Sunday, January 29, 2012

Morningstar Ramps Up Analyst Ratings for Mutual Funds. Positive Bias Continues.

UPDATE: 8/1/12 - You can see updated ratings as of 6/30/12 here.
Morningstar continues to roll-out its new 'forward-looking' analyst ratings for mutual funds. When I wrote about these ratings in November after their initial launch they had ratings for 349 funds. They have increased that to 410 (as of 12/31/2011). You can download the complete listing here.

As a refresher here is what Morningstar says about it's new rating system
"Unlike the backward-looking Morningstar Rating™ (often referred to as the "star rating"), which assigns 1 to 5 stars based on a fund's past risk- and load-adjusted returns versus category peers, the Analyst Rating is the summary expression of Morningstar's forward-looking analysis of a fund. Morningstar analysts assign the ratings on a five-tier scale with three positive ratings of Gold, Silver, and Bronze, a Neutral rating, and a Negative rating.
The Analyst Rating is based on the analyst's conviction in the fund's ability to outperform its peer group and/or relevant benchmark on a risk-adjusted basis over the long term. If a fund receives a positive rating of Gold, Silver, or Bronze, it means Morningstar analysts think highly of the fund and expect it to outperform over a full market cycle of at least five years."
So far it appears that this system is going to suffer from the same problems which plague stock ratings.....a lack of negative ratings. Despite the fact that the majority of mutual funds under-perform their benchmarks, only 4% of Morningstar's 410 analyst ratings are "negative".

Morningstar has still not clarified how 21 index funds have managed to receive "metal" ratings. After all, how does an index fund outperform it's benchmark? By their own definitions, the best an index fund should be rated is "neutral". Yet every index fund they have rated up to this point has received a rating higher than Neutral (with the majority getting 'gold' ratings).

Below is a chart breaking down fund attributes by each rating

Nothing too shocking here. The average fund receiving their highest "forward looking" grade also has a higher backward looking star rating. Fund expenses are lower and manger tenure is longer. The most questionable aspect comes into play regarding fund size. Many funds that performed well in the past did not necessarily do so with large asset bases, the assets usually came after the performance. With "gold" rated funds having such large asset bases on average, will they be able to outperform going forward?

I will be checking up on Morningstar's roll-out of their new ratings from time to time and will definitely check up again this time next year to see how this batch of ratings has performed.

Monday, January 23, 2012

Who Owns The World's Financial Assets? And Why Are U.S. Households So Fascinated With Stocks?

I came across an interesting report from McKinsey Global Institute. The report includes a breakdown of the ownership of the world's financial assets as of the end of 2010. I used their information to make the below chart. 

What is interesting is the U.S. fascination with equities. It should be noted that the definition of financial assets in their report excludes "the value of real estate, derivatives, physical assets such as gold, and equity in unlisted companies."  The total value of the world's financial assets equaled $198.1 Trillion and the total value of all equities equaled $53.7 Trillion. Clearly equities, bonds, bank deposits and such are massively overshadowed by the notional value of the derivatives market which is over $700 Trillion.

Drilling down to the household level in the US reveals some more interesting observations. However, unfortunately this does not include retirement accounts (but that would only increase the equity allocation since US retirement accounts hold about a 60% allocation to stocks).

The yellow line in the graph is the inflation-adjusted S&P index. You can see how long-term market trends have affected investors asset allocations through time, with investors predictably increasing/decreasing allocations at the wrong times. But I think what is clear here, is that everyone who is saying that investors are too pessimistic.....they don't know what true pessimism looks like. Investor pessimism in the US looks more like their allocations in 1945-1950 or 1975-1990. Coincidentally, that is also when generational buying opportunities presented themselves......Sorry folks, now is not a generational buying opportunity by any stretch of the imagination, despite all those who use idiotic forward PE ratio's or useless graphs of the "fed model" to tell you otherwise. Please see below some more useful market valuation indicators which actually have a strong correlation with subsequent longer-term returns (this chart is from Doug Short at Advisor Perspectives)

The market is by no means cheap. In fact, it has only been more expensive than this (based on the Shiller PE10 ratio) about 20% of the time (and those resulted in poor longer-term returns). 

If you want to see true investor pessimism towards stocks, then look no further than Japan

And a sampling of some other countries........

I have little doubt that as the US population continues to age and the younger generation gets a sour taste in their mouth regarding stocks we will see the overall allocation to stocks by US investors continue to decline, then finally when everyone believes stocks are a losers game, it will finally be the next generational buying opportunity.

Thursday, January 19, 2012

World Bank Issues The World A Rare Reality Check

The World Bank recently released it's "Global Economic Prospects" report for 2012. Organizations such as the World Bank tend to do their fair share of sugar-coating issues, however, their most recent report is about as blunt as you are likely to see from them in regards to the economic outlook.
"The world economy has entered a very difficult phase characterized by significant downside risks and fragility."
" a result forecasts have been significantly downgraded."
"However, even achieving these much weaker outturns is very uncertain."
"While contained for the moment, the risk of a much broader freezing up of capital markets and a global crisis similar in magnitude to the Lehman crisis remains. In particular, the willingness of markets to finance the deficits and maturing debt of high-income countries cannot be assured. Should more countries find themselves denied such financing, a much wider financial crisis that could engulf private banks and other financial institutions on both sides of the Atlantic cannot be ruled out. The world could be thrown into a recession as large or even larger than that of 2008/09."
Oh and for all those who are still deluding themselves into believing the idea that Europe will avoid a recession in 2012. According to the World Bank "Europe appears to have entered recession" which they estimate to have begun in the 4th Quarter of last year. Again this should not be a surprise to anybody, but for some reason people deny it until organizations such as these put their official stamp of approval on it (and there will probably still be deniers all the way up until each individual country makes it official.....big delay).

Here is a chart of the World Bank's estimates for GDP growth using 3 different scenarios they presented

According to the world bank regarding the baseline forecast...
"The baseline projections.....assume that efforts to-date and those that follow prevent the sovereign-debt stress of the past months from deteriorating further, but fail to completely eradicate market concerns."
I think their baseline assumptions are pretty optimistic. And regarding the contained crisis scenario...
"it is assumed that one or two small Euro Area economies (equal to about 4 percent of Area GDP) face a serious credit squeeze.
"It is assumed in this scenario that although borrowing costs in other European economies rise and banks tighten lending conditions due to losses in the directly affected economies, adequate steps are taken in response to the crisis to ensure that banking-sector stress in Europe is contained and does not spread to the rest of the high income world."
And finally regarding the larger crisis scenario....
"the freezing up of credit is assumed to spread to two larger Euro Area economies (equal to around 30 percent of Euro Area GDP)."
"Repercussions to the Euro Area, global financial systems and precautionary savings are much larger because the shock is 6 times larger"
In their conclusion:
The global economy is at a very difficult juncture. The financial system of the largest economic bloc in the world is threatened by a fiscal and financial crisis that has so far eluded policymakers’ efforts to contain it. Outside of Europe, high-income country growth, though strengthening, remains weak in historical perspective. At the same time some of the largest and most dynamic developing countries have entered a slowing phase.
These are not auspicious circumstances, and despite the significant measures that have been taken, the possibility of a further escalation of the crisis in Europe cannot be ruled out. Should this happen, the ensuing global downturn is likely to be deeper and longer-lasting than the recession of 2008/2009 because countries do not have the fiscal and monetary space to stimulate the global economy or support the financial system to the same degree as they did in 2008/09. While developing countries are in better shape than high-income countries, they too have fewer resources available (especially if international capital is not available to support deficit spending). No country and no region will escape the consequences of a serious downturn.
I'll leave you with random charts I found interesting from the report

Yes that is China growing from using 5% of the world's metal consumption to about 41% how much of that consumption is productive vs wasted building ghost cities, is another question.

Thursday, January 12, 2012

When Should Wall Street 'Investment Strategists' Be Fired? Calling Out "Dr. Bob" Froehlich

In most professions if you are consistently wrong you lose your job. If for some reason you do not lose your job, you will at least lose your credibility. Oddly, that is rarely the case with Wall Street Investment Strategists. In fact, regardless of how their calls turn out, many show up day after day on the media circuit merry-go-round (and investment conference merry-go-round).

What brings this up is a recent meeting I attended where Dr. Bob Froehlich was the main speaker. You have probably seen him on CNBC, Fox News and the like. Somehow I seem to cross paths with "Dr. Bob" a couple times a year. He currently is the "Chief Investment Strategist" for The Hartford. He used to have essentially the same job for DWS Investments. In fact, I remember a rep from the firm bringing him by our office in mid-2008. And yes, he was in full permabull mode. According to him, The Fed was gonna keep lowering rates and you don't want to fight the fed! It was worth a good chuckle (after all, he still thought housing was only a "subprime" problem).

If you ever wanted a shining example of a "permabull" this is him. In his own words from his Jan 3rd commentary he says "As a strategist who always sees the glass half full......" However, honestly, I'm not sure he ever sees the glass as anything but completely full. Now there is nothing wrong with being optimistic....But blind optimism does justice to no investor.

Just to illustrate how consistently bullish this guy is...........BussinessWeek April 2000 - Branding a Bull, Kemper-Style (yes folks, this is about a week after the market peak, when the S&P was around 1500).
"Undoubtedly another reason Scudder Kemper is "branding" itself by featuring Froehlich is that he's an unabashed bull. He has produced a series of audio tapes called From Wall Street to Main Street that extols the great benefits of investing in stocks. He has penned a recent book, The Three Bears are Dead!, which makes the case that the "three bears" of investing--inflation, interest rates, and government spending--all died in 1997. And Froehlich is a big believer in "Boomernomics"--that is, that baby boomers are just starting to drive the economy and stock market and that their impact will be much greater than anyone thought, prolonging the bull market well into the 2010s. The Chicago Tribune wrote about Froehlich, "There are [those] who have the eyes to see the dust in the distance, ears to hear the hoofbeats of the thundering herd, and noses to smell the money to be made. One of those is Robert Froehlich."
Dr. Bob couldn't smell money to be made if someone shoved it up his nose. That is, unless we are talking about how he really makes his money (because we know it's not by investing). He knows he makes his money as an "investment strategist" by selling blind optimism.

Yes "Boomernomics" would prolong the bull market well into the 2010s.......and nearly 12 years later here we are........

Despite his continued bad calls, mutual fund companies continue to employ this guy. Why? Because apparently they believe optimism sells! When DWS Investments finally got rid of the guy in late 2008 (after another market crash he was completely blindsided by), Hartford was quick to swoop up the hype machine.

Dr. Bob puts out his 10 investment themes yearly and they tend to always be good for a laugh. For example, the below was Dr Bob's Top 10 Investment Themes for 2011.
Not Quite......

Well let's first look at how his sector bets turned out (I included commodities using the S&P GSCI). Dr. Bob's sector "overweights" are in red.

Gee, if he only would have picked financials he would have been picking all the WORST performing sectors. The story isn't really any different if we look at global sector performance either (except the negative numbers are much larger).

How about his country overweights? China and Germany were both down about 18%. That compares to the MSCI World index which was down just over 7%. Clearly not a good call. And it goes without saying that his call to overweight international stocks (with an emphasis on emerging markets) and underweighting the dollar were both bad calls.

Now anyone can get calls wrong, and everybody does. But the consistency with which he makes bad calls and the degree to which he misses every crisis is amazing.

So what are his themes for 2012?
10) STRATEGY: Overweight Large-Cap Stocks  
9) STRATEGY: Invest in Tax-Free Municipal Bonds 
8) STRATEGY: Overweight Dividend-Paying Stocks Over Non-Dividend-Paying Stocks.
7) STRATEGY: Invest in Japan
6) STRATEGY: Invest in International Bonds 
5) STRATEGY: Overweight the Energy Sector
4) STRATEGY: Overweight the Health Care Sector
3) STRATEGY: Invest in China
2) STRATEGY: Overweight the Media Industry
1) STRATEGY: Invest in Commodities 
It will be hard for him to do worse than 2011. Here are a few gems from the above letter. First in regards to China
"I believe the economy has a major reversal growing at 9.5% to 10% instead of the 7%-7.5% consensus the market is currently calling for in 2012."
He was also very adamant about the China story when I saw him speak. The funny thing is this part where he claims to be able to spot bubbles...
"Look, the one thing that I’ve learned in my 35-year career is what the chart looks like for an asset bubble. It looks just like gold where the chart simply goes higher, and higher, heading straight up with no end in sight"
So he has had a 35 year career but about 23 years or so into it he wasn't able to spot the tech bubble, and then he wasn't able to spot the real estate bubble. But NOW he has it down! Wait, what was that about China again? So he learned to spot bubbles but yet doesn't see one in Chinese Real Estate?

But the best is this one, and he repeated this many times also when he spoke.
"First of all, Europe won’t fall into a recession"
The above is a perfect reflection of how long Dr. Bob stays in denial. The reality is the Eurozone is already in recession!

Again, the purpose of this post was not to point out individual bad calls (although I did that). The purpose was to point out how ridiculous it is that the financial industry pays so much attention to (and regurgitates) opinions without any regard to the credibility or supporting facts behind those opinions.

Let me leave you with Dr. Bob's most ironic comment from his most recent letter. This is from his theme #9: Invest in Tax-Free Municipal Bonds (where he tries to call out Meredith Whitney for her call on Muni's)
"It never ceases to amaze me how the doom and gloomers tend to get all of the media headlines and hype. I guess it’s true that “bad news” sells"
News for you Dr. Bob. If bad news sells, why do you still have a job? Furthermore if accuracy matters, why do you have a job? And while he doesn't say it in his letter, when I heard him speak, he actually spoke about how upset he was that Meredith Whitney "was not held accountable" for her call! Really Bob? Really?

Saturday, January 7, 2012

Infographic All About Gold. How about Platinum?

At the bottom of this post is an interesting infographic about Gold provided by numbersleuth. So if all the gold in the world would provide 5 rings for every person......what would it be for platinum? And the better question is, since platinum is the most rare of precious metals and actually has industrial uses as well, why is platinum over $200/oz cheaper than it's less rare counterpart? 

History says we have an anomaly (although not yet at record levels). Maybe by the time platinum gets it's own infographic the ratio will be a little more normalized.......

(click image to see larger on numbersleuth)
All The World's Gold

Monday, January 2, 2012

The List of Companies & Governments Preparing for Euro Breakup Grows

The list of companies and governments putting plans and systems in place to handle a breakup of the Euro continues to grow. Last week The Telegraph reported the UK "Treasury plans for Euro failure":
"The Treasury is working on contingency plans for the disintegration of the single currency that include capital controls.
The preparations are being made only for a worst-case scenario and would run alongside similar limited capital controls across Europe, imposed to reduce the economic fall-out of a break-up and to ease the transition to new currencies. 
Officials fear that if one member state left the euro, investors in both that country and other vulnerable eurozone nations would transfer their funds to safe havens abroad. Capital flight from weak euro nations to the UK would drive up sterling, dealing a devastating blow to the Government’s plans to rebalance the economy towards exports."
The bold was added by me.....Clearly that should say "perceived" safe havens. To think currencies from indebted counties like the UK, Japan and the US are true "safe havens" is wishful thinking.
"Britain’s response to a euro meltdown would reflect measures taken by Argentina when it dropped the dollar peg in 2002 and by Czechoslovakia after the country broke in two in 1993, according to sources. Faced with a massive capital inflow, the Czech Republic temporarily imposed taxes on foreign inflows to banks and capped the amount of overseas credit domestic banks could use.
In addition to the risk of an appreciating currency, dealing with potential UK corporate exposures to the euro poses a considerable challenge for the Treasury.
Britain’s top four banks have about £170bn of exposure to the troubled periphery of Greece, Ireland, Italy, Portugal and Spain through loans to companies, households, rival banks and holdings of sovereign debt. For Barclays and Royal Bank of Scotland, the loans equate to more than their entire equity capital buffer."
Here is a nice chart from economist Steve Keen's debtwatch blog on the distribution of debt in the UK

You can expect that UK Government debt line (orange) to continue to explode as it absorbs (via bailouts) the coming defaults in the UK Finance sector (black line). Want to think about the possible magnitude we are talking about? And we thought the US finance sector was bloated........

What was that about running to the safe haven of the UK? If you think running to your slaughter is a good idea then be my guest. The UK will eventually have no choice but to print, print, print.

So despite ongoing denials to any possibility of a Euro breakup. A wide range of companies  and governments are putting plans and systems in place for that very possibility. Not a bad idea considering that the "possibility" will eventually be reality despite all the denials. The only question is which countries will be left in the Euro, if any, and how long will it take to play out?

Friday, December 23, 2011

Full Release of Federal Reserve Emergency "Lending" Program data 2007-2009

Bloomberg has released the complete spreadsheets in a ZIP file  of the Federal Reserve Emergency 'lending' programs from 2007-2009 (don't we all wish we could borrow on those terms?). From Bloomberg:
"To download a zip file of the spreadsheets, go to For an explanation of the files, see the one labeled “1a Fed Data Roadmap.”
"Bloomberg News obtained information about the discount window and ST OMO through the Freedom of Information Act. While the Fed initially rejected a request for discount-window information, Bloomberg LP, the parent company of Bloomberg News, filed a federal lawsuit to force disclosure and won in the lower courts. In March, the U.S. Supreme Court decided not to intervene in the case, and the Fed released more than 29,000 pages of transaction data."
While we have read stories throughout the year on this information it had not yet been made available in this format.

Bloomberg has also updated their interactive chart which is quite interesting.....Couldn't embed it here but the image will take you to their chart.

However, it should be noted
"Bloomberg excluded foreign-currency liquidity swaps because names of commercial banks that borrowed under the program haven’t been disclosed to the public."
So it still remains unknown 3 years later who was bailed out with $586 Billion via foreign-currency swaps .

Friday, December 16, 2011

GDP Estimates 2012 Vs. 2008 and More Economic Consensus Groupthink

The Wall Street Journal recently released it's December Survey of Economists. This is where you generally get to hear about the current consensus groupthink. In the survey, 54 economists gave their projections for GDP in 2012 (among many other things). I decided to compare this years projections for the year ahead to what these great minds saw coming in December 2007 (the month the last recession started). Does anything about this strike anyone else as quite similar........

Now just maybe if they would have added a negative sign to their 2008 forecasts they would have been pretty spot on (considering GDP for the year finished down -2.5%). The December 2007 survey included 51 "economists"....yet not 1 came up with a negative GDP projection. Here we are now in 2011, with the European situation, the rest of the developed world including the US and Japan soaked in debt, and China trying to build ghost cities until someone rises from the dead, and not one of the 54 "economists" is willing to project anything lower then 1.3%? Interesting......

What else do they have to say?

With the unemployment rate right now at 8.6% (due to massive labor force shrinkage) the consensus is things will essentially stay as is. Funny, anyone know what the unemployment rate was in December of 2007? 5.0%. And what was the consensus for the end of 2008? 5.1%. In reality it tuned out to be 9.9% and yet not one of the economists predicted anything above 5.6%. Nice work guys.

Some more on unemployment....

Yikes, they can't predict one year ahead and now their being asked about the unemployment situation 3 years out? Anyone know how I can get in touch with James F. Smith from Parsec Financial Management who made that 5.0% projection? Because I would gladly pull a Mitt Romney on him and bet him $10,000 that's not gonna happen!

Alright, What about Treasury Rates?

Looks like they are calling for rates to rise from the current level of 1.85% to 2.75% (we can be sure this is due to their more optimistic view of the overall economy and not worries of the US ever expanding debt situation). In Dec of 2008 when it was 4.1% consensus said it would move up slightly to 4.28% (the yield ended 2008 down to 2.25%)

So what about their views on the probability of a recession in the US in the next 12 months?

23% and nobody puts the odds at higher then 40%? What about the Eurozone? Surely they must realize the Eurozone is already in a recession -- After all, the OECD already declared as much (and they are never the first to spot anything)

Really? You can't even get them to admit "yes" on a Eurozone recession which is clearly already happening? Well, what should we expect.......this is what they thought in July 2008 (7 months after the last US recession already started).

Ok so maybe we should interpret anything in the 50% range as their version of certainty LOL!

Will at least one member leave the Eurozone? 48%? Guess that should mean it's pretty near certain!

That may be about the biggest dispersion of views you will see on a subject from these groupthinkers.

Ah the joys of "economist" forecasts!

Friday, December 9, 2011

Real Estate Markets in Canada, China and Australia = CaCA

The investment world loves its acronyms (BRICS, PIIGS...etc) but I thought it was missing one which describes the housing markets in Canada, China and Australia. Then it hit me like a bag of.......CaCA! While Canadians, Chinese and Australians appear to still be living in a world of denial, evidence that their housing booms are in fact bubbles has been overwhelming. Similar to the smell of, yup, CaCA.

The Bank of Canada recently released its December "Financial System Review". It highlights some concerns about Canadian household finances and housing prices. However, it mostly down plays the housing concerns in typical central banker speak.
"In Canada, the elevated levels of household debt and housing prices require continued vigilance and close co-operation among Canadian authorities."
"Some measures of housing affordability suggest continued imbalances, owing to the robust performance of this market. In particular, house prices remain very high relative to income (Chart 26). Since the adverse impact of elevated residential property prices on affordability has been largely offset by low interest rates, affordability would be considerably curtailed if interest rates were closer to historical norms (Chart 27).
Certain areas of the national housing market may be more vulnerable to price declines, particularly the multiple-unit segment of the market, which is showing signs of disequilibrium: the supply of completed but unoccupied condominiums is elevated, which suggests a heightened risk of a correction in this market."
Gee, where does that 3rd paragraph sound familiar (see around the 1:20 mark in the below video, although the whole thing is classic.).  Obviously, in the US, it was more then the condo market and it will be in Canada too. Although, Vancouver will be Canada's version of Miami.

Clearly Canada's party will end at some point. Then in Australia we have another disaster waiting to happen (although, it has likely already begun there). Similar to Canada, it's fate was only delayed after the 2008 crash. The case of Australia's bubble is laid out in great detail in "Bubbling Over: The End of Australia’s $2 Trillion Housing Party" by Philip Soos.

Believe it or not, housing prices cannot deviate from rents by that margin forever. Fundamentals do matter.

Then of course we have China. What more can be said about China's pending disaster. We had all seen the videos of China ghost cities and malls. Of course the deniers are still in full force claiming that China's centrally planned economic structure has everything under control.......until reality becomes undeniable. The question is not whether it will burst, but how long the Chinese government can prop it up. Some of the ghost cities are already being hit such as China's city of Ordos which is discussed below. More pictures of China's out of control building can be seen here.

And as Reuters recently reported:
"After a housing bubble that doubled values in 35 cities between 2004 and 2009, prices are now falling nationwide. The central bank said on Friday property prices had reached a turning point while banks are worried a price slide of 20 percent could trigger panic selling."
"But prices in Ordos have already fallen below the level that analysts say would cause serious problems if mirrored nationally.
Prices have plummeted 20-30 percent in certain property developments in Beijing and Shanghai.
Nationwide, the decline is so far more modest. Home prices fell slightly in October from September for the first time this year, official data showed, but private surveys indicated prices began falling in September and continued through November.
With local governments often dependent on land sales to fund payments on a staggering 10.7 trillion yuan (1.1 trillion pounds) of debt, Beijing worries that a collapsing property market will trigger a wave of defaults that in turn will hit the banks."
"In Ordos, the government announced a bailout fund of between 7.5 billion and 10 billion yuan to support its beleaguered developers.
Still, that may not be enough. A commercial real estate agent, who only gave his surname Li, said that despite the government actions he was planning to return to his native Guangdong Province after six unsuccessful months in Kangbashi.
"There isn't much commercial real estate here. You need private businesses for that, and here it's all government money." 
The shock to natural resource demand from a China real estate bust is what will really bring the Australian and Canadian markets back to reality quickly. After all, its CaCA, a big interconnected mess!

Monday, December 5, 2011

Currency Analysis, Euro Breakup: Current Value of the Euro and Future Value of the Deutsche Mark

An interesting report came out from Normura Global Reseach looking at what Euro area currencies might look like if the Euro was no more.

There are nice write-ups about the report by the Financial Times and Forbes (so I will not get into that here). However, the question I continue to have is why is the Euro continuing to be valued so high? If every national currency (except for Germany, barely) would trade lower......then why is the combined currency still trading where it is?

And if this analysis is remotely accurate then people better start inventing new reasons why Germany should not leave the Euro for the Deutsche Mark. So far the only reason people come up with is that a stronger currency (a new Deutsche Mark) would hurt their export based economy. However, as shown in the chart, that revaluation higher would barely amount to anything. While there might be an initial flight to the 'assumed' safety of the new Deutsche Mark, people should not forget that Germany would also have to recapitalize its banks to absorb the losses that they would incur from a Euro breakup and PIIGS defaults -- Quickly weakening their currency.