October 31, 2007
In the wake of today's 25-basis-point cut in interest rates by the Federal Reserve, the not-so-subtle message is that the economy will weaken. But the cut comes just hours after the Bureau of Labor Statistics told us that economic growth was higher than expected in the third quarter at a respectable 3.9%. Not only is that slightly faster than the annualized real 3.8% growth in the second quarter, that's the fastest pace since Q1 2006.
Of course, no one expects that the 3.9% is a prelude to something better, or even the standard for the foreseeable future. The Fed, to cite one source, expects the economy to slow. If a downshift is coming, diminished consumer spending will be the reason, probably due to the ongoing fallout from housing.
But there was no sign of that in today's GDP report. In fact, personal consumption expenditures, which are GDP's driving force, jumped 3.0% in Q3. What's more, consumer purchases of durable goods rose at an even faster pace, ascending 4.4%--well above the economy's overall rate of expansion.
For the casual observer looking only the numbers, this may not look like the onset of trouble. Yet the Fed's expecting something less than perfection. Indeed, the central bank is now convinced that the odds of a slowdown or worse outweigh the risk of inflation or the fallout of what lower interest rates will do to an already battered dollar.
"Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance," the Fed explained in its FOMC statement today. "However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction."
If so, then there's more to worry about with oil continuing to trade above $90 a barrel. The only thing worse than a recession is one that comes with record-high oil prices. No wonder then that the Fed remains wary on the inflation front as well, even if it's not yet prepared to do anything about it. "Readings on core inflation have improved modestly this year," the FOMC statement advised, "but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation."
Being Halloween today, one could have forgiven the stock market for thinking this all added up to an October 31 fright. In fact, stocks found reason to rally. The combination of lower interest rates and a still-robust economy (at least when viewed in a rear-view mirror) looked compelling to Wall Street.
But as we've all learned anew in recent months, economic numbers aren't always what they appear to be on the first blush. The future, of course, will unfold in only one way. Alas, the possible paths are numerous, and handicapping the odds of one vs. another isn't getting any easier. It's easy to think that the path will continue to favor the bulls. Indeed, recent history offers only inspiration. All the major asset classes continue to roar. But that, we fear, is an extraordinary trend nearing its end.
Something has to give. We don't know what freshly minted statistic will break the camel's back, nor do we have a clue when it'll arrive. But the age of handsome returns as far as the eye can see won't last. The world just doesn't work like that, even if recent history suggests otherwise.
In fact, that dark outlook gives us hope as long-term investors because it will offer the opportunity to buy at lower prices, thereby dispensing higher expected returns that come with lower prices when dealing in broad asset classes. Exactly how this scenario will unfold is still a mystery--which asset class or classes will stumble and when? Such a great unknown is uncomfortable from an investment perspective. Then again, history suggests that comfort rarely goes hand in hand with maximizing returns in the long run.
October 30, 2007
BACK FROM THE GRAVE
Actually, beta never died, as many have proclaimed over the years. In fact, beta's never been more influential.
As yours truly detailed in the November issue of Wealth Manager, beta's very much alive and kicking. What's more, beta's at the heart of a number of cutting-edge of a number of portfolio applications in the 21st century.
Beta, of course, is a risk measure that's pivotal in the Capital Asset Pricing Model, which lays much of the foundation for indexing. Although CAPM is more than 40 years old, this durable theory continues to inspire innovation in portfolio management.
CAPM isn't perfect, of course. The world is a complicated place, and no one theory can capture all the nuances that collectively define the global capital markets. Yet CAPM does a pretty good job of delivering the goods when its lessons are translated into indexing. Meanwhile, creative minds in finance keep trying to improve CAPM as a tool for the real world. Witness the ongoing love affair with ETFs, which speak volumes about the market's enduring embrace of beta. But ETFs are just the tip of the iceberg in the evolving story that is beta.
For a closer look at why you should care, read on…
October 29, 2007
THE TROUBLE WITH SUCCESS
It's an ancient problem, although as "problems" go it's one of the better ones to have since it implies that you have money to manage. But it's a problem nonetheless, and it becomes increasingly obvious as an investment portfolio grows.
Reviewing the nest egg of yours truly over the weekend revived the challenge anew of how to keep the growth relatively high in relative terms without assuming an imprudent amount of risk. Like many investors, your editor has done quite well since 2002. So it goes when bull markets bloom like weeds. Buy now what? The portfolio's bigger, and so is the hurdle to keep up the momentum.
It should come as no shock to learn that growing a fund of, say, $100,000 at 10% per annum is far easier than keeping a $1 million fund rising at the same rate. Yes, it can be done, but it requires increasing amount of skill, luck or both.
The problem is further compounded at this juncture in the investment/economic cycle, or so we believe. There are more than a few risks swirling about the capital markets these days. The fact that most markets are at or near all-time highs suggests one or two things to the jaded mind producing the text before you.
The point being that reaching for the extra return at this point may be dangerous, perhaps more so than usual. Yet the incentive for reaching today is probably higher than it's been in some time. Given the capacity for bull markets to lift all boats and raise expectations, most investors have portfolios that are materially larger compared to, say, five years previous. Some of that can be attributed to skill, but most of the growth was no doubt spawned by the genius of a bull market.
Whatever the reason for the growth, investors who take the time to analyze their portfolios and properly calculate trailing performance will realize that the rate of growth has, most likely, declined as the bull party has marched on. This is the nature of growth. If an investor mints $100,000 of growth from $1 million of assets this year, the return is 10%. Producing another $100,000 of growth next year naturally leads to a lesser relative return (9.09%) because the portfolio begins with at $1.1 million.
The temptation, of course, is to find a way to produce $110,000 of growth on that $1.1 million portfolio, which would again deliver a gain of 10%. But the task becomes progressively tougher as the size of the portfolio increases. There are natural constraints on returns under conditions of rising assets. If the laws of investing were otherwise, the most skilled managers might sit atop portfolios larger than the GDP of entire nations.
But this is not how the world works. If we consider the distribution of returns over time for, say, domestic equity mutual funds, it's clear that a bell curve generally applies. In other words, the great majority of returns are middling, either slightly above or below average. The extreme returns, either far above or far below average are the exception.
Something similar applies to individuals as well. The range of returns would likely be more extreme in the negative and the positive, but only because individuals are more likely to go off the deep end in terms of investing strategies relative to conventional professional money managers, who generally think in herd-like terms.
The lesson is nonetheless the same for everyone: maintaining a portfolio's rate of return requires greater inputs of skill or luck. Luck being what it is, we can all agree that skill is really the only game in town. With that in mind, we're reminded of Grinold and Kahn's fundamental law of active management, which quantitatively asserts that the productivity of money management is a function of skill and so-called breadth, or the opportunities for applying that skill.
In other words, a great investor can only become greater if he has more chances to make decisions. Alternatively, if an investor can't increase his skill (which generally applies to most of us), then the only way to improve investment productivity is by expanding the opportunity set of investments. For instance, assuming a given level of skill, an investor who limits his worldview to domestic stocks and bonds has X opportunity. But if he begins considering foreign stocks, his opportunity becomes X+Y. If he adds foreign bonds to the mix, the opportunity becomes X+Y+Z. And so on.
Theoretically, the opportunity to be a more productive investor is unlimited. In addition to adding asset classes, there's the potential to trade securities within those asset classes, along with a myriad of factor exposures to embrace, such as exploiting the so-called small-cap effect by going long a small-cap index and shorting a large-cap index.
But the physics of investing invariably steps in to spoil the fun. Increasing one's investment breadth inevitably leads to rising pressures on skill. Indeed, the broader your investment horizons, the greater the need for skill to manage the expanding roster of assets and strategies. You may be an authority on stock picking, but how do you fare in choosing bonds? Or currencies? Or commodities? And while the demands on skill can be muted by sticking to asset classes, the issues of rebalancing and asset allocation become more taxing on an intellectual level as the assets under management rise and the embrace of asset classes broaden. Short of a brain transplant, the only way to materially improve skill (assuming a sophisticated investor) is to tap additional resources, i.e., hire an advisor or build your own research team.
In short, there's no free lunch. Winning the money game comes at an intellectual cost and/or a willingness to embrace greater risk. Even then, there's no guarantee of a payoff. As we've learned over the years, some of the smartest investors can suffer the biggest losses. Perhaps they weren't so smart after all, lending support to the counsel dispatched years ago by Charles Ellis: Investing is a loser's game eventually. Avoiding big losses, in other words, tends to yield more productivity than running after big gains in the long run.
October 24, 2007
VOLATILITY & CORRELATION UPDATE
The last few months have been a roller coaster if you look at the markets through the prism of return. But what's the view if we survey the investment landscape via volatility and correlation? Has the world really changed all that much by these metrics?
Let's start with volatility, which we define as the standard deviation of monthly total returns for the trailing 36 months. Graphing that measure of risk on a rolling basis for each of the major asset classes over time reveals that the great decline in volatility in recent years remains intact, as our chart below illustrates.
Yes, volatility has in fact spiked if we calculate volatility on a daily or weekly basis. But the spikes have yet to show up in any meaningful way on longer-term measures of volatility, as you can see in the chart above. That doesn't mean that long run vols will stay low, although they might. But for the moment, the jury's still out on whether market volatilities generally have entered a new era, which is to say a higher plateau.
Meanwhile, what's the trend been for diversification of late? We're defining diversification here as correlation between monthly returns for the trailing 36 months. Looking how several asset classes stack up on that measure on a rolling basis against U.S. equities (Russell 3000), it's clear from our second chart below that recent history is a mixed bag (1.0 is perfect positive correlation; 0.0 is no correlation; less than zero is negative correlation).
Bonds (LB Aggregate) and commodities (DJ-AIG) are still potent diversification tools relative to U.S. stocks, but less so these days than in the past. The trend of rising correlation is especially strong between REITs and U.S. stocks. Meanwhile, foreign stocks (EAFE and MSCI Emerging Markets) continue to provide slightly more diversification compared to domestic equities.
The good news is that risk-adjusted returns are enhanced by adding asset classes with less than perfect correlation to a portfolio's existing holdings. By that standard, owning a broad array of the major asset classes still makes sense. Alas, diversification isn't quite what it used to be. On the other hand, beggars can't be choosy.
October 22, 2007
REFLECTING ON RISK
Last week's stock market swoon reminds that there's no shortage of worries to distract investors. For some pundits, the rising anxiety appears excessive. The economy still looks healthy in general. One widely read columnist over the weekend noted that consumers are still lining up to buy various luxury goods in his hometown. As a result, the odds of anything more than a mild slowdown look remote, he reasoned.
Yes, the risk of expecting the apocalypse is almost always a poor bet. The world always seems to muddle through even the worst disasters. War, terrorism, high inflation, misguided government policy, and so on are events forever hanging over the economy. Meanwhile, the ebb and flow of capitalism has been known to push markets to excess. Yet life goes on and patience usually pays off in the long run. Such are the virtues of looking past the headlines of the moment and on to the opportunities of the future.
We couldn't agree more. Strategic-minded investors should maintain perspective and keep emotions in check. But that includes recognizing that a perennially sunny disposition harbors risk too. That includes the recognition that even if the long term works out, which it usually does, the short term can try investors' souls and push the best-laid plans of mice and men to do unproductive and even self-destructive things.
It's easy to proclaim allegiance to the long term when markets are rising, as they've been doing for the better part of the past five years--at least until last week. But how many of those who champion strategic virtue will hold true to the vision when the hour is darkest?
Such is the challenge of emotion, which is perhaps the greatest enemy of investment success. The human brain is a wonder, but when it comes to making decisions about money it's not necessarily hard-wired for success, as a fascinating new book from Jason Zweig details (Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich).
But we digress. Back to the economy. Yes, it's looking good, more or less, although the rosy overview stems from looking backward. It's worth reminding that economic growth always looks like it's going to continue, right up until the point when the good times stop.
Yes, warning signs usually precede such moments of upheaval and reversal. The problem is that there are always warning signs. Separating the false warning signs from the relevant ones is what keeps economists in businesses, and most investors humbled over time.
Even the greatest of economic booms aren't perfect; something's always misfiring, something's always suffering, something always looks like it may fester into something worse. For the most part, the imperfections are consumed by the expansionary winds. In short, it pays to be bullish most of the time.
Sometimes, however, there's reason to be a bit more cautious than usual. And now is one of those times, we believe. Yes, we could be wrong. We've been wrong before, and we'll no doubt be wrong again. Wrong because of timing. And even if we're right this time, we then run the risk of staying too cautious for too long. If fate deems us correct in promoting caution now, we may irrationally cling to the mindset for longer than necessary, and thereby miss the inevitable upturn that follows.
So it goes. Risk is always and forever present, in the markets and in our decisions, and it's constantly provoking us to do the wrong thing. Fortunately, most of the risk that inhabits the capital markets and the global economy can be offset by taking a long-term bullish view. Yet even this disciplined minority should sleep with one eye open. As Nassim Nicholas Taleb has written, the deficiency of evidence for a particular outcome shouldn't be confused with a guarantee of how the world works.
Yet for those with the discipline to remain truly focused on opportunities for the next five, 10 or 20 years, the world may very well end up being a kinder, gentler place. For everyone else, the investment horizon unfolds one day at a time. That's a self-defeating view, and it's one that can and should be muted by any and all means necessary. But it can never be fully banished, which is probably why many studies show that investors generally receive a good deal less of the performance than the markets dispense over time.
Perhaps that's one reason why the financial gods invented diversification and the utilitarian pleasures of cash. Indeed, the only thing better than being a disciplined long-term bull is being a disciplined long-term bull with the capacity to buy when blood runs in the street.
October 19, 2007
IT WAS 20 YEARS AGO TODAY...
For those of us who were watching that day, October 19, 1987 is forever seared into the memory banks. One doesn't easily forget a 20% correction in the stock market that arrived in a matter of hours.
This reporter, working at a small trade magazine at the time, remembers the day vividly. The daily routine at the office began as usual, but as the morning gave way to afternoon all ears turned to the radio (the medium of choice for breaking news in those days). By 2 p.m, no one was working; all gathered in the conference room, listening to the updates on the spectacular collapse in stock prices. The selling grew more intense as the minutes ticked by. By the close of trading, we could only guess at what a 20% drop meant for the weeks and months ahead.
The obvious analogy was the crash of 1929 and the Great Depression that followed. Would history repeat itself in 1987 and beyond? Fortunately, the answer was "no." The massive selling of October 19, 1987 was an isolated event, virtually unrelated to the economy. The Federal Reserve played a pivotal role in stopping the chaos in the market from infecting the general economy. Rather than squeezing credit supply, as the central bank did in the early 1930s, the Fed learned its lesson and instead pumped huge amounts of liquidity into the system in the days and weeks after the '87 crash. By most accounts, that timely act was crucial in containing the carnage.
Twenty years on, what have we learned as investors? Buy on the dips. That has become the mantra for many, and the lesson was forged in 1987 and several times since. The latest example has come in the last several months. Reacting to the subprime woes of August, Bernanke and company dispatched an aggressive 50-basis-point cut in interest rates last month. The medicine worked its magic once again. The late-summer correction in U.S. stocks has since reversed, and the Fed's timely injection of liquidity has figured prominently in the renaissance.
In fact, the Fed has come through for the bulls each and every time trouble has reared its ugly head. Buying on the dips has been a fabulously profitable strategy over the past 20 years. Investors, as a result, are a more confident bunch today than in 1987.
There are few absolute truths in investing, but a member of that exclusive club is the iron law that expected returns and trailing performance are negatively correlated. To the extent that prices have run up in the past, future performance will be lower. That may or may not hold over the short term, which we loosely define as less than five years. But if we look out over longer stretches, the rash of bull markets in virtually everything gives us pause for calculating future returns.
Strategic-minded investors will recognize that after a portfolio is broadly diversified among the major asset classes--stocks, bonds, commodities and real estate--the remaining question of great import is how much cash, if any, to hold. The question's always timely, of course, and arguably even more so these days.
For the past 20 years, cash has only been a drag on performance. If you expect the next 20 years to be the same, cash still looks like trash. Pondering the future as informed by the past, however, one might wonder if the Fed can continue smoothing over the rough spots indefinitely with no blowback of consequence. If you have some doubts, perhaps holding a bit more cash than usual has merit, if only as a tool for taking advantage of future turmoil.
Then again, perhaps the bulls can keep roaring for longer than a reasonable observer might expect. It's easy to think so. Risk has paid off big time and so we've all been beneficiaries for the better part of past 20 years. As a result, we're all at risk of extrapolating the past into the future and assume that winning is a constant. But having won the risk game for so long, it's only prudent to consider if wealth preservation should now take precedence. The answer will vary for each and every investor. But generally speaking, with most markets at or near record highs, now's as good a time as any to ask the tough questions. Let the inquiry begin.
October 18, 2007
ANOTHER WARNING SIGN?
Sometimes the numbers send out a warning, sometimes not. Deciding which one prevails and when is part of what makes the dismal science interesting--and frustrating.
The challenge presents itself anew today in the wake of this morning's update on initial jobless claims. What, if anything, are the numbers telling us? Taken at face value, the answer's clear: the number of workers filing for unemployment benefits jumped last week to the highest level since late August. That could signify nothing more than the usual give and take that accompanies this volatile data series when measured in seasonally adjusted terms, as our chart below shows.
Statistically, we're still within the "normal" range, based on a reading of recent history. But until and if initial claims move materially higher, it's still an open question if there's an early warning sign brewing here in terms of the economy's future path.
Traders, of course, are an impatient bunch and so they aren't inclined to wait for additional context. Consider trading in Fed funds futures, which have already read this morning's news and decided that it's best to assume that the economy is weakening on the margins. Such thinking has inspired buying in the November '07 contract to the point that the crowd's becoming increasingly convinced that the Fed will cut rates again by 25 basis points at the next FOMC meeting on October 30/31.
Whether another rate cut will keep the bulls happy generally is another question. Judging by this morning's slide in stocks, it'll take more than 25 to keep the train rolling.
October 17, 2007
INFLATION UP, HOUSING DOWN.
As economic reports go, this morning's updates don't easily lend themselves to positive spins.
On the inflation front, the government today advised that pricing pressures are again bubbling. As a result, consumer prices rose at an annual pace of 2.8% through September. That equals the previous annual peak (set back in March of this year) and is the highest since August 2006.
Meanwhile, new housing starts continued tumbling last month, the Census Department reported. The annualized total of starts in September dropped more than 10% from August. Measured over the past year, the annualized level of September's housing starts was down nearly 31%. The bottom line: September's tally of new housing starts is the lowest in absolute terms since the early 1990s.
Today's vision of more housing weakness while inflation appears to be picking up a head of steam should encourage no one. The spin meisters, it seems, have their work cut out for them. Then again, as we've all learned anew in recent weeks, it's best not to jump to conclusions. The data are subject to revisions and so today's truth could be tomorrow's statistical casualty.
Perhaps, although it's still hard to overlook the latest set of numbers and think that all's well. Anything's possible, but the prospect of future data revisions won't save the deteriorating state of the housing market. Indeed, September's darkness is just another extension in a long line of housing ills.
Even a rock-ribbed optimist must admit that the residential real estate market shows little, if any, signs of stabilizing. In fact, one can persuasively make the argument, based on today's numbers, that the market is still getting worse in absolute and relative terms. The same can be said for the trend in building permits, which is a forward-looking gauge for real estate. Alas, the latest profile on this front continues to look troubling: Building permits for privately owned housing units in September were 7.3% below the revised August rate and nearly 26% under the revised September estimate.
As for inflation, there's more wiggle room for debating what comes next. That leaves the opportunity for arguing that there's nothing to worry about. Headline CPI inflation advanced only 2.8% for the year through September. That's a step up from the pace of recent months, but still quite middling based on the experience in recent years.
Then again, with oil prices setting new record highs in recent days, any confidence that inflation's a dead issue is subject to revisions, and not necessarily in favor of the optimists. Indeed, consider the price trends already in force that are most likely to weigh heavily on the American consumer. As our chart below shows, prices for those goods and services that are essential for the average household are rising at a pace well above inflation generally. A major exception: housing costs are looking tame, but the underlying reasons aren't likely to inspire, as noted above.
The good news for investors who take diversification to heart is that a portfolio designed to hedge against the major economics risks will likely fare better relative to portfolios that make heavy bets that the best of times will continue indefinitely. For instance, asset allocation that incorporates commodities and non-dollar factors into the strategic plan are pulling their weight.
In the long run, diversification's still your only friend. Excepting, of course, for those who truly know what's coming.
October 16, 2007
AND EMERGING MARKETS DEBT MAKES TEN
It's been a long time coming, but it's finally arrived.
Investors can now buy the betas for all the major asset classes. The latest arrival is PowerShares Emerging Markets Sovereign Debt ETF (Amex: PCY), which was launched last week. As a result, all ten of the major capital and commodity asset classes are now available for the first time in index-tracking exchange-listed securities (see our nearby ETF list in the left-hand column under Standard Betas).
PCY is notable for the fact that it's the first time that emerging markets debt has been indexed for the U.S. investing public. But as with any new index fund, the first question is always: What's the underlying benchmark?
PCY tracks DB Emerging Markets USD Liquid Balanced Index. In deference to the regulatory and trading demands for ETFs, the benchmark sacrifices scope in exchange for a relatively selective approach that focuses on "the most liquid" dollar-denominated emerging markets debt. A similarly narrow approach is used for profiling the respective asset classes targeted by SPDR Lehman International Treasury Bond ETF (Amex: BWX) and iShares iBoxx $ High Yield Bond ETF (Amex: HYG).
As for PCY, one to three bonds are held for each country represented in the portfolio allocation. How are the representative bonds chosen? Here's the explanation from Deutsche Bank, which manages the index:
The index selects, from the eligible bond(s), those with the biggest Z spread from each country at rebalancing. Roughly speaking, this is the bond that has the highest likely excess return compared to swaps among a group of bonds from the same country with similar risks and very high correlation. This Z Spread method is an effective and simple way to pick up relative values amongst bonds with different maturities from the same emerging market country.
The leading country weights for PCY's index as of June 30 were:
1. Columbia (6.54%)
2. Turkey (6.42%)
3. Brazil (6.33%)
4. Peru (6.32%)
5. Bulgaria (6.31%)
6. Philippines (6.31%)
Although PCY is new, a back-tested calculation of its index posted a 17.07% annualized return and a 5.60% annualized volatility for March 1, 1999 through August 23, 2007, according to Deutsche Bank. Of course, one must take such history with a grain of salt. All the more so, given the potent bull markets blowing through emerging markets generally in recent years.
As a long-term proposition, however, the allure of emerging markets debt boils down to diversification. The asset class has a history of moving independently from the other leading slices of world's capital and commodity markets. And as the financial academics have long proclaimed, mixing assets with low correlations promotes superior risk-adjusted portfolio returns.
WIth that in mind, consider how another emerging markets debt index compares to the usual benchmark suspects in terms of correlations for monthly total returns:
On paper, at least, emerging markets bonds look encouraging. But there are caveats, as always. That starts with the fact that the asset class, like so many others, has run skyward for some time. That may or may not discourage investors, but they should at least be aware of the history before jumping in.
Meanwhile, there's the question of whether the underlying index for PCY effectively captures the emerging markets debt profile. Based on the benchmark's quantitative history, it appears to be a serviceable proxy. But one might wonder how the index will fare in the real world via an ETF, which carries a 50 basis point fee. The expense, by the way, is on the low side compared with the actively managed mutual funds in the niche. But within the ETF universe, a 50-basis-point fee is far from the lowest, although it matches the cost for the recently launched SPDR Lehman International Treasury Bond ETF, which targets foreign government bonds from developed markets.
Ideally, we'd like to see a range of ETF and mutual fund choices for each of the major asset classes. Competition, after all, ultimately serves the end users. That happy state of affairs prevails in some corners, most notably for U.S. equities. But evolution is a slow process. For the moment, let's be happy with the fact that all investors can now build institutional-quality portfolios by way of the world's major betas. That's progress, by our definition. But the game has only just begun.
October 12, 2007
ANOTHER ROUND OF WARNINGS ON PRICING PRESSURE
No, we're not going to jump to conclusions. But neither can we dismiss this morning's producer price report for September.
PPI last month rose by an aggressive 1.1%, the highest since February's 1.2%. Yes, looking at recent history it's clear that PPI's monthly pace has been higher as well as lower. And, of course, PPI is a volatile data series and subject to dramatic revisions. (Gee, where have we heard that one before?).
Nonetheless, it's hard not to notice the worrisome trend in PPI now unfolding, as our chart below illustrates.
On a 12-month rolling basis, the annual pace in PPI is moving up (again) too. The 4.4% rise for the year through last month is the highest in more than a year. The recent reprieve in wholesale pricing pressure appears, for the moment, to be over.
The PPI trend is that much more notable when you consider it in context with yesterday's report on September import prices. Once again, the trend is up: on a 12-month basis, import prices rose 5.2% last month, the highest annual pace since August 2006, as you can see from the second chart below.
Pricing pressures, in short, appear to be bubbling once more. And if the two data series above aren't enough, here's one more reason to think twice before dismissing the pricing trend: the retail sales report for September, released this morning. The strong 0.6% rise last month, along with the 5.0% annual pace through September, suggests that consumer spending remains alive and kicking. The notion that the economy's about to descend into recession looks that much more remote. If so, pricing pressures generally are likely to remain robust in the coming months and perhaps well into next year.
How, then, might this alter the Fed's perception of economic events? In particular, when the FOMC meets next on October 31, what will the group decide for interest rates? Will it be time to rethink the 50 basis point cut from September?
The thought already seems to be on the collective mind of those trading Fed funds futures. The November '07 contract's price, for instance, has been slowly but steadily falling for the past two weeks, suggesting that the market's starting to ponder the idea that a) there are no more rate cuts looming; b) a rate hike, though still unlike, is no longer beyond the pale at some point.
No, you can't read too much into any one number. But when several reports start sending similar messages, it's time to pay attention. With that in mind, we look to next week's update on consumer prices for September. Will CPI confirm or deny the PPI and import price numbers? Tune in next Wednesday morning for an answer...
October 11, 2007
THE OUTLOOK ACCORDING TO ONE ECONOMIST
The August employment report initially created quite a stir. More than a few observers of the economic scene thought the recession clouds were finally gathering. But a month later, the government revised its estimate of nonfarm payroll numbers up and the world suddenly looked brighter. One can only guess at how the Fed will react at the October 31 FOMC meeting.
For some thoughts on where the economy's headed, and where it's been, today we turn to Robert Dieli, president and founder of RDLB, Inc., an economic research and management consulting firm in Lombard, Illinois that publishes its reports for subscribers at NoSpinForecast.com. Bob's a valuable source for this reporter, and a fresh visit with him is timely, given all the questions swirling about on matters of macro relevance. What follows is his take on the current economic climate, a view written by Dieli--exclusively for The Capital Spectator. As a preview, he doesn't think a recession's imminent. For the details, read on...
When the August employment figures were first released, we wrote to our subscribers that they should not take the number too seriously. Our first reason for saying that was because close inspection of the August jobs report showed that most of the decline was due to a drop in state and local education employment. That suggested that something was out of its normal seasonal pattern, or that there had been an incomplete response to the employment survey. In any case, the revision in the jobs report for September, which showed employment growth for August and September, confirmed our suspicion.
Our second reason is seen in the chart below. Note that significant revisions are common between the first and second editions of the employment report. It is on those grounds that we publish this chart in our analysis of the jobs figures every month.
The chart above also shows that in September 2006, the initial estimate was quite small, suggesting some weakness might be developing. That impression was dispelled with the revisions. As a general rule, it's best to wait for the second report before trying to draw conclusions. But, in the overheated atmosphere that prevailed in early September 2007, it was easy to get sucked in by the headline.
As for the question about the threat of recession, let's start by looking at the second chart below, which shows the year-over-year percent change in total nonfarm payrolls going back to 1955. We like this chart for a variety of reasons because it helps put the current situation into perspective. The chart also addresses the recession issue directly: the shaded areas are the recession periods, as dated by the National Bureau of Economic Research. As you can see there, the onset of several recessions occurred after the rate of growth of payroll employment dropped below 1% (the red line). We are not there yet, and we may not get there for some time.
For the current expansion, the annual change in payroll employment peaked at 2.14% in March 2006 and it's been trending steadily downward since. The 2.14% pace was the lowest peak rate of growth of any expansion since 1955. The question remains: Is the current slowdown similar to those that occurred in the middle of the expansions during 1982-1990 and 1991-2001, when the Fed adjusted interest rates and moved from a recovery-generation stance to an expansion-maintenance stance? Or, is the current descent associated with a cycle peak?
We have been saying for most of this year that the Fed was going to have to find the right set of circumstances to lower the Fed funds rate target because of what was going on in Chart 2. The sub-prime liquidity flap and the lousy first estimate of August employment forced the Fed's hand. The question now is whether the actions taken to date are enough to get payroll employment to reverse course. We addressed some of those issues in this month’s report to our subscribers.
The employment statistics are useful in trying to assess the threat of recession, but additional analysis is needed and so we developed a forward-looking indicator called the Aggregate Spread. (For a full description of how the indicator works, please visit my website at www.nospinforecast.com and click on The Tour.) This measures the likelihood of a business cycle peak or trough occurring within the next nine months. As you can see in Chart 3 below, the indicator advises that there's little chance of a recession starting any time soon.
Since 1968, recessions have started around the time the Aggregate Spread went negative and ended when it went back to the plus side. The latest reading is +258. As the chart also makes plain, when the number descends to the +200 range we usually start getting news that all is not well in the economy. And so it has been in this expansion. We reached +200 from above around the time Katrina hit. We have been advising our subscribers for about a year that we are in the phase of the cycle where bad news is not uncommon. But we have also told them that it will take more than just a little bad news to tilt the economy into a full-fledged downturn. The black vertical lines on the chart correspond to the last three dates on which the Federal Open Market Committee (FOMC) cut rates in response to a financial market crisis. In all three cases, the Aggregate Spread was well above zero and it was quite some time before the number reached zero.
The last minutes of the FOMC included a policy directive stating that “the FOMC seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output.” Those words, and the level and trend of our leading indicator bring us to the conclusion that the recession threat is not high at this time.
October 10, 2007
INDEXING FOREIGN BONDS...FINALLY!
Last week's launch of the first foreign bond ETF in the U.S. has received a muted reception so far, but it looks like a big deal to us. Diversification is the reason.
Yes, actively managed funds targeting foreign bonds have been around for years. But with the arrival of SPDR Lehman International Treasury Bond ETF (Amex: BWX), the asset class's beta is now finally available in something approaching its pure form. The first foreign bond index fund, in other words, is here.
That's good news for a number of reasons, starting with the price of entry. Consider that there are 84 "world bond" mutual funds (distinct portfolios), according to Morningstar Principia software. (There are another 26 "emerging markets bond" portfolios, but we're overlooking this group since the new ETF focuses on investment grade government debt.) The gross expense ratios for world bond funds range from a high of 4.99% (ouch!) down to 0.19%. Sixty-six of the 84 portfolios charge 0.51% or higher, which is to say that 66 world bond mutual funds charge more than the 0.50% expense ratio for new foreign bond ETF.
True, 0.50% isn't cheap when compared with the lowest fees in the ETF universe, which is as low as seven basis points. But foreign bonds aren't your garden variety asset class, which is why it's taken so long to see this corner of the marketplace indexed. Meanwhile, 50 basis points isn't so high as to destroy the fundamental case for buying this slice of beta.
The basic appeal of foreign bonds is the diversification benefits they offer to most other asset classes. As the table below shows, there's low and in some cases virtually zero correlation between foreign bonds (represented here by the Citi World Gov't Bond Index Non-$ Index, unhedged) and the major asset classes. You'd expect no less between stocks and bonds generally, and foreign bonds certainly live up to that expectation. But what's surprising is the low correlation between foreign bonds and U.S. bonds, as measured by the 0.38 correlation for the three years through last month for the Lehman Bros. U.S. Aggregate and the Citi WGBI.
Strategic-minded investors should also take note that there's low correlation between foreign bonds and commodities, REITs and high-yield bonds. Rarely has so much diversification been available for just 50 basis points. Indeed, how many investors are paying 2 and 20 for hedge funds on the belief that adding "alternative investments" will bring diversification benefits?
Simply stated, foreign bonds pack a diversification punch, raising the potential for enhancing risk-adjusted returns. One reason that foreign bonds march to the beat of their own drummer is the fact that economic and inflation cycles differ in nations around the world. Bonds, being sensitive to such factors, invariably move differently in one nation vs. another. This independence of cycles will prevail until and if there's one central bank dispensing one currency for everyone (don't hold your breath).
That leads us to the second factor: currency. Owning overseas bonds means buying securities denominated in currencies other than the greenback. As such, investors are embracing a risk factor that's not generally used in conventional portfolios of stocks, bonds or even commodities (which are generally priced in dollars around the world). Yes, forex is a volatile realm, fraught with more than a few dangers, particularly for the uninitiated. On the other hand, the risk is easily contained by limiting foreign bond portfolio weightings to reflect one's tolerance for such hazards.
In fact, the forex effect will probably do more good than harm over time when used in moderation and in context with other risk factors. That's because diversification's value increases as you tap more risk factors, particularly when the factors are largely independent from one another.
As for the new ETF, it's encouraging to learn that the portfolio will track the Lehman Brothers Global Treasury Ex-U.S. Capped Index (in unhedged dollar terms), which targets non-U.S. investment-grade government debt. By and large, the portfolio will hold sovereign bonds issued by nations in the developed world and the currency factor won't be hedged. The "capped" reference reflects the index's efforts at keeping Japan's prodigious supply bonds from dominating the portfolio and thereby causing havoc with the regulatory constraints that require ETF portfolios to be "diversified."
To date, U.S. investors, particularly retail investors have yawned at the opportunities available in the foreign bond market. If you add up the assets in mutual funds and ETFs with some degree of foreign bond exposure, it's well under $100 billion. That's peanuts compared to the roughly $20 trillion-plus of foreign bonds with maturities of one year or more in the world, according to numbers from the Bank for International Settlements. Most of the planet's fixed-income securities are outside the U.S., suggesting that a portion of a diversified portfolio should look beyond the U.S. when it comes to bonds.
October 9, 2007
A TIPS CONUNDRUM?
By the government's reckoning, inflation could hardly be less of a threat. Why, then, have inflation-indexed Treasuries performed so well in the 21st century?
TIPS, after all, are designed to thrive on higher inflation. The higher inflation goes, the better TIPS will perform. Conversely, lower inflation implies lesser performance for TIPS, in both absolute and relative terms. Meantime, if inflation's under control, doesn't that imply that the unhedged bonds paying nominal yields will do better? If not, why would anyone buy unhedged bonds if they're doomed to underperform regardless of inflation's pace?
Before you answer, let's turn to the real world track records. For the year through August, the consumer price index (CPI) rose by just 1.9%. Rarely in the past 10 years has CPI's annual pace been so low, which is to say that it's usually been higher. This has a direct bearing on TIPS for the simple reason that the bonds' principal is directly tied to the fluctuations in CPI. Higher CPIs translate into higher TIPS values, and vice versa.
Speaking of facts, inflation-indexed Treasuries have been the clear winner compared with a variety of relevant fixed-income benchmarks that are unhedged when it comes to inflation. One example can be seen in our chart below, which compares the Lehman Bros. U.S. Treasury TIPS Index to the Lehman Bros. U.S. Aggregate Bond Index, a popular measure of the domestic universe of investment-grade bonds sans inflation hedges.
As you can see, TIPS are winning the race and the triumph has been unfolding for some time. Most of the superior performance has come since 2001. For the five years through last month, the LB TIPS Index posted an annualized 5.35% total return, well above the LB Aggregate's 4.13%. TIPS also held the lead for the past five years against other indices, such as the LB Government Intermediate and LB Government Long indices.
Why have inflation-indexed bonds enjoyed a performance edge over their nominal-rate counterparts? Conceivably, there are several answers, although one in particular begs for attention, namely: one corner of the bond market expects inflation will be higher than CPI suggests.
Skeptics might argue that the TIPS market is just wrong, and that inflation is contained and in no danger of causing trouble for the foreseeable future. The official inflation numbers published by the government suggest no less. Extending this line of thinking implies that TIPS have it all wrong. But can a liquid, widely analyzed corner of the government bond market be so wrong for so long?
It's anyone's guess if TIPS will continue to lead the fixed-income pack. Without benefit of knowing next year's inflation numbers, much less next month's, we're at a loss to venture a guess. The safest route is, of course, to own TIPS and conventional bonds.
That said, we'll conclude with one question: If TIPS have so done well in recent years when inflation has been officially reported as conquered, how might inflation-indexed Treasuries fare if inflation gathers a bit more upside momentum?
October 8, 2007
THE HORSE RACE SO FAR...
No one knows what's coming, but as we write, the view looks pretty good. In fact, it's downright amazing. Of course, seeing what looks like near perfection requires a rear-view mirror. If we choose that bias, ours is a golden moment. Let's bask in it, fully aware that it may or may not offer clues for what awaits.
Year to date, through Friday, October 5, Latin America glitters brightest of all if we carve up the planet's equity markets by the familiar labels. Advancing 49% in total return dollar terms is the standard by which most other carvings fall short, as our table below shows. Of course, "falling short" still looks pretty good for the most part in absolute terms. (All numbers throughout are courtesy of S&P/Citigroup Global Equity Indices.)
Meanwhile, the sick man of the equity markets within the developed world this year surely goes to Japan, which has advanced by less than 2% YTD. If this is the best the world's second-largest economy can muster in a stellar investment year such as 2007, one might wonder what's the outlook when times turn tougher?
No, you don't have to answer now. Sleep on it. Meanwhile, consider our second table below, which ranks the equity realm by current dividend yield. By that standard, Europe is tops, standing high with a 3.2% yield. On a relative basis, at least, that's as good as it gets. Alas, poor Japan still looks unpromising with a current yield of just 1.3%.
Moving on to price-earnings ratio, Latin America looks impressive again, offering the least expensive pool of equities, based on this metric's 4.5 p/e, calculated on a trailing 12-month basis. As the third table below shows, there's a wide range of p/e ratios in the world, all the way up to the relatively pricey (yep, you guessed it) Japan, at 20.1
In fact, as our final two tables below advise, Latin America wins the global race on two additional fundamental metrics: return on equity and price to cash flow. The question is whether the strong fundamentals in Latin America offset the risk that comes now that the region's basking in the glow of the bulls? One might want to lean on the side of caution when answering. Consider, for instance, that Latin America's value status via a trailing p/e prism fades quite a bit when looking at the region by way of forward-looking p/e estimates.
In fact, one might ask if the equity markets generally are deserving of new capital, considering that we sit at or near record highs as far as the eye can see. Better to ask the tough questions when times are good rather than waiting to pose such queries when blood runs in the streets.
On that score, one might think of this post as a public service announcement for investors. We now return you to the bull market, already in progress...
October 5, 2007
Gilda Radner's Emily Litella on the Saturday Night Live of yore used to respond with a sheepish "Never mind" when proven wrong. That roughly approximates our reaction to this morning's September employment report.
It turns out that the initial jobs report for August was wrong, and by more than a little. You may recall that the government's first report for August showed the first net loss (-4,000) in nonfarm payrolls in four years. It wasn't hard to jump to conclusions. But as we learned today, there was no loss in August, which actually posted a revised 89,000 gain. What's more, the initial estimate for September showed a 110,000 rise in nonfarm payrolls--the highest since May.
Par for the course, we might add. Economic data is always and everywhere subject to revisions. So it goes. As such, the fear that the economy's about to slip into recession is, for the moment, on hold. At least until next week, when a fresh batch of numbers is released and we can all adjust our outlook one more time.
If nothing else, the world (including your humbled editor) has learned once again that trying to see the future by looking into the past shares all the safety qualities of driving drunk in rush hour with one hand tied behind your back. Forecasting is invariably laden with risk--and more than we know. True for economic forecasting, true for the capital and commodity markets. There are simply too many variables with too many relationships suffering too many exogenous events to believe that true clarity will be forthcoming any time soon if ever.
By that reasoning, we should all close up shop, find something productive to do (like planting trees or helping the sick), buy the global portfolio as determined by Mr. Market's cap weights for our retirement portfolios and move on. This, of course, is the ultimate default portfolio, perfect for investors with no particular view on the future but nonetheless eager to maximize return and minimize risk. Any takers? No? We didn't think so.
So, then, it's back to business. Yes, the economic gods hoodwinked us again. Now what? Okay, we admit it: we're a glutton for punishment, so let's dust ourselves off, pick up our shattered egos and take another look at the data as it now stands, all the while remaining fully aware that we just can't seem to learn from our mistakes.
Enough. Proceed from here at your own risk. As our chart below shows, the labor market's showing signs of life--one might say surprisingly so. Nonetheless, 100,000-plus new jobs per month hardly looks like a boom. It's pretty good by recent standards, but the trend still looks down. All of which brings us back to the old question: Is the economy just slowing or headed for something worse?
For obvious reasons, we're even more reluctant to venture a guess, at least in public. That leaves us to ponder the longer-term perspective for possible clues. That includes looking at nonfarm payroll changes on 12-month rolling percentage basis, which we've conveniently graphed below. It's clear that the economy's capacity for minting new jobs is looking tired. Yes, that could change, and for reasons that nobody currently understands. But for the moment, the trend is the trend and mere mortals must decide if it has legs.
As for the financial gods, otherwise known as the leaders of the Federal Reserve, there's the more immediate question of interest rates. More to the point, how does the 50-basis-point cut of a few weeks back look in context with today's employment update? Dare we say that if the Fed knew then what we all know now, the FOMC might have acted different on September 18? But shame on us for even posing such a thought, which only encourages more speculation.
Of course, aren't we all speculators in the end? Perhaps, unless we take the advice dispensed above and simply buy the global portfolio as determined by Mr. Market. Decisions, decisions...
October 4, 2007
ANOTHER LOOK AT INFLATION
Inflation is a familiar subject on these digital pages. As a risk factor, however, it's been mostly a non issue, or so the government's official inflation numbers advise. We worry about inflation just the same. One reason arises from the possibility that commodities are in a secular bull market, energy in particular. We've discussed why that may spell higher inflation down the road. In the October issue of Wealth Manager, we looked into the topic in a bit more detail. Inflation may ultimately prove to be tame after all. But let's not be hasty. Before you make a final decision, consider one of the risks that could derail the sunny outlook. To probe the darker side, read on...
October 3, 2007
IF NOT NOW, WHEN?
Now more than an ever an upside surprise is needed.
Higher-than-expected earnings are always good news for the stocks market. But as third-quarter reports start rolling in the weeks ahead, another upside surprise would be extremely timely in the fall of '07. Anything less may spell trouble above and beyond the usual risks.
Optimism has clearly been the dominant force of late. Despite the various financial blows that frightened investors in August and convinced the Fed to cut interest rates by 50 basis points two weeks ago, the stock market has more or less survived and even thrived. Equities are either at peaks or within shouting distance of all-time highs, depending on the index. The implication: the future looks rosy.
That's a bold statement considering the lingering worries thrown off by real estate woes of late. Home sales, to cite one statistic, continue falling. There's also the question of whether the labor market is set to contract, as suggested by the August employment report, which posted the first net loss in four years. Recession, in short, has been on the minds of many these past few weeks. But judging by the stock market, such worries are merely the stuff of overactive imaginations.
In fact, let's not minimize the message emanating from Wall Street. The future looks damn good, equity traders are collectively shouting. "Equity investors clearly don't see a significant risk of recession or a major slowing in corporate earnings," Sal Guatieri, senior economist at BMO Nesbitt Burns, told The Globe and Mail on Monday.
If you don't like that reasoning for why stocks are still rising, there's an alternative view making the rounds. The prospect of higher interest rates is powering higher stock prices. An intriguing theory, but one that may look paper thin when viewed in context with the longer term. The Fed cut rates because it perceives the odds have risen for an economic slowdown, if not worse. If that's good for stocks, how does one explain the past few years, when the Fed raised interest rates in the face of a strengthening economy? Anything's possible, but the idea that stocks are set to rise in economic cycles of growth and decline doesn't sound convincing. At some point, stocks have to fall, or least stop rising. The operative question: under what conditions might that occur?
Of course, if the view is that earnings will still grow, well, at least the conceptual framework on that one is sound. In turn, that leaves the actual earnings for Q3, along with the question: Is another season of earnings reports poised to impress?
Looking backward, Q2 reminds that positive surprises can still happen in '07. As Zacks.com noted on Monday, positive surprises dominated disappointments by a ratio of 3.5:1. In other words, Q2's median surprise was "a very healthy 3.45%," according to Zacks. "The median growth rate was far higher than was expected as we entered the earning season, coming in at 13.5% [for Q2]."
For some time now it's been easy to assume that the natural order of the universe is for relatively high earnings growth. Again quoting Zacks: "The second quarter was the 20th quarter, a.k.a. five years, of consecutive double-digit growth in median year-over-year EPS growth for S&P 500 firms."
Could it roll on? Perhaps, but the hour's late. Nonetheless, the crowd doesn't see it that way. The current median outlook for Q3 year-over-year earnings growth for the S&P 500 is 9.0%, Zacks reported. That's just under the double-digit wire but respectable just the same.
Slower, yes, but hardly the end of the world. Adding to the confidence of lower-but-still-strong earnings growth is the argument that a fair chunk of U.S. corporate earnings come from overseas operations. That, in effect, is a hedge on the risk that the U.S. economy stumbles.
Nonetheless, some trouble makers are starting to use the phrase "sucker's rally" to describe the action of late. And today, Wall Street Journal columnist Jonathan Clements warns: "Corporate profits are in danger -- even if we don't get a recession." One reason is that corporate profits have been on a roll for some time, rising at much faster pace than the economy's overall growth rate. That, Clements reminds, can't last forever. Neither can the foreign-earnings boost continue to surge higher indefinitely. That's always true, of course, but the notion of limits carries more import at particular moments of time vs. another. Let's just say that October 2007 is January 2003 when it comes to looking at forward earnings expectations.
Then again, it's time to dispatch our standard boilerplate and repeat that no one knows what's coming, least of all us. Maybe earnings growth will continue surprising on the upside for longer than one might reasonably expect. Your editor, for one, has been humbled for some time as to the power of the major asset classes to continue rising. All of which underscores the point that there are risks to being defensive too soon as well as cautious too late. Each and every investor has to make that decision.
Meantime, one might ask: If now's not a good time to cut back on equities, particularly U.S. equities, when might such a moment come? Call us crazy, but selling high and buying low is still the only game in town. Beyond that generalized view of money management, the devil remains firmly entrenched in the details.
October 1, 2007
BULL MARKETS EVERYWHERE...AGAIN
A casual observer of financial markets might have expected worse after August. Much worse. If you've been keeping up with the media reports, red ink looked like a sure thing for September.
In fact, the exact opposite graced September as all the major asset classes ran higher last month. One might reasonably be surprised at the outcome. After all, the Federal Reserve cut interest rates by an aggressive 50 basis points two weeks back, a decision in anticipation that the subprime/housing fallout would take a hefty toll on the economy and, by extension, the capital markets. Trouble may yet be coming, but as you can see from our chart below, everything was in the black for September.
If you weren't reading the day-by-day analysis and instead looked only at monthly total returns, you might think that all's well and by more than a little.
All was particularly well last month in emerging market equities, which was firmly in first place for September's biggest gain. Indeed, EEM surged nearly 12% last month. Emerging market stocks have rarely performed better on a calendar month basis in dollar terms.
Commodities had an impressive month as well. DJP added 8% in September, driven by higher prices for oil and gold, to name but two of the more obvious climbers. In third place: EFA, a proxy for developed market stocks.
Clearly, foreign stocks and commodities were the place to be in September. One reason: the dollar was in the dumps.
If the dollar and dollar-based assets are on the defensive globally, it comes as no great surprise to find that non-dollar assets and commodities are the prime beneficiaries. Owning securities denominated in anything other than the buck needed no explanation in September. Meanwhile, because commodities are typically priced in dollars, a falling greenback invariably means that more of the currency is needed to purchase the same quantity of oil, gold, etc. Inflation, in short, is the natural result of a depreciating currency and the rise in commodity prices proves the point.
The dollar's slump last month was the primary force in the investing universe. As such, the dollar news was a significant diversion from the domestic economic ills that still loom over the U.S. Subprime and housing woes haven't evaporated; they've simply been displaced by the dollar-generated bull markets in foreign equities and commodities.
That leaves the question: Will domestic issues return to the fore in driving returns among the major asset classes?
Perhaps. Meanwhile, one could reason that the good times in foreign equities and commodities have encouraged investors to stay bullish on U.S. stocks as well. Bullish thinking is nothing if not infectious. Indeed, U.S. stocks posted an impressive gain last month--one of the best so far this year. Even REITs appear to be knee-deep in comeback mode.
All of which brings us back to square one: everything's in a bull market...again. Year to date, only REITs are in the red, although given the momentum of late that could turn to black once more. Pondering the possibility suggests that 2007 be another year when all the major asset classes post gains. If so, that will be five years running (calendar years) with everything blessed by the bull with the lone exception of foreign developed government bonds, which lost ground in 2005.
By our calculations, the gains have never run on for so long among so many with almost no interruption. Of course we've been saying that for some time now only to watch markets surge higher.