end 2015, which would equate to a 14% return, including dividends.

Market Review

The U.S. markets led in 2014, with the S&P 500 Index returning 13.7% and the MSCI World ex-U.S. Index falling -6.7%. U.S. equities and convertibles benefited from still-accommodative policy and better economic fundamentals in the U.S., while a global quest for income and macro uncertainties supported the 10-year Treasury (Figures 2 and 3).

Still, the adage “every bull market climbs a wall of worry” certainly held true as U.S. stocks surmounted a range of concerns over the course of 2014, starting with Chair Yellen’s comments that interest rates might rise sooner than anticipated and fears that Europe would slip back into recession. As the year progressed, renewed concerns about the Fed’s timeline for raising rates created more headwinds, as did Russia’s bellicose stance toward Ukraine. The uncertainty around Russia and sanctions against the country took a particular toll on the euro zone as business and consumer confidence weakened. During the fourth quarter, markets were spooked by the potential for an Ebola pandemic and anxiety about declining oil prices as OPEC kept production high in the face of mounting global growth concerns.

Ultimately, optimism about global recovery, accommodative monetary policy—particularly in Europe—and solid corporate earnings growth won out in the U.S. market. Strong merger-and-acquisitions and buyback activity also provided key support to the market, as low corporate borrowing costs and high earnings yields made M&A and buybacks highly accretive to companies.

Against a backdrop of “risk-on, risk-off” vacillations, sector performance lacked a discernable pattern between traditional growth and defensive sectors. In a market with no clear direction, utilities led within the S&P 500 Index, followed by health care, technology and consumer staples (Figure 4). Within the growth stock universe, the markets rewarded names with low P/Es and the lowest expected earnings-per-share growth (Figure 5), as well as those with high dividend yields and large market caps.

Outlook

In addition to oil, other commodity prices have tumbled (Figure 6), suggesting that we’re seeing more than the impact of dissent within OPEC. Even so, we believe the global economy can continue to grow, albeit at a measured and uneven pace. Among major economies, conditions look healthiest in the United States. Plunging commodity prices may well be a harbinger of global economic weakness, but the recent strength in job growth, auto sales, and housing (Figures 7, 8 and 9) suggest that a U.S. recession is not imminent. Given the Fed’s willingness to take a “patient” approach in the face of falling energy prices and weakening global economic conditions, we expect continued accommodative monetary policy, with short-term interest rates staying put throughout most of 2015.

There has been much debate about the benefits and detriments of lower oil prices. During the holiday season, the “tax cut” of lower gas prices was heralded as a boon to consumers and retailers, although December retail sales were weak. However, with oil now below $50 a barrel (what many view as the marginal breakeven cost to extract oil), the consumption benefits of lower prices begin to be overshadowed by a deleterious income effect to businesses and industries with direct or indirect ties to the energy sector—hence the market’s recently amplified anxiety. Exploration-and-production (E&P) companies will have opportunities to reduce production over the next three to six months, the typical length of drilling leases. As current leases expire, E&P companies can moderate production to a less extreme supply-demand imbalance.

Based on past energy collapses, oil could fall another 10%–15% (to around $40 a barrel) before stabilization occurs, creating pockets of economic weakness in select industries and regions as well as spurring market volatility. However, we believe the negative economic impacts of plummeting oil prices can be contained, at least in the U.S. In the past, energy crises typically have not been catalysts for U.S. recessions. As Figure 10 shows, energy crises did not trigger broader economic collapses in 1984 and 1996, while the energy crisis of 2008-2009 was a byproduct of the housing market collapse. The diversification in the U.S. economy can provide a degree of resilience—notably, the energy sector represents less than 2% of GDP and energy companies represent 12% of earnings within the S&P 500. If the energy crisis were to infect other sectors of the economy, the Fed has considerable latitude to forestall rate increases, given the lack of inflationary pressures.

Moreover, we believe increased energy independence in the Americas should have a positive long-term economic impact for the U.S., due to reduced foreign policy spending, a benefit the markets do not appear to perceive—yet. There would also be benefits if Russia retreated from the provocative stance that characterized its foreign policy in 2014.

The dollar has staged a brisk rally as global growth concerns have grown (Figure 11). We expect the dollar to remain strong through 2015, reflecting the better economic fundamentals in the U.S. versus many other economies. At this point, we don’t view the strong dollar as a hurdle to U.S. economic growth, again due to the more balanced nature of the economy. That said, many companies have already guided lower for 2015 due to the strong dollar’s impact on their overall earnings and we need to be vigilant in our research about this impact going forward.

Europe is more of a wild card. When we view Europe relative to the other regions of the global economy, we see weaker growth fundamentals, as well as monetary accommodation and liquidity that has been inadequate but appears poised to loosen. While momentum has been weak, we expect it to stabilize and improve, and valuations are cheaper. The euro zone has officially crossed through the deflationary threshold (Figure 12), providing increased incentive for the ECB and German finance ministers to break through their stalemate. We believe the ECB will take more dramatic steps during the first quarter to increase the size of its balance sheet (i.e., quantitative easing) toward 2012 levels, although it is too soon to tell over what time period QE will take place.

Meanwhile, in Japan, domestic economic fundamentals remain weak, but corporate fundamentals are improving and the sales tax increase appears to have been put off. Monetary policy remains highly accommodative, and we’re encouraged by the recent uptick in corporate stock buybacks.

In the emerging markets, we expect continued divergence in economic fortunes as commodity prices fall and we enter the third year of what will likely be a multi-year cyclical strong-dollar environment. Against the backdrop of weak commodity prices, countries such as Russia, Brazil and Malaysia will likely face stiffer headwinds, versus India and China. We continue to view China’s recent stimulus efforts as being in-line with its longer-term strategy to move demand to the private sector with a focus on services and consumption. Although we have some shorter-term concerns about valuations and currency risk, we also believe the case for India is compelling over the medium- to longterm, supported by new leadership, reforms, infrastructure spending and better controlled inflationary pressures.

Positioning

While these next months may not be comfortable for investors, we do see many opportunities. With oil prices likely to stabilize over the next several months and the ECB and Germany reaching a consensus on stimulus and structural reforms, we believe equity markets can resume their upward climb for 2015. In our view, steady U.S. GDP growth, quantitative easing in Europe, nearly non-existent inflationary pressures, and the widening spread between equity yields and 10-year Treasury yields (Figure 13) will stimulate renewed merger-and-acquisition and buyback activity, providing support to the equity market, as in 2014.

Although valuations in some sectors of the equity market may be stretched, valuations and fundamentals are attractive overall. The earnings yields of stocks remain extremely compelling relative to inflation, as well as Treasury yields. We continue to expect a longer-thantypical recovery cycle given the depth of the Great Recession, and believe the collapse in energy prices may elongate the recovery further as the Fed follows its patient approach. In our view, we are still in the middle innings of recovery, which supports the case for growth stocks. At 1.2x, the premium for U.S. large-cap growth over large-cap value is well below the 3.0x multiple of the technology bubble peak and less than the 1.4x average since 1990.

We remain overweight secular and cyclical growth opportunities in areas such as technology, health care, consumer discretionary and financials. We are underweight defensive names and also believe it is too soon to emphasize late-cycle industrials, materials, energy and other commodities. We are highly cautious regarding names with extreme multiples relative to underlying growth rates, given our expectation for near-term volatility and our anticipation of rising rates by late 2015.

Similarly, in non-U.S. markets, we continue to favor technology and consumer companies, viewing these areas as better positioned to navigate the crosscurrents coming from a strong dollar, weak commodity prices and slowing global growth. We continue to seek out opportunities tied to the consumer, as weaker commodity prices may provide the euro zone and countries such as China, India, Indonesia, and Japan with additional flexibility to pursue more accommodative monetary policies; these in turn could serve as a tailwind to consumption. We remain underweight the commodity complex as well as materials, although there may be opportunities to increase commodity exposure this year, as valuations and fundamentals warrant. We believe our focus on strong balance sheets, sustainable growth, valuations and comprehensive credit analysis will remain paramount, as we expect a few credit surprises to shake the markets.

In regard to regional positioning, we were generally underweight Europe for most of 2014 but believe opportunities will likely increase as 2015 progresses. While Mario Draghi hasn’t shown the ability to inspire shock-and-awe as Prime Minister Abe has in Japan, we believe additional quantitative easing from the ECB can provide a catalyst to improve economic fundamentals as well as a tailwind to the equity markets. In this environment, we are focusing on export-oriented companies benefiting from the weaker euro and asset reflation plays.

We began ramping up Japan exposure during the second half of 2014, and are currently equal-to-slightly overweight across most of our global and non-U.S. strategies. This upcoming earnings season may well provide opportunities to tilt further to Japanese equities. Despite the advance in the equity markets during the fourth quarter of 2014, valuations remain attractive—particularly versus the U.S. market—while many companies have improved capital and operating efficiencies that could translate into improved earnings.

In the emerging markets, we expect the bifurcation of returns we saw in 2014 to continue in 2015. Within our top-down framework, we favor countries positioned to benefit from secular tailwinds, such as China, Mexico, Indonesia, India and the Philippines. In regard to China, we continue to seek ways to capitalize on the country’s shift toward a greater emphasis on consumption and services. Reflecting a more cautious stance toward countries where economic reforms have less momentum, we expect to remain underweight Russia, Brazil, and Malaysia.

Convertibles

Because they have hybrid characteristics, convertibles can provide equity upside participation with potentially reduced volatility when stock markets decline. Historically, convertibles have performed well during volatile but generally upwardly moving equity markets—the environment we believe we will see in 2015—because convertibles benefit from their sensitivity to rising equities while the embedded option to convert into common stock becomes more valuable with the rise in volatility. Convertible issuers also tend to be more growth oriented, and therefore may be better positioned for the environment that we believe we are in.

However, we do not believe that all convertibles are equally well suited to this environment. During 2013 and the early portion of 2014, the market generally favored convertibles with high equity sensitivity, but since mid-2014, we’ve seen a more pronounced preference for convertibles that offer more balanced risk and reward attributes. We expect issuance for 2015 to stay in line with that of the past two years ($89 billion in 2014 and $93 billion in 2013), supported by economic expansion in the U.S., rising equity markets, and volatility (which can increase investor demand for the asset class).

Conclusion

While we expect near-term volatility associated with falling oil prices and weak economic growth in Europe to continue over the next few months, we remain bullish about the global economy and equity markets overall. Despite the impact of reduced capital spending on oil and oil-related sectors, we see U.S. GDP growth of 2.5%–3.0% in 2015 and corporate earnings growth in the 6%–7% range. We believe the start of QE in Europe will ease concerns about global growth. With share buybacks and M&A activity helping provide a floor, inexpensive valuations and an improving economy should allow the U.S. market to move 12% higher by year end, providing an equity return of around 14%.

The S&P 500 Index is considered generally representative of the U.S. equity market. The MSCI World Index is considered generally representative of the market for developed market equities. The MSCI World ex-U.S. Index is a market capitalization weighted index composed of companies representative of the market structure of developed market countries in North America (excluding the U.S.), Europe and Asia Pacific regions. The MSCI Emerging Markets Index is a free float adjusted market capitalization index cited as a measure of the performance of emerging market equities. The Nasdaq Index is an index composed of stocks that are listed on the Nasdaq stock exchange. The Russell 3000 Growth Index is considered generally representative of the U.S. growth stock market. The Russell 3000 Value Index is considered generally representative of the U.S. value stock market. The Russell 2000 Index is considered generally representative of the U.S. small-cap stock market. The BofA Merrill Lynch VXA0 Index is considered generally representative of the U.S. convertible market. The Consumer Price Index (CPI) measures the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

Price-to-earnings ratio (P/E) is a valuation ratio of a company’s current share price compared to its per-share earnings.

Earnings-per-share (EPS) is the portion of a company’s profit allocated to each share of common stock.

Earnings yield is earnings divided by stock price. Quantitative easing refers to central bank bond buying activities.

This material is distributed for informational purposes only. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the information mentioned, and while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.

Outside the U.S., this presentation is directed only at professional/sophisticated investors and it is for their exclusive use and information. This document should not be shown to or given to retail investors.

Investments in overseas markets pose special risks, including currency fluctuation and political risks, and greater volatility than typically associated with U.S. investments. These risks are generally intensified for investments in emerging markets.

The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably. These price movements may result from factors affecting individual companies, sectors or industries.

Fixed-income securities are subject to interest rate risk. If rates increase, the value of fixed-income investments generally declines.

NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE

Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.Calamos Investments LLC

2020 Calamos Court | Naperville, IL 60563-2787
800.582.6959 | www.calamos.com | caminfo@calamos.com

Calamos Investments LLP
No. 1 Cornhill | London, EC3V 3ND, UK
Tel: +44 (0) 20 3178 8838 | www.calamos.com/global
© 2014 Calamos Investments LLC. All Rights Reserved.

Calamos® and Calamos Investments® are registered trademarks of Calamos Investments LLC.

OUTLKCOM 18055 0115Q O C

[description] => GDP growth for 2015 is likely to be 2.0%-2.5% globally and 2.5%-3.0% in the U.S. Oil prices may fall further but are likely to stabilize over the next several months. The ECB is likely to ramp up QE in the first quarter. These next months are likely to be volatile, but equities have more room to run. Low corporate borrowing costs and high dividend yields should encourage continued M&A and buyback activity, providing support to equity valuations. With the U.S. in the middle innings of the recovery, the case for secular and cyclical growth companies remains strong. [author] => Team [legacyinterface_firm_id] => 487 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 17:39:46 [created_by] => 948 [modified_on] => 2015-01-20 17:43:31 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2385 [hits] => 0 ) [16] => stdClass Object ( [legacyinterface_commentary_id] => 2320 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15557 [apv_conversation_id] => 3234 [content_type] => market-commentary [title] => Davos - And the Euro [slug] => ft_012015 [fulltext] =>

Perfect! Last week, the Swiss National Bank in reaction to market pressure, ended its crawling peg against the euro. The Swiss Franc surged 40% versus the euro, before settling around 20% higher, and roughly 17% against the already strong dollar. So, guess what? Attendees at The World Economic Forum – an annual gaggle of the global financial elite held in Davos, Switzerland, which starts today – just saw their trip get a lot more expensive.

Most people who attend (or who aspire to attend) just call the meeting “Davos.” It’s been described as a meeting of the 1% - wealthy business CEO’s, high-ranking government officials, heads of international organizations, and, occasionally a famous economist, artist, professor, or author. And, don’t forget the press – they are everywhere.

For the most part, the meeting is made up of people who believe the “elite,” in business and government – the ones often called the “smartest people in the room” – can “fix” just about any problem that exists in the economy or society.

Last year’s theme was “Resilient Dynamism.” No joking; to the people at Davos that actually means something, or at least they all pretend that it does. This year, it’s “The Reshaping of the World: Consequences for Society, Politics and Business.” Some attendees actually think a central authority can Reshape the World and still have Resilient Dynamism.

Reading the agenda items, it sounds like an interesting conference. The panels will fret about financial market risk, inequality, global warming and talk about designing the perfect regulatory environment for fixing all these things.

While they may not say it exactly like this, they believe a “partnership between government, business and academia will produce a ‘better’ world.” And why shouldn’t they; many of them would be the central planners in that supposedly better world. But what these government, business, and academic officials just found out is that markets ultimately control prices, not central planners.

The Swiss National Bank, the central bank of Switzerland, had previously tied the local Swiss Franc to the

value of the euro. It did this to prevent the Swiss Franc from rising too much against the euro, which would, in theory, have made Swiss exports less competitive.

But, Switzerland has an excellent long-term monetary track record. The Swiss Franc has generally gained strength versus other currencies (even the US dollar) in the past 45 years. As a result, investors from around the world still prized investing in Switzerland. Moreover, with the European Central Bank threatening more quantitative easing, these two forces (one long-term and one short-term) put upward pressure on the Swiss Franc. To offset that upward pressure the central bank had been intervening in the foreign exchange market by buying Euros, issuing more Swiss Francs and racking up losses.

Continuing the peg would have swelled its balance sheet even further. In the end the “smartest Swiss in the room” were forced to cave to market forces. The world was aghast. Journalists, politicians, central bankers, and all forms of central planners were stymied. Their best laid plans of more QE to solve Eurozone problems took a massive hit. This is a lesson we doubt will be learned.

In the end, markets always win. You can only fight them for so long. The foreign exchange markets wanted the Swiss Franc higher because it represented the collective wisdom of people protecting their own assets, not just the Mandarins at the central bank who had temporarily decided it’d be better if the Swiss Franc didn’t move higher.

Keep that in mind when you hear breathless interviews and reporting from Davos in the week ahead, on what the smart set, the elites think about world problems and how to solve them. Because in the end, what they often say is that they know better than markets. But, the Invisible Hand, which most of them refuse to believe in, and many try to control, is simply more powerful.

If they really want to “Reshape the World,” Davos attendees will agree that getting out of the way and trusting that Invisible Hand is a much better solution than the ones they will likely dream up.

 This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy. 

© First Trust Advisors

[description] => Perfect! Last week, the Swiss National Bank in reaction to market pressure, ended its crawling peg against the euro. The Swiss Franc surged 40% versus the euro, before settling around 20% higher, and roughly 17% against the already strong dollar. So, guess what? Attendees at The World Economic Forum – an annual gaggle of the global financial elite held in Davos, Switzerland, which starts today – just saw their trip get a lot more expensive. [author] => Brian Wesbury, Robert Stein [legacyinterface_firm_id] => 154 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 17:44:40 [created_by] => 948 [modified_on] => 2015-01-20 17:44:51 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2386 [hits] => 0 ) [17] => stdClass Object ( [legacyinterface_commentary_id] => 2311 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 0 [apv_conversation_id] => [content_type] => market-commentary [title] => [slug] => -3 [fulltext] => [description] => [author] => [legacyinterface_firm_id] => 0 [published_on] => 2015-01-19 [digest_date] => 2015-01-19 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 0 [post_to_legacy_database] => 0 [enabled] => 0 [created_on] => 2015-01-19 02:54:02 [created_by] => 947 [modified_on] => 0000-00-00 00:00:00 [modified_by] => 0 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2377 [hits] => 0 ) [18] => stdClass Object ( [legacyinterface_commentary_id] => 2309 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15546 [apv_conversation_id] => 3214 [content_type] => market-commentary [title] => QE and the ECB: "Authorize" is a Slippery Word [slug] => hussman_011815 [fulltext] =>

Last week, the Swiss National Bank abandoned its attempt to tie the Swiss franc to the euro. For the past three years, the SNB has been trying to keep the franc from appreciating relative to the rest of Europe by accumulating euros and issuing francs. As the size of Switzerland’s foreign exchange holdings began to spiral out of control, Switzerland finally pulled the plug. The Swiss franc immediately soared by 49% (from 0.83 euros/franc to 1.24 euros/franc), but later stabilized to about 1 euro/franc. While numerous motives have been attributed to the Swiss National Bank, the SNB made its reasons clear: "The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified." In effect, the SNB simply did what the German Bundesbank wishes it could do: abandon the policies of European Central Bank president Mario Draghi, and the euro printing inclinations he embraces.

A quick update on what we call our "joint parity" estimates of currency valuation (see our recent discussion of the Japanese Yen in Iceberg at the Starboard Bow). Considering long-term purchasing power parity (which certainly does not hold in the short-run) jointly with interest rate parity (see Valuing Foreign Currencies), we presently estimate reasonable valuations of about $1.35 for the euro, and about $1.13 for the Swiss Franc - so after the wild currency moves of last week, we suddenly view the Swissie to be almost precisely where we think it should be relative to the dollar. At least one hedge fund and a number of FX brokerages were wiped out last week as their customers were caught with leveraged short positions against the franc. Data from the CME shows asset managers and leveraged money heavily short the euro (with commercial dealers on the other side), and by our estimates, the decline in the euro is overextended. That's a high-risk combination for euro shorts.

The chart below may offer some insight into what the SNB was thinking last week, from the perspective of our own joint-parity estimates of currency valuation. The chart reflects data just before the SNB abandoned its peg to the euro (data for the euro reflects the German DM prior to 1999, appropriately scaled). Back in August 2011, the Swiss franc surged to significant overvaluation relative to the euro. That’s when the SNB instituted the peg, attempting to hold the exchange rate at 1.20 francs per euro (just under 0.84 euros per franc). Prior to last week’s move, the overvaluation of the franc – relative to the euro – was no longer evident, and the franc had become substantially undervalued relative to the dollar. Having abandoned that peg, the franc has surged to what we view as fair value relative to the U.S. dollar.

Notably, the FX markets are providing some information here. From the standpoint of the EUR/CHF, the current exchange rate (now about 1.0 euros per franc) suddenly opens up a fresh gap versus the euro, which would be eliminated at a USD/EUR exchange rate of about $1.35/euro. That is, a fair value of 1.13 USD/CHF divided by a fair value of 0.84 EUR/CHF implies a fair value of 1.35 USD/EUR. Put simply, we view the Swiss franc as fairly valued against the U.S. dollar, but the U.S. dollar as overvalued relative to the euro (and most currencies). Conversely, from the standpoint of the dollar, the euro appears to have overshot to the downside. We expect that the Swiss franc will move back toward about 0.84 euros/franc (about 1.20 francs/euro), but not by depreciating sharply relative to the dollar. Rather we expect that both the dollar and the Swiss franc are likely to depreciate relative to the euro - conversely, that the euro is likely to appreciate relative to the dollar and the franc.

This week, the European Central Bank will authorize a fresh program of quantitative easing in Europe. My impression is that the structure of this venture will be far different from what seems to be commonly envisioned (and priced into an exchange rate that is has already overshot to the downside). The political realities for Germany have led it to shift its focus from opposing QE outright to changing the structure under which QE will proceed. It’s that potential impact on the structure of QE that seems underappreciated. Germany has two primary interests here. One is to ensure that any losses are borne by the individual member states, and the second is that as few euros as possible are created with the backing of questionable sovereign debt. Put simply, Germany’s agreement to allow QE to proceed is likely attached to particular strings that limit its exposure to the sovereign debt of its less credit-worthy neighbors.

Under Article 16 of the Protocol that established the European System of Central Banks (ESCB), the ECB Governing Council has the exclusive right to authorize the creation of euros, but either the ECB or the individual national central banks can issue those euros. The ECB will authorize a large QE program this week, but my impression is that the details will leave the ECB itself responsible for executing only a fraction of the announced program, with the remaining majority of the program (perhaps 60-75%) being nothing more than the option for each national central bank to purchase its own country’s government bonds, at its own discretion, and its own risk. Moreover, that option is likely to be limited to something on the order of 25% of the outstanding government debt of each respective country.

With German government debt trading at negative yields out to maturities of 5 years, German buying of German debt would essentially guarantee a loss to the Bundesbank. As a result, the likelihood that Germany will act on the option to buy that debt seems rather slim. The same argument holds, if to a lesser extent, for other credit-worthy countries in the Eurozone, which means that the bulk of that option will be taken up by smaller and less credit-worthy members. With a cap of perhaps 25% of total government debt, the actual size of QE when implemented is likely to be dramatically smaller than whatever number is announced this week. That certainly doesn’t rule out an ebullient knee-jerk response to whatever massive number is announced, but pay attention to the details, because they are likely to have a significant effect on what happens next. We’ll see.

Bottom line – “authorize” is a slippery word.

A flexible view toward a market collapse or a further bubble

For our part, I’ll reiterate what I’ve emphasized since June, when we completed our long and awkward transition from our pre-2009 methods to our present methods of classifying market return/risk profiles (see A Better Lesson than “This Time is Different” to review that narrative): The near-term outcome of speculative, overvalued markets isconditional on investor preferences toward risk-seeking or risk-aversion, and those preferences can be largely inferred from observable market internals and credit spreads. The difference between an overvalued market that becomes more overvalued, and an overvalued market that crashes, has little to do with the level of valuation and everything to do with investor risk preferences. Yet long-term investment outcomes remain chiefly defined by those valuations.

So if market internals, credit spreads, lopsided sentiment and other factors improve measurably – even with valuations as extreme as they are at present – we would expect to shift to an outlook more along the lines of “constructive with a safety net.” For now, we have a hard-negative view of equity market risk, but that will change as observable conditions shift.

I’ll emphasize again that while market internals, sentiment, credit spreads and other factors were included in the ensemble methods that came out of our stress-testing against Depression-era data, the ensembles didn’t sufficiently capture their effect in bubble periods. Part of the reason is that overvaluation has reliably poor outcomes over the complete market cycle. That effect is so strong that in any study that draws data from multiple cycles, the negative average effect of overvaluation tends to dominate when you estimate the prospective return/risk profile. In order to capture bubble-tolerant factors, we had to impose them as overlays. The reason I call the period from 2009 to mid-2014 an “awkward transition” is exactly because it required us to address a series of interrelated problems, with the full-cycle ones addressed fairly early on, but QE creating the need to address features that have appeared only during the most speculative periods in the historical record.

Probably the best way to show the effect of completing those adaptations is to reprint a chart from the June 16, 2014 comment Formula for Market Extremes. In the chart below, each line tracks the cumulative total return of the S&P 500 Index, restricted to various return/risk classifications that we identify from observable valuations, market action, and so forth. In prior market cycles, severely overvalued, overbought, overbullish syndromes were followed fairly quickly by significant market losses. The ensemble methods that came out of our stress-testing efforts picked up that regularity. Unfortunately, the main effect of speculative yield-seeking resulting from QE and zero interest rate policies was to reduce the overlap and increase the delay between the emergence of those syndromes on one hand, and the shift toward risk aversion among investors (which we infer from observable market internals, credit spreads, and related factors). As a result, we saw sustained periods where conditions were severely overvalued, overbought, and overbullish, yet the market continued to advance.

So while the ensemble methods certainly navigated full-cycles well, we’ve seen much more persistent risk-seeking in the period since 2009, resulting in the excruciating tendency for the market to advance despite overvalued, overbought, overbullish syndromes that had a more immediate effect in other cycles. If you go back to the September 9, 2013 comment The Lesson of the Coming Decade, you’ll see we were still facing a residual of that problem at that time. Again, the lessons to be drawn from the recent cycle aren’t that historically reliable measures of valuation are irrelevant, but are instead about the conditions that distinguish overvalued markets that tend to continue higher from overvalued markets that drop like a rock. In my view, we completed the necessary adaptations in June. The purple line shows the effect of the overlays that we’ve implemented. As I’ve noted in other comments (see Iceberg at the Starboard Bow), the typical outcome for the S&P 500 in conditions that match the present are even more severe.

We remain hard-negative toward the equity market, but that view will remain flexible to new evidence – which may allow some variant of “constructive with a safety net” if internals and credit spreads improve, even in the absence of improved valuation.

As always, we can’t offer assurances about the future, or that any of the lessons from market history will be of use in market cycles still ahead of us. But I can offer assurance that we’ve completed this adaptation in a way that’s robust to every market cycle we’ve observed across history, including Depression-era data, post-war data, and the period since 2009.

In Honor and Remembrance of Dr. Martin Luther King, Jr.

Dr. King noted that he tried to speak on the subject below at least once a year. That still seems an appropriate way to honor him. If you've never read Dr. King's writings, this talk is a good place to start. The road to peace always begins with the recognition by each side that the person they would call their enemy also suffers. In our common humanity, each of us might be like the other if we had suffered the same way – whether that suffering takes the form of injustice, poverty, violence, abuse, or even ignorance. In a world where people – on both sides of the word “enemy” – seem so inclined to carelessly pour their reservoir of suffering onto others without recognizing their shared humanity, our best cause for hope still resides in the wisdom of peacemakers like Dr. King. One can’t read his words without coming away better for it.

Loving Your Enemies 
November 17 1957

“I want to use as a subject from which to preach this morning a very familiar subject, and it is familiar to you because I have preached from this subject twice before to my knowing in this pulpit. I try to make it a, something of a custom or tradition to preach from this passage of Scripture at least once a year, adding new insights that I develop along the way out of new experiences as I give these messages. Although the content is, the basic content is the same, new insights and new experiences naturally make for new illustrations.

“So I want to turn your attention to this subject: "Loving Your Enemies." It's so basic to me because it is a part of my basic philosophical and theological orientation—the whole idea of love, the whole philosophy of love. In the fifth chapter of the gospel as recorded by Saint Matthew, we read these very arresting words flowing from the lips of our Lord and Master: "Ye have heard that it has been said, ‘Thou shall love thy neighbor, and hate thine enemy.' But I say unto you, Love your enemies, bless them that curse you, do good to them that hate you, and pray for them that despitefully use you; that ye may be the children of your Father which is in heaven."

“Over the centuries, many persons have argued that this is an extremely difficult command. Many would go so far as to say that it just isn't possible to move out into the actual practice of this glorious command. But far from being an impractical idealist, Jesus has become the practical realist. The words of this text glitter in our eyes with a new urgency. Far from being the pious injunction of a utopian dreamer, this command is an absolute necessity for the survival of our civilization. Yes, it is love that will save our world and our civilization, love even for enemies.

“Now let me hasten to say that Jesus was very serious when he gave this command; he wasn't playing. He realized that it's hard to love your enemies. He realized that it's difficult to love those persons who seek to defeat you, those persons who say evil things about you. He realized that it was painfully hard, pressingly hard. But he wasn't playing. We have the Christian and moral responsibility to seek to discover the meaning of these words, and to discover how we can live out this command, and why we should live by this command.

“Now first let us deal with this question, which is the practical question: How do you go about loving your enemies? I think the first thing is this: In order to love your enemies, you must begin by analyzing self. And I'm sure that seems strange to you, that I start out telling you this morning that you love your enemies by beginning with a look at self. It seems to me that that is the first and foremost way to come to an adequate discovery to the how of this situation.

“Now, I'm aware of the fact that some people will not like you, not because of something you have done to them, but they just won't like you. But after looking at these things and admitting these things, we must face the fact that an individual might dislike us because of something that we've done deep down in the past, some personality attribute that we possess, something that we've done deep down in the past and we've forgotten about it; but it was that something that aroused the hate response within the individual. That is why I say, begin with yourself. There might be something within you that arouses the tragic hate response in the other individual.

“This is true in our international struggle. Democracy is the greatest form of government to my mind that man has ever conceived, but the weakness is that we have never touched it. We must face the fact that the rhythmic beat of the deep rumblings of discontent from Asia and Africa is at bottom a revolt against the imperialism and colonialism perpetuated by Western civilization all these many years.

“And this is what Jesus means when he said: "How is it that you can see the mote in your brother's eye and not see the beam in your own eye?" And this is one of the tragedies of human nature. So we begin to love our enemies and love those persons that hate us whether in collective life or individual life by looking at ourselves.

“A second thing that an individual must do in seeking to love his enemy is to discover the element of good in his enemy, and every time you begin to hate that person and think of hating that person, realize that there is some good there and look at those good points which will over-balance the bad points.

“Somehow the "isness" of our present nature is out of harmony with the eternal "oughtness" that forever confronts us. And this simply means this: That within the best of us, there is some evil, and within the worst of us, there is some good. When we come to see this, we take a different attitude toward individuals. The person who hates you most has some good in him; even the nation that hates you most has some good in it; even the race that hates you most has some good in it. And when you come to the point that you look in the face of every man and see deep down within him what religion calls "the image of God," you begin to love him in spite of. No matter what he does, you see God's image there. There is an element of goodness that he can never slough off. Discover the element of good in your enemy. And as you seek to hate him, find the center of goodness and place your attention there and you will take a new attitude.

“Another way that you love your enemy is this: When the opportunity presents itself for you to defeat your enemy, that is the time which you must not do it. There will come a time, in many instances, when the person who hates you most, the person who has misused you most, the person who has gossiped about you most, the person who has spread false rumors about you most, there will come a time when you will have an opportunity to defeat that person. It might be in terms of a recommendation for a job; it might be in terms of helping that person to make some move in life. That's the time you must do it. That is the meaning of love. In the final analysis, love is not this sentimental something that we talk about. It's not merely an emotional something. Love is creative, understanding goodwill for all men. It is the refusal to defeat any individual. When you rise to the level of love, of its great beauty and power, you seek only to defeat evil systems. Individuals who happen to be caught up in that system, you love, but you seek to defeat the system.

“The Greek language, as I've said so often before, is very powerful at this point. It comes to our aid beautifully in giving us the real meaning and depth of the whole philosophy of love. And I think it is quite apropos at this point, for you see the Greek language has three words for love, interestingly enough. It talks about love as eros. That's one word for love. Eros is a sort of, aesthetic love. Plato talks about it a great deal in his dialogues, a sort of yearning of the soul for the realm of the gods. And it's come to us to be a sort of romantic love, though it's a beautiful love. Everybody has experienced eros in all of its beauty when you find some individual that is attractive to you and that you pour out all of your like and your love on that individual. That is eros, you see, and it's a powerful, beautiful love that is given to us through all of the beauty of literature; we read about it.

“Then the Greek language talks about philia, and that's another type of love that's also beautiful. It is a sort of intimate affection between personal friends. And this is the type of love that you have for those persons that you're friendly with, your intimate friends, or people that you call on the telephone and you go by to have dinner with, and your roommate in college and that type of thing. It's a sort of reciprocal love. On this level, you like a person because that person likes you. You love on this level, because you are loved. You love on this level, because there's something about the person you love that is likeable to you. This too is a beautiful love. You can communicate with a person; you have certain things in common; you like to do things together. This is philia.

“The Greek language comes out with another word for love. It is the word agape. And agape is more than eros; agape is more than philia; agape is something of the understanding, creative, redemptive goodwill for all men. It is a love that seeks nothing in return. It is an overflowing love; it's what theologians would call the love of God working in the lives of men. And when you rise to love on this level, you begin to love men, not because they are likeable, but because God loves them. You look at every man, and you love him because you know God loves him. And he might be the worst person you've ever seen.

“And this is what Jesus means, I think, in this very passage when he says, "Love your enemy." And it's significant that he does not say, "Like your enemy." Like is a sentimental something, an affectionate something. There are a lot of people that I find it difficult to like. I don't like what they do to me. I don't like what they say about me and other people. I don't like their attitudes. I don't like some of the things they're doing. I don't like them. But Jesus says love them. And love is greater than like. Love is understanding, redemptive goodwill for all men, so that you love everybody, because God loves them. You refuse to do anything that will defeat an individual, because you have agape in your soul. And here you come to the point that you love the individual who does the evil deed, while hating the deed that the person does. This is what Jesus means when he says, "Love your enemy." This is the way to do it. When the opportunity presents itself when you can defeat your enemy, you must not do it.

“Now for the few moments left, let us move from the practical how to the theoretical why. It's not only necessary to know how to go about loving your enemies, but also to go down into the question of why we should love our enemies. I think the first reason that we should love our enemies, and I think this was at the very center of Jesus' thinking, is this: that hate for hate only intensifies the existence of hate and evil in the universe. If I hit you and you hit me and I hit you back and you hit me back and go on, you see, that goes on ad infinitum. It just never ends. Somewhere somebody must have a little sense, and that's the strong person. The strong person is the person who can cut off the chain of hate, the chain of evil. And that is the tragedy of hate – that it doesn't cut it off. It only intensifies the existence of hate and evil in the universe. Somebody must have religion enough and morality enough to cut it off and inject within the very structure of the universe that strong and powerful element of love.

“I think I mentioned before that sometime ago my brother and I were driving one evening to Chattanooga, Tennessee, from Atlanta. He was driving the car. And for some reason the drivers were very discourteous that night. They didn't dim their lights; hardly any driver that passed by dimmed his lights. And I remember very vividly, my brother A. D. looked over and in a tone of anger said: "I know what I'm going to do. The next car that comes along here and refuses to dim the lights, I'm going to fail to dim mine and pour them on in all of their power." And I looked at him right quick and said: "Oh no, don't do that. There'd be too much light on this highway, and it will end up in mutual destruction for all. Somebody got to have some sense on this highway."

“Somebody must have sense enough to dim the lights, and that is the trouble, isn't it? That as all of the civilizations of the world move up the highway of history, so many civilizations, having looked at other civilizations that refused to dim the lights, and they decided to refuse to dim theirs. And Toynbee tells that out of the twenty-two civilizations that have risen up, all but about seven have found themselves in the junk heap of destruction. It is because civilizations fail to have sense enough to dim the lights. And if somebody doesn't have sense enough to turn on the dim and beautiful and powerful lights of love in this world, the whole of our civilization will be plunged into the abyss of destruction. And we will all end up destroyed because nobody had any sense on the highway of history.

"Somewhere somebody must have some sense. Men must see that force begets force, hate begets hate, toughness begets toughness. And it is all a descending spiral, ultimately ending in destruction for all and everybody. Somebody must have sense enough and morality enough to cut off the chain of hate and the chain of evil in the universe. And you do that by love.

“There's another reason why you should love your enemies, and that is because hate distorts the personality of the hater. We usually think of what hate does for the individual hated or the individuals hated or the groups hated. But it is even more tragic, it is even more ruinous and injurious to the individual who hates. You just begin hating somebody, and you will begin to do irrational things. You can't see straight when you hate. You can't walk straight when you hate. You can't stand upright. Your vision is distorted. There is nothing more tragic than to see an individual whose heart is filled with hate. He comes to the point that he becomes a pathological case. For the person who hates, you can stand up and see a person and that person can be beautiful, and you will call them ugly. For the person who hates, the beautiful becomes ugly and the ugly becomes beautiful. For the person who hates, the good becomes bad and the bad becomes good. For the person who hates, the true becomes false and the false becomes true. That's what hate does. You can't see right. The symbol of objectivity is lost. Hate destroys the very structure of the personality of the hater.

“The way to be integrated with yourself is be sure that you meet every situation of life with an abounding love. Never hate, because it ends up in tragic, neurotic responses. Psychologists and psychiatrists are telling us today that the more we hate, the more we develop guilt feelings and we begin to subconsciously repress or consciously suppress certain emotions, and they all stack up in our subconscious selves and make for tragic, neurotic responses. And may this not be the neuroses of many individuals as they confront life that that is an element of hate there. And modern psychology is calling on us now to love. But long before modern psychology came into being, the world's greatest psychologist who walked around the hills of Galilee told us to love. He looked at men and said: "Love your enemies; don't hate anybody." It's not enough for us to hate your friends because—to to love your friends—because when you start hating anybody, it destroys the very center of your creative response to life and the universe; so love everybody. Hate at any point is a cancer that gnaws away at the very vital center of your life and your existence. It is like eroding acid that eats away the best and the objective center of your life. So Jesus says love, because hate destroys the hater as well as the hated.

“Now there is a final reason I think that Jesus says, "Love your enemies." It is this: that love has within it a redemptive power. And there is a power there that eventually transforms individuals. That's why Jesus says, "Love your enemies." Because if you hate your enemies, you have no way to redeem and to transform your enemies. But if you love your enemies, you will discover that at the very root of love is the power of redemption. You just keep loving people and keep loving them, even though they're mistreating you. Here's the person who is a neighbor, and this person is doing something wrong to you and all of that. Just keep being friendly to that person. Keep loving them. Don't do anything to embarrass them. Just keep loving them, and they can't stand it too long. Oh, they react in many ways in the beginning. They react with bitterness because they're mad because you love them like that. They react with guilt feelings, and sometimes they'll hate you a little more at that transition period, but just keep loving them. And by the power of your love they will break down under the load. That's love, you see. It is redemptive, and this is why Jesus says love. There's something about love that builds up and is creative. There is something about hate that tears down and is destructive. So love your enemies.

“There is a power in love that our world has not discovered yet. Jesus discovered it centuries ago. Mahatma Gandhi of India discovered it a few years ago, but most men and most women never discover it. For they believe in hitting for hitting; they believe in an eye for an eye and a tooth for a tooth; they believe in hating for hating; but Jesus comes to us and says, "This isn't the way."

“As we look out across the years and across the generations, let us develop and move right here. We must discover the power of love, the power, the redemptive power of love. And when we discover that we will be able to make of this old world a new world. We will be able to make men better. Love is the only way. Jesus discovered that.

“And our civilization must discover that. Individuals must discover that as they deal with other individuals. There is a little tree planted on a little hill and on that tree hangs the most influential character that ever came in this world. But never feel that that tree is a meaningless drama that took place on the stages of history. Oh no, it is a telescope through which we look out into the long vista of eternity, and see the love of God breaking forth into time. It is an eternal reminder to a power-drunk generation that love is the only way. It is an eternal reminder to a generation depending on nuclear and atomic energy, a generation depending on physical violence, that love is the only creative, redemptive, transforming power in the universe.

“So this morning, as I look into your eyes, and into the eyes of all of my brothers in Alabama and all over America and over the world, I say to you, "I love you. I would rather die than hate you." And I'm foolish enough to believe that through the power of this love somewhere, men of the most recalcitrant bent will be transformed. And then we will be in God's kingdom.”

The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Please see periodic remarks on the Fund Notes and Commentary page for discussion relating specifically to the Hussman Funds and the investment positions of the Funds.

---

Prospectuses for the Hussman Strategic Growth Fund, the Hussman Strategic Total Return Fund, the Hussman Strategic International Fund, and the Hussman Strategic Dividend Value Fund, as well as Fund reports and other information, are available by clicking "The Funds" menu button from any page of this website.

Estimates of prospective return and risk for equities, bonds, and other financial markets are forward-looking statements based the analysis and reasonable beliefs of Hussman Strategic Advisors. They are not a guarantee of future performance, and are not indicative of the prospective returns of any of the Hussman Funds. Actual returns may differ substantially from the estimates provided. Estimates of prospective long-term returns for the S&P 500 reflect our standard valuation methodology, focusing on the relationship between current market prices and earnings, dividends and other fundamentals, adjusted for variability over the economic cycle (see for exampleInvestment, Speculation, Valuation, and Tinker BellThe Likely Range of Market Returns in the Coming Decade and Valuing the S&P 500 Using Forward Operating Earnings ).

[description] => The ECB will authorize a large QE program this week, but my impression is that the details will leave the ECB itself responsible for executing only a fraction of the announced program, with the remaining majority of the program (perhaps 60-75%) being nothing more than the option for each national central bank to purchase its own country’s government bonds, at its own discretion, and its own risk. Moreover, that option is likely to be limited to something on the order of 25% of the outstanding government debt of each respective country. [author] => John Hussman [legacyinterface_firm_id] => 218 [published_on] => 2015-01-18 [digest_date] => 2015-01-18 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-18 14:58:42 [created_by] => 945 [modified_on] => 2015-01-19 03:08:21 [modified_by] => 947 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2375 [hits] => 0 ) [19] => stdClass Object ( [legacyinterface_commentary_id] => 2310 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15547 [apv_conversation_id] => 3215 [content_type] => market-commentary [title] => Weighing the Week Ahead: The Message from Fourth Quarter Earnings [slug] => newarc_011815 [fulltext] =>

Investors have another holiday-shortened week and a light calendar of economic data. Last week included the “official” start of earnings season, but things really heat up now.

I expect market participants to be watching closely for The Message from Corporate Earnings.

Prior Theme Recap

In last week’s WTWA I predicted that there would be a focus on the message from the bond market. That was very accurate, even more so if extended to commodity prices which traded in tandem. Some cited copper prices. Brett Steenbarger had the trader perspective on multiple markets. Sober Look inferred a rising risk of deflation. It was a consistent theme on CNBC. Gavyn Davies thinks the commodity markets are right, but that stocks have not incorporated that viewpoint. Interesting. The stock market I was following seems pretty much in knee-jerk reaction to the commodity news. Hale Stewart has a more balanced conclusion, with an interesting angle on the commodity trading from Chinese hedge funds. Whatever viewpoint you choose, it was a good guess for last week’s theme.

Bond yields moved lower still, but the explanations remained varied. Michael Aneiro at Barron’s Current Yield captures all of the factors:

New reasons for yields to fall keep coming from all directions on a seemingly daily basis. Early last week the World Bank cut its forecast for global growth, and Treasury yields fell. On Wednesday, the Commerce Department reported that U.S. retail sales fell by 0.9% in December, the sharpest drop in a year, and Treasury yields fell. On Thursday, Switzerland’s central bank ended a longstanding exchange-rate cap, causing the Swiss franc to soar versus the euro, boosting safe-haven investments and causing Treasury yields to fall.

Feel free to join in my exercise in thinking about the upcoming theme. We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead.

This Week’s Theme

There is much less economic news in the holiday-shortened week ahead. The State of the Union Address will attract some attention on Tuesday evening, but there is a lot of advance information. The ECB will announce QE plans on Thursday, but that is also widely anticipated.

I expect the real focus for the week to be corporate earnings – always important, but now even more so. Analyst expectations are dropping rapidly. (Bespoke).

  1. Outlook. Will corporations express greater worries about Europe and China or some confidence in future prospects. FactSet reports that 84% of companies have beaten expectations so far. Guidance is 4-2 positive (yes, only six cases). It does not feel like it was very good. Market standards seem demanding.
  2. Energy companies. Are the earnings for this sector (and by implication the overall market) overstated? This could prompt some revised thinking. Earnings expert Brian Gilmartin remains confident about earnings growth ex-energy, looking for a year-over-year gain of 6.7%. He is more cautious about energy.
  3. Energy cap-ex and employment. There has already been a move to attribute the bulk of employment gains to growth in the U.S. energy business – direct and indirect. Any job cuts will get highlighted as evidence, as was the case in the Schlumberger report.

As always, I have some additional ideas in today’s conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.
  2. It is better than expectations.

The Good

There was a normal news week, with a negative tilt.

  • A government shutdown is “off the table” according to Senate Republicans. This removes one significant market worry. (The Hill).
  • An advisory European Court gave a preliminary OK to the ECB’s quantitative easing plan. (BreakingViews) Normally I would not even mention this, but Art Cashin said that people would be checking the news at 4 AM. The positive story did not seem to help that day’s trading! Many remain skeptical on the plan because of expected limitations. (FT)
  • CPI increases remain low. Brian Wesbury has a complete analysis showing that the results would be even lower without items like imputed rent.
  • Industrial production registered a slight beat.
  • Job openings reached another multi-year high. The market is treating this as a positive, so I’ll call it “good,” but the number of quits declined again. Most would be surprised to learn that 2.6 million people voluntarily left jobs last month. (BLS).
  • Michigan sentiment hit an 11-year high with a reading of 98.1. This has been a good coincident indicator for employment and consumption, so perhaps the lower gas prices are having an effect. Doug Short’s chart of this is still the best, drawing together all of the key factors and providing a good historical perspective.

Dshort michigan sentiment

The Bad

The bad news included some significant economic reports.

  • State of the Union – early leaks. I may be jumping the gun a bit here, but the prospects for Tuesday’s SOTU address do not seem market-friendly. I have been hoping for a spell of coalition-building requiring a bit of bipartisan cooperation. The early hints about the speech suggest a more aggressive theme. Sometimes these are trial balloons, so we shall see. (Washington Post).
  • Initial jobless claims rose to 316K, a recent high, as did the four-week moving average. We all watch this closely. Calculated Risk has the story as well as a helpful chart.

WeeklyClaimsJan152015

  • Retail sales declined by 0.9%, much worse than expectations. Scott Grannis notes the impact of reduced gasoline sales and cites the ex-gasoline number as a decline of 0.3%. Doug Short adjusts for both population and inflation, producing a much more pessimistic picture.

DShort Retail Sales

The Ugly

The Swiss revaluation fallout. John Lounsbury explains why the actual economic impacts are modest. Not so the impacts on traders who got buried on highly-leveraged bets on the currency relationships. This is what happens when you are trying to make big returns on a very slight edge. Some immediately looked for falling dominoes of the Lehman variety. The FT has an objective account of motivations. We would do better to look for other crowded hedge fund trades that could easily go wrong. Jeremy Hill describes four trends that have a wide trader following, calling them “blackjack trades” because they are “double down, double up.” Which of the four stands on its own merits?

Noteworthy

My email forwarding service sent out an old item last week, for no apparent reasons. The service was originally Feedburner, but it has been purchased by Google. Our only explanation is that it was a warning shot because of last week’s little joke: “Google is moving into the auto insurance business. Isn’t the company also pushing a driverless car? Coincidence no doubt!” It’s not nice to poke fun at Google!

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts.  Think of The Lone Ranger. No award this week, but nominations are welcome.

Fans of the Silver Bullet can check out our annual review of award winners, just in case you missed one. Most investors have been bamboozled by one or more of these stories, so an annual review can be helpful.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key indicators.

Georg Vrba: has developed an array of interesting systems. Check out his site for the full story. We especially like his unemployment rate recession indicator, confirming that there is no recession signal. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds. Georg has a new method for TIAA-CREF asset allocation. He has added a method for Vanguard Dividend Growth Funds. I am following his results and methods with great interest. You should, too. Georg’s update this week was his BCI index, also showing very low recession changes.

BCI-Fig-1-1-15-2015

Myles Udland at Business Insider, a source we cite frequently, has a story about a potential inversion of the yield curve, which is supposedly “rapidly approach” a recession signal. I am including the chart for consideration. I wish that Myles would give equal time to the first-rate recession sources I have been featuring for almost four years. A balanced account would include those who have been accurate. Each of them considers the yield curve as part of the modeling. All do a better job than Udland’s source.

january 15 cotd

The Week Ahead

It is a light week for economic data, but there are some important releases.

The “A List” includes the following:

  • Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
  • Housing starts and building permits (W). Follow permits for a leading indicator on this important sector.
  • Leading indicators (F). Somewhat controversial but widely followed.
  • Crude oil inventories (Th). Attracting a lot more attention these days.

The “B List” includes the following:

  • Existing home sales (F).
  • Chinese economic data (T). Q4 GDP, industrial production, and retail sales.

One wild card might be the State of the Union speech on Tuesday night. The market would welcome credible ideas about tax reform, for example.

Mostly, attention will focus on earnings reports.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix held a bullish stance throughout the week, despite the continuing turbulence. There is still plenty of uncertainty reflected by the extremely high percentage of sectors in the penalty box. There has also been some rapid changes in the top sectors. Our current position is still fully invested in three leading sectors, but Felix’s overall market rating has slipped a bit. We’ll downgrade it to neutral in our regular “month ahead” forecast, but it is a close call. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

As I have noted for two weeks, Felix continues to feature selected energy holdings.

Joe Fahmy has advice for biotech traders, and it is quite good – start with ETFs and the larger names until you have done more research. His comments, especially about position size, have a much wider application. Many traders blow out by getting too big. The go by what they want to earn, not by what they can risk. The also under-estimate risk.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. We have recently updated our current ideas for investors.

Other Advice

Here is our collection of great investor advice for this week:

Sectors and ETFs

Ben Carlson has a great article analyzing winning sectors from past years and changing trends. There are many good charts and he suggests several lessons. Here is one chart to consider. Meanwhile, my forecast is that last year’s winners will be this year’s losers and vice-versa. One unusual year begets another.

sector-performance-2003-2008-and-2009-2014

Stock Ideas

Goldman’s 18 most expensive stocks.

CNBC had a great interview with leading fund manager Noah Blackstein. While the topic is listed as opportunities in Canadian stocks, Noah explained an interesting trade he has noted. Funds are going long debt in energy companies and short the stocks. This is working for the moment, but could shift quickly. This is an interesting observation from a savvy observer.

Eddy Elfenbein provides some thoughts about Google, including the chart below. As is often the case, I agree with his Google analysis. It is a good time for the company to show what PE multiple is justified. (We do not yet own it for most clients, but it is on our watch list). More importantly, Eddy’s clear-headed analysis and great graphic representation show how value investors pick stocks.

image1452

Value in long-term MLP’s? (WSJ)

Energy Prices

Short-term a 5% rally on Friday. Signs of a bottom?

Long-term energy prospects related to China. Car ownership is 70 per 1000 population. In the US it is 800. Car ownership relates strong to GDP per capita, so you can do the math. Paulo Santos has a nice article with good evidence and some interesting charts.

Market Prospects

Economist David Rosenberg says that it is “hard to be bearish on stocks.” I have special respect for those who are led by data, willing to adjust opinions. He has lost some loyal followers from the perma-bear community (although apparently still invited to the Mauldin conference). Take a few minutes to watch the video.

Investor Psychology

I was surprised that there was little mention of the logic problem from last week. Was it too easy for our sophisticated readership?

Buttonwood reminds us of easy it is to confuse skill and luck. Try your hand at this quiz (which 80% get wrong) as well as the key takeaway:

Jack is looking at Anne but Anne is looking at George. Jack is married, but George is not. Is a married person looking at an unmarried person? A) Yes, B) No or C) cannot be determined.

Answer in the conclusion.

Final Thought

I do not know how earnings season will play out this week. My list of things to watch is good, but the market seems to be demanding a parlay of positive indications:

  1. Beating the whisper number for earnings;
  2. Beating the revenue expectations;
  3. Business growth –organic, not from mergers or purchases;
  4. Solid “quality of earnings” with no gimmicks or accounting moves;
  5. A credible, positive outlook.

These are always factors, but the early returns suggest the bar is high this quarter. Markets are looking to earnings reports for any sign that the economy has weakened.

Puzzle solution. Most think that the information is not enough to reach a conclusion. They answer is actually “Yes.” Try considering both cases – Anne married and not married.

© New Arc Investments

http://dashofinsight.com

[description] => I do not know how earnings season will play out this week. My list of things to watch is good, but the market seems to be demanding a parlay of positive indications: Beating the whisper number for earnings; Beating the revenue expectations; Business growth –organic, not from mergers or purchases; Solid “quality of earnings” with no gimmicks or accounting moves; A credible, positive outlook. 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=> frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [cookie] => JInputCookie Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( [get] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [start] => 120 ) [inputs:protected] => Array ( ) ) [post] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [cookie] => JInputCookie Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [files] => JInputFiles Object ( [decodedData:protected] => Array ( ) [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( [get] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [start] => 120 ) [inputs:protected] => Array ( ) ) [post] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [cookie] => JInputCookie Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [files] => JInputFiles Object ( [decodedData:protected] => Array ( ) [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [env] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [request] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [start] => 120 [limitstart] => 120 [option] => com_legacyinterface [view] => commentaries [Itemid] => 616 ) [inputs:protected] => Array ( ) ) [server] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [HTTP_AUTHORIZATION] => [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8 [HTTP_ACCEPT_ENCODING] => gzip [HTTP_ACCEPT_CHARSET] => ISO-8859-1,utf-8;q=0.7,*;q=0.7 [HTTP_ACCEPT_LANGUAGE] => en-us,en;q=0.5 [HTTP_REFERER] => http://wordpress.hubtech.tv/?start=120 [HTTP_USER_AGENT] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729) [HTTP_HOST] => wordpress.hubtech.tv [HTTP_CONNECTION] => Keep-Alive [PATH] => /sbin:/usr/sbin:/bin:/usr/bin [SERVER_SIGNATURE] => [SERVER_SOFTWARE] => Apache/2.4.16 (Amazon) PHP/5.5.31 [SERVER_NAME] => wordpress.hubtech.tv [SERVER_ADDR] => 10.28.13.29 [SERVER_PORT] => 80 [REMOTE_ADDR] => 186.89.97.165 [DOCUMENT_ROOT] => /var/www/html/apcms [REQUEST_SCHEME] => http [CONTEXT_PREFIX] => [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms [SERVER_ADMIN] => ben@hubtech.tv [SCRIPT_FILENAME] => /var/www/html/apcms/index.php [REMOTE_PORT] => 64633 [GATEWAY_INTERFACE] => CGI/1.1 [SERVER_PROTOCOL] => HTTP/1.1 [REQUEST_METHOD] => GET [QUERY_STRING] => start=120 [REQUEST_URI] => /?start=120 [SCRIPT_NAME] => /index.php [PHP_SELF] => /index.php [REQUEST_TIME_FLOAT] => 1524775397.572 [REQUEST_TIME] => 1524775397 ) [inputs:protected] => Array ( ) ) [session] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [__default] => Array ( [session.counter] => 1 [session.timer.start] => 1524775398 [session.timer.last] => 1524775398 [session.timer.now] => 1524775398 [session.client.browser] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729) [registry] => Joomla\Registry\Registry Object ( [data:protected] => stdClass Object ( [com_legacyinterface] => stdClass Object ( [commentaries] => stdClass Object ( [limitstart] => 120 [filter_order] => published_on [filter_order_Dir] => desc ) ) ) ) [user] => JUser Object ( [isRoot:protected] => [id] => 0 [name] => [username] => [email] => [password] => [password_clear] => [block] => [sendEmail] => 0 [registerDate] => [lastvisitDate] => [activation] => [params] => [groups] => Array ( [0] => 9 ) [guest] => 1 [lastResetTime] => [resetCount] => [requireReset] => [_params:protected] => Joomla\Registry\Registry Object ( [data:protected] => stdClass Object ( ) ) [_authGroups:protected] => Array ( [0] => 1 ) [_authLevels:protected] => Array ( [0] => 1 [1] => 1 ) [_authActions:protected] => [_errorMsg:protected] => [_errors:protected] => Array ( ) [aid] => 0 ) ) ) [inputs:protected] => Array ( ) ) [jrequest] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) ) ) [env] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) [request] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [start] => 120 [limitstart] => 120 [option] => com_legacyinterface [view] => commentaries [Itemid] => 616 ) [inputs:protected] => Array ( ) ) [server] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [HTTP_AUTHORIZATION] => [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8 [HTTP_ACCEPT_ENCODING] => gzip [HTTP_ACCEPT_CHARSET] => ISO-8859-1,utf-8;q=0.7,*;q=0.7 [HTTP_ACCEPT_LANGUAGE] => en-us,en;q=0.5 [HTTP_REFERER] => http://wordpress.hubtech.tv/?start=120 [HTTP_USER_AGENT] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729) [HTTP_HOST] => wordpress.hubtech.tv [HTTP_CONNECTION] => Keep-Alive [PATH] => /sbin:/usr/sbin:/bin:/usr/bin [SERVER_SIGNATURE] => [SERVER_SOFTWARE] => Apache/2.4.16 (Amazon) PHP/5.5.31 [SERVER_NAME] => wordpress.hubtech.tv [SERVER_ADDR] => 10.28.13.29 [SERVER_PORT] => 80 [REMOTE_ADDR] => 186.89.97.165 [DOCUMENT_ROOT] => /var/www/html/apcms [REQUEST_SCHEME] => http [CONTEXT_PREFIX] => [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms [SERVER_ADMIN] => ben@hubtech.tv [SCRIPT_FILENAME] => /var/www/html/apcms/index.php [REMOTE_PORT] => 64633 [GATEWAY_INTERFACE] => CGI/1.1 [SERVER_PROTOCOL] => HTTP/1.1 [REQUEST_METHOD] => GET [QUERY_STRING] => start=120 [REQUEST_URI] => /?start=120 [SCRIPT_NAME] => /index.php [PHP_SELF] => /index.php [REQUEST_TIME_FLOAT] => 1524775397.572 [REQUEST_TIME] => 1524775397 ) [inputs:protected] => Array ( ) ) [session] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( [__default] => Array ( [session.counter] => 1 [session.timer.start] => 1524775398 [session.timer.last] => 1524775398 [session.timer.now] => 1524775398 [session.client.browser] => Mozilla/5.0 (Windows; U; Windows NT 5.1; pt-PT; rv:1.9.1.2) Gecko/20090729 Firefox/3.5.2 (.NET CLR 3.5.30729) [registry] => Joomla\Registry\Registry Object ( [data:protected] => stdClass Object ( [com_legacyinterface] => stdClass Object ( [commentaries] => stdClass Object ( [limitstart] => 120 [filter_order] => published_on [filter_order_Dir] => desc ) ) ) ) [user] => JUser Object ( [isRoot:protected] => [id] => 0 [name] => [username] => [email] => [password] => [password_clear] => [block] => [sendEmail] => 0 [registerDate] => [lastvisitDate] => [activation] => [params] => [groups] => Array ( [0] => 9 ) [guest] => 1 [lastResetTime] => [resetCount] => [requireReset] => [_params:protected] => Joomla\Registry\Registry Object ( [data:protected] => stdClass Object ( ) ) [_authGroups:protected] => Array ( [0] => 1 ) [_authLevels:protected] => Array ( [0] => 1 [1] => 1 ) [_authActions:protected] => [_errorMsg:protected] => [_errors:protected] => Array ( ) [aid] => 0 ) ) ) [inputs:protected] => Array ( ) ) [jrequest] => JInput Object ( [options:protected] => Array ( ) [filter:protected] => JFilterInput Object ( [tagsArray] => Array ( ) [attrArray] => Array ( ) [tagsMethod] => 0 [attrMethod] => 0 [xssAuto] => 1 [tagBlacklist] => Array ( [0] => applet [1] => body [2] => bgsound [3] => base [4] => basefont [5] => embed [6] => frame [7] => frameset [8] => head [9] => html [10] => id [11] => iframe [12] => ilayer [13] => layer [14] => link [15] => meta [16] => name [17] => object [18] => script [19] => style [20] => title [21] => xml ) [attrBlacklist] => Array ( [0] => action [1] => background [2] => codebase [3] => dynsrc [4] => lowsrc ) ) [data:protected] => Array ( ) [inputs:protected] => Array ( ) ) ) ) [files] => JInputFiles Object ( [decodedData:protected] => Array ( ) [options:protected] => Array 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In 2010, International Business Machines’ (IBM) then-CEO Sam Palmisano unveiled the company’s 2015 Roadmap in which management detailed its plans to grow (non-GAAP) operating earnings to “at least $20” per share by 2015.  This plan was the successor to a 2010 Roadmap, originally unveiled in 2007, in which management outlined its plan to deliver “at least $10” in earnings per share by 2010.  Since the company ultimately exceeded its 2010 Roadmap expectations and delivered $11.52 in 2010 earnings per share, the 2015 Roadmap was generally met with enthusiasm by IBM shareholders.  However, the 2015 Roadmap has proven to be a bumpy ride.  On October 20, 2014, along with a disappointing third quarter earnings report, current CEO Ginni Rometty disclosed that the company will fail to achieve “at least $20” in (non-GAAP) operating earnings per share, the cornerstone of the much-publicized 2015 Roadmap.  This development provides a worthwhile context within which to assess some of the advantages and disadvantages of long-term earnings roadmaps, and provide an update on why we continue to view IBM as an attractive investment despite management’s acknowledgement that the 2015 Roadmap was overly optimistic.

Pros and Cons of Long-Term Earnings Roadmaps

While I am not a proponent of long-term earnings roadmaps, I can understand the appeal of such a tactic to the CEO of a business like IBM.  IBM’s core businesses are generally much less volatile and much more resilient than typical technology businesses, and a long-term earnings roadmap was one method of illustrating this.  In addition to conveying management’s view that the company’s operating earnings could nearly double between 2011 and 2015, the 2015 Roadmap detailed the favorable operating margin impact of operating leverage in the company’s software business, cost reductions in its services businesses, and a continuing business mix shift toward more profitable products and services.  Recognizing that technology companies’ capital allocation track records have been mixed at best, the 2015 Roadmap also included an expectation that the company would generate approximately $100 billion in free cash flow between the beginning of 2011 and the end of 2015.  Management committed that approximately 70% of that free cash flow would be returned to shareholders in the form of dividends ($20 billion) and share repurchases ($50 billion), and that an additional $20 billion would be used for acquisitions. 

Although these objectives seemed reasonable enough at the outset of IBM’s 2015 Roadmap, the long-term earnings roadmap inevitably became a short-term earnings roadmap as time passed and 2015 approached.  As revenue growth proved more challenging to achieve than management anticipated, the company also became more aggressive in its share repurchases.  At the end of the third quarter of 2014, with five quarters remaining in the timeframe covered by the 2015 Roadmap, the company had already exceeded the $50 billion total share repurchase commitment by $4 billion.  Some investors questioned whether these repurchases were the best use of capital, or were simply driven by management’s desire to reduce the share count in hopes of meeting the 2015 Roadmap operating earnings per share target.  While we were generally pleased that IBM was repurchasing shares at a discount to our estimate of intrinsic value, we would have been concerned had these share repurchases been funded by drastic reductions in research and development spending.  Because research and development is an important driver of product enhancement and innovation, and thus future revenue and profit, we believe it is important to monitor IBM’s commitment to research and development (R&D) spending despite a focus on cutting costs in other areas.  As illustrated in Table 1, during the years covered by the 2015 Roadmap, R&D spending remained approximately 6% of revenue, consistent with the years preceding the 2015 Roadmap.

 

 

IBM’s R&D spending provides an interesting contrast to Hewlett-Packard’s R&D spending between its fiscal years 2002 and 2010.  To be fair, Hewlett-Packard made large acquisitions of both Compaq and Electronic Data Systems that somewhat decreased the company’s necessary R&D spending as a percentage of revenue, but in my view, this only explains part of the significant reduction in the company’s R&D spending.

Underinvestment in R&D can have substantial negative impacts on a business, as was ultimately the case at Hewlett-Packard.  So while we generally view IBM’s share repurchases as an attractive use of capital, we believe it is imperative that the share repurchases be done in combination with a continued commitment to R&D spending. 

In my view, possibly the most significant downside of earnings roadmaps is the excessive focus placed on a single year’s earnings, which in the case of IBM was 2015.  I would much prefer that management focus on continuously growing the intrinsic value of the business rather than managing the expectations of employees, analysts, and the press with regard to any single year of earnings.  While we were disappointed that IBM failed to execute on portions of its 2015 Roadmap, the company’s 2015 earnings and free cash flow are a relatively small component of our estimate of intrinsic value, and we continue to believe that IBM shares are priced well below their intrinsic value.

Attractive Businesses at an Attractive Price

IBM’s software and services businesses account for the vast majority of the company’s profits, and each business has characteristics that make it fundamentally attractive and resilient.  IBM’s software, the largest contributor of profit, is integral to the functioning of customers’ IT environments, and customers rarely want to endure the complexity and cost associated with switching to another provider.  The services businesses give IBM an opportunity to solve substantial problems for customers in a mutually value-creating manner, and these service engagements often result in increased customer trust and dependence on IBM solutions.  In addition to software and services, IBM possesses what is essentially a monopoly in the mature but lucrative mainframe hardware market and also operates a non-mainframe hardware business and a relatively small but profitable financing business. 

We believe the combination of these businesses constitutes an attractive technology company that is well-positioned to grow intrinsic value per share over the long-term.  The disappointment associated with the company’s 2015 Roadmap, and uncertainty about future growth, has resulted in a market price that is well below our estimate of IBM’s per share intrinsic value.  If management is able to execute relative to fundamental expectations that are now lower than what was detailed in the 2015 Roadmap, we believe that IBM shares will provide attractive returns to shareholders.

 

The views expressed are those of the research analyst as of January 2015, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. DIAMOND HILL® is a registered trademark of Diamond Hill Investment Group, Inc.

© 2015 Diamond Hill Capital Management, Inc. All Rights Reserved.

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If anyone had any doubt how severely the global economy has been distorted by the actions of central bankers, the "surprise" announcement last week by the Swiss National Bank (SNB) to no longer peg the Swiss franc to the euro should provide a moment of crystal clarity. The decision sent the franc up almost 30% in intraday trading, a scale of movement that is unprecedented for a major currency in the modern era. Although very few in the media or on Wall Street fully understand the ramifications, the situation that forced the Swiss to abandon the peg will soon be faced by bankers of much larger countries in the coming years, the implications of which can have more profound implications for global financial markets.      

Other than the immediate fluctuations in exchange rates, the primary reaction to the Swiss move has been indignation. The airwaves have been awash with officials and investors who have felt betrayed by an irresponsible bank that has not only squandered its own credibility but has also damaged the reputation of all central banks. Despite the complaints of now-ruined foreign-exchange speculators, who believed recent statements from the SNB that it would continue to enforce the peg, a blindsided policy reversal was its only viable option. Any hint that the policy was about to change, or could change, would have resulted in the same mass buying of Swiss francs.

But the only thing the SNB did wrong (other than initiating the peg in the first place) was to admit that the policy was unsustainable and have the courage to reverse course. In so doing, they violated the first rule of central banking, which appears to be: Never admit to making a mistake.   

Although the move is not as dramatic a change as the recently defeated gold reserve referendum would have likely produced (see my prior commentary), the abandonment of the peg makes Switzerland the first major economy to surrender in the international currency war. It has decided not to race to the bottom, and it has understood that a cheap currency does not solve economic problems. The decision gives a long-delayed victory to the Swiss people. 

With a centuries-old legacy of economic independence, the Swiss initially had the good sense to avoid joining the monetary quagmire that became the Eurozone. But with the 2011 euro peg, the country de facto joined the currency union. This tasked a country with a population of just over 8 million people to support the euro, a falling currency used by 335 million people locked in a dysfunctional political union, with governments that have been serially unable to deal with horrific debt profiles. According to tradingeconomics.com, 2013 figures show Switzerland has a debt-to-GDP ratio of just 35.4%. In contrast, the Eurozone has an extremely high ratio of 90.9%. Taking on that kind of dead weight was a very big job for a very small country.

Predictably, the numbers got very silly very fast. In 2009, Switzerland's foreign exchange was $92 billion (SNB Annual Report), representing just 17.5% of its annual GDP. This was high by national standards, but well within the range of most developed countries (The U.S. now has almost no foreign exchange reserves - just .9% of GDP). But in order to maintain the peg, the SNB had to buy hundreds of billions of euros annually. Over the past six years, the tab came to almost $10,000 per year per Swiss citizen. These are enormous sums, even for a rich country. As a result, by the end of 2013 Switzerland's foreign exchange reserves had swelled to $488 billion (SNB Monthly Statistical Bulletin, Dec. 2014) or 71% of its annual GDP. This dwarfs the reserves-to-GDP levels held by the globe's two primary foreign exchange depositories, China (41.3%) and Japan (24.4%).

In retrospect the task was absurd. It was like asking a 100 lb. jockey to perpetually piggyback a 600 lb. sumo wrestler. But the real problem came in recent months when the European Central Bank came closer to announcing a program of quantitative easing, which would have brought even more downward pressure on the euro, requiring the SNB to pick up the buying pace even further. Asking the Swiss to shoulder the QE burden was like asking the jockey to carry the Sumo wrestler into an all-you-can-eat sushi bar. Given that grim reality, the SNB had no choice but to lay down its burden.

Despite this prospect of an open-ended euro buying cul-de-sac, mainstream economists have argued that the move will decimate Switzerland's finances and ruin its economy. They argue that by letting the euro fall, the SNB will suffer immediate losses on the hundreds of billions of euros it now holds in reserve. While this is true, it ignores all the hundreds of billions, if not trillions, of francs that the Swiss would have had to spend (to buy euros) in coming years to maintain the peg. Modern economists believe that the money needed could have been printed out of thin air with no cost to the Swiss economy. But to believe that is to believe in fairy tales.

But when you look at it clearly, Japan, China, and many emerging economies find themselves in roughly the same boat as Switzerland. They are continually inflating their own foreign exchange reserves in order to enforce an unofficial peg against the U.S. dollar. However, in no othercountry has the relative scale of foreign exchange purchases been as dramatic as in Switzerland. But if the Fed unexpectedly launches another round of QE, which I believe it will, then the rest of the world will have to face the same decision as Switzerland had; whether to continue to throw good money after bad, or to cut and run and take the pain now.

Those still in shock by what they see in the rear view mirror had better focus their attention on what lies ahead. To me, the mother of all pegs is the one provided by China to the U.S. dollar. Both the yuan and the Hong Kong dollar are pegged to the U.S. dollar, and China has spent far more money than Switzerland defending its peg. Should China pull the plug on the dollar, our economy has a much larger drain to go down. The Europeans had only recently begun to rely on Switzerland, yet America has been limping on China's crutch for decades. Since our reliance is much greater, so too is the potential impact once it's removed.

Another difference is that while the Swiss are few in number relative to the population of the Eurozone, per capita income in Switzerland is higher. In contrast, China has a larger population than the United States, but its people subsist on much lower incomes. So it's not the rich subsidizing the less well off, but the Chinese poor subsidizing America's middle class. As a result, the immediate gain to China and loss to America will be that much greater than is the case with Switzerland and Europe.

In the future the Swiss surrender may be looked at as the first significant counter-attack against our current global system of monetary insanity. The mistake was not ending this peg, but in adopting it in the first place. The Swiss once again have a strong currency with expanded purchasing power. Yes, Swiss exporters may lose market share to international rivals. But the amount of Swiss francs they will actually earn from each unit sold will likely increase. So the Swiss may be able to export less and still earn the same money. In addition, the cost of imports will fall, allowing the Swiss to buy more with less. 

Contrary to the common current belief, the goal of an economy is not to manufacture more products for others to buy, but to be able to buy more products yourself.  In that respect, exports are merely the means to achieving that end. The less you need to export to pay for your imports the better. In other words, the goal of an economy is to consume, not to work. If we could consume without working we would happily do so. Working without consuming, not so much. In the past, the Swiss prospered with one of the world's strongest currencies. It will do so again.

Ironically, without the support of the SNB in propping up the euro, full-blown European QE may now be a more remote possibility, and a euro rally against the dollar may not be too far off. Goldman Sachs noted the Swiss' message is that QE is going to be done and perhaps even larger than previously thought. But, with tough love from Switzerland perhaps the European Union may choose to consider real economic reforms rather than risk QE without a Swiss safety net to catch the euro if it starts to tumble uncontrollably. In fact, the forces now in motion, accelerated by the SNB's move, may push the Fed that much closer to launching QE4. Since the "long dollar, short euro" trade is predicated on the expectation of QE in Europe and rate hikes in the U.S., if we end up with QE4 in the U.S. and no QE at all in Europe, the fireworks in the foreign exchange market are just getting started.

© Euro Pacific Capital

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  • Amid lower forward-looking returns, investors are focusing on multi-asset solutions, enhanced beta, income and alternatives in Asia-Pacific.
  • PIMCO is prepared to address these themes, drawing upon our time-tested investment process that combines high-level macroeconomic views with thorough on-the-ground research. 
Over the past several months, it has been my privilege to visit many of PIMCO’s clients throughout the Asia-Pacific region. Japan, Asia ex Japan, Australia and New Zealand together compose a large and diverse set of economies; still, we have observed five important common themes that have emerged among the region’s investors:
1. A recognition of lower forward-looking returns,2. A focus on multi-asset solutions,3. A desire to look beyond traditional betas in both fixed income and equities,4. A preference for income-oriented investment solutions and5. An increased interest in harnessing the potential value of alternative investments.
 
As we head into 2015, PIMCO is prepared to address these themes, drawing upon our time-tested investment process that combines high-level macroeconomic views with thorough on-the-ground research.Theme 1: Recognition of lower forward-looking returns 
As noted in PIMCO’s December Cyclical Outlook, the markets have largely priced in the New Neutral reality of lower secular policy rates and lower market returns. The drop in oil prices may temporarily buoy some markets and hurt oil-producing economies, with an overall neutral to modestly positive impact on global growth. However, while this cyclical phenomenon plays out, the secular horizon still portends an environment where lower returns will be the rule rather than the exception.

We were privileged at our December Cyclical Forum to be joined by former U.S. Federal Reserve Chairman Dr. Ben Bernanke, who suggested that global central bankers are likely to remain focused on growth in the real economy in determining the course of monetary policy. Considering that growth is likely to remain measured and that therefore policy rates are likely to remain low, market returns are unlikely to be as ebullient as we have seen in recent years. In turn, this reduces the ability of traditional stock and bond returns to suffice as the engines of a modern investment portfolio.

Theme 2: A focus on multi-asset solutions 
We continue to see strong client interest in multi-asset solutions that transcend single asset classes to capitalize on a broad range of potential return drivers. Here in Asia-Pacific, these strategies may be particularly appealing to clients as first steps in deploying assets offshore, given the diversification and multi-sector accessibility they confer, as well as for clients seeking to move into higher-discretion, higher-return target strategies while limiting downside risk.

PIMCO offers a broad array of multi-asset solutions with long-term track records, including strategies with a real return orientation, strategies that express PIMCO’s broad “best ideas” and strategies that integrate our absolute return offerings while explicitly managing downside risk.

Theme 3: Looking beyond traditional betas 
For decades, PIMCO has provided innovative solutions for enhancing traditional bond and stock betas. Client demand for these solutions has burgeoned in recent years, in light of both the limitations to traditional betas and the abilities of these “smart beta” and “liquid alternatives” solutions to help clients meet investment objectives.

In fixed income, PIMCO’s unconstrained strategies seek to move beyond traditional fixed income returns and source alpha opportunities without the limitations of a benchmark. With the ability to modulate interest rate sensitivity and harness a global opportunity set, these strategies provide investors with valuable flexibility in the face of a lower return environment. Similarly, strategies that seek to opportunistically isolate alpha sources in credit, mortgages and commodities can be powerful additions to a portfolio.

In equity space, PIMCO’s StocksPLUS strategies, including the four-time winner of the U.S. Lipper Best Funds Group Large Company Equity award (2010, 2011, 2012, 2013), have been joined by a robust set of offerings in our Fundamental Index-based product suite. The latter strategies have grown from a collaboration with our partners at Research Affiliates, a pioneer in fundamental indexing. Because traditional market-capitalization-weighted indexes tend to overweight overpriced securities, fundamental indexes seek to structurally outperform traditional indexes by investing in securities that are underpriced relative to fundamentals and selling securities that are overpriced relative to fundamentals. PIMCO portfolio managers then add a layer of active fixed income management to this “smart beta” approach, presenting a compelling investment solution.

Theme 4: Income-oriented solutions 
Our clients’ increasing focus on income-oriented solutions is supported by both demographic trends and market realities. An aging global population naturally focuses on steady sources of income, and uncertainty about long-term market returns augments investor focus on income generation in the near term.

PIMCO’s Income strategy is managed by our Group CIO, Dan Ivascyn, and managing director Alfred Murata. Last year, Dan and Alfred were jointly recognized as 2013 Morningstar Fixed-Income Fund Managers of the Year (U.S.). Investors continue to utilize this strategy in pursuit of income without sacrificing a strong risk management focus.

Another income-generation-focused strategy that has attracted interest from investors in Asia-Pacific is the Capital Securities strategy. This strategy blends macroeconomic analysis with rigorous credit research to identify securities that may outperform bank equities and traditional high yield bonds.

Theme 5: Exploring alternatives 
PIMCO’s alternatives strategies target high returns while aiming to reduce portfolio volatility by focusing on uncorrelated sources of alpha.

We have seen a broad array of approaches to alternatives in Asia-Pacific: Some investors favor direct investments in hedge funds and/or private equity strategies, some prefer fund-of-funds approaches and some primarily seek co-investment opportunities. PIMCO currently offers hedge fund strategies (global macro, relative value, commodity) and private equity strategies (opportunistic real estate and opportunistic credit). We plan to grow this important business to target opportunities that our alternatives portfolio management team identifies, and serve increasing client demand for these solutions. We look forward to continuing the dialogue on this important opportunity set in the coming months.

The above list is by no means exhaustive, but it does represent what many Asia-Pacific investors are prioritizing in 2015.

In closing, let me express my gratitude for the time our clients have taken to share their investment needs and priorities; these exchanges enable PIMCO to serve investors more effectively. We stand ready to support our clients however we can, and we wish you a happy, healthy and prosperous 2015.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Absolute return portfolios may not fully participate in strong positive market rallies. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

Smart beta refers to a benchmark designed to deliver a better risk and return trade-off than conventional market cap weighted indices. PIMCO’s liquid alternative strategies are without the principal lock-ups of traditional private equity funds and hedge funds and include separate accounts whose holdings can be liquidated at a client’s request subject to current market conditions, mutual funds that can be liquidated at NAV on a daily basis and ETFs that can be liquidated on the secondary market under normal market conditions. There is no guarantee that a security will be able to be liquidated in a timely fashion or when it would be most advantageous to do so.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors. Investors should consult their investment professional prior to making an investment decision.

The Morningstar Fixed Income Fund Manager of the Year award (2013) is based on the strength of the manager, performance, strategy and firm's stewardship. Morningstar named Dan Ivascyn and Alfred Murata the 2013 Fixed Income Manager of the Year (US). The Lipper Fund Best Group over 3 Years Large Equity award (2013) recognizes funds that have delivered consistently strong risk-adjusted performance, relative to peers

This material contains the opinions of the authors but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark or registered trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. THE NEW NEUTRAL and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Pacific Investment Management Company LLC in the United States and throughout the world.

©2015, PIMCO.

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On New Year’s Eve, King Abdullah of Saudi Arabia was hospitalized with pneumonia.  According to reports, he is taking visitors and will probably survive this illness.  On the other hand, the king is at least 90 years old and is becoming increasingly frail.  

In light of his advanced age and declining health, an analysis of royal succession in Saudi Arabia is in order.  This process is becoming increasingly uncertain.  Unlike many European royal families, Saudi successions are not based on primogeniture; instead of passing from the king to his eldest son, it passes to a brother.  Due to the advancing age of the second generation of princes, this process is becoming increasingly problematic. 

We will begin this report with a history of Saudi kings.  Following this history is an examination of the current Saudi succession, focusing on the Crown Prince and who remains as potential kings among the “second generation” of the Saudi Royal Family.  In this context, we will analyze the challenges facing the kingdom and how the succession issue will likely complicate the manner in which these issues are resolved.  As always, we will conclude with potential market ramifications. 

History

Saudi Arabia was founded by Ibn Saud, a charismatic sheik who created the modern kingdom.  Through military campaigns and intermarriage, Ibn Saud gradually unified the territory on the Arabian Peninsula to create the modern Saudi state.  During this process, he had at least 22 wives and 45 sons, 36 who survived to adulthood.  He ruled Saudi Arabia from its founding in 1932 to 1953.  

Due the large number of sons, Ibn Saud created a succession plan that would shift from brother to brother rather than from the eldest brother to his eldest son (the aforementioned primogeniture).  

The first successor was King Saud, the oldest son of Ibn Saud who survived into adulthood.  He was a favorite of the founder.  Unfortunately, he proved to be a problematic king.  Saud ruled as if the country were his personal fiefdom, instead of a country.  His policies were mercurial; sometimes, he would support Arab nationalist movements, only to later support American policy in the region which opposed nationalist programs.  His personal habits were extravagant; he took on huge debts that the kingdom struggled to service.  Increasingly at odds with his younger brother Faisal, it appeared a civil conflict might develop.  However, the family and clergy were able to pressure Saud to abdicate in favor of Faisal in 1964. 

Unlike Saud, Faisal, the third son of Ibn Saud, was a cautious, sober man who did not share the extravagant habits of his older brother.  He became King in 1964 after being Saud’s prime minister.  Known for personal piety and thrifty habits, Faisal put the kingdom’s fiscal house in order.  

He also introduced public education in the kingdom (for both genders) and ended slavery.  His foreign policy was anti-communist and pan-Islamic.  Opposing the Arab nationalist movements of Hafez Assad and Gamal Nasser, Faisal wanted to build a pan-Islamic movement that would unify the region based on religion and monarchy.  Unlike many of his successors, he preferred a more inclusive position on Islam, embracing both Sunni and Shia. This position actually undermined the influence of clergy in Saudi Arabia, who tended to support a rather strict form of Sunni Islam.  During his reign, relations with the U.S. were generally positive due to his opposition to communism.  However, Faisal was anti-Zionist and U.S. support for Israel in the 1973 Yom Kippur War led Faisal to order the OPEC oil embargo on the U.S., which led to a quadrupling of oil prices.  

Faisal was assassinated by a half-nephew, Faisal bin Musaid, in 1975.  It is unclear why Musaid murdered his uncle; Musaid’s brother had been killed by Saudi security forces when he attacked a television station Faisal had commissioned.  Some sources argue that the assassination was to avenge his brother’s death.  Musaid did study in the U.S. at the University of Colorado and was arrested in Boulder for possession of LSD and hashish.  Some speculate that drug use may have caused insanity.  Regardless, he was executed in June 1975 on the charge of regicide. 

Khalid, the fourth oldest son (who survived to adulthood) became the fourth king of Saudi Arabia.  Interestingly enough, Khalid’s older brother, Muhammad, renounced any claim to the throne, paving the way for his younger brother to become king.  Muhammad was a close confidante of both King Khalid and his successor, Fahd, discussed below.  However, due to his very conservative views, Muhammad was not considered flexible enough to be king, a flaw he seemed to recognize. 

Khalid was seen as a caretaker monarch.  He had only a passing interest in politics, although he did ensure that all major decisions required his approval.  His disinterest was part of the reason he was popular among the princes.  Khalid’s reign was characterized by significant economic development.  The combination of his predecessor’s austerity and the massive revenue infusion that followed the spike in oil prices after the Arab Oil Embargo funded this expansion.  He also was less tolerant of religious diversity than Faisal, which boosted the status of the local clerics. Khalid had the unfortunate job of dealing with the 1979 seizure of the Grand Mosque in Mecca.  This led to military operations against the militants.  It also led Khalid to become even more supportive of religious conservativism.  

Khalid suffered from heart disease and had a series of heart attacks and major cardiac surgeries.  In 1982, he suffered a fatal heart attack and was succeeded by the prime minister and Crown Prince Fahd.  

Fahd was the eighth son of Ibn Saud (seventh oldest son to achieve adulthood).  He was also the eldest son of Saud and Hassa al-Sudairi,1 one of the favorite wives of the founder.  Two older sons of Saud, Prince Nasser and Prince Saad, were passed over when Fahd was crowned as king.  Prince Nasser, who was born to a lower ranked wife, was considered unfit due to a scandal that occurred when he was governor of the Riyadh province.  Prince Saad was believed to be of weak character and not deemed to have the qualities for leadership. 

King Fahd was considered worldly in his personal behavior, known for lavish trips to Europe.  He made several significant foreign policy decisions during his reign.  Fearing the Iranian Revolution, he actively supported Saddam Hussein’s Iraq during the Iran-Iraq War.  His oil minister, Zaki Yamani, abandoned the kingdom’s OPEC role of swing producer in 1986; this led to a collapse in oil prices and was partly responsible for the downfall of the Soviet Union.  Eventually, Fahd, not a fan of the influential Yamani, unceremoniously fired him.2 King Fahd also invited the U.S. military to Saudi Arabia in the autumn of 1990 after Saddam Hussein invaded and annexed Kuwait.  President Bush and Secretary of State Jim Baker built a large coalition to oust Iraq from Kuwait, using Saudi Arabia as a base of operations.  Although the execution of the war was impressive, anger at the king for allowing “infidels” to operate in the land of Mecca and Medina spawned al Qaeda, led by Osama bin Laden. 

Fahd opposed social reform and spent heavily on military hardware, most likely due to fears caused by the Iran-Iraq War and the First Gulf War.  Spending on defense cut expenditures on infrastructure, which weakened economic growth outside the energy sector.

In 1992, Fahd tried to create a more formal system of succession, allowing the current king to name his successor instead of relying on informal decisions by the sons of Ibn Saud.  The edict allowed the sitting king to select by his own criteria, permitting him to pass over those with seniority and setting the stage for moving to the grandsons of Ibn Saud. 

Already in poor health due to smoking, diabetes and obesity, Fahd suffered a major stroke in 1995.  Crown Prince Abdullah began to run the kingdom on a regular basis following King Fahd’s stroke. 

King Abdullah took control of the kingdom after Fahd’s death on May 27, 2005.  He is the 10th son of Ibn Saud; despite the power of the sons of Sudairi, Abdullah became king due to his role as de facto regent for 10 years before King Fahd died.  Abdullah has been a popular king.  In contrast to Fahd, his personal piety and demeanor have improved the standing of the royal family among Saudis.  He has promoted some reforms to the Saudi economy, including joining the World Trade Organization, and has made modest moves to ease religious restrictions and support religious diversity.  For example, in 2012, he replaced the head of the religious police with a more moderate figure.  This isn’t to say Abdullah is democratizing the kingdom, but he is attempting to ease internal tensions.  

Current Issues

In foreign policy, Saudi Arabia maintains relations with the U.S., although tensions have been rising over the Obama administration’s detente with Iran.  The kingdom also opposed America’s policy to allow Egyptian leader Hosni Mubarak’s removal from power.  Saudi leaders were concerned about the U.S. ouster of Saddam Hussein, and given the chaos that has developed in Iraq, these concerns were warranted.  Abdullah approved the Saudi military incursion in Bahrain to quell Shia unrest.  The Saudi government dramatically increased social spending in light of the “Arab Spring” to quell domestic calls for democracy.  

Although Saudi Arabia has opposed Islamic democracy movements, like the Muslim Brotherhood, recently, there is evidence that policy may be changing.  In general, Saudi Arabia was uncomfortable with the Islamic parties in Turkey on fears that an Islamic alternative to monarchy would encourage similar movements in the kingdom.  However, that posture is coming under scrutiny.  If the alternatives to Islamic monarchy are secular dictators, jihadist insurgencies or Shiite theocracy, perhaps the Muslim Brotherhood or similar groups are a better substitute.  We will be watching to see if the Saudis try to support such an alternative to the Islamic State in Syria and Iraq.  

The other major issue is Saudi Arabia’s decision to let oil prices fall.  The situation is somewhat similar to 1986.  At this point, we believe Abdullah supports Oil Minister Ali Naimi’s decision to allow prices to fall, but given the king’s health issues and advanced age, royal influence on this policy may be lacking.  As we will discuss below, Abdullah does not have an effective regent and so oil policy may be operating somewhat independently of the monarchy.  If so, there may be less than a thorough understanding of the geopolitical risks the oil policy may be creating. 

The Succession Issue

King Abdullah has outlived two crown princes, Prince Sultan and Prince Nayef.  Both deceased crown princes were members of the Sudairi Seven.  The current heir apparent, Crown Prince Salman, also a Sudairi, has serious medical issues.  He has suffered a stroke, has had back surgery and is reportedly suffering from Alzheimer’s disease.  Although there are 10 remaining princes who, in theory, could be king, most have health, experience or personality issues that all but eliminate them as candidates.  Abdullah has probably appointed the last “king eligible” prince, Muqrin, to the post of deputy crown prince.  He is the youngest surviving prince of Ibn Saud.  This would suggest he is next in line if Salman cannot take office; however, if Abdullah dies and Salman becomes king, it is unclear if Abdullah’s appointment will remain in force or if Salman will appoint his own successor.  

Essentially, it is highly likely that within the next decade the third generation of the House of Saud will take power in the kingdom.  To facilitate succession to the third generation, King Abdullah created the Allegiance Council in 2006.  The council, comprised of senior members of the royal family, in theory, would approve Abdullah’s successor’s crown prince.  As we move to the third generation, the council would face the unenviable task of selecting from a large number of princes with a wide dispersion of talents and support within the family.  There is no clear line of succession in the third generation.  This increases the risks to the oil markets and the region. 

Ramifications

The issue of Saudi succession is probably not imminent.  Even if King Abdullah does not outlive his third crown prince, it isn’t obvious that his designated successor, Salman, could take power or actually run the kingdom given his health issues.  Although there are concerns about the viability of a Muqrin administration, we suspect the royal family will accept him as king simply to avoid the looming problems that shifting to the next generation will certainly bring.  

Deputy Crown Prince Muqrin is young by second generation standards; he will turn 70 in September.  As noted above, there are other living sons of Ibn Saud, but none are generally considered strong candidates for king, due to personality, age, experience or health issues.  Even Muqrin wasn’t considered a strong candidate until he was named deputy crown prince by King Abdullah.  Given Muqrin’s age and health, his ascension to king would likely give the royal family perhaps a decade before power shifts to the next generation.  However, as the above history shows, kings can abdicate, be assassinated or face deteriorating health.  It is certain that, at some point, the royal family will need to prepare for a new generation to run the kingdom and create a more set line of succession to avoid the current uncertainty.

For now, the greatest immediate risks to the region and markets from this issue are if (a) Abdullah were to become incapacitated or die, and (b) Crown Prince Salman simply isn’t capable of ruling.  Since it isn’t clear that Prince Muqrin would take power, a succession battle could develop sooner than expected.  Given the challenges Saudi Arabia faces, from dwindling American power in the region to a stronger Iran and the breakdown of nation states in the area, a power vacuum in Saudi Arabia would be profoundly dangerous.  If conditions deteriorate, it would likely end the current bear market in oil and lead to higher overall inflation in the developed world.  

Bill O’Grady

January 20, 2015

 

This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinion of the author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

 


1 Hassa al-Sudairi bore seven sons who survived to adulthood.  They are considered perhaps the most influential of Ibn Saud’s sons and are nicknamed “the Sudairi Seven.”

According to Daniel Yergin, Yamani learned of his sacking by hearing it on television. 

Yergin, D. (1991). The Prize: The Epic Quest for Oil, Money, and Power (p. 763). New York: Simon & Schuster.

Confluence Investment Management LLC

Confluence Investment Management LLC is an independent, SEC Registered Investment Advisor located in St. Louis, Missouri.  The firm provides professional portfolio management and advisory services to institutional and individual clients.  Confluence’s investment philosophy is based upon independent, fundamental research that integrates the firm’s evaluation of market cycles, macroeconomics and geopolitical analysis with a value-driven, fundamental company-specific approach.  The firm’s portfolio management philosophy begins by assessing risk, and follows through by positioning client portfolios to achieve stated income and growth objectives.  The Confluence team is comprised of experienced investment professionals who are dedicated to an exceptional level of client service and communication.  

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[description] => King Abdullah of Saudi Arabia was recently hospitalized with pneumonia. In light of his advanced age and declining health, an analysis of royal succession in Saudi Arabia is in order. We will begin with a history of Saudi kings and follow with an examination of the current Saudi succession, focusing on the Crown Prince and who remains as potential kings among the “second generation” of the Saudi Royal Family. We will analyze the challenges facing the kingdom and how the succession issue will likely complicate the way these issues are resolved, and conclude with potential market ramifications. [author] => Bill O'Grady [legacyinterface_firm_id] => 98 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 15:54:29 [created_by] => 948 [modified_on] => 2015-01-21 15:55:25 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2393 [hits] => 0 ) [4] => stdClass Object ( [legacyinterface_commentary_id] => 2328 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15565 [apv_conversation_id] => 3243 [content_type] => market-commentary [title] => Greece's Perilous Odyssey [slug] => abbett_012115 [fulltext] =>

Greeks will go to the polls on January 25. The outcome may lead to debt repudiation, other severe losses on assets, and the beginning of the end of the common currency. Even if Europe avoids the worst, the best anyone can hope for is heightened levels of uncertainty. It is not a pretty picture, and the blame for this mess is so widespread that it would take a book just to name the people and institutions responsible.

The Story So Far
Greece has for some time occupied the epicenter of Europe’s troubles. It was, after all, Athens that in 2009 triggered the Continent’s still-raging fiscal-financial crisis by admitting that it had misled about its financial health. Since then, Greece has received two European Union (EU) bailouts, totaling €240 billion, each conditioned on budget austerity and other economic reforms pressed by the EU, the European Central Bank (ECB), and the International Monetary Fund (IMF), the so-called troika. These reforms included measures to privatize government assets and steps to make the economy more dynamic and competitive through labor market and regulatory reforms. Greece has stuck to its promised budget austerity, though not without considerable angst and political close calls. Though troika monitors remain disappointed about other reform efforts, they had pretty much concluded that Athens had come far enough to emerge from bailout strictures. The country’s budget had balanced, they noted, and the economy was beginning to grow, albeit haltingly and from a deep recession.1

But crisis has found Greece again. This latest phase arises from a quirk in Greece’s political process. The largely ceremonial position of president is vacant. Prime Minister Antonis Samaras of the new Democracy party—center-right, pro-austerity, pro-cooperation with the troika—put forward Stavros Dimas for the post. Normally, this would have been a political non-event. Dimas ran unopposed. But the left-leaning, anti-austerity Syriza party, then leading in the polls, realized that a failure to get sufficient votes would trigger a general election. It worked with other opposition parties, including the far-right and actively anti-Europe Golden Dawn party, to vote down Dimas. Prime Minister Samaras had to call an election. Perhaps because Syriza’s lead in the polls had by then narrowed, he decided on an earlier rather than a later date. Now this quirk has raised the chance of an anti-austerity coalition coming into power in Athens and with it possibly an end to Greek cooperation with the troika, even an end to Greek membership in the common currency.2   

Uncertainties Inside Uncertainties
It is entirely possible that Samaras will return to office. Syriza’s lead has already shrunk from double-digits not too long ago to only three percentage points, according to some polls, well within their statistical margin of error. But even with a Samaras victory, uncertainties would remain. No doubt chastened by his defeat in the presidential poll and by the need to have called an election, he could easily show a greater willingness to soften austerity policies and delay other reforms still longer. Europe in time might find him and his new coalition much less cooperative than he or it once were. And this is the most stable and predictable of the potential environments that could emerge from the Greek vote.3    

A Syriza victory, with its volatile leader, Alexis Tsipras, as prime minister, would open a myriad of possibilities, one more destabilizing than the other. Actually, there is no way to know what sort of agenda he might put in place. He has over the last couple of years talked out of so many sides of his mouth that Greeks going to the polls later this month really cannot know for what or against what they are voting. When Syriza first gained popularity, Tsipras expressed unrestrained hostility to Greece’s membership in the euro and argued that Athens should repudiate much of its debt. More recently, he has softened his resistance to euro membership, though he still espouses a determination to tear up the austerity conditions imposed by the troika. His current position on debt repudiation remains ambiguous. All this could, of course, change again after a newly elected Prime Minister Tsipras had time to meet with German chancellor Angela Merkel, ECB president Mario Draghi, and the IMF.4     

Against such a backdrop, the election promises anything from an ambiguous moderation in Greece’s playbook all the way to an exit from the common currency, what journalists in the early days of the current crisis referred to as “Grexit.” It is little wonder, then, that markets quickly upped the interest rate charged on Greek borrowing, from about 5.5% a few weeks ago to 9.5% right after the election was called.5

Possibilities—Some Helpful, Most Destructive       
For the Greeks, these more extreme possibilities could cut two ways. On the positive side, an exit from the euro and a return to a depreciated drachma would aid growth by making Greek goods and services cheaper to the rest of the world and, accordingly, more competitive. Debtors within Greece would benefit, too, having the ability to discharge their obligations in a currency much depreciated against the euro. On the negative side, such a prospect would destroy wealth. Greek savers would see the global purchasing power of their assets drop with a drachma depreciation, whatever initial conversion rate the government determined.

For those holding the outstanding overhang of euro-denominated Greek debt, the matter could get even more complex. An outright repudiation would, of course, bring complete losses to lenders, most directly to banks elsewhere in Europe and indirectly to anyone who holds equity in or the debt obligations of these European banks. That would include many American financial institutions and investors. A rescheduling of the debt, perhaps by lengthening maturities or arbitrarily reducing the stated interest payments, would cause less drastic immediate losses, but losses nonetheless. These hardships would occur whether Greece stayed in the euro or exited, though it is an open question whether the rest of the eurozone would allow Greece to remain in the common currency after repudiating its debt or unilaterally rescheduling it.

An exit from the euro would add still more complications. Greece could return to the drachma and still honor its euro debt, though the government would face a great burden in doing so, since it would take a lot of depreciated drachmas to meet those euro obligations. It is possible, if not especially likely, that Greece could exit the euro and insist on rescheduling the outstanding debt in drachma, imposing a huge loss on lenders, though not as much as with outright repudiation. No doubt such a move would create international lawsuits and take years to resolve. In any of these possibilities, Greece would find it much more difficult and expensive to borrow on international financial markets, especially with a return to the drachma, for then lenders would insist on a special premium to protect them against possible future currency losses, certainly a greater premium than they would demand with euro-denominated debt.

In one respect, Greece can matter only little to Europe or the eurozone. It is too small to threaten the basics of either European economics or finance. Its gross domestic product (GDP), at the equivalent of $243 billion in 2013, is not even a fifth the size of Spain’s, only slightly more than one-tenth the size of Italy’s, and barely more than one-twentieth the size of Germany’s economy. Greece’s outstanding debts amount to only 1.0% of all European bank assets. It would not be a happy day if those Greek assets were to become worthless, but it would hardly become the stuff of a financial catastrophe. The financial system would remain no less sound than it is presently, and Europe’s economy might even look marginally stronger with Greece gone.6

But in another respect, a Greek exit or debt rescheduling could have serious ramifications by pointing up alternatives for other beleaguered members of Europe’s periphery. Any debt repudiation, with or without an exit from the common currency, could tempt other heavily indebted nations to fellow suit, entirely or partially, as a way to ease their immediate burdens. Even if Greece were to take no more drastic a step than to renegotiate the austerity strictures of its bailout, others might ask for similar concessions. Granting them would undermine EU efforts at control and delay the continent’s return to overall financial health. It also could erode critical German support by putting the lie to the promises Berlin gave to convince German taxpayers to bankroll the bailout. And if Athens were to withdraw from the euro, questions about the ultimate viability of the common currency would grow, complicating any efforts at financial healing and making it that much more difficult to hold this experiment together. 

Likelihoods    
To assess which of these directions is likely, however, is clearly impossible at this juncture. What is clear, though, is that for the foreseeable future, Europe will labor under more uncertainty than previously, and with three prospects: 1) Greece will continue for some time to pay considerably higher borrowing rates than it did just a few weeks ago, which could in time undermine some of the budget gains the country has made even if in the interim Athens holds to its austerity promises; 2) to the extent that Greek intransigence grows, fears over a general turn in this direction elsewhere in Europe’s periphery will tend to raise borrowing costs there, even if these governments make no overt statements or actions to step away from austerity; and 3) prospects for the eurozone will remain ever more doubtful than in the past, weighing further on the euro’s value and making it still more difficult than it already is for the zone’s leadership, particularly at the ECB, to plan or otherwise conduct its business effectively.  

1 See, “Greece Crisis: Schaeuble Warns Over Reform,” BBC News, December 30, 2014.
2 See, Renee Maltezou and Deepa Babington, “Small Parties to Play Outsized Role in Greek Election,” Reuters, December 30, 2014.
3 See, “First Round Failure,” The Economist, December 18, 2014.
4 See, “The Euro’s Next Crisis,” The Economist, January 3, 2015.
5 Data from Bloomberg.
6 Data from Eurostat.

© Lord Abbett

[description] => At best, the black sheep of the eurozone family is a troubling source of uncertainty for policymakers and global markets—at worst, it’s a potential disaster. [author] => Milton Ezrati [legacyinterface_firm_id] => 273 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 15:58:57 [created_by] => 948 [modified_on] => 2015-01-21 15:59:08 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2394 [hits] => 0 ) [5] => stdClass Object ( [legacyinterface_commentary_id] => 2329 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15566 [apv_conversation_id] => 3244 [content_type] => market-commentary [title] => European Head Fake? [slug] => lpl_012115 [fulltext] =>

The European Central Bank (ECB) is likely to announce a quantitative easing (QE) program involving European sovereign bond purchases at its upcoming policy meeting on January 22, 2015. Recall back in September of 2014, in our two-part Weekly Market Commentary “Don’t Fight the ECB?” we highlighted several reasons for favoring U.S. equities and largely avoiding European equities, despite the ECB’s prior stimulus efforts and potential for outright QE. With QE likely forthcoming, we revisit the opportunity in Europe, which we believe may be setting the stage for a head fake.

WHAT WE ARE WATCHING

As we evaluate the opportunity in European equities, here is what we
are watching:

·        Economic growth

·        Inflation

·        Earnings

·        Valuations

·        Loan growth

·        Relative strength

Economic growth gap between the U.S. and Europe is widening. The U.S. economy has been growing faster than Europe in recent years based on real gross domestic product (GDP). Based on the Bloomberg-tracked consensus of economists’ forecasts for the fourth quarter, Eurozone GDP grew 0.9% during 2014, compared with 2.3% for the U.S. We expect that gap may widen in 2015, as our forecast for U.S. GDP growth (discussed in our Outlook 2015: In Transit publication) is at least 3%.* Even with QE, we do not expect growth in Europe to accelerate in the near term, and as a result we expect this growth gap may widen — although the gap in the third quarter of 2014 of more than 4% (5.0% in the U.S. versus 0.6% in the Eurozone) is not expected to be sustained.

*As noted in the Outlook 2015, LPL Financial Research expects GDP to expand at a rate of 3% or higher, which matches the average growth rate of the past 50 years. This is based on contributions from consumer spending, business capital spending, and housing, which are poised to advance at historically average or better growth rates in 2015. Net exports and the government sector should trail behind.

Deflation risk remains high. Sluggish growth and structural challenges (more on that to come) have led to deflation in Europe, which could result in delayed purchases and investment, further slowing the economy. December 2014 annual inflation in the Eurozone was just -0.2%, or 0.8% excluding food and energy (Eurostat data), not anywhere close to the ECB’s 2% target. Meanwhile, inflation expectations have continued to fall. QE could help a bit in this regard, but we do not expect it to be enough to drive a sustained gain in prices, especially when considering the lack of economic growth.

Earnings mirage. Earnings are expected to increase by 25% in Europe, year over year, in the fourth quarter of 2014. But the gain is all due to depressed financial sector earnings a year ago, which are propping up earnings growth for that sector, while revenue growth is nonexistent. Just three Euro Stoxx 600 sectors are expected to grow earnings based on Thomson Reuters estimates, while eight S&P 500 sectors are expected to grow earnings year over year (for an overall expected mid-single-digit gain). Although S&P 500 revenue is only expected to grow about 1% during the fourth quarter of 2014 (despite the 15% expected drop in energy revenue), that looks good compared with the 2.1% revenue drop expected for Europe. We expect slow growth and extremely low inflation to continue to weigh on European earnings, despite the export benefit of the weak euro.

European valuations look cheaper than they are. European stock valuations (excluding the United Kingdom) are lower than those in the United States based on price-to-earnings ratios (PE) [Figure 1], and they have gotten cheaper since we last wrote on the subject. The discount is currently 12% on a trailing PE basis and 17% on a forward basis. Adjusting for sector mix (the S&P 500 is much more growth oriented, which carries higher valuations), these discounts close significantly. For example, technology makes up about 17% of the S&P 500, compared with just 4% of the MSCI Europe Index, while the MSCI Europe has about triple the weight of the S&P 500 in telecoms and utilities (11% versus 4%). Given the economic growth gap and sector mix, we currently do not find the valuation discount to the U.S. particularly attractive.

Credit still not flowing. The fractured banking system may mute the effectiveness of QE, because increases in the money supply have not translated into loan growth [Figure 2]. Banks are still undercapitalized and some of the region’s banks still have problems with bad loans, which, when combined with economic uncertainty, is constraining lending. Credit is the fuel for economic growth and European private sector lending — though falling more slowly — is still down 1.1%, year over year, in the latest reported period (November 2014).

Relative strength trend still negative. Since the start of the current bull market in March 2009, European stocks have struggled mightily, relative to the U.S. In 2014, Europe’s loss (based on the MSCI Europe Index) trailed the S&P 500’s 13.7% gain (total return) by more than 19 percentage points, and Europe has slightly underperformed the U.S. so far this year through January 15, 2015 [Figure 3]. From a technical perspective, we have not yet seen enough sustained relative momentum to signal an attractive opportunity relative to the U.S (we should note we are getting closer in emerging markets [EM]).

CONCLUSION

Although we would view a potentially bold QE program from the ECB as an incremental positive, the ongoing growth and deflation challenges in Europe leave us still with a strong preference for the U.S. and a belief that any short-term rally may be short lived. For overseas opportunities, we would first look to EM with a focus on Asia. European valuations have become a bit more attractive and the weak euro may help drive more exports, but we would like to see more fundamental and technical improvement — and get past the risk that the ECB disappoints — before considering a possible Europe trade. 

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not ensure against market risk.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

All investing involves risk including loss of principal.

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The MSCI Europe Index captures large and mid cap representation across 15 developed markets (DM) countries in Europe.

The STOXX Europe 600 Index is derived from the STOXX Europe Total Market Index and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid, and small capitalization companies across 18 countries of the European region.

DEFINITIONS

Eurostat is the statistical office of the European Union situated in Luxembourg. Its task is to provide the European Union with statistics at European level that enable comparisons between countries and regions.

The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio.

The money supply is an economic term for the total amount of currency and other liquid assets available in an economy at a point in time. There are several ways to define this number. M1 includes physical money such as coins and currency, checking accounts (demand deposits), and Negotiable Order of Withdrawal (NOW) accounts. M2 includes all of M1, plus time-related deposits, savings deposits, and non-institutional money-market funds. M3 includes all of M2, as well as large time deposits, institutional money-market funds, short-term repurchase agreements and other larger liquid assets. M3 is considered the broadest measure of an economy’s money supply.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

Tracking #1-346125 (Exp. 01/16)

© LPL Financial

[description] => The much anticipated European Central Bank (ECB) policy meeting this week may include a quantitative easing (QE) program announcement. Although we would view a potentially bold QE program from the ECB as an incremental positive, the ongoing growth and deflation challenges in Europe leave us still with a strong preference for the U.S. [author] => Burt White [legacyinterface_firm_id] => 490 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 16:12:36 [created_by] => 948 [modified_on] => 2015-01-21 16:12:48 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2395 [hits] => 0 ) [6] => stdClass Object ( [legacyinterface_commentary_id] => 2330 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15567 [apv_conversation_id] => 3245 [content_type] => market-commentary [title] => Investor implications of QE by the ECB [slug] => merk_012115 [fulltext] =>

cartoon

Background

First some background: Draghi argues that the law requires the ECB to pursue an inflation target of close to 2%. To achieve this, he says the ECB will alter the “size, pace, and composition” of its balance sheet. A couple of months ago, he further indicated he would like to get back to the 2012 size of the ECB balance sheet.

The size of a central bank’s balance sheet is colloquially referred to as the amount of money “printed,” even if no physical currency is printed. Most central banks “print” money by buying bonds (also referred to as quantitative easing, or QE). When they buy securities from a bank, they literally create the money out of thin air, as they simply provide a credit to the bank with the stroke of a keyboard. That’s what the Federal Reserve and Bank of England have done. That’s what the Bank of Japan is currently doing. When pursuing QE, central banks dictate how much money is being “printed.” The general idea behind QE is that it eases credit conditions and encourages banks to lend more. In the U.S., QE caused excess liquidity (i.e., unneeded cash) to build up in the banking system. Fortunately for the banks, they can earn some small amount of interest on that excess US dollar cash from the Fed through interest paid on excess reserves.

The ECB balance sheet has historically been demand based. In other words, rather than ‘printing’ money, the ECB has provided liquidity against collateral. In 2012, banks extensively accessed the ECB’s facilities. As there has been little demand for borrowing in the real economy, banks first parked the excess cash with the ECB, then started to return the liquidity once they were allowed to do so, causing the ECB balance sheet to shrink once again:

graph 1

A couple of things have changed since 2012:

The ECB all but promises to keep rates low for an extended period;

Rather than earning interest, banks are now charged for parking cash at the ECB in the form of a negative deposit rate.

If you put yourself into the shoes of a bank: why would you sell your securities for cash, unless you have a project to fund? Holding cash has become expensive because of negative deposit rates. Furthermore, because the ECB promises to keep rates low, why not hold off in accessing liquidity until there is real demand from borrowers?

It should be clear, though, that the negative deposit rate at the ECB makes comparing today’s balance sheet to that of 2012 akin to comparing apples to oranges. Not content with low inflation expectations, Draghi is expected to announce a QE program this Thursday. Let’s keep in mind that anyone selling bonds to the ECB must do something with the cash. QE programs in other countries allowed banks to earn some interest on their excess cash. At the ECB, sellers will have to pay the ECB to in order to hold excess cash. As a result, sellers will think twice before selling. Having said that, at the right price, there will be sellers. However, we are now moving from apples and oranges to bananas – pardon the pun: any amount of buying by the ECB will be more potent with negative interest rates on cash deposits at the ECB, casting serious doubts over whether it is appropriate to state that the 2012 size of the balance sheet is the appropriate size.

Given publicly available comments, odds are that the ECB intends to “print” approximately €600 billion trough QE, although estimates range from €500 billion to substantially higher. More likely is an open-end program where Draghi will announce a pace of purchases, then indicate the ECB will adjust the “size, pace and composition” of the balance sheet, as needed.

Draghi’s excuse

So what’s going on? Here’s what spooks Draghi:

graph 2

Without becoming too technical, the cryptically titled “5y5y inflation expectations” are longer-term inflation expectations in the Eurozone. Basically: the fear is that the ECB misses out on its mandated target of close to 2% inflation. As central banks control the printing press, the theory goes, they should be able to control inflation. For comparison, please see the chart below that shows a similar trend in the U.S.:

chart

In the past, former Fed Chair Bernanke announced new rounds of QE when inflation expectations were falling as they are today. Not now. The U.S. recovery is said to be on track; and those pesky low inflation expectations are merely a distortion in the data based on falling oil prices.

In contrast, Draghi shrugs off the benefit of low oil prices and clings to the ECB’s legal mandate to boost inflation. Never mind that the ECB has said many times that a key problem preventing growth in the Eurozone is its “broken transmission mechanism,” i.e. impaired banks. While banks in the Eurozone are gradually getting healthier, the emphasis is on gradual: it takes time. With a more well-functioning transmission mechanism in the U.S., our analysis shows, should demand for borrowing pick up, inflation has a much easier time gaining foot in the U.S. In contrast, it’s very difficult to induce inflation in the Eurozone with banks unwilling and/or unable to lend.

Never mind that sanctions against Russia are a significant headwind to growth. Never mind that Germany has engaged in structural reform and as a result is doing just fine and doesn’t need QE. German economic sentiment is picking up. In contrast, the laggards in the Eurozone may sorely need structural reform, but are getting QE instead.

We have to conclude that Draghi is using falling inflation expectation as an excuse to pursue QE.

Draghi’s real motivation

Draghi gave what we believe is his real motivation in a press conference last summer: structural reform with a high exchange rate is politically very difficult. Namely, with a strong euro, workers have to accept lower wages to become more competitive. The alternative is to increase competitiveness through a weaker exchange rate, avoiding the difficult process of telling workers that their wages need to be cut. The backlash against structural reform has shown to Draghi – and this is our interpretation – that pain thresholds have been reached. As such, Draghi clings to the ECB’s inflation target to come to the rescue of governments.

Except, of course, that the will for structural reform might evaporate when the ECB takes away the pressure for reform. While not perfect, amazing steps towards reform were taken when bond markets forced policy makers to their knees. None of that anymore, so it seems.

Draghi has argued that a weaker euro would be inflationary. An implicit goal of QE appears to be to weaken the euro. Indeed, the euro has weakened from a high of 1.3993 versus the greenback last May to 1.1547 as of this writing.

Hurdles

It should also be noted that Draghi has earned himself a reputation that he is not afraid of over-delivering. However, he faces the practical problem that European debt markets aren’t as liquid as U.S. markets. Draghi has indicated he wants to foster rather than inhibit trading; however, the Bank of Japan has all but destroyed liquidity in Japanese Government Bonds as that central bank gobbles up securities. Odds are that a quarter of the securities the ECB is going to buy are German bonds. With yields already negative for German 5 year notes, it will be interesting to see how far Draghi is willing to push them down. In some cases the ECB may be buying bonds with negative yields, thus guaranteeing a loss to the ECB. Various news stories have indicated that the ECB will also buy securities of supra-national agencies, such as the European Investment Bank. The ECB can implement a €600 billion bond purchase program; many observers –including us – doubt, however, that the ECB could dramatically ramp up that program. And when it comes to managing inflation expectations, the unlimited bazooka is what matters.

The other practical problem is the potential political backlash against QE. On Tuesday, German Chancellor Angela Merkel spoke at an event with Draghi in the audience: "I have only one plea ... and that is aimed at all the representatives of the ECB: it must be avoided that any action taken by the ECB in any respect whatsoever could result in the impression that what needs to be done in the fiscal and competitive spheres could be pushed into the background."

Investor implications

When it comes to QE, expectations matter. In fact, in the U.S., the announcement of QE might have had a bigger impact than its implementation. In Japan, both announcement and implementation have had an impact, although it needs to be said that the program at the BOJ is of a much bigger scale than the Fed’s program ever was. If we look at the Eurozone, the above chart says it all: the market is not impressed, inflation expectations in the Eurozone continue to fall. The hurdles listed above appear to be meaningful.

In the meantime, “everyone” says the euro has to weaken. Even the Swiss National Bank has thrown in the towel. Speculative positions on the U.S. dollar show an extremely bullish sentiment. What could possibly go wrong?

When exchange rates move, they do so in anticipation that a central bank “will do the right thing” – or at least the thing that’s expected of them. So if inflation ticks up, for example, a country’s currency often rises as a central bank is expected to raise rates. It’s then months later that reality kicks in and the currency adjusts downward again if the central bank is not living up to expectations. In case of the U.S. dollar, investors appear to be counting on a hawkish Fed. We call the Fed’s posturing one of wishful thinking, doubting they can be so tough in light of falling inflation expectations. The Fed’s promise to be patient in raising rates appears to signal that they indeed want to be, well, late.

Not surprisingly, gold has done quite well in this environment: with real interest rates firmly in negative territory in much of the world – including the U.S., this shiny brick that pays no interest appears to be a formidable competitor.

Implications for investors go much further, though: central banks may be becoming a destabilizing force. The Swiss example shows how imbalances can correct violently as policies are reversed. What happened to the Swiss franc can happen to stocks and bonds. For more details on this, please read my OpEd in the Financial Times.

Axel Merk

Axel Merk is President & CIO of Merk Investments
Manager of the Merk Funds

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Merk Investments LLC makes no representation regarding the advisability of investing in the products herein. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice and is not intended as an endorsement of any specific investment. The information contained herein is general in nature and is provided solely for educational and informational purposes. The information provided does not constitute legal, financial or tax advice. You should obtain advice specific to your circumstances from your own legal, financial and tax advisors. As with any investment, past performance is no guarantee of future performance.

© Merk Investments

 

[description] => Is European Central Bank (ECB) head Draghi’s determination to purchase government bonds turning Europe into a banana republic? What are the implications not only for the euro and U.S. dollar, but gold, stocks and bonds? Our analysis shows that conventional wisdom may be proven wrong in more than one way. [author] => Axel Merk [legacyinterface_firm_id] => 292 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 16:22:45 [created_by] => 948 [modified_on] => 2015-01-21 16:23:14 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2396 [hits] => 0 ) [7] => stdClass Object ( [legacyinterface_commentary_id] => 2331 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15568 [apv_conversation_id] => 0 [content_type] => market-commentary [title] => Tocqueville Gold Strategy Investor Letter: Year End 2014 [slug] => tocqueville_012115 [fulltext] =>

It is a little-known fact that gold outperformed all currencies in 2014, except for the US dollar. In dollar terms gold declined 1.7 percent, but as the table below shows, it posted solid gains against all other currencies. While the dollar price of gold was essentially flat in 2014, highly negative media coverage created the impression that gold was a disaster. Negative sentiment weighed heavily on the performance of gold-mining shares, with our benchmark XAU index down 17.3 percent. Meanwhile, dollar bulls appear dangerously overcommitted to the greenback, with open interest at an all-time high. The dollar’s strength relative to other currencies has camouflaged the strength of gold. Both dollar and gold strength in our opinion portend trouble ahead for financial assets (click here). It seems to us that with financial assets at all-time highs and red flags proliferating, this is an opportune moment to acquire cheap wealth insurance in the form of physical metal and precious-metal mining shares.
 


 

We share the view of many contrarians that the six-year bull market in equities has been powered in large part by the Fed’s policy of zero-interest rates and quantitative easing, which has driven investors into risky assets. As noted by Fred Hickey in his January 4, 2015, newsletter (High Tech Strategist), “The market’s price to sales ratio is at an all-time high, the market capitalization to GDP ratio (Warren Buffett’s favorite indicator) is the second highest in history…. The Shiller Cyclically Adjusted P/E Ratio for the S&P is 27. That level has been exceeded only two times before – in 1929 and 2000.”
 

It seems to be the consensus view, and it is certainly the party line of the Fed, that the money printing of the past six years is history. As Hickey points out, if the fuel for the market advance has been spent, what is there left to support lofty equity valuations? Numerous factors point to spreading economic weakness for the global economy. These include the weakness of foreign currencies relative to the US dollar (which increases the debt load of dollar-denominated debt, fueling the growth of emerging market economies), falling commodity prices, widening credit spreads, and a broad assortment of feeble economic reports that market bulls choose to ignore. If we are correct in our view, corporate earnings are set to decline, undercutting a key pillar of the bullish case for equities.
 

We believe that a serious market correction, or the onset of a bear market, would exert extreme pressure on the Fed to reverse course and resume money printing. The Fed, most likely aware that their credibility is at stake, would probably resist this option at all costs. Capitulation to market weakness by the Fed at this juncture would in our opinion lead to the evaporation of confidence in all central banks, since investors would be forced to accept the proposition that money printing, once started, can never be stopped.
 

A return to quantitative easing would be transformational for the perception of gold. We believe the transformation would happen suddenly. As noted by investment luminary Paul Singer in a letter to his clients, confidence, especially when it is not deserved, is a thin veneer. When confidence falls apart, the consequences can be quite severe. In a recent interview, Jeffrey Gundlach, CEO of investment giant DoubleLine, commented, “It is interesting how you have been beginning to see signs of investor concern around the edges about the health of the economy and about the financial system. Historically, when junk bonds give up the ghost and treasuries remain firm, it is a signal that something is not right.” In our view, the hidden strength of gold during 2014 is another sign that investors are starting to sense that something is not right.
 

We believe that capital is beginning to scramble towards higher ground in anticipation of a monetary crisis. To us, this explains the relative strength of the US dollar. The same concern is reflected in the less obvious strength of gold. As of this writing, the euro price of gold has surpassed the 1,000 level. The downtrend of the past three years seems to have been broken in euro terms. Investment flows from Asia continue strong. China and India now buy as much gold as the mining industry produces. While the Chinese central bank remains secretive, not having updated gold reserves reporting since 2009, the sharp decline in purchases of US Treasuries (see below) implies a step up in gold purchases.
 

Central bank buying, led by Russia, is robust; central banks have added gold bullion to reserves for 14 straight quarters. Political pressure to repatriate gold bullion has also been on the rise. Countries considering or successfully repatriating gold include the Netherlands, France, Belgium, Austria, and Germany. As noted by Casey Research, repatriation has led to the biggest drawdown in gold held at the NY Fed in more than 100 years.
 

Source: MeridianMacro
 

We believe that a breakdown of trust in financial intermediaries – including bullion banks, “synthetic” gold substitutes such as ETFs, and derivatives, as well as the integrity of central-bank custodial relationships – is behind the growing clamor to repatriate physical gold bars owned by sovereign states. Ebbing confidence is not limited to the official sector. Gunvor, the world’s fifth-largest commodity trader, decided to discontinue gold trading in part “because of difficulties in finding steady supplies of gold where the origin could be well documented” (Bloomberg, 12/12/14). Grant Williams, of Vulpes Investment Management, explains, “Because of the mass leasing and rehypothecation programs [the use by financial institutions of clients’ assets, posted as collateral] by central banks, there are multiple claims on thousands of bars of gold. The movement to repatriate gold supplies runs the risk of causing a panic by central banks.”
 

Loss of trust is the genesis of bank runs. Bullion banking is a fractional reserve system in which large amounts of credit are extended based on a relatively small quantity of physical metal. Sovereign gold bars are a major component of the credit base. We believe this is a story to watch very closely in the coming year.
 

It seems to us that that the circle of those disparaging gold has dwindled to a rear guard of hard-core, dollar-centric addicts still hooked on a monetary policy designed to herd investors into risky assets. In a truly Orwellian transposition, gold, the safest asset in history, is maligned by the financial media as risky, while financial assets at near-record valuations are viewed as compelling. In the simplistic logic that passes for financial wisdom, if equities are good, then gold must be bad. If there has been a Greenspan/Bernanke put for equities, why not a Yellen cap for gold?
 

Such a notion might explain the fearless manner in which gold has been periodically trashed. A skidding $US gold price confirms that all is well. “Synthetic” gold, created by bullion banks for propriety-trading desks, high-frequency traders, and commodity traders, is dumped (often following Fed policy pronouncements) onto thin markets during non-trading hours to trigger stops and spread panic. No physical gold changes hands during such raids. Sellers abandon any pretext of “best execution,” the usual standard for discrete distribution of positions. Instead, the raids are crafted to smash the price with as much noise as possible.
 

We believe that the gold market has been manipulated, which to us is no surprise. Rigging has become a central feature of financial markets since the onset of quantitative easing. Too-big-to-fail banks, US and European, have admitted to manipulating Libor, energy, and currencies. Zero-interest rates and quantitative easing are to us blatant manipulations of bonds, interest rates, and equities. Why should gold be exempt? On December 15, 2014, a class-action lawsuit filed in the United States District Court, Southern District of New York (In Re: Commodity Exchange, Inc., Gold Futures and Options Trading Litigation) named the Bank of Nova Scotia, Barclays plc, Deutsche Bank AG, HSBC plc, and Société Générale SA as defendants on allegations of price fixing in the gold market. The various allegations in the Complaint include the following:
 

The PM Fixing aligns with the opening of the New York market, and specifically the Commodity Exchange, Inc. (COMEX) market on which gold futures and other derivative contracts are traded…. The economic and other evidence overwhelmingly shows that Defendants sought to avoid the uncertainties and risks associated with the gold derivatives market – i.e., that the market would move against a Defendant’s short position – by agreeing to manipulate the PM Fixing through repeated conduct to artificially suppress the price of gold.
 

The Complaint is now in the hands of the district judge. The allegations are supported by exhaustive statistical data, similar to those produced in the previous successful action against Libor manipulation. The defendants have filed a motion to dismiss; the judge will decide in the coming months whether to allow the case to proceed. If the case proceeds, we would hope it results in placing important participants on the witness stand. However, should it get to that point, there is a possibility that the defendants could propose a settlement to avoid discovery, which in our opinion would be disappointing.
 

Regardless of how the litigation is resolved, we believe that the scrutiny from regulators in Germany, Switzerland, and the UK (FCA), along with these legal actions, has already caused a change in behavior by bullion banks and other institutions involved in price manipulation. Deutsche Bank, for example, has withdrawn from precious-metals trading. In other cases, internal and external legal scrutiny of precious-metals trading activity will most likely lead to reduced participation by many of these institutions.
 

For investors, the overriding question is what these changes might imply for future gold prices. In the short run, we believe that price raids mounted by synthetic supply will become less frequent and less intense. We believe that in time, should our expectation prove correct, the gold market may come to seem less dangerous and perhaps less mysterious to those who wish to initiate long exposure. Over the longer term, we believe that the diminished presence of Western institutions in precious metals markets, and the supplies of synthetic gold in which they specialize, will allow the very bullish supply and demand equation for physical metal to be reflected in the price. Should this shift occur in concert with a diminished role for the US dollar as a reserve currency – a prospect most certainly desired by the BRICs and other developing economies – gold will play an expanded role and the dollar gold price will benefit. The perfect storm for gold would be for these structural changes in the gold market to occur in conjunction with a loss of confidence in central bankers.
 

Mining Stocks
 

While gold held its own during 2014, mining stocks did not. Even though our benchmark XAU index rose 20.60 percent through the first half of the year, those gains were more than erased during the second half; on the year the index declined 17.29 percent. However, the index does not tell the entire story. Many of our holdings showed decent gains during the year, and on the whole our clients’ portfolios outperformed the index by a substantial amount.
 

Positive factors for the mining industry include declining costs (oil being a major input) and better discipline applied to capital allocations. Scotiabank estimates that each $1/barrel decline in the oil price translates into a $1/ounce reduction in cash costs. The impact of oil alone therefore would amount to a roughly 7-percent reduction in production costs globally. In addition, the strength of the US dollar also impacts costs favorably, as most of the world’s gold is produced outside the US. These two factors alone, in our estimation, would result in a 10-percent decline in global cash costs for the coming year. The benefits of cost-cutting initiatives, including significant workforce reductions launched in 2013 and 2014, are likely to become more visible in 2015 and beyond.
 

For the intermediate term, mine supply seems likely to decline (assuming flat gold prices), which should ultimately be constructive for gold prices. The industry is in the midst of a period of reassessment and restructuring that began at the end of 2013. There are many new CEOs whose principal mandate is to improve returns on capital. Obviously, some companies will be more successful than others in achieving those returns. Overall, we expect to see divestitures, balance-sheet improvement, and M&As.
 

A good part of our success last year arose from our exposure to the royalty companies. Their business thrives during periods of capital scarcity for gold miners. In addition, several of our important holdings were able to add value through the advancement of mine construction or astute acquisitions. Lastly, one of our largest holdings, Osisko Mining, was taken over by Agnico Eagle and Yamana. The residual piece of the original company has been reconfigured as a royalty company and remains an important holding.
 

It is essential to remember that the gold-mining industry is not monolithic. There are some companies that are well managed and are able to create value despite the difficult gold market of the past few years. Of course, there are other companies that seem to destroy value year in and year out. Clearly, our strategy is to concentrate our holdings in those companies that add value for shareholders during difficult periods, independent of the gold price. When the gold market improves, we believe that our core holdings will perform consistent with the gold price and our relevant benchmarks.
 

With all best wishes for a prosperous 2015!

John Hathaway
Senior Portfolio Manager
© Tocqueville Asset Management L.P.
January 15, 2015
 

This article reflects the views of the author as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast or opinion will be realized.
 

References to stocks, securities or investments should not be considered recommendations to buy or sell. Past performance is not a guide to future performance. Securities that are referenced may be held in portfolios managed by Tocqueville or by principals, employees and associates of Tocqueville, and such references should not be deemed as an understanding of any future position, buying or selling, that may be taken by Tocqueville. We will periodically reprint charts or quote extensively from articles published by other sources. When we do, we will provide appropriate source information. The quotes and material that we reproduce are selected because, in our view, they provide an interesting, provocative or enlightening perspective on current events. Their reproduction in no way implies that we endorse any part of the material or investment recommendations published on those sites.
 

Source:  Tocqueville
Author:  John Hathaway
[description] => John Hathaway, manager of the Tocqueville Gold Fund (TGLDX), looks back at the performance of gold over 2014, noting that: "in dollar terms gold declined 1.7 percent, but…it posted solid gains against all other currencies," and that "the dollar’s strength relative to other currencies has camouflaged the strength of gold." [author] => John Hathaway [legacyinterface_firm_id] => 431 [published_on] => 2015-01-21 [digest_date] => 2015-01-21 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-21 16:27:24 [created_by] => 948 [modified_on] => 2015-01-21 16:27:49 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2397 [hits] => 0 ) [8] => stdClass Object ( [legacyinterface_commentary_id] => 2312 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15548 [apv_conversation_id] => 3226 [content_type] => market-commentary [title] => The Swiss Release the Kraken! [slug] => mauldin_012015 [fulltext] =>

“Below the thunders of the upper deep,
Far far beneath in the abysmal sea,
His ancient, dreamless, uninvaded sleep
The Kraken sleepeth: faintest sunlights flee….

“There hath he lain for ages, and will lie
Battening upon huge sea-worms in his sleep,
Until the latter fire shall heat the deep;
Then once by man and angels to be seen,
In roaring he shall rise and on the surface die.”

– Alfred, Lord Tennyson, “The Kraken

"The exact contrary of what is generally believed is often the truth."

– Jean De La Bruyère

“Cry ‘Havoc!’ And let slip the dogs of war!”

– William Shakespeare, Julius Caesar, Act III, Scene I

“No mas!”

 – Roberto Duran to the referee at the end of his fight with Sugar Ray Leonard, 1980

If you want evidence that central bankers play by their own rules, regardless of what they say or what conventional wisdom tells us, last week’s action by the Swiss National Bank should pretty much fill the bill. My friend Anatole Kaletsky, in a CNBC interview not long after the announcement, quipped (with a completely straight face) that just as James Bond has a license to kill, central bankers have a license to lie.

Swiss National Bank Chairman Thomas Jordan had assured us just the week before that the Swiss would continue to “hold the peg” whereby the SNB kept the value of the Swiss franc from rising higher than €1.22. “The cap is absolutely central,” he said. And SNB Vice Chairman Jean-Pierre Danthine said publicly only last Monday that the peg would remain a cornerstone of Swiss banking policy.

Early Thursday morning the Swiss abandoned that policy. Much of the press coverage in the (largish) wake of their surprise move has focused on the costs to banks and hedge funds around the world, but you have to realize that serious pain is being felt in Switzerland itself. Every bank and business that held non-Swiss-franc debt or investments took an immediate 15–20%+ haircut on its holdings. Swiss investors lost at least 10% on investments in their own stock market and more on shares they held in other stock markets. Forty percent of Swiss exports go to the Eurozone, and the Swiss franc is now over 30% higher than it was five years ago – with almost half that movement coming in one day. Those exporters just got hammered.

And this was not a painless policy decision for the SNB. Citibank estimates the SNB’s losses to be close to 60 billion Swiss francs. Let’s try to add a little perspective on that. The US is (very) roughly 40 times the size of Switzerland in both GDP and population. At today’s conversion rate, the Swiss lost something like $70 billion if Citibank is right. That’s like the US Federal Reserve’s losing $2.8 trillion. That, my friends, will leave a red mark on any central bank’s balance sheet. Not that the Swiss can’t afford it or that they’re going to be out on the corner with a tin cup, but they do have a considerable quantity of euros that are now much less valuable. And dollars and yen and pounds and renminbi. But then again, they are in the privileged position of having a currency that the rest of the world wants, so much that in order to hold it you will have to take a haircut on your deposits at the SNB, a haircut that is going to increase (more on that later).

There are also serious losses in the international banking community. We are just now beginning to learn how many funds and brokerages will have to close.

Do you think that SNB Chairman Thomas Jordan will be going into the local restaurants and getting high-fives and fist bumps? Exactly what do you think his reception will be in Davos (where he is scheduled to appear)? Christine Lagarde, the managing director of the IMF, gave a somewhat frosty reply to my friend Steve Liesman at CNBC when he asked her only a few hours after Jordan’s move (in what was clearly an already-scheduled interview) about her thoughts on the surprise announcement. She was not amused, but she kept her professional stage smile in place. (It was a very good interview.)

In Norse mythology, the Kraken was a sea monster that attacked ships unaware. In Greek mythology, it was a pet sea monster (of either Hades or Zeus) that would be released upon enemies that annoyed its master. It has been an iconic figure in comics and movies for the last 30 years. “Release the Kraken!” is the standard line prior all hell breaking loose.

In an era when central bankers are supposed to be more open, collaborative, and communicative, what would make the Swiss National Bank decide to turn on a dime and shock the markets – to release the Kraken, as it were? Note that in fact all hell did break loose. Rather than delivering hints accompanied by a few well-placed leaks, the Swiss decided it would be best to completely surprise the markets. It will be a long time before we get the full story on what must have been going through their heads as they reached the decision.

I have spent the last few days reading a great deal and talking with friends, trying to understand the “why” of the suddenness of the Swiss action. If we can get some insight into this question, perhaps it will give us a few clues as to upcoming global central bank policy changes in general and the problems facing Europe in particular.

While I do fully intend to try to reduce the length of my letters this year, this one is going to be longer because it will contain a significant number of charts. We’ll look at the data that made Thomas Jordan and his team at the SNB throw in the towel on their peg policy, and I think we should look at it in depth. Just as Roberto Duran walked away from Sugar Ray Leonard at the end of the eighth round of their famous fight in 1980, telling the referee “No mas,” the SNB signaled that it had had all the pain it could deal with.

The First Casualty of the Currency Wars

My last book, Code Red, was all about the currency wars that I expect to dominate the latter part of this decade, triggered by Japan’s massive quantitative easing. Jonathan Tepper and I pointed out that, going forward, it is every central banker for himself. While the world’s central bankers typically matriculated at the same schools and espouse the same beliefs, and while they regularly meet each other at conferences and BIS meetings and freely employ words like cooperation and collaboration in their dealings with one another, the reality is that they are all politically captive to the countries they serve.

While central bankers may espouse independence from their governments, they do live and work in their particular countries and are largely responsible for those countries’ economic well-being. They are going to do whatever they feel is necessary to help their governments and domestic businesses perform as well as they can, while trying to maintain the stability of their local currencies.

Japan is not going to cater to Korea with its monetary policy; neither is Indonesia really interested in helping Singapore or Malaysia; and countries like Switzerland and Sweden carve out their own paths on the flanks of the Eurozone. The US Federal Reserve has made clear on many occasions that it is not responsible for the policy decisions and outcomes of any other country. If you were the Swiss National Bank and looked at the following data, what would you do? The simple fact is that Europe and the Eurozone just don’t make sense; nor, given the recent Swiss action, do they seem to be pursuing the sorts of policies that would improve their condition.

It’s not just about deflation. Switzerland is experiencing deflation and yet has full employment, a balanced budget, and a positive trade balance. Germany, France, Austria, Belgium, the Netherlands, Finland, Sweden, and Denmark are all either in deflation or close to it.

Recent central bank policy has led to the anomaly of negative interest rates. Negative rates began to show up a few years ago and are now pervasive. I’m going to post close to a dozen charts from Bloomberg. You might want to save this letter so you can show it to your grandkids in 30 years when they complain about aberrant economic conditions and volatility. “Kids, you have no idea what we went through back in the mid-teens! It was way wacko back then.”

Each chart for a European country compares the yield curve from a month ago to today’s. As you can see, rates have moved strongly downward.

Note in the first chart that Switzerland’s 10-year yield is NEGATIVE (-0.08%).

Germany’s yield curve is negative through six years! Which almost forces you out the yield curve, bringing 10-year rates down to below 50 basis points!

Seriously, can you understand a world where French four-year bonds have a negative yield? Or where their 10-year bonds yield about a third of the US rate?

Netherlands rates turn positive four years out – whoopee.

Belgium, with debt-to-GDP of 101%, has negative rates. Go figure.

Meanwhile, Italy has debt-to-GDP of 133% and growing by 4-5% a year and a 10-year bond yielding less than that of the US 10-year.

Spain – all positive, but with a 10-year that pays less than Italy’s.

Gotta love the Portuguese 10-year at 2.97.

Ireland has debt-to-GDP close to 125% and lower rates throughout the yield curve than the US rates.

Rates are even falling in Greece … if you want to go out 17 years.

And here are the US and Japan, for reference.

Japan’s 7-year is almost negative (+0.1%).

Not only are the Swiss not holding the peg, they have put out the “Not Welcome” mat, lowering their negative interest rates to -0.75%, with the implication that if that isn’t enough, they will drop them to -1.5%. You want a Swiss safe haven? It will cost you. And the irony is that many will pay it. Losing only 0.75% a year sounds really good if you are Russian. (The Danes moved their negative rates to -0.2% this morning just to make sure no one starts to see them as a rent-free safe haven.)

Then you look around at the rest of Europe, and what you see, mostly, are problems. Where is the growth going to come from? Russian corporations and oligarchs have taken out massive Swiss-denominated loans, as has much of Eastern Europe. More than one million Hungarians are in dire straits. Nearly 65% of the country's household mortgages are denominated in foreign currencies – mostly Swiss francs, according to the National Bank of Hungary. And according to Bloomberg News, more than 40% of mortgages on the books of Poland’s banks are denominated in Swiss francs. When the borrowed currency surges against the borrower’s home currency, the effective cost of that debt balloons.

Pity the Poor Swiss

To help us understand the mindset of the Swiss central banker, let’s turn to a tongue-in-cheek analysis of the problems of the SNB by my friend Charles Gave. (Charles has a wicked-sharp sense of humor at all times, but he’s at his best when skewering economists.)

They [the SNB] didn’t mind pegging the Swiss franc to the Deutsche mark, but it is becoming more and more obvious that the euro is more a lira than a mark. A clear sign is the decline of the euro against the US dollar.

Mr. Draghi has been trying to talk the euro down for at least a year. This should not come as a surprise. After all, in the old pre-euro days, every time Italy had a problem, the solution was always to devalue.

But the Swiss, not being as smart as the Italians, do not believe in devaluations. You see, in Switzerland they have never believed in the ‘euthanasia of the rentier’, nor have they believed in the Keynesian multiplier of government spending, nor have they accepted that the permanent growth of government spending as a proportion of gross domestic product is a social necessity. The benighted Swiss, just down from their mountains where it was difficult to survive the winters, have a strong Neanderthal bias and have never paid any attention to the luminaries teaching economics in Princeton or Cambridge. Strange as it may seem, they still believe in such queer, outdated notions as sound money, balanced budgets, local democracy, and the need for savings to finance investments. How quaint!

Of course, the Swiss are paying a huge price for their lack of enlightenment. For  example, since the move to floating exchange rates in 1971, the Swiss franc has risen from CHF4.3 to the US dollar to CHF0.85 and appreciated from CHF10.5 to the British pound to CHF1.5. Naturally, such a protracted revaluation has destroyed the Swiss industrial base and greatly benefited British producers [not!]. Since 1971, the bilateral ratio of industrial production has gone from 100 to 175... in favor of Switzerland.

And for most of that time Switzerland ran a current account surplus, a balanced budget, and suffered almost no unemployment, all despite the fact that nobody knows the name of a single Swiss politician or central banker (or perhaps because nobody knows a single Swiss politician or central banker, since they have such limited power? And that all these marvelous results come from that one simple fact: their lack of power.)

The last time I looked, the Swiss population had the highest standard of living in the world – another disastrous long-term consequence of not having properly trained economists of the true faith.

Draghi: Quantitative Teasing

“Whatever it takes!” was Draghi’s mantra just a few years ago. He has been promising action for all that time and has basically delivered nothing. As I noted a few weeks ago, he has pushed his “street cred” to the limit. He really has to deliver something at the January 22 ECB meeting, or the markets will simply no longer believe him. If he doesn’t do something significant, I think the euro could rip higher, applying even more deflationary pressure throughout Europe.

(Note that there is really nothing all that bad about deflation unless you have a high level of debt and your budget isn’t balanced. Then you get caught in a debt spiral, which forces you into something that has come to be universally abhorred, called austerity, which in other days and times was simply called living within your means.)

Draghi is not lacking in the desire to be more like Bernanke and Yellen. The problem is that he must win consensus among the board of governors of the ECB. To do any serious quantitative easing without the approval of Germany and its Bundesbankers would create very serious problems for him in Europe.

It now appears that what the ECB will do is compromise. They will go ahead to do QE, but each country will assume responsibility for its own bonds. Under that plan, Germany will not be responsible for French or Italian or Spanish bonds bought by the ECB. The ultimate responsibility will be with the national central banks of the individual countries.

This would create a “silo effect” and have long-term implications. To take one example, as noted above, Italy has 133% debt-to-GDP, and its debt is growing at 3 to 4% a year. Now, if the ECB began to purchase Italian debt, the cost of that debt would fall. Since Italy has to refinance (and purchase new) at least 10% of its debt this year with an average cost of well over 3.5%, it could lower its overall interest cost. But given that the country is in deflation and will likely be in its third straight year of recession, deficits will be higher than forecast, and debt-to-GDP will increase.

As we have noted on numerous occasions, Japan no longer has a functioning bond market without the Bank of Japan. What happens when Italian debt rises in cost to the point that individuals no longer want to buy that debt and the market essentially becomes the European Central Bank? Crazy? I think not. It won’t happen this year or the next or even for a few years after that; but unless Italy gets its budgetary house in order – something that will be difficult given its huge pension and healthcare obligations and poor demographics, debt-to-GDP of 150% or 160% is possible by the end of the decade. That is the level at which Greece became a problem a few years ago.

Now, I understand that all my Italian readers will point out that Italy is not Greece, but they both have to coddle the bond market with a reassurance that those who bought will get paid. And given the track record of Italy over the last century, it is not altogether clear to me that you can approach Italian debt with 100% confidence. I know, it’s different this time; but bond buyers are a fickle lot. You buy government bonds because you want to avoid risk.

Draghi is going to have to fight the perception that he is enabling countries to avoid dealing with their imbalances, even as he tries to improve the terms of trade by forcing the euro down.

The common wisdom is that now the Germans are fighting against assuming Italian debt by putting it on the books of the ECB. But Will Denyer points out this morning that there is reason to think that the various countries might actually want that debt for a time, until it can indeed be mutualized in some distant future. Writing for GaveKal, he says:

The US has just provided a remarkable example of the third option at work. Last year, the US Treasury paid a record amount of interest, roughly US$430bn. But over the same period the Fed remitted almost US$100bn to the Treasury, thanks to a balance sheet bloated by QE operations. If we net out remittances from the Fed, the Treasury’s interest payments fall by almost a quarter. Or, to put it another way, with US$17.6trn in debt outstanding in 2014, this effectively lowered the Treasury’s interest cost by around 50bp. And that is before we factor in any effect on market rates.

But what about the eurozone, where many governments are involved? Normally, any profits made by the ECB are pooled and distributed to member countries in proportion to the central bank’s capital subscription weightings, which are based on population and gross domestic product. That means Germany gets the most, then France, and so on... These outflows pay no attention to where the profits came from. In a QE program today, most of the profits are not going to come from German or French bonds, which yield next to nothing. Most are going to come from the smaller peripheral governments that are currently paying more interest on their debt. We don’t need to do any math to figure out that QE done by the ECB would result in a massive transfer of wealth from the periphery to Germany and France. This is true almost regardless of how purchases are apportioned.

What would make a big difference is if the ECB made an exception to its normal profit-sharing practices, and said that all profits on Portuguese bonds will go back to the Portuguese government, all profits on Italian bonds go back to the Italian government, and so on…. In this structure, all eurozone governments would benefit from QE, at the expense of anyone holding the currency (just as happened in the US, UK, Japan…). The German government would also benefit from any central bank purchases of its debt, but it will no longer also receive a massive transfer of wealth from the periphery.

While everyone is talking about how Germany may demand that credit risk be isolated within each country, that may be a mirage. It may well be the peripheral governments that want the profits from QE to stay within each country – so they can reap all of the regular benefits of currency debasement.

What does this mean for markets? However it is structured, QE is likely to weigh on the euro (that is, if the ECB actually debases its currency on a scale that lives up to lofty expectations). A big QE announcement would also probably lift equity prices, at least initially.

So what caused the Swiss to act? I think it was in part that they looked at the general weakness of Europe and its seeming inability to pursue reforms or to address its imbalances in any realistic manner. Many Eurozone leaders seem to think the European Central Bank has magic in its vaults and simply hope that the Germans can be persuaded to release some of that growth pixie dust. The Swiss look at their own experience and see the continued growth of debt and unfunded obligations in Europe as a real problem.

On top of all the other developments, the European Court of Justice issued a preliminary ruling on Wednesday that allows the ECB to employ quantitative easing. There are rumors that the ECB is going to propose a package that may run as high as €2 trillion – countered by “leaks” that suggest the total will be a fraction of that amount. Frankly, the market has priced in €500 billion already. If Draghi doesn’t deliver a multiple of that, I think we will see a disappointed market.

Was the Swiss banking and business community given a heads-up? Were there phone calls from one desk to another? Clearly, there are communication channels. And the timing of the ECJ ruling and the announcement by the SNB the next day is more than suspicious. (Yes, I know it’s a preliminary ruling, but do you really think it will get changed?)

I think the SNB looked down the road and saw the euro at parity to the dollar (which is where Draghi and the rest of Europe would like to have it), realized how much they would have to spend and ultimately lose to maintain the euro peg, and decided it simply wasn’t worth the cost. That $70 billion loss could turn into a $150 billion loss before you knew it.

Simply removing the peg and taking that much buying off the table will in itself begin to reduce the value of the euro. Will the Swiss begin to move some of their rather large euro holdings to US dollars and other currencies? That move would seem the logical follow-on, and it would push the euro down even farther.

In 2002 I said the euro would rise to $1.50 and then fall back to parity. We do seem to be on that journey. This is not, of course, a one-way trip; and I would expect the euro to correct upwards at some point before resuming its downward journey.

The interesting question will be, if the ECB starts down the path of QE, at what point will it feel it can stop? Will it depend on an inflation-target number? It doesn’t seem likely that QE can actually deliver inflation in a deleveraging world – and Europe must at some point deleverage. Thus, we could see QE in the Europe for a rather long time.

The Eurozone is simply unbalanced, and a monetary policy appropriate for Italy or Spain is not appropriate for Finland or Germany.

Unless and until its members create a fiscal union and come up with some formula to mutualize their debt, the Eurozone will remain imbalanced and will become increasingly likely to break up. Ironically, if they fail to pursue QE, there will be a crisis sooner rather than later; but a crisis is precisely what they need in order to address the present imbalances. They are not going to substantially reform their labor and budgetary processes except in the act of crisis resolution.

A significant QE package (on the order of €1 trillion or more per year) may be enough to postpone the crisis for at least several years. And perhaps that is all they intend to do, thinking that somehow they can all get a handle on their budgets and that growth will magically ensue in a world where debt has already overwhelmed the markets and governments have grown too large relative to the private sector that is necessary to support those governments. Stir into that mix healthcare and pension obligations that are even larger than those in the United States, and you have a surefire formula for a major crisis at some point in the future.

Traders tend to act as if the current trend will never end. For some odd reason, they trust central bankers, when the truth is that central bankers will lie when they feel it is necessary. As Anatole said, they believe they have a license to lie. But one way and another, the current relative quiet in Europe will not hold indefinitely.

My friend Mohamed El-Erian has this to say about the Swiss National Bank decision:

Following the abrupt removal of the currency peg, Switzerland is now looking at a period of bumpy economic and financial adjustment. Being a relatively “open economy”, in which trade and tourism play an important role, Swiss companies face a considerable competitiveness challenge ahead. The country will also have to deal with issues of currency mismatches, as well as having to battle larger, externally induced deflationary forces.

But the implications extend far beyond Switzerland. Countries with Swiss franc denominated liabilities, such as Hungary, now have to deal with a major adverse valuation shock.

More importantly in terms of global systemic effects, politicians in the core economies within the eurozone – including Germany, Austria, Finland and the Netherlands – will see the SNB’s move as a reaffirmation of the dangers of substituting financial engineering for real economic reform. As such, they will be less willing to accommodate the hyperactivism of the ECB. And while this is unlikely to stop the ECB from doing more, it may increase the legal, reputational and unity risks it takes in doing so.

Then there are the consequences for a global economy which, in the absence of a comprehensive policy response in the advanced world, has ended up overly reliant on central bank interventions. Given that their tools cannot reach directly and sufficiently at what holds back growth and jobs, these central banks have been forced to use the partial channel of financial asset prices to influence real economic outcomes.

To this end, central banks have sought to repress market volatility as a means of encouraging risk taking that would then boost asset prices and thus encourage greater household consumption (via the wealth effect) and corporate investment (via animal spirits).

We are already in a currency war, where Japan and China feel the need to protect their competitiveness. Europe now feels compelled to follow. The furthering of various country’s campaigns in this war is creating massive divergence among the major central banks and an environment in which the dollar is likely to become much stronger than it otherwise would.

If the ECB does deliver massive QE, that course has the potential to set off an even uglier set of events than followed on Japan’s Halloween surprise. We could see a series of emerging-market crises, a rush to global risk aversion on top of divergence, and the USD carry trade might unwind quite forcefully, creating a very ugly feedback loop. The risk of financial shocks to the rest of the world – particularly to Europe’s thinly capitalized banking system and China’s questionably solvent financials – is enormous.

Trouble is, the “appropriate” measures needed to keep Eurozone risks at bay may be toxic for the rest of the world, and the “appropriate” policy for the rest of the world may be toxic for the Eurozone. Europe’s grinding further into deflation until the EMU collapses – by the ballot or by the bullet – is an ugly scenario for the world, but a far less immediate risk than that of a violent unwind in the USD carry trade.

It’s every central bank for itself, and I imagine Draghi, too, intends to surprise. Stay tuned.

The Cayman Islands, Zurich, Florida, and New York

I see Grand Cayman, Zurich, and Florida on my schedule, and New York is also looking likely in March. I am “entertaining” the Mauldin Economics writing and management team starting this weekend here in Dallas. Then in February it’s on to the Caymans. It has been awhile since I was in the Cayman Islands, and this time I’ll take a short hop over to Little Cayman to visit my friend Raoul Pal for a few days. A brilliant macroeconomist and trader, Raoul has now based himself in Little Cayman, although he frequently flies to visit clients. In March I’ll be in Zurich (and maybe some other parts of Europe) and then hop back over the pond to Orlando. I will be in NYC later that month, and DC is calling. Not to mention La Jolla. The present wonderful period of reduced travel is coming to an end.

The quote at the beginning of the letter from Jean de la Bruyère, the 17th century French philosopher, is one of my favorites and got me to wondering what else he might have written. Since research no longer requires a trip to the library but merely a few clicks, I was able to spend a good bit of time with the gentleman, even though he shuffled off this mortal coil some 320 years ago. Besides the usual French Enlightenment thoughts, he had a great deal to say about friendship and other personal relationships. Here’s a nice one: “Two persons cannot long be friends if they cannot forgive each other's little failings.”

But my favorite is: “To be among people one loves, that's sufficient; to dream, to speak to them, to be silent among them, to think of indifferent things; but among them, everything is equal.” (Here are more quotes from him.)

My own happiest times are when I am with family and friends. And I am particularly lucky in the number of friends I have. Old friends are the best, but new friends are wonderful, too, as there is so much to learn and share.

This weekend my fellow writers at Mauldin Economics begin to show up from around the world. Jawad Mian, whom you will get to know more about, comes Saturday evening, then Jared Dillian on Sunday, along with Olivier Garret and Ed D’Agostino. Tony Sagami shows up Monday from Bangkok via Montana. I think Worth Wray will be here Sunday as well. Later in the week I’ll be joined by my new partners (yet to be announced) in what will become Mauldin Portfolios, a portfolio design and management firm geared to helping you create portfolios for your clients that work in the present challenging environment. We’ll do our best to understand the opportunities and risks in front of us, both those the market presents and the more direct business challenges. Long days, but the cameraderie will be sufficient, as de la Bruyère might say.

He also gave us a thought on book writing: “Making a book is a craft, like making a clock; it needs more than native wit to be an author.” And while that is a feel-good line for those who are published, the truth is closer to this pithy observation from Winston Churchill:

Writing is an adventure. To begin with, it is a toy and an amusement. Then it becomes a mistress, then it becomes a master, then it becomes a tyrant. The last phase is that just as you are about to be reconciled to your servitude, you kill the monster and fling him to the public.

Your hoping to slay a few monsters and fling a few books at you this year analyst,

John Mauldin

 

© Mauldin Economics

www.mauldineconomics.com

[description] => In an era when central bankers are supposed to be more open, collaborative, and communicative, what would make the Swiss National Bank decide to turn on a dime and shock the markets – to release the Kraken, as it were? Note that in fact all hell did break loose. Rather than delivering hints accompanied by a few well-placed leaks, the Swiss decided it would be best to completely surprise the markets. It will be a long time before we get the full story on what must have been going through their heads as they reached the decision. [author] => John Mauldin [legacyinterface_firm_id] => 287 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 05:29:56 [created_by] => 945 [modified_on] => 2015-01-20 05:30:42 [modified_by] => 945 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2378 [hits] => 0 ) [9] => stdClass Object ( [legacyinterface_commentary_id] => 2313 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15549 [apv_conversation_id] => 3227 [content_type] => market-commentary [title] => 5 Things To Ponder: A View Of A Correction [slug] => streettalk_012015 [fulltext] =>

It has been a rough start to a new year as all of the gains following the end of the Federal Reserve's flagship "QE-3"campaign have been erased.

 SP500-MonthlyGains-011515

As I discussed yesterday, there is currently little concern by the majority of Wall Street analysts that anything is currently wrong with the markets. While earnings estimates are rapidly being guided down, it is likely only a temporary issue due to plunging oil prices. However, not to worry, the economy is set to continue its upward growth trajectory.

Maybe that is the case. But as investors we should always have a watchful eye on the things that could possibly go wrong that could lead to a rapid decline in investment capital. As I stated last week:

"What I find most interesting is that there is very little concern that something could negatively impact the markets. In fact, if anything would actually happen, it will just be a mild 10-15% correction. The problem is that historically, such outcomes have only been found in "rarified air." Could this time be different? Sure, anything is possible. However, as an investor my primary concern should be the protection of my limited investment capital against unmitigated destruction."

This week's reading list is a variety of opinions on the state of the markets and the risk that currently prevail. This is of keen interest to me as an "almost fully invested bear."


1) Market Madness Started With End Of QE by Jeff Cox via CNBC

"For nearly six years running, the U.S. stock market has withstood a myriad of body blows, from a stuttering economic recovery to a debt crisis in Europe to massive political instability in Washington.

Underpinning each move higher was the knowledge that the Federal Reserve would keep the printing presses running, with aggressive quantitative easing programs that sent market confidence high and asset prices soaring.

Now, though, comes a shock that has Wall Street reeling: The Black Swan-like collapse in oil prices that has provided a stern test of whether equity markets can survive nearly free of Fed hand-holding."

Read Also:  Bullish For The Right Reasons by First Trust

2) Markets Are Freaking Out For No Good Reason by Matt O'Brien via The Washington Post

"Markets might be efficient, but, boy, can they be stupid sometimes.

The latest brouhaha came, like it did a few months ago, over a surprisingly bad retail number. Markets expected it to fall 0.2 percent in December, but in reality it fell 0.9 percent.

Cue the freakout: The Dow was down 300 points at 1:30, falling about 1.75 percent. Bond yields on U.S. Treasury debt are falling, too, a sign that people are hunting for safety."

Retail-Treasuries

Read Also: These 6 Gurus Are (Mostly) Bullish For 2015 by Howard Gold via MarketWatch

 3) Navigating High Stock Valuations In A Deflationary World by GaveKal Capital Blog

"As we highlighted yesterday, stock valuations jumped again in December to another cycle high. As the first two charts show, the cyclically adjusted P/E multiple has only been higher on several occasions and the median stock is trading at a record price to cash flow multiple as far back as we have data. These high valuation levels leave stocks at risk.

High stock valuations and growing signs of deflation pose all sorts of risks to portfolios, so an important question is what kind of asset allocation is likely to mitigate some of those risks?"

GaveKal-Valuation-011515

Read Also: The Most NOT Hated Bull Market by Meb Faber via Meb Faber Research

Sentiment-Faber

4) How To Defend Your Money From A Bear Market by Michael Sincere via MarketWatch

"Skeptics are ridiculed as “naysayers,” “permabears” or “doom and gloomers.” As the bull market goes higher, many investors think that maybe it really is different this time. Maybe central banks have the power to keep markets levitated indefinitely.

Meanwhile, the bubble gets bigger and bigger, until complacent investors accept the bubble as the “new norm.” Nowadays, uber-bulls believe this market is unstoppable, while some experts have made predictions of Dow 20,000 in 2015."

Read Also: The Stock Markets Dilemma by Jeffrey Snider via Alhambra Partners

5) The One Chart Bear Case For US Stocks by Dan McCrum via Financial Times

"Tuesday’s presentation was a variation on that theme, with the investor warning that while lower oil prices help the US economy, watch out for the impact of the shale boom deflating. A few choice slides below, starting with one to keep in mind on the US stock market.

We always hesitate to use the word unprecedented. Still, another year of gains for US stocks would be the seventh in a row and, well…"

Gundlach-Stocks-BearCase-011515

Read Also: Jeff Gundlach Presentation via Business Insider


Bonus Read:  Perma Bull Throws In The Towel by Zerohedge


"As the bull market goes on, people who take great risks achieve great rewards, seemingly without punishment. It's like crime without punishment or sex without sin." - Ron Chernow

Lance Roberts

Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of "Street Talk with Lance Roberts", Chief Editor of "The X-Factor" Investment Newsletter and the Streettalklive daily blog. Follow Lance on Facebook, Twitter and Linked-In.

© Streettalk Live

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US equities have now fallen three weeks in a row. At its low on Friday, SPX was 5% off its high on December 29.

The lows a week ago pierced the 20-weekly ma. Strong uptrends remain above this line (arrows).  This week, the market fell through again and then recovered, again. In the past, a close below the 20-wma has often led to a touch of the weekly Bollinger band bottom, currently at 189 (yellow). The key 20-wma level is now 200.5.


That SPY has fallen to its 20-wma on consecutive weeks is a sign of weakness. It's impressive that it keeps recovering but repeated touches normally leads to failure.

In the last 2 years, a 3 week decline of 5% has been the extent of most pullbacks in US equities. November 2012 was the last time a pullback lasted much longer. Expecting much more has been a losing proposition.



There are a few factors in equity's favor heading into this week.

Probably the most important is that the ECB has a policy meeting on Thursday, at which it may well provide details on its version of quantitative easing in order to combat the slump in European demand. Announcements to this effect have been greeted with enthusiasm in the past. It is not hard to imagine equities rising the next few days in anticipation. This was probably the catalyst for Friday's gain of 1.3%.

There was probably a short term low in equity bullishness this week. DSI (daily sentiment) was at a level consistent with recent lows in SPX (data from Chad Gassaway).



Similarly, equity put/call has also been elevated over the past month; when this rolls over, SPX has usually moved higher (data from Larry McMillan).



What is worrisome about put/call is the ratio started to roll lower a week ago, during which time equities have fallen. That has not been the pattern in the past; the rollover has lagged the lows in equities. To that end, note that there were no spikes higher in put/call this week, despite a strong sell off.

Likewise, although these surveys can lag, it must be noted that both AAII (individual investors) and NAAIM (active managers) saw anincrease in bullishness this week. NAAIM respondents are 87% net long equities, an increase from 71% the week before. Both of these are consistent with put/call rolling lower.

It's rarely a positive when investors become more bullish as price heads lower, and that seems to be the case now. This makes us skeptical of how significant equities will rise before heading lower.

The Vix term structure also inverted this week. Vix has been elevated for most of the past month. Lows in SPX have mostly corresponded to times when the term structure has inverted. The watch out is that the early January inversion quickly reversed.



Finally, US treasuries might have experienced a blow off top, at least short term. Treasury investors' optimism (lower panel) has spiked higher, and these spikes usually correspond to at least a plateau in appreciation (data from Sentimentrader).



This happens to correspond to 30-year treasuries nearing a 20 year channel top; monthly RSI (5) is 90, which has also been consistent with a near term price plateau or top. Money moving out of treasuries would normally (but not always) benefit equities.



On balance, a rise in equities this week seems likely but, again, we are skeptical how far a bounce will go.

SPY has now fallen three weeks in a row. Excluding the 2008 bear market, SPY has fallen three weeks in a row 16 other times since 2003. In 15 of those, the index at least retested its low of the third week within the next three weeks. The one exception was in March 2004; price rose one week, but was lower 7 weeks later.



The same is true with RUT. It has been down three weeks in a row 14 other times since 2003, 13 of which were at the low again within three weeks. The one exception was last February; price rose the next 4 weeks, but was lower after 10 weeks.



The key watch out from the start of the year has been NDX. It was the only US index to peak in November and then make a lower high in December. NDX continues to lead to the downside; it slightly undercut its December lows this week. There are now two low highs and a lower low in NDX. That constitutes a downtrend. The pattern is a descending triangle (flat bottom, lower tops); these break lower 64% of the time according to Tom Bulkowski.


A potential positive for NDX is a trend line (dashed) from November 2013 that comes in near 4050, about 1% below Friday's low. There is also a 6 week supply of trading volume between 4000 and 4090 from August to October (yellow) that might provide support on further weakness. For now, the near term trend is down.

A week ago, SPX, RUT and DJIA did not have a lower high like NDX; now, all do. And all three are now also under their 50-dma. On weakness, the next obvious target is the December low. For DJIA, that happens to be near its 200-dma as well. On strength, look for resistance at last weeks high near 17,900 (dashed red line).



SPY now has a lower high. It is under a declining 5-dma and 13-ema; the 50-dma is flat. At best, this is a weak price trend. Regaining 203 would turn the slope of the 13-ema positive but 205 looks more formidable; that is the location of the line from the lower highs and its also weekly R1 next week and the pivot for the month of January. Regaining that level would be very positive. Like DJIA, the December low and the 200-dma are the obvious targets on weakness.



Since the start of the year, SPY has now gapped up 8 of 11 days, yet the price has moved lower 8 out of 11 days. In other words, the market drifts up over night and then mostly sells off during the day. The overnight gaps have netted a gain of $3.20, but SPY is lower YTD by $3.90. There has been more distribution than price is showing. It's not healthy.

Many sectors have retraced to their December lows. Banks have now lost that level. The same is true for transports. All the cyclical sectors are below their 50-dma; what are considered defensives (healthcare, utilities and staples) are all above their 50-dma. This pattern, too, is not healthy.



At its low this week, SPY was back at levels it traded at in August. There has been a lot of movement but not a lot of net progress.

What's going on? In early December, SPX completed a period of 7 weeks higher in a row. We looked at prior instances since the 1980s (here). There were 10 others; in 8 of these, SPX struggled to move higher for two months or longer. Some of these corresponded to major tops. In two instances, SPX largely continued higher. We seem to be repeating what has happened in the majority of cases; choppy, sideways action. US equities might be digesting the large gains made over the past 3 years; this has happened many times before and may well continue for several more months.



Lastly, outside the US, the highly disliked emerging markets are setting up an ascending triangle under 39.5. You can see it has formed this same pattern at lows before. Recall that fund managers are very underweight this region; a set up for outperformance in the past. Emerging markets correlate with commodities, so stabilization in oil and copper are likely to be necessary.



Monday is a market holiday to commemorate MLK. The days following are seasonally weak.

Our weekly summary table follows.

© The Fat Pitch

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The economy

Drop in energy  prices  dominates global headlines

As we enter the holiday season and consumers look for a little extra cash to spend, they shouldn’t have to look too far. The price of oil has fallen nearly 40% since its annual peak in mid- June.  This has helped drive down the national price of gasoline to an average of roughly $2.75 per gallon.  The economic implications on a global scale are somewhat mixed, with major oil importers benefiting the most.  The U.S. continues to consume more oil than it produces, but advances in technology and domestic production have been increasing at a rapid pace.  Beyond energy, the backdrop for the U.S. economy continues to be strong, with a third quarter GDP estimate of 3.9% and a labor market that continues to plod along; although improvements are still needed.  The strong close to 2014 is providing a robust tailwind for the domestic economy entering the New Year, whereas many countries overseas continue to cope with slower growth and potential deflation.

The bond market

Treasury  rates  drop across all maturities

Contrary to the trend for much of this year, interest rates dropped across the yield curve in November, providing a positive boost for bond prices.  The flattening of the U.S. Treasury yield curve has been a point of interest in 2014, with rates on shorter-term bonds rising and longer-term bonds continuing to fall. A flattening and potentially inverted yield curve can be a signal of slow growth on the horizon.  However, with the Federal Reserve manipulating rates to a greater extent than seen historically, this is not necessarily a foregone conclusion.  Their bond purchase program, although now completed, has had the biggest impact on the long end of the curve, while the prospect of a higher federal funds rate in 2015 is placing upward pressure on short-term rates. With this scenario in play, it remains prudent to be well-diversified along the short and intermediate portion of the yield curve.

The stock market

Stocks push higher  in November

The Dow Jones Industrial Average reached record highs yet again in November after fully working its way back from a sell-off in September / October.  Large and mid-cap domestic stocks continue to lead the way, with small caps and foreign equities trailing well behind.   Central banks around the world continue to look for new ways to stimulate economic growth, but these measures have not necessarily translated into strong stock returns.  The European Central Bank is delaying until early 2015 for additional stimulus measures, causing markets in Germany and France to drop more than 5% year to date.  On a positive note, a recent surprise interest rate cut in China did have a constructive impact on their stock returns, and U.S. markets are capitalizing on strong corporate earnings and a stable economy.  While numerous record highs are a cause for worry amongst some investors, we still believe fundamentals justify the current trend.

Economic Trends

Headlines

U.S. grows continues to be strong,  while  energy  market sells off.

Large  cap stocks once again lead markets higher in November.

Emerging markets lag, but see new measures put in place to help growth.

Energy  stocks take major hit in November as oil prices approach the $60 / barrel level.

Fixed income markets

China  steps into easing measures with a surprise rate cut.

Survey  shows investors now betting on  run for Treasuries (meaning interest rates will fall).

Bronfman E.L. Rothschild, LP is a registered investment advisor. Securities, when offered, are offered through Baker Tilly Capital, LLC, member of FINRA and SIPC; Office of

Supervisory Jurisdiction located at 10 Terrace Court, Madison, WI 53718, phone 800.362.7301. Bronfman E.L. Rothschild, LP and Baker Tilly Capital, LLC are not affiliated.

This publication should not be viewed as a recommendation, an offer to sell, or a solicitation of an offer to buy a particular security or service. The commentary provided is for informational purposes only and should not be relied on for accounting, legal, tax, or investment advice. Financial information is from third-party sources. While such information is believed to be reliable, it is not verified or guaranteed. Performance of any indexes is provided for reference and competitive purposes only without factoring any fees, commissions, and other charges. Individual results achieved by investors will be different from those of the indexes. Indexes are unmanaged; one cannot invest directly into an index. The views and opinions expressed are those of Bronfman E.L. Rothschild, LP, and they are subject to change at any time. Past performance does not imply or guarantee future results. Investing in securities involves risks, including possible loss of principal. Diversification cannot assure a profit or guarantee against a loss. Investing involves other forms of risk that are not described here. For that reason, you should contact an investment professional before acting on any information in this publication. 

© Bronfman E.L. Rothschild

[description] => The drop in energy prices dominates global headlines and the economic implications on a global scale are somewhat mixed, with major oil importers benefiting the most. Beyond energy, the backdrop for the U.S. economy continues to be strong, with a third quarter GDP estimate of 3.9% and a labor market that continues to plod along; although improvements are still needed. The strong close to 2014 is providing a robust tailwind for the domestic economy entering the New Year, whereas many countries overseas continue to cope with slower growth and potential deflation. [author] => Kevin Moloney [legacyinterface_firm_id] => 502 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 16:55:27 [created_by] => 948 [modified_on] => 2015-01-20 17:00:00 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2381 [hits] => 0 ) [12] => stdClass Object ( [legacyinterface_commentary_id] => 2316 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15555 [apv_conversation_id] => 3232 [content_type] => market-commentary [title] => Swiss Surprise: National Bank Ends Currency Cap [slug] => invesco_012015 [fulltext] =>

On Jan. 15, the Swiss National Bank (SNB) unexpectedly abandoned its policy to cap the value of the franc at 1.2 euros.1 Over the past few years, the SNB has had to sell billions of francs to buy euros to prevent an excessive appreciation of the domestic currency ― a too-strong currency could dent the country’s export business. The prospect of quantitative easing (QE) in Europe raised the prospect of more franc sales, more euro purchases, and the significant risk of potentially large foreign exchange losses for the SNB. It therefore changed tack by abandoning the cap but cutting official interest rates further to -0.75% from -0.25%.1 As a result, the franc has appreciated 17.5% versus the euro and 16.5% versus the US dollar,2 although we believe there could be further volatility ahead.

What are the implications? 

Interest rate markets:

Overall, we believe the move should have a positive impact on European rates markets. After the SNB printed francs and bought euros, it would recycle the euros into short-dated government bonds. Although the SNB is now stepping away from that process, negative interest rates in Switzerland could lead money to leave the Swiss banking system and find its way into other bond markets with positive nominal yields (and probably longer duration than the markets where the SNB was buying). Moreover, foreign assets have suddenly become much cheaper in Swiss franc terms.

Currency markets:

On the currency side, the SNB was one of the biggest buyers of euros in the market, so the euro has weakened. The market has also assumed that the SNB caught wind of what the ECB is planning in terms of QE and sold euros on the back of this. The trend for a weaker trade-weighted euro was already in place, and this could exacerbate those selling pressures. The euro appears to be the key funding currency (i.e., the best currency to sell to fund long currency positions) and we believe this is a clear negative for the euro.

Swiss economy:

We expect the largest negative impact will be on Switzerland itself. Inflation is already running at -0.3%3 year over year, and a strong currency could push it deeper into negative territory. The central bank has lost credibility in its battle against deflation, so it will probably need to take deposit rates even lower, and Swiss bonds could soon have negative yields out to 10-year maturities. Meanwhile, we expect Swiss companies with large foreign earnings to see Swiss franc profits reduced, and Swiss stocks were down sharply on the announcement (in Swiss franc terms).2 It will also be important to watch for any idiosyncratic risks, such as the collateral impacts of Swiss franc carry trades being unwound.

1 Source: Swiss National Bank

2 Source: Bloomberg LP, Jan. 15, 2015

3 Source: Swiss Federal Statistical Office

Important Information

Idiosyncratic risk is specific to an asset or a small group of assets and has little or no correlation with market risk.

Carry trade is a strategy in which traders borrow a currency that has a low interest rate and use the funds to buy a different currency that is paying a higher interest rate.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.

©2015 Invesco Ltd. All rights reserved.

[description] => On Jan. 15, the Swiss National Bank (SNB) unexpectedly abandoned its policy to cap the value of the franc at 1.2 euros.1 Over the past few years, the SNB has had to sell billions of francs to buy euros to prevent an excessive appreciation of the domestic currency - a too-strong currency could dent the country’s export business. [author] => Rob Waldner, Nicholas Wall, Ray Uy [legacyinterface_firm_id] => 225 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 17:01:50 [created_by] => 948 [modified_on] => 2015-01-20 17:26:04 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2382 [hits] => 0 ) [13] => stdClass Object ( [legacyinterface_commentary_id] => 2317 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15553 [apv_conversation_id] => 3230 [content_type] => market-commentary [title] => The Politics of Economic Stupidity [slug] => prosyn_012015 [fulltext] =>

NEW YORK – In 2014, the world economy remained stuck in the same rut that it has been in since emerging from the 2008 global financial crisis. Despite seemingly strong government action in Europe and the United States, both economies suffered deep and prolonged downturns. The gap between where they are and where they most likely would have been had the crisis not erupted is huge. In Europe, it increased over the course of the year.

Developing countries fared better, but even there the news was grim. The most successful of these economies, having based their growth on exports, continued to expand in the wake of the financial crisis, even as their export markets struggled. But their performance, too, began to diminish significantly in 2014.

In 1992, Bill Clinton based his successful campaign for the US presidency on a simple slogan: “It’s the economy, stupid.” From today’s perspective, things then do not seem so bad; the typical American household’s income is now lower. But we can take inspiration from Clinton’s effort. The malaise afflicting today’s global economy might be best reflected in two simple slogans: “It’s the politics, stupid” and “Demand, demand, demand.”

Click here to read more

© Project Syndicate

[description] => In 2014, the world economy remained stuck in the same rut that it has been in since emerging from the 2008 global financial crisis. But we know how to escape our current malaise, which suggests that the big problem facing the world in 2015 is political, not economic. [author] => Joseph Stiglitz [legacyinterface_firm_id] => 345 [published_on] => 2015-01-20 [digest_date] => 2015-01-20 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-20 17:16:00 [created_by] => 948 [modified_on] => 2015-01-20 17:16:11 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2383 [hits] => 0 ) [14] => stdClass Object ( [legacyinterface_commentary_id] => 2318 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15554 [apv_conversation_id] => 3231 [content_type] => market-commentary [title] => Despite Escalating Volatility, U.S. Fundamentals Remain Sound [slug] => nuveen_012015 [fulltext] =>

U.S. equities declined for a third straight week, with the S&P 500 Index dropping 1.2%.1 Defensive areas such as utilities and telecommunications were the best-performing sectors, while the financial sector was hit the hardest.1 Notwithstanding last week’s decision by the Swiss National Bank to remove its currency peg, the fundamental backdrop has not changed much in recent weeks. We attribute the fall in equity prices to ongoing worries about the collapse in oil prices and the ripple effect on the global financial system.

Weekly Top Themes

1. Retail sales levels fell in December, but longer-term trends remain positive. Sales excluding gasoline dropped 0.4% last month,2 but we think it would be an overreaction to suggest that the retail sector is in trouble. Over the past six and twelve months, sales ex-gas were up 4.4% and 5.3%, respectively.2

2. Inflation looks steady, but may be due to fall. The headline Consumer Price Index (CPI) fell 0.4% in December and core CPI was unchanged.3 Core CPI was up 0.8% year-over-year.3 Given the sharp decline in energy prices, we expect core CPI may turn negative in February or March.

3. We believe lower oil prices produce a net benefit to the U.S. economy. Declining oil prices help consumers and users of energy. Oil producers are hurt by this trend, but this group is relatively small. Nonfarm payrolls show 140 million people are employed in the United States, with 931,000 working in the oil and gas industry.4 In other words, less than 1% of total U.S. employment is based in the energy sector.

4. Near-term earnings trends may be disappointing, but we remain optimistic about the coming year. As the fourth quarter earnings season begins, current S&P 500 estimates are for a paltry 1% year-over-year gain, with weakness centered in the energy sector.5 Looking ahead, we believe an improving economy and healthy profit margins should help corporate earnings to rebound.

5. The U.S. dollar may be overdue for a pullback. The dollar has rallied substantially over the past few months, due to falling oil prices plus diverging economic growth and monetary policies between the United States and other countries. We think these long-term trends will persist, but some sort of nearterm consolidation or counter-rally in the dollar may occur.6. European growth remains under pressure. We expect the eurozone to continue to struggle as long as bank lending remains depressed, inflation remains close to zero and governments remain unwilling to increase spending. The growing possibility of additional easing action by the European Central Bank (ECB) will help, but likely won’t be enough to pull Europe out of its doldrums.

7. Investors have a long list of events and data to react to this week. Earnings results will get their share of attention, and this week also features a rash of Chinese economic data, the President’s State of the Union address, an ECB meeting and elections in Greece.

Sentiment Falters, Yet Equities Still Look Attractive

The sharp decline in oil has contributed to a fall in equity prices and in bond yields, as it has sparked global deflation fears and undermined confidence in the global economy. The fundamental supply and demand factors behind falling prices are real, but we believe prices may have overshot and the current turmoil should diminish. The souring of investment sentiment seems out of sync with increasing evidence of economic acceleration.

The pickup in volatility is unnerving, but we encourage investors to ride out the equity market turbulence. Those with longer-term horizons may want to consider using periods of weakness to add to positions as well. We expect the coming year to be a positive one for global equities in both absolute terms and relative to Treasuries. We think both the economy and corporate earnings are strengthening, and global monetary policy remains supportive. Commodity price volatility remains a risk, and equities are likely to remain vulnerable until oil prices stabilize. We think equities will be able to overcome this risk.

1 Source: Morningstar Direct, as of 1/16/15 2 Source: U.S. Department of Commerce 3 Source: Bureau of Labor Statistics 4 Source: Deutsche Bank Research 5 Source: MRB Partners 

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

RISKS AND OTHER IMPORTANT CONSIDERATIONS

The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.

Nuveen