Archive for June, 2012
These days, pundits continue to talk about how the same financial crisis plaguing Greece and its fellow PIIGS partners (Portugal, Ireland, Italy & Spain) is about to plow through the eurozone and then ultimately the remaining global economy with no mercy. If all the focus is being placed on a diminutive, calamari-eating, Ouzo-drinking society like Greece, whose economy matches the size of Maryland, then why not evaluate an even more miniscule, PIIGS prequel country…Iceland.
That’s right, the same Iceland that just four years ago people were calling a “hedge fund on ice.” You know, that frozen island that had more foreign depositors investing in their banks than people living in the country. Before Icelandic banks became more than 75% of the overall stock market, and Gordon Gekko became the country’s patron saint, Iceland was more known for fishing. The fishing industry accounted for about half of Iceland’s exports, and the next largest money maker may have been Bjork, the country’s famed and quirky female singer.
In looking back at the financial crisis of 2008-2009, as it turned out, Iceland served as a canary in the global debt binging coal mine. In order to attract the masses of depositors to Icelandic banks, these financial institutions offered outrageous, unsustainable interest rates to yield-starved customers. How did the Icelandic bankers offer such high rates? Well of course, it was those can’t-lose American subprime mortgages that were offering what seemed like irresistibly high yields. Of course, what seemed like a dream at the time, eventually turned into a nightmare once the scheme unraveled. Ultimately, it became crystal clear that the subprime borrowers could not pay the outrageous rates, especially after rates unknowingly reset to untenable levels for many borrowers.
At the peak of the crisis, the Icelandic banks were holding amounts of debt exceeding six times the Icelandic GDP (Gross Domestic Product) and these lenders suffered more than $100 billion in losses. One of the Icelandic banks was even funding a large condominium project in my neighboring Southern California city of Beverly Hills. When the excrement hit the fan after Lehman Brothers went bankrupt, it didn’t take long for Iceland’s stock market to collapse by more than -95%; Iceland’s Krona to crumple; and eventually the trigger of Iceland’s multi-billion bailout by numerous constituents, including the IMF (International Monetary Fund).
Bitter Medicine First, Improvement Next
Today, four years after the subprime implosion and Lehman debacle, the hedge fund on ice known as Iceland is beginning to thaw, and their economic picture is looking much brighter (see charts below). GDP growth is the highest it has been in four years (4.5% recently); the stock market has catapulted upwards (almost doubling from the lows); and the Iceland unemployment rate has declined from over 9% a few years ago to about 7% today.
Re-jiggering a phony economy with a faulty facade cannot be repaired overnight. However, now that the banking system has been allowed to clear out its excesses, Iceland can move forward. One tailwind behind the economy has been Iceland’s weaker currency, which has led to a +17% increase in foreign tourist nights at Icelandic hotels through April this year. What’s more, tourist traffic at Iceland’s airport hit a record in May. Iceland has taken its bitter medicine, adjusted, and is currently reaping some of the rewards.
Although the detrimental effects of austerity experienced by the economies and banks of Greece, Spain, and Italy crowd out most of today’s headlines, Iceland is not the only country to make painful changes to its fiscal ways and then taste the sweetness of progress. Let’s not forget the Guinness drinking Irish. Ireland, like Greece, Portugal, and Spain received a bailout, but Ireland’s banking system was arguably worse off than Spain’s, yet Ireland has seen its borrowing costs on its 10-year bond decrease dramatically from 9.2% at the beginning of 2011 to about 7.4% this month (still high, but moving in the right direction). The same can be said for the United States. Our banks were up against the ropes, but after some recapitalization, tighter oversight, and stricter lending standards, our banks have gotten back on track and have helped assist our economy grow for 11 consecutive quarters (albeit at uninspiring growth rates).
The austerity versus growth debate will no doubt continue to circulate through media circles. In my view, these arguments are too simplistic and one dimensional. Every country has its unique culture and distinct challenges, but even countries with massive financial excesses can steer themselves back to a path of growth. A floating hedge fund on ice to the north of us has proven that fact to us, as we witness brighter days beginning to thaw Iceland’s chilly economy to expansion again.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in Lehman Brothers, Guinness, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Investors vote on stocks every day by buying shares in favored positions and selling shares in those out-of-favor. But shouldn’t voting on stocks be different from voting for politicians? Actually, no! Now, politicians can be traded just like traditional stocks or other liquid securities. If you don’t believe me, then you should check out www.Intrade.com. Intrade is an online trading platform that is home to various prediction markets that forecast the probability of outcomes of various real-world events, including who will win the 2012 U.S. Presidential election. Just like investors can trade IBM on the New York Stock Exchange (NYSE) or Apple Inc. (AAPL) on the NASDAQ exchange, so too can individuals trade election shares in Barack Obama (ticker: OBMA) and Mitt Romney (ticker: RMNY) on the Intrade platform (see chart below).
By definition, the trading mechanics of Intrade involve a resolution of a particular event structured as a binary “Yes” or “No” result. Similar to a sports bet, Intrade eventually declares a winning or losing outcome – but there are no ties. For example, by November 6, 2012, we will know whether Obama’s shares will be trading either at $10 per share, if he becomes re-elected, or $0 per share if he loses to Romney. Just like a stock, traders can go long Obama shares, if they think he will win, or short Obama shares, if they think he will lose. Analogous to stocks, holding periods may vary too. Traders can either hold their position until the event expiration, and realize a gain or loss, or instead traders can lock in shorter-term profits/losses by closing a position before the official outcome ends.
Another great thing about Intrade’s prediction markets is that each event share price can be quickly converted to an outcome probability. So as you can see from Obama’s Intrade chart above, the current $5.28 share price signifies a 52.8% probability of Obama winning the 2012 Presidential election. No need to worry about distracting stock-splits, share offerings, or stock buybacks that could distort the true underlying dynamics of the Intrade event fundamentals.
Bizarre Bets and Over-the-Top Trades
Crazy Super Bowl “prop” bets have been around for ages, and the senseless nature of the bets did not disappoint this year, if you consider the following ridiculous Super Bowl XLVI prop bets:
• Will it take Kelly Clarkson longer or shorter than 1 minute 34 seconds to sing the National Anthem?
• Will Madonna’s hair color be blonde when she begins the Super Bowl Halftime show?
• How many times will model Giselle Bundchen be shown on TV during the game?
• What Color will the Gatorade be that is dumped on the Head Coach of the Winning Super Bowl Team?
I think you get the idea from these examples, and I believe Intrade figured out the quirky benefits as well. Betting on unusual or strange outcomes can be a lucrative endeavor.
Here are just a few of the bizarre and remarkable events you can trade on Intrade:
Rules of the Game
You may be asking yourself, “All this betting/trading sounds like fun, but isn’t this Intrade thing illegal gambling?” If your thought process went in this direction, you are not alone – I asked myself the same question. I’m no attorney, but the apparent loophole for Intrade’s business operation appears to be tied to its foreign incorporation in Ireland. Less apparent is how American law applies to Intrade as referenced in a recent New York Times article that states, “It is unclear whether American law applies to Intrade.”
Although U.S. residents may not be able to trade legally on Intrade, roaming the site may provide some quirky entertainment and provide profound answers to critical questions like, “Do extraterrestrials exist?; How much money will the new Batman movie make at the box office?; And which President are we going to get stuck with for the next four years?” Surfing around on Intrade can be a blast, but if it gets too boring, you can always go back to trading regular stocks.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and Wade Slome have no affiliation with Intrade. SCM and some of its clients own certain exchange traded funds and AAPL, but at the time of publishing SCM had no direct position in NYX, IBM any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The globe is awash in debt, deficits are exploding, and the Euro is about to collapse…right? Well, then why in the heck are six countries out of the G-7 seeing their 10-year sovereign debt trade at 2.5% or lower on a consistent downward long-term trajectory? What’s more, three of the six countries witnessing their rates plummet are from Europe, despite pundits continually calling for the demise of the eurozone.
Here is a snapshot of 10-year sovereign debt yields for the majority of the G-7 countries over the last few decades:
The sole G-7 member missing from the bond yield charts above? Italy. Although Italy’s deficits are not massive (Italy actually has a smaller deficit than U.S. as % of GDP: 3.9% in 2011), its Debt/GDP ratio has been large and rising (see chart below):
As the globe has plodded through the financial crisis of 2008-2009, investors have flocked to the perceived stability of these larger developed countries’ bonds, even if they are merely better homes in a bad neighborhood right now. PIMCO likes to call these popular sovereign bonds, “cleaner dirty shirts.” Buying sovereign debt from these less dirty shirt countries, without sensitivity to price or yield, has been a lucrative trade that has worked consistently for quite some time. Now, however, with sovereign bond yields rapidly approaching 0%, it becomes mathematically impossible to fall lower than the bottom rate floor that developed countries are standing on.
Bond bears have been wrong about the timing of the inevitable bond price reversal, myself included, but the bulls are skating on thinner and thinner ice as rates continue moving lower. The bears may prolong their bragging rights if interest rates continue downward, or persist at these lower levels for extended periods of time. Eventually the “buy the dips” mentality dies, as we so poignantly experienced in 2000 when the technology dips turned into outright collapse.
The Flies in the Bond Binging Ointment
As long as equities remain in a trading range, the “risk-off” bond binging arguments will continue holding water. If corporate earnings remain elevated and stock buybacks carry on, the pain of deflating real returns will eventually become too unbearable for investors. As the insidious rising prices of energy, healthcare, food, leisure, and general costs keep eating away everyone’s purchasing power, even the skeptics will become more impatient with the paltry returns they are currently earning. Earning negative real returns in Treasuries, CDs, money market accounts, and other conservative investments, is not going to help millions of Americans meet their future financial goals. Due to the laundry list of global economic concerns, large swaths of investors are still running and hiding, but this is not a sustainable strategy longer term. The danger from these so-called “safe,” low-yielding asset classes is actually riskier than the perceived risk, in my view.
With that said, I’ve consistently held there are a subset of investors, including a significant number of my Sidoxia Capital Management clients, who are in the later stage of retirement and have a rational need for capital preservation and income generating assets (albeit low yielding). For this investor segment, portfolio construction is not executed due to an opportunistic urge of chasing potential outsized rates of return, but more-so out of necessity. Shorter time horizons eliminate the prudence of additional equity exposure because of the extra associated volatility. Unfortunately, many of the 76 million Baby Boomers will statistically live another 20 – 30 years based on actuarial life expectations and under-save, so the risks of being too conservative can dramatically outweigh the risks of increasing equity exposure. This is all stated in the context of stocks paying a higher yield than long-term Treasuries – the first time in a generation.
Short-term risks and uncertainties remain high, with Greek election outcomes unknown; a U.S. Presidential election in flux; and an impending domestic fiscal cliff that needs to be addressed. But with interest rates accelerating towards 0% and investors’ fright-filled buying of pricey, low-yielding asset classes, many of these risks are already factored into current valuations. As it turns out, the pain of panic can be more detrimental than being stuck in over-priced assets, driven by rates dancing near an absolute floor.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Article is an excerpt from previously released Sidoxia Capital Management’s complementary June 2012 newsletter. Subscribe on right side of page.
Traditional music records have been replaced with CDs (compact discs) and digital downloads. Although the problem of a broken record repeating itself is no longer an issue, our financial markets have not conquered the problem of repetition. More specifically, the timing of the -6.3% stock market decline during May (as measured by the S&P 500 index), coincides with the same broken sell-offs we have temporarily experienced over the last two summers. First, we had the “Flash Crash” in the summer of 2010, and then the debt ceiling debate and credit downgrade of 2011.
So far, the “Sell in May and go away” mantra has followed the textbook lessons over the last few years, but as you can see from the chart below, the short-lived seasonal sell-offs have been followed by significant advances (up +33% from 2010 lows and up +29% from the 2011 lows). Given the global challenges, a two-steps forward, one-step back pattern in equity markets should not be seen as overly surprising by investors.
Although the late-spring and summer doldrums have not been a joy-ride in recent years, these overly simplistic seasonal trading rules of thumb have not been exceedingly reliable either. For example, even though the months of May in 2010-2012 produced negative returns, the previous 25 Mays going back to 1985 produced positive returns more than 2/3 of the time. Rather than fiddle with these unreliable, unscientific trading rules, individuals would be better served by listening to famous Jedi Master Yoda from Star Wars, who so astutely noted, “Uncertain, the future is.”
Voting Machines and Scales
Given the spread of globalization and technology, the speed of news dissemination has never been faster. With the 2008-2009 financial crisis still burned into investors’ minds, the default response to any scary news item is to shoot first and ask questions later. Renowned long-term investing legend Ben Graham famously highlighted, “In the short run the market is a voting machine. In the long run it’s a weighing machine.”
As it relates to short-run current events, here are some of the items that investors were voting on (no pun intended) this month:
Europe, Europe, Europe: This problem has been with us for some time now, and there are no signs it will disappear anytime soon. In a game of chicken between the EU (European Union) and Greek legislators, fresh elections are taking place on June 17th, which will ultimately determine if Greece will exit the Euro monetary union or stick to the bitter medicine of austerity prescribed by the key European decision-makers in Germany. As Greece attempts to clean up its own mess, European politicians and G-20 leaders around the globe are scrambling to create plans that ring-fence countries like Spain and Italy from succumbing to a Greek-born contagion.
Presidential Politics: If you haven’t been living in a cave for the last six months, you probably know that 2012 is a presidential election year. Regardless of your politics, there are big questions surrounding the economy, jobs, deficits, debt, taxes, entitlements, defense, gay marriage, and other important issues. Answers to many of these questions will remain unclear until we get closer to the elections. The financial markets do not like uncertainty, so probabilities would indicate volatility will remain par for the course for the foreseeable future.
Facebook Folly: Despite my warnings, Facebook’s initial public offering (IPO) failed to live up to the social media giant’s hype – the share price has fallen -22% since the shares originally priced. Great companies do not always make great stocks, especially when a relatively new kid on the block has his company’s stock initially valued at a hefty price-tag of more than a $100 billion. Finger pointing is being spread liberally on the botched Facebook deal (e.g., Morgan Stanley, NASDAQ, Facebook), but no need to shed a tear for 28-year-old founder Mark Zuckerberg since his ownership stake in the company is still valued at around $15 billion – enough to cover a European trip to McDonald’s with his newlywed wife.
Dimon in a Rough Spot: Jamie Dimon, the poster child of the banking industry (and CEO of JP Morgan Chase – JPM), dropped a bomb on the investment community earlier in the month by explaining how a rogue “whale” trader racked up $2 billion in initial losses (and growing) by taking excessive risk and throwing controls into the wind.
Chinese Dragon Losing Steam: The #2 global economy has been losing some steam as witnessed by slowing industrial production and GDP growth (Gross Domestic Product). In turn, the self correcting economic forces of supply and demand have provided relief to consumers and corporations in the form of lower fuel, energy, and commodity prices. Chinese leaders are not sitting still – there are plans of accelerating infrastructure spending and assisting banks in the form of capital injections and lower reserve requirements.
As I discussed in a previous Investing Caffeine article (see The European Dog Ate My Homework), although the current headlines remain gloomy, that will always be the case. Just a few years ago, Bear Stearns, Lehman Brothers, AIG, CDS (credit default swaps), and subprime mortgages were the boogeymen. In the 1980s, we had the Savings & Loan financial crisis and the infamous 1987 Crash. During the 1970s, the Vietnam War, Nixon’s impeachment proceedings, and rising inflation were the dominating issues. Since then, the equity markets are up over 20x-fold – time will always reward those patient long-term investors. Despite all the doom and gloom, stock markets have roughly doubled over the last three years and all the major indexes remain solidly in the black for the year. Choppy waters are likely to remain as we approach this year’s elections, but for those who understand broken records often repeat themselves, there’s a good chance the music will eventually sound much better.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including commodities, inflation protection, floating rate bonds, real estate, dividend, and alternative investment ETFs), but at the time of publishing SCM had no direct position in FB, MCD, JPM, MS, NDAQ, AIG, Lehman Brothers, Bear Stearns, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.