The Big Picture |
- US Dollar Strength and US Stocks
- As goes early-January, so goes Nothing
- 10 MLK Day Reads
- Gross: Buy TIPS and BlackRock Build America
| US Dollar Strength and US Stocks Posted: 20 Jan 2015 02:00 AM PST US Dollar Strength and US Stocks
Readers who wish to see the entire piece may request it from Talley Léger via the "Contact Us" link on his website. Please note that Talley is co-author with me of our new book, the second edition of From Bear to Bull with ETFs. It is now available in e-book and paperback at Amazon. Let's embellish on Talley's point. We know about currency volatility and fluctuations in the foreign exchange markets. The most recent and dramatic lesson has come with the Swiss National Bank's abrupt policy change that removed the peg of the Swiss franc to the euro. Several days of market turmoil followed. Revelations continue as this is written. There are reports of some fully collapsed entities that had invested with a wrong-way bet on the Swiss franc. For details concerning one, see Bloomberg. Markets are still trying to figure out the damage wrought by the Swiss action. Reports of debt risk in Poland and Hungary have surfaced. There are reports of troubles in the eurozone with an Austrian bank. For details see WSJ. We expect more revelations as the days pass. But what about the dollar? There is little evidence that the Swiss action will interfere with the strengthening trend of the US dollar. In fact, many expect both the dollar (USD) and the Swiss franc (CHF) to show stronger results against many other currencies, including the euro and the yen. We agree with that general assessment but want to distinguish between the Swiss and the US central banks. The difference between CHF and USD is that the Swiss will actively impose a negative interest rate on deposits denominated in Swiss francs in order to discourage inflows from non-Swiss sources. Switzerland has used this tactic in the past. In the US, the Federal Reserve will not impose a negative interest rate and is expected to commence a gradual extraction from quantitative easing (QE) by the end of this year. So The Fed will be raising rates, while the Swiss will be lowering them. And the US dollar is the world's reserve currency so the US is not worried about inflows. US central bank policy is focused on the US economy. Switzerland's issues are of secondary importance for Federal Reserve officials. At Cumberland, we expect the Fed's policy rate to reach about 0.50% by the end of 2015. Others have differing estimates of the path of restoration of normalcy by the Fed. And we believe that the Fed itself has not fully decided. So if the Fed doesn't know, how can anyone outside the Fed know? There is market-based pricing that estimates the path of Fed restoration. On January 15, Barclays calculated this path to lead to a 2.5% fed funds rate in 2022. Barclay's work suggests that "the market is pricing in the fed funds rate to remain below 2% until 2019." LIBOR futures-based estimation gives a similar path. The bottom line for the Fed's policy is an expectation of very low rates for several more years. So what will happen to the USD? BCA Research observes that "the U.S. dollar moves in big cycles." They estimate that USD "trade-weighted" strengthening is up 23% so far in this cycle. BCA notes that the cycle in the 1990s involved a total move of 53%. The move of the late 1970s to mid-1980s was 57% according to their estimates. They add JPMorgan Chase as a research source in their calculation. If BCA is correct, we may not be even halfway through the strengthening move. And Switzerland's action is not a significant weight in the traded-weighted calculation. The bottom line is that this seems to be a cycle of dollar strengthening that will be measured in years. And if Talley is correct, the influence of the strengthening dollar, while important for sector selection, is not enough to derail a bull market by itself. We agree. At Cumberland, we have been emphasizing the domestic sectors in our US ETF strategies. Utilities are 95% sourced in the US. They are overweighted in our domestic US ETF portfolios. ~~~ David R. Kotok, Chairman and Chief Investment Officer  |
| As goes early-January, so goes Nothing Posted: 19 Jan 2015 09:00 AM PST Salil Mehta is a popular statistician and risk strategist, who has developed a unique method to teach quantitative techniques. He blogs at Statistical Ideas. ~~~ We’ve started the year with a sizable downward market pattern, which is making market participants think in ill-advised ways. Eight of the first eleven trading days (S&P 500) were negative. If we use a binomial distribution model, it would show a 9% probability of seeing >8 down days of the first 11 days (focus on green color below). So it’s rare, but not necessarily significant. Note that throughout this article, we sometimes equally express 8 of 11 trading days as 8/11. Now instead of the theoretical models that under-emphasize mathematical kurtosis in financial markets (Ch.3 of Statistics Topics, or here), if we examine the empirical market history, then we would appreciate a further case for how rare is such a pattern. And of 64 prior years (from 1951 through 2014), only 6% of those years fit this criteria (focus on orange color below). In science, we traditionally often rely on p-values of 5% to be significant; so 6% is not far from such threshold. In any event, the actual probability may actually seem rarer still. Since the last time we had such a pattern (>8 down days of the first 11 trading days) was 37 years ago, in the late 1970s!  Part of the reason there is a focus on the portion of initial trading days that have been down, is that the overall market performance over these first 11 trading days has been anything but remarkable. YTD of -1.9%. Over the same 64-year period (though 2014) the market has initially changed a similar -1.9% or worse, on 22% of those years (and the last of which were just a half-dozen years ago). So nowhere near more exotic, for market participants to focus on versus the current “down days” pattern that only 6% of the years fit.Still, given the sizable downward market pattern, it is natural to ask: “What now?” For example, does the initial downward S&P 500 pattern foretell something concerning the performance for the rest of January, or even for the rest of 2015? It turns out that neither of these latter questions can be resolved by assessing these statistics from the initial trading days. For more on how lay people and many professionals can insanely bungle their understanding of probability, see these articles from an endless well of the same: here, Wall Street Journal, and Financial Times. We’ll show in the comprehensive pairs of modeling charts below, how despite the sizable downward market pattern, there is little we can infer about the rest of the year, let alone for just the immediate rest of the month! For amusement value, we identify the last year (2014) in red text color. And to be excruciatingly thorough, we note that the impact of January versus the remaining 11 months is no different from the noise we see below. What these charts show is that this adorable notion of “As goes x, so goes y” is basically a case of dangerous people abusing probability to confuse anyone into believing there is definitely a there there.  So sure seeing a drop in 8 of 11 initial trading days, and being down 2% for the year, is enough to create some short-term “panic” among market participants (focus on grey color of top chart above to assess the degree of personal, over-confidence we are continuing to head lower for the foreseeable future). But as we have proven in various parts of this academic blog, all of this playing around with statistics that others do is simply a silly exercise. Trying too hard with the markets just bloats one’s hubris and reduces the intelligence we should be having. It also dangerously puts our financial interests at risk. Look no further than the intraday FXCM business fiasco from last week, which had the potential to again destabilize financial markets we in Washington had worked hard to calm. In the realm of probability, we should probe deeper into anyone’s suggestion of drawing a relationship (either in business, or anywhere else in life), where there are regular false positive errors occurring. In this case, such errors are from over-emphasizing the importance of initial annual trading days, in order to in any way evaluate where the market is likely to go.
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| Posted: 19 Jan 2015 04:00 AM PST Good Monday morning. Markets are closed for the Martin Luther King Day holiday int he states — so no train for me – but no worries, we still have your reads queued up:
What are you reading?
Falling Rates Spur Revival in Market for Mortgages
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| Gross: Buy TIPS and BlackRock Build America Posted: 19 Jan 2015 02:30 AM PST Barron’s Roundtable member Gross reflects on the dangers of global debt, and suggests two ways for investors to profit in a low-rate environment. Bill Gross: Buy TIPS and This Closed-End Fund  |
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