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: 1379367  Threads: 1  Questions: 194691  Slow queries: 0  Opens: 62  Flush tables: 1  Open tables: 55  Queries per second avg: 0.141
                                    [sqlstate] => 00000
                                    [protocol_version] => 10
                                    [thread_id] => 18034
                                    [warning_count] => 0
                                )

                            [count:protected] => 17
                            [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] => 340
                                    [limitstart] => 340
                                    [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] => 340
                                                )

                                            [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
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                                                                            [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] => 340
                                                                )

                                                            [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] => 340
                                                                                )

                                                                            [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
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                                                                                        )

                                                                                )

                                                                            [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
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                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
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                                                                                                            [17] => object
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                                                                                                            [21] => xml
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                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
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                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [start] => 340
                                                                                                )

                                                                                            [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
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                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

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

                                                                                                )

                                                                                            [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
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                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
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                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
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                                                                                                            [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
                                                                                                (
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                                                                                                    [attrArray] => Array
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                                                                                            [data:protected] => Array
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                                                                                            [inputs:protected] => Array
                                                                                                (
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                                                                                    [env] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
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                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
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                                                                                            [data:protected] => Array
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                                                                                            [inputs:protected] => Array
                                                                                                (
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                                                                                    [request] => JInput Object
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                                                                                            [options:protected] => Array
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                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
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                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
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                                                                                                )

                                                                                            [data:protected] => Array
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                                                                                                    [limitstart] => 340
                                                                                                    [option] => com_legacyinterface
                                                                                                    [view] => commentaries
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                                                                                            [inputs:protected] => Array
                                                                                                (
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                                                                                        )

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

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

                                                                                                    [attrArray] => Array
                                                                                                        (
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                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
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                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [HTTP_AUTHORIZATION] => 
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                                                                                                    [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate
                                                                                                    [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                                                    [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
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                                                                                                    [REMOTE_ADDR] => 54.83.81.52
                                                                                                    [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] => 44432
                                                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                                                    [SERVER_PROTOCOL] => HTTP/1.0
                                                                                                    [REQUEST_METHOD] => GET
                                                                                                    [QUERY_STRING] => start=340
                                                                                                    [REQUEST_URI] => /?start=340
                                                                                                    [SCRIPT_NAME] => /index.php
                                                                                                    [PHP_SELF] => /index.php
                                                                                                    [REQUEST_TIME_FLOAT] => 1516439376.859
                                                                                                    [REQUEST_TIME] => 1516439376
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                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

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

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

                                                                                                    [attrArray] => Array
                                                                                                        (
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                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
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                                                                                                            [4] => basefont
                                                                                                            [5] => embed
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                                                                                                            [7] => frameset
                                                                                                            [8] => head
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                                                                                                            [12] => ilayer
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                                                                                                            [14] => link
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                                                                                                    [attrBlacklist] => Array
                                                                                                        (
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                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [__default] => Array
                                                                                                        (
                                                                                                            [session.counter] => 1
                                                                                                            [session.timer.start] => 1516439377
                                                                                                            [session.timer.last] => 1516439377
                                                                                                            [session.timer.now] => 1516439377
                                                                                                            [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                                                (
                                                                                                                    [data:protected] => stdClass Object
                                                                                                                        (
                                                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                                                (
                                                                                                                                    [commentaries] => stdClass Object
                                                                                                                                        (
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                                                                                                                                            [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
                                                                                                (
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                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
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                                                                                                    [tagsMethod] => 0
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                                                                                                    [tagBlacklist] => Array
                                                                                                        (
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                                                                                                            [12] => ilayer
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                                                                                                            [17] => object
                                                                                                            [18] => script
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                                                                                                            [20] => title
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                                                                                                    [attrBlacklist] => Array
                                                                                                        (
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                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                )

                                                                        )

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

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

                                                                                    [attrArray] => Array
                                                                                        (
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                                                                                    [tagsMethod] => 0
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                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

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

                                                                                    [attrArray] => Array
                                                                                        (
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                                                                                    [attrBlacklist] => Array
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                                                                                )

                                                                            [data:protected] => Array
                                                                                (
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                                                                                    [limitstart] => 340
                                                                                    [option] => com_legacyinterface
                                                                                    [view] => commentaries
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                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

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

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

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
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                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
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                                                                                            [12] => ilayer
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                                                                                            [18] => script
                                                                                            [19] => style
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                                                                                    [attrBlacklist] => Array
                                                                                        (
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                                                                                )

                                                                            [data:protected] => Array
                                                                                (
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                                                                                    [HTTP_HOST] => wordpress.hubtech.tv
                                                                                    [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate
                                                                                    [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                                    [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] => 54.83.81.52
                                                                                    [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] => 44432
                                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                                    [SERVER_PROTOCOL] => HTTP/1.0
                                                                                    [REQUEST_METHOD] => GET
                                                                                    [QUERY_STRING] => start=340
                                                                                    [REQUEST_URI] => /?start=340
                                                                                    [SCRIPT_NAME] => /index.php
                                                                                    [PHP_SELF] => /index.php
                                                                                    [REQUEST_TIME_FLOAT] => 1516439376.859
                                                                                    [REQUEST_TIME] => 1516439376
                                                                                )

                                                                            [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
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                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
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                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
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                                                                                    [attrBlacklist] => Array
                                                                                        (
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                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                    [__default] => Array
                                                                                        (
                                                                                            [session.counter] => 1
                                                                                            [session.timer.start] => 1516439377
                                                                                            [session.timer.last] => 1516439377
                                                                                            [session.timer.now] => 1516439377
                                                                                            [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                                (
                                                                                                    [data:protected] => stdClass Object
                                                                                                        (
                                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                                (
                                                                                                                    [commentaries] => stdClass Object
                                                                                                                        (
                                                                                                                            [limitstart] => 340
                                                                                                                            [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
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                                                                                        )

                                                                                )

                                                                            [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
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                                                                            [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] => 340
                                                                    [limitstart] => 340
                                                                    [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_HOST] => wordpress.hubtech.tv
                                                                    [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate
                                                                    [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                    [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] => 54.83.81.52
                                                                    [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] => 44432
                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                    [SERVER_PROTOCOL] => HTTP/1.0
                                                                    [REQUEST_METHOD] => GET
                                                                    [QUERY_STRING] => start=340
                                                                    [REQUEST_URI] => /?start=340
                                                                    [SCRIPT_NAME] => /index.php
                                                                    [PHP_SELF] => /index.php
                                                                    [REQUEST_TIME_FLOAT] => 1516439376.859
                                                                    [REQUEST_TIME] => 1516439376
                                                                )

                                                            [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] => 1516439377
                                                                            [session.timer.last] => 1516439377
                                                                            [session.timer.now] => 1516439377
                                                                            [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                (
                                                                                    [data:protected] => stdClass Object
                                                                                        (
                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                (
                                                                                                    [commentaries] => stdClass Object
                                                                                                        (
                                                                                                            [limitstart] => 340
                                                                                                            [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
                                                            [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
                                                        )

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                                    [title] => Rate Hikes To Start in 2015
                                    [slug] => ft_121814
                                    [fulltext] => 

Unlike most meetings, today’s actions by the Federal Reserve were chock full of implications for the future course of monetary policy. At long last, the Fed finally removed the language in its statement that short-term interest rates will remain at essentially zero for a “considerable time” and replaced it with language that the Fed will be “patient” before starting to increase rates.

Several months ago, Fed Chair Janet Yellen let it slip that she thinks a “considerable time” means about six months. As a result, we are increasingly confident in our forecast that the first rate hike will come by June 2015, six months from now.

What’s striking about the rest of the Fed’s policy statement is how focused it is on the labor market, altering the wording of its statement as well as its economic projections slightly here and there to signal its own increased confidence in job creation and declining unemployment.

The obsession with the labor market helps explain why the Fed was willing to look past the recent oil-induced drop in overall inflation. Remember, the Fed doesn’t care as much about where inflation is today as where its own models are projecting inflation to go over the next few years. And while it expects inflation to remain low for the time being, it sees this as temporary and that one of the reasons inflation will rebound is improvement in the labor market. The Fed may be the most ardent advocate of the Keynesian Phillips Curve in the world.

When the Fed starts raising rates it is unlikely to raise rates at every meeting, as was done in the past two prolonged rate hike cycles under Alan Greenspan in the late 1990s and Ben Bernanke in the middle of the prior decade. Yellen cautioned against this view at the press conference following the meeting. In addition, the “dot matrix” showing where policymakers think interest rates will go over the next few years suggests the Fed will, for the first year of rate hikes, alternate between raising short-term rates at one meeting and then pausing at the next, making for one rate hike of 25 basis points per quarter through mid-2016.

The “median” dot may suggest a slightly faster pace of rate hikes, but we’re guessing that, as the leader of the Fed, Yellen will ultimately get her way and she is probably on the dovish side of the dot matrix. With the highest dot being the most hawkish, Yellen is probably around dot number 12, give or take, and that dot shows three rate hikes in 2015 and six in 2016.

Another issue is when the Fed’s balance sheet will go back to normal. We’re still forecasting that the Fed will keep reinvesting principal payments from its asset holdings to maintain the balance sheet at roughly $4.4 trillion through at least late 2015.

Notably, this last meeting for 2014 must have been a contentious one. Three members dissented. Once again, Minneapolis Fed president Narayana Kocherlakota disagreed from the dovish side, saying inflation was too low. The two other dissents were from hawks. Dallas President Richard Fisher thought rate hikes should come earlier and Philadelphia President Charles Plosser thought the statement was too focused on the timing of rate hikes rather than the economic conditions that would generate rate hikes. In addition, Plosser thought the statement was not optimistic enough.

The bottom line is that while the Fed is still behind the curve, it’s at least finally pointed in the right direction, and, barring some major shift in its outlook for the economy, the clock is ticking on rate hikes. Nominal GDP – real GDP growth plus inflation – is up 4.0% in the past year and up at a 3.9% annual rate in the past two years. A federal funds target rate of nearly zero is too low given this growth. It’s also too low given well-tailored policy tools like the Taylor Rule.

In the meantime, hyperinflation is not in the cards; the Fed will keep paying banks enough to keep the money multiplier depressed. But, given loose policy, we expect gradually faster growth in nominal GDP for the next couple of years. In turn, the bull market in equities will continue and the bond market is due for a fall.

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] => Unlike most meetings, today’s actions by the Federal Reserve were chock full of implications for the future course of monetary policy. At long last, the Fed finally removed the language in its statement that short-term interest rates will remain at essentially zero for a “considerable time” and replaced it with language that the Fed will be “patient” before starting to increase rates. [author] => Brian Wesbury, Robert Stein [legacyinterface_firm_id] => 154 [published_on] => 2014-12-18 [digest_date] => 2014-12-18 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-18 15:39:42 [created_by] => 948 [modified_on] => 2014-12-18 15:40:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2179 [hits] => 0 ) [1] => stdClass Object ( [legacyinterface_commentary_id] => 2114 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15353 [apv_conversation_id] => [content_type] => market-commentary [title] => A Tale of Two Markets [slug] => guggenheim_121814 [fulltext] =>

As seasoned investors are well aware, financial markets and economic trends seldom move in straight lines. Nowhere was this old adage more evident than in the discrepancy between last week’s domestic economic data releases and the performance of the stock market. Although U.S. equities suffered their biggest one-week drop since May 2012 on the back of declining oil prices, American consumer confidence reached new post-recession highs, with retail spending for the month of November comfortably beating expectations.

While the U.S. economic expansion continues to power forward, the international situation is becoming increasingly grim. The recent decline in the ruble, which Russia attempted to slow with a surprise rate hike of 6.5 percentage points to 17 percent, is reminiscent of the early stages of the 1998 Russian crisis. Elsewhere, the European Central Bank has fallen behind the curve, Abenomics in Japan is stalling, and China is making the painful adjustment to slower growth. Nevertheless, while international events are likely to get worse and energy prices are likely headed lower, I don’t envision a larger economic malaise spreading to the United States in the near term.

Understandably, investors are currently spending the majority of their time worrying about oil and where the price bottom is. The United Arab Emirates’ energy minister announced over the weekend that OPEC is standing behind its Nov. 27 decision not to cut the group’s collective output target of 30 million barrels per day, which highlights the blatant lack of pricing discipline within the organization. As oil continues its decline, pressure is increasingly mounting on credit markets, especially high-yield corporate bonds, where energy-related borrowers represent 15-20 percent of the market.

The flip side is that as spreads widen, we get closer to the levels where large investors, such as pension funds and insurance companies, start to see value in the high-yield market, which should help stabilize credit spreads. Ultimately, what investors should prepare for is an extended period of depressed oil prices. Oil still has substantial downside room to run before reaching a level of stability. Once stabilized, depressed oil prices will create another “tale of two markets”— companies with oil exposure and those without.

Chart of the Week

Leading Indicators Suggest No Recession

Plunging oil markets and faltering growth expectations around the world have raised fears about the sustainability of the current U.S. economic expansion. The economic data, though, suggest that these fears are largely unfounded. The Conference Board’s Leading Economic Index, which is made up of 10 forward-looking economic and financial indicators, has not fallen since January and has been gaining momentum throughout the year. Until we see the LEI approach negative year-over-year growth, which has preceded the last seven recessions, the U.S. economy should continue to ride out the storm emanating from overseas.

THE CONFERENCE BOARD LEADING ECONOMIC INDEX AND U.S. RECESSIONS

The Conference Board Leading Economic Index and U.S. Recessions

Economic Data Releases

U.S. Consumer Confidence and Industrial Production Rise
  • University of Michigan Consumer Confidence continued to make post-recession highs in the preliminary December reading, jumping to 93.8 from 88.8.
  • Industrial production beat estimates in November, rising 1.3 percent, the best month since May 2010, on the back of a surge in consumer goods output.
  • The Empire State Manufacturing Survey unexpectedly dropped to -3.6 from 10.2 in December, the lowest level in nearly two years.
  • The NAHB Housing Market Index inched down to 57 from 58 in December. Regional indexes were mixed, with the Northeast showing the largest decline.
  • Housing starts disappointed in November, falling 1.6 percent to 1.03 million. Multi-family starts were up while single family starts fell.
  • Building permits fell to 1.04 million from 1.09 million in November, a larger-than-expected decline.
  • The Consumer Price Index dropped to 1.3 percent in November, a nine-month low. Prices, excluding food and energy, ticked down to 1.7 percent.
  • The Producer Price Index continued to decline in November, reaching 1.4 percent, an eight-month low.
Mixed Data Out of Europe and Asia
  • Euro zone industrial production missed estimates for October, inching up just 0.1 percent. The prior month was also revised down to 0.5 percent.
  • The euro zone manufacturing PMI improved more than expected in December, reaching a five-month high of 50.8. The services PMI rose for the first time since July, up to 51.9.
  • Germany’s manufacturing PMI climbed back into expansion in December, beating expectations by rising to 51.2 from 49.5. The services PMI fell to a 17-month low of 51.4.
  • Germany’s ZEW survey rebounded slightly in December, rising to 10 from 3.3 in the current situation index. The expectations index experienced a sharper improvement, rising to the highest level since April at 34.9.
  • The French manufacturing PMI declined for a third straight month in December, falling to 47.9 from 48.4. The services PMI rose to 49.8, a four-month high.
  • The U.K. CPI dropped to 1.0 percent in November, the fifth straight decline and the lowest since 2002.
  • China’s HSBC manufacturing PMI fell for a second consecutive month in December to 49.5, entering contraction for the first time in seven months.
  • Industrial production in China slowed more than expected in November, dropping to 7.2 percent year-over-year growth from 7.7 percent.
  • Growth in Chinese retail sales accelerated to 11.7 percent year over year in November, the first acceleration since May.
  • Japan’s Tankan survey of large manufacturers inched down to 12 from 13 in the fourth quarter. The outlook index fell to a three-quarter low.
  • Japanese export growth slowed in November, dropping to 4.9 percent from 9.6 percent.

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2014, Guggenheim Partners. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

© Guggenheim Partners

[description] => A solid run of domestic data has set the United States apart from a beleaguered world. [author] => Scott Minerd [legacyinterface_firm_id] => 186 [published_on] => 2014-12-18 [digest_date] => 2014-12-18 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-18 15:42:42 [created_by] => 948 [modified_on] => 2014-12-18 15:43:54 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2180 [hits] => 0 ) [2] => stdClass Object ( [legacyinterface_commentary_id] => 2115 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15354 [apv_conversation_id] => [content_type] => market-commentary [title] => 2014 Year End Letter [slug] => osterweis_121814 [fulltext] =>

Dear Client,

As 2014 comes to a close, we want to provide an update on the energy sector. Energy has been making headlines as oil prices have reached unexpected lows. As discussed below, while the decline in oil prices is creating volatility in the energy sector, we believe that there continues to be opportunity in this sector and that the low oil prices should prove beneficial to U.S. and global economic growth.

The price of oil began to slip from its highs in June with the decline continuing through the third quarter before plunging in late November. The proximate cause is a mismatch between growing global supply and stagnating demand. The weakness in demand was not a big surprise given the well documented, recent economic slowdown in Europe, Japan and China. The growth in supply did not come as a surprise either. U.S. and Canadian producers delivered sharp increases in production in each of the last two years and the consensus view was that North American production would continue to expand at a nearly 1.0 million barrel-per-day rate in 2014 and again in each of the next several years. The big surprise that undermined the oil markets occurred in September, October and November, when Libyan production came back on stream and Saudi Arabia did nothing in response. As the weeks passed without any sign of a reduction in Saudi production, the price of oil started to fall. When OPEC met formally on Thanksgiving Day and the Saudis officially and definitively said that they would not cut back production to steady the price of oil, the markets collapsed. For all intents and purposes, the Saudi message to the world was that the OPEC cartel is finished.

There has been much speculation about the motivation of the Saudis. The official Saudi position is that they needed to cut the price of oil to maintain market share in critical Asian markets. This is no doubt true, but the universal expectation was that the Saudis would do just that in the name of steadying the price of oil in the $90-$110 range. After all, they are the largest OPEC producer by a factor of more than two and they ramped up capacity and production over the past several years to keep prices from quickly rising when political unrest in other OPEC countries led to supply shortfalls. It stood to reason that they would pull back their production to pre-Arab Spring levels as output resumed from other OPEC producers. Why, then, did the Saudis decide to keep producing this fall at these new higher levels at the expense of prices dropping below the range they had been defending for the past three years? We think the answer is that they determined that longer term prices above $90 per barrel would lead to ever increasing supply out of North America and therefore require the Saudis to continuously reduce their production to keep markets balanced. They concluded that no other producer would step in and reduce output. The result over just the next 3-5 years would have been a massive reduction in Saudi output and market share — possibly in the range of 30-50%! We believe their bet is that by letting the price of oil fall, market forces will now slow the rate of production increases globally, especially in North America. They believe that many of the new unconventional oil wells in the U.S. are unprofitable with prices below $70. The same is true for many of the mega ultra-deep water, oil sands and Arctic projects around the world that may have very low extraction costs but very high capital costs.

With prices nearing $60 per barrel, it is a good bet that the pace of oilfield development around the world will slow meaningfully in the coming 6-12 months and remain at subdued levels until the price rises back above the $80 level. It is impossible to know just how low the price will fall in coming weeks and months. Some high cost production should get shut down at a price below $50, but, more importantly, we think fewer new shale wells will get drilled and even some drilled wells waiting for completion may not get completed. Consequently, supply should start to contract by next spring/summer and oil prices will likely rebound by next fall.

The macro level implications of lower oil prices are positive for all net oil consuming countries, including the U.S., Europe and the major Asian economies (Japan, China, India, et al). The U.S. seems likely to be the clear winner. The benefits of lower oil prices should be greater for the U.S. than for most of our trading partners because the rising U.S. dollar (driven by low global interest rates and commodity costs) offsets some of the benefits to these other economies. The clear losers are Russia, Iran, Nigeria, Venezuela and a number of other net oil exporting countries that are heavily dependent on oil revenues and who need a price in excess of $100 per barrel to balance their fiscal regimes.

For the U.S. economy, lower oil prices generally increase discretionary income for consumers. This can translate into higher spending on both durable (cars, houses, etc.) and non-durable (clothing, leisure, dining, etc.) goods. Consumers are likely to buy larger, less fuel efficient cars and trucks, which means the auto industry should sell both more vehicles and more of their most profitable larger models. The combination of lower oil prices and a stronger dollar (which leads to lower import prices) suggests that inflation will stay lower longer than would have been the case had oil prices remained in the $90-$110 range. Lower inflation likely means that the Federal Reserve (the Fed) will be able to keep interest rates lower for longer, allowing unemployment to fall further and wages to rise more before the Fed feels the need to raise rates. Slowing domestic shale development will probably detract from U.S. economic growth, but lower oil prices should be a net benefit to the economy.

In terms of what declining oil prices mean for our equity strategy, we have been uncomfortable with commodity companies for some time, going back to the collapse in the natural gas markets in 2008 and more recently with the slowing in the Chinese economy. History has shown us that a worldwide investment boom to increase supply of any commodity in response to high prices almost always results in a price collapse when the new supply hits the market. For this reason the focus of our investing in the energy patch for the past five years has been on companies that benefit from rising volumes – not prices. Our investments make their money moving other people’s energy around without actually taking title to the commodity itself.

At present, our equity strategy has only one direct commodity company: Occidental Petroleum (OXY). We own OXY because its current management team is conducting a sweeping restructuring and downsizing initiative that should result in a smaller, more profitable and more focused company with little or no debt, the lowest costs in the industry and decades of attractive growth potential even if prices never get back above $100 per barrel. All of the other energy holdings in our strategy are infrastructure companies with little or no direct commodity exposure. These companies own and operate strategically critical gathering, processing, storage and/or shipping assets that generate fee-based revenues. While it is certainly possible that these companies’ growth will be slower in the years ahead with oil prices closer to $60 than $100 per barrel, we believe they should still be able to both maintain and grow their earnings, cash flows and dividends/distributions to equity holders. In fact, the collapse in oil prices may make their storage assets more attractive given that the expected future price of oil is higher than the current price. This creates an incentive to store oil today and sell it at higher prices in the future. Also, consumption of oil, as well as the refined products derived from oil such as gasoline, diesel and jet fuel, may rise in response to lower prices. This could increase demand for certain pipeline and storage assets. Ironically, natural gas could also get a lift from lower oil prices, because of one of the odd secrets of the boom in shale oil production: Much of what comes out of many shale oil wells is natural gas and related natural gas liquids. If far fewer oil wells are drilled in the next 6-12 months, this will likely result in less natural gas, potentially firming its price, which would benefit a number of our infrastructure holdings.

None of this means that our energy holdings will be spared from short-term volatility related to the collapsing price of oil. As we recently saw, Master Limited Partnerships (MLPs) experienced indiscriminate selling in the wake of declining oil prices. However, we continue to have high conviction in our MLPs and believe that longer-term they will prove to be valuable assets for our investors. Additionally, as the price of oil continues to be under pressure, we may be able to find some high quality energy exploration and production companies that would normally be out of our price range.

Looking at fixed income, our exposure to energy is also underweight commodity energy producers. While we have felt for some time that the next possible bubble would be in energy commodity producers, given the huge investments made in the past several years, we have made selective investments in service companies that are focused on treating waste produced mainly from producing wells. These wells are less likely to be shut down as the discovery and drilling costs are behind them. We have also made investments in infrastructure and storage companies, which, as discussed above, are much less sensitive to the price of the commodity and may actually benefit from a positively sloping future price curve for oil. This has not, however, prevented them from being tarred with the energy label as many investors who were overweight the sector attempt to pare holdings going into year end. If our view is correct that as future supply is curtailed and economic strength gains momentum, we could likely see a rebound as early as late 2015.

We will further discuss our economic perspective in our January Investment Outlook, but in general we continue to believe that the U.S. is well-positioned to maintain its slow growth trajectory. Some are even saying that the U.S. has entered into a period that none of us here have ever seen – a deflationary boom. We don’t expect weakness in Europe, Japan or China to spill over to the U.S. because the U.S. is well insulated from global trade flows. That said, we are mindful of the many risks that could affect our outlook, such as geopolitical unrest, sudden declines in consumer/business confidence, a downdraft in economic activity or a corporate profit collapse. Right now we think these risks are remote, but we continue to vigilantly monitor them.

Best wishes for a very happy and prosperous 2014.                                                                 

John Osterweis                       Matt Berler                               Carl Kaufman

Past performance is no guarantee of future results.

This commentary contains the current opinions of the author as of the date above, which are subject to change at any time. This commentary has been distributed for informational purposes only and is not a recommendation or offer of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

OPEC refers to the Organization of the Petroleum Exporting Countries.

Fund holdings and allocations are subject to change at any time and should not be considered a recommendation to buy or sell any security. As of 9/30/2014, the Osterweis Fund, the Osterweis Strategic Investment Fund and the Osterweis Institutional Equity Fund held 2.99%, 1.88% and 3.16% of Occidental Petroleum, respectively.

Cash Flow measures the cash generating capability of a company by adding non-cash charges (e.g. depreciation) and interest expense to pretax income.

© Osterweis Capital Management

[description] => As 2014 comes to a close, we want to provide an update on the energy sector. Energy has been making headlines as oil prices have reached unexpected lows. As discussed below, while the decline in oil prices is creating volatility in the energy sector, we believe that there continues to be opportunity in this sector and that the low oil prices should prove beneficial to U.S. and global economic growth. [author] => John Osterweis, Matt Berler, Carl Kaufman [legacyinterface_firm_id] => 327 [published_on] => 2014-12-18 [digest_date] => 2014-12-18 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-18 15:47:42 [created_by] => 948 [modified_on] => 2014-12-18 15:48:11 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2181 [hits] => 0 ) [3] => stdClass Object ( [legacyinterface_commentary_id] => 2101 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15340 [apv_conversation_id] => [content_type] => market-commentary [title] => Where Did The New Middle Class Citizens Go? [slug] => smead_121714 [fulltext] =>

Dear Fellow Investors,

The "well known fact" with regards to oil over the last decade read like this: because of huge GDP growth in emerging markets like China, there were going to be 400 million new middle class citizens born of uninterrupted prosperity; they were going to want all the autos, consumer goods, $10,000 watches and food that Americans have. The demand for commodities was going to be endless because capitalism practiced under authoritarian control was going to be better than the "invisible hand" of the free market. No recessions or depressions required.

Now, with oil dropping from $95 per barrel to below $57 through the first half of December 2014, many pundits seem to focus on the over-supply of oil and falling demand in a slowing global economy. But we think they miss the long-term view.

As long-duration common stock investors, we don’t see oil dropping merely because OPEC and Bakken Shale have produced too much supply. Instead, we see oil’s demise as a symptom of something larger: the unwinding of a globally synchronized trade tied to the “well known fact” stated above.

Part of the job of the long-term contrarian investor is to identify a body of economic information which is not only known to all market participants, but has been acted upon by anyone in the marketplace who wishes to participate. We call this the “well known fact.” If we know where the vast majority of investors are, then we can contentiously go where they are not.

Nearly every major institutional and high-net-worth individual investor had to adjust their portfolio to this particular “fact” about China and the emerging markets over the last decade. The most successful money managers of the prior decade, who had successfully participated early in the “well known fact,” were validated and received adulation for promoting it (think BRIC-trade). As Warren Buffett likes to say, “What the wise man does at the beginning, fools do at the end.”

The boom created by a once-in-a-generation and massive capital re-allocation toward everything related to the globally-synchronized trade did what all booms do. It turned to bust. Few experts or pundits view it this way, but for many it’s often tough to see the forest through the trees.

We think it would be helpful at this point to review other psychologically-driven boom-bust cycles to analyze the depth of their declines and the duration of the bear market which followed. In this way, we might prosper from the disarray of investment managers and the largest institutional pools. They remained trapped chasing an over-capitalized belief in the 400 million new middle-class citizens on "a permanently higher plateau" in commodities.

Go-Go Mutual Fund Boom Peaked in 1968

  • Well Known Fact: Technology sparked by the space race was limitless.
  • Result: Small-Cap Stock Boom.
  • Declines to 1974 Bear-Market Low 60-80%.
  • Duration: 6 years.

Nifty-Fifty Large-Cap Stock Boom 1972

  • Well Known Fact: 50 companies having limitless earnings growth and consistency.
  • Result: Institutions had 74% of their portfolio in common stocks at the beginning of 1973.
  • Declines of 50-80% and no ultimate bottom until 1982.
  • Duration: 10 years.

Commodity Boom of the 1970s peaking in 1981

  • Well Known Fact: Never ending double-digit inflation demanded investments which benefit from inflation (Oil, Gold, etc.).
  • Result: stock, Gold stock and Commodity Boom.
  • Declines of 70% in Oil and 60% in Gold ending in 1999.
  • Duration: 18 years.


Tech Bubble 2000

  • Well Known Fact: The Internet Will Change Our Lives.
  • Result: Tech-Heavy NASDAQ Index fell 78% and isn't back to even 15 years later.
  • Duration 3 Years.


Residential Real Estate 2005

  • Well Known Fact: Houses always go up in value and are geographically diverse.
  • Result: Homes fell 50% in hottest markets and the leverage attached to them created the biggest financial meltdown since the 1930s, helping to cause a 50% decline in stock prices.
  • Duration: 7 Years.


What can we as long-duration common stock investors glean from reviewing these past episodes of financial euphoria? First, it appears that stocks confess sins and cleanse faster than other asset classes. Second, the connection to leverage and the inter-connectedness of multiple asset classes seemed to cause longer-duration declines in the past. For example, tech stocks had very little debt and most investors weren't using margin in 1999. Therefore, the grief didn’t spread to the real economy; however, owners of leveraged oil tax shelters and garden-style apartments in the Sun Belt in 1981 were illiquid and everything inflation-related was tied together.

Third, our observations suggest that asset quality affects decline duration. Exxon paid dividends from 1981-1999, while gold and commodity indexes didn't. Investors had something to fall back on like earnings, free cash flow and dividends.

Lastly, how fast can money managers purge? Most institutions and high-net worth individual investors have the stamp of the well-known-fact all over their portfolios as evidenced by studies like the 2013 NACUBO study of endowments and foundations. It should take years to rearrange their commitment to all aspects of the globally-synchronized trade.

What do we look for among common stocks as we bargain hunt in sectors which get unwound by a vicious bear market following the unwinding of a “well known fact?” We will watch for the shaming of the globally-synchronized-trade apologists in the media and the closing or liquidation of sector mutual funds, ETFs, hedge fund and private equity vehicles tied to the globally-synchronized trade. This is historically what occurs near the bottom as capacity contracts severely. So far, nobody has even been criticized yet, let alone vilified. Wait for the time when few are mentioning the new 400-million middle class citizens and when the word "damn" gets put in front of the stocks, commodities and asset classes involved. Finally, we believe that you shouldn’t give too much weighting to any mid-December 2014 explanation which doesn't include the psychology of a boom/bust cycle and the long-duration nature of the law of supply and demand.

Warm Regards,

William Smead

The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

© Smead Capital Management

[description] => The "well known fact" with regards to oil over the last decade read like this: because of huge GDP growth in emerging markets like China, there were going to be 400 million new middle class citizens born of uninterrupted prosperity; they were going to want all the autos, consumer goods, $10,000 watches and food that Americans have. [author] => William Smead [legacyinterface_firm_id] => 392 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:20:04 [created_by] => 948 [modified_on] => 2014-12-17 16:23:12 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2167 [hits] => 0 ) [4] => stdClass Object ( [legacyinterface_commentary_id] => 2102 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15341 [apv_conversation_id] => [content_type] => market-commentary [title] => If Corporate America Is Investing in Sustainability, Then Why Aren’t You? [slug] => advisorshares_121714 [fulltext] =>

By: Michael Marinus Young, AdvisorShares Institutional Consultant

“Thanks, but I don’t believe in that stuff…”

While traveling the country this fall, that was the response we received from some financial advisors after the introduction of an investment that focuses on sustainability. When pressed to explain, the common refrain was “ESG or SRI investments underperform, and I want my clients invested in the best companies”.

Unfortunately, thirty seconds in an elevator or hallway is not enough time to build the case for sustainability. But here on AlphaBaskets, we’re afforded the space and time to better explain why Sustainability should matter to them, and you. And rather than start from scratch, let us lead you to a recent piece from Fast Company: http://www.fastcoexist.com/3036010/why-is-goldman-sachs-advocating-for-sustainability

If “Accenture, Deloitte, Goldman Sachs, Harvard Business School, McKinsey & Company, and PricewaterhouseCoopers have released data-driven case studies, global surveys, and exhaustive reports offering compelling proof that using business as a force for good is also good for business”, then how could a financial professional ignore the facts and say “thanks, but I don’t believe in that stuff”? Willful ignorance or a deep-seeded bias? Maybe. Whatever the reason, this cognitive dissonance is present when the facts conflict with preconceived notions.

SRI (Socially Responsible Investing) may have evolved into ESG (Environmental, Social and Governance), but ESG is still a three-letter acronym that some will dismiss as a niche. A three-letter acronym doesn’t describe the future of investing - it just reinforces the negative reaction from the uninitiated or under-educated. This is a movement in the investing world that isn’t going away. Corporate Sustainability, Shareholder Advocacy and Activism, Community Investing, Targeted Divesting, and Impact investing are all parts of the broader message that is gaining the attention of both corporations and investors. If a self-described financial professional does not see that, they’ll be left on the sideline as the industry around them continues to innovate and evolve.

Here’s the funny thing… If a financial advisor asked us to convince them, we wouldn’t even start with all the facts. We would begin with the following logic: Your clients are paying attention to this, learning about this, and looking for guidance. Many of your clients have children, and those children are paying attention to this new shift in investing. Those children are the people that will inherit the accounts you manage, so if you aren’t connecting with them… You won’t be their financial advisors. Beyond potential underperformance, you are risking losing accounts because “you don’t believe in that stuff”.

The question should not be whether you believe in “that stuff”, but rather: “I wonder if there’s an ETF for that?”

© AdvisorShares

[description] => Unfortunately, thirty seconds in an elevator or hallway is not enough time to build the case for sustainability. But here on AlphaBaskets, we’re afforded the space and time to better explain why Sustainability should matter to them, and you. [author] => Michael Marinus Young [legacyinterface_firm_id] => 14 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:26:06 [created_by] => 948 [modified_on] => 2014-12-17 16:26:27 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2168 [hits] => 0 ) [5] => stdClass Object ( [legacyinterface_commentary_id] => 2103 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15342 [apv_conversation_id] => [content_type] => market-commentary [title] => Plunging Oil Prices Spark Fears of Global Recession [slug] => halbert_121714 [fulltext] =>

IN THIS ISSUE:

1.  Could Plunging Oil Prices Portend Something Worse?

2.  Worst Week For Dow Jones Stocks Since 2011

3.  Americans Finally Turning Bullish on the Economy

4.  National Debt Topped $18 Trillion in Late November

Overview

Today, we touch on several bases. No doubt everyone reading this noticed that stocks tanked last week, and now seem to be moving in lockstep with oil prices. While consumers welcome cheaper gas and heating oil prices, there is a growing fear that the collapse in oil prices may be a harbinger of a global recession.

Despite worries that the oil price plunge is pulling down stock prices, the latest Reuters/University of Michigan Consumer Sentiment Index soared to a near eight-year high this month. Expectations for a better job market helped power the Index from 88.8 in November to 93.8 this month, well above expectations.

Finally, I am sad to report that our national debt topped $18 trillion on November 28 according to the Treasury Department. It was not widely reported by the mainstream media, of course. While our annual budget deficits have come down significantly from the first four years of the Obama administration, we are still on-track to hit a whopping $20+ trillion national debt by 2019.

Could Plunging Oil Prices Portend Something Worse?

Cratering crude oil prices may be a blessing to cash-strapped American consumers, but it’s a double-edged sword when it comes to the overall economy. The problem for the overall economy is not so much the drop in oil prices as it is the velocity at which oil prices have fallen.

The plunge from a peak of just over $107 (West Texas Intermediate) per barrel in the early summer to today’s sub- $56 is a massive drop of apprx. 45% in just a few short months, most of which has come in the last few weeks. This has analysts worrying that something worse may well be going on.

The rapid fall in crude prices is a telling sign to some Wall Street analysts and economists that there may be a global recession taking hold and the slowing growth is pushing oil lower. Remember, at the height of the financial crisis, crude got down into the high $30s a barrel at the end of 2008 as the US and Europe went into a recession.

Some forecasters believe that energy pricing forces have gone well beyond the supply/demand models and are now considering other geopolitical developments. As I wrote last week, I know of no forecasters that predicted oil prices would fall this far this fast.

There are plenty of commodity fund operators and hedge fund managers holding high-yield energy bonds that are taking it on the chin. Plus, several of the largest banks came out last week saying that while business in general was good, trading revenue will be down from last quarter – presumably due to losses in energy positions.

The banks did not attribute it to oil’s slide but, given the collapse in crude prices, it should be safe to assume that their profits from rising bond prices of late were dampened by plummeting oil prices in their commodity holdings and cratering high-yield energy plays, which may default at some point.

Crude Oil WTI

The swift collapse in energy prices has certainly taken a toll on our fastest-growing US industry and our country’s #1 job producer since the recession – domestic drilling for oil and natural gas. As the price of WTI crude is now below $55 a barrel, domestic drillers in Pennsylvania and the upper Midwest may be hard-pressed to keep production going full throttle.

At stake are nearly two million well-paying jobs. According to the most recent Bureau of Labor Statistics figures, the average worker in the oil and natural gas industry was making $107,198. That’s almost $58,000 higher than the average annual pay across all industries.

Big Oil is definitely feeling the pinch. ConocoPhillips just slashed its 2015 capital-expenditures budget by a whopping 20% to $13.5 billion earlier this month. The more than $3 billion budget cut was significantly larger than analysts were expecting.

In the past, lower oil prices were beneficial to the US economy, and they will be this time as well. Yet there are growing fears that the current collapse in energy prices may be a harbinger of a global recession. This explains why the plunge in oil prices spilled over into the equity markets last week and so far this week.

Worst Week For Dow Jones Stocks Since 2011 

US stocks were pummeled last week as investors, rattled by collapsing oil prices and concerned about the health of the global economy, fueled triple-digit losses in blue-chip stocks. The S&P 500 ended the week with the biggest loss in two-and-a-half years, down over 3.5%, while the Dow Jones Industrial Average recorded its largest weekly decline since September 2011. Both markets were down again yesterday.

Last week’s jarring selloff came on the heels of seven straight weeks of gains and was closely linked to the precipitous fall in oil prices, sending a measure of volatility, the VIX, to its highest level since October 17.

Crude oil futures dropped more than 12% over the past week as global supply continued to outstrip demand, while the International Energy Agency cut its forecast for global demand yet again.  Despite that, OPEC voted earlier this month not to cut daily oil production despite its own forecast that global demand for its oil is now the lowest since 2003.

You would think that those facts alone would sufficiently explain the sudden plunge in oil prices. Yet investors are growing increasingly concerned that the global economy might be succumbing to deflation, a consistent decline in prices that usually leads to recessions and depressions.

Plunging crude prices

Stocks plunged from mid-September through mid-October before staging a sharp rebound that culminated with the Dow hitting a new all-time high earlier this month on the back of a strong US jobs report. Heading into last week, many investors were predicting that the Dow would soon top 18,000 for the first time.

But the sharp sell-off in oil has changed all that. Crude prices are now below $55 a barrel, their lowest level in more than five years. Energy stocks have been hit hard as a result.  However, oil stocks were not the only big losers last week – and that could be another sign that investors are growing more nervous about the overall market and a weakening global economy.

It will be interesting to see how much longer this trend can last. If oil prices continue to drop and the economies of Europe, Asia and Latin America weaken further, that eventually has to hurt the US economy at some point.  

Americans Finally Turning Bullish on the Economy

While it remains to be seen how the oil price plunge plays out, lower gasoline and heating oil prices are boosting consumer sentiment. Pessimism and doubt have dominated how Americans see the economy for many years. Now, in a hopeful sign for the economic outlook, confidence is suddenly picking up.

Expectations for a better job market helped power the Thomson Reuters/University of Michigan Consumer Sentiment Index to a near eight-year high in December, according to data released on Friday. The Index jumped from 88.8 in November to a higher than expected 93.8 this month.

Consumer Sentiment Index

US consumers also saw sharp drops in gasoline prices as a shot in the arm, and the survey added heft to strong November retail sales data (+0.7%) that has showed Americans getting into the holiday shopping season with gusto. Surging expectations signal very strong consumption over the next few months.

While improvements in sentiment haven’t always translated into similar spending growth, consumers at the very least are feeling the warmth of several months of robust hiring, including 321,000 new jobs created in November.

When asked in the survey about recent economic developments, more consumers volunteered good news versus bad news than in any month since 1984, said the poll’s director, Richard Curtin. Moreover, half of all consumers expected the economy to avoid a recession over the next five years, the most favorable reading in a decade, Curtin said.

The data bolsters the view that the US economy is turning a corner and that worker wages could begin to rise more quickly, laying the groundwork for the Federal Reserve to begin hiking its benchmark interest rate next year.

Many investors polled see the Fed raising rates in mid-2015, and the FOMC will likely debate at its meeting today and tomorrow whether to keep a pledge that borrowing costs will stay at rock bottom for a“considerable time.”

Consumers polled also see higher inflation ahead. Over the next year, they expect a 2.9% increase in prices, up from a 2.8% annual rate in November, according to the sentiment survey. Their expectations run quite counter to recent price data. The Labor Department reported that its producer price index dropped 0.2% last month, brought about by falling gasoline prices. Prices overall were soft last month, even excluding the drag from gasoline.

National Debt Topped $18 Trillion in Late November

On November 28, the Treasury Department reported that the national debt stood at $18,005,549,328,561. It was the first time ever that our debt was above $18 trillion. That exceeds total Gross Domestic Product of$17.555 trillion as of the end of the 3Q. So our national debt was 103% of GDP as of the last Friday in November.

The debt was at $10.6 trillion when President Obama took office in 2009 but has increased by 70% – or$7.3 trillion – during his roughly six years in office. That compares to roughly $4 trillion that was added to the national debt during all eight years of the George W. Bush presidency. Obama is on-track to double the amount Bush added to the debt.

When campaigning for the White House in 2008, then-candidate Obama routinely criticized President Bush for running up the national debt by $4 trillion, calling it unpatriotic” and “irresponsible.” By his own reasoning then, he has reached a new level of irresponsibility.

Even worse, Obama promised at least four times in 2009 that he would cut the deficit in half by the end of his first term. Despite these promises, he racked-up deficits larger than all previous presidents combined and ran four consecutive $1+ trillion deficits:

FY2009  $1.413 trillion FY2011  $1.299 trillion
FY2010  $1.294 trillion FY2012  $1.090 trillion

The new $18 trillion national debt figure reached on the Friday after Thanksgiving drew little attention in the media largely because the federal deficit – the amount the US government spends annually in excess of revenue – has dropped in recent years from roughly $1.4 trillion in FY2009 to $506 billion in FY2014, according to the Congressional Budget Office. 

The CBO expects the budget deficit to fall further to $469 billion in FY2015, but then it projects the annual deficits to begin rising again and approach $1 trillion by 2022 and beyond. Even with these lower annual deficits, the CBO projects that our national debt will top $20 trillion in FY2019.

Interest expense on the national debt is what usually sinks heavily indebted countries. The near-zero interest rate environment we have today masks the problem. When we return to normal interest rates, say 6%, the interest on the national debt will jump to apprx. 25% of tax receipts. We have recently seen what happens to countries with debt problems similar to ours. Spain, Portugal, Greece, and Argentina have all been brought to their knees by excessive debt.

For all these reasons, fiscal conservatives argue that the unprecedented national debt is still a huge problem. Count me among them! Kevin Broughton, spokesman for the Tea Party Patriots, calculates that the debt, when divided equally among the US population, means that “every man, woman and child in the country owes $56,250.” 

To see US national debt in live time click here.

Composition of the National Debt

Of the $18.005 trillion in debt at the end of November, $12.923 trillion is “debt held by the public” and$5.082 trillion is “intra-governmental holdings.” Debt held by the public consists of all the outstanding Treasury bills, notes and bonds held by individuals, corporations, foreign governments and others.

Intra-governmental debt of $5.08 trillion includes special securities held by US government trust funds and special funds – or basically IOUs from the federal government for money that it “borrowed” from Social Security, Medicare and other trust funds.

U.S. National Debt

[Note that the chart above from the Heritage Foundation was created last month,
before the national debt topped $18 trillion.]

As noted above, our national debt of $18.005 trillion equals 103% of GDP, if we include both the debt held by the public and the intra-governmental debt. Many analysts, however, only consider the debt held by the public as our national debt. They figure that the intra-governmental debt is money the government owes to itself. That is very misleading!

Intra-governmental debt consists of the debts that the federal government owes to itself through more than 100 government trust funds (Social Security, Medicare, etc.), revolving accounts, and other special accounts.

All of the Treasury securities held by the various government trust funds and other accounts mature at some point and must be repurchased, just like the debt held by the public. Thus, no matter how one treats intra-governmental debt, it must be repaid and should be included in any illustration of our national debt.

So when you read that the Congressional Budget Office estimates our “debt to GDP ratio” is only 74%, you will know that the true ratio is 103% if we add intra-governmental debt – as we certainly should!

Warmest holiday wishes,

Gary D. Halbert

Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

© Halbert Wealth Management

[description] => Today, we touch on several bases. No doubt everyone reading this noticed that stocks tanked last week, and now seem to be moving in lockstep with oil prices. While consumers welcome cheaper gas and heating oil prices, there is a growing fear that the collapse in oil prices may be a harbinger of a global recession. [author] => Gary Halbert [legacyinterface_firm_id] => 191 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:28:13 [created_by] => 948 [modified_on] => 2014-12-17 16:28:36 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2169 [hits] => 0 ) [6] => stdClass Object ( [legacyinterface_commentary_id] => 2104 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15343 [apv_conversation_id] => [content_type] => market-commentary [title] => The Median Stock Is Once Again Negative YTD [slug] => gavekal_121714 [fulltext] =>

The median year-to-date performance in the MSCI World Index with two weeks of trading left is -1%. The median stock was up 20% at this point last year and was up 13% at this point in 2012.

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The developed country with the worst median performance YTD is MSCI Portugal. The median stock is down 35%. The developed country with the best median performance YTD is MSCI New Zealand. The median stock in MSCI New Zealand is up 14% in USD terms.

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The major country indices in Europe are all unsurprisingly negative year-to-date. The median stock in MSCI Germany is down 10%, in MSCI France is down 10%, in MSCI Italy is down 12% and in MSCI Spain is 8%

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The median performance year-to-date in the MSCI USA is 9%. The only other developed country indices with positive median performance YTD are MSCI Hong Kong (6%) and MSCI Ireland (6%).

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© GaveKal Capital

[description] => The median year-to-date performance in the MSCI World Index with two weeks of trading left is -1%. The median stock was up 20% at this point last year and was up 13% at this point in 2012. [author] => Team [legacyinterface_firm_id] => 173 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:30:13 [created_by] => 948 [modified_on] => 2014-12-17 16:30:29 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2170 [hits] => 0 ) [7] => stdClass Object ( [legacyinterface_commentary_id] => 2105 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15344 [apv_conversation_id] => [content_type] => market-commentary [title] => Are Bonds Really Less Risky than Equities? [slug] => bernstein_121714 [fulltext] =>

It’s practically an investing axiom that government bonds are much less volatile than equities. But that depends on how you look at it. In fact, our research suggests that income streams from stocks are actually much less volatile than those of government bonds.

This counterintuitive point raises interesting observations for investors. Namely, the less sensitive you are to price volatility, the more attractive the yield from equities may become.

Over the long term, global equities have had an annualized volatility of nearly 17% versus about 8% for government bonds.1 This analysis is based on a century of data from 1900 to 2000 from the London Business School. By this measure, equities have clearly been riskier than bonds.

However, the picture looks very different looking at real returns, i.e., adjusted for inflation—especially if you decompose the total real return of equities into two components: the contribution from capital appreciation and the contribution from dividend yields. This analysis shows that share prices (capital appreciation) have been quite volatile over 10-year holding periods (Display). Dividend yields, though they have fallen somewhat over time, have been much more stable.

 

Comparing the real return of bonds over the same period with the dividend yield from equities also paints an interesting picture (Display). Bonds did very well in the 1980s and 1990s (and, for that matter, also over the most recent decade) as interest and inflation rates fell. However, bonds struggled during decades in which inflation and interest rates rose. In contrast, the real return from dividends was positive every decade. In other words, seen through the lens of producing an income stream to meet an investor’s purchasing needs, equities don’t look quite so risky after all.

Why might these observations matter? Most investors have assets because they have liabilities. Liabilities often take the form of a series of inflation-linked payments that need to be made over several years. So owning real income streams that meet those expected payments is the essence of asset-liability matching, in our view. And for investors without explicit liability matching needs, generating stable streams of real income is becoming increasingly important in a world of volatility. Yet the common perception that equities are more volatile than bonds often creates a barrier for investors to consider stocks as a reliable source of income. 

In a recent blog, our colleagues pointed out that an equity income approach is probably more appropriate for investors with long-term goals. While the shares are likely to appreciate over time, stock price volatility means the value of the initial investment will fluctuate (see upper display). But of course, an investor doesn’t necessarily have to choose to be exposed to either equity or bond income.

In fact, there are good reasons to have a bit of both, in our view. Income streams between equities and bonds are not perfectly correlated. For example, we measured that the percentage yield from the Barclays Global Treasuries Index has had a negative correlation of –0.6 with the percentage yield from the MSCI World Equity Index since 2001. So by combining income streams from a range of asset classes, we think investors should be able to generate more consistent income and, importantly, income growth.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.AllianceBernstein Limited is authorized and regulated by the Financial Conduct Authority in the United Kingdom.

Patrick Rudden is co-manager, Dynamic Diversified Portfolio at AllianceBernstein (NYSE:AB).


[1] Source: Dimson, Marsh and Staunton, Triumph of the Optimists: 101 Years of Global Investment Returns

© AllianceBernstein

[description] => It’s practically an investing axiom that government bonds are much less volatile than equities. But that depends on how you look at it. In fact, our research suggests that income streams from stocks are actually much less volatile than those of government bonds. [author] => Patrick Rudden [legacyinterface_firm_id] => 20 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:33:00 [created_by] => 948 [modified_on] => 2014-12-17 16:33:13 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2171 [hits] => 0 ) [8] => stdClass Object ( [legacyinterface_commentary_id] => 2089 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15328 [apv_conversation_id] => [content_type] => market-commentary [title] => Allocating to Alternative Investment Strategies [slug] => forward_121614 [fulltext] =>

Following the market declines in 2008 and 2009, many investors have shown interest in alternative investment strategies such as hedge funds and mutual funds that employ hedge fund-like strategies. These types of strategies have been around a long time, but until recently their use among individual investors has been somewhat limited. So, investors and their advisors have had to tackle a series of new challenges, such as trying to identify good managers or determining what is a reasonable allocation to alternatives. Some investors have been disappointed by the performance of alternative investment strategies. Part of their disappointment can be attributed to the fact that stocks have been in a very persistent bull market with very low volatility, which is a challenge for any strategy that utilizes a hedging activity. However, I believe the problem may be that most investors have struggled with understanding how to allocate to alternative investment strategies and that poor allocation decisions have led to less-than-optimal portfolio results.

I think that many investors have elected to view alternative investment strategies as a separate asset class from stocks and bonds and have cut out a portion of their portfolio to allocate to one or more strategies. In reality, hedge funds and their mutual fund brethren are in fact stock and bond investments that are executed differently than traditional funds. Therefore, investors should still consider alternative investment strategies to be stock and bonds and allocate to them to enhance their overall allocation strategy. Let’s look at a way that we could use hedge funds to complement a traditional allocation strategy.

Forming an opinion on market conditions
The most important part of determining an allocation is to have an opinion about the market conditions (i.e., bull or bear market). There are dozens of ways this can be accomplished, but I am partial to using something akin to the Sharpe ratio to determine market conditions in which I use 100 day percentage change and its standard deviation to normalize average return per unit of risk. I calculate this for each month-end; any reading above zero is a bull market and any reading below zero is a bear market for the coming month. Here are the results of applying a monthly market condition analysis to the MSCI ACWI:

Market Performance Using a Monthly Market Condition Analysis

 

Total Return

Standard Deviation

Max Monthly Gain

Max Monthly Loss

Bull

7.53%

12.96%

9.52%

-14.15%

Bear

-2.08%

20.03%

11.48%

-19.91%

MSCI ACWI

4.52%

15.50%

11.48%

-19.91%

Source: Bloomberg, 12/31/89 – 09/30/14.
This hypothetical example is for illustrative purposes only and does not represent the returns of any particular investment. Past performance does not guarantee future results.

As you can see, this method has definitely been able to separate good markets from bad markets and is a way that an investor can determine how to adjust allocations based on market conditions. Let’s now take this market condition analysis and apply it to hedge funds. Below is an analysis that takes the market condition of the MSCI ACWI as discussed above and examines the performance of the HFRI hedge fund indices in the month following each market condition. The results are summarized below:


As shown in the table, during bull markets for stocks, equity hedged and event driven strategies perform the best. During bear markets, macro and relative value strategies tend to perform best. This makes sense since relative value strategies tend to use bonds, and managed futures strategies are in the macro category. So, an investor can use this knowledge to guide their allocations based on market conditions.

In Part 2, I will show how an investor can actually execute on this idea.

In part 1 of this series, I introduced a simple way to identify when we are in a bull or bear market. I then took this method and examined how certain types of hedge funds have performed in each of these market conditions. This week, I am going to use this information to propose a simple allocation strategy that an investor could employ in order to determine which alternative strategies (or alternatives) should be used and where to deploy them in the portfolio. First, let’s look at how most investors use alternatives today.

Most common use of alternative investments
Many investors and their advisors have approached allocating to alternatives as if they were a new asset class. In other words, the allocations to asset classes include stocks, bonds, cash and alternatives. One such allocation might proportionately decrease allocations to stocks and bonds in order to include a broad mix of different types of alternatives. For example, an investor with 60% stocks and 40% bonds might move to a mix of 48% stocks, 32% bonds and 20% alternatives (see chart below). For reference, I also included the use of fund of funds since they represent a professionally managed mix of alternatives.

 

 

Total Return

Vol.

Max Monthly Return

Min Monthly Return

Sharpe Ratio

Opportunity Cost

60% Stocks/40% Bonds

6.99%

10.19%

7.50%

-13.30%

0.38

0.00%

48% Stocks/32% Bonds/20% Alts*

7.90%

9.00%

6.90%

-11.90%

0.53

-3.21%

48% Stocks/32% Bonds/20% Alts**

7.09%

8.84%

6.60%

-11.90%

0.45

-4.05%

Sources: Bloomberg and HFRI, 12/31/89-9/30/14
*The alternatives portion is allocated equally to the following HFRI indices: Equity Hedged, Relative Value, Macro and Event Driven.
**The alternatives portion is allocated to the HFRI Fund of Funds Composite Index.
This hypothetical example is for illustrative purposes only and does not represent the returns of any particular investment. Past performance does not guarantee future results.

As the analysis illustrates, using alternatives as a separate asset class is a pretty good method, although it appears that it is better to just choose a broad basket of equally weighted strategies rather than using a fund of fund strategy. However, in both cases the return was more desirable than the fixed 60% stock/40% bond strategy, and the volatility and capital drawdown were better.

The issue of allocating to alternatives in this way isn’t really the long-term characteristics of this approach, but rather the “opportunity cost” of using alternatives. To analyze this cost I calculated the annualized return of those months where using alternatives underperformed the simple 60/40 mix. On average the equally weighted mix of alternatives missed by 0.27% roughly 47% of the time. So, as an investor, you have to ask yourself if that opportunity cost is worth the additional 0.81% of annualized return. Some investors might just shrug at the benefits of including alternatives, especially when you consider the extra time needed to research, monitor and manage alternatives. This is why I think there is a better approach to managing your alternative allocations.

A dynamic approach to allocating alternative investment strategies
As I discussed last week, I think that investors would benefit from thinking about alternatives not as a separate asset class but as an extension of stocks and bonds. In fact, most alternatives use stocks and bonds but also include various hedging techniques. With that in mind, I looked at allocating to more equity-oriented strategies (HFRI Equity Hedged Index and HFRI Event Driven Index) when the market conditions indicator is bullish, and to more defensive strategies (HFRI Macro Index and HFRI Relative Value Index) when the market conditions indicator is bearish, taking from bonds in a bull market and stocks in a bear market. Specifically, my mix in a bull market is 40% stocks, 20% bonds, 10% equity hedged and 10% event driven. In a bear market, my mix is 20% stocks, 40% bonds, 10% relative value and 10% macro. This is referred to as the dynamically weighted allocation in the chart below.

 

 

 

 

Total Return

Vol.

Max Monthly Return

Min Monthly Return

Sharpe Ratio

Opportunity Cost

60% Stocks/40% Bonds

6.99%

10.19%

7.50%

-13.30%

0.38

0.00%

48% Stocks/32% Bonds/20% Alts*

7.90%

9.00%

6.90%

-11.90%

0.53

-3.21%

48% Stocks/32% Bonds/20% Alts**

7.09%

8.84%

6.60%

-11.90%

0.45

-4.05%

Dynamically Weighted Allocation

8.86%

9.36%

7.90%

-10.00%

0.61

-3.95%

Sources: Bloomberg and HFRI, 12/31/89-9/30/14
*The alternatives portion is allocated equally to the following HFRI indices: Equity Hedged, Relative Value, Macro and Event Driven.
**The alternatives portion is allocated to the HFRI Fund of Funds Composite Index.
This hypothetical example is for illustrative purposes only and does not represent the returns of any particular investment. Past performance does not guarantee future results.

 

As you can see, the dynamically weighted allocation approach delivers the best results pretty much across the board: highest return, lowest capital drawdown and highest Sharpe Ratio. Additionally, the opportunity cost is fairly comparable (although higher) to the fixed allocation method with an average monthly miss of 0.33%, but less frequent at 41% of the time. This is actually 16 fewer months of underperformance compared to the fixed allocation method. In this case, an investor would realize an increased annual return of 1.87%, which is probably worth the headache of the extra time and effort needed to manage the managers and allocations of the alternative strategies. This method is, of course, not a silver bullet. I would suspect that with some additional effort in refining the market signal and expanding the list to include the substrategies in the HFRI universe, an investor could probably improve returns, volatility and even the opportunity cost. However, I think this is a great starting point in developing your own approach to allocating to alternatives and I hope you find it useful.

 

RISKS

Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

Alternative strategies typically are subject to increased risk and loss of principal. Consequently, investments such as mutual funds which focus on alternative strategies are not suitable for all investors.

Asset allocation does not assure profit or protect against risk.

Nathan J. Rowader is a registered representative of ALPS Distributors, Inc.

One cannot invest directly in an index

Sharpe ratio is a ratio developed by Nobel laureate William F. Sharpe to measure how a fund performs relative to the risk it takes.

MSCI ACWI (All Country World Index) is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global developed and emerging markets. One cannot invest directly in an index.

HFRI Equity Hedge Index maintains positions both long and short in primarily equity and equity derivative securities.

 

HFRI Event-Driven Index maintains positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments.

 

HFRI Fund of Funds Composite Index is an equal-weighted index comprised of fund of funds. The index includes over 600 constituents, both domestic and offshore funds.

 

HFRI Macro Index maintains positions in a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets.

HFRI Relative Value Index

© Forward Investing

[description] => Following the market declines in 2008 and 2009, many investors have shown interest in alternative investment strategies such as hedge funds and mutual funds that employ hedge fund-like strategies. These types of strategies have been around a long time, but until recently their use among individual investors has been somewhat limited. [author] => Nathan Rowader [legacyinterface_firm_id] => 160 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 14:44:20 [created_by] => 948 [modified_on] => 2014-12-16 15:05:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2155 [hits] => 0 ) [9] => stdClass Object ( [legacyinterface_commentary_id] => 2090 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15329 [apv_conversation_id] => [content_type] => market-commentary [title] => ​​Strategy Spotlight: An Update on PIMCO’S Fundamental Index-Based Product Suite [slug] => pimco_121614 [fulltext] =>

The Fundamental IndexPLUS AR strategies combine the best of what passive indexing and active management aim to deliver: broadly representative, transparent equity exposure plus the potential for meaningful equity market outperformance. 

One of the reasons many investors find Fundamental IndexPLUS AR so compelling is that it delivers two independent sources of potential equity market outperformance – the return of the absolute return bond alpha strategy above that of the money market cost, plus the returns of the Enhanced RAFI equity strategy over a market-capitalization-weighted equity index. 

PIMCO manages the absolute return bond strategy, which adds a complementary source of alpha and diversification potential to the Fundamental IndexPLUS AR strategies, and has almost 30 years of experience in adding bond market alpha onto stock market returns. 

Research Affiliates is responsible for the equity strategy, which builds on their groundbreaking work on Fundamental Indexation by adding additional enhancements and active insights. 

September 30th marked the third anniversary of the launch of PIMCO’s innovative International Fundamental IndexPLUS AR and Small Company Fundamental IndexPLUS AR strategies. Designed to deliver two sources of excess return potential to investors in addition to the return of the equity market, the strategies are extensions of the U.S.-based Fundamental IndexPLUS AR strategy launched in 2005. They are also part of PIMCO’s broader suite of Fundamental Index StocksPLUS strategies, which also include emerging market equity, global equity and equity market neutral strategies.

In this Q&A, Rob Arnott, Founder and Chairman of Research Affiliates, and Sabrina Callin, PIMCO managing director and product manager, discuss this innovative Fundamental Index-based equity approach, and how these unique equity strategies combine the strengths of PIMCO and Research Affiliates to provide a powerful path forward for equity investors.

Q: How does the collaboration between Research Affiliates and PIMCO contribute to the success of the Fundamental Index StocksPLUS suite of strategies? 
Arnott: PIMCO was one of the very first affiliates to launch products based on the Fundamental Index concept – well before “Smart Beta” was all the rage. When we launched the Fundamental IndexPLUS AR strategy in June 2005, we envisioned a suite of products that would draw on the collective strengths of PIMCO and Research Affiliates, including both firms’ insights, process and people. We believed then and we believe now that this combination will deliver materially superior results to our investors.

Our team at Research Affiliates manages the Enhanced RAFI (Research Affiliates Fundamental Index) equity strategy, which is offered exclusively in partnership with PIMCO. Our research suggests that a process that selects and weights stocks based on underlying company economic fundamentals instead of market capitalization produces powerful results in historical testing, well above cap-weighted benchmarks, all over the world, including U.S. large cap, small company, international, global and emerging market equities.

PIMCO’s team manages the absolute return bond strategy, which adds a complementary source of alpha and diversification potential to the Fundamental IndexPLUS AR strategies. PIMCO has almost 30 years of experience in adding bond market alpha onto stock market returns. If PIMCO can beat the money market rate – which drives the pricing of the equity-linked instruments used to gain access to the Enhanced RAFI portfolios – then there are multiple complementary and uncorrelated alphas.

Q: Can you provide more detail on the advantages of Enhanced RAFI and how it is managed? 
Arnott: Research Affiliates is responsible for the excess returns of Enhanced RAFI relative to the corresponding cap-weighted equity index benchmark. The largest excess return driver is the rebalancing aspect to the strategy. Companies whose prices appreciate more than the fundamental scope of the business (as measured by sales, cash flow, book value and dividends) get trimmed. Conversely, we boost exposure to securities that fall in price more than business fundamentals. In short, we sell recent winners and buy recent losers.

Our long-term research suggests that this contra-trading, against the market’s most extravagant recent “bets,” is worth roughly 2% in excess returns, across various markets around the world, with low turnover and economically representative exposure. So the people on the opposite side of these contrarian trades – the legions who buy recent winners and sell recent losers – in theory “pay” us 2% excess returns. For example the Enhanced RAFI US Large Index returned 3.51% annualized vs. the S&P 500 during our sample period from 12/31/1962 to 10/31/2014. We all know people who behave this way. They’re the return chasers who have been identified in studies like Russ Kinnel’s “Mind the Gap,” and some of our own work (see “Slugging it out in the Equity Arena,” by John West and Ryan Larson at Research Affiliates).

We believe these excess returns are structural and persistent – not in every quarter or every year, of course, but over the long term. Furthermore, with Enhanced RAFI we add additional screens to the stock selection process. For example, we emphasize companies with high quality earnings and de-emphasize or eliminate companies that show potential signs of distress. We also adjust our stock positions in an effort to achieve better diversification of our active “bets,” with less dramatic bets (over- or underweight) among the large companies and slightly more aggressive bets (again, over- or underweight) among the smaller companies. Finally, we use a rebalancing mechanism that allows momentum to run its course, rather than contra-trading against market momentum too hastily.

Q: What value does PIMCO bring to these unique equity strategies? 
Callin: The PIMCO Enhanced RAFI-based StocksPLUS strategies combine the best of what passive indexing and active management aim to deliver: broadly representative, transparent equity exposure plus the potential for meaningful equity market outperformance. Rather than buying physical stocks, we use equity-linked instruments, which tend to provide approximately the same returns as owning the underlying stocks, to gain Enhanced RAFI exposure in exchange for paying a money-market-based interest rate. The key benefit is that we do not have to pay cash for the equity exposure up front. Because the equity ownership can be obtained at a money-market-based cost, it allows equity investors to potentially use their money more efficiently and to capitalize on their longer-term time horizon to a much greater degree. If the cash was then invested at a money market rate, for example, the total return to the investors would be approximately the same as the return of the equity index. We believe a better approach is to invest that cash in a high quality, absolute return bond alpha strategy – the “PLUS” component – which is designed to outperform the money-market-based financing rate, thereby delivering returns above those provided by the equity strategy.

Basically, if you believe PIMCO can outperform a money market rate, then that translates into a belief that the PIMCO active management component should deliver additional value to equity investors.

One of the reasons many investors find Fundamental Index StocksPLUS strategies so compelling is that they deliver two independent sources of potential equity market outperformance for every unit of capital invested in the strategy – the return of the absolute return bond alpha strategy above that of the money market cost, plus the returns of the Enhanced RAFI equity strategy over a market-capitalization-weighted equity index. In addition, each potential source of return is likely to have a relatively low correlation with one another, offering potentially meaningful diversification benefits.

Q: Can you discuss the backgrounds of the portfolio management team? 
Callin: The highly qualified management team has more than 100 years of collective investment experience across all major global asset classes. In addition to Rob and his expert team at Research Affiliates, the PIMCO portfolio management team includes managing directors Saumil Parikh, Mohsen Fahmi and Sudi Mariappa. By extension, Mohit Mittal and Dan Ivascyn, PIMCO’s Group Chief Investment Officer, who are members of the broader Unconstrained Bond portfolio management team, are also active contributors. Importantly, while each portfolio management team member individually contributes significant expertise and unique perspectives, they also draw on the collective depth and breadth of the entire PIMCO team in managing the absolute return bond alpha strategy component of these strategies, and specifically on our equity trading specialists in maintaining the Enhanced RAFI exposure using index-linked instruments.

The team approach has long served as a hallmark of the PIMCO investment process. And it is with this framework, team and process that we look forward to continuing to pursue attractive returns for equity investors in the year ahead.

Q: Many investors don’t associate PIMCO with equities, yet PIMCO won the Lipper Equity Manager of the Year award in 2010, 2011, 2012 and 2013 in the U.S. Is this an anomaly? 
Callin: I believe it is unprecedented for one company to win the Lipper Equity Manager of the Year award four times in a row, but remember, unlike many other equity strategies, our approach captures two independent sources of structurally based value add for investors, building on the long-established team approach that combines the strengths and insights of both Research Affiliates and PIMCO. Taken together, we believe these teams and strategies are poised to deliver very attractive results to equity investors prospectively. And now, perhaps more than ever, equity strategies that deliver meaningful excess returns – in addition to the return of the equity market – may be key to allowing investors to meet their return targets going forward. ​

Past performance is not a guarantee or a reliable indicator of future results. In managing the strategy’s investments in Fixed Income Instruments, PIMCO utilizes an absolute return approach; the absolute return approach does not apply to the equity index replicating component of the strategy. 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. 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. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their 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. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Swaps are a type of derivative; swaps are increasingly subject to central clearing and exchange-trading. Swaps that are not centrally cleared and exchange-traded may be less liquid than exchange-traded instruments. 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. Diversification does not ensure against loss.

The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility. 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 long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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[description] => The Fundamental IndexPLUS AR strategies combine the best of what passive indexing and active management aim to deliver: broadly representative, transparent equity exposure plus the potential for meaningful equity market outperformance. [author] => Sabrina Callin, Robert Arnott [legacyinterface_firm_id] => 335 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 14:47:19 [created_by] => 948 [modified_on] => 2014-12-16 14:47:32 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2156 [hits] => 0 ) [10] => stdClass Object ( [legacyinterface_commentary_id] => 2091 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15330 [apv_conversation_id] => [content_type] => market-commentary [title] => Busting the Myth About Size [slug] => research_121614 [fulltext] =>

Many market participants (including investors, product providers, and analysts alike) assume that, just as value stocks on average outperform growth, small-cap stocks on average outperform large-caps. Unlike value, however, and contrary to popular opinion, there is little solid evidence that stock size affects performance.

 

A recent Research Affiliates article by Hsu and Kalesnik (2014) concluded that there are at best three factors from which investors can benefit through passive investing: market, value, and low beta. The size premium was conspicuously missing from that short list. In this article we explore empirical evidence behind the size premium in more detail. The summary below offers a preview of our findings. We let the reader examine the evidence and draw his or her own conclusion. In our opinion the preponderance of evidence does not support the existence of a size premium.

 

 

We are not arguing that investors should stop investing in small stocks. A portfolio of small stocks offers a certain level of diversification in an investment program dominated by large-stock strategies. Moreover, major anomalies are stronger in the universe of small stocks (likely because small stocks are more prone to mispricing). Thus, small stocks have the potential to serve as an alpha pool for skilled active managers and rules-based strategies that primarily target factors other than size. Nonetheless, we are skeptical that investors will earn a higher return simply by preferring small stocks over large.

 

Updating the Evidence
Banz (1981) reported that small-cap stocks outperformed large-cap stocks. For the subsequent decade the phenomenon Banz observed was considered a curious anomaly. The situation changed in 1993, when Eugene Fama and Kenneth French suggested that small stocks may expose investors to some undiversifiable risk that warrants a higher required rate of return. At that moment, the size factor took its place alongside the market and value factors in the original Fama–French three-factor model. Carhart (1997) then made the case for momentum as a fourth return factor. Today the most standard equity pricing model used in academia includes four factors: market, value, size, and momentum.

But consider this: What if a large company were split, on paper only, into two small companies? Suppose there is no change in operations, and imagine that one of the small companies booked all the cash flows on even-numbered days of the month, and the other one accounted for all the cash on odd days. In this scenario, it would be most surprising if the small companies both delivered higher returns than the original large company. Yet the size premium is precisely based on the expectation that small-cap stocks will outperform large-cap stocks!

 

For any reasonable economic theory explaining why small-cap stocks are supposed to outperform large-cap stocks, there is an equally plausible theory explaining why the reverse should be true. The source of the specific risk postulated by Fama and French (1993) was unclear 21 years ago, and it is still murky today. Theoretical explanations for the size premium were provided after researchers observed the anomalous regularity in returns—not the other way around. Today investors believe in the size premium on the basis of empirical evidence, not on theoretical arguments. So let’s turn to the evidence with updated data.

 

Following the methodology employed in Fama and French (2012), we grouped stocks in each country by size into two portfolios. The large stock portfolio consists of the top 90% of the market by market capitalization, and the small stock portfolio consists of the bottom 10% of the market. Stocks within the large and small portfolios are weighted by market capitalization. To measure the premium we looked at the arithmetic difference between the small and large stock portfolio returns. We report in Table 1 the average annualized returns, volatilities, and t-statistics in 18 major developed countries from January 1982 to July 2014. Table 1 also displays data for the United States over the longer period from July 1926 to July 2014.

 

 

In the 88-year U.S. sample, the size premium is 3.4% per annum. Assuming a normal distribution of premium estimates (we will discuss later why this assumption may not be warranted), the size premium is statistically significant with a t-stat of 2.38, which corresponds to a p-value of 1.7%. After 1981, when Banz’s paper appeared, the premium is positive in the United States and positive on average in the international sample, but it is not statistically significant anywhere. The substantial, statistically significant average return observed in the long-term U.S. dataset is the main reason why size is popularly believed to be one of the most important factors.

 

Examining the U.S. Data
Existence of the size premium in the United States is practically an article of faith in the practice of asset management as well as the academic literature. The empirical evidence, however, does not stand up very well to closer scrutiny. The data are doubtful for several reasons, including overestimated small-cap returns due to missing data on delisted stocks; the absence of transaction costs in the calculation of index returns; biases resulting from data-mining and the publishing process; and misestimated statistical measures based on the assumption of normality. In addition, there proves to be no return advantage on a risk-adjusted basis. 

 

Delisting bias. Shareholders do not necessarily lose the full amount of their investment in a company when it is delisted from a major stock exchange. Often the stock can still be traded in the over-the-counter (OTC) market, and the investor may receive some residual value if the company is liquidated. Nonetheless, returns on stocks after they have been delisted are likely to be very negative. Moreover, all companies are subject to business and financial risks that might result in their stock’s falling short of listing requirements, but small stocks by market capitalization are appreciably more likely to be removed from an exchange. Shumway (1997) pointed out that regular performance databases overestimated small-cap stock returns because they did not include returns on delisted stocks. If a database that is used in simulating portfolios omits the strongly negative returns of delisted stocks, the hypothetical results will be better than what actual portfolios can achieve in practice.

 

To estimate the impact of the delisting bias on the size premium, Shumway and Warther (1999) looked at the smallest and the most distressed stocks for which they could obtain reliable data, namely, stocks listed on the NASDAQ exchange. We represent their findings in Figure 1. The chart shows the average monthly returns for 20 groups of stocks sorted by size before and after correcting for the upward bias in the database. Clearly, the smallest stocks are significantly more affected by the delisting bias. After adjusting for the delisting bias, the statistical significance of the size premium completely disappears. It is unreasonable to suppose that the effect Shumway and Warther quantified for NASDAQ stocks is missing from other exchanges.

 

 

Transaction costs. Theoretical simulations ignore an important component of investment performance measurement: trading expenses—the actual costs of buying or selling investments. Small stocks by definition have much lower trading capacity and, correspondingly, much higher transaction costs. Soon after the first articles documenting the size effect appeared, researchers asked how much of the premium remains when trading costs are taken into account. Stoll and Whaley (1983) showed that transaction costs accounted for a significant part of the size premium for stocks listed on the New York Stock Exchange and the American Stock Exchange. 

 

Data-mining and reporting bias. There are literally hundreds of known factors in the existing literature, and many papers documenting new factors are published every year. In our opinion the vast majority of these factors are spurious products of data-mining. We are not alone in taking a skeptical position. Lo and MacKinlay (1990), Black (1993), and MacKinlay (1995), among others, have argued that many factors, notably including size, are likely to be a result of data-mining. And, in finance no less than the physical and biological sciences, striking results—especially new discoveries—tend to win the competition for space in academic journals. 

 

The standard procedure for determining whether a factor is statistically significant is to see if its t-stat crosses a certain threshold. Normally the threshold is set at 1.96 for a 5% confidence level. With a t-stat of 2.38, the U.S. size premium passes this test for the 1926–2014 sample. But Harvey, Liu, and Zhu (2014) rightly observed that if many researchers are looking for statistical irregularities, then the 1.96 criterion is too low; it allows many inherently random outliers to be misidentified as valid factors. They argue that the threshold for the size factor should have been closer to a t-stat of 2.50 in 1993.1  Size does not pass this test.

 

Non-normality of returns. Standard statistical testing assumes that the estimate of a variable—in this case, the average of the size premium—quickly converges to a normal distribution.2  If, however, the underlying data include large outliers, then the assumption of normality is unfounded. The differences between the small and large stock portfolio returns exhibit just such outliers. Figure 2 is a histogram of the return differences. For comparison, we display on the same chart a normal distribution with the same mean and standard deviation.

 

 

We indicate on the chart four extreme outliers of 6 sigma or higher. “Sigma” may be an unfamiliar statistical term, so let us put these outlier returns in perspective. The 23.6% premium registered in January 1934 is a 6-sigma event. If it were drawn from normal distribution, this would be a one-in-67-million-year event, like the one that wiped out the dinosaurs. The 27.2% difference in returns in September 1939 is a 6.9-sigma event; in a normal distribution, it would have about a one-in-five chance of occurring in the 4.5 billion years since the planet earth came into existence. The 33.8% premium in August 1932 is an 8.6-sigma event, and the 51.6% premium in May 1933 is a 13.1-sigma event. If these last two outliers were drawn from a normal distribution, each would have much less than a one-in-a-hundred chance of occurring in the entire 13.8 billion years the universe has existed. 

 

To add to the problem, all four outliers occurred in the 1930s. If they were removed, the estimated size premium in Table 1 would drop from 3.4% to 1.9% and lose statistical significance. (There is a similar outcome in the post-war period: The estimated size premium is about 1.9% premium with a t-stat of 1.52.) We do not argue, however, that truncating or otherwise transforming the sample will give us a better estimate. What happened in the 1930s is very valuable information about the economy and the stock market. The average return from the full sample, including the unadjusted outliers, is the best estimate available as long as the statistical bounds around it are borne in mind. If the size premium is predicated on exceedingly rare events, then we’ll have to wait many lifetimes to determine with confidence whether or not it exists. 

 

No risk-adjusted benefit. Academics are interested in the arithmetic average returns in a simulated long/short portfolio, but practitioners are concerned with the actual risk-adjusted returns that they can generate from their investments—and the majority do not engage in short-selling. We display in Table 2 the average geometrically chained cumulative returns of the long-only portfolios of small and large stocks. These results are produced using the same databases we used earlier in this article, so they contain the same biases that we noted above. 

 

 

Small stocks outperform large stocks in this sample, but, because small stocks are generally more volatile, the Sharpe ratios reveal that small-cap investing provides a miniscule advantage in the risk-adjusted return. If investors are switching from large stocks to small in the hope of a premium, they should realize that they are increasing the volatility, too. The estimates of average returns are very noisy, and are likely overstated due to the biases we described earlier; the estimates of volatility on the other hand are real. (Estimates of the mean are always less certain than estimates of standard deviation.) We suggest that investors seeking higher returns consider boosting their overall equity allocation rather than chasing the illusory size premium in an attempt to add risk on the cheap within the existing allocation. A large-cap stock portfolio would have higher returns than a mix of small-cap stocks and risk-free assets designed to have the same volatility. In other words, the added risk of small-cap stocks is essentially uncompensated. Note that even in the only data set with a statistically significant size premium (i.e., the U.S. full sample from 1926–2014), the Sharpe ratio is actually lower for small stocks.

 

Concluding Remarks
We placed our inquiry in a historical context, starting with Banz’s (1981) paper, because the widespread belief in a size premium is largely a result of its early discovery. Market capitalization data were readily available to early researchers writing doctoral dissertations and journal articles, and, as we have seen, the performance of small stocks was exceptional in the 1930s. Eugene Fama was one of Rolf Banz’s professors at the University of Chicago; in fact, as a member of Banz’s dissertation committee, he was intimately familiar with Banz’s research on the small-cap anomaly.3  Fama and Kenneth French included the size premium in their influential three-factor model, an analytical advance that opened the gate for empirical research into studying factors previously unexplained by then-existing theories. Riding on the popularity of the Fama–French theory, the size premium was soon entrenched in the pantheon of risk factors. 

 

Berk (1997) argued that the size premium observed in the data is nothing more than a poor way of value investing. Value investing relies on buying cheaply priced companies as measured by a ratio of price to company fundamentals. Investing based on size, measured by company market capitalization, would use only the price side of the valuation measure. Because it would therefore use only a fraction of the relevant information, the strategy is significantly weaker than a value strategy that uses prices as they relate to company fundamentals. In our view, Berk’s argument is, to date, the strongest explanation why the size premium is observed. 

 

However, we go one step further. If Berk questioned the size premium as a separate factor, we question the size premium as a phenomenon. Today, more than 30 years after the initial publication of Banz’s paper, the empirical evidence is extremely weak even before adjusting for possible biases. The return premium is not statistically significant in any of the international markets, whether taken alone or in combination. The U.S. long-term size premium is driven by the extreme outliers, which occurred three-quarters of a century ago. These extreme outliers confound the standard techniques of setting confidence bounds around the estimated premium. Finally, adjusting for biases, most notably the delisting bias, makes the size premium vanish. If the size premium were discovered today, rather than in the 1980s, it would be challenging to even publish a paper documenting that small stocks outperform large ones. All this evidence makes us question the existence of the size premium as such.

 

We are not arguing that investors should completely abandon small stocks. Small stocks are more volatile than large stocks, and they receive considerably less attention from sell-side analysts. Consequently, small stocks are more likely to be mispriced. The major anomalies are, in fact, stronger in the small-cap sector. Small stocks are more attractive as an alpha pool to be fished by skillful active managers and exploited by rules-based value and momentum strategies.

 

Endnotes

1. The authors argue further that “a newly discovered factor today should have a t-ratio that exceeds 3.0.” Page 35.

2. This result relies on the central limit theorem, which says that, as the number of random observations increases, the arithmetic average converges to a normal distribution. If the observations include extreme outliers, the convergence can be either extremely slow or may not occur at all.

3. Fox (2009), page 204.

 

References

Banz, Rolf W. 1981. “The Relationship Between Return and Market Value of Common Stocks.” Journal of Financial Economics, vol. 9, no. 1 (March):3-18.

 

Berk, Jonathan B. 1997. “Does Size Really Matter?” Financial Analysts Journal, vol. 53, no. 5 (September/October):12–18.

 

Black, Fischer. 1993. “Beta and Return.” Journal of Portfolio Management, vol. 20, no. 1 (Fall):8–18.

 

Carhart, Mark M. 1997. “On Persistence in Mutual Fund Performance.” Journal of Finance, vol. 52, no. 1 (March):57–82.

 

Fama, Eugene F., and Kenneth R. French . 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, vol. 33, no. 1 (February):3–56.

 

———. 2012. “Size, Value, and Momentum in International Stock Returns.” Journal of Financial Economics, vol. 105, no. 3 (September):457–472.

 

Fox, Justin. 2009. The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street. HarperCollins e-books. 

 

Harvey, Campbell R., Yan Liu, and Heqing Zhu. 2014. “…And the Cross-Section of Expected Returns.” NBER Working Paper No. 20592. Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2513152## OR Available at nber.org/papers/w20592.

 

Hsu, Jason and Vitali Kalesnik. 2014. “Finding Smart Beta in the Factor Zoo.” Research Affiliates (July).

 

Lo, Andrew W., and A. Craig MacKinlay. 1990. “Data-Snooping Biases in Tests of Financial Asset Pricing Models.” Review of Financial Studies, vol. 3, no. 3 (Fall):431–467.

 

MacKinlay, A. Craig. 1995. “Multifactor Models Do Not Explain Deviations from the CAPM.” Journal of Financial Economics, vol. 38, no. 1 (May):3–28.

 

Shumway, Tyler. 1997. “The Delisting Bias in CRSP Data.” Journal of Finance, vol. 52, no. 1 (March):327-340. 

 

Shumway, Tyler, and Vincent A. Warther. 1999. “The Delisting Bias in CRSP’s Nasdaq Data and Its Implications for the Size Effect.” Journal of Finance, vol. 54, no. 6 (December):2361–2379.

 

Stoll, Hans R. and Robert E. Whaley. 1983. “Transaction Costs and the Small Firm Effect.” Journal of Financial Economics, vol. 12, no. 1 (June):57–79.

© Research Affiliates

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A former economic colleague, and mentor, used to say: “In the Bible, it says an ounce of gold will buy a fine suit of clothing.” We have read the Bible, and we haven’t found this, although there could be some high-powered math, using talents, cubits, frankincense and myrrh that make it true.

Nonetheless, the point stands – over long periods of time, relative value remains somewhat constant. Gold is trading at $1,210/oz. today and that’s about the cost of a fine suit. There are suits that cost more, and less, but, well, you get the point.

The reason we bring this up, is that the same “relative price relationship” should hold true for other commodities over time. The gold-oil ratio (using West Texas Intermediate crude prices) has averaged 15.8 over the past 30 years – meaning one ounce of gold would buy 15.8 barrels of oil.

In 2005, the ratio reached a low of 6.7; in 1986, it hit a high of 30.1. From 1990-1999 oil prices averaged $19.70/bbl and gold prices averaged $351/oz – a ratio of 17.8. Today, oil is $57/bbl and gold is $1,210/oz., meaning an ounce of gold will buy 21.2 barrels of oil.

In other words, relative to history, either oil is cheap or gold is expensive. Looking at other commodity price relationships, like silver, shows the same thing. One interesting fact is that in the past 30 years, the CPI is up 126%, while oil is up 116%, showing that, right now, with oil prices down almost $50 from their recent peak, oil has risen about the same as a broad basket of consumer goods.

This doesn’t mean that oil prices can’t fall further. After all, markets do what markets do. What it does mean is that the recent collapse in oil prices is not a sign of broad deflation. It is result of a shift in the “oil supply curve” to the right, due to new technologies in energy – horizontal drilling and hydraulic fracturing. Remember, the supply curve slopes upward from the lower left to the upper right. When a new technology increases supply at any price, like the invention of the tractor did with crops, the entire supply curve shifts. When this happens, output rises and prices fall, unless there is a shift in demand.

These days, two things are happening to keep a lid on demand. First, developing economies, like China and Russia are experiencing slower growth. Second, new technologies – like LED lighting, more efficient computer chips and less waste in office buildings, homes and manufacturing – are reducing energy consumption. For example, an iPad uses $1.36 of electricity every year, while a desktop computer uses $30 of electricity per year.

So, a right-ward shift in the supply curve is occurring at the same time demand is falling short of what was previously expected. In other words, the decline in oil prices is due to macro-economic forces, and those forces are mostly good, not bad. As a result, the drop in oil prices is a good sign, not one that indicates economic problems. The drop in stock prices last week, if it was based on the idea that falling oil prices are a negative thing, is temporary.

More importantly, most relative price indicators suggest the oil price decline has gone too far. Using the current price of gold, a barrel of oil is fairly valued near $77. Alternatively, comparing oil to multiple different prices, including a fine suit of clothing, oil is fairly valued somewhere between $55 and $70/bbl.

Bottom line: stocks and oil have fallen too much. Stocks should rebound soon and, barring a collapse in gold, we look for stability and then rising prices for oil in the years ahead.

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. 

© Fortigent

[description] => A former economic colleague, and mentor, used to say: “In the Bible, it says an ounce of gold will buy a fine suit of clothing.” We have read the Bible, and we haven’t found this, although there could be some high-powered math, using talents, cubits, frankincense and myrrh that make it true. [author] => Brian Wesbury, Robert Stein [legacyinterface_firm_id] => 159 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 14:52:19 [created_by] => 948 [modified_on] => 2014-12-16 14:52:33 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2158 [hits] => 0 ) [12] => stdClass Object ( [legacyinterface_commentary_id] => 2093 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15332 [apv_conversation_id] => [content_type] => market-commentary [title] => An Interest Rate Hike? Check Out Long Bonds, US Dollar Index, Demographics And Money Multiplier. [slug] => sbt_121614 [fulltext] =>
  • Inflation is out of sight in terms of Treasury bond yields, dollar exchange rates and demographic outlook – let’s not even mention energy costs!
  • Much of the FED’s monetary base expansion did not flow into consumption or, more importantly, entrepreneurial productive investments!Money multiplier is more like a fractional now, since not even credit increased the money available for Main Street the way it used to.
  • Why raise interest rates if new dollars did not really filter through to the aggregate money stock readily accessible for spending?
  • The only worry in sight is probably financial assets inflation due to carry trade and Wall Street’s more speculative moves.

Lately, I have my eyes focused on interest rates. This should not be a surprise. October has just put an end to yet another spree of money printing and Central Bank interference on the market.

I have been hearing and reading a lot of comments on some imminent rate hike by the FOMC in the coming year of 2015. Well, when it comes to interest rates, we should break that down instead of taking it all as just one single thing.

The Federal Open Market Committee (FONC) gathers eight times a year to deliberate on the targeted Federal Funds rate (Fed Funds). By trading government securities, the New York Fed affects the federal funds rate. This rate is just a target rate that guides overnight loans. Depository institutions are required to keep a fraction of their deposits as reserve at central banks. Those that have a surplus balance lend it to institutions that are short of their reserve requirements. These routine transactions are very brief loans that involve no collaterals. As the term overnight indicates, they are usually settled in the next day. It is just a way of redistributing reserves between banks. So banks may borrow these Fed Funds to avoid an overdraft on their reserve account. Fed Funds are immediately available as cash for spending, unlike checks that must be cleared before being accessible as money. Though these loans are extremely short-lived, the Fed Fund rate is obviously annualized as reference. When the FOMC raises this target rate, to a certain extent, it discourages banks to move money so freely, and this affects the economy. The weighted average of all Fed Fund transaction rates is calculated as the Fed Fund effective rate.

But for us, interest rates involve a lot more than that. In corporate finance, there are certificates of indebtedness, also called debentures, bonds or notes, which are medium- to long-term debt instruments used by large companies to borrow money at some rate of interest. National debt securities are usually seen as less risky than many private debt instruments. It may be ironic that governments with not so responsible politicians may borrow money cheaper (paying less interest) than more responsibly managed companies, but the reasoning is that countries do not go bankrupt disappearing from the map. And the tradable debt securities that offer the best liquidity are the U.S. Treasuries, not just because of the sheer size of the U.S. economy, but also due to the unrivaled size of the U.S. public debt. These Treasuries are also seen as very low-risk instruments, since they are secured by the full faith and credit of the United States government.

These Treasuries are issued with different maturities and sold in auctions. There are short-term Treasury Bills (with maturities up to 1 year) Treasury Notes (with longer maturities up to 10 years) and finally Treasury Bonds (with maturities greater than 10 years). Just as there are different maturities, there are also different interest rates. Short-term T-Bills normally involve less risk and therefore lower interest rates (yield). On the other hand, longer-term T-Bonds usually pay more interest because more time involves more unforeseeable variables in the economy.

So maybe the FOMC raises the Fed Funds rate a tad. It is currently at 0 to 0.25% annualized. Last month’s effective rate was 0.09%. But if this happens, I would see it more as a bluff or an attempt to probe the markets’ response. I do not see any fundamentals for a progression of rate hikes. And if a move occurs, I do not believe it would be that relevant on the longer end of the yield curve. The market has already been narrowing the spread between short- and long-term interest rates by lowering the long end of the curve. Every time a QE ended, T-Bond demand has increased, suggesting its popularity among investors, institutions and even foreign central banks. Usually, the long end of the yield curve is way higher than the short end. When long-term interest rates get closer to short-term rates, this signals worries. Buyers fear that the economy may face problems ahead, so they are willing to settle for lower interest rates right now.

This is already noticeable since the tapering of QE3 began in January.

 

I believe we will continue to see the flattening of the yield curve, but much more due to the lowering of the long end (20- and 30-year-Bond yields), than actually a rise in the short end of the T-Bills.

Six years after the collapse of Lehman Brothers, we still see a down trend of long-term interest rates. And this is not because of the FED buying long bonds, it is actually in spite of the FED’s asset purchases. During the last three episodes of quantitative easing, interest rates of long bonds have actually gone higher. That is correct! 20- and 30-year Treasuries got less expensive and their yields went up! Not exactly what we expected from the Fedspeak we all heard. Read more about it in this earlier text. But every time the FED withdrew its QE, the market came right back to buying bonds and lowering long-term rates. I do expect we will see more of the same behavior in 2015. This move of institutions, investors and central banks into the long end of the yield curve, buying long bonds and accepting lower yields, suggest confidence in the U.S. Dollar. Any dollar devaluation would imply in more inflation in the U.S. and higher interest rates, devaluing prices of 20- and 30-year Treasury Bonds. So the market seems to believe that the dollar will hold its value and maybe appreciate.

There are two popular sayings that I find very instructive when following the market with all those marketeers out there, the first one is “Put your money where your mouth is!” and the second is “When money talks, bullshit walks!” So, instead of paying too much attention to all the noise, chatter and hubris from a crowd of talking heads, I find it more productive to see what the market is really doing with the money. (I must mention that I am NOT a believer in the Rational Expectations or Efficient Market theories, I just try to pay more attention to what is being done, instead of what is mostly being said)

One way I try to observe and analyze any inflation expectations already implicit in the behavior of investors is comparing interest rates. For that I use the interest rate of long U.S. Treasury Bonds with constant maturity (for all their trustworthiness) and divide them by the interest rates of lower quality debt instruments that are referred to as High Yield or Junk Bonds and do not hold investment grade from rating agencies. For the numerator, I’m using the 20-year Treasury constant maturity rate just because the 30-year bonds were not issued from 2002 to 2006. For the denominator, I adopted an index published by Bank of America Merrill Lynch that tracks corporate debt with a CCC or worse rating (BofA Merrill Lynch US Corporate C Index). These are bonds of lower quality that offer higher yields.

The underlying logic is that when the economy is growing, there are fewer worries about the quality of the debt. A higher tide lifts all boats. More confident, investors buy junk bonds with higher yields instead of T-Bonds that pay less interest. But the growing demand for higher risk and higher yields happen to raise junk bond prices and drive down their yields. If the economy prospers, inflation usually picks up and that hurts those people that have safer T-Bonds but lower yields. Inflation may bite a big chunk off those already lower interest rates. This tends to hurt the demand for Treasuries and, with their falling prices, their rates tend to move up. The following diagram summarizes the idea:

 

From what I have noticed, the ratio between interest rates of these different groups of debt securities tends to anticipate the behavior of inflation in the U.S. by several months!

 

The inflation lags in these charted lines seem to have been affected by the collapse of Lehman Brothers in September 2008. Before Lehman, the yields ratio used to anticipate the general course of inflation to come by more than a year. Apparently, the panic and the Fed’s QE have disturbed the average time divergence, shortening it to just a few or several months. I find this anticipation observed in the interest rates ratio very interesting, since people tend to believe that interest rates move as a consequence of the observed inflation, that is: after the fact. But, as the chart above suggests, inflation seems to be more like a delayed manifestation. Investors, institutions and companies have perceptions and form expectations for the economy that seem to guide their behavior in the bond market much faster than the consumer price index can externalize it.

In spite of that, the chart shows a last wave that started to move up in June 2012 and reached a top around the end of 2013 (mostly in lockstep with Quantitative Easing Three) and then drops during the course of 2014 (again in lockstep with the Tapering of QE3, when the Fed gradually withdrew its interference in the market and in the U.S. monetary base). This last wave did not manifest itself in any measurable inflation. Not yet, at least. But we have seen roughly 30 months go by since that trough in June 2012, and such a long time lag seems odd. It is more likely that we will not see an echo manifestation in consumer prices. Therefore, that ratio’s last wobbly behavior may have been more of a distortion initiated by QE3 and then corrected by this year’s Tapering.

If with the first two editions of Quantitative Easing (QE1 and QE2) the Fed was indeed able to move first the expectations that guided the bond market and then, secondly, inflation, with QE3 only the bond market participants seemed to react. Inflation just shrugged its shoulders and marched on sideways.

There seems to be an important message here: anti-cyclical monetary policies of the Fed may indeed be losing effect. Even though QE3 was still able to generate expectations and repercussions on Wall Street (which we saw reflected in the yields of different Bonds), the real economy of Main Street (represented by the consumer price index) seemed already unresponsive to the latest Fed’s monetary stimulus. This cannot be neglected! QE3 was indeed the fourth intervention from the Fed in the last 6 years. There were QE1, QE2, Operation TWIST and QE3. QE3 was not just the longest, but also the most expensive of these interferences. Check out below the dimension and chronology of these interventions in the market.

 

Personally, I am flabbergasted by the fact that the Fed has been acting almost nonstop in the market for the last six years! QE1, QE2, Operation TWIST and QE3 stretched for sixty two months altogether. So in a total of seventy two months since QE1 was announced on November the 25th of 2008, only for measly ten months the markets were not babysat by the Fed.

Just like an organism may develop tolerance and resistance to a particular chemical substance that has regularly been administered, the world may be getting also less sensitive to John Maynard Keynes’ catecheses and the indoctrination of his prominent central bank evangelists.

But if we look elsewhere, we may notice that this weak inflation conundrum seems to be echoing in different indicators. Another one of them is the U.S. Dollar Index, which measures the value of the dollar against a basket of different currencies. If the devaluation of the dollar (that elusive goal of the Fed!) would cause inflation, we must also concede that an appreciation of the U.S. currency shall have a disinflationary effect on consumer prices (or maybe even deflationary). American imports get cheaper with a stronger dollar. Since the U.S. imports more than it exports, the country ends up importing disinflation from abroad! And to illustrate this inverse correlation between the dollar value and consumer price inflation, I have charted the U.S. Dollar Index inverted (upside down) superposed to the U.S. CPI inflation recorded since September 2006. And here too, we see a certain anticipation of the Dollar Index that suggests further disinflation.

 

Like in 2008, 2010 and 2012, we may see inflation rate reaching down to 1% a year - and this will raise a lot more hair on the Federal Reserve Board this time (and I don’t mean this literally just because Bernanke is out). So far, the Fed’s pattern has been to turn on the presses and start minting dollars for QE as soon as inflation gets scarily close to 1%. But I bet this time they will hesitate a bit more! Besides their own experience showing less effectiveness, other factors may delay any tactical move from the Fed. First, it seems more prudent to let the economy toddle on its own for a while, just to check out the strength of its legs and how far it can get without leaning on the Fed. And second, if the world did not learn enough from Japan’s 1990 demise to prevent a similar crisis, it may be paying more attention to its present dire straits.

Japan is showing us that an exaggeration of monetary stimulus, with faster minting of money and the devaluation of the Yen, is not generating much positive result in its economy. It sure revived Japanese inflation from an overextended comatose state! But annualized GDP growth came out negative for the last two quarters (-6.7% 2ndQ and -1.9% 3rdQ). The same happened to industrial production, its annualized growths were actually retractions of -14% and -7.5% for the same respective quarters of 2014. Despite an inflation of +2.9% in October (assaulting for Japanese standards), the 3rd quarter GDP (Gross Domestic Product by Expenditure in Constant Prices) contracted -1.1% compared to the same quarter of 2013. So Japan may be swapping its deflation for an even more destabilizing stagflation.

 

The policy of Yen printing acceleration, devaluing the Yen, may have cheapened Japanese exports, but it inflated the costs of imported products and materials for Japanese industries and consumers. This caused a large number of bankruptcies in Japan. The problem did not become worse due to the providential (but expected) bust of the oil bubble.

 

To forcibly devalue a currency, trying to intimidate a population (that is already ageing and shrinking) into spending and consuming more is an audacious, and seemingly also irresponsible, stake.

There has been a series of mistakes and irresponsible behavior in the global economy. Especially the excessive credit directed to the most advanced (and already mature) economies (if only a large part of that financing had been directed to research and development of new technology in alternative sources of energy, instead of overconsumption plus real estate and financial speculation, perhaps both the economy and the climate could be in a different state of affairs). It was really unfortunate that regulatory agencies did not exhort the abusive leveraging of the private sector in developed nations, especially in view of Japan’s precedent - an economic jam that dates as far back as 1990. But two wrongs don’t make right. And it seems to me that a massive series of remedial central bank actions that exceed the already excruciating six-year span may very well be another mistake!

Central banks also seem to try to compensate for a several-decade-long drop in nativity rate and a declining young population by pumping new money into the financial system. As if freshly minted dollars in the banks could substitute younger people on the streets! And by saying this, I mean that there is a good correlation too between inflation trends and the number of teenagers and young adults in the economy. We must acknowledge that raising kids involves money – and not just a little of it! Youngsters have a characteristic need to fit into the world. This heightened search for identity, social activity and popularity boosts consumption. Young people crave fashionable clothes, accessories and all sorts of distractions, goods and gadgets. They also start to eat a lot more! Don’t even mention college expenses! This pushes consumption up, but rarely contributes enough for the production output in the economy. The equilibrium between supply and demand is affected, tilting heavier on the latter.  Many economists seem to neglect this demographic and social aspect of the economy. I have shown the relationship before in a text titled “The Rock ‘n’ Roll in the Market”. There, I simply used the number of births for each year in the U.S. (adjusted to immigration) and charted it with a 21-year delay superposed to CPI inflation. The correlation was clear for all to see. In a more recent study I tried yet a different approach. In the chart below, I am representing a wider range of youths, between 16 and 22 years of age, and I am also dividing them by the overall U.S. population to obtain the percentage of these young individuals. The U.S. does not face the same problem that Japan is facing, but still, the demographic profile is yet another fundamental that suggests a period of very modest inflation.

 

The Fed has been printing dollars and expanding the monetary base. It is moving these dollars forward by buying debt securities. This already expanded monetary base, normally, would yet be multiplied by the credit operations of commercial banks, which happen under the fractional-reserve banking system. This money multiplier effect makes the stock of money readily accessible for spending (M1) greater than the monetary base itself. So M1 is usually a multiple of the monetary base! But then again, that is what normally happened, and not what we are seeing since Lehman’s collapse and all this QE frenzy.

When demand for credit is reduced due to the aging of baby-boomers or an already debt-saturated population, offering more credit to people becomes a real challenge. If monetary policies are efficient in constraining a fast-paced economy and consumption, pushing ahead an economy that is stalling and in need of deleveraging is a much more complicated issue. Thus we hear that famous comparison with pushing on a string. You can use it to pull and hold back the economy, but not to push it forward. This is exactly what we are seeing.

The stock of money readily available for spending (M1) is not a multiple of the monetary base anymore, not since 2008. There has been not enough demand for it! M1 actually became a fraction of the total amount of dollars in the monetary base. In other words, a substantial portion of these minted dollars has never been converted into consumption or entrepreneurial fixed capital formation, and let’s not even mention credit concession!

 

The question is: if a considerable chunk of the monetary base was never translated into accessible money and much less multiplied by bank credit, then why so much talk about the FOMC raising Fed Fund rates? Why would they print all this money and months after, just render an even larger fraction of it into couch-potato-dollars without letting it work its way into the real economy of Main Street? Under my scrutiny, I have not identified any potential inflationary threat on the horizon. (1) Not in the expectations and behavior reflected in the long-bond market; (2) not in the recent appreciation of the U.S. Dollar; and (3) not in the demographic profile of the United States. I dare to say that the only conceivable, but still speculative reasons for any interest rate hike by the FOMC would be either (A) a bluff or a decoy to sell “inflationary expectations” to the people and see if they bite the bait and behave in a way that may actually produce some real inflation, or (B) simply a way of shaking up the U.S. stock market and try to prevent the expansion of a larger bubble in stocks.

Anyway, based on the Fed’s results and those of the more desperate Bank of Japan, maybe central bankers should act with more modesty and caution when handling their power. After all, it is known that with great power comes also great responsibility!

Copyright © Sebastião Buck Tocalino - De Olho Na Bolsa

 

DISCLAIMER: Any opinions expressed by the author may be personal and controversial. This is not an investment recommendation! This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by De Olho Na Bolsa in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. All data used and shown here were gathered from accredited sources that we believe to be trustworthy, reputable and accessible to market participants. De Olho Na Bolsa expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing. INVESTMENT DECISIONS INVOLVE RISKS! For your safety we suggest you should seek the professional advice and guidance of a reputable brokerage firm and portfolio manager.

[description] => Inflation is out of sight in terms of Treasury bond yields, dollar exchange rates and demographic outlook – let’s not even mention energy costs! Much of the FED’s monetary base expansion did not flow into consumption or, more importantly, entrepreneurial productive investments! Money multiplier is more like a fractional now, since not even credit increased the money available for Main Street the way it used to. [author] => Sebastiao Buck Tocalino [legacyinterface_firm_id] => 499 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 15:03:57 [created_by] => 948 [modified_on] => 2014-12-16 15:04:24 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2159 [hits] => 0 ) [13] => stdClass Object ( [legacyinterface_commentary_id] => 2094 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15333 [apv_conversation_id] => [content_type] => market-commentary [title] => U.S. Housing: Still Room to Grow? [slug] => abbett_121614 [fulltext] =>

The prospect of Federal Reserve rate hikes has brought out much concern about the durability of the housing recovery. That is understandable. Any increase in rates threatens to raise the cost of supporting a mortgage, and the housing recovery, though far from following a powerful trend, has added to the admittedly tepid general recovery.          

Still, it would be easy to exaggerate the impact of planned Fed actions. To begin with, policymakers intend to raise rates only slowly and cautiously. They will remain sensitive to the economy’s reaction, including housing. For another, housing remains historically affordable, so that any rate hikes, particularly the modest ones that this Fed contemplates, are not likely to shut down buying as dramatically as some seem to fear. Finally, other factors, most especially the willingness of banks to extend credit for real estate, likely will improve during the time before the Fed makes its rate moves. The housing recovery will, then, likely proceed, albeit slowly as it has to date, even after the Fed begins its promised rate increases.

The Recovery So Far
From its lows of 2009, the housing market has made an uneven, but on balance substantive recovery. It remains substandard, however, in two crucial respects, relative to past cyclical recoveries and especially compared to the precipitous drop that preceded it. Sales of new houses fell some 81% during the Great Recession, from a high of about 1.4 million units a year in 2005 to about 400,000 in spring 2009, when the general economic recovery began. The recessionary pressure in the sector was so powerful that even as the general recovery proceeded, sales of new homes actually fell an additional 32.5%, to lows of 270,000 in spring 2011. Only then, fully two years into the general economic recovery, did new homes begin their upturn. This growth proceeded in fits and starts, averaging about 17% a year, which is impressive in a vacuum, perhaps, but leaves housing nowhere near to recovering the ground it had lost. As of September this year (the most recent period for which data are available), sales of new homes stood at a yearly rate of 467,000, fully 66% below their former highs from before the bust of the Great Recession.    

New construction has followed a similar pattern. Housing starts peaked at an annual rate of 2.2 million units in fall 2005 and fell almost 78% during the Great Recession, to a low of 478,000, at an annual pace. They began a modest recovery in spring 2009 along with the overall economic recovery. But two years later, in spring 2011, when new home sales at last began to grow again, starts were only some 25% above their recession lows, a minuscule recovery given the steepness of the previous slide. The pace of recovery has picked up since, but in October 2014 (the most recent period for which data are available), starts averaged barely above 1.0 million a year, still almost 55% below their pre-recession highs. 

Though hardly impressive in light of the previous downturn, these gains have contributed to the economy’s overall growth path, though most of that help has emerged only recently. Early in the recovery, the housing growth was so slight that, according to the Bureau of Economic analysis at the Commerce Department, residential construction actually detracted from the pace of overall growth in 2010. Housing added a minuscule 0.02 percentage points a year to overall growth in the real gross domestic product (GDP) in 2011 and 2012. In 2013 and 2014 so far, it has added a still small 0.17 percentage points a year to overall growth.3 Its contribution to employment gains has been only slightly better. Construction jobs accounted for only some 5.9% of total jobs created in the recovery since 2009, though during the past couple of years such jobs have averaged a modestly higher 8.5% of the total.4

Reasons
The biggest help for housing so far has come from increased levels of affordability. The severe drop in real estate prices during the Great Recession and the even more precipitous drop in mortgage rates have lessened the burden of the average mortgage on the average family’s income. Here, the figures are striking. Between 2008 and 2011, when new home purchases finally turned up again, the median price of a single-family house in this country had fallen by more than 20%, according to the National Association of Realtors (NAR). The rate on the average fixed mortgage had dropped more than 200 basis points (bps), or by more than 30%, according to the Fed. The rate on a variable mortgage fell even more dramatically. Though the median family income actually fell during this time, these price and rate declines improved those families’ ability to support a mortgage. Affordability (to use the NAR’s term) improved more than 70%.

Two impediments held back the pace of recovery, however. One was the loss of confidence in the household sector. Concerns and insecurities engendered by the pain of the Great Recession dissuaded many from stretching—as they might have previously—for the house of their dreams. The second impediment to recovery was the decline in confidence among lenders. The huge mistakes of the housing boom and the subsequent losses during the recession prompted banks and other mortgage lenders to tighten credit standards in general and especially where residential real estate was concerned. Even as the overall recovery progressed, bank lending for real estate fell 5.5% in 2010, 3.8% in 2011, 1.1% in 2012, and 1.0% in 2013. It only just began to turn up this year, and then only at an average annual rate of less than 3.0%. As affordable as housing had become, borrowers simply could not get the necessary credit.  Anecdotal evidence suggests that a great many of the purchases that did occur were made for cash, and by business or well-heeled buyers who planned to rent the properties rather than live in them.5 

Prospects for the Future
This balance of forces seems poised to change, though it should still support a modest recovery going forward. On the negative side, rising real estate prices already have begun to erode the superior affordability comparisons. The prospect of Fed rate hikes likely assures further erosion on this score. No doubt, actions on both fronts will tend to squeeze out the marginal buyer and so tend to slow the housing recovery. But that should not halt growth altogether.    

Even the prospective deterioration in affordability could hardly be described as intense. Housing, as mentioned, remains, in a historical context, affordable. Both real estate prices and mortgage rates are well below their former highs. Affordability, as calculated by the NAR, though down from its 2011 highs, remains 60% better than before the housing bust began and, remarkably, some 25% better than it averaged throughout the 1990s.Even if mortgage rates were to rise by 100 bps and real estate prices were to accelerate their recent rising trend, it would still take until 2016 before affordability deteriorated to its state in the 1990s and early 2000, and much longer still to reach the kind of severe constraints that could create a downturn. And since the Fed has made clear its intentions to raise rates cautiously along a gentle path, it will no doubt take a good deal longer than this for it to add those 100 bps to mortgage rates.7

If a gradual deterioration in affordability will tend to slow but not stop the housing expansion, other impediments, those holding housing back thus far, likely will improve. Homebuyers’ confidence and aggressiveness are, admittedly, hard to quantify, but signs of improvement are evident in the 11.5% rise during the past year in the University of Michigan’s consumer sentiment index.Mortgage lenders also have begun to ease their former reluctance to extend credit for real estate. The Fed’s survey of senior lending offices describes an easing in requirements generally, a change that no doubt explains the real estate lending growth described earlier. These positives will no doubt develop only gradually. But at the margin, their turn should relieve the former drag on home-buying and so promote the general recovery in the area.9        

The pace of housing sales and construction might even quicken slightly under the changing mix of influences. A more conservative expectation would look for this changing mix of influences to sustain the housing recovery on the moderate path it has already established. Whatever record the precise statistics eventually show, investors can rest secure that, barring some presently unforeseen shock, a recovery will continue in one form or another for quite some time to come, despite plans at the Fed.

1 Data from the Department of Commerce.

2 Ibid.

3 Ibid.

4 Data from the Department of Labor.

5 Data from the Federal Reserve.

6 Data from the National Association of Realtors.

7 Data from the Federal Reserve.

8 Data from the University of Michigan.

9 Data from the Federal Reserve.

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

© Lord Abbett

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While today's better than expected rise in the flash PMI indicator (black line) for the euro zone is a welcome surprise, it would seem that it will take quite a bit more improvement before we can reasonably expect substantial progress in the recovery of important metrics such as GDP or industrial production:

 
image
 
image
 
By country, France continues to lag behind Germany:
 
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Stocks and other risky assets experienced particularly violent moves last week, and given uneven global growth and the impending tightening of U.S. monetary conditions, I think we are likely to see more turbulence ahead. As I discuss in my weekly commentary, there are two forces driving the volatility.

Uneven Global Growth, Despite U.S. Resilience.As we saw last week, countervailing forces are pulling stocks in opposite directions. Next to more evidence that the U.S. economy is improving, we are seeing several signs of slowing growth outside the United States: weak import/export data from China, multiple downgrades of global oil demand accompanied by a further plunge in prices, more stringent collateral requirements in China and renewed angst over European politics.

This dichotomy between the U.S. and the rest of the world was stark, but economic resilience at home does not mean U.S. assets are immune to the global slowdown. The S&P 500 Index traded down to a five-week low, with energy and technology leading the way down on concerns over global growth. Volatility spiked and reached its highest level since June 2013, consistent with a further widening of credit spreads. The sell-off in high yield has been largely driven by growing concerns over energy issuers.

But the biggest losses were once again in the commodity sector. U.S. benchmark WTI crude slipped below $60/barrel, the lowest level since July 2009. With risky assets selling-off, investors are fleeing to safe havens such as German bunds and U.S Treasuries.

Global politics. Unlike the rest of the world, a fairly quiet year in politics seems to be in store for the United States, with midterm elections over and the presidential election still two years away. Indeed, the U.S. Congress just barely managed to squeeze a funding bill through and avert another government shutdown. However, the political dynamics for many parts of the world are very different. We are seeing global politics reemerge as a key investment driver, be it a risk or potential opportunity.

The risk comes from Europe. Last Monday, Greek Prime Minister Antonis Samaras surprised everyone by moving up the date for a Greek parliamentary vote for a new president. (The first vote will take place on Dec. 17, but the final round does not occur until late in the month.) It is not clear the government can reach the necessary majority to maintain power.

Anxiety over the election and the potential for a new government in Greece less committed to reform is already being felt in asset prices. Not only did Greek assets sink on the news last week, but broader European equities suffered one of their worst weeks in months, reflecting investor concerns that the ramifications would be felt throughout the eurozone.

While European politics represent a risk, Japan’s may offer an opportunity. Results from Sunday’s election indicate that the ruling LDP party maintained its super-majority in Japan’s lower house (The Diet). The strong showing by the LDP party will—in theory—give Prime Minister Shinzo Abe the political clout to push through more pro-growth policies, including trimming the corporate tax to 20%, enacting labor market reform, and deregulating the energy and farming sectors. All of these, in our assessment, would further strengthen the case for Japanese stocks.

 

Source: Bloomberg

 

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor toThe Blog and you can find more of his posts here.

 

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

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[description] => Stocks and other risky assets experienced particularly violent moves last week, and given uneven global growth and the impending tightening of U.S. monetary conditions, I think we are likely to see more turbulence ahead. As I discuss in my weekly commentary, there are two forces driving the volatility. [author] => Russ Koesterich [legacyinterface_firm_id] => 50 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 15:13:18 [created_by] => 948 [modified_on] => 2014-12-16 15:13:35 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2162 [hits] => 0 ) [16] => stdClass Object ( [legacyinterface_commentary_id] => 2097 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15336 [apv_conversation_id] => [content_type] => market-commentary [title] => Is the Grinch Stealing Investors’ Christmas? [slug] => fpi_121614 [fulltext] =>

It was 1957. My Mom settled down with my brothers, sister, and me and began to read. It was a book by one of my favorites, Dr. Seuss.  Unless you have spent the time since then living in a van down by the river, you’ve either read the book (or had it read to you), seen the TV cartoon account (1966) or Jim Carrey in Ron Howard’s motion picture version (2000) of How the Grinch Stole ChristmasEven the song has been a hit!

In the story, the Grinch, an evil villain, lives on a mountain top high above the village of Whoville.   The tiny Whos that inhabit the town are a happy lot, and that greatly disturbs the crusty old Grinch.  Together with his faithful but confused dog, Max, Mr. Grinch sets out on Christmas Eve to steal Christmas from the Whos below.

As I watched the stock and commodity markets fall last week, I could not help but think of Mr. Grinch. December is the time of the Santa Claus rally in stocks.  Christmas time is almost always a period of rising stock market prices.  Over the last 100 years, December registers the most consistently positive returns (75%) of any month. 

 
Source: Bespoke Investment Group

Last week, though, I saw an Internet post by an investor that said, “I was thinking of taking advantage of the Santa Claus rally to put a few dollars to work this year, but after the decline this week I’m not so sure.”

Truth is, though, as I pointed out last week, December almost always sees a decline that precedes the year-end rally.  Over 100 years of Dow history suggests a bottom on December 11th on average.  More recent data point to December 15th as the bottom of the mid-December slump. 

Whichever, the true “Santa Clause rally” actually occurs at month’s end (the last five days of the month plus the first two days of the year end is the official definition).  The period is almost 80% positive and usually delivers about half of December’s monthly gains.  And small-cap stocks (this year’s laggard) tend to benefit even more than the Dow stocks.

But enough of market history – isn’t this time different?  Oil prices have gone back underground, slipping about 50% since their high point a number of months ago.   

Source: Bespoke Investment Group

There is no doubt that oil’s precipitous fall has been noticed by investors.  In the past, however, falling oil prices have been good for the economy as more dollars are made available to consumers. 

The conflict this year is that with the US now being the top oil producing nation, the impact on the fast-growing oil producing companies in this country and our GDP growth rate may offset the advantage to consumers.  Some even believe that this is an attempt by the OPEC nations to drive many of our fledgling producers out of business.

While it is difficult to know which scenario will prevail, we do know that uncertainty is bad for the markets. However, odds do favor that the fall in prices will soon end or at least consolidate for a time. After all, we have now seen the third worst decline in oil prices since the eighties. 

I looked back in history to see how stocks (the S&P 500) have done after the ten worst oil price declines since 1983.  The results were not conclusive.  While stocks rose for the week-, month-, quarter-, and six-month periods after the top five declines ended, they declined for all periods for the top ten averages.  The number of positive outcomes was right around 50% in both studies.

With such a mixed bag of results, I think the stock market before year end will resume the post-October rally where it left off. Realize that even for most of the oil price decline, the stock market has been rocketing higher.  A new all-time high in the S&P 500 was registered just a week ago last Friday! 

Yet to borrow a phrase from early in the stock market boom of the eighties, “This is one of the most hated bull markets in history!”  Investors just don’t believe in it, have passed up the opportunity to benefit from it, and remain woefully underinvested in equities.  Given the number of actively managed strategies available to investors to gain their stock market exposure while having an exit plan in the event of a crash, this is hard to understand.  I sympathize with poor confused Max.

Last week’s economic reports provided ample evidence that the economy is on the right track on many fronts.  Giant leaps higher that defied expectations were registered across the board in the period.  For example, such gains were recorded in the NFIB Small Business Optimism Index, and the Retail Sales report, while the University of Michigan Confidence Index soared to its highest level since 2007.  In all, twelve of fourteen economic reports beat the average expert prediction last week.

At the same time, interest rates slid lower propelled by buying from foreign investors seeking refuge from their economic weakness and the rising Dollar.  When I reviewed my credit card reports from my Australia and New Zealand trip last month, I found a better than 10% advantage in Dollar purchasing power.  When I recently crossed our border to our northern neighbor, Canada, I found a 15% advantage!

I know the Grinches out there will point not only to the oil disruption, but also to the widely expected Federal Reserve actions to raise interest rates as reasons to be fearful of stocks.  The counter to the latter is that 1) inflation readings, even ex-oil, keep declining, giving the Fed few reasons to be in a hurry to raise rates, 2) it will take a greater increase in interest rates than what is contemplated to slow this economy down, and 3) higher interest rates will cause the Dollar to decline, putting even more pressure on our economic friends who are already facing lower sales and production.

Each week brings another commentator coming forward to agree with my opinion since this talk of higher rates began.  They argue that rates are likely to stay low longer and that Fed action is likely to be delayed longer than most think.  But time will tell.  Even if we are wrong, rates are so low presently that I don’t think a moderate increase will have a significant impact on stock prices or the secular bull market that we are now in. 

Yes, we will have a 20% correction – probably in the next twelve months, but a recession or return to the 50%-plus declines that twice punctuated stocks in the Secular Bear Market of the first decade of this century do not seem to be in the immediate future.

If you fast (?) forward 25 years after my mom’s first reading of How the Grinch Stole Christmas, you’d find me as Christmas neared sitting on the side of the bed with two small boys curled up, fascinated by the tale Dad was spinning for them. 

The illustrations were great, the Grinch was fearsome, and, yes, all the signs of Christmas were vacuumed into his massive bag and carted away. But best of all, when morning came, the inhabitants of Whoville were seen crowded into the town square, undisturbed and celebrating the true meaning of Christmas.

The Grinch’s heart was softened.  All the commercial parts of Christmas were returned.  And the last sighting of the Grinch was of him joining in the celebration, having learned the true value of Christmas.

I don’t think the Grinch will steal this year’s Santa Claus rally, but if he does, don’t be frightened. We are likely still in the early stages of a secular bull market that could have more than a decade to run before it’s done.  By the time it has run its course, I believe investors will be doing plenty of celebrating in their own town squares.

All the best,

Jerry

© Flexible Plan Investments

[description] => It was 1957. My Mom settled down with my brothers, sister, and me and began to read. It was a book by one of my favorites, Dr. Seuss. Unless you have spent the time since then living in a van down by the river, you’ve either read the book (or had it read to you), seen the TV cartoon account (1966) or Jim Carrey in Ron Howard’s motion picture version (2000) of How the Grinch Stole Christmas! Even the song has been a hit! [author] => Jerry Wagner [legacyinterface_firm_id] => 156 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 15:18:36 [created_by] => 948 [modified_on] => 2014-12-16 15:18:52 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2163 [hits] => 0 ) [17] => stdClass Object ( [legacyinterface_commentary_id] => 2098 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15337 [apv_conversation_id] => [content_type] => market-commentary [title] => High Anxiety [slug] => rj_121614 [fulltext] =>

Federal Reserve policymakers meet this week to set monetary policy. The key concern is the timing of policy normalization. Officials may be anxious to begin lifting short-term interest rates, but they need to be very careful about managing market expectations. The risks of tightening too soon or too late are not symmetric and with the financial markets in turmoil, the Fed will not want to add to the level of anxiety.

The liftoff for short-term interest rates will be driven largely by the Fed’s view of the labor market. There are many labor market gauges. The Labor Market Conditions Index, a composite of 24 indicators, provides a good summary (according to Fed Chair Yellen). While there is some choppiness from month to month, the underlying trend suggests that labor market slack is being gradually taken up and momentum in the job market has been strong in recent month. Still, a lot of slack remains and it will likely be two years or more before we get to what might be considered “normal” labor market conditions.

Working back from where the job market is expected to be in two years and assuming a slow pace of rate hikes (25 bps per FOMC meeting), then it would seem appropriate to begin tightening around the middle of next year. The Fed would not be hitting the brakes. Rather, it would simply be gradually taking the foot off the gas pedal.

What are the risks of tightening too soon or two late? If the Fed tightens too soon and the economy slows, it will have a limited ability to correct course, as short-term interest rates are already close to zero and officials will be very reluctant to pursue another round of quantitative easing. If the Fed tightens too late, the economy would begin to overheat and inflation would begin to rise. However, the Fed has the scope to raise short-term interest rates more rapidly – that is, it has a greater ability to correct its course.

In 2011, inflation picked up. Some observers feared that the Fed was behind the curve and wanted it to unwind accommodation. Instead, the Fed cited “temporary factors” and focused on core inflation, and continued to act aggressively. The current low inflation trend is also seen, by many Fed officials, as transitory. Low inflation, by itself, is not enough to postpone a Fed tightening. However, the conditions driving low inflation matter. For example, some of the drop in energy prices reflects increased supply. The Fed need not worry about that. However, some of the drop reflects weaker demand, which is a concern. Yet, the drop in demand is coming from the rest of the world. It’s not due to weakness in the domestic economy.

What about the stronger dollar? Would the Fed postpone tightening to reduce the upward pressure on the greenback? Remember, the exchange rate of the dollar is not the Fed’s responsibility. The dollar is under the Treasury’s jurisdiction (although the Fed may intervene in the currency markets on behalf of the Treasury). Yet, the Fed needs to consider the impact of a stronger dollar. A stronger dollar, as we’ve seen, puts downward pressure on commodity prices, but the impact at the consumer level is usually small. It takes a major move in prices of raw materials to move consumer prices even a little. The exception is oil, where the decline has a bigger impact and shows up relatively quickly. Still, oil prices are not expected to fall forever. They should stabilize at some point.

Following NY Fed President Dudley’s recent speech, we now know that the Fed will also consider the financial market reactions (or overreactions) to its policy moves, and possibly react to the market’s reaction. The recent stock market turmoil and drop in long-term interest rates makes the Fed’s decision to remove the “considerable time” phrase a lot more complex. Janet Yellen can attempt to calm the financial markets in her press conference, but will the markets listen?

© Raymond James

[description] => Federal Reserve policymakers meet this week to set monetary policy. The key concern is the timing of policy normalization. Officials may be anxious to begin lifting short-term interest rates, but they need to be very careful about managing market expectations. The risks of tightening too soon or too late are not symmetric and with the financial markets in turmoil, the Fed will not want to add to the level of anxiety. [author] => Scott Brown [legacyinterface_firm_id] => 356 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 15:20:11 [created_by] => 948 [modified_on] => 2014-12-16 15:20:37 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2164 [hits] => 0 ) [18] => stdClass Object ( [legacyinterface_commentary_id] => 2099 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15338 [apv_conversation_id] => [content_type] => market-commentary [title] => Please Make it Stop! [slug] => rj_121614a [fulltext] =>

He said: “Jeff, you sure were right in Thursday morning’s verbal strategy comments when you said we should get a bounce following Wednesday’s 90% Downside Day, but that that bounce should not hold and for the perfect set-up to occur for the Santa Rally would be to have the S&P 500 come back down and travel into the 2000 – 2010 level.”

I said: “Sometimes you get lucky.”

He said: “Do you still think the right level is 2000 – 2010?”

I said: “I do, or maybe even a little overshoot to the downside given today’s action.”

He said: “Well, the S&P is at 2012, is that close enough to buy?”

I said: “It’s Friday, and while the markets can do anything, once they are into one of these downside skeins they rarely bottom on a Friday. I did see it happen once in the Bankers’ Panic of 1907, but it is pretty rare.”

He said: “Okay, I will wait until next week, but please ‘make it stop’!”

That was a conversation I had with one of our financial advisors last Friday and I truly share his pain, especially in the energy space. Andrew Adams and I have written numerous times about rude crude and its nasty decline, as well as the reasons for it. I have scribed my thoughts about “oil as a weapon,” actually I first heard that concept from Bob Hardy, but last week my friend Arthur Cashin included this quip from arguably the best strategic thinker on Wall Street, namely Don Coxe of Coxe Advisors:

“... By October, it was becoming clear to us and others that Saudi Arabia and its Gulf Emirate allies could not afford to continue petro-pricing business as usual with sectarian wars exploding out of control, threatening the entire region. In particular, they were infuriated that the Shia regime in Syria was being propped up by Iran and Russia. Moreover, Iran seemed to be getting closer to becoming a nuclear power with each month. Amid the chaos, the Islamic State terrorists had suddenly become a formidable challenge to the entire region, and they were getting increasing revenues from oil properties they had seized. The Saudis had long since concluded that U.S. President Barack Obama was a weak reed – at best. So, we believe they felt forced to stop the cash flows to Syria, Iran and the Islamic State and deter Russia.They decided to keep pumping oil, allegedly to fight fracking, but also to weaken their regional foes. No one knows how long this strategy will continue. The Gulf States have trillions in sovereign wealth funds to back their budgets. Our pal Bob Hardy, who writes the invaluable Geostrat blog, has been talking about oil as a weapon for a longtime – going back to a meeting between Prince Bandar and President Putin late last year. While the meeting was private, sources say the meeting turned contentious when Putin refused to ease back on support for Syria and Iran in exchange for Saudi ‘help’ in maintaining or even boosting the oil price. The reason the Saudis didn't move earlier may have been ‘market conditions’. They needed U.S. fracking supplies to build to a level that would make destabilizing the equilibrium very easy and not require a large and obvious production boost.”

Obviously, oil is in the news and was the highlight of last week with a concurrent “hit” to our equity markets on news the International Energy Agency had reduced its oil demand outlook due to falling consumption. The highlight of my week, however, was spending three to four hours with Putnam portfolio manager (PM) Jerry Sullivan, who manages the Putnam Multi-Cap Core A Fund (PMYAX/$17.10), which I own. I like the fund because at $230 million it is small and nimble. However, Jerry also runs the much larger Putnam Investors A Fund (PINVX/$21.29). Having worked closely with Peter Lynch in an era gone by, Jerry employs many of the same tenets Peter used. Like Peter he keeps it pretty simple with three basic “buckets.” First is the Legacy Bucket that uses large cap boring stocks that tend not to go down much over the long term. Bucket two is the Smart Money Bucket, where he tracks insider non-option buying/selling as reflected in SEC document Form 4. The third bucket is termed Special Situations, which needs no explanation. Other Putnam funds I have written about in the past, and that I own, include: Putnam Fund for Growth & Income (PGRWX/$20.95) PM Bob Ewing, Putnam Voyager Fund (PVOYX/$29.48) PM Nick Thakore, Putnam Capital Spectrum Fund (PVSAX/$38.09) PM David Glancy, and Putnam Diversified Income A Fund (PDINX/$7.53) PM Bill Kohli; and yes, I have personally met with all of these portfolio managers and like their investment styles.

As for the stock market, as most of you know I was looking for early month weakness to set up the Santa Rally, but I thought the weakness would begin the first week of December and I did not think it would be as severe as what we saw recently. Indeed, last week the equity markets suffered their worst point decline in three years with the D-J Industrials losing ~678, while the S&P 500 (SPX/2002.33) shed ~73 points, leaving the SPX about 2 points above its 50-day moving average of 2000.75. The dive took the SPX into the 2000 – 2010 zone I referenced in Thursday morning’s comments and has left the McClellan Oscillator more oversold than it was at the October 15, 2014 “selling climax” low. I think the downside is mostly played out here and would look for some kind of trading low during the beginning of this week. The question then becomes, “Will that be the start of the Santa Rally into year-end?” To answer that question we will need to look at the quality/durability of any rally that develops, but at worst I believe the rally would play itself out in the 2030 – 2040 level and then come back down into the 1970 – 1980 zone before Santa arrives on Wall Street. In any event, we should know the answer to said question by the end of this week. Meanwhile, the economic reports continued to look good last week with 14 of the 17 economic reports coming in better than expected, Retail Sales topping estimates, the NFIB Small Business Optimism Index hitting its highest level in seven years, and the University of Michigan’s Confidence Report at its best level since 2007. To be sure, things are getting better!

The call for this week: This week will determine when we will start the Santa Rally. As stated, I think the downside is mostly played out here and would look for some kind of trading low during the beginning of this week. The question then becomes, “Will that be the start of the Santa Rally into year-end?” To answer that question we will need to look at the quality/durability of any rally that develops, but at worst I believe the rally would play itself out in the 2030 – 2040 level and then come back down into the 1970 – 1980 zone before Santa arrives on Wall Street. Last week I took another shot at trying to pick the bottom of crude oil’s decline when oil was testing its 15-year uptrend line at $60. Alas, that level did not hold either (strike 2). Over the weekend I came across an interesting oil to gold chart that suggests while we are not there yet, we are very close to a bottom (maybe third time is the charm?). Accordingly, I continue to think buying the midstream MLPs into year-end makes sense. I would also note that some of the names mentioned by our fundamental analyst on the midstream MLP conference call last week already look to have bottomed. Well, so much for “never on a Friday” as the S&P futures are better by 13.50 points at 6 a.m. on the passing of a budget. We will have to now see if the 2030 – 2040 level stops the “Budget Blast.”

© Raymond James

[description] => He said: “Jeff, you sure were right in Thursday morning’s verbal strategy comments when you said we should get a bounce following Wednesday’s 90% Downside Day, but that that bounce should not hold and for the perfect set-up to occur for the Santa Rally would be to have the S&P 500 come back down and travel into the 2000 – 2010 level.” [author] => Jeffrey Saut [legacyinterface_firm_id] => 356 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 15:21:32 [created_by] => 948 [modified_on] => 2014-12-16 15:24:29 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2165 [hits] => 0 ) [19] => stdClass Object ( [legacyinterface_commentary_id] => 2100 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15339 [apv_conversation_id] => [content_type] => market-commentary [title] => Oil, Employment, and Growth [slug] => mauldin_121614 [fulltext] =>

Last week we started a series of letters on the topics I think we need to research in depth as we try to peer into the future and think about how 2015 will unfold. In forecasting US growth, I wrote that we really need to understand the relationships between the boom in energy production on the one hand and employment and overall growth in the US on the other. The old saw that falling oil prices are like a tax cut and are thus a net benefit to the US economy and consumers is not altogether clear to me. I certainly hope the net effect will be positive, but hope is not a realistic basis for a forecast. Let’s go back to two paragraphs I wrote last week:

Texas has been home to 40% of all new jobs created since June 2009. In 2013, the city of Houston had more housing starts than all of California. Much, though not all, of that growth is due directly to oil. Estimates are that 35–40% of total capital expenditure growth is related to energy. But it’s no secret that not only will energy-related capital expenditures not grow next year, they are likely to drop significantly. The news is full of stories about companies slashing their production budgets. This means lower employment, with all of the knock-on effects.

Lacy Hunt and I were talking yesterday about Texas and the oil industry. We have both lived through five periods of boom and bust, although I can only really remember three. This is a movie we’ve seen before, and we know how it ends. Texas Gov. Rick Perry has remarkable timing, slipping out the door to let new governor Greg Abbott to take over just in time to oversee rising unemployment in Texas. The good news for the rest of the country is that in prior Texas recessions the rest of the country has not been dragged down. But energy is not just a Texas and Louisiana story anymore. I will be looking for research as to how much energy development has contributed to growth and employment in the US.

Then the research began to trickle in, and over the last few days there has been a flood. As we will see, energy production has been the main driver of growth in the US economy for the last five years. But changing demographics suggest that we might not need the job-creation machine of energy production as much in the future to ensure overall employment growth.

When I sat down to begin writing this letter on Friday morning, I really intended to write about how falling commodity prices (nearly across the board) and the rise of the dollar are going to affect emerging markets. The risks of significant policy errors and an escalating currency war are very real and could be quite damaging to global growth. But we will get into that next week. Today we’re going to focus on some fascinating data on the interplay between energy and employment and the implications for growth of the US economy. (Note: this letter will print a little longer due to numerous charts, but the word count is actually shorter than usual.)

But first, a quick recommendation. I regularly interact with all the editors of our Mauldin Economics publications, but the subscription service I am most personally involved with is Over My Shoulder.

It is actually very popular (judging from the really high renewal rates), and I probably should mention it more often. Basically, I generally post somewhere between five and ten articles, reports, research pieces, essays, etc., each week to Over My Shoulder. They are sent directly to subscribers in PDF form, along with my comments on the pieces; and of course they’re posted to a subscribers-only section of our website. These articles are gleaned from the hundreds of items I read each week – they’re the ones I feel are most important for those of us who are trying to understand the economy. Often they are from private or subscription sources that I have permission to share occasionally with my readers.

This is not the typical linkfest where some blogger throws up 10 or 20 links every day from Bloomberg, the Wall Street Journal, newspapers, and a few research houses without really curating the material, hoping you will click to the webpage and make them a few pennies for their ads. I post only what I think is worth your time. Sometimes I go several days without any posts, and then there will be four or five in a few days. I don’t feel the need to post something every day if I’m not reading anything worth your time.

Over My Shoulder is like having me as your personal information assistant, finding you the articles that you should be reading – but I’m an assistant with access to hundreds of thousands of dollars of research and 30 years of training in sorting it all out. It’s like having an expert filter for the overwhelming flow of information that’s out there, helping you focus on what is most important.

Frankly, I think the quality of my research has improved over the last couple years precisely because I now have Worth Wray performing the same service for me as I do for Over My Shoulder subscribers. Having Worth on your team is many multiples more expensive than an Over My Shoulder subscription, but it is one of the best investments I’ve ever made. And our combined efforts and insights make Over My Shoulder a great bargain for you.

For the next three weeks, I’m going to change our Over My Shoulder process a bit. Both Worth and I are going to post the most relevant pieces we read as we put together our 2015 forecasts. This time of year there is an onslaught of forecasts and research, and we go through a ton of it. You will literally get to look “over my shoulder” at the research Worth and I will be thinking through as we develop our forecasts, and you will have a better basis for your own analysis of your portfolios and businesses for 2015.

And the best part of it is that Over My Shoulder is relatively cheap. My partners are wanting me to raise the price, and we may do that at some time, but for right now it will stay at $39 a quarter or $149 a year. If you are already a subscriber or if you subscribe in the next few days, I will hold that price for you for at least another three years. I just noticed on the order form (I should check these things more often) that my partners have included a 90-day, 100% money-back guarantee. I don’t remember making that offer when I launched the service, so this is my own version of Internet Monday.  

You can learn more and sign up for Over My Shoulder right here.

And now to our regularly scheduled program.

The Impact of Oil On US Growth

I had the pleasure recently of having lunch with longtime Maine fishing buddy Harvey Rosenblum, the long-serving but recently retired chief economist of the Dallas Federal Reserve. Like me, he has lived through multiple oil cycles here in Texas. He really understands the impact of oil on the Texas and US economies. He pointed me to two important sources of data.

The first is a research report published earlier this year by the Manhattan Institute, entitled “The Power and Growth Initiative Report.” Let me highlight a few of the key findings:

1. In recent years, America’s oil & gas boom has added $300–$400 billion annually to the economy – without this contribution, GDP growth would have been negative and the nation would have continued to be in recession.

2. America’s hydrocarbon revolution and its associated job creation are almost entirely the result of drilling & production by more than 20,000 small and midsize businesses, not a handful of “Big Oil” companies. In fact, the typical firm in the oil & gas industry employs fewer than 15 people. [We typically don’t think of the oil business as the place where small businesses are created, but for those of us who have been around the oil patch, we all know that it is. That tendency is becoming even more pronounced as the drilling process becomes more complicated and the need for specialists keeps rising. – John]

3. The shale oil & gas revolution has been the nation’s biggest single creator of solid, middle-class jobs – throughout the economy, from construction to services to information technology.

4. Overall, nearly 1 million Americans work directly in the oil & gas industry, and a total of 10 million jobs are associated with that industry.

Oil & gas jobs are widely geographically dispersed and have already had a significant impact in more than a dozen states: 16 states have more than 150,000 jobs directly in the oil & gas sector and hundreds of thousands more jobs due to growth in that sector.

Author Mark Mills highlighted the importance of oil in employment growth:

The important takeaway is that, without new energy production, post-recession US growth would have looked more like Europe’s – tepid, to say the least. Job growth would have barely budged over the last five years.

Further, it is not just a Texas and North Dakota play. The benefits have been widespread throughout the country. “For every person working directly in the oil and gas ecosystem, three are employed in related businesses,” says the report. (I should note that the Manhattan Institute is a conservative think tank, so the report is pro-energy-production; but for our purposes, the important thing is the impact of energy production on recent US economic growth.)

The next chart Harvey directed me to was one that’s on the Dallas Federal Reserve website, and it’s fascinating. It shows total payroll employment in each of the 12 Federal Reserve districts. No surprise, Texas (the Dallas Fed district) shows the largest growth (there are around 1.8 million oil-related jobs in Texas, according to the Manhattan Institute). Next largest is the Minneapolis Fed district, which includes North Dakota and the Bakken oil play. Note in the chart below that four districts have not gotten back to where they were in 2007, and another four have seen very little growth even after eight years. “It is no wonder,” said Harvey, “that so many people feel like we’re still in a recession; for where they live, it still is.”

To get the total picture, let’s go to the St. Louis Federal Reserve FRED database and look at the same employment numbers – but for the whole country. Notice that we’re up fewer than two million jobs since the beginning of the Great Recession. That’s a growth of fewer than two million jobs in eight years when the population was growing at multiples of that amount.

To put an exclamation point on that, Zero Hedge offers this thought:

Houston, we have a problem. With a third of S&P 500 capital expenditure due from the imploding energy sector (and with over 20% of the high-yield market dominated by these names), paying attention to any inflection point in the US oil-producers is critical as they have been gung-ho “unequivocally good” expanders even as oil prices began to fall. So, when Reuters reports a drop of almost 40 percent in new well permits issued across the United States in November, even the Fed's Stan Fischer might start to question [whether] his [belief that] lower oil prices are "a phenomenon that’s making everybody better off" may warrant a rethink.

Consider: lower oil prices unequivocally “make everyone better off.” Right? Wrong. First: new oil well permits collapse 40% in November; why is this an issue? Because since December 2007, or roughly the start of the global depression, shale oil states have added 1.36 million jobs while non-shale states have lost 424,000 jobs.

The writer of this Zero Hedge piece, whoever it is (please understand there is no such person as Tyler Durden; the name is simply a pseudonym for several anonymous writers), concludes with a poignant question:

So, is [Fed Vice-Chairman] Stan Fischer's “not very worried” remark about to become the new Ben “subprime contained” Bernanke of the last crisis?

Did the Fed Cause the Shale Bubble?

Next let’s turn to David Stockman (who I think writes even more than I do). He took aim at the Federal Reserve, which he accuses of creating the recent “shale bubble” just as it did the housing bubble, by keeping interest rates too low and forcing investors to reach for yield. There may be a little truth to that. The reality is that the recent energy boom was financed by $500 billion of credit extended to mostly “subprime” oil companies, who issued what are politely termed high-yield bonds – to the point that 20% of the high-yield market is now energy-production-related.

Sidebar: this is not quite the same problem as subprime loans were, for two reasons: first, the subprime loans were many times larger in total, and many of them were fraudulently misrepresented. Second, many of those loans were what one could characterize as “covenant light,” which means the borrowers can extend the loan, pay back in kind, or change the terms if they run into financial difficulty. So this energy-related high-yield problem is going to take a lot more time than the subprime crisis did to actually manifest, and there will not be immediate foreclosures. But it already clear that the problem is going to continue to negatively (and perhaps severely) impact the high-yield bond market. Once the problems in energy loans to many small companies become evident, prospective borrowers might start looking at the terms that the rest of the junk-bond market gets, which are just as egregious, so they might not like what they see. We clearly did not learn any lessons in 2005 to 2007 and have repeated the same mistakes in the junk-bond market today. If you lose your money this time, you probably deserve to lose it.

The high-yield shake-out, by the way, is going to make it far more difficult to raise money for energy production in the future, when the price of oil will inevitably rise again. The Saudis know exactly what they’re doing. But the current contretemps in the energy world is going to have implications for the rest of the leveraged markets. “Our biggest worry is the end of the liquidity cycle. The Fed is done. The reach for yield that we have seen since 2009 is going into reverse,” says Bank of America (source: The Telegraph).

Contained within Stockman’s analysis is some very interesting work on the nature of employment in the post-recession US economy. First, in the nonfarm business sector, the total hours of all persons working is still below that of 2007, even though we nominally have almost two million more jobs. Then David gives us two charts that illustrate the nature of the jobs we are creating (a topic I’ve discussed more than once in this letter). It’s nice to have somebody do the actual work for you.

The first chart shows what he calls “breadwinner jobs,” which are those in manufacturing, information technology, and other white-collar work that have an average pay rate of about $45,000 a year. Note that this chart encompasses two economic cycles covering both the Greenspan and Bernanke eras.

So where did the increase in jobs come from? From what Stockman calls the “part-time economy.” If I read this chart right and compare it to our earlier chart from the Federal Reserve, it basically demonstrates (and this conclusion is also borne out by the research I’ve presented in the past) that the increase in the number of jobs is almost entirely due to the creation of part-time and low-wage positions – bartenders, waiters, bellhops, maids, cobblers, retail clerks, fast food workers, and temp help. Although there are some professional bartenders and waiters who do in fact make good money, they are the exception rather than the rule.

It’s no wonder we are working fewer hours even as we have more jobs.

Oil in 2015

With all that as a backdrop, let us return to our original task, which was to think about what will impact the US and global economies in 2015. I’ve been talking to friends and contacts who are serious players in the energy-production sector. This is my takeaway.

The oil-rig count is already dropping, and it will continue to drop as long as oil stays below $60. That said, however, there is the real possibility that oil production in the United States will actually rise in 2015 because of projects already in the works. If you have already spent (or committed to spend) 30 or 40% of the cost of a well, you’re probably going to go ahead and finish that well. There’s enough work in the pipeline (pardon the pun) that drilling and production are not going to fall off a cliff next quarter. But by the close of 2015 we will see a significant reduction in drilling.

Given present supply and demand characteristics, oil in the $40 range is entirely plausible. It may not stay down there for all that long (in the grand scheme of things), but it will reduce the likelihood that loans of the nature and size that were extended the last few years will be made in the future. Which is entirely the purpose of the Saudis’ refusing to reduce their own production. A side benefit to them (and the rest of the world) is that they also hurt Russia and Iran.

Employment associated with energy production is going to fall over the course of next year. It’s not all bad news, though. Employment that benefits from lower energy prices is likely to remain stable or even rise. Think chemical companies that use natural gas as an input as an example.

I am, however, at a loss to think of what could replace the jobs and GDP growth that the energy complex has recently created. Certainly, reduced production is going to impact capital expenditures. This all leads one to begin thinking about a much softer economy in the US in 2015.

What If We Just Need Fewer Jobs?

We must balance this problematic analysis against research that Harvey Rosenblum (whom we met at the top of the letter) and my good friend (and likewise Maine fishing buddy) John Silvia, the chief economist at Wells Fargo, have just produced. John is a very solid economist who has his head on straight (in addition to being a really nice guy).

John asked the question, “What if we just need fewer jobs?”:

Job growth is a function of both the supply of and demand for labor. With labor force participation having fallen sharply since the Great Recession and growth in the working-age population slowing, growth in the supply of labor, measured by labor force growth, looks to have downshifted in recent years. As a result, the number of new jobs needed each month to keep the unemployment rate steady has also declined. We estimate that from 2015 to 2020, payroll growth of around 65,000 jobs per month should be sufficient to absorb new entrants into the labor force and to exert neutral pressure on the unemployment rate. This marks a notable downshift from a trend of around 150,000 in the 1980s and 1990s, and even the early 2000s when trend employment growth slowed to around 120,000.

Harvey and I talked about this research, and while we are probably going to ask John for the spreadsheets and more details as to his basic assumptions, anyone who studies demography knows that a serious falloff in the number of new babies began some 23 years ago. And while I don’t think that Baby Boomers are going to retire following the same patterns that we saw in previous generations, there will certainly be an increase in those who think of themselves as retired, reducing the participation rate.

An immediate takeaway from this analysis is that if job growth continues to bump along in the 200,000 range, it will not be too long before there is wage pressure, especially in skilled jobs. That would be good news for workers. If we couple that pressure with a change in the silly rule that says that anyone working more than 30 hours is considered to be full-time and move the number of hours considered to be full-time work to 40 (I think that has a good possibility of passing next year), it will mean that workers (especially those who are younger) get more hours, more income, and better jobs. It will also mean that the unemployment rate will trend down, even if employment growth is not up to historical standards. And let’s make no mistake, it has not been.

Putting today’s rather pathetic job growth in context, George Will writes this week in the National Review:

The euphoria occasioned by the economy adding 321,000 jobs in November indicates that we have defined success down. In the 1960s, there were nine months in which more than 300,000 jobs were added, the last being June 1969, when there were about 117 million fewer Americans than there are now. In the 1980s, job growth exceeded 300,000 in 23 months, the last being November 1988, when there were about 75 million fewer Americans than today.

To demonstrate how young people “are not getting the kind of start others got,” Camp offers a graph charting the “fraction of young adults living with older family members.” Beginning in the middle of the last decade, the line goes almost straight up, to almost 46 percent. For those 25 to 34, median household income plunged 8.9 percent between June 2009 and June 2012, the first three years of the recovery.”

We’re going to stop here before the letter runs too long. Next week we really will get to the global economy and especially the dollar story. We will have to address the very sad question, “Are we really going to have to focus on Greece again?” And while I tend to vigorously disagree with Paul Krugman’s policy analysis and prescriptions, he pretty much gets it right in talking about the problems of Greece in his latest New York Times column “Mad as Hellas.” It is all so very sad.

He ends up talking about the rise of protest parties all over Europe. That is something I have addressed in this letter as well, and it is a disconcerting phenomenon. He concludes with the comment:

But there’s a reason they’re [protest movements] on the rise. This is what happens when an elite claims the right to rule based on its supposed expertise, its understanding of what must be done – then demonstrates both that it does not, in fact, know what it is doing, and that it is too ideologically rigid to learn from its mistakes.

And I totally agree with that statement. I think that’s precisely the lesson we should learn from the 2014 US elections, as well. The irony is that many of us would consider Paul Krugman to be part of that elite. Just saying.

Cincinnati, the Cayman Islands, and Florida

I sent you an email last week noting that we have reopened our Mauldin Economics VIP Program. Subscribers get access to all our current editors at a much-reduced rate. It really is the best deal we offer all year, and perhaps you should consider giving yourself a little gift. I am very proud of our team and the analysis we produce. You get Yield Shark, Bull’s Eye Investor, Rational Bear, Just One Trade, and Transformational Technology Alert, all for just $1,745/year, which is a significant discount from their collective $7,679 published retail value.

I am home for the rest of the month (with perhaps a quick trip to DC being the one outing), but the calendar for next year is beginning to fill up. I see Cincinnati, Grand Cayman, and Florida on my schedule. It has been a while since I’ve been in the Cayman Islands, and this time I will 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. He is also a partner with Grant Williams in Real Vision Television, a fascinating new take on internet investment TV. I’ll be writing more about it in the future.

On a very personal note, everyone is aware of the “We Can’t Breathe” protests that are taking place in response to a very tragic incident in New York. Reasonable people can disagree on what the response should be or on how to interpret the facts of that particular incident, but it is not difficult for me to understand the frustrations of the African-American community.

I have two adopted black sons (now adults) along with my five other children (two of them Asian-American). I can tell you that my experience has been that as teenagers they were far more likely to be pulled over and harassed or arrested for things my white children would have been simply told to stop doing and then sent on their way. For the police it seemed to be a problem for my black sons to drive my car around my (admittedly mostly white) neighborhood. There were clearly double standards, both in some of the public and private schools my children attended. I had to be careful not to put them in certain situations that would cause them frustrations. To pretend there is still not a double standard in our society is to whistle past the graveyard. That said, I don’t want to seem like I’m giving a pass to what is clearly all too often a broken family structure and cultural acceptance of certain inappropriate behaviors among young black men. The frustrations of all parties stem from very real problems. There are no simple answers, and much of the really hard work needs to be done in local communities.

The whole racial issue has vastly improved since I was young. Projections are that by 2020 around 10% of people in the US will be biracial. That is expected to grow to 20% by 2050 and is clearly going to change the way that we (and especially our children) interact with each other. I will have my fifth biracial grandchild sometime later this month. I hope the world they grow up in is considerably different from the world I grew up in or even today’s world. But recent events demonstrate that we still have some miles left on the journey to a truly colorblind system. Rather than defending a system that clearly still has issues that need to be dealt with, we need to face the problems and figure out how to make a world we want all of our children to grow up in.

And on that note, it’s time to hit the send button. Have a great week.

Your working on his Christmas shopping analyst,

John Mauldin
subscribers@mauldineconomics.com

[description] => Last week we started a series of letters on the topics I think we need to research in depth as we try to peer into the future and think about how 2015 will unfold. In forecasting US growth, I wrote that we really need to understand the relationships between the boom in energy production on the one hand and employment and overall growth in the US on the other. 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[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] => 340 ) [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] => 340 [limitstart] => 340 [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_HOST] => wordpress.hubtech.tv [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/) [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8 [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] => 54.83.81.52 [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] => 44432 [GATEWAY_INTERFACE] => CGI/1.1 [SERVER_PROTOCOL] => HTTP/1.0 [REQUEST_METHOD] => GET [QUERY_STRING] => start=340 [REQUEST_URI] => /?start=340 [SCRIPT_NAME] => /index.php [PHP_SELF] => /index.php [REQUEST_TIME_FLOAT] => 1516439376.859 [REQUEST_TIME] => 1516439376 ) [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] => 1516439377 [session.timer.last] => 1516439377 [session.timer.now] => 1516439377 [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/) [registry] => Joomla\Registry\Registry Object ( [data:protected] => stdClass Object ( [com_legacyinterface] => stdClass Object ( [commentaries] => stdClass Object ( [limitstart] => 340 [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] => 340 [limitstart] => 340 [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_HOST] => wordpress.hubtech.tv [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/) [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8 [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] => 54.83.81.52 [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] => 44432 [GATEWAY_INTERFACE] => CGI/1.1 [SERVER_PROTOCOL] => HTTP/1.0 [REQUEST_METHOD] => GET [QUERY_STRING] => start=340 [REQUEST_URI] => /?start=340 [SCRIPT_NAME] => /index.php [PHP_SELF] => /index.php [REQUEST_TIME_FLOAT] => 1516439376.859 [REQUEST_TIME] => 1516439376 ) [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] => 1516439377 [session.timer.last] => 1516439377 [session.timer.now] => 1516439377 [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/) [registry] => Joomla\Registry\Registry Object ( [data:protected] => stdClass Object ( [com_legacyinterface] => stdClass Object ( [commentaries] => stdClass Object ( [limitstart] => 340 [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] => 340 [limitstart] => 340 [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_HOST] => wordpress.hubtech.tv [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/) [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8 [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] => 54.83.81.52 [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] => 44432 [GATEWAY_INTERFACE] => CGI/1.1 [SERVER_PROTOCOL] => HTTP/1.0 [REQUEST_METHOD] => GET [QUERY_STRING] => start=340 [REQUEST_URI] => /?start=340 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Unlike most meetings, today’s actions by the Federal Reserve were chock full of implications for the future course of monetary policy. At long last, the Fed finally removed the language in its statement that short-term interest rates will remain at essentially zero for a “considerable time” and replaced it with language that the Fed will be “patient” before starting to increase rates.

Several months ago, Fed Chair Janet Yellen let it slip that she thinks a “considerable time” means about six months. As a result, we are increasingly confident in our forecast that the first rate hike will come by June 2015, six months from now.

What’s striking about the rest of the Fed’s policy statement is how focused it is on the labor market, altering the wording of its statement as well as its economic projections slightly here and there to signal its own increased confidence in job creation and declining unemployment.

The obsession with the labor market helps explain why the Fed was willing to look past the recent oil-induced drop in overall inflation. Remember, the Fed doesn’t care as much about where inflation is today as where its own models are projecting inflation to go over the next few years. And while it expects inflation to remain low for the time being, it sees this as temporary and that one of the reasons inflation will rebound is improvement in the labor market. The Fed may be the most ardent advocate of the Keynesian Phillips Curve in the world.

When the Fed starts raising rates it is unlikely to raise rates at every meeting, as was done in the past two prolonged rate hike cycles under Alan Greenspan in the late 1990s and Ben Bernanke in the middle of the prior decade. Yellen cautioned against this view at the press conference following the meeting. In addition, the “dot matrix” showing where policymakers think interest rates will go over the next few years suggests the Fed will, for the first year of rate hikes, alternate between raising short-term rates at one meeting and then pausing at the next, making for one rate hike of 25 basis points per quarter through mid-2016.

The “median” dot may suggest a slightly faster pace of rate hikes, but we’re guessing that, as the leader of the Fed, Yellen will ultimately get her way and she is probably on the dovish side of the dot matrix. With the highest dot being the most hawkish, Yellen is probably around dot number 12, give or take, and that dot shows three rate hikes in 2015 and six in 2016.

Another issue is when the Fed’s balance sheet will go back to normal. We’re still forecasting that the Fed will keep reinvesting principal payments from its asset holdings to maintain the balance sheet at roughly $4.4 trillion through at least late 2015.

Notably, this last meeting for 2014 must have been a contentious one. Three members dissented. Once again, Minneapolis Fed president Narayana Kocherlakota disagreed from the dovish side, saying inflation was too low. The two other dissents were from hawks. Dallas President Richard Fisher thought rate hikes should come earlier and Philadelphia President Charles Plosser thought the statement was too focused on the timing of rate hikes rather than the economic conditions that would generate rate hikes. In addition, Plosser thought the statement was not optimistic enough.

The bottom line is that while the Fed is still behind the curve, it’s at least finally pointed in the right direction, and, barring some major shift in its outlook for the economy, the clock is ticking on rate hikes. Nominal GDP – real GDP growth plus inflation – is up 4.0% in the past year and up at a 3.9% annual rate in the past two years. A federal funds target rate of nearly zero is too low given this growth. It’s also too low given well-tailored policy tools like the Taylor Rule.

In the meantime, hyperinflation is not in the cards; the Fed will keep paying banks enough to keep the money multiplier depressed. But, given loose policy, we expect gradually faster growth in nominal GDP for the next couple of years. In turn, the bull market in equities will continue and the bond market is due for a fall.

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] => Unlike most meetings, today’s actions by the Federal Reserve were chock full of implications for the future course of monetary policy. At long last, the Fed finally removed the language in its statement that short-term interest rates will remain at essentially zero for a “considerable time” and replaced it with language that the Fed will be “patient” before starting to increase rates. [author] => Brian Wesbury, Robert Stein [legacyinterface_firm_id] => 154 [published_on] => 2014-12-18 [digest_date] => 2014-12-18 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-18 15:39:42 [created_by] => 948 [modified_on] => 2014-12-18 15:40:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2179 [hits] => 0 ) [1] => stdClass Object ( [legacyinterface_commentary_id] => 2114 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15353 [apv_conversation_id] => [content_type] => market-commentary [title] => A Tale of Two Markets [slug] => guggenheim_121814 [fulltext] =>

As seasoned investors are well aware, financial markets and economic trends seldom move in straight lines. Nowhere was this old adage more evident than in the discrepancy between last week’s domestic economic data releases and the performance of the stock market. Although U.S. equities suffered their biggest one-week drop since May 2012 on the back of declining oil prices, American consumer confidence reached new post-recession highs, with retail spending for the month of November comfortably beating expectations.

While the U.S. economic expansion continues to power forward, the international situation is becoming increasingly grim. The recent decline in the ruble, which Russia attempted to slow with a surprise rate hike of 6.5 percentage points to 17 percent, is reminiscent of the early stages of the 1998 Russian crisis. Elsewhere, the European Central Bank has fallen behind the curve, Abenomics in Japan is stalling, and China is making the painful adjustment to slower growth. Nevertheless, while international events are likely to get worse and energy prices are likely headed lower, I don’t envision a larger economic malaise spreading to the United States in the near term.

Understandably, investors are currently spending the majority of their time worrying about oil and where the price bottom is. The United Arab Emirates’ energy minister announced over the weekend that OPEC is standing behind its Nov. 27 decision not to cut the group’s collective output target of 30 million barrels per day, which highlights the blatant lack of pricing discipline within the organization. As oil continues its decline, pressure is increasingly mounting on credit markets, especially high-yield corporate bonds, where energy-related borrowers represent 15-20 percent of the market.

The flip side is that as spreads widen, we get closer to the levels where large investors, such as pension funds and insurance companies, start to see value in the high-yield market, which should help stabilize credit spreads. Ultimately, what investors should prepare for is an extended period of depressed oil prices. Oil still has substantial downside room to run before reaching a level of stability. Once stabilized, depressed oil prices will create another “tale of two markets”— companies with oil exposure and those without.

Chart of the Week

Leading Indicators Suggest No Recession

Plunging oil markets and faltering growth expectations around the world have raised fears about the sustainability of the current U.S. economic expansion. The economic data, though, suggest that these fears are largely unfounded. The Conference Board’s Leading Economic Index, which is made up of 10 forward-looking economic and financial indicators, has not fallen since January and has been gaining momentum throughout the year. Until we see the LEI approach negative year-over-year growth, which has preceded the last seven recessions, the U.S. economy should continue to ride out the storm emanating from overseas.

THE CONFERENCE BOARD LEADING ECONOMIC INDEX AND U.S. RECESSIONS

The Conference Board Leading Economic Index and U.S. Recessions

Economic Data Releases

U.S. Consumer Confidence and Industrial Production Rise
  • University of Michigan Consumer Confidence continued to make post-recession highs in the preliminary December reading, jumping to 93.8 from 88.8.
  • Industrial production beat estimates in November, rising 1.3 percent, the best month since May 2010, on the back of a surge in consumer goods output.
  • The Empire State Manufacturing Survey unexpectedly dropped to -3.6 from 10.2 in December, the lowest level in nearly two years.
  • The NAHB Housing Market Index inched down to 57 from 58 in December. Regional indexes were mixed, with the Northeast showing the largest decline.
  • Housing starts disappointed in November, falling 1.6 percent to 1.03 million. Multi-family starts were up while single family starts fell.
  • Building permits fell to 1.04 million from 1.09 million in November, a larger-than-expected decline.
  • The Consumer Price Index dropped to 1.3 percent in November, a nine-month low. Prices, excluding food and energy, ticked down to 1.7 percent.
  • The Producer Price Index continued to decline in November, reaching 1.4 percent, an eight-month low.
Mixed Data Out of Europe and Asia
  • Euro zone industrial production missed estimates for October, inching up just 0.1 percent. The prior month was also revised down to 0.5 percent.
  • The euro zone manufacturing PMI improved more than expected in December, reaching a five-month high of 50.8. The services PMI rose for the first time since July, up to 51.9.
  • Germany’s manufacturing PMI climbed back into expansion in December, beating expectations by rising to 51.2 from 49.5. The services PMI fell to a 17-month low of 51.4.
  • Germany’s ZEW survey rebounded slightly in December, rising to 10 from 3.3 in the current situation index. The expectations index experienced a sharper improvement, rising to the highest level since April at 34.9.
  • The French manufacturing PMI declined for a third straight month in December, falling to 47.9 from 48.4. The services PMI rose to 49.8, a four-month high.
  • The U.K. CPI dropped to 1.0 percent in November, the fifth straight decline and the lowest since 2002.
  • China’s HSBC manufacturing PMI fell for a second consecutive month in December to 49.5, entering contraction for the first time in seven months.
  • Industrial production in China slowed more than expected in November, dropping to 7.2 percent year-over-year growth from 7.7 percent.
  • Growth in Chinese retail sales accelerated to 11.7 percent year over year in November, the first acceleration since May.
  • Japan’s Tankan survey of large manufacturers inched down to 12 from 13 in the fourth quarter. The outlook index fell to a three-quarter low.
  • Japanese export growth slowed in November, dropping to 4.9 percent from 9.6 percent.

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2014, Guggenheim Partners. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

© Guggenheim Partners

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Dear Client,

As 2014 comes to a close, we want to provide an update on the energy sector. Energy has been making headlines as oil prices have reached unexpected lows. As discussed below, while the decline in oil prices is creating volatility in the energy sector, we believe that there continues to be opportunity in this sector and that the low oil prices should prove beneficial to U.S. and global economic growth.

The price of oil began to slip from its highs in June with the decline continuing through the third quarter before plunging in late November. The proximate cause is a mismatch between growing global supply and stagnating demand. The weakness in demand was not a big surprise given the well documented, recent economic slowdown in Europe, Japan and China. The growth in supply did not come as a surprise either. U.S. and Canadian producers delivered sharp increases in production in each of the last two years and the consensus view was that North American production would continue to expand at a nearly 1.0 million barrel-per-day rate in 2014 and again in each of the next several years. The big surprise that undermined the oil markets occurred in September, October and November, when Libyan production came back on stream and Saudi Arabia did nothing in response. As the weeks passed without any sign of a reduction in Saudi production, the price of oil started to fall. When OPEC met formally on Thanksgiving Day and the Saudis officially and definitively said that they would not cut back production to steady the price of oil, the markets collapsed. For all intents and purposes, the Saudi message to the world was that the OPEC cartel is finished.

There has been much speculation about the motivation of the Saudis. The official Saudi position is that they needed to cut the price of oil to maintain market share in critical Asian markets. This is no doubt true, but the universal expectation was that the Saudis would do just that in the name of steadying the price of oil in the $90-$110 range. After all, they are the largest OPEC producer by a factor of more than two and they ramped up capacity and production over the past several years to keep prices from quickly rising when political unrest in other OPEC countries led to supply shortfalls. It stood to reason that they would pull back their production to pre-Arab Spring levels as output resumed from other OPEC producers. Why, then, did the Saudis decide to keep producing this fall at these new higher levels at the expense of prices dropping below the range they had been defending for the past three years? We think the answer is that they determined that longer term prices above $90 per barrel would lead to ever increasing supply out of North America and therefore require the Saudis to continuously reduce their production to keep markets balanced. They concluded that no other producer would step in and reduce output. The result over just the next 3-5 years would have been a massive reduction in Saudi output and market share — possibly in the range of 30-50%! We believe their bet is that by letting the price of oil fall, market forces will now slow the rate of production increases globally, especially in North America. They believe that many of the new unconventional oil wells in the U.S. are unprofitable with prices below $70. The same is true for many of the mega ultra-deep water, oil sands and Arctic projects around the world that may have very low extraction costs but very high capital costs.

With prices nearing $60 per barrel, it is a good bet that the pace of oilfield development around the world will slow meaningfully in the coming 6-12 months and remain at subdued levels until the price rises back above the $80 level. It is impossible to know just how low the price will fall in coming weeks and months. Some high cost production should get shut down at a price below $50, but, more importantly, we think fewer new shale wells will get drilled and even some drilled wells waiting for completion may not get completed. Consequently, supply should start to contract by next spring/summer and oil prices will likely rebound by next fall.

The macro level implications of lower oil prices are positive for all net oil consuming countries, including the U.S., Europe and the major Asian economies (Japan, China, India, et al). The U.S. seems likely to be the clear winner. The benefits of lower oil prices should be greater for the U.S. than for most of our trading partners because the rising U.S. dollar (driven by low global interest rates and commodity costs) offsets some of the benefits to these other economies. The clear losers are Russia, Iran, Nigeria, Venezuela and a number of other net oil exporting countries that are heavily dependent on oil revenues and who need a price in excess of $100 per barrel to balance their fiscal regimes.

For the U.S. economy, lower oil prices generally increase discretionary income for consumers. This can translate into higher spending on both durable (cars, houses, etc.) and non-durable (clothing, leisure, dining, etc.) goods. Consumers are likely to buy larger, less fuel efficient cars and trucks, which means the auto industry should sell both more vehicles and more of their most profitable larger models. The combination of lower oil prices and a stronger dollar (which leads to lower import prices) suggests that inflation will stay lower longer than would have been the case had oil prices remained in the $90-$110 range. Lower inflation likely means that the Federal Reserve (the Fed) will be able to keep interest rates lower for longer, allowing unemployment to fall further and wages to rise more before the Fed feels the need to raise rates. Slowing domestic shale development will probably detract from U.S. economic growth, but lower oil prices should be a net benefit to the economy.

In terms of what declining oil prices mean for our equity strategy, we have been uncomfortable with commodity companies for some time, going back to the collapse in the natural gas markets in 2008 and more recently with the slowing in the Chinese economy. History has shown us that a worldwide investment boom to increase supply of any commodity in response to high prices almost always results in a price collapse when the new supply hits the market. For this reason the focus of our investing in the energy patch for the past five years has been on companies that benefit from rising volumes – not prices. Our investments make their money moving other people’s energy around without actually taking title to the commodity itself.

At present, our equity strategy has only one direct commodity company: Occidental Petroleum (OXY). We own OXY because its current management team is conducting a sweeping restructuring and downsizing initiative that should result in a smaller, more profitable and more focused company with little or no debt, the lowest costs in the industry and decades of attractive growth potential even if prices never get back above $100 per barrel. All of the other energy holdings in our strategy are infrastructure companies with little or no direct commodity exposure. These companies own and operate strategically critical gathering, processing, storage and/or shipping assets that generate fee-based revenues. While it is certainly possible that these companies’ growth will be slower in the years ahead with oil prices closer to $60 than $100 per barrel, we believe they should still be able to both maintain and grow their earnings, cash flows and dividends/distributions to equity holders. In fact, the collapse in oil prices may make their storage assets more attractive given that the expected future price of oil is higher than the current price. This creates an incentive to store oil today and sell it at higher prices in the future. Also, consumption of oil, as well as the refined products derived from oil such as gasoline, diesel and jet fuel, may rise in response to lower prices. This could increase demand for certain pipeline and storage assets. Ironically, natural gas could also get a lift from lower oil prices, because of one of the odd secrets of the boom in shale oil production: Much of what comes out of many shale oil wells is natural gas and related natural gas liquids. If far fewer oil wells are drilled in the next 6-12 months, this will likely result in less natural gas, potentially firming its price, which would benefit a number of our infrastructure holdings.

None of this means that our energy holdings will be spared from short-term volatility related to the collapsing price of oil. As we recently saw, Master Limited Partnerships (MLPs) experienced indiscriminate selling in the wake of declining oil prices. However, we continue to have high conviction in our MLPs and believe that longer-term they will prove to be valuable assets for our investors. Additionally, as the price of oil continues to be under pressure, we may be able to find some high quality energy exploration and production companies that would normally be out of our price range.

Looking at fixed income, our exposure to energy is also underweight commodity energy producers. While we have felt for some time that the next possible bubble would be in energy commodity producers, given the huge investments made in the past several years, we have made selective investments in service companies that are focused on treating waste produced mainly from producing wells. These wells are less likely to be shut down as the discovery and drilling costs are behind them. We have also made investments in infrastructure and storage companies, which, as discussed above, are much less sensitive to the price of the commodity and may actually benefit from a positively sloping future price curve for oil. This has not, however, prevented them from being tarred with the energy label as many investors who were overweight the sector attempt to pare holdings going into year end. If our view is correct that as future supply is curtailed and economic strength gains momentum, we could likely see a rebound as early as late 2015.

We will further discuss our economic perspective in our January Investment Outlook, but in general we continue to believe that the U.S. is well-positioned to maintain its slow growth trajectory. Some are even saying that the U.S. has entered into a period that none of us here have ever seen – a deflationary boom. We don’t expect weakness in Europe, Japan or China to spill over to the U.S. because the U.S. is well insulated from global trade flows. That said, we are mindful of the many risks that could affect our outlook, such as geopolitical unrest, sudden declines in consumer/business confidence, a downdraft in economic activity or a corporate profit collapse. Right now we think these risks are remote, but we continue to vigilantly monitor them.

Best wishes for a very happy and prosperous 2014.                                                                 

John Osterweis                       Matt Berler                               Carl Kaufman

Past performance is no guarantee of future results.

This commentary contains the current opinions of the author as of the date above, which are subject to change at any time. This commentary has been distributed for informational purposes only and is not a recommendation or offer of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

OPEC refers to the Organization of the Petroleum Exporting Countries.

Fund holdings and allocations are subject to change at any time and should not be considered a recommendation to buy or sell any security. As of 9/30/2014, the Osterweis Fund, the Osterweis Strategic Investment Fund and the Osterweis Institutional Equity Fund held 2.99%, 1.88% and 3.16% of Occidental Petroleum, respectively.

Cash Flow measures the cash generating capability of a company by adding non-cash charges (e.g. depreciation) and interest expense to pretax income.

© Osterweis Capital Management

[description] => As 2014 comes to a close, we want to provide an update on the energy sector. Energy has been making headlines as oil prices have reached unexpected lows. As discussed below, while the decline in oil prices is creating volatility in the energy sector, we believe that there continues to be opportunity in this sector and that the low oil prices should prove beneficial to U.S. and global economic growth. [author] => John Osterweis, Matt Berler, Carl Kaufman [legacyinterface_firm_id] => 327 [published_on] => 2014-12-18 [digest_date] => 2014-12-18 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-18 15:47:42 [created_by] => 948 [modified_on] => 2014-12-18 15:48:11 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2181 [hits] => 0 ) [3] => stdClass Object ( [legacyinterface_commentary_id] => 2101 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15340 [apv_conversation_id] => [content_type] => market-commentary [title] => Where Did The New Middle Class Citizens Go? [slug] => smead_121714 [fulltext] =>

Dear Fellow Investors,

The "well known fact" with regards to oil over the last decade read like this: because of huge GDP growth in emerging markets like China, there were going to be 400 million new middle class citizens born of uninterrupted prosperity; they were going to want all the autos, consumer goods, $10,000 watches and food that Americans have. The demand for commodities was going to be endless because capitalism practiced under authoritarian control was going to be better than the "invisible hand" of the free market. No recessions or depressions required.

Now, with oil dropping from $95 per barrel to below $57 through the first half of December 2014, many pundits seem to focus on the over-supply of oil and falling demand in a slowing global economy. But we think they miss the long-term view.

As long-duration common stock investors, we don’t see oil dropping merely because OPEC and Bakken Shale have produced too much supply. Instead, we see oil’s demise as a symptom of something larger: the unwinding of a globally synchronized trade tied to the “well known fact” stated above.

Part of the job of the long-term contrarian investor is to identify a body of economic information which is not only known to all market participants, but has been acted upon by anyone in the marketplace who wishes to participate. We call this the “well known fact.” If we know where the vast majority of investors are, then we can contentiously go where they are not.

Nearly every major institutional and high-net-worth individual investor had to adjust their portfolio to this particular “fact” about China and the emerging markets over the last decade. The most successful money managers of the prior decade, who had successfully participated early in the “well known fact,” were validated and received adulation for promoting it (think BRIC-trade). As Warren Buffett likes to say, “What the wise man does at the beginning, fools do at the end.”

The boom created by a once-in-a-generation and massive capital re-allocation toward everything related to the globally-synchronized trade did what all booms do. It turned to bust. Few experts or pundits view it this way, but for many it’s often tough to see the forest through the trees.

We think it would be helpful at this point to review other psychologically-driven boom-bust cycles to analyze the depth of their declines and the duration of the bear market which followed. In this way, we might prosper from the disarray of investment managers and the largest institutional pools. They remained trapped chasing an over-capitalized belief in the 400 million new middle-class citizens on "a permanently higher plateau" in commodities.

Go-Go Mutual Fund Boom Peaked in 1968

  • Well Known Fact: Technology sparked by the space race was limitless.
  • Result: Small-Cap Stock Boom.
  • Declines to 1974 Bear-Market Low 60-80%.
  • Duration: 6 years.

Nifty-Fifty Large-Cap Stock Boom 1972

  • Well Known Fact: 50 companies having limitless earnings growth and consistency.
  • Result: Institutions had 74% of their portfolio in common stocks at the beginning of 1973.
  • Declines of 50-80% and no ultimate bottom until 1982.
  • Duration: 10 years.

Commodity Boom of the 1970s peaking in 1981

  • Well Known Fact: Never ending double-digit inflation demanded investments which benefit from inflation (Oil, Gold, etc.).
  • Result: stock, Gold stock and Commodity Boom.
  • Declines of 70% in Oil and 60% in Gold ending in 1999.
  • Duration: 18 years.


Tech Bubble 2000

  • Well Known Fact: The Internet Will Change Our Lives.
  • Result: Tech-Heavy NASDAQ Index fell 78% and isn't back to even 15 years later.
  • Duration 3 Years.


Residential Real Estate 2005

  • Well Known Fact: Houses always go up in value and are geographically diverse.
  • Result: Homes fell 50% in hottest markets and the leverage attached to them created the biggest financial meltdown since the 1930s, helping to cause a 50% decline in stock prices.
  • Duration: 7 Years.


What can we as long-duration common stock investors glean from reviewing these past episodes of financial euphoria? First, it appears that stocks confess sins and cleanse faster than other asset classes. Second, the connection to leverage and the inter-connectedness of multiple asset classes seemed to cause longer-duration declines in the past. For example, tech stocks had very little debt and most investors weren't using margin in 1999. Therefore, the grief didn’t spread to the real economy; however, owners of leveraged oil tax shelters and garden-style apartments in the Sun Belt in 1981 were illiquid and everything inflation-related was tied together.

Third, our observations suggest that asset quality affects decline duration. Exxon paid dividends from 1981-1999, while gold and commodity indexes didn't. Investors had something to fall back on like earnings, free cash flow and dividends.

Lastly, how fast can money managers purge? Most institutions and high-net worth individual investors have the stamp of the well-known-fact all over their portfolios as evidenced by studies like the 2013 NACUBO study of endowments and foundations. It should take years to rearrange their commitment to all aspects of the globally-synchronized trade.

What do we look for among common stocks as we bargain hunt in sectors which get unwound by a vicious bear market following the unwinding of a “well known fact?” We will watch for the shaming of the globally-synchronized-trade apologists in the media and the closing or liquidation of sector mutual funds, ETFs, hedge fund and private equity vehicles tied to the globally-synchronized trade. This is historically what occurs near the bottom as capacity contracts severely. So far, nobody has even been criticized yet, let alone vilified. Wait for the time when few are mentioning the new 400-million middle class citizens and when the word "damn" gets put in front of the stocks, commodities and asset classes involved. Finally, we believe that you shouldn’t give too much weighting to any mid-December 2014 explanation which doesn't include the psychology of a boom/bust cycle and the long-duration nature of the law of supply and demand.

Warm Regards,

William Smead

The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

© Smead Capital Management

[description] => The "well known fact" with regards to oil over the last decade read like this: because of huge GDP growth in emerging markets like China, there were going to be 400 million new middle class citizens born of uninterrupted prosperity; they were going to want all the autos, consumer goods, $10,000 watches and food that Americans have. [author] => William Smead [legacyinterface_firm_id] => 392 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:20:04 [created_by] => 948 [modified_on] => 2014-12-17 16:23:12 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2167 [hits] => 0 ) [4] => stdClass Object ( [legacyinterface_commentary_id] => 2102 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15341 [apv_conversation_id] => [content_type] => market-commentary [title] => If Corporate America Is Investing in Sustainability, Then Why Aren’t You? [slug] => advisorshares_121714 [fulltext] =>

By: Michael Marinus Young, AdvisorShares Institutional Consultant

“Thanks, but I don’t believe in that stuff…”

While traveling the country this fall, that was the response we received from some financial advisors after the introduction of an investment that focuses on sustainability. When pressed to explain, the common refrain was “ESG or SRI investments underperform, and I want my clients invested in the best companies”.

Unfortunately, thirty seconds in an elevator or hallway is not enough time to build the case for sustainability. But here on AlphaBaskets, we’re afforded the space and time to better explain why Sustainability should matter to them, and you. And rather than start from scratch, let us lead you to a recent piece from Fast Company: http://www.fastcoexist.com/3036010/why-is-goldman-sachs-advocating-for-sustainability

If “Accenture, Deloitte, Goldman Sachs, Harvard Business School, McKinsey & Company, and PricewaterhouseCoopers have released data-driven case studies, global surveys, and exhaustive reports offering compelling proof that using business as a force for good is also good for business”, then how could a financial professional ignore the facts and say “thanks, but I don’t believe in that stuff”? Willful ignorance or a deep-seeded bias? Maybe. Whatever the reason, this cognitive dissonance is present when the facts conflict with preconceived notions.

SRI (Socially Responsible Investing) may have evolved into ESG (Environmental, Social and Governance), but ESG is still a three-letter acronym that some will dismiss as a niche. A three-letter acronym doesn’t describe the future of investing - it just reinforces the negative reaction from the uninitiated or under-educated. This is a movement in the investing world that isn’t going away. Corporate Sustainability, Shareholder Advocacy and Activism, Community Investing, Targeted Divesting, and Impact investing are all parts of the broader message that is gaining the attention of both corporations and investors. If a self-described financial professional does not see that, they’ll be left on the sideline as the industry around them continues to innovate and evolve.

Here’s the funny thing… If a financial advisor asked us to convince them, we wouldn’t even start with all the facts. We would begin with the following logic: Your clients are paying attention to this, learning about this, and looking for guidance. Many of your clients have children, and those children are paying attention to this new shift in investing. Those children are the people that will inherit the accounts you manage, so if you aren’t connecting with them… You won’t be their financial advisors. Beyond potential underperformance, you are risking losing accounts because “you don’t believe in that stuff”.

The question should not be whether you believe in “that stuff”, but rather: “I wonder if there’s an ETF for that?”

© AdvisorShares

[description] => Unfortunately, thirty seconds in an elevator or hallway is not enough time to build the case for sustainability. But here on AlphaBaskets, we’re afforded the space and time to better explain why Sustainability should matter to them, and you. [author] => Michael Marinus Young [legacyinterface_firm_id] => 14 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:26:06 [created_by] => 948 [modified_on] => 2014-12-17 16:26:27 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2168 [hits] => 0 ) [5] => stdClass Object ( [legacyinterface_commentary_id] => 2103 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15342 [apv_conversation_id] => [content_type] => market-commentary [title] => Plunging Oil Prices Spark Fears of Global Recession [slug] => halbert_121714 [fulltext] =>

IN THIS ISSUE:

1.  Could Plunging Oil Prices Portend Something Worse?

2.  Worst Week For Dow Jones Stocks Since 2011

3.  Americans Finally Turning Bullish on the Economy

4.  National Debt Topped $18 Trillion in Late November

Overview

Today, we touch on several bases. No doubt everyone reading this noticed that stocks tanked last week, and now seem to be moving in lockstep with oil prices. While consumers welcome cheaper gas and heating oil prices, there is a growing fear that the collapse in oil prices may be a harbinger of a global recession.

Despite worries that the oil price plunge is pulling down stock prices, the latest Reuters/University of Michigan Consumer Sentiment Index soared to a near eight-year high this month. Expectations for a better job market helped power the Index from 88.8 in November to 93.8 this month, well above expectations.

Finally, I am sad to report that our national debt topped $18 trillion on November 28 according to the Treasury Department. It was not widely reported by the mainstream media, of course. While our annual budget deficits have come down significantly from the first four years of the Obama administration, we are still on-track to hit a whopping $20+ trillion national debt by 2019.

Could Plunging Oil Prices Portend Something Worse?

Cratering crude oil prices may be a blessing to cash-strapped American consumers, but it’s a double-edged sword when it comes to the overall economy. The problem for the overall economy is not so much the drop in oil prices as it is the velocity at which oil prices have fallen.

The plunge from a peak of just over $107 (West Texas Intermediate) per barrel in the early summer to today’s sub- $56 is a massive drop of apprx. 45% in just a few short months, most of which has come in the last few weeks. This has analysts worrying that something worse may well be going on.

The rapid fall in crude prices is a telling sign to some Wall Street analysts and economists that there may be a global recession taking hold and the slowing growth is pushing oil lower. Remember, at the height of the financial crisis, crude got down into the high $30s a barrel at the end of 2008 as the US and Europe went into a recession.

Some forecasters believe that energy pricing forces have gone well beyond the supply/demand models and are now considering other geopolitical developments. As I wrote last week, I know of no forecasters that predicted oil prices would fall this far this fast.

There are plenty of commodity fund operators and hedge fund managers holding high-yield energy bonds that are taking it on the chin. Plus, several of the largest banks came out last week saying that while business in general was good, trading revenue will be down from last quarter – presumably due to losses in energy positions.

The banks did not attribute it to oil’s slide but, given the collapse in crude prices, it should be safe to assume that their profits from rising bond prices of late were dampened by plummeting oil prices in their commodity holdings and cratering high-yield energy plays, which may default at some point.

Crude Oil WTI

The swift collapse in energy prices has certainly taken a toll on our fastest-growing US industry and our country’s #1 job producer since the recession – domestic drilling for oil and natural gas. As the price of WTI crude is now below $55 a barrel, domestic drillers in Pennsylvania and the upper Midwest may be hard-pressed to keep production going full throttle.

At stake are nearly two million well-paying jobs. According to the most recent Bureau of Labor Statistics figures, the average worker in the oil and natural gas industry was making $107,198. That’s almost $58,000 higher than the average annual pay across all industries.

Big Oil is definitely feeling the pinch. ConocoPhillips just slashed its 2015 capital-expenditures budget by a whopping 20% to $13.5 billion earlier this month. The more than $3 billion budget cut was significantly larger than analysts were expecting.

In the past, lower oil prices were beneficial to the US economy, and they will be this time as well. Yet there are growing fears that the current collapse in energy prices may be a harbinger of a global recession. This explains why the plunge in oil prices spilled over into the equity markets last week and so far this week.

Worst Week For Dow Jones Stocks Since 2011 

US stocks were pummeled last week as investors, rattled by collapsing oil prices and concerned about the health of the global economy, fueled triple-digit losses in blue-chip stocks. The S&P 500 ended the week with the biggest loss in two-and-a-half years, down over 3.5%, while the Dow Jones Industrial Average recorded its largest weekly decline since September 2011. Both markets were down again yesterday.

Last week’s jarring selloff came on the heels of seven straight weeks of gains and was closely linked to the precipitous fall in oil prices, sending a measure of volatility, the VIX, to its highest level since October 17.

Crude oil futures dropped more than 12% over the past week as global supply continued to outstrip demand, while the International Energy Agency cut its forecast for global demand yet again.  Despite that, OPEC voted earlier this month not to cut daily oil production despite its own forecast that global demand for its oil is now the lowest since 2003.

You would think that those facts alone would sufficiently explain the sudden plunge in oil prices. Yet investors are growing increasingly concerned that the global economy might be succumbing to deflation, a consistent decline in prices that usually leads to recessions and depressions.

Plunging crude prices

Stocks plunged from mid-September through mid-October before staging a sharp rebound that culminated with the Dow hitting a new all-time high earlier this month on the back of a strong US jobs report. Heading into last week, many investors were predicting that the Dow would soon top 18,000 for the first time.

But the sharp sell-off in oil has changed all that. Crude prices are now below $55 a barrel, their lowest level in more than five years. Energy stocks have been hit hard as a result.  However, oil stocks were not the only big losers last week – and that could be another sign that investors are growing more nervous about the overall market and a weakening global economy.

It will be interesting to see how much longer this trend can last. If oil prices continue to drop and the economies of Europe, Asia and Latin America weaken further, that eventually has to hurt the US economy at some point.  

Americans Finally Turning Bullish on the Economy

While it remains to be seen how the oil price plunge plays out, lower gasoline and heating oil prices are boosting consumer sentiment. Pessimism and doubt have dominated how Americans see the economy for many years. Now, in a hopeful sign for the economic outlook, confidence is suddenly picking up.

Expectations for a better job market helped power the Thomson Reuters/University of Michigan Consumer Sentiment Index to a near eight-year high in December, according to data released on Friday. The Index jumped from 88.8 in November to a higher than expected 93.8 this month.

Consumer Sentiment Index

US consumers also saw sharp drops in gasoline prices as a shot in the arm, and the survey added heft to strong November retail sales data (+0.7%) that has showed Americans getting into the holiday shopping season with gusto. Surging expectations signal very strong consumption over the next few months.

While improvements in sentiment haven’t always translated into similar spending growth, consumers at the very least are feeling the warmth of several months of robust hiring, including 321,000 new jobs created in November.

When asked in the survey about recent economic developments, more consumers volunteered good news versus bad news than in any month since 1984, said the poll’s director, Richard Curtin. Moreover, half of all consumers expected the economy to avoid a recession over the next five years, the most favorable reading in a decade, Curtin said.

The data bolsters the view that the US economy is turning a corner and that worker wages could begin to rise more quickly, laying the groundwork for the Federal Reserve to begin hiking its benchmark interest rate next year.

Many investors polled see the Fed raising rates in mid-2015, and the FOMC will likely debate at its meeting today and tomorrow whether to keep a pledge that borrowing costs will stay at rock bottom for a“considerable time.”

Consumers polled also see higher inflation ahead. Over the next year, they expect a 2.9% increase in prices, up from a 2.8% annual rate in November, according to the sentiment survey. Their expectations run quite counter to recent price data. The Labor Department reported that its producer price index dropped 0.2% last month, brought about by falling gasoline prices. Prices overall were soft last month, even excluding the drag from gasoline.

National Debt Topped $18 Trillion in Late November

On November 28, the Treasury Department reported that the national debt stood at $18,005,549,328,561. It was the first time ever that our debt was above $18 trillion. That exceeds total Gross Domestic Product of$17.555 trillion as of the end of the 3Q. So our national debt was 103% of GDP as of the last Friday in November.

The debt was at $10.6 trillion when President Obama took office in 2009 but has increased by 70% – or$7.3 trillion – during his roughly six years in office. That compares to roughly $4 trillion that was added to the national debt during all eight years of the George W. Bush presidency. Obama is on-track to double the amount Bush added to the debt.

When campaigning for the White House in 2008, then-candidate Obama routinely criticized President Bush for running up the national debt by $4 trillion, calling it unpatriotic” and “irresponsible.” By his own reasoning then, he has reached a new level of irresponsibility.

Even worse, Obama promised at least four times in 2009 that he would cut the deficit in half by the end of his first term. Despite these promises, he racked-up deficits larger than all previous presidents combined and ran four consecutive $1+ trillion deficits:

FY2009  $1.413 trillion FY2011  $1.299 trillion
FY2010  $1.294 trillion FY2012  $1.090 trillion

The new $18 trillion national debt figure reached on the Friday after Thanksgiving drew little attention in the media largely because the federal deficit – the amount the US government spends annually in excess of revenue – has dropped in recent years from roughly $1.4 trillion in FY2009 to $506 billion in FY2014, according to the Congressional Budget Office. 

The CBO expects the budget deficit to fall further to $469 billion in FY2015, but then it projects the annual deficits to begin rising again and approach $1 trillion by 2022 and beyond. Even with these lower annual deficits, the CBO projects that our national debt will top $20 trillion in FY2019.

Interest expense on the national debt is what usually sinks heavily indebted countries. The near-zero interest rate environment we have today masks the problem. When we return to normal interest rates, say 6%, the interest on the national debt will jump to apprx. 25% of tax receipts. We have recently seen what happens to countries with debt problems similar to ours. Spain, Portugal, Greece, and Argentina have all been brought to their knees by excessive debt.

For all these reasons, fiscal conservatives argue that the unprecedented national debt is still a huge problem. Count me among them! Kevin Broughton, spokesman for the Tea Party Patriots, calculates that the debt, when divided equally among the US population, means that “every man, woman and child in the country owes $56,250.” 

To see US national debt in live time click here.

Composition of the National Debt

Of the $18.005 trillion in debt at the end of November, $12.923 trillion is “debt held by the public” and$5.082 trillion is “intra-governmental holdings.” Debt held by the public consists of all the outstanding Treasury bills, notes and bonds held by individuals, corporations, foreign governments and others.

Intra-governmental debt of $5.08 trillion includes special securities held by US government trust funds and special funds – or basically IOUs from the federal government for money that it “borrowed” from Social Security, Medicare and other trust funds.

U.S. National Debt

[Note that the chart above from the Heritage Foundation was created last month,
before the national debt topped $18 trillion.]

As noted above, our national debt of $18.005 trillion equals 103% of GDP, if we include both the debt held by the public and the intra-governmental debt. Many analysts, however, only consider the debt held by the public as our national debt. They figure that the intra-governmental debt is money the government owes to itself. That is very misleading!

Intra-governmental debt consists of the debts that the federal government owes to itself through more than 100 government trust funds (Social Security, Medicare, etc.), revolving accounts, and other special accounts.

All of the Treasury securities held by the various government trust funds and other accounts mature at some point and must be repurchased, just like the debt held by the public. Thus, no matter how one treats intra-governmental debt, it must be repaid and should be included in any illustration of our national debt.

So when you read that the Congressional Budget Office estimates our “debt to GDP ratio” is only 74%, you will know that the true ratio is 103% if we add intra-governmental debt – as we certainly should!

Warmest holiday wishes,

Gary D. Halbert

Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

© Halbert Wealth Management

[description] => Today, we touch on several bases. No doubt everyone reading this noticed that stocks tanked last week, and now seem to be moving in lockstep with oil prices. While consumers welcome cheaper gas and heating oil prices, there is a growing fear that the collapse in oil prices may be a harbinger of a global recession. [author] => Gary Halbert [legacyinterface_firm_id] => 191 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:28:13 [created_by] => 948 [modified_on] => 2014-12-17 16:28:36 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2169 [hits] => 0 ) [6] => stdClass Object ( [legacyinterface_commentary_id] => 2104 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15343 [apv_conversation_id] => [content_type] => market-commentary [title] => The Median Stock Is Once Again Negative YTD [slug] => gavekal_121714 [fulltext] =>

The median year-to-date performance in the MSCI World Index with two weeks of trading left is -1%. The median stock was up 20% at this point last year and was up 13% at this point in 2012.

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The developed country with the worst median performance YTD is MSCI Portugal. The median stock is down 35%. The developed country with the best median performance YTD is MSCI New Zealand. The median stock in MSCI New Zealand is up 14% in USD terms.

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The major country indices in Europe are all unsurprisingly negative year-to-date. The median stock in MSCI Germany is down 10%, in MSCI France is down 10%, in MSCI Italy is down 12% and in MSCI Spain is 8%

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The median performance year-to-date in the MSCI USA is 9%. The only other developed country indices with positive median performance YTD are MSCI Hong Kong (6%) and MSCI Ireland (6%).

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© GaveKal Capital

[description] => The median year-to-date performance in the MSCI World Index with two weeks of trading left is -1%. The median stock was up 20% at this point last year and was up 13% at this point in 2012. [author] => Team [legacyinterface_firm_id] => 173 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:30:13 [created_by] => 948 [modified_on] => 2014-12-17 16:30:29 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2170 [hits] => 0 ) [7] => stdClass Object ( [legacyinterface_commentary_id] => 2105 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15344 [apv_conversation_id] => [content_type] => market-commentary [title] => Are Bonds Really Less Risky than Equities? [slug] => bernstein_121714 [fulltext] =>

It’s practically an investing axiom that government bonds are much less volatile than equities. But that depends on how you look at it. In fact, our research suggests that income streams from stocks are actually much less volatile than those of government bonds.

This counterintuitive point raises interesting observations for investors. Namely, the less sensitive you are to price volatility, the more attractive the yield from equities may become.

Over the long term, global equities have had an annualized volatility of nearly 17% versus about 8% for government bonds.1 This analysis is based on a century of data from 1900 to 2000 from the London Business School. By this measure, equities have clearly been riskier than bonds.

However, the picture looks very different looking at real returns, i.e., adjusted for inflation—especially if you decompose the total real return of equities into two components: the contribution from capital appreciation and the contribution from dividend yields. This analysis shows that share prices (capital appreciation) have been quite volatile over 10-year holding periods (Display). Dividend yields, though they have fallen somewhat over time, have been much more stable.

 

Comparing the real return of bonds over the same period with the dividend yield from equities also paints an interesting picture (Display). Bonds did very well in the 1980s and 1990s (and, for that matter, also over the most recent decade) as interest and inflation rates fell. However, bonds struggled during decades in which inflation and interest rates rose. In contrast, the real return from dividends was positive every decade. In other words, seen through the lens of producing an income stream to meet an investor’s purchasing needs, equities don’t look quite so risky after all.

Why might these observations matter? Most investors have assets because they have liabilities. Liabilities often take the form of a series of inflation-linked payments that need to be made over several years. So owning real income streams that meet those expected payments is the essence of asset-liability matching, in our view. And for investors without explicit liability matching needs, generating stable streams of real income is becoming increasingly important in a world of volatility. Yet the common perception that equities are more volatile than bonds often creates a barrier for investors to consider stocks as a reliable source of income. 

In a recent blog, our colleagues pointed out that an equity income approach is probably more appropriate for investors with long-term goals. While the shares are likely to appreciate over time, stock price volatility means the value of the initial investment will fluctuate (see upper display). But of course, an investor doesn’t necessarily have to choose to be exposed to either equity or bond income.

In fact, there are good reasons to have a bit of both, in our view. Income streams between equities and bonds are not perfectly correlated. For example, we measured that the percentage yield from the Barclays Global Treasuries Index has had a negative correlation of –0.6 with the percentage yield from the MSCI World Equity Index since 2001. So by combining income streams from a range of asset classes, we think investors should be able to generate more consistent income and, importantly, income growth.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.AllianceBernstein Limited is authorized and regulated by the Financial Conduct Authority in the United Kingdom.

Patrick Rudden is co-manager, Dynamic Diversified Portfolio at AllianceBernstein (NYSE:AB).


[1] Source: Dimson, Marsh and Staunton, Triumph of the Optimists: 101 Years of Global Investment Returns

© AllianceBernstein

[description] => It’s practically an investing axiom that government bonds are much less volatile than equities. But that depends on how you look at it. In fact, our research suggests that income streams from stocks are actually much less volatile than those of government bonds. [author] => Patrick Rudden [legacyinterface_firm_id] => 20 [published_on] => 2014-12-17 [digest_date] => 2014-12-17 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-17 16:33:00 [created_by] => 948 [modified_on] => 2014-12-17 16:33:13 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2171 [hits] => 0 ) [8] => stdClass Object ( [legacyinterface_commentary_id] => 2089 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15328 [apv_conversation_id] => [content_type] => market-commentary [title] => Allocating to Alternative Investment Strategies [slug] => forward_121614 [fulltext] =>

Following the market declines in 2008 and 2009, many investors have shown interest in alternative investment strategies such as hedge funds and mutual funds that employ hedge fund-like strategies. These types of strategies have been around a long time, but until recently their use among individual investors has been somewhat limited. So, investors and their advisors have had to tackle a series of new challenges, such as trying to identify good managers or determining what is a reasonable allocation to alternatives. Some investors have been disappointed by the performance of alternative investment strategies. Part of their disappointment can be attributed to the fact that stocks have been in a very persistent bull market with very low volatility, which is a challenge for any strategy that utilizes a hedging activity. However, I believe the problem may be that most investors have struggled with understanding how to allocate to alternative investment strategies and that poor allocation decisions have led to less-than-optimal portfolio results.

I think that many investors have elected to view alternative investment strategies as a separate asset class from stocks and bonds and have cut out a portion of their portfolio to allocate to one or more strategies. In reality, hedge funds and their mutual fund brethren are in fact stock and bond investments that are executed differently than traditional funds. Therefore, investors should still consider alternative investment strategies to be stock and bonds and allocate to them to enhance their overall allocation strategy. Let’s look at a way that we could use hedge funds to complement a traditional allocation strategy.

Forming an opinion on market conditions
The most important part of determining an allocation is to have an opinion about the market conditions (i.e., bull or bear market). There are dozens of ways this can be accomplished, but I am partial to using something akin to the Sharpe ratio to determine market conditions in which I use 100 day percentage change and its standard deviation to normalize average return per unit of risk. I calculate this for each month-end; any reading above zero is a bull market and any reading below zero is a bear market for the coming month. Here are the results of applying a monthly market condition analysis to the MSCI ACWI:

Market Performance Using a Monthly Market Condition Analysis

 

Total Return

Standard Deviation

Max Monthly Gain

Max Monthly Loss

Bull

7.53%

12.96%

9.52%

-14.15%

Bear

-2.08%

20.03%

11.48%

-19.91%

MSCI ACWI

4.52%

15.50%

11.48%

-19.91%

Source: Bloomberg, 12/31/89 – 09/30/14.
This hypothetical example is for illustrative purposes only and does not represent the returns of any particular investment. Past performance does not guarantee future results.

As you can see, this method has definitely been able to separate good markets from bad markets and is a way that an investor can determine how to adjust allocations based on market conditions. Let’s now take this market condition analysis and apply it to hedge funds. Below is an analysis that takes the market condition of the MSCI ACWI as discussed above and examines the performance of the HFRI hedge fund indices in the month following each market condition. The results are summarized below:


As shown in the table, during bull markets for stocks, equity hedged and event driven strategies perform the best. During bear markets, macro and relative value strategies tend to perform best. This makes sense since relative value strategies tend to use bonds, and managed futures strategies are in the macro category. So, an investor can use this knowledge to guide their allocations based on market conditions.

In Part 2, I will show how an investor can actually execute on this idea.

In part 1 of this series, I introduced a simple way to identify when we are in a bull or bear market. I then took this method and examined how certain types of hedge funds have performed in each of these market conditions. This week, I am going to use this information to propose a simple allocation strategy that an investor could employ in order to determine which alternative strategies (or alternatives) should be used and where to deploy them in the portfolio. First, let’s look at how most investors use alternatives today.

Most common use of alternative investments
Many investors and their advisors have approached allocating to alternatives as if they were a new asset class. In other words, the allocations to asset classes include stocks, bonds, cash and alternatives. One such allocation might proportionately decrease allocations to stocks and bonds in order to include a broad mix of different types of alternatives. For example, an investor with 60% stocks and 40% bonds might move to a mix of 48% stocks, 32% bonds and 20% alternatives (see chart below). For reference, I also included the use of fund of funds since they represent a professionally managed mix of alternatives.

 

 

Total Return

Vol.

Max Monthly Return

Min Monthly Return

Sharpe Ratio

Opportunity Cost

60% Stocks/40% Bonds

6.99%

10.19%

7.50%

-13.30%

0.38

0.00%

48% Stocks/32% Bonds/20% Alts*

7.90%

9.00%

6.90%

-11.90%

0.53

-3.21%

48% Stocks/32% Bonds/20% Alts**

7.09%

8.84%

6.60%

-11.90%

0.45

-4.05%

Sources: Bloomberg and HFRI, 12/31/89-9/30/14
*The alternatives portion is allocated equally to the following HFRI indices: Equity Hedged, Relative Value, Macro and Event Driven.
**The alternatives portion is allocated to the HFRI Fund of Funds Composite Index.
This hypothetical example is for illustrative purposes only and does not represent the returns of any particular investment. Past performance does not guarantee future results.

As the analysis illustrates, using alternatives as a separate asset class is a pretty good method, although it appears that it is better to just choose a broad basket of equally weighted strategies rather than using a fund of fund strategy. However, in both cases the return was more desirable than the fixed 60% stock/40% bond strategy, and the volatility and capital drawdown were better.

The issue of allocating to alternatives in this way isn’t really the long-term characteristics of this approach, but rather the “opportunity cost” of using alternatives. To analyze this cost I calculated the annualized return of those months where using alternatives underperformed the simple 60/40 mix. On average the equally weighted mix of alternatives missed by 0.27% roughly 47% of the time. So, as an investor, you have to ask yourself if that opportunity cost is worth the additional 0.81% of annualized return. Some investors might just shrug at the benefits of including alternatives, especially when you consider the extra time needed to research, monitor and manage alternatives. This is why I think there is a better approach to managing your alternative allocations.

A dynamic approach to allocating alternative investment strategies
As I discussed last week, I think that investors would benefit from thinking about alternatives not as a separate asset class but as an extension of stocks and bonds. In fact, most alternatives use stocks and bonds but also include various hedging techniques. With that in mind, I looked at allocating to more equity-oriented strategies (HFRI Equity Hedged Index and HFRI Event Driven Index) when the market conditions indicator is bullish, and to more defensive strategies (HFRI Macro Index and HFRI Relative Value Index) when the market conditions indicator is bearish, taking from bonds in a bull market and stocks in a bear market. Specifically, my mix in a bull market is 40% stocks, 20% bonds, 10% equity hedged and 10% event driven. In a bear market, my mix is 20% stocks, 40% bonds, 10% relative value and 10% macro. This is referred to as the dynamically weighted allocation in the chart below.

 

 

 

 

Total Return

Vol.

Max Monthly Return

Min Monthly Return

Sharpe Ratio

Opportunity Cost

60% Stocks/40% Bonds

6.99%

10.19%

7.50%

-13.30%

0.38

0.00%

48% Stocks/32% Bonds/20% Alts*

7.90%

9.00%

6.90%

-11.90%

0.53

-3.21%

48% Stocks/32% Bonds/20% Alts**

7.09%

8.84%

6.60%

-11.90%

0.45

-4.05%

Dynamically Weighted Allocation

8.86%

9.36%

7.90%

-10.00%

0.61

-3.95%

Sources: Bloomberg and HFRI, 12/31/89-9/30/14
*The alternatives portion is allocated equally to the following HFRI indices: Equity Hedged, Relative Value, Macro and Event Driven.
**The alternatives portion is allocated to the HFRI Fund of Funds Composite Index.
This hypothetical example is for illustrative purposes only and does not represent the returns of any particular investment. Past performance does not guarantee future results.

 

As you can see, the dynamically weighted allocation approach delivers the best results pretty much across the board: highest return, lowest capital drawdown and highest Sharpe Ratio. Additionally, the opportunity cost is fairly comparable (although higher) to the fixed allocation method with an average monthly miss of 0.33%, but less frequent at 41% of the time. This is actually 16 fewer months of underperformance compared to the fixed allocation method. In this case, an investor would realize an increased annual return of 1.87%, which is probably worth the headache of the extra time and effort needed to manage the managers and allocations of the alternative strategies. This method is, of course, not a silver bullet. I would suspect that with some additional effort in refining the market signal and expanding the list to include the substrategies in the HFRI universe, an investor could probably improve returns, volatility and even the opportunity cost. However, I think this is a great starting point in developing your own approach to allocating to alternatives and I hope you find it useful.

 

RISKS

Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

Alternative strategies typically are subject to increased risk and loss of principal. Consequently, investments such as mutual funds which focus on alternative strategies are not suitable for all investors.

Asset allocation does not assure profit or protect against risk.

Nathan J. Rowader is a registered representative of ALPS Distributors, Inc.

One cannot invest directly in an index

Sharpe ratio is a ratio developed by Nobel laureate William F. Sharpe to measure how a fund performs relative to the risk it takes.

MSCI ACWI (All Country World Index) is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global developed and emerging markets. One cannot invest directly in an index.

HFRI Equity Hedge Index maintains positions both long and short in primarily equity and equity derivative securities.

 

HFRI Event-Driven Index maintains positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments.

 

HFRI Fund of Funds Composite Index is an equal-weighted index comprised of fund of funds. The index includes over 600 constituents, both domestic and offshore funds.

 

HFRI Macro Index maintains positions in a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets.

HFRI Relative Value Index

© Forward Investing

[description] => Following the market declines in 2008 and 2009, many investors have shown interest in alternative investment strategies such as hedge funds and mutual funds that employ hedge fund-like strategies. These types of strategies have been around a long time, but until recently their use among individual investors has been somewhat limited. [author] => Nathan Rowader [legacyinterface_firm_id] => 160 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 14:44:20 [created_by] => 948 [modified_on] => 2014-12-16 15:05:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2155 [hits] => 0 ) [9] => stdClass Object ( [legacyinterface_commentary_id] => 2090 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15329 [apv_conversation_id] => [content_type] => market-commentary [title] => ​​Strategy Spotlight: An Update on PIMCO’S Fundamental Index-Based Product Suite [slug] => pimco_121614 [fulltext] =>

The Fundamental IndexPLUS AR strategies combine the best of what passive indexing and active management aim to deliver: broadly representative, transparent equity exposure plus the potential for meaningful equity market outperformance. 

One of the reasons many investors find Fundamental IndexPLUS AR so compelling is that it delivers two independent sources of potential equity market outperformance – the return of the absolute return bond alpha strategy above that of the money market cost, plus the returns of the Enhanced RAFI equity strategy over a market-capitalization-weighted equity index. 

PIMCO manages the absolute return bond strategy, which adds a complementary source of alpha and diversification potential to the Fundamental IndexPLUS AR strategies, and has almost 30 years of experience in adding bond market alpha onto stock market returns. 

Research Affiliates is responsible for the equity strategy, which builds on their groundbreaking work on Fundamental Indexation by adding additional enhancements and active insights. 

September 30th marked the third anniversary of the launch of PIMCO’s innovative International Fundamental IndexPLUS AR and Small Company Fundamental IndexPLUS AR strategies. Designed to deliver two sources of excess return potential to investors in addition to the return of the equity market, the strategies are extensions of the U.S.-based Fundamental IndexPLUS AR strategy launched in 2005. They are also part of PIMCO’s broader suite of Fundamental Index StocksPLUS strategies, which also include emerging market equity, global equity and equity market neutral strategies.

In this Q&A, Rob Arnott, Founder and Chairman of Research Affiliates, and Sabrina Callin, PIMCO managing director and product manager, discuss this innovative Fundamental Index-based equity approach, and how these unique equity strategies combine the strengths of PIMCO and Research Affiliates to provide a powerful path forward for equity investors.

Q: How does the collaboration between Research Affiliates and PIMCO contribute to the success of the Fundamental Index StocksPLUS suite of strategies? 
Arnott: PIMCO was one of the very first affiliates to launch products based on the Fundamental Index concept – well before “Smart Beta” was all the rage. When we launched the Fundamental IndexPLUS AR strategy in June 2005, we envisioned a suite of products that would draw on the collective strengths of PIMCO and Research Affiliates, including both firms’ insights, process and people. We believed then and we believe now that this combination will deliver materially superior results to our investors.

Our team at Research Affiliates manages the Enhanced RAFI (Research Affiliates Fundamental Index) equity strategy, which is offered exclusively in partnership with PIMCO. Our research suggests that a process that selects and weights stocks based on underlying company economic fundamentals instead of market capitalization produces powerful results in historical testing, well above cap-weighted benchmarks, all over the world, including U.S. large cap, small company, international, global and emerging market equities.

PIMCO’s team manages the absolute return bond strategy, which adds a complementary source of alpha and diversification potential to the Fundamental IndexPLUS AR strategies. PIMCO has almost 30 years of experience in adding bond market alpha onto stock market returns. If PIMCO can beat the money market rate – which drives the pricing of the equity-linked instruments used to gain access to the Enhanced RAFI portfolios – then there are multiple complementary and uncorrelated alphas.

Q: Can you provide more detail on the advantages of Enhanced RAFI and how it is managed? 
Arnott: Research Affiliates is responsible for the excess returns of Enhanced RAFI relative to the corresponding cap-weighted equity index benchmark. The largest excess return driver is the rebalancing aspect to the strategy. Companies whose prices appreciate more than the fundamental scope of the business (as measured by sales, cash flow, book value and dividends) get trimmed. Conversely, we boost exposure to securities that fall in price more than business fundamentals. In short, we sell recent winners and buy recent losers.

Our long-term research suggests that this contra-trading, against the market’s most extravagant recent “bets,” is worth roughly 2% in excess returns, across various markets around the world, with low turnover and economically representative exposure. So the people on the opposite side of these contrarian trades – the legions who buy recent winners and sell recent losers – in theory “pay” us 2% excess returns. For example the Enhanced RAFI US Large Index returned 3.51% annualized vs. the S&P 500 during our sample period from 12/31/1962 to 10/31/2014. We all know people who behave this way. They’re the return chasers who have been identified in studies like Russ Kinnel’s “Mind the Gap,” and some of our own work (see “Slugging it out in the Equity Arena,” by John West and Ryan Larson at Research Affiliates).

We believe these excess returns are structural and persistent – not in every quarter or every year, of course, but over the long term. Furthermore, with Enhanced RAFI we add additional screens to the stock selection process. For example, we emphasize companies with high quality earnings and de-emphasize or eliminate companies that show potential signs of distress. We also adjust our stock positions in an effort to achieve better diversification of our active “bets,” with less dramatic bets (over- or underweight) among the large companies and slightly more aggressive bets (again, over- or underweight) among the smaller companies. Finally, we use a rebalancing mechanism that allows momentum to run its course, rather than contra-trading against market momentum too hastily.

Q: What value does PIMCO bring to these unique equity strategies? 
Callin: The PIMCO Enhanced RAFI-based StocksPLUS strategies combine the best of what passive indexing and active management aim to deliver: broadly representative, transparent equity exposure plus the potential for meaningful equity market outperformance. Rather than buying physical stocks, we use equity-linked instruments, which tend to provide approximately the same returns as owning the underlying stocks, to gain Enhanced RAFI exposure in exchange for paying a money-market-based interest rate. The key benefit is that we do not have to pay cash for the equity exposure up front. Because the equity ownership can be obtained at a money-market-based cost, it allows equity investors to potentially use their money more efficiently and to capitalize on their longer-term time horizon to a much greater degree. If the cash was then invested at a money market rate, for example, the total return to the investors would be approximately the same as the return of the equity index. We believe a better approach is to invest that cash in a high quality, absolute return bond alpha strategy – the “PLUS” component – which is designed to outperform the money-market-based financing rate, thereby delivering returns above those provided by the equity strategy.

Basically, if you believe PIMCO can outperform a money market rate, then that translates into a belief that the PIMCO active management component should deliver additional value to equity investors.

One of the reasons many investors find Fundamental Index StocksPLUS strategies so compelling is that they deliver two independent sources of potential equity market outperformance for every unit of capital invested in the strategy – the return of the absolute return bond alpha strategy above that of the money market cost, plus the returns of the Enhanced RAFI equity strategy over a market-capitalization-weighted equity index. In addition, each potential source of return is likely to have a relatively low correlation with one another, offering potentially meaningful diversification benefits.

Q: Can you discuss the backgrounds of the portfolio management team? 
Callin: The highly qualified management team has more than 100 years of collective investment experience across all major global asset classes. In addition to Rob and his expert team at Research Affiliates, the PIMCO portfolio management team includes managing directors Saumil Parikh, Mohsen Fahmi and Sudi Mariappa. By extension, Mohit Mittal and Dan Ivascyn, PIMCO’s Group Chief Investment Officer, who are members of the broader Unconstrained Bond portfolio management team, are also active contributors. Importantly, while each portfolio management team member individually contributes significant expertise and unique perspectives, they also draw on the collective depth and breadth of the entire PIMCO team in managing the absolute return bond alpha strategy component of these strategies, and specifically on our equity trading specialists in maintaining the Enhanced RAFI exposure using index-linked instruments.

The team approach has long served as a hallmark of the PIMCO investment process. And it is with this framework, team and process that we look forward to continuing to pursue attractive returns for equity investors in the year ahead.

Q: Many investors don’t associate PIMCO with equities, yet PIMCO won the Lipper Equity Manager of the Year award in 2010, 2011, 2012 and 2013 in the U.S. Is this an anomaly? 
Callin: I believe it is unprecedented for one company to win the Lipper Equity Manager of the Year award four times in a row, but remember, unlike many other equity strategies, our approach captures two independent sources of structurally based value add for investors, building on the long-established team approach that combines the strengths and insights of both Research Affiliates and PIMCO. Taken together, we believe these teams and strategies are poised to deliver very attractive results to equity investors prospectively. And now, perhaps more than ever, equity strategies that deliver meaningful excess returns – in addition to the return of the equity market – may be key to allowing investors to meet their return targets going forward. ​

Past performance is not a guarantee or a reliable indicator of future results. In managing the strategy’s investments in Fixed Income Instruments, PIMCO utilizes an absolute return approach; the absolute return approach does not apply to the equity index replicating component of the strategy. 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. 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. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their 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. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Swaps are a type of derivative; swaps are increasingly subject to central clearing and exchange-trading. Swaps that are not centrally cleared and exchange-traded may be less liquid than exchange-traded instruments. 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. Diversification does not ensure against loss.

The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility. 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 long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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[description] => The Fundamental IndexPLUS AR strategies combine the best of what passive indexing and active management aim to deliver: broadly representative, transparent equity exposure plus the potential for meaningful equity market outperformance. [author] => Sabrina Callin, Robert Arnott [legacyinterface_firm_id] => 335 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 14:47:19 [created_by] => 948 [modified_on] => 2014-12-16 14:47:32 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2156 [hits] => 0 ) [10] => stdClass Object ( [legacyinterface_commentary_id] => 2091 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15330 [apv_conversation_id] => [content_type] => market-commentary [title] => Busting the Myth About Size [slug] => research_121614 [fulltext] =>

Many market participants (including investors, product providers, and analysts alike) assume that, just as value stocks on average outperform growth, small-cap stocks on average outperform large-caps. Unlike value, however, and contrary to popular opinion, there is little solid evidence that stock size affects performance.

 

A recent Research Affiliates article by Hsu and Kalesnik (2014) concluded that there are at best three factors from which investors can benefit through passive investing: market, value, and low beta. The size premium was conspicuously missing from that short list. In this article we explore empirical evidence behind the size premium in more detail. The summary below offers a preview of our findings. We let the reader examine the evidence and draw his or her own conclusion. In our opinion the preponderance of evidence does not support the existence of a size premium.

 

 

We are not arguing that investors should stop investing in small stocks. A portfolio of small stocks offers a certain level of diversification in an investment program dominated by large-stock strategies. Moreover, major anomalies are stronger in the universe of small stocks (likely because small stocks are more prone to mispricing). Thus, small stocks have the potential to serve as an alpha pool for skilled active managers and rules-based strategies that primarily target factors other than size. Nonetheless, we are skeptical that investors will earn a higher return simply by preferring small stocks over large.

 

Updating the Evidence
Banz (1981) reported that small-cap stocks outperformed large-cap stocks. For the subsequent decade the phenomenon Banz observed was considered a curious anomaly. The situation changed in 1993, when Eugene Fama and Kenneth French suggested that small stocks may expose investors to some undiversifiable risk that warrants a higher required rate of return. At that moment, the size factor took its place alongside the market and value factors in the original Fama–French three-factor model. Carhart (1997) then made the case for momentum as a fourth return factor. Today the most standard equity pricing model used in academia includes four factors: market, value, size, and momentum.

But consider this: What if a large company were split, on paper only, into two small companies? Suppose there is no change in operations, and imagine that one of the small companies booked all the cash flows on even-numbered days of the month, and the other one accounted for all the cash on odd days. In this scenario, it would be most surprising if the small companies both delivered higher returns than the original large company. Yet the size premium is precisely based on the expectation that small-cap stocks will outperform large-cap stocks!

 

For any reasonable economic theory explaining why small-cap stocks are supposed to outperform large-cap stocks, there is an equally plausible theory explaining why the reverse should be true. The source of the specific risk postulated by Fama and French (1993) was unclear 21 years ago, and it is still murky today. Theoretical explanations for the size premium were provided after researchers observed the anomalous regularity in returns—not the other way around. Today investors believe in the size premium on the basis of empirical evidence, not on theoretical arguments. So let’s turn to the evidence with updated data.

 

Following the methodology employed in Fama and French (2012), we grouped stocks in each country by size into two portfolios. The large stock portfolio consists of the top 90% of the market by market capitalization, and the small stock portfolio consists of the bottom 10% of the market. Stocks within the large and small portfolios are weighted by market capitalization. To measure the premium we looked at the arithmetic difference between the small and large stock portfolio returns. We report in Table 1 the average annualized returns, volatilities, and t-statistics in 18 major developed countries from January 1982 to July 2014. Table 1 also displays data for the United States over the longer period from July 1926 to July 2014.

 

 

In the 88-year U.S. sample, the size premium is 3.4% per annum. Assuming a normal distribution of premium estimates (we will discuss later why this assumption may not be warranted), the size premium is statistically significant with a t-stat of 2.38, which corresponds to a p-value of 1.7%. After 1981, when Banz’s paper appeared, the premium is positive in the United States and positive on average in the international sample, but it is not statistically significant anywhere. The substantial, statistically significant average return observed in the long-term U.S. dataset is the main reason why size is popularly believed to be one of the most important factors.

 

Examining the U.S. Data
Existence of the size premium in the United States is practically an article of faith in the practice of asset management as well as the academic literature. The empirical evidence, however, does not stand up very well to closer scrutiny. The data are doubtful for several reasons, including overestimated small-cap returns due to missing data on delisted stocks; the absence of transaction costs in the calculation of index returns; biases resulting from data-mining and the publishing process; and misestimated statistical measures based on the assumption of normality. In addition, there proves to be no return advantage on a risk-adjusted basis. 

 

Delisting bias. Shareholders do not necessarily lose the full amount of their investment in a company when it is delisted from a major stock exchange. Often the stock can still be traded in the over-the-counter (OTC) market, and the investor may receive some residual value if the company is liquidated. Nonetheless, returns on stocks after they have been delisted are likely to be very negative. Moreover, all companies are subject to business and financial risks that might result in their stock’s falling short of listing requirements, but small stocks by market capitalization are appreciably more likely to be removed from an exchange. Shumway (1997) pointed out that regular performance databases overestimated small-cap stock returns because they did not include returns on delisted stocks. If a database that is used in simulating portfolios omits the strongly negative returns of delisted stocks, the hypothetical results will be better than what actual portfolios can achieve in practice.

 

To estimate the impact of the delisting bias on the size premium, Shumway and Warther (1999) looked at the smallest and the most distressed stocks for which they could obtain reliable data, namely, stocks listed on the NASDAQ exchange. We represent their findings in Figure 1. The chart shows the average monthly returns for 20 groups of stocks sorted by size before and after correcting for the upward bias in the database. Clearly, the smallest stocks are significantly more affected by the delisting bias. After adjusting for the delisting bias, the statistical significance of the size premium completely disappears. It is unreasonable to suppose that the effect Shumway and Warther quantified for NASDAQ stocks is missing from other exchanges.

 

 

Transaction costs. Theoretical simulations ignore an important component of investment performance measurement: trading expenses—the actual costs of buying or selling investments. Small stocks by definition have much lower trading capacity and, correspondingly, much higher transaction costs. Soon after the first articles documenting the size effect appeared, researchers asked how much of the premium remains when trading costs are taken into account. Stoll and Whaley (1983) showed that transaction costs accounted for a significant part of the size premium for stocks listed on the New York Stock Exchange and the American Stock Exchange. 

 

Data-mining and reporting bias. There are literally hundreds of known factors in the existing literature, and many papers documenting new factors are published every year. In our opinion the vast majority of these factors are spurious products of data-mining. We are not alone in taking a skeptical position. Lo and MacKinlay (1990), Black (1993), and MacKinlay (1995), among others, have argued that many factors, notably including size, are likely to be a result of data-mining. And, in finance no less than the physical and biological sciences, striking results—especially new discoveries—tend to win the competition for space in academic journals. 

 

The standard procedure for determining whether a factor is statistically significant is to see if its t-stat crosses a certain threshold. Normally the threshold is set at 1.96 for a 5% confidence level. With a t-stat of 2.38, the U.S. size premium passes this test for the 1926–2014 sample. But Harvey, Liu, and Zhu (2014) rightly observed that if many researchers are looking for statistical irregularities, then the 1.96 criterion is too low; it allows many inherently random outliers to be misidentified as valid factors. They argue that the threshold for the size factor should have been closer to a t-stat of 2.50 in 1993.1  Size does not pass this test.

 

Non-normality of returns. Standard statistical testing assumes that the estimate of a variable—in this case, the average of the size premium—quickly converges to a normal distribution.2  If, however, the underlying data include large outliers, then the assumption of normality is unfounded. The differences between the small and large stock portfolio returns exhibit just such outliers. Figure 2 is a histogram of the return differences. For comparison, we display on the same chart a normal distribution with the same mean and standard deviation.

 

 

We indicate on the chart four extreme outliers of 6 sigma or higher. “Sigma” may be an unfamiliar statistical term, so let us put these outlier returns in perspective. The 23.6% premium registered in January 1934 is a 6-sigma event. If it were drawn from normal distribution, this would be a one-in-67-million-year event, like the one that wiped out the dinosaurs. The 27.2% difference in returns in September 1939 is a 6.9-sigma event; in a normal distribution, it would have about a one-in-five chance of occurring in the 4.5 billion years since the planet earth came into existence. The 33.8% premium in August 1932 is an 8.6-sigma event, and the 51.6% premium in May 1933 is a 13.1-sigma event. If these last two outliers were drawn from a normal distribution, each would have much less than a one-in-a-hundred chance of occurring in the entire 13.8 billion years the universe has existed. 

 

To add to the problem, all four outliers occurred in the 1930s. If they were removed, the estimated size premium in Table 1 would drop from 3.4% to 1.9% and lose statistical significance. (There is a similar outcome in the post-war period: The estimated size premium is about 1.9% premium with a t-stat of 1.52.) We do not argue, however, that truncating or otherwise transforming the sample will give us a better estimate. What happened in the 1930s is very valuable information about the economy and the stock market. The average return from the full sample, including the unadjusted outliers, is the best estimate available as long as the statistical bounds around it are borne in mind. If the size premium is predicated on exceedingly rare events, then we’ll have to wait many lifetimes to determine with confidence whether or not it exists. 

 

No risk-adjusted benefit. Academics are interested in the arithmetic average returns in a simulated long/short portfolio, but practitioners are concerned with the actual risk-adjusted returns that they can generate from their investments—and the majority do not engage in short-selling. We display in Table 2 the average geometrically chained cumulative returns of the long-only portfolios of small and large stocks. These results are produced using the same databases we used earlier in this article, so they contain the same biases that we noted above. 

 

 

Small stocks outperform large stocks in this sample, but, because small stocks are generally more volatile, the Sharpe ratios reveal that small-cap investing provides a miniscule advantage in the risk-adjusted return. If investors are switching from large stocks to small in the hope of a premium, they should realize that they are increasing the volatility, too. The estimates of average returns are very noisy, and are likely overstated due to the biases we described earlier; the estimates of volatility on the other hand are real. (Estimates of the mean are always less certain than estimates of standard deviation.) We suggest that investors seeking higher returns consider boosting their overall equity allocation rather than chasing the illusory size premium in an attempt to add risk on the cheap within the existing allocation. A large-cap stock portfolio would have higher returns than a mix of small-cap stocks and risk-free assets designed to have the same volatility. In other words, the added risk of small-cap stocks is essentially uncompensated. Note that even in the only data set with a statistically significant size premium (i.e., the U.S. full sample from 1926–2014), the Sharpe ratio is actually lower for small stocks.

 

Concluding Remarks
We placed our inquiry in a historical context, starting with Banz’s (1981) paper, because the widespread belief in a size premium is largely a result of its early discovery. Market capitalization data were readily available to early researchers writing doctoral dissertations and journal articles, and, as we have seen, the performance of small stocks was exceptional in the 1930s. Eugene Fama was one of Rolf Banz’s professors at the University of Chicago; in fact, as a member of Banz’s dissertation committee, he was intimately familiar with Banz’s research on the small-cap anomaly.3  Fama and Kenneth French included the size premium in their influential three-factor model, an analytical advance that opened the gate for empirical research into studying factors previously unexplained by then-existing theories. Riding on the popularity of the Fama–French theory, the size premium was soon entrenched in the pantheon of risk factors. 

 

Berk (1997) argued that the size premium observed in the data is nothing more than a poor way of value investing. Value investing relies on buying cheaply priced companies as measured by a ratio of price to company fundamentals. Investing based on size, measured by company market capitalization, would use only the price side of the valuation measure. Because it would therefore use only a fraction of the relevant information, the strategy is significantly weaker than a value strategy that uses prices as they relate to company fundamentals. In our view, Berk’s argument is, to date, the strongest explanation why the size premium is observed. 

 

However, we go one step further. If Berk questioned the size premium as a separate factor, we question the size premium as a phenomenon. Today, more than 30 years after the initial publication of Banz’s paper, the empirical evidence is extremely weak even before adjusting for possible biases. The return premium is not statistically significant in any of the international markets, whether taken alone or in combination. The U.S. long-term size premium is driven by the extreme outliers, which occurred three-quarters of a century ago. These extreme outliers confound the standard techniques of setting confidence bounds around the estimated premium. Finally, adjusting for biases, most notably the delisting bias, makes the size premium vanish. If the size premium were discovered today, rather than in the 1980s, it would be challenging to even publish a paper documenting that small stocks outperform large ones. All this evidence makes us question the existence of the size premium as such.

 

We are not arguing that investors should completely abandon small stocks. Small stocks are more volatile than large stocks, and they receive considerably less attention from sell-side analysts. Consequently, small stocks are more likely to be mispriced. The major anomalies are, in fact, stronger in the small-cap sector. Small stocks are more attractive as an alpha pool to be fished by skillful active managers and exploited by rules-based value and momentum strategies.

 

Endnotes

1. The authors argue further that “a newly discovered factor today should have a t-ratio that exceeds 3.0.” Page 35.

2. This result relies on the central limit theorem, which says that, as the number of random observations increases, the arithmetic average converges to a normal distribution. If the observations include extreme outliers, the convergence can be either extremely slow or may not occur at all.

3. Fox (2009), page 204.

 

References

Banz, Rolf W. 1981. “The Relationship Between Return and Market Value of Common Stocks.” Journal of Financial Economics, vol. 9, no. 1 (March):3-18.

 

Berk, Jonathan B. 1997. “Does Size Really Matter?” Financial Analysts Journal, vol. 53, no. 5 (September/October):12–18.

 

Black, Fischer. 1993. “Beta and Return.” Journal of Portfolio Management, vol. 20, no. 1 (Fall):8–18.

 

Carhart, Mark M. 1997. “On Persistence in Mutual Fund Performance.” Journal of Finance, vol. 52, no. 1 (March):57–82.

 

Fama, Eugene F., and Kenneth R. French . 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, vol. 33, no. 1 (February):3–56.

 

———. 2012. “Size, Value, and Momentum in International Stock Returns.” Journal of Financial Economics, vol. 105, no. 3 (September):457–472.

 

Fox, Justin. 2009. The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street. HarperCollins e-books. 

 

Harvey, Campbell R., Yan Liu, and Heqing Zhu. 2014. “…And the Cross-Section of Expected Returns.” NBER Working Paper No. 20592. Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2513152## OR Available at nber.org/papers/w20592.

 

Hsu, Jason and Vitali Kalesnik. 2014. “Finding Smart Beta in the Factor Zoo.” Research Affiliates (July).

 

Lo, Andrew W., and A. Craig MacKinlay. 1990. “Data-Snooping Biases in Tests of Financial Asset Pricing Models.” Review of Financial Studies, vol. 3, no. 3 (Fall):431–467.

 

MacKinlay, A. Craig. 1995. “Multifactor Models Do Not Explain Deviations from the CAPM.” Journal of Financial Economics, vol. 38, no. 1 (May):3–28.

 

Shumway, Tyler. 1997. “The Delisting Bias in CRSP Data.” Journal of Finance, vol. 52, no. 1 (March):327-340. 

 

Shumway, Tyler, and Vincent A. Warther. 1999. “The Delisting Bias in CRSP’s Nasdaq Data and Its Implications for the Size Effect.” Journal of Finance, vol. 54, no. 6 (December):2361–2379.

 

Stoll, Hans R. and Robert E. Whaley. 1983. “Transaction Costs and the Small Firm Effect.” Journal of Financial Economics, vol. 12, no. 1 (June):57–79.

© Research Affiliates

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A former economic colleague, and mentor, used to say: “In the Bible, it says an ounce of gold will buy a fine suit of clothing.” We have read the Bible, and we haven’t found this, although there could be some high-powered math, using talents, cubits, frankincense and myrrh that make it true.

Nonetheless, the point stands – over long periods of time, relative value remains somewhat constant. Gold is trading at $1,210/oz. today and that’s about the cost of a fine suit. There are suits that cost more, and less, but, well, you get the point.

The reason we bring this up, is that the same “relative price relationship” should hold true for other commodities over time. The gold-oil ratio (using West Texas Intermediate crude prices) has averaged 15.8 over the past 30 years – meaning one ounce of gold would buy 15.8 barrels of oil.

In 2005, the ratio reached a low of 6.7; in 1986, it hit a high of 30.1. From 1990-1999 oil prices averaged $19.70/bbl and gold prices averaged $351/oz – a ratio of 17.8. Today, oil is $57/bbl and gold is $1,210/oz., meaning an ounce of gold will buy 21.2 barrels of oil.

In other words, relative to history, either oil is cheap or gold is expensive. Looking at other commodity price relationships, like silver, shows the same thing. One interesting fact is that in the past 30 years, the CPI is up 126%, while oil is up 116%, showing that, right now, with oil prices down almost $50 from their recent peak, oil has risen about the same as a broad basket of consumer goods.

This doesn’t mean that oil prices can’t fall further. After all, markets do what markets do. What it does mean is that the recent collapse in oil prices is not a sign of broad deflation. It is result of a shift in the “oil supply curve” to the right, due to new technologies in energy – horizontal drilling and hydraulic fracturing. Remember, the supply curve slopes upward from the lower left to the upper right. When a new technology increases supply at any price, like the invention of the tractor did with crops, the entire supply curve shifts. When this happens, output rises and prices fall, unless there is a shift in demand.

These days, two things are happening to keep a lid on demand. First, developing economies, like China and Russia are experiencing slower growth. Second, new technologies – like LED lighting, more efficient computer chips and less waste in office buildings, homes and manufacturing – are reducing energy consumption. For example, an iPad uses $1.36 of electricity every year, while a desktop computer uses $30 of electricity per year.

So, a right-ward shift in the supply curve is occurring at the same time demand is falling short of what was previously expected. In other words, the decline in oil prices is due to macro-economic forces, and those forces are mostly good, not bad. As a result, the drop in oil prices is a good sign, not one that indicates economic problems. The drop in stock prices last week, if it was based on the idea that falling oil prices are a negative thing, is temporary.

More importantly, most relative price indicators suggest the oil price decline has gone too far. Using the current price of gold, a barrel of oil is fairly valued near $77. Alternatively, comparing oil to multiple different prices, including a fine suit of clothing, oil is fairly valued somewhere between $55 and $70/bbl.

Bottom line: stocks and oil have fallen too much. Stocks should rebound soon and, barring a collapse in gold, we look for stability and then rising prices for oil in the years ahead.

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. 

© Fortigent

[description] => A former economic colleague, and mentor, used to say: “In the Bible, it says an ounce of gold will buy a fine suit of clothing.” We have read the Bible, and we haven’t found this, although there could be some high-powered math, using talents, cubits, frankincense and myrrh that make it true. [author] => Brian Wesbury, Robert Stein [legacyinterface_firm_id] => 159 [published_on] => 2014-12-16 [digest_date] => 2014-12-16 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-16 14:52:19 [created_by] => 948 [modified_on] => 2014-12-16 14:52:33 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2158 [hits] => 0 ) [12] => stdClass Object ( [legacyinterface_commentary_id] => 2093 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15332 [apv_conversation_id] => [content_type] => market-commentary [title] => An Interest Rate Hike? Check Out Long Bonds, US Dollar Index, Demographics And Money Multiplier. [slug] => sbt_121614 [fulltext] =>
  • Inflation is out of sight in terms of Treasury bond yields, dollar exchange rates and demographic outlook – let’s not even mention energy costs!
  • Much of the FED’s monetary base expansion did not flow into consumption or, more importantly, entrepreneurial productive investments!Money multiplier is more like a fractional now, since not even credit increased the money available for Main Street the way it used to.
  • Why raise interest rates if new dollars did not really filter through to the aggregate money stock readily accessible for spending?
  • The only worry in sight is probably financial assets inflation due to carry trade and Wall Street’s more speculative moves.

Lately, I have my eyes focused on interest rates. This should not be a surprise. October has just put an end to yet another spree of money printing and Central Bank interference on the market.

I have been hearing and reading a lot of comments on some imminent rate hike by the FOMC in the coming year of 2015. Well, when it comes to interest rates, we should break that down instead of taking it all as just one single thing.

The Federal Open Market Committee (FONC) gathers eight times a year to deliberate on the targeted Federal Funds rate (Fed Funds). By trading government securities, the New York Fed affects the federal funds rate. This rate is just a target rate that guides overnight loans. Depository institutions are required to keep a fraction of their deposits as reserve at central banks. Those that have a surplus balance lend it to institutions that are short of their reserve requirements. These routine transactions are very brief loans that involve no collaterals. As the term overnight indicates, they are usually settled in the next day. It is just a way of redistributing reserves between banks. So banks may borrow these Fed Funds to avoid an overdraft on their reserve account. Fed Funds are immediately available as cash for spending, unlike checks that must be cleared before being accessible as money. Though these loans are extremely short-lived, the Fed Fund rate is obviously annualized as reference. When the FOMC raises this target rate, to a certain extent, it discourages banks to move money so freely, and this affects the economy. The weighted average of all Fed Fund transaction rates is calculated as the Fed Fund effective rate.

But for us, interest rates involve a lot more than that. In corporate finance, there are certificates of indebtedness, also called debentures, bonds or notes, which are medium- to long-term debt instruments used by large companies to borrow money at some rate of interest. National debt securities are usually seen as less risky than many private debt instruments. It may be ironic that governments with not so responsible politicians may borrow money cheaper (paying less interest) than more responsibly managed companies, but the reasoning is that countries do not go bankrupt disappearing from the map. And the tradable debt securities that offer the best liquidity are the U.S. Treasuries, not just because of the sheer size of the U.S. economy, but also due to the unrivaled size of the U.S. public debt. These Treasuries are also seen as very low-risk instruments, since they are secured by the full faith and credit of the United States government.

These Treasuries are issued with different maturities and sold in auctions. There are short-term Treasury Bills (with maturities up to 1 year) Treasury Notes (with longer maturities up to 10 years) and finally Treasury Bonds (with maturities greater than 10 years). Just as there are different maturities, there are also different interest rates. Short-term T-Bills normally involve less risk and therefore lower interest rates (yield). On the other hand, longer-term T-Bonds usually pay more interest because more time involves more unforeseeable variables in the economy.

So maybe the FOMC raises the Fed Funds rate a tad. It is currently at 0 to 0.25% annualized. Last month’s effective rate was 0.09%. But if this happens, I would see it more as a bluff or an attempt to probe the markets’ response. I do not see any fundamentals for a progression of rate hikes. And if a move occurs, I do not believe it would be that relevant on the longer end of the yield curve. The market has already been narrowing the spread between short- and long-term interest rates by lowering the long end of the curve. Every time a QE ended, T-Bond demand has increased, suggesting its popularity among investors, institutions and even foreign central banks. Usually, the long end of the yield curve is way higher than the short end. When long-term interest rates get closer to short-term rates, this signals worries. Buyers fear that the economy may face problems ahead, so they are willing to settle for lower interest rates right now.

This is already noticeable since the tapering of QE3 began in January.

 

I believe we will continue to see the flattening of the yield curve, but much more due to the lowering of the long end (20- and 30-year-Bond yields), than actually a rise in the short end of the T-Bills.

Six years after the collapse of Lehman Brothers, we still see a down trend of long-term interest rates. And this is not because of the FED buying long bonds, it is actually in spite of the FED’s asset purchases. During the last three episodes of quantitative easing, interest rates of long bonds have actually gone higher. That is correct! 20- and 30-year Treasuries got less expensive and their yields went up! Not exactly what we expected from the Fedspeak we all heard. Read more about it in this earlier text. But every time the FED withdrew its QE, the market came right back to buying bonds and lowering long-term rates. I do expect we will see more of the same behavior in 2015. This move of institutions, investors and central banks into the long end of the yield curve, buying long bonds and accepting lower yields, suggest confidence in the U.S. Dollar. Any dollar devaluation would imply in more inflation in the U.S. and higher interest rates, devaluing prices of 20- and 30-year Treasury Bonds. So the market seems to believe that the dollar will hold its value and maybe appreciate.

There are two popular sayings that I find very instructive when following the market with all those marketeers out there, the first one is “Put your money where your mouth is!” and the second is “When money talks, bullshit walks!” So, instead of paying too much attention to all the noise, chatter and hubris from a crowd of talking heads, I find it more productive to see what the market is really doing with the money. (I must mention that I am NOT a believer in the Rational Expectations or Efficient Market theories, I just try to pay more attention to what is being done, instead of what is mostly being said)

One way I try to observe and analyze any inflation expectations already implicit in the behavior of investors is comparing interest rates. For that I use the interest rate of long U.S. Treasury Bonds with constant maturity (for all their trustworthiness) and divide them by the interest rates of lower quality debt instruments that are referred to as High Yield or Junk Bonds and do not hold investment grade from rating agencies. For the numerator, I’m using the 20-year Treasury constant maturity rate just because the 30-year bonds were not issued from 2002 to 2006. For the denominator, I adopted an index published by Bank of America Merrill Lynch that tracks corporate debt with a CCC or worse rating (BofA Merrill Lynch US Corporate C Index). These are bonds of lower quality that offer higher yields.

The underlying logic is that when the economy is growing, there are fewer worries about the quality of the debt. A higher tide lifts all boats. More confident, investors buy junk bonds with higher yields instead of T-Bonds that pay less interest. But the growing demand for higher risk and higher yields happen to raise junk bond prices and drive down their yields. If the economy prospers, inflation usually picks up and that hurts those people that have safer T-Bonds but lower yields. Inflation may bite a big chunk off those already lower interest rates. This tends to hurt the demand for Treasuries and, with their falling prices, their rates tend to move up. The following diagram summarizes the idea:

 

From what I have noticed, the ratio between interest rates of these different groups of debt securities tends to anticipate the behavior of inflation in the U.S. by several months!

 

The inflation lags in these charted lines seem to have been affected by the collapse of Lehman Brothers in September 2008. Before Lehman, the yields ratio used to anticipate the general course of inflation to come by more than a year. Apparently, the panic and the Fed’s QE have disturbed the average time divergence, shortening it to just a few or several months. I find this anticipation observed in the interest rates ratio very interesting, since people tend to believe that interest rates move as a consequence of the observed inflation, that is: after the fact. But, as the chart above suggests, inflation seems to be more like a delayed manifestation. Investors, institutions and companies have perceptions and form expectations for the economy that seem to guide their behavior in the bond market much faster than the consumer price index can externalize it.

In spite of that, the chart shows a last wave that started to move up in June 2012 and reached a top around the end of 2013 (mostly in lockstep with Quantitative Easing Three) and then drops during the course of 2014 (again in lockstep with the Tapering of QE3, when the Fed gradually withdrew its interference in the market and in the U.S. monetary base). This last wave did not manifest itself in any measurable inflation. Not yet, at least. But we have seen roughly 30 months go by since that trough in June 2012, and such a long time lag seems odd. It is more likely that we will not see an echo manifestation in consumer prices. Therefore, that ratio’s last wobbly behavior may have been more of a distortion initiated by QE3 and then corrected by this year’s Tapering.

If with the first two editions of Quantitative Easing (QE1 and QE2) the Fed was indeed able to move first the expectations that guided the bond market and then, secondly, inflation, with QE3 only the bond market participants seemed to react. Inflation just shrugged its shoulders and marched on sideways.

There seems to be an important message here: anti-cyclical monetary policies of the Fed may indeed be losing effect. Even though QE3 was still able to generate expectations and repercussions on Wall Street (which we saw reflected in the yields of different Bonds), the real economy of Main Street (represented by the consumer price index) seemed already unresponsive to the latest Fed’s monetary stimulus. This cannot be neglected! QE3 was indeed the fourth intervention from the Fed in the last 6 years. There were QE1, QE2, Operation TWIST and QE3. QE3 was not just the longest, but also the most expensive of these interferences. Check out below the dimension and chronology of these interventions in the market.

 

Personally, I am flabbergasted by the fact that the Fed has been acting almost nonstop in the market for the last six years! QE1, QE2, Operation TWIST and QE3 stretched for sixty two months altogether. So in a total of seventy two months since QE1 was announced on November the 25th of 2008, only for measly ten months the markets were not babysat by the Fed.

Just like an organism may develop tolerance and resistance to a particular chemical substance that has regularly been administered, the world may be getting also less sensitive to John Maynard Keynes’ catecheses and the indoctrination of his prominent central bank evangelists.

But if we look elsewhere, we may notice that this weak inflation conundrum seems to be echoing in different indicators. Another one of them is the U.S. Dollar Index, which measures the value of the dollar against a basket of different currencies. If the devaluation of the dollar (that elusive goal of the Fed!) would cause inflation, we must also concede that an appreciation of the U.S. currency shall have a disinflationary effect on consumer prices (or maybe even deflationary). American imports get cheaper with a stronger dollar. Since the U.S. imports more than it exports, the country ends up importing disinflation from abroad! And to illustrate this inverse correlation between the dollar value and consumer price inflation, I have charted the U.S. Dollar Index inverted (upside down) superposed to the U.S. CPI inflation recorded since September 2006. And here too, we see a certain anticipation of the Dollar Index that suggests further disinflation.

 

Like in 2008, 2010 and 2012, we may see inflation rate reaching down to 1% a year - and this will raise a lot more hair on the Federal Reserve Board this time (and I don’t mean this literally just because Bernanke is out). So far, the Fed’s pattern has been to turn on the presses and start minting dollars for QE as soon as inflation gets scarily close to 1%. But I bet this time they will hesitate a bit more! Besides their own experience showing less effectiveness, other factors may delay any tactical move from the Fed. First, it seems more prudent to let the economy toddle on its own for a while, just to check out the strength of its legs and how far it can get without leaning on the Fed. And second, if the world did not learn enough from Japan’s 1990 demise to prevent a similar crisis, it may be paying more attention to its present dire straits.

Japan is showing us that an exaggeration of monetary stimulus, with faster minting of money and the devaluation of the Yen, is not generating much positive result in its economy. It sure revived Japanese inflation from an overextended comatose state! But annualized GDP growth came out negative for the last two quarters (-6.7% 2ndQ and -1.9% 3rdQ). The same happened to industrial production, its annualized growths were actually retractions of -14% and -7.5% for the same respective quarters of 2014. Despite an inflation of +2.9% in October (assaulting for Japanese standards), the 3rd quarter GDP (Gross Domestic Product by Expenditure in Constant Prices) contracted -1.1% compared to the same quarter of 2013. So Japan may be swapping its deflation for an even more destabilizing stagflation.

 

The policy of Yen printing acceleration, devaluing the Yen, may have cheapened Japanese exports, but it inflated the costs of imported products and materials for Japanese industries and consumers. This caused a large number of bankruptcies in Japan. The problem did not become worse due to the providential (but expected) bust of the oil bubble.

 

To forcibly devalue a currency, trying to intimidate a population (that is already ageing and shrinking) into spending and consuming more is an audacious, and seemingly also irresponsible, stake.

There has been a series of mistakes and irresponsible behavior in the global economy. Especially the excessive credit directed to the most advanced (and already mature) economies (if only a large part of that financing had been directed to research and development of new technology in alternative sources of energy, instead of overconsumption plus real estate and financial speculation, perhaps both the economy and the climate could be in a different state of affairs). It was really unfortunate that regulatory agencies did not exhort the abusive leveraging of the private sector in developed nations, especially in view of Japan’s precedent - an economic jam that dates as far back as 1990. But two wrongs don’t make right. And it seems to me that a massive series of remedial central bank actions that exceed the already excruciating six-year span may very well be another mistake!

Central banks also seem to try to compensate for a several-decade-long drop in nativity rate and a declining young population by pumping new money into the financial system. As if freshly minted dollars in the banks could substitute younger people on the streets! And by saying this, I mean that there is a good correlation too between inflation trends and the number of teenagers and young adults in the economy. We must acknowledge that raising kids involves money – and not just a little of it! Youngsters have a characteristic need to fit into the world. This heightened search for identity, social activity and popularity boosts consumption. Young people crave fashionable clothes, accessories and all sorts of distractions, goods and gadgets. They also start to eat a lot more! Don’t even mention college expenses! This pushes consumption up, but rarely contributes enough for the production output in the economy. The equilibrium between supply and demand is affected, tilting heavier on the latter.  Many economists seem to neglect this demographic and social aspect of the economy. I have shown the relationship before in a text titled “The Rock ‘n’ Roll in the Market”. There, I simply used the number of births for each year in the U.S. (adjusted to immigration) and charted it with a 21-year delay superposed to CPI inflation. The correlation was clear for all to see. In a more recent study I tried yet a different approach. In the chart below, I am representing a wider range of youths, between 16 and 22 years of age, and I am also dividing them by the overall U.S. population to obtain the percentage of these young individuals. The U.S. does not face the same problem that Japan is facing, but still, the demographic profile is yet another fundamental that suggests a period of very modest inflation.

 

The Fed has been printing dollars and expanding the monetary base. It is moving these dollars forward by buying debt securities. This already expanded monetary base, normally, would yet be multiplied by the credit operations of commercial banks, which happen under the fractional-reserve banking system. This money multiplier effect makes the stock of money readily accessible for spending (M1) greater than the monetary base itself. So M1 is usually a multiple of the monetary base! But then again, that is what normally happened, and not what we are seeing since Lehman’s collapse and all this QE frenzy.

When demand for credit is reduced due to the aging of baby-boomers or an already debt-saturated population, offering more credit to people becomes a real challenge. If monetary policies are efficient in constraining a fast-paced economy and consumption, pushing ahead an economy that is stalling and in need of deleveraging is a much more complicated issue. Thus we hear that famous comparison with pushing on a string. You can use it to pull and hold back the economy, but not to push it forward. This is exactly what we are seeing.

The stock of money readily available for spending (M1) is not a multiple of the monetary base anymore, not since 2008. There has been not enough demand for it! M1 actually became a fraction of the total amount of dollars in the monetary base. In other words, a substantial portion of these minted dollars has never been converted into consumption or entrepreneurial fixed capital formation, and let’s not even mention credit concession!

 

The question is: if a considerable chunk of the monetary base was never translated into accessible money and much less multiplied by bank credit, then why so much talk about the FOMC raising Fed Fund rates? Why would they print all this money and months after, just render an even larger fraction of