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January 31, 2013
ISM Manufacturing Index: January 2013 Preview
The ISM Manufacturing Index is projected to post a marginal rise to 50.9 in tomorrow's January update , based on The Capital Spectator's average econometric forecast. That's modestly above the neutral 50 reading and roughly in line with three consensus forecasts.
Here's a closer look at the numbers, followed by brief summaries of the methodologies behind The Capital Spectator's projections:
VAR-1: A vector autoregression model that analyzes the history of industrial production in context with the ISM Manufacturing Index. The forecasts are run in R with the "vars" package.
VAR-8: A vector autoregression model that analyzes eight economic time series in context with the ISM Manufacturing Index. The eight additional series: industrial production, private non-farm payrolls, index of weekly hours worked, US stock market (S&P 500), real personal income less current transfer receipts, real personal consumption expenditures, spot oil prices, and the Treasury yield spread (10 year Note less 3-month T-bill). The forecasts are run in R with the "vars" package.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of the ISM Manufacturing Index in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of the ISM Manufacturing Index in R via the "forecast" package.
Posted by jp at 5:20 PM | Comments (0)
US Nonfarm Private Payrolls: Jan 2013 Preview
A monthly increase of 176,000 for private nonfarm payrolls in January is expected in tomorrow's update from the Labor Department, based on The Capital Spectator's average econometric forecast. That's slightly higher than December's gain, but is moderately below a pair of consensus forecasts.
Here's a closer look at the numbers, followed by brief summaries of the methodologies behind The Capital Spectator's projections:
VAR-8: A vector autoregression model that analyzes eight economic time series in context with private payrolls. The eight additional series: ISM Manufacturing Index, industrial production, aggregate weekly hours of production and nonsupervisory employees in the private sector, the stock market (S&P 500), real personal income excluding current transfer receipts, real personal consumption expenditures, spot oil prices, and the Treasury yield spread (10-year less 3-month T-bill). The forecasts are run in R with the "vars" package.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of private payrolls in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of private payrolls in R via the "forecast" package.
R-1: A linear regression model that analyzes the historical record of ADP private payrolls in context with the Labor Department's estimate of US private payrolls .The historical relationship between the variables is applied to the more recently updated ADP data to project private payrolls. The computations are run in R.
Posted by jp at 3:14 PM | Comments (0)
Personal Income Surges In December On "Special Payments"
Disposable personal income (DPI) in December surged by 2.7% compared with November's level, although the gain "was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates," the government advises. By contrast, personal consumption expenditures increased a modest 0.2% last month, or about half the rate in November.
The temporary special payments that dramatically raised the growth rate of DPI last month makes it difficult to analyze the data as it relates to the business cycle. We'll know more in a month on this front when the data normalizes. As for personal consumption, the December gain was sluggish, but the increase marks the 9th rise in 2012 vs. three monthly declines for PCE last year.
Looking at the year-over-year changes for DPI and PCE shows continued growth. The sharp annual increase for DPI at 2012's close is suspect, due to the special payments last month. PCE, meanwhile, advanced 3.6% for the year through December, or roughly in line with the annual pace in recent months. Consumer spending, in short, continues to grow but at an unspectacular rate.
RBS economist Guy Berger notes "a fair amount of resilience in demand" in the consumer sector. "But, this quarter doesn’t look great for spending as there will be some intense headwinds.”
For now, the income and spending numbers continue to support the case for expecting modest growth. The question is how far last month's unusually strong DPI will retreat back to a "normal" range in the January report? As for the implications on spending, the optimistic outlook is that the large injection of income into households last month will smooth over some of the rough edges when it comes to consumption in this year's first quarter.
Maybe, but this is no time for blind optimism. The potential for across-the-board spending cuts in federal spending in March lurks just around the corner unless Congress intervenes. "The biggest threat to the recovery now appears to be Washington," the Washington Post reminds.
That's a warning that resonates strongly after yesterday's unexpected drop in fourth-quarter GDP, due largely to an unusually steep drop in defense spending. Yes, the business cycle seems to be heavily dependent on government largess at the moment. Is this something new? Or has the dependency been there all along, and we simply overlooked this fact in a period when spending more was assumed to be locked in stone? But that's an assumption, as we learned yesterday, that's in immediate need of an attitude adjustment.
Posted by jp at 9:29 AM | Comments (0)
January 30, 2013
Personal Spending: December 2012 Preview
Personal consumption spending in December is expected to rise 0.3% on a seasonally adjusted monthly basis in nominal terms, according to The Capital Spectator's average econometric forecast.That compares with a 0.4% gain in the previous report. The average projection for December is roughly in line with several consensus forecasts based on surveys of economists.
Here's a closer look at the numbers, followed by brief summaries of the methodologies behind The Capital Spectator's projections:
VAR-1: A vector autoregression model that analyzes the history of personal income in context with personal consumption expenditures. The forecasts are run in R with the "vars" package.
VAR-3: A vector autoregression model that analyzes three economic time series in context with personal consumption expenditures. The three additional series: US private payrolls, personal income, and industrial production. The forecasts are run in R with the "vars" package.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of personal consumption expenditures in R via the "forecast" package to project future values.
ES: An exponential smoothing model that analyzes the historical record of personal consumption expenditures in R via the "forecast" package to project future values.
R-1: A linear regression model that analyzes the historical record of personal consumption expenditures in context with retail sales. The historical relationship between the variables is applied to the more recently updated retail sales data to project personal consumption expenditures. The computations are run in R.
Posted by jp at 8:24 PM | Comments (0)
Personal Income: December 2012 Preview
Personal income in December is expected to rise 0.3% on a seasonally adjusted monthly basis in nominal terms, according to The Capital Spectator's average econometric forecast.That compares with a 0.6% gain in the previous report. The average projection for December is substantially lower than the predictions in three consensus forecasts via surveys of economists.
Here's a closer look at the numbers, followed by brief summaries of the methodologies behind The Capital Spectator's projections:
VAR-1: A vector autoregression model that analyzes the history of personal consumption expenditures in context with US personal income. The forecasts are run in R with the "vars" package.
VAR-3: A vector autoregression model that analyzes three economic time series in context with personal income. The three additional series: US private payrolls, personal consumption expenditures, and industrial production. The forecasts are run in R with the "vars" package.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of personal income in R via the "forecast" package to project future values.
ES: An exponential smoothing model that analyzes the historical record of personal income in R via the "forecast" package to project future values.
R-1: A linear regression model that analyzes the historical record of personal income in context with US private payrolls. The historical relationship between the variables is applied to the more recently updated payrolls data to project personal income. The computations are run in R.
Posted by jp at 7:41 PM | Comments (0)
Q4 GDP Delivers A Big Downside Surprise
The US economy unexpectedly contracted in the fourth quarter of 2012, the government reports. That's a big surprise for many analysts, including yours truly. The 0.1% decline in GDP in the final three months of last year is the first negative quarterly comparison since the Great Recession ended in mid-2009.
"You got a combination of inventories and defense which are taking more than 2 percentage points off the growth rate," Nigel Gault, chief U.S. economist at IHS Global Insight, tells Reuters. "This is not an indicator of recession."
Colleague Paul Edelstein agrees. “This really was a story about a payback in national defense spending," he explains via Bloomberg. "Consumer spending growth picked up, fixed investment was fairly strong.”
Indeed, a quick look at the GDP report reminds that this far from an across-the-board wash-out. Personal consumption expenditures in Q4 rose 2.2%, up from 1.6% in Q3, for instance. And while gross private domestic investment retreated 0.6% in the final three months of 2012, the nonresidential and residential components posted robust increases—the best quarterly comparisons, in fact, since 2012's Q1.
The hefty retreat in exports and government spending, combined with a reversal in inventories, tipped the scales overall to the dark side, with defense spending taking an unusually steep dive—the most, in fact, in 40 years. Yet slow-growth appears to remain intact in the private sector generally, as a close reading of the monthly indicators has shown recently.
Nonetheless, the macro bears will seize on today's GDP report as evidence that the economy entered a new recession in Q4. But that still looks like a long-shot claim based on a broad array of economic numbers, including today's January jobs data from ADP. In addition, several December reports delivered upbeat news, including housing starts, industrial production, and retail sales. Keep in mind too that a broader view of the business cycle via the Chicago Fed National Activity Index is also signaling modest growth through December.
Does today's Q4 GDP report contradict the encouraging news from other macro metrics? More precisely, does the dramatic fall in defense spending, along with a quarterly retreat in inventories and exports, overwhelm the slow-growth trend in much of the private sector that's persisted in recent months? I'm skeptical.
This much, however, is clear. If today's dark headline GDP number is a true reflection of the macro trend, the negative signals will start showing up in the January indicators. For the moment, there's no sign of deterioration, as the January ADP Employment report implies. That's only one number, of course, but more are coming, starting with tomorrow's personal income and spending report and fresh numbers on jobless claims. Friday, of course, brings word of the Labor Department's estimate of nonfarm payrolls, followed by the January report for the ISM Manufacturing Index.
Is the Q4 GDP report telling us that we've been blindsided by otherwise upbeat economic news? Doubtful, but if we've been hoodwinked we'll know fairly soon. Stay tuned….
Posted by jp at 10:33 AM | Comments (0)
ADP: January Payrolls Climb The Most In 11 Months
Private payrolls increased by 192,000 in January, according to this morning's ADP Employment Report. That's a bit stronger than December's 185,000 gain and it's the best monthly pop in nearly a year. Today's release tells us that jobs creation remains at a stable, if not slightly better pace relative to the trend in recent months. In turn, that sets us up for thinking positively about Friday's January payrolls report from the Labor Department. Meanwhile, it seems that the economy's capacity for moderate growth appears to be intact in the new year, at least as far as jobs are concerned via ADP's analysis.
“The job market is slowly, but steadily, improving," says Mark Zandi, chief economist of Moody’s Analytics, in a press release that accompanied today's report. "Monthly job gains appear to have accelerated from near 150,000 to closer to 175,000. Construction is finally kicking into gear and more than offsetting the weakness in manufacturing. The recent gains may be overstating any improvement, particularly in the context of recent revivals in growth at the start of the past three years, but the gains are encouraging nonetheless.”
An econometric review of the historical relationship between the ADP data and the private-sector payrolls numbers from the government implies that Friday's official jobs update will post a modest improvement over December's 168,000 gain, which was the lowest monthly increase since last June. Running a regression analysis on the monthly changes for the ADP and government numbers, and assuming the relationship holds for January, suggests that Friday's increase will be on the order of roughly 191,000 for private jobs.
Precise forecasts are always suspect, of course, but today's ADP report implies that the government's January payrolls report will deliver another decent, if not necessarily impressive, number. In that case, we'll have another data point to consider for assuming that the slow-growth trend for the economy survived the fiscal cliff debate last month and remains alive and kicking in the new year.
Yes, the January numbers have only started to trickle in, and so it's premature to say anything definitive about the kick-off for 2013. So far, however, the few data points we do have continue to lean in a positive direction.
Posted by jp at 9:25 AM | Comments (0)
January 29, 2013
Asset Allocation & Rebalancing: (Still) Competitive Together
Passive asset allocation will never win any awards or front-page profiles, but it's a competitive strategy that quietly and consistently delivers average to above-average performance relative to a broad spectrum of multi-asset class funds. That's been the message through the years, as noted in the periodic updates on this front (see last October's review of the numbers, for instance). Has anything changed three months later? Not really. Owning a wide selection of the major asset classes continues to give the majority of higher-priced active strategies a run for their money.
For instance, here's how the horse race stacks up for the 10 years through the end of 2012 (see chart below). Once again, the Global Market Index (GMI), which is an unmanaged value-weighted mix of the major asset classes, has remained competitive against active funds that are fishing in the same strategic waters. To be precise, GMI's trailing 10-year annualized total return continues to hang out in the 75th-percentile performance neighborhood vs. nearly 1,300 actively managed multi-asset class mutual funds with at least 10 years of history. Not bad for a know-nothing strategy that can be implemented for less than 50 basis points by anyone and everyone.
A regular regimen of year-end rebalancing back to market weights has a habit of juicing GMI's returns a bit, pushing the 10-year results modestly higher, as shown by GMI-R. Equally weighting all the asset classes and rebalancing back to equality every December 31 does even better (see GMI-E).
Here's how the chart above looks in terms of the underlying numbers:
The message once again is that you can grab quite a lot of the risk premia in the world with broad diversification across asset classes for minimal effort. Rebalancing the mix is a simple overlay for controlling risk, and it holds out a decent chance of boosting performance slightly through time. The combination of those two investing decisions is a powerful pairing. For most folks (and probably a good number of institutional investors as well) that's about as far as they should travel on the money management road. Yes, some brilliant investors do better, but that thinly populated club is likely to be a lonely gathering at the annual reunion.
Should we be surprised by GMI's routinely competitive results? Not really. As I discussed in some detail in Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor 
Theory wouldn't mean much if the empirical record dispensed a radically different result. But as you can see from the chart above, along with a number of other real-world studies, you can do a lot with basic techniques, a bit of patience, and low-cost ETFs and mutual funds. That doesn't mean that you shouldn't try to do more. But the big mistake of many if not most investors is that they try to do too much.
Posted by jp at 9:29 AM | Comments (0)
January 28, 2013
Durable Goods Orders Post A Surprisingly Strong December Gain
Durable goods orders increased by a surprisingly strong 4.6% in December, closing out the year with the highest monthly gain since September. The increase was nearly three times above the consensus forecast of 1.6%, based on Econoday's estimates. Much of the gain was due to a sharp rise in aircraft orders, a volatile component that often trips up many short-term predictions for this series. Excluding transportation, new orders for durable goods still advanced, but by a considerably lesser 1.3% pace. Business investment (capital goods orders less defense and aircraft), by contrast, increased a tepid 0.2%, which suggests that corporate America's appetite for laying out large sums of money for plant and equipment remains sluggish.
Nonetheless, it's hard not to notice that that new orders in the last three months have been growing. That's a notable change from the summer.
Stepping back and looking at the broad trend, however, still looks discouraging. The year-over-year change in new orders is treading water at best. The two-year deceleration has left the trend meandering in flat-line territory. It's unclear if this is just a pause before persistent declines infect the numbers vs. a respite in advance of stronger year-over-year comparisons in 2013.
The good news is that most of the other economic indicators reflect moderate growth through December. From industrial production to retail sales to housing starts, for instance, the big picture is that the economy was firmly if not dramatically moving forward through the end of last year. That's generally been the message all along, as the updates to The Capital Spectator Economic Trend Index have shown recently (including this update from a few weeks ago).
It's not exactly clear why new orders have been so sluggish recently compared with other economic series. Some blame on uncertainty linked to the fiscal debates in Washington, or the lack of strong growth generally in the economy. Whatever the reason, the weakness in durable goods orders should be treated as an outlier unless we see deterioration in a number of other key indicators. New orders are modestly useful for analyzing the business cycle, but as a lone variable in isolation these numbers should be taken with a grain of salt. The tail should never wag the dog when it comes to evaluating macro trends. That's true for any one time series, of course, and the caveat is especially relevant for durable goods orders.
Posted by jp at 9:32 AM | Comments (0)
January 26, 2013
Book Bits | 1.26.13
● After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead
By Alan Blinder
Interview with author via The New York Times
Q: You write, “Our best hope is to minimize the consequences when bubbles go splat — and they inevitably will.” How much confidence do you have that when the next bubble goes splat, we will be ready, willing and able to contain the damage?
A: Less than I wish I had. But I’m at least hopeful that some of the lessons we’ve learned, and some of the actions we’ve taken, will make the next bubble less damaging than the last ones. For example, we now understand better the dangers that lurk in high leverage, overly complex financial instruments, and lax (or nonexistent) regulation.
● The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy
By Michael Pettis
Summary via publisher, Princeton University Press
China's economic growth is sputtering, the Euro is under threat, and the United States is combating serious trade disadvantages. Another Great Depression? Not quite. Noted economist and China expert Michael Pettis argues instead that we are undergoing a critical rebalancing of the world economies. Debunking popular misconceptions, Pettis shows that severe trade imbalances spurred on the recent financial crisis and were the result of unfortunate policies that distorted the savings and consumption patterns of certain nations. Pettis examines the reasons behind these destabilizing policies, and he predicts severe economic dislocations--a lost decade for China, the breaking of the Euro, and a receding of the U.S. dollar--that will have long-lasting effects.
● Modern Portfolio Theory: Foundations, Analysis, and New Developments
By Jack Clark Francis and Dongcheol Kim
Summary via publisher, Wiley
Modern portfolio theory (MPT), which originated with Harry Markowitz's seminal paper "Portfolio Selection" in 1952, has stood the test of time and continues to be the intellectual foundation for real-world portfolio management. This book presents a comprehensive picture of MPT in a manner that can be effectively used by financial practitioners and understood by students. Modern Portfolio Theory provides a summary of the important findings from all of the financial research done since MPT was created and presents all the MPT formulas and models using one consistent set of mathematical symbols. Opening with an informative introduction to the concepts of probability and utility theory, it quickly moves on to discuss Markowitz's seminal work on the topic with a thorough explanation of the underlying mathematics.
● Market Monetarism: Roadmap to Economic Prosperity
By Marcus Nunes and Benjamin Mark Cole
Reference via The Money Illusion (Scott Sumner)
Marcus Nunes and Benjamin Cole are familiar names to those who follow market monetarist ideas. Marcus has an excellent blog, and has supplied me with some of my best ideas. Benjamin Cole is a frequent commenter and a very persuasive writer. Now they have produced the first book applying market monetarist ideas to monetary policy during recent decades. I wrote the foreword:
... Nunes and Cole are part of a new movement called “market monetarism” which first arose on the internet and has recently revolutionized the way economists think about monetary policy in a deep slump. Prior to the recession, the standard formula called for adjusting interest rates up and down in order to target inflation. The hope was that a low and stable inflation rate would insure economic prosperity. We now know that this policy is not enough.
...If readers take an open-minded look at the evidence in this book, I believe they will be very surprised by what they see. The financial crisis and Great Recession that followed were not at all what they seemed to be at the time. The profession is beginning to come around to the market monetarist view of the importance of a stable growth path for nominal GDP, and this perspective casts a whole new light on the events of the past 5 years.
● Skating Where the Puck Was: The Correlation Game in a Flat World
By William Bernstein
Review via The Chicago Tribune
This time of year, many investors begin to reflect on the past 12 months in the market. Did stocks sail higher than bonds? Was it better to own Apple or Google? Did some mutual funds outperform others?
It's certainly OK to do this type of review, but if it tempts you to make drastic changes in your portfolio, experts say to watch out. You may be doing more harm than good.
That was one of the conclusions that William Bernstein, a financial adviser and author, made in his new e-book, "Skating Where the Puck Was: The Correlation Game in a Flat World."Bernstein found that even among institutional investors — the pros who manage university endowments and public pension funds — there is a tendency to chase after the next "big idea."
● The Public Debt Problem: A Comprehensive Guide
By Pierre Lemieux
Summary via publisher, Palgrave Macmillan
The European public debt problem was in the making long before the 2007-2009 recession, as budget deficits had become endemic. A similar crisis is now developing in America, where the same fundamental causes have been at work. The Public Debt Problem analyzes the situation of public debts in America and reviews official forecasts for the federal government. The author carefully explains the main concepts (budget deficit, public debt, etc.) and analytical tools (discounting, government accounting, Treasury securities, bonds, yields, etc.) necessary to understand the issues.
● Big Data, Big Analytics: Emerging Business Intelligence and Analytic Trends for Today's Businesses
By Michael Minelli, Michele Chambers, and Ambiga Dhiraj
Summary via publisher, Wiley
The availability of Big Data, low-cost commodity hardware and new information management and analytics software has produced a unique moment in the history of business. The convergence of these trends means that we have the capabilities required to analyze astonishing data sets quickly and cost-effectively for the first time in history. These capabilities are neither theoretical nor trivial. They represent a genuine leap forward and a clear opportunity to realize enormous gains in terms of efficiency, productivity, revenue and profitability.
Posted by jp at 4:10 AM | Comments (0)
January 25, 2013
Q4:2012 US GDP Nowcast Update | 1.25.2013
Fourth-quarter US GDP is expected to increase 2.0% in next week's initial report from the government, according to The Capital Spectator's average econometric nowcast. That's up from the previous 1.6% nowcast published on January 7. The higher nowcast reflects several upbeat economic reports for December data that have been published over the last two weeks. The official Q4 data is scheduled for release on January 30, when the Bureau of Economic Analysis will publish its initial GDP estimate for the last three months of 2012. (All GDP percentage changes cited are quoted as real seasonally adjusted annual rates.)
In last year's third quarter, GDP advanced 3.1%, according to the current BEA estimate. Although the current 2.0% nowcast represents a substantial deceleration from Q3's pace, it's strong enough for expecting that the economy is on track to report a moderate rate of growth in the final three months of 2012. Note too that The Capital Spectator's 2.0% nowcast for Q4 GDP growth is above several recently published forecasts, including The Wall Street Journal's 1.6% consensus prediction via a January 4-8 survey of economists.
Here's a closer look at the individual nowcasts:
Here's a review of how the Q4 nowcasts have evolved since early November:
Finally, here's a brief profile for each of The Capital Spectator's nowcasts:
R-4: This estimate is based on a multiple regression in R of historical GDP data vs. quarterly changes for four key economic indicators: real personal consumption expenditures, real personal income less government transfers, industrial production, and private non-farm payrolls. The model estimates the statistical relationships from the early 1970s to the present. The estimates are revised as new data is published.
R-10: This model also uses a multiple regression framework based on numbers dating to the early 1970s and updates the estimates as new data arrives. The methodology is identical to the 4-factor model above, except that R-10 uses additional factors—10 in all—to nowcast GDP. In addition to the data quartet in the 4-factor model, the 10-factor nowcast also incorporates the following six series:
• ISM Manufacturing PMI Composite Index
• housing starts
• initial jobless claims
• the stock market (S&P 500)
• crude oil prices (spot price for West Texas Intermediate)
• the Treasury yield curve spread (10-year Note less 3-month T-bill)
ARIMA-GDP: The econometric engine for this nowcast is known as an autoregressive integrated moving average. This ARIMA model uses GDP's history, dating from the early 1970s to the present, for anticipating the target quarter's change. As the historical GDP data is revised, so too is the nowcast, which is calculated in R via the “forecast” package, which optimizes the prediction model based on the data set's historical record.
ARIMA 4: This model is similar to the ARIMA technique above in terms of the econometric application, but with a key difference. Instead of using historical GDP data as a lone input, the ARIMA 4 model analyzes four historical data sets to predict GDP: real personal consumption expenditures, real personal income less government transfers, industrial production, and private non-farm payrolls.
VAR-4: This vector autoregression model uses four data series in search of interdependent relationships for estimating GDP. The historical data sets in the R-4 and ARIMA 4 models above are also used in VAR-4, albeit with a different econometric engine. As new data is published, so too is the VAR-4 nowcast. The data sets range from the early 1970s to the present, using the "vars" package in R to crunch the numbers.
Posted by jp at 4:15 AM | Comments (0)
January 24, 2013
A New (Temporary?) Glitch In The Jobless Claims Data
The January economic data is starting to trickle in, and so far the signals are encouraging. Well, mostly encouraging. There's a question about the year-over-year change in unadjusted jobless claims, which are posting an increase for the second week in a row. But the seasonally adjusted numbers are still trending positive, and so the warning in the raw data may be a statistical quirk rather than a genuine warning. Supporting the case for optimism for the first month of the new year so far is today's strong gain in the Markit US Manufacturing Purchasing Managers Index (PMI) for January.
It's still far too early to say anything close to definitive about January, but let's bide our time anyway with a look at what we've seen so far. Let's start with today's jobless claims data. New filings for unemployment benefits fell again last week, dropping to 330,000 on a seasonally adjusted basis—a five-year low. As the chart below shows, last week's total was another convincing strike downward into new territory in the post-Great Recession period. So far, so good.
But there's a puzzling lack of follow-through in the year-over-year change in the unadjusted data. For the second week in a row, the raw claims data has increased over its year-earlier level. On its face, this is troubling. But a closer look at the numbers suggests this is a temporary glitch, which isn't unprecedented for a data series that's known for lots of volatility in the short run.
Supporting the case for seeing the glass half full: the seasonally adjusted data continues to trend lower, both on a weekly basis and on a year-over-year basis. There's also quite a bit of encouraging news in the December economic reports, and today's January data point from Markit on the PMI front extends the upbeat numbers into January for the moment.
So what should we make of the annual rise in the unadjusted weekly claims data? For now, it looks like a statistical digression. It's not the first time that the usually reliable year-over-year comparison fell off the wagon. It'll be a different story, of course, if the annual increases persist.
We'll know soon enough. Indeed, next week brings more January numbers, including the all-important payrolls data and the ISM Manufacturing Index. I remain cautiously optimistic that the positive trend we've seen in a wide array of reports recently will roll on. But there's always a statistical fly in the ointment, and it happens to be unadjusted jobless claims this time around. But one or two pests at a picnic isn't a reason to pack up.
Posted by jp at 12:10 PM | Comments (0)
Debt & The Business Cycle: A Useful But Incomplete Explanation
Steve Clemons and Richard Vague tell us that it's all, or at least mostly, about debt. The financial crisis and the Great Recession were "caused primarily by a massive private debt buildup," they write in a recent white paper: "How To Predict The Next Financial Crisis." The authors will be speaking next month at a conference on the topic at the Global Interdependence Center in Philadelphia and presumably they'll lay out the evidence in some detail. They're certainly on solid ground when they link debt with financial crises. History is quite clear on this point. But let's be careful here. Citing debt as the main catalyst that routinely triggers recessions across time is surely going too far.
This may sound like a subtle distinction, but it's critical nonetheless. Financial crises and recessions often strike simultaneously, but one event has been known to arrive without the other at times. For example, the credit crunch of 1966—"the first financial crisis in the postwar period," as Martin Wolf labeled it in Financial Crisis: Understanding the Postwar U.S. Experience
Even so, it's essential to recognize the toxic relationship between debt and financial crises, a connection that Gary Gorton analyzed thoroughly in his recent book: Misunderstanding Financial Crises: Why We Don't See Them Coming
No wonder that a financial crisis can push an economy into recession. Or is it the other way around? Do recessions cause financial crises?
Analysts can be excused for not answering directly, at least not in absolute and definitive terms. The problem is that no one's really sure what's driving business cycles, or even if they're a natural, inevitable part of capitalism vs. a byproduct of misguided policy and ill-advised decisions in the private sector, which is to say a phenomenon that can be "cured." In any case, let's not conflate a diagnosis with an explanation. It's easy to identify events that precede and/or accompany downturns, but correlation isn't necessarily causation—a caveat of no small import in the land of macroeconomics.
A quick example is the popular observation that consumption declines just ahead of and/or during recessions. A naïve observer could claim that falling consumption causes recessions. True, but one could just as easily ask: What causes consumption to fall? Economists have been looking for answers to such answers in the context of the business cycle for over two centuries, and it's not obvious that we're any wiser today than in 1819, when Sismondi first identified the alternating periods of expansions and slumps as a distinct trend in economics.
If you study the ebb and flow of the economy in history you'll soon discover that there are few constants for identifying cause and effect in a timely manner. Perhaps the only reliable forecast is that there's another recession out there somewhere. In my own work in trying to untangle the various factors that collectively drive the economy's rise and fall in real time it's clear that there's an evolving mix of triggers that are linked with recessions. For instance, I track 14 broad economic and financial indicators and individually they present a mixed record in terms of signaling the onset of a new downturns through history. Collectively, however, they provide a richer roadmap for anticipating another drop in economic output. The record's hardly perfect with a carefully selected lineup of indicators, but the record's better compared to indicators in isolation throughout economic history.
This brings us back to debt and its connection with the business cycle. The simple reality is that debt is a problem, can be a problem, if the economy's slipping into recession. That's another way of saying that debt is far less threatening during an expansion. In fact, debt may not be a problem at all under the right conditions. Granted, there are limits to how much debt an economy can bear—even a growing economy—without pushing the macro climate into the danger zone. But deciding where those limits lie, in relative or absolute terms, is a murky business. Why? Much depends on whether the economy is growing or shrinking and how the other key variables compare at a given point in time.
It's tempting to say that high debt causes recessions, but the empirical record offers no easy lessons. Debt levels can increase for years without the onset of recession. That implies that there are other triggers to consider for understanding the business cycle. Monetary policy, employment, consumer spending, and so on, are hardly irrelevant here. Debt is surely a factor, but it's a contributing factor, and one with fluctuating degrees of influence through time.
Explaining the big picture from a theoretical perspective opens up another dimension of analysis, and complication. The standard Keynesian view is that slumps are a byproduct of weak/falling aggregate demand. By contrast, market monetarists emphasize that recessions are primarily due to a central bank's willingness to let nominal gross domestic product (NGDP) fall, an explanation that assumes that monetary policy can prevent or substantially lessen the economy's fall from expansionary grace.
Every corner of macroeconomic analysis is controversial, of course, as it has been over the past two centuries. Deciding how an economy moves away from equilibrium, or even if such a state exists, is the raw material for great debates and precious little agreement. Par for the course in macro. So when someone claims that all is explained by analyzing debt, or any one factor, sign me up as a skeptic.
No one can ignore debt when it comes to dissecting the business cycle. Sometimes it's the elephant in the room. But assuming that’s all we need to know from here on out is assuming empirical facts not in evidence.
Posted by jp at 8:05 AM | Comments (0)
January 23, 2013
Two More Betas For The Global Market Index
The Global Market Index (GMI) is expanding its asset class horizons. Starting with the numbers as of December 31, 2012, GMI's allocations will add foreign REITs and foreign high-yield bonds to the mix. Next week, when I publish the monthly update on asset class returns through January, these two betas will make their formal debut. (For new readers who are wondering what I’m talking about, here’s the latest monthly update of the major asset classes and GMI.) The reasoning behind this change is that the arrival of ETFs that track these markets makes it easy and cost-efficient to allocate to non-US REITs and high-yield bonds. Considering the history of these markets in context with other asset classes, there's also a strategic/tactical argument for adding foreign REITs and foreign high-yield bonds to the investment opportunity set. The correlations between the new additions and the usual suspects is still fairly high, but it's well short of perfect positive correlation. Accordingly, there's opportunity in these betas for enhancing the rebalancing bonus, if only on the margins.
In the grand scheme of the market-weighted GMI, which is never rebalanced, the new betas on the block will have a minimal effect on risk and return for the foreseeable future. Offshore REITs and junk bonds constitute a small slice of the global capital markets. The market value of foreign junk bonds is about 10% of the non-US global investment-grade corporate bond market as of 2012's close, according to data from Markit Economics and Citigroup. Foreign REITs represent a relatively larger share of the global market cap for real estate securities, according to data from Standard & Poor's: roughly 40%, with US REITs grabbing the remaining 60% slice of the pie, as of December 31, 2012. Of course, the fact that REITs represent a tiny piece of the global capital markets is an artifact of securitization—the true value of real estate proper is dramatically higher than the market cap for REITs. As such, adding foreign REITs based on market cap adds up to a marginal change as well for the market-value weighted GMI. Should you own a bigger slice of REITs in your portfolio to accurately reflect the world's property values? Possibly, although I'll leave that topic for another day.
For consistency, GMI and its counterparts will reflect the changes from December 31 onward. Alternatively, there's an argument for restating the entire GMI history by recalculating returns from the benchmark's 1997 start date. But this path is problematic for an index that is first and foremost designed as an investable measure of the major asset classes. In a bid to maintain its real-world, investable track record--as it currently exists--I've opted to add foreign REITs and foreign junk bonds from here on out, and leave the historical record as is.
In order to add the new allocations and maintain the continuity of GMI it's necessary to finance the extra investments from elsewhere in the portfolio. For simplicity, I'm simply taking the appropriate market-value share out of investment-grade foreign corporate bonds to finance the foreign high-yield addition; foreign REITs are equivalently financed from the existing domestic REIT allocation. The bottom line: GMI's net asset value is continuous and unaffected by the two extra betas.
The indexes that will represent the new asset classes in GMI: Markit iBoxx Global Developed Market ex-US High Yield and S&P Global ex-US REIT. Following the rules elsewhere in GMI's use of foreign assets, the unhedged-currency versions of the indexes will be used to calculate GMI's returns. In other words, the assets of the indexes are priced in local currencies and routinely translated back into US dollars at current market rates for generating performance data. That's fairly standard when it comes to pricing foreign assets in mutual funds and ETFs. For good or ill, it also exposes the portfolio to forex risk, which is arguably another layer of diversification, albeit embedded in the assets as opposed to carving out a separate allocation for currencies.
For GMI in its ETF version (GMI-F), which is designed as an investable benchmark, I'll use two funds as proxies for the asset class additions: iShares Global ex-USD High Yield Corp Bond (HYXU) and Vanguard Global ex-US Real Estate ETF (VNQI). Both of these ETFs have competition, and so no one should assume that these are the only product choices for the betas in question. But for our purposes here, this pair represents a reasonable solution for securitizing the beta additions to GMI when it comes to calculating GMI-F.
Although the influence of the new asset classes on GMI will be slight, due to the relatively small market caps, foreign REITs and high yield bonds will have a somewhat larger impact on the rebalanced version of GMI through time, aka GMI-R. An even larger influence is likely for the equal-weighted version of GMI (GMI-E).
The main incentive for adding these asset classes is that they deserve routine analysis and consideration for portfolio design. Indeed, buying and selling these betas is no more difficult than trading US equities or bonds writ large. If you have strong views on foreign junk or foreign REITs, you may decide to overweight, underweight or ignore the assets entirely. In fact, no less is applicable for all the asset classes. But when it comes to monitoring the broad set of betas in the world, it's no longer reasonable to ignore REITs and junk in foreign markets.
The opportunity set for GMI now stands at 14 in terms of defining the major asset class—15, if you include cash, which isn't used for calculating GMI or its counterparts. Yes, most if not all of the 14 asset classes can be further divided into a more granular set of markets, depending on the investment strategy and the assets under management. In addition, one could just as easily argue that the major asset classes should be categorized by risk factor—value vs. growth stocks, for instance, or momentum vs. capitalization. The sky's the limit for defining risk. But as a first approximation of the world's betas, the following list captures the lion's share of the primary drivers of risk factors available to everyone. What you do with these betas is something else entirely, but at the very least you should be aware of the menu if you're going to take a seat in the restaurant.
Ultimately, the goal in calculating GMI is one of tracking how a broad set of the major asset classes perform through time sans active management. As such, GMI and its counterparts are robust benchmarks, since anyone and everyone can replicate the results with minimal effort. In short, a Ph.D. in finance isn't required.
If nothing else, GMI provides a roadmap for thinking about how (or if?) to customize the passive mix of the world's primary betas. As discussed frequently on these pages, the record with a passive allocation to everything is competitive if not impressive vs. a wide array of strategies and funds intent on beating Mr. Market's portfolio (see my analysis here, for instance). With the addition of foreign REITs and junk bonds, the competitive aspect of GMI will likely rise a bit, particularly for the rebalanced and equal-weight versions. History shows rather convincingly that rebalancing a broad set of betas lays a solid foundation for earning a respectable risk premium through the years. More is better, up to a point, when it comes to rebalancing. Assuming, of course, that "more" is defined intelligently.
For my money, defining the world's major asset classes is a powerful starting point for surveying the possibilities. The fact that passive asset allocation tends to deliver average to above-average results only sweetens the deal. Adding two more betas—betas that deserve a spot at the asset allocation table--will likely add a bit more sugar to Mr. Market's cocktail.
Posted by jp at 9:23 AM | Comments (0)
January 22, 2013
Chicago Fed Nat'l Activity Index: US Economy Ended 2012 With Modest Growth
The Chicago Fed National Activity Index (CFNAI) slipped marginally to a monthly reading of +0.02 in December from an upwardly revised +0.27 in November, the Chicago Federal Reserve reports. Today's update translates to a three-month moving average (CFNAI-MA3) of -0.11, or comfortably above the -0.70 level that's considered to be the tipping point for the onset of recessions. CFNAI, a weighted average of 85 indicators, is designed as a benchmark of US economic activity broadly defined.
The December reading of the CFNAI-MA3 offers another strong signal for arguing that the US economy ended 2012 in a recession-free state and that modest growth rolls on. That's been the message all along. As I noted earlier this month, business cycle risk is low, based on a broad reading of economic and financial indicators through December. That analysis has only strengthened in the two weeks since I ran the numbers. As more December data has been published, the overall trend has remained positive. Examples include the upbeat news on retail sales, industrial production, and housing starts through last month, followed by today's CFNAI release.
No one will confuse the macro trend as unusually strong, however. As the CFNAI press release notes, "economic growth moderated in December." The Chicago Fed advises that "December’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend." Nonetheless, the soft trend has been enough to keep the economy out of the cyclical ditch, at least through the December, based on the numbers published to date.
The debate about January and beyond is, of course, wide open. But December's profile, and 2012's as well, shows a clear bias on the side of growth. Yes, data revisions could come back to haunt us. But at the moment, with a broad array of generally positive numbers published through the end of last year, it's reasonable to expect that any negative revisions will be marginal in terms of the broad trend.
Posted by jp at 9:28 AM | Comments (0)
January 21, 2013
Chicago Fed Nat'l Activity Index: December 2012 Preview
The three-month average of the Chicago Fed National Activity Index (CFNAI) is expected to decline incrementally to -0.21 in tomorrow's December update, according to The Capital Spectator's average econometric forecast. That's virtually unchanged from CFNAI's -0.20 three-month average for November. The consensus forecast of economists calls for a slightly higher reading of -0.09 in the December report. A value below -0.70 indicates an "increasing likelihood" that a recession has started, the Chicago Fed advises.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections:
VAR-4A: A vector autoregression model that analyzes four economic time series to project the Chicago Fed National Activity Index: the Capital Spectator Economic Trend Index, the Capital Spectator Economic Momentum Index, the Philadelphia Fed US Leading Indicator, and the Philadelphia Fed US Coincident Economic Activity Indicator. The forecasts are run in R with the "vars" package.
VAR-4B: A vector autoregression model that analyzes four economic time series to project the Chicago Fed National Activity Index: US private payrolls, real personal income less current transfer receipts, real personal consumption expenditures, and industrial production. The forecasts are run in R with the "vars" package.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of the Chicago Fed National Activity Index in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of the Chicago Fed National Activity Index in R via the "forecast" package.
Posted by jp at 4:06 AM | Comments (0)
January 19, 2013
Book Bits | 1.19.13
● The Leaderless Economy: Why the World Economic System Fell Apart and How to Fix It
By Peter Temin and David Vines
Summary via publisher, Princeton University Press
The Leaderless Economy reveals why international financial cooperation is the only solution to today's global economic crisis. In this timely and important book, Peter Temin and David Vines argue that our current predicament is a catastrophe rivaled only by the Great Depression. Taking an in-depth look at the history of both, they explain what went wrong and why, and demonstrate why international leadership is needed to restore prosperity and prevent future crises.
● Green Gone Wrong: Dispatches from the Front Lines of Eco-Capitalism
By Heather Rogers
Summary via publisher, Verso
Faced with climate change, many counsel “going green,” encouraging us to buy organic food or a “clean” car, for example. But can we rely on consumerism to provide a solution to the very problems it has helped cause? Heather Rogers travels from Paraguay to Indonesia, via the Hudson Valley, Detroit, and Germany’s Black Forest, to investigate green capitalism, and argues for solutions that are not mere palliatives or distractions, but ways of engaging with how we live and the kind of world we want to live in.
● Following the Trend: Diversified Managed Futures Trading
By Andreas Clenow
Summary via publisher, Wiley
During bull and bear markets, there is a group of hedge funds and professional traders which have been consistently outperforming traditional investment strategies for the past 30 odd years. They have shown remarkable uncorrelated performance and in the great bear market of 2008 they had record gains. These traders are highly secretive about their proprietary trading algorithms and often employ top PhDs in their research teams. Yet, it is possible to replicate their trading performance with relatively simplistic models. These traders are trend following cross asset futures managers, also known as CTAs. Many books are written about them but none explain their strategies in such detail as to enable the reader to emulate their success and create their own trend following trading business, until now.
● Rethinking Expectations: The Way Forward for Macroeconomics
Edited by Roman Frydman and Edmund S. Phelps
Summary via publisher, Princeton University Press
This book originated from a 2010 conference marking the fortieth anniversary of the publication of the landmark "Phelps volume," Microeconomic Foundations of Employment and Inflation Theory, a book that is often credited with pioneering the currently dominant approach to macroeconomic analysis. However, in their provocative introductory essay, Roman Frydman and Edmund Phelps argue that the vast majority of macroeconomic and finance models developed over the last four decades derailed, rather than built on, the Phelps volume's "microfoundations" approach. Whereas the contributors to the 1970 volume recognized the fundamental importance of according market participants' expectations an autonomous role, contemporary models rely on the rational expectations hypothesis (REH), which rules out such a role by design.
● Banking the World: Empirical Foundations of Financial Inclusion
Edited by Robert Cull, Asli Demirgüç-Kunt, and Jonathan Morduch
Review via The Enlightened Economist
“Half the world is unbanked,” is the title of an early chapter of a new book, Banking the World, edited by Robert Cull and others. Counterintuitive as it seems, for those of us living in countries with too much banking, too little banking is a big problem. For a long time the best, indeed one of the only, books on the issue of financial services for the truly poor has been Portfolios of the Poor, edited by Daryl Collins and others (see also the terrific Portfolios of the Poor website for additional material).
● Investing In Municipal Bonds: How to Balance Risk and Reward for Success in Today’s Bond Market
By Philip Fischer
Summary via publisher, McGraw Hill
The bond investor's guide to striking the right balance between risk and reward to maximize profitability in today's market: Provides an overview of the bond market, describes the "personalities" of specific bonds, and offers an insightful look at the 2008 financial crisis as it relates to bonds.
● Plan Your Prosperity: The Only Retirement Guide You'll Ever Need, Starting Now--Whether You're 22, 52 or 82
By Ken Fisher
Review via The New York Times
[Fisher] argues that your investing should be “benchmark” driven.
Here is how this could work — and the example is ours, not his: You decide how much you want to make on your money — say, 8 percent — and what kind of investments you are comfortable with. We will assume that it’s a mix of 60 percent stocks and 40 percent bonds. Then you find an appropriate measuring stick. For this example, you would use a balanced index — 60 percent of which tracked a broad stock market index like the Wilshire 5000, and 40 percent of which mirrored a broad bond index like the Barclays Capital U.S. Aggregate.
Then you would either buy a mutual fund, like the Vanguard Balanced Index fund, designed to match the benchmark, or build a portfolio on your own that mimicked it.
The fact that we had to create an example underscores a flaw with the book: it is very short on specifics. And that is by design. Mr. Fisher says up front that he is not going to offer benchmark or asset-allocation recommendations. His reasoning is that he doesn’t want to make explicit suggestions without knowing your specific hopes and circumstances. One size, he says, does not fit all.
Posted by jp at 4:55 AM | Comments (0)
January 18, 2013
A Real-World Benchmark For Asset Allocation
There are two main channels for engineering successful outcomes for strategic-minded investors, but there are many ways to fail. To boost the odds that the former will work in your favor, it's important to stay focused on key factors that will drive investment results, for good or ill. The first is asset allocation. It's easy and inexpensive to diversify across asset classes on a global basis, thanks to the proliferation of ETFs and mutual funds. Why would you do that? Risk management. Rebalancing is the other big variable. The two together are a powerful combination. By holding a broad array of assets you're in strong position to exploit price volatility, which is the raw material for earning a rebalancing bonus. But before you do anything, ask yourself one question: Are you confident that you can beat the pros by doing it yourself?
There are a number of strong choices for one-stop shopping when it comes to multi-asset class funds. Yes, many charge excessive fees and use questionable strategies. No wonder that most of these products compare poorly with a passive asset allocation. Among the handful of exceptions is the Vanguard Star Fund (VGSTX). Its fairly long track record, impressive performance history, and low expense ratio (0.34%) is a winning mix. It also adds up to a robust real-world benchmark for multi-asset class investing. Even if you don’t own it and have no plans to buy it, it's worth your time to periodically check in with its performance. It's also a handy reference point for stress testing the many professionally managed products that claim to offer some secret sauce for investing.
For some perspective, here's how VGSTX compares to a few of the usual benchmarks that show up on these pages, including the Global Market Index, a passive mix of the major asset classes:
As you can see, Vanguard Star is competitive with GMI, and then some. Not only has it earned a modestly higher return for the decade just passed, it’s delivered that result with roughly an equal amount of risk relative to GMI. The comparison is even more impressive once you recognize that VGSTX incurs real-world costs, whereas GMI is a paper index that suffers none of the frictions that otherwise plague investors and money managers.
I’m not trying to say that VGSTX is the only fund you need, or that it’s the absolute best of the bunch and so stellar results are a given for all of eternity. Instead, the point is simply that it's a reasonably strong benchmark that reminds us that when you diversify across a broad set of asset classes, you do two things. One, you remove a fair amount of the risk that inhabits, and has been known to plague, individual asset classes (and their components) from time to time. Two, it puts you in a strong position to take advantage of volatility.
Asset allocation doesn’t remove the systematic risk that lurks across asset classes, of course. But that’s a story (and a risk-management issue) for another day. Meanwhile, it's worth repeating that multi-asset class diversification is a simple and efficient way to minimize quite a lot of the standard demons. It's a powerful message, and one that's all to often lost in the noise of the day-to-day news cycle in financial media.
Rebalancing a wide mix of assets adds another dimension that further enhances risk management’s results after diversifying across asset classes. VGSTX offers both. Is it perfect? No. For instance, I’d like to see a bit more variety in its asset allocation strategy—foreign bonds, for instance. In any case, history suggests that you could do a lot worse than VGSTX. Can you do better? Yes, but that takes work, mainly via a stronger rebalancing strategy that’s optimized to squeeze more risk premia from the major asset classes.
Are you up to the challenge? The answer for many investors, and quite a few institutions, is clearly "no." Trading costs, taxes, and emotion are the main challenges. Even the brightest of the bunch will have a hard time beating VGSTX (and comparable strategies) through time. The real tragedy is that many investors are clueless that basic investment strategies are so tough to beat. The good news is that you can hitch your star to Vanguard’s Star, or build something similar on your own.
There’s one small catch, though: you’ll have to undergo an attitude adjustment relative to the crowd's view of money. How so? Charlie Ellis said it best in his classic book on investing: It’s all about focusing on Winning the Loser's Game.
Posted by jp at 10:36 AM | Comments (0)
January 17, 2013
Housing Starts Rise Sharply In 2012's Final Month
New residential construction in December rose substantially more than expected, posting a 12.1% increase last month (seasonally adjusted annual rate). Yours truly and several consensus forecasts were looking for a solid but considerably lesser growth rate of around 3.0%, as I noted yesterday. The key point, of course, is that the housing recovery remains on track, as today's update reminds in rather convincing terms.
Housing starts are near a five-year high. A similarly bullish trend also describes the recent data for newly issued housing permits, which are considered a leading indicator of starts. Although permits rose only marginally in December, that's enough to keep this series near a five-year high as well.
From a business cycle perspective, today's housing report data delivers another positive number for the December economic profile. Last month's tally of housing starts is nearly 37% above the year-earlier level.
Starts are one of the indicators in The Capital Spectator Economic Trend Index (CS-ETI), and with the latest news this data series enters the December column with a familiar refrain: growth. As I noted in last week's update of CS-ETI, recession risk remained low, based on available data. A week later, the observation still stands; in fact is considerably stronger, after a week of economic updates.
In the last few days we learned that both retail sales and industrial production posted gains in December and, more importantly, remained in positive territory on a year-over-year basis. Housing starts round out the week with a third installment of encouraging news.
In short, it's all but certain now that 2012 escaped recession. That's no surprise, of course. A broad reading of the numbers all along has routinely told us that the economy's momentum was firmly in the positive column, as CS-ETI has shown for months. Yes, the data points for personal income and spending numbers for December are yet to come. And there's always the potential for data revisions that paint a far darker cyclical picture. Anything's possible, as always. Based on the available numbers, however, the case is quite firm for expecting that the final analysis on the business cyclical history for 2012 will declare the year as one that was recession-free.
Posted by jp at 10:13 AM | Comments (0)
Research Review | 1.17.2013 | Asset Allocation
Strategic Asset Allocation: The Global Multi-Asset Market Portfolio 1959-2011
Ronald Doeswijk (Robeco), et al.| November 2012
The portfolio of the average investor contains important information for strategic asset allocation purposes. This portfolio shows the relative value of all assets according to the market crowd, which one could interpret as a benchmark or the optimal portfolio for the average investor. We determine the market values of equities, private equity, real estate, high yield bonds, emerging debt, non-government bonds, government bonds, inflation linked bonds, commodities, and hedge funds. For this range of assets, we estimate the invested global market portfolio for the period 1990-2011. For the main asset categories equities, real estate, non-government bonds and government bonds we extend the period to 1959-2011. To our understanding, we are the first to document the global multi-asset market portfolio at these levels of detail for such a long period of time.
Value and Momentum Everywhere
Clifford Asness (AQR Capital Management), et al. | June 2012
We study the returns to value and momentum strategies jointly across eight diverse markets and asset classes. Finding consistent value and momentum premia in every asset class, we further find strong common factor structure among their returns. Value and momentum are more positively correlated across asset classes than passive exposures to the asset classes themselves. However, value and momentum are negatively correlated both within and across asset classes. Our results indicate the presence of common global risks that we characterize with a three factor model. Global funding liquidity risk is a partial source of these patterns, which are identifiable only when examining value and momentum simultaneously across markets. Our findings present a challenge to existing behavioral, institutional, and rational asset pricing theories that largely focus on U.S. equities.
Risk-Factor Diversification and Portfolio Selection
Scott Pappas (Griffith University), et al. | August 2012
Traditionally, investment portfolios have been constructed with a focus on what asset classes to invest in and how much to invest in each. Recent research, however, has shown that focusing on risk-factor allocations, rather than asset class allocations, can result in better risk-adjusted portfolio performance. The existing literature has focused on simple allocation strategies such as equal-weighted and equal-risk-weighted portfolios. In addition to these simple allocation techniques, this paper compares the performance using mean-variance analysis, and presents evidence that the outperformance of risk-factor diversification may not be as conclusive as has been previously presented in the literature. While confirming some of the prior findings on risk-factor diversification, the research shows that previous findings may be subject to strong caveats. Specifically, the evidence suggests that the selection of risk-factors, portfolio selection techniques and time-period have a large impact on performance outcomes.
Investing Under Inflation Risk
George Crawford and Jim Kyung-Soo Liew | August 2012
Inflation, a quiet but growing concern, is complicated by its unpredictability in timing and severity. A survey of 110 years of inflation data suggests that Treasury Bills track inflation better than equities or bonds, and this result is robust across 19 countries. In most periods of high inflation in these countries, however, equities produced much higher, though more volatile, returns, but in some periods returns were much lower. Observation of periods of high inflation in the US and other countries suggests that while Treasury Bills track inflation best optimal hedging portfolio composition varies over time. In the more recent periods from 1980 to June 2012, however, evidence exists for inclusion of alternatives to Treasury Bills such as HML, SMB, and some “Stealth Fighters.” Furthermore, within the most recent period, evidence suggests that TIPs and trend-following dynamic strategies, as proxied by CISDM EW CTA, appear to help track inflation in the absence of Treasury Bills. Consideration of gold and real estate suggests that these asset classes, although popular, are unlikely to be good candidates to hedge against inflation. Our results suggest that inflation can be tracked, but methodologies that include dynamic weighting schemes should be employed since the relationship amongst inflation, assets and investment strategies is very complex.
Population Aging and the Effects on Real Estate and Financial Asset Returns
Huong Vina Nguyen (Brandeis University) | May 2012
This paper investigates the effects of each age group in the population on housing prices, the returns on different classes of bonds and the excess returns on equity across countries and over time. Previous empirical research focusing on a single country found a negative effect of the ratio of the old to working population on the returns to all assets. However, a more complete framework that encompasses both individuals' consumption-saving decision and portfolio allocation may advance our understanding of how population aging influences asset returns. I construct a high-order polynomial estimation of the demographic structure and then run an unbalanced panel regression with time fixed effects on the change in housing prices (37 countries), total returns of equity indices (53 countries) and total returns on bonds (53 countries). The results show that population aging has the strongest effect on housing prices. Real returns on housing and bond decline as the population gets older. On the other hand, equity premium is higher in countries with relatively older population indicating that risk aversion increases with age. As a robustness check, the joint estimation results using Seemingly Unrelated Regressions are consistent with the individual regressions.
Posted by jp at 6:06 AM | Comments (0)
January 16, 2013
Industrial Production Increased Moderately In December
Industrial production increased 0.3% in December, which is a slightly faster pace than expected. Nonetheless, the general forecast of a slowdown in growth for last month proved to be accurate. That's not a surprise, given the sharp 1.0% rise in industrial production in November, which was primarily due to an unsustainable snapback after the weather-related interruptions from Hurricane Sandy in October. Overall, industrial activity continues to grow a modest pace. December's report brings another positive contribution to the year-end economic profile. With today's update, there's even a stronger case for arguing that the economy ended 2012 in an expansion mode. But the latest news on the industrial front also raises some new challenges for thinking about January's numbers and beyond.
But first, let's recap the monthly data. As the first chart shows, industrial production increased in December for the second consecutive month. The manufacturing component posted a considerably stronger rise at year's end.
On a year-over-year basis, industrial production increased 2.2% through December. That's a decent if unspectacular rate of growth… if it holds. But as the next chart shows, the annual pace has been slipping recently--December's 2.2% gain is near the lowest levels in several years.
The issue here is whether the deceleration will continue in 2013. If it does, that will raise concerns about the economy overall, particularly if we see confirming signs of deceleration in other indicators.
For now, however, it's not obvious that industrial production is caught in a downward spiral. Even if it was, the relatively upbeat trends in other indicators through last month offer some positively biased offsetting ballast--including yesterday's encouraging retail sales report. But with macro risk lurking in the debt ceiling debate, it's hard to take anything for granted at the moment.
Nonetheless, it's getting easier to project that 2012 is on course to remain recession free. Thanks largely to the folks in Washington, however, 2013 may be another matter.
Posted by jp at 10:01 AM | Comments (0)
Housing Starts: December 2012 Preview
Housing starts in December are expected to rise 3.1% on a seasonally adjusted monthly basis, according to The Capital Spectator's average econometric forecast. That compares with a 3.0% decline in the previous report. The projection is roughly in line with consensus forecasts from economists.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections:
VAR-3: A vector autoregression model that analyzes three economic series to project housing starts: new home sales, newly issued permits for residential construction, and the monthly supply of homes for sale. VAR analyzes the interdependent relationships of these series with housing starts through history. The forecasts are run in R using the "vars" package.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of housing starts in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of housing starts in R via the "forecast" package.
Posted by jp at 4:30 AM | Comments (0)
Weekly Jobless Claims: 12 January 2013 Preview
Initial claims for jobless benefits will decline slightly in tomorrow's weekly update, based on The Capital Spectator's average econometric forecast. New claims for the week through January 12 will dip to 369,000 on a seasonally adjusted basis vs. the previously reported 371,000. The projection is in line with consensus forecasts via surveys of economists.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections:
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of the data series in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of the data in R via the "forecast" package.
Posted by jp at 4:01 AM | Comments (0)
January 15, 2013
Retail Sales Deliver Another Positive Number For December's Economic Profile
Retail sales beat expectations with a moderately strong 0.5% rise in December (seasonally adjusted), the Census Bureau reports. After stripping out gasoline sales, retail purchases rose even more, advancing 0.8% for the month. The numbers look encouraging on a year-over-year basis too, with retail sales advancing 4.7% for the 12 months through December. That's up a decent amount from November's 4.1% annual rate. The main takeaway in is that retail sales ended 2012 on a strong note, which puts another nail in the coffin for predictions that the economy wouldn't escape last year without stumbling into a new recession.
December's pop in consumption was broadly distributed, with most major sectors of the retail space posting gains. The two exceptions: gasoline sales and electronic/appliance stores. Nonetheless, the relatively strong, broad-based jump in retail sales last month adds another data point on the side of growth for the December economic profile.
The conspicuous year-end upturn in the annual rate of growth is particularly encouraging as it suggests that the deceleration in the trend has hit a floor. In turn, that's a signal that consumer spending isn't collapsing, as some analysts have been predicting.
Reviewed in context with a broad array of economic and financial indicators, today's retail sales report drops another clue for anticipating that 2012 will remain recession free when the final numbers are published on the business cycle via NBER. In fact, there's been minimal evidence all along in support of the claim that the economy was slipping over the cyclical edge. Month after month, the updates of The Capital Spectator Economic Trend Index have shown that recession risk has remained low. That was true in last week's update, its predecessor in early December, its counterpart in November, and so on, back through the previous months.
Notice a trend? I do. An expansive review of the numbers, across a wide spectrum of the economy and the markets, dispenses useful information for analyzing the business cycle. It's not magic, but a sober reading of the numbers helps... a lot! Yes, you can see a bit deeper if you look a bit broader when it comes to macro.
Today's retail sales update alone could be an outlier, of course. But in the context of the generally positive December data that's piling up, it's hard to ignore the writing on the wall when it comes to evaluating the economy's 2012 exit point. Nonetheless, the primary mission is to look for warning signs... from multiple perspectives. For now, thankfully, those warning signs are in the minority.
There are more economic reports to come to complete the December profile, and it's always dangerous to assume too much, one way or the other. Nonetheless, the numbers in hand so far offer scant statistical support for painting a dark picture of the primary trend. January and beyond, of course, are wide open for debate. On that note, we can't dismiss the potential for a self-induced recession in the new year, courtesy of our representatives in Washington via the debt ceiling debate. Using the numbers available today, however, tells a relatively bright story. That's no insurance policy against the uncertainty of tomorrow, but it ain't hay either.
Posted by jp at 9:38 AM | Comments (0)
US Industrial Production: Dec 2012 Preview
Tomorrow's report on industrial production (08:30am eastern) for December is projected to post a modest 0.1% gain, according to The Capital Spectator's average econometric forecast. That's a sluggish pace compared with November's strong 1.1% increase. Economists generally anticipate a 0.2% rise for December's industrial production, based on consensus forecasts.
Here's how the numbers stack up, followed by brief definitions for the methodologies behind The Capital Spectator's projections:
R-1: A linear regression model using the ISM Manufacturing Index to predict industrial production. The historical relationship between the variables is applied to the more recently updated ISM data to project industrial production. The computations are run in R.
R-4: A linear regression model using four variables to project industrial production: US private payrolls, an index of weekly hours worked for production/nonsupervisory employees in private industries, the ISM Manufacturing Index, and the stock market (S&P 500). The historical relationships between the variables are applied to the more recently updated data to project industrial production. The computations are run in R.
VAR-1: A vector autoregression model using the ISM Manufacturing Index to predict industrial production. VAR analyzes the interdependent relationships of the variables through history. The forecasts are run in R using the "vars" package.
VAR-7: A vector autoregression model using seven variables to project industrial production: US private payrolls, an index of weekly hours worked for production/nonsupervisory employees in private industries, the ISM Manufacturing Index, the stock market (S&P 500), real personal income less current transfer receipts, real personal consumption expenditures, and oil prices. VAR analyzes the interdependent relationships through history. The forecasts are run in R using the "vars" package.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of industrial production in R via the "forecast" package to project future values of the data set.
ES: An exponential smoothing model that analyzes the historical record of industrial in R via the "forecast" package to project future values of the data set.
Posted by jp at 4:06 AM | Comments (0)
January 14, 2013
One Man's View From The Top: The Top 100 Finance Blogs
Brett Scott, an ex-derivatives broker who now blogs at Suitpossum, asks: "What are the 100 Top (Anglo-Saxon) Finance Blogs?" His answer (in the form of a "Pseudo-Scientific Study") includes the digital explorations of yours truly (I'm honored), along with a wide array of sites ranging from the popular to the relatively obscure. It's always fun to dig through these lists to discover new blogs and find an excuse to reconnect with familiar sites that, for one reason or another, have fallen off the radar. One intriguing blog on the list that caught my eye, and somehow managed to elude your editor until now: The Research Puzzle.
Posted by jp at 3:14 PM | Comments (0)
US Retail Sales: Dec 2012 Preview
Tomorrow's report on retail sales for December (8:30am eastern) is projected to show a 0.3% gain for the month, according to The Capital Spectator's average econometric forecast. That's slightly higher than the 0.2% consensus forecast from several surveys of economists. In November, retail sales rose 0.3%, the government reported last month.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections:
R-2: A linear regression model using two variables--an index of weekly hours worked for production/nonsupervisory employees in private industries and the stock market (S&P 500)--to predict retail sales. The computations are run in R.
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of retail sales in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of retail sales in R via the "forecast" package.
VAR-6: A vector autoregression model that analyzes six economic time series in search of interdependent relationships through history to predict retail sales. The forecasts are run in R with the "vars" package using historical data for the following indicators: US private payrolls, industrial production, index of weekly hours worked for production/nonsupervisory employees in private industries, the stock market (S&P 500), disposable personal income, and personal consumption expenditures.
Posted by jp at 4:10 AM | Comments (0)
January 12, 2013
Book Bits | 1.12.13
● Successful Investing Is a Process: Structuring Efficient Portfolios for Outperformance
By Jacques Lussier
Summary via publisher, Wiley
What do you pay for when you hire a portfolio manager? Is it his or her unique experience and expertise, a set of specialized analytical skills possessed by only a few? The truth, according to industry insider Jacques Lussier, is that, despite their often grandiose claims, most successful investment managers, themselves, can't properly explain their successes. In this book Lussier argues convincingly that most of the gains achieved by professional portfolio managers can be accounted for not by special knowledge or arcane analytical methodologies, but proper portfolio management processes whether they are aware of this or not. More importantly, Lussier lays out a formal process-oriented approach proven to consistently garner most of the excess gains generated by traditional analysis-intensive approaches, but at a fraction of the cost since it could be fully implemented internally.
● The Good Rich and What They Cost Us
By Robert Dalzell
Summary via publisher, Yale University Press
This timely book holds up for scrutiny a great paradox at the core of the American Dream: a passionate belief in the principle of democracy combined with an equally passionate celebration of the creation of wealth. Americans treasure an open, equal society, yet we also admire those fortunate few who amass riches on a scale that undermines social equality. In today's era of "vulture capitalist" hedge-fund managers, internet fortunes, and a growing concern over inequality in American life, should we cling to both parts of the paradox? Can we? To understand the problems that vast individual fortunes pose for democratic values, Robert Dalzell turns to American history. He presents an intriguing cast of wealthy individuals from colonial times to the present, including George Washington, one of the richest Americans of his day, the "robber baron" John D. Rockefeller, and Oprah Winfrey, for whom extreme wealth is inextricably tied to social concerns.
● It Didn't Have to Be This Way: Why Boom and Bust Is Unnecessary-and How the Austrian School of Economics Breaks the Cycle
By Harry C. Veryser
Summary via publisher, ISI Books
Why is the boom-and-bust cycle so persistent? Why did economists fail to predict the economic meltdown that began in 2007—or to pull us out of the crisis more quickly? And how can we prevent future calamities? Mainstream economics has no adequate answers for these pressing questions. To understand how we got here, and how we can ensure prosperity, we must turn to an alternative to the dominant approach: the Austrian School of economics. Unfortunately, few people have even a vague understanding of the Austrian School, despite the prominence of leading figures such as Nobel Prize winner F. A. Hayek, author of The Road to Serfdom. Harry C. Veryser corrects that problem in this powerful and eye-opening book. In presenting the Austrian School’s perspective, he reveals why the boom-and-bust cycle is unnatural and unnecessary.
● Becoming Europe: Economic Decline, Culture, and How America Can Avoid a European Future
By Samuel Gregg
Op-ed by author, via The New York Post
In one sense, to say that America is becoming like Europe seems odd. After all, when it comes to its dominant political ideas, religious culture, institutions and history, America is obviously Europe’s child.
That, however, is not what Europeanization means today. Instead it’s about the spread throughout America of economic expectations and arrangements directly at odds with our republic’s founding. These lead to the prioritizing of economic security over economic liberty; to the state annually consuming close to 50% of GDP; to the ultimate economic resource (i.e., people) aging and declining in numbers; to extensive regulation becoming the norm; and perhaps above all, to a situation in which economic incentives lie not in work, economic creativity and risk-taking, but rather in access to political power.
● Contagion: How Commerce Has Spread Disease
By Mark Harrison
Review via The Times Higher Education
Mark Harrison's medical history books are always big. Contagion is another masterful reach across continents and time, beginning in the 14th century and ending today.
It is a history of disease and a history of commerce in equal measure. The premise is familiar: infectious disease always tracks along commercial routes, deriving from, but also threatening, the more productive versions of exchange represented by trade. Almost everyone who writes about the history of contagion notes this. Few offer the historical substance behind the commonplace observation, however. None has done so with Harrison's combination of carefully executed detail and grand scope.
Posted by jp at 4:26 AM | Comments (0)
January 11, 2013
It's Official: US November Sales Increased Across The Board
Some analysts have been predicting a collapse in sales for the US economy. One prominent economist announced in a recent round of TV interviews that sales generally were in the process of "rolling over." On that assumption, the economy is in recession, he explained. But a funny thing happened on the way to the collapse: sales have held up, and even turned up. Yesterday's November update on wholesale trade figures is the latest data point that contradicts the pessimistic view on the macro trend.
Wholesale trade sales rose a respectable 2.3% in November, the Census Bureau reports. That follows the previously released updates on November retail sales (+ 0.3%) and November manufacturers' sales (+0.4%). The message is clear: sales in November increased across a broad spectrum of the US economy.
More importantly, the year-over-year trend remains positive through November for all three data sets. In fact, the pace of annual growth overall has turned modestly higher vs. recent history. The latest numbers through November show that the year-over-year percentage increases range from 3.7% (manufacturing and retail) to 5.6% (wholesale).
For a clearer look at how the annual rates compare, let's focus on recent history. Here's how each of the sales indicators stacks up in terms of annual changes, including an aggregate measure of all three, as shown by the gray bars. Overall, manufacturing, wholesale and retail sales rose 4.3% in November vs. a year earlier. That's up from October's 3.2% increase and comfortably above the low growth rates in the summer. No one will confuse the recent increases as historically strong comparisons, but the numbers don't equate with an economy that's contracting either.
Ok, but how does December look? It's still early, but the incoming data for last month so far is encouraging, as I discussed earlier this week. Yes, the future is surely loaded with surprises. Based on the numbers in hand, however, the case for arguing that modest growth remains the path of least resistance continues to look like a reasonable view.
Posted by jp at 6:07 AM | Comments (0)
January 10, 2013
Jobless Claims Increased Slightly Last Week, But The Trend Remains Encouraging
Today's weekly update on jobless claims is a good example of how the inherent noise in this data series can mislead us if we're overly focused on the most recent data points. New filings for jobless benefits rose 4,000 last week to a seasonally adjusted 371,000, pushing claims up to the highest level in a month. The rise is a modest surprise relative to expectations, which projected a slight decline, although the previous week's total was revised down and so the net effect is close to neutral. In any case, today's numbers look a bit discouraging, but a deeper review paints a substantially brighter picture.
First, let's start with the weekly seasonally adjusted figures, which receive most of the attention. As the chart below shows, new claims have been stuck in neutral recently. By some accounts, that's all you need to know. But if we're looking at this series for a robust read in the context of analyzing the business cycle, we'll have to dig a bit deeper.
In particular, let's review the year-over-year percentage change for the raw claims numbers—before any seasonal adjustment. By this measure, last week's report delivered good news: claims dropped more than 14% for the week through January 5 compared with the year-earlier figure. That's the biggest rate of annual decline since last October. By itself it could be more noise, of course. But as the second chart reminds, annual declines of 5%-to-10% have been the general rule for the past year. The bottom line: new claims continue to trend lower, even if it's not obvious in the latest report.
This is no trivial point. When you review changes in jobless claims on a year-over-year basis across the decades it's clear that declines by this measure are strongly correlated with broad economic growth. One indicator alone is always suspect, of course, which is why it's essential to monitor a broad array of economic and financial indicators. For some perspective on that front, here's my recent update on the US economy's profile, which continues to look encouraging as of January 8.
The trend in jobless claims doesn't disagree. Does that mean there's nothing to worry about? Hardly. Jobs growth is positive, and several indicators for the labor market are moving in the right direction, as are a number of other metrics for the economy. But jobs growth is modest by historical standards and there's no shortage of hazards that could create trouble tomorrow, next week, and beyond.
At the top of the list of potential troubles: politics, namely: the debate over the debt ceiling. In what by now has become a familiar and disturbing story, our representatives in Washington are again moving perilously close to derailing the economy's modest growth trend of late with nonsensical arguing over short-term fiscal issues. Looking solely at the numbers suggests the recovery rolls on. The main question for the moment is whether the Beltway crowd will engineer an alternative reality.
Posted by jp at 9:53 AM | Comments (0)
Context Is (Still) King For Portfolio Design & Management
It happened again. I was reading a story about the apparent hazards that are expected to derail an asset class that's in my portfolio and I thought, gee, I better sell. The article presented a strong case for seeing red in the near future. But then I remembered that the asset class is just one piece of my diversified portfolio, and that my rebalancing strategy will take care of any extremes in the various components. Thinking about the big picture for my personal asset allocation reminded me that the article wasn't all that applicable to my situation after all. Once again, my initial emotional reaction turned out to be not so helpful after all in money matters.
Stories about the alleged opportunities and risks for a given asset class at a specific point in time are a staple in the financial media. Some of them are actually right, but not always. I should know, since I've been known to write a few of these gems through the years. But every time you read one of these articles you should remember that the information is almost always presented in a strategic vacuum in terms of your portfolio. That's inevitable, of course, since only you know what's in your portfolio, and so only you know how much relevance, if any, applies when it comes to current news on a relatively narrow slice of the world's capital and commodity markets. In other words, analyzing assets in isolation of your total portfolio can lead to bad investment choices.
The caveat wouldn't mean much if we had something approaching near certainty that the analysis du jour for a given asset class was accurate. In that case, we could throw all the standard rules about risk management out the window. In the real world, of course, imperfection infects every effort to peel away the cloud of unknowing on the morrow. Fortunately, there's a reasonably effective solution: asset allocation and rebalancing.
When you hold a broadly defined portfolio of the major asset classes, you're always prepared to exploit return volatility, regardless of the source or whether it's a total surprise or widely anticipated. Once you wrap your head around this idea, many of the updates from the usual suspects lose their relevance for your portfolio.
We can and should debate the details for structuring a portfolio in terms of defining asset classes, how many to own, etc. But the key point is that in order to harvest risk premia from price volatility, you first must own a broad set of assets. That means owning a mix of winners and losers on a regular basis, and not getting too worked up over any one piece of the portfolio at one point in time. Ideally, you'll own an expansive set of assets that maximize the supply of low and negative correlations across the portfolio--an essential feature for profiting from rebalancing opportunities.
Yes, it all boils down to buy low and sell high. Duh! But obvious lessons all too often remain elusive for investors on the road to earning a decent return. One reason is there's a tendency of going off the deep end in deciding that a certain asset class should be avoided, or that another asset is a sure thing and so it's time to overweight in the extreme. The problem is that if you spend any time studying the historical record of all the asset classes, in context with one another, it's clear that surprises are a constant. The implication: own everything and focus like a laser beam on managing the mix.
To take a recent example: US Treasury bonds. How many times over the last several years have you heard that they're in a bubble? The countless warnings sounded reasonable. But did you also know that Treasuries have delivered handsome returns in recent years? The iShares Barclays 20+ Year Treasury Bond ETF (TLT), for instance, generated a 14% annualized total return over the last three years through January 9.
What should you do now? The same thing you should have been doing all along: diversify and rebalance. If you've owned Treasuries for, say, the last three years, you should have been rebalancing the portfolio periodically. If so, you've been harvesting some of the tidy gains from government bonds recently and in the process kept a lid on the Treasury allocation. Same old, same old. It's not exciting, but it works.
Suffice to say, you can always find smart people telling you to buy, or sell, just about anything. But stellar track records based on this advice, alas, tend to be the exception.
Don't misunderstand: it's essential to sell overpriced assets at some point and favor the underpriced ones. In fact, that's everyone's goal. Results, of course, vary dramatically. One way to systematically boost the odds of earning average-to-above average returns relative to the crowd is to diversify broadly and rebalance periodically. The first phase of this one-two strategy is easy: buy a varied mix of ETFs, for instance. The second phase is tricky, although you can probably do quite well with a simple rebalancing strategy of, say, returning the asset weights back to pre-set levels once a year, or something along those lines. This is one simple way to keep bubble pricing at bay, while also making sure that you'll also ride the wave when the today's out-of-favor asset classes mounts a revival.
Truth be told, there are numerous intriguing possibilities for designing rebalancing rules to juice performance, reduce risk, or both. But even the world's greatest rebalancing strategy faces serious headwinds in a portfolio that holds too few asset classes. Keep that in mind the next time you read an article that seems to hold all the answers about one asset class. Context is critical in portfolio design and management, even if it's routinely overlooked in today's hot investing story.
Posted by jp at 6:26 AM | Comments (2)
January 9, 2013
Weekly Jobless Claims: 5 January 2013 Preview
Tomorrow's weekly update on jobless claims is expected to report a modest decline from the previous estimate, according to The Capital Spectator's average econometric forecast. New claims are projected to slip 5,000 to a seasonally adjusted 367,000 for the week through January 5. That's roughly in line with consensus forecasts via surveys of economists.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections:
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of the data series in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of the data in R via the "forecast" package.
Posted by jp at 10:02 AM | Comments (0)
Mediocrity Strikes Again
It's true for stocks, it's true for bonds—yes, it's even true for hedge funds. As The Economist reminds, delivering market-beating performance over time relative to a conventional asset mix is tough, and the financial wizards in the land of hedge funds aren't immune. "A simple-minded investment portfolio—60% of it in shares and the rest in sovereign bonds—has delivered returns of more than 90% over the past decade, compared with a meagre 17% after fees for hedge funds," the magazine reports. Sound familiar?
It's now widely accepted, or at least widely known, that zero-sum math rules within a given asset pool. As Bill Sharpe explained, "There's no escaping "Arithmetic of Active Management." Savvy marketing hype doesn't change this fact. Nor does charging two and twenty. Like mortality and taxes, financial gravity catches up with all of us (or at least most of us) in time. That's not to say that you can't find big winners, or big losers. But the majority of performance results relative to an appropriate (i.e., objective) benchmark has a habit of dispensing unimpressive track records as a general rule.
I say "unimpressive" because it's no great feat to earn average returns. The main question is how much you pay for mediocrity. This is no trivial issue. In fact, after you factor in fees, trading expenses, and taxes, representative benchmarks for a particular market or even trading strategy have a tendency to dispense above-average returns. No wonder that indexing is competitive next to a broad definition of active strategies intent on delivering positive alpha.
Even passive asset allocation that holds the major asset classes holds up rather impressively against the crowd of professionals who collectively promise to do better than average (and charge a fee in advance that assumes no less). Comparing the Global Market Index (GMI), a passively weighted mix of all the major asset classes, against 1,200-plus mutual funds with multi-asset-class strategies over the past decade tells the story. For instance, here's how the returns stack up through a recent 10-year period, as I reported back in October:
GMI ended up near the 75th percentile for performance. That's probably high relative to what you should expect for the next 10 years. But average to above-average results are good bet, in part because you can replicate GMI for less than 50 basis points with ETFs. By contrast, the active strategies depicted in the chart above nip you for two, three, and even four times as much. Over time, that's the equivalent of trying to run a race with a couple of bricks tied to your feet.
These types of studies are now a staple in financial research. The lesson for most folks is that broad diversification across asset classes, and periodic rebalancing of those assets, will capture average to above-average returns on a fairly reliable basis through time. The flip side of this lesson is that trying too hard in money management boosts the odds of ending up with high-priced mediocrity, or worse.
Granted, a relative few will beat the odds. Predictably, this is where the crowd focuses. The dirty little secret, however, is that the upper decile or quartile of performers is often a fluctuating mix of names. By contrast, a representative benchmark is a dependably average to above-average performer. This empirical fact, however, is the equivalent of a wet rag when it comes to popularity contests among investment strategies. Considering the returns that most folks end up with, however, that's a costly oversight.
Posted by jp at 5:31 AM | Comments (0)
January 8, 2013
U.S. Economic Profile | 1.08.13
The US economy continued to grow in December. That's the message from the incoming numbers for last month, echoing the analysis from our previous update a month ago. Although several key reports for December are still missing, the numbers published so far suggest that the economy ended 2012 on an upbeat note. Anything's possible, of course, when it comes to yet-to-be published and revised indicators. But the early analysis of the December economic profile tells us that the odds remain low that the end of last year will mark the start of a new recession.
Let's dig into the data for some perspective on how the broad trend looks at this point. In the table below, eight of 14 indicators in The Capital Spectator Economic Trend Index (CS-ETI) published for December are trending positive.
Here's how the 14 indicators stack up on an historical basis as tracked by a diffusion index, aka CS-ETI, which measures the share of this data set that's trending positive in terms of a three-month rolling average. With readings in the 75%-to-90% range in recent months, the odds of a new recession appear low. What would change the analysis? If CS-ETI falls below 60%, which would constitute a warning that the trend is weakening. A drop under 50% would be a virtual certainty that the business cycle has crashed. The good news is that we're nowhere near those tipping points.
For another perspective on the 14 indicators in the table above, let's consider another measure of the business cycle: The Capital Spectator Economic Momentum Index (CS-EMI), which was introduced last month. The basic idea here is to measure the median percentage change in the 14 indicators for another perspective on the business cycle. Here's how CS-EMI compares through history on a three-month rolling basis. As you can see, the readings for this indicator are also favorable for arguing that growth still has the upper hand
Returning to CS-ETI, here's how this macro benchmark compares when we convert the underlying data into recession-risk probabilities via a probit model. Here too the numbers suggest that another downturn is a low-probability event through December. Analyzing its index counterpart--CS-EMI--in terms of a probit model tells a similar story.
Finally, let's model the near-term outlook by estimating the next several monthly values for CS-ETI's three month averages. I generated forecasts for each of CS-ETI's indicators, independently, using an ARIMA model via the "forecast" package in R. Next, I aggregated the results to estimate CS-ETI for the next several months by filling in the missing numbers for each of the monthly data sets. It's safe to assume that a fair amount of error infects any one forecast, although aggregating the individual estimates can minimize the risk a bit if some of the errors cancel each other out. For some context, the chart below tracks earlier estimates and compares them with the actual values that were reported later. As you can see, the estimates so far have been useful for developing some intuition about where CS-ETI is headed. Looking ahead still suffers all the usual caveats, but the current outlook suggests that CS-ETI's readings will remain comfortably on the side of growth.
Overall, the numbers tell us that recession risk appears low through December, based on the latest economic reports. That's no guarantee that the updates in the weeks ahead won't bring darker news. But if the economy is set to deteriorate, the signals will be conspicuous as new data arrives and previously published numbers are revised downward. For now, however, the outlook remains relatively encouraging for anticipating that the economy will continue forge ahead with a modest growth trend.
Posted by jp at 4:24 AM | Comments (0)
January 7, 2013
Q4:2012 US GDP Nowcast Update | 1.07.2013
The US economy is expected to grow 1.6% in 2012's fourth quarter, according to The Capital Spectator's average econometric nowcast. That's up slightly from the previous 1.5% nowcast, published on December 17. The current outlook for 1.6% growth looks sluggish when compared with the 3.1% rise for Q3, as reported by the Bureau of Economic Analysis (BEA). The official Q4 data is scheduled for release on January 30, when the BEA will publish its initial GDP estimate for the last three months of 2012. (GDP percentage changes are quoted as real seasonally adjusted annual rates.)
Our current Q4 nowcast is based on the latest economic indicators available through January 4, which reflects an incomplete profile in terms of the December numbers. As the remaining updates for last month roll in, there's a chance that the Q4 nowcast will rise. Several key reports for December are due next week, including retail sales, industrial production, and housing starts. But with most of Q4's numbers already published, the odds are dwindling for a substantial upside revision for our nowcast. Keep in mind too that if numbers yet to come are considerably weaker than expected, the Q4 nowcast may fall.
Meantime, here's a look at the individual nowcasts:
Next, here's a recap of how our nowcasts for Q4:2012 GDP have evolved in real time over the last two months:
Finally, here's a brief profile for each of The Capital Spectator's nowcasts:
R-4: This estimate is based on a multiple regression in R of historical GDP data vs. quarterly changes for four key economic indicators: real personal consumption expenditures, real personal income less government transfers, industrial production, and private non-farm payrolls. The model estimates the statistical relationships from the early 1970s to the present. The estimates are revised as new data is published.
R-10: This model also uses a multiple regression framework based on numbers dating to the early 1970s and updates the estimates as new data arrives. The methodology is identical to the 4-factor model above, except that R-10 uses additional factors—10 in all—to nowcast GDP. In addition to the data quartet in the 4-factor model, the 10-factor nowcast also incorporates the following six series:
• ISM Manufacturing PMI Composite Index
• housing starts
• initial jobless claims
• the stock market (S&P 500)
• crude oil prices (spot price for West Texas Intermediate)
• the Treasury yield curve spread (10-year Note less 3-month T-bill)
ARIMA-GDP: The econometric engine for this nowcast is known as an autoregressive integrated moving average. This ARIMA model uses GDP's history, dating from the early 1970s to the present, for anticipating the target quarter's change. As the historical GDP data is revised, so too is the nowcast, which is calculated in R via the “forecast” package, which optimizes the prediction model based on the data set's historical record.
ARIMA 4: This model is similar to the ARIMA technique above in terms of the econometric application, but with a key difference. Instead of using historical GDP data as a lone input, the ARIMA 4 model analyzes four historical data sets to predict GDP: real personal consumption expenditures, real personal income less government transfers, industrial production, and private non-farm payrolls.
VAR-4: This vector autoregression model uses four data series in search of interdependent relationships for estimating GDP. The historical data sets in the R-4 and ARIMA 4 models above are also used in VAR-4, albeit with a different econometric engine. As new data is published, so too is the VAR-4 nowcast. The data sets range from the early 1970s to the present, using the "vars" package in R to crunch the numbers.
Posted by jp at 4:52 AM | Comments (0)
January 5, 2013
Book Bits | 1.5.13
● The Physics of Wall Street: A Brief History of Predicting the Unpredictable
By James Owen Weatherall
Review via Kirkus Reviews
A young physicist and contributor to Slate and Scientific American, Weatherall (Logic and Philosophy of Science/Univ. of California, Irvine) was puzzled when experts began blaming the 2008 economic collapse on physicists who created complex financial instruments for Wall Street. He wondered: What do physicists have to do with the economy? The author explains how physicists have been predicting the unpredictable on Wall Street for 30 years, accounting for such hedge-fund successes as Jim Simons’ Renaissance Technologies, whose staff, loaded with physics and math doctorates, produced a remarkable 2,478.6 percent return in the decade from 1988 to 1998.
● Pound Foolish: Exposing the Dark Side of the Personal Finance Industry
By Helaine Olen
Review via The New York Times
It's rare to come across a realistic and readable book about personal finance. Most are laden with rosy promises, followed by acronyms and turgid advice. Helaine Olen, a freelance journalist, offers an exception with “Pound Foolish: Exposing the Dark Side of the Personal Finance Industry” (Portfolio, $27.95). It’s a take-no-prisoners examination of the ways she says we have been scared, misled or bamboozled by those purporting to help us achieve financial security.
● The Land of Too Much: American Abundance and the Paradox of Poverty
By Monica Prasad
Summary via publisher, Harvard University Press
The Land of Too Much presents a simple but powerful hypothesis that addresses three questions: Why does the United States have more poverty than any other developed country? Why did it experience an attack on state intervention starting in the 1980s, known today as the neoliberal revolution? And why did it recently suffer the greatest economic meltdown in seventy-five years? Although the United States is often considered a liberal, laissez-faire state, Monica Prasad marshals convincing evidence to the contrary. Indeed, she argues that a strong tradition of government intervention undermined the development of a European-style welfare state. The demand-side theory of comparative political economy she develops here explains how and why this happened.
● The Unloved Dollar Standard: From Bretton Woods to the Rise of China
By Ron McKinnon
Summary via publisher, Oxford University Press
The world dollar standard is an accident of history that greatly facilitates international trade and exchange-even trade not directly involving the United States. Since 1945, the dollar has been the key currency for clearing international payments among banks including interventions by governments to set exchange rates, the dominant currency for invoicing trade in primary commodities, and the principal currency in official exchange reserves.... This book presents a perspective on the role of the dollar exchange rate in undergirding multilateral trade on a global basis, both as a facilitator and as an anchor. Instability in the dollar standard is linked to commodity price bubbles, particularly spikes in the world price of oil in the 1970s and since 2007.
● The Trend Following Bible: How Professional Traders Compound Wealth and Manage Risk
By Andrew Abraham
Summary via publisher, Wiley
Profiting from long-term trends is the most common path to success for traders. The challenge is recognizing the emergence of a trend and determining where to enter and exit the market. The Trend Following Bible shows individual traders and investors how to profit from this approach by trading like today's top commodity trading advisors. In this book, author Andrew Abraham stresses the importance of a disciplined, consistent methodology, with stringent risk controls, that allows you to catch big trends, while limiting losses on unprofitable trades. By trading in this manner, he shows you how to successfully achieve market-beating returns over the long term and multiple your trading capital along the way.
● Wall Street Values: Business Ethics and the Global Financial Crisis
By Michael Santoro and Ronald Strauss
Summary via publisher, Cambridge University Press
Wall Street Values chronicles the transformation of Wall Street’s business model from serving clients to proprietary trading and explains how this shift undermined the ethical foundations of the modern financial industry. Michael A. Santoro and Ronald J. Strauss argue that postmillennial Wall Street is not only “too big to fail” but also a threat to the economy even when it succeeds. They describe how, more than a year before the government acknowledged the financial crisis, Wall Street icon Goldman Sachs saved itself by misleading its clients and impeding the information flow needed for the efficient functioning of free markets, thereby prolonging the mortgage bubble and adding to the financial and human cost of the crisis.
● The Efficient Market Hypothesists: Bachelier, Samuelson, Fama, Ross, Tobin and Shiller
By Colin Read
Summary via publisher, Palgrave Macmillan,
The Efficient Market Hypothesists is the fourth book in a series of discussions about the 'great minds' in the history and theory of finance. While the first three volumes in the series examined the Life Cyclists, the Portfolio Theorists and the rise of the quants, respectively, in this fourth book, Colin Read investigates the concept of an efficient market, describing the evolution of thought since the turn of the twentieth century through to the present day and modern financial theory.
Posted by jp at 4:48 AM | Comments (0)
January 4, 2013
US Labor Dept Says Private Sector Jobs Rose 168k In December
Private-sector payrolls increased by a seasonally adjusted 168,000 in December, the Labor Department reports. That's a bit shy of my average econometric forecast that was published yesterday, and considerably lower than the ADP estimate of last month's rise in payrolls. Nonetheless, today's jobs report reflects a modest pace of growth that provides another encouraging data point for expecting that the full December economic profile will show an economy that continues to expand.
The labor market grew last month in all the major goods-producing categories and across most of the services sector. The main exception: retail trade, which shed 11,000 jobs, a sharp retreat from November's 63,000 gain. Looking beyond the monthly data, however, suggests that the pace of private-sector jobs creation remained on a modest-growth track through the end of 2012. Private-sector payrolls increased 1.7% in December vs. a year earlier, or in line with the annual growth rate that's prevailed since last spring.
The labor market, in sum, continues to grow modestly, as it has for most of the past year. Despite the uncertainty linked to the fiscal cliff debates in Washington last month, jobs growth rolled on. Perhaps the number of new positions would have been higher if the Beltway crowd wasn't so dysfunctional in managing the nation's budget. In any case, there are no obvious signs of doom in today's jobs report in terms of evaluating the business cycle.
“The labor market continues to recover,” Brian Jones, a senior U.S. economist at Societe Generale, tells Bloomberg. “The pace of hiring is respectable, and the unemployment rate will gradually keep coming down. With the fiscal cliff having been averted, this should be good for job growth. The labor market will continue to make progress this year.”
Today's jobs report is hardly a blow-out performance, but it's strong enough to support Jones' outlook. Surprised? You shouldn't be. A broad review of economic and financial indicators has been dropping clues all along that the economy is in no imminent danger of slipping into a new recession. Yes, growth is subpar relative to economic history, but it's sufficiently strong to keep the US out of the macro ditch. That's shocking news for some bearish analysts, but it seems that they've forgotten Yogi Berra's advice: "You can observe a lot just by watching.”
Posted by jp at 9:08 AM | Comments (0)
January 3, 2013
US Nonfarm Private Payrolls: Dec 2012 Preview
A monthly increase of 177,000 for private nonfarm payrolls in December is expected in tomorrow's update (8:30am eastern) from the Labor Department, based on The Capital Spectator's average econometric forecast. That estimate is higher by roughly 20,000 to 30,000 compared with a pair of consensus forecasts published by Econoday.com and Briefing.com.
Here's a closer look at the numbers, followed by brief definitions of the methodologies behind The Capital Spectator's projections.
R-1: A linear regression model using one variable--ADP private payrolls--to predict the US Labor Department's estimate of private payrolls. The computations are run in R.
VAR-8: A vector autoregression model that analyzes eight economic time series in search of interdependent relationships through history to predict private payrolls. The forecasts are run in R with the "vars" package using historical data for the following indicators: ISM Manufacturing Index, industrial production, aggregate weekly hours of production and nonsupervisory employees in the private sector, the stock market (S&P 500), real personal income excluding current transfer receipts, real personal consumption expenditures, spot oil prices, and the Treasury yield spread (10-year less 3-month T-bill).
ARIMA: An autoregressive integrated moving average model that analyzes the historical record of the target data series in R via the "forecast" package.
ES: An exponential smoothing model that analyzes the historical record of the target data series in R via the "forecast" package.
Posted by jp at 4:22 PM | Comments (0)
ADP: Payrolls Increased At A Faster Pace In December
The economy's pace of jobs creation accelerated in December, according to this morning's update of the ADP Employment Report. Private sector payrolls increased by 215,000 last month, a robust increase from November's upwardly revised 148,000 gain. That's the biggest monthly gain since February. The implication, of course, is that tomorrow's official report on payrolls from the US Labor Department will deliver upbeat news as well.
“The job market held firm in December despite the intensifying fiscal cliff negotiations in Washington," says Mark Zandi, chief economist of Moody’s Analytics, in an ADP press release today. "Businesses even became somewhat more aggressive in their hiring at year end. Most encouraging is the revival in construction jobs, although the December gain was likely lifted by rebuilding after Superstorm Sandy. The job market ended 2012 on a more solid footing.”
The degree of the gain in today's ADP number surprised most analysts, including yours truly, but the general trend of continued growth is hardly a shock. Jobless claims, for example, have returned to a pattern that implies further expansion in the labor market in the new year. Although today's weekly claims report shows a moderate rise last week, the broad picture continues to look favorable for payrolls, based on this indicator.
New claims rose 10,000 last week to a seasonally adjusted 372,000, the Labor Department reports. But the four-week moving average for this volatile series fell to 360,000—virtually unchanged from the previous week's level, which is the lowest since 2008.
A more persuasive clue that the claims data continues to signal growth is the unadjusted year-over-year percentage changes for this series. Stripping out the seasonal adjustment factor and focusing on the annual trend reveals that claims slid 8% last week vs. a year ago. That's in line with the pattern for the past year or so. Save for the temporary pop from the hurricane in late-October, claims are still falling at a robust pace, and that's an encouraging clue for expecting that the labor market will continue to grow.
Today's news builds on yesterday's December update for the ISM Manufacturing Index, which moved above 50 again, which implies that the sector is still growing. December's economic profile still has a long way to go in terms of releases, but the numbers so far are encouraging. November's strong growth trend hinted at no less. All of which flies in the face of claims by some analysts that the economy is deteriorating. Emotionally speaking, that may sound like a reasonable diagnosis, but the numbers tell a different story.
Indeed, the message all along has been that the economic expansion rolls on. That's been clear if you've been watching a broad cross section of economic reports and quantitatively measuring the trend. Some observers of the business cycle have a habit of cherry-picking the numbers and drawing conclusions from small samples. In the end, however, the truth will out. But don't hold you breath waiting for mea culpas. There's a general tendency in macro to ignore the mistakes and instead make another forecast. That's fine, assuming the underlying methodology is sound. But as last year reminds, in vivid detail, sound methodologies in business cycle analysis are the exception rather than the rule.
Posted by jp at 9:30 AM | Comments (0)
Will Relatively Low Inflation Expectations Persist In 2013?
The new abnormal is still with us in the new year, but will 2013 break this strange relationship? I'm referring to the unusually close positive connection between the stock market and the implied inflation forecast via the yield spread between the 10-year Treasury Note and its inflation-indexed counterpart. Historically speaking, expectations of higher inflation haven't been a reliable source of enthusiasm for the bulls, but the last several years have turned that rule on its head. When the Treasury market smells higher inflation these days, equities tend to rally, and vice versa. That's been the dance for much of the past five years. Will it continue in the year ahead?
The answer depends on how the crowd perceives the state of macro in the US. To the extent that investors believe that the business cycle has returned to what might be called "normal", the new abnormal is doomed and higher inflation will again be seen as the enemy. Exactly when this transition arrives is anyone's guess. Based on the numbers through the first day of trading in 2013, however, it appears that the new abnormal is still with us.
One reason for remaining cautious on thinking that the new abnormal is set to evaporate in the near terms is the long-running decline and fall of inflation expectations. For instance, the Cleveland Fed's estimates show that the 10-year expected inflation rate has been trending down rather persistently for 30 years. Its current estimate calculates the 10-year inflation rate at 1.52%--quite a bit lower than the 2.48% rate via the Treasury yield spread as of yesterday.
Relatively low and falling inflation raises the specter of deflation, which is no one's idea of fun when economic growth generally is moderate at best. No wonder that under these conditions there's a tendency to see higher inflation as productive. The stock market certainly sees it that way. (For a theoretical review of this connection, see David Glasner paper on the so-called Fisher effect.)
Mr. Market's views are clear enough, but the new abnormal remains controversial if not dismissed by some analysts, including central bankers. “I do not see an overall argument for letting inflation rise to levels where we might scare the market,” Dallas Fed President Richard Fisher said last September. “We have seen a sharp rise in inflation expectations. If you let this get out of hand, then I think we will have a market reaction.”
Out of hand? Several months on, the risk continues to look fairly low that inflation is poised to become a clear and present danger. One day, and perhaps sooner than we think, the benign state of higher inflation expectations will become more threatening. At that point, the Federal Reserve's bloated balance sheet will have to be downsized by selling off most of the bonds it bought in recent years as part of its monetary stimulus program. Yes, that's going to be a tricky process, but handled properly it's not inevitable that the worst fears of some analysts will be realized.
Meantime, we're still in the new abnormal until further notice. No one will ring a bell when this strange trip ends, although a persistent divergence between changes in inflation expectations and equity prices will likely signal a change in the macro weather. But don't worry too much. This change isn't going to arrive suddenly. Major changes in macro unfold fairly slowly, despite what some pundits would have you believe.
Posted by jp at 4:47 AM | Comments (0)
January 2, 2013
ISM Manufacturing Index Rises For December
The manufacturing sector closed 2012 on an upbeat note, according to today's December report for the ISM Manufacturing Index. This widely followed benchmark rose to 50.7, up from 49.5 in November. A reading above 50 is considered a sign of growth and so the manufacturing sector overall is again leaning towards the forces of light rather than darkness, if only slightly.
Today's report is hardly a robust reading in terms of reversing November's weakness. But the first major statistical clue for December's economic profile offers a bit of comfort for thinking that the economy overall will continue to post favorable numbers for 2012's final month. The November profile of a broad array of indicators certainly looks encouraging, and today's update on the ISM index leaves room for thinking positively that a bias for growth generally will roll over into December.
Still, the fact that the composite ISM index continues to hover around a neutral 50 reading reminds that manufacturing is still vulnerable. Meantime, one might wonder how much damage the fiscal cliff factor inflicted on the economy generally. Yes, the risk has been largely defused, thanks to the tortured yea vote today in the House. That's probably a net plus for the economy in the near term, but it's unclear what effect, if any, the long-running debate has already unleashed in terms of reduced growth.
Today's ISM news, however, offers some support for thinking that the economy still had some forward momentum as 2012 faded into history. The stock market is clearly impressed with the combination of a resolution of the fiscal cliff peril and a relatively upbeat ISM report. As I write this morning, the S&P 500 is up a strong 1.9% in today's session.
Yup, the macro news in 2013 remains positive... so far. That doesn't mean much on January 2, but the 1,000-mile journey for the year ahead is off to a decent if still-precarious start.
Posted by jp at 10:47 AM | Comments (0)
Major Asset Classes | December 2012 | Performance Review
The year just passed was kind to investors holding risky assets. The Global Market Index (GMI), a passive benchmark that holds a broad mix of the world's major asset classes, posted a strong 11.0% total return in 2012. That's a sharp rebound from 2011's disappointing 1.1% decline.
GMI's handsome gain for the year was fueled by powerful gains in emerging market stocks (+18.2% in 2012), REITS (+17.8%), and foreign equities in developed markets (+17.3%). The only loser of any significance in broad terms: commodities overall, which fell slightly (-1.1%), largely due to lesser energy costs.
An 11% gain for GMI represents a fairly high bar for active managers in historical terms. In order to beat the benchmark within the context of a diversified strategy, managers had to take on a good deal more risk. For those that did, and failed, the comparisons with GMI (and similar indices) for 2012 are apt to be harsh.
Assuming, of course, you're looking at the numbers. Benchmark analysis for asset allocation isn't widespread, and so managers with relatively weak hands for 2012 will probably go unnoticed. It's also easier to charge a higher fee for broad diversification across asset classes compared with single-asset class strategies.
How much is asset allocation advice worth? In search of an answer, you might start by asking how the real world results of a manager compare with GMI. Even better, take a look at how the investable version of GMI fared. This is simply replicating GMI with representative ETFs, a strategy that costs less than 50 basis points and returned 12% last year, as noted in the table above. Portfolio advice that charges more than 50 basis points may still be worth the price tag, but you should have a clear idea of why you're paying more.
If your answer is primarily based on expectations of earning superior returns through time, that's usually a sign of trouble. Why? I'll outsource the answer to Bill Sharpe's classic explanation: The Arithmetic of Active Management, a.k.a., the zero-sum reality for the supply of investment returns. Risk-adjusted performance is another story, but that's a topic for another day.
Posted by jp at 4:58 AM | Comments (0)
January 1, 2013
A Sober New Year...
It seems that we have a new fiscal deal in a new year. For the moment, at least: "U.S. President Barack Obama and Senate leaders Monday reached a New Year's budget agreement that would let income-tax rates rise for the first time in nearly 20 years, maintain unemployment benefits for millions of people and blunt the impact of spending cuts that were looming as part of the so-called 'fiscal cliff.'" A hair of the fiscal dog, one might say. Well, it's been a good year so far. Of course, the legislation still has to receive the green light from the House. Better keep that extra bottle of bubbly handy, just in case. The only question: Will we need it to celebrate or mourn? Stay tuned....
Posted by jp at 7:46 AM | Comments (0)