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My inaugural appearance with Greg Hunter of USA Watchdog back in July generated more views on YouTube than any interview I’ve ever done (over 100,000). As such, I was thrilled to be invited on as a repeat guest on his show last week.
In our latest talk, we discussed the clear and present danger of the TPP, the 2016 U.S. Presidential election, as well as what I think could be a “extinction level event” for the global economy.
Enjoy.
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With stocks soaring, now that the “Brainard” risk factor has been fully unwound after the Fed governor’s surprisingly dovish speech which has essentially killed any probability of a September rate hike and unleashing today’s “”Violent Rally In Risk” Today” as predicted earlier, one would expect that there is only smooth sailing not only until the September 21 FOMC meeting, leaving only the post-election December 13-14 Fed meeting potentially in play.
Still, at least according to one advisor, GS Banque’s Loic Schmid, it is prudent to keep some volatility protection on after the recent risk-off episode. As a reminder, in mid-July Schmid suggested buying the VIX, a trade that has been profitable ahead of the Friday surge…
… and while he says that he is taking profits on half the position, he is also keeping the other half on for the following reasons:
One key risk factor Loic forgot, the one which most directly catalyzed the recent sell-off, is how and when the BOJ will pursue the steepening of its bond curve. With the 10Y JGB now parked precariously on the unchanged line, nothing has been resolved as far as the Japanese market is concerned, where as we reported before, Kuroda and Abe are now seeking a way to push up longer yields to provide some comfort to long-suffering pension funds and banks, desperately seeking some Net Interest Margin. It is this “inverse twist” that is now the biggest risk facing Japanese, and by implication – thanks to record high cross-asset correlation – global risk prices.
Indeed, as we said last week, any risk of a prolonged market selloff is to only be found with the BOJ, because as Loic notes, when it comes to the Fed, “it is interesting to observe that every time the FED might raise interest rates, equity markets sell-off…” And as everyone knows by now, the markets win every single time.
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Submitted by Emily Zanotti via HeatSt.com,
Hillary Clinton’s doctor now says the Democratic presidential candidate, 68, was officially diagnosed with pneumonia sometime on Friday, and has been campaigning with the serious respiratory illness for a week, leading to her “medical episode” at Sunday morning’s September 11th memorial event.
When it comes to candidates (rather than office holders) the rules actually come from the political parties, not the Constitution. For Republicans, if a Presidential candidate dies or drops out, the RNC has to either convene a new convention or take an official poll of the RNC’s state representatives to select a replacement candidate. Most likely, the RNC would move the running mate up to the top of the bill, in order to preserve what fundraising has already been done for the ticket.
But for the Democrats, it’s not so clear. The Democratic National Committee reserves the right to replace a candidate who dies or drops out, and it doesn’t provide additional details in its by-laws. So presumably the Democrats would have to make up the process up as they go along. The DNC could entrust replacing Clinton to a central DNC brain trust or, more likely, replicate the RNC’s system, handing the vote over to the committee’s state delegates.
Tim Kaine
The DNC would likely want to retain the support of major donors who’ve already given to the Clinton-Kaine ticket, and would probably just bump Tim Kaine up from the Veep slot. Kaine would simply slide up the ticket, choose a new running mate, hope the ballots could be reprinted in time, and carry on just as Clinton had.
But, of course, this is 2016 and anything can happen.
The Open Slot
Donald Trump has proven to be a wild card candidate: he’s spent no money, compared to Clinton’s million-dollar ad buys, and raised virtually nothing compared to his Democratic opponents, and he’s still running neck and neck with Clinton nationwide. So the DNC would likely have to consider whether Kaine could retain Clinton’s razor-thin lead, or whether they’d need a more capable candidate.
The DNC might naturally lean towards Joe Biden who said he didn’t want to campaign, but has never said, openly, that he’d prefer not to be President. Biden is neither Clinton nor Trump, making him an easy favorite in the Presidential contest (though, it’s likely any number of cartoon characters, inanimate objects and D-list celebrities would also easily pull into the lead), and he’d have the backing of President Obama, who could unite the party with a call to action to unite behind his Vice President.
Also likely contenders: Bernie Sanders and Elizabeth Warren (both progressive candidates with a large swath of support within the Democratic party), New York governor Andrew Cuomo, Virginia’s Jim Webb, even second runner up Martin O’Malley.
Chelsea Clinton
There’s a longtstanding tradition in American politics of spouses stepping in after an unexpected death. Take Missouri’s Jean Carnahan, for instance, who stood in for her husband Mel after he died in a plane crash three weeks before the Missouri Senate election. After Mel won posthumously, she served in the Senate for two years. Future Senator Olympia Snowe first entered politics after the death of her husband, a Maine state representative, in a car wreck. Likewise, Mary Bono’s long political career began when her husband Sonny died in a skiing incident.
Bill Clinton is prohibited by the 22nd Amendment of the Constitution from running. If a Clinton were to step in for Hillary, it would likely be Chelsea, who at 36 is just old enough, in terms of the Constitution, to be president.
The Filing Deadlines
Most states’ campaign filing deadlines have already passed – and as some independent candidates, including conservative Evan McMullin are finding, states aren’t normally open to extending the period of time candidates have to file the paperwork necessary to put their names on the Presidential ballot.
For the Democratic replacement, though, as long as they have the party’s blessing, it’s likely officials could simply replace Clinton name any time up to a month before election day (ballots are usually printed and mailed about three weeks before). It’s also possible that Congress could postpone or move election day, but that would be an extreme step.
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When torrential rain left thousands of Louisianans homeless last month, hundreds of volunteers flooded into the state to help pick up the pieces.
And when those volunteers needed a place to stay—along with some flood victims who were unable to return to their homes in the wake of the disaster—it was Airbnb that helped to answer the call. The room-sharing service waived all service fees for rooms in Louisiana and allowed individual property owners to rent rooms for free in the weeks after the flooding—essentially turning Airbnb into an online marketplace for free bedding when a warm place to sleep was most important.
“We have an ability to help people, at least in the short term, to get a comfortable bed, a home-cooked meal ― which is a very different experience from what they’d get in a shelter,” Airbnb spokesman Nick Shapiro told The Huffington Post.
Shapiro said at least 180 Airbnb users took advantage of the free posting option, which remained live until the first week of September—about three weeks after flooding caused by biblical rainfall (one part of the state recorded 31 inches of rain in less than two days) killed 13 people and left more than 20,000 homeless.
It’s not the first time Airbnb activated its disaster response tool, which first launched in the wake of the so-called “superstorm Sandy” that hit New York City in 2012. The company has used the disaster response option to waive all fees and allow for free rentals on at least 20 occasions, the Huffington Post reported.
The speed and generosity of Airbnb’s response to the flooding in Louisiana (or after Sandy) stands in stark contrast to government-led disaster recovery efforts. After Sandy, it took four days for the first FEMA relief center to be operational—and then it ran out of water on the first day. Poor distribution networks left thousands of gallons of FEMA-provided gasoline in places where it wasn’t needed while people in other parts of the New York metro area experienced shortages.
Louisiana is no stranger to the good intentions and questionable results of federal disaster recovery efforts, of course. There was no Airbnb when Hurricane Katrina hit the state in 2005, but it was another private sector business—Wal-Mart—that stepped in to provide valuable supplies along a better distribution network than FEMA had.
“While state and federal officials have come under harsh criticism for their handling of the storm’s aftermath, Wal-Mart is being held up as a model for logistical efficiency and nimble disaster planning, which have allowed it to quickly deliver staples such as water, fuel and toilet paper to thousands of evacuees,” the Washington Post reported at the time.
That shouldn’t really be surprising. After all, successful businesses survive by getting people the things they need when they need them. Wal-Mart is always going to be better at providing supplies after a disaster because it practices doing that (albeit with lower stakes) every single day. The same is true with Airbnb when it comes to providing people with a place to sleep—it has already built the online network necessary to connect people, and it has access to millions of users who are already willing to open their homes and bedrooms to strangers. After Sandy, and in anticipation of future storms, Airbnb sent hurricane preparedness information to 100,000 users in states bordering the Gulf of Mexico and the Atlantic Ocean.
No matter how many fake disaster drills FEMA runs, the bureaucrats overseeing the federal response to floods and fires will never be able to replicate that.
In Louisiana, some state lawmakers actually want to make things worse. State Rep. Jonathan Perry, R-Lafayette, has introduced a bill requiring volunteers to have government-issued permission slips before they would be able to help with disaster recovery. Perry’s proposal would require training and certification for so-called “Good Samaritans” like the “Cajun Navy” that provided boats to help flood victims evacuate and rescue some of their belongings.
If the government can’t do disaster recovery as well as the private sector, could it at least not make things any harder?
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"You get nothing… it's all here in black and white… shit's so bad out there that you get no interest rate hike!!"
Maybe she has a point…
But buy stocks because earnings expectations for 2016 just hit cycle lows…
Post-Rosengren…
And Post-Brainard…
Equities soared today – the biggest jump in over 2 months (since the Brexit rebound)…
Notably, S&P tradex extremely technically – tumbing yesterday through the 50-day moving average, testing the 100DMA (2120) this morning and bouncing up to the 50DMA (2163)…
The S&P's bounce was a 61.8% fibonacci retracement…
Investors rushed into the safety of Biotech stocks…
No sectors managed to get green over the past two days… (on the day healthcare outperformed but the entire complex moved linearly)…
After 2 days of serious (Saudi?) selling, Treasuries flatlined today (with the short-end outperforming -2bps, versus the long-end 0bps)…
Notably the Japanese yield curve continues to steepen dramatically…
The USD Index slid lower all day but did not unwind all of the gains from Friday…
Commodities all ended green today with crude rescued for no good reason at all… but we note only copper is green for the last 2 days…
Charts: Bloomberg
Bonus Chart: The Most Important Chart of the day…
Bonus Bonus Chart: Just a reminder, before we see today's data, that Friday saw the biggest Emerging Market fund outflow in history…
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Submitted by Ronan Manly, BullionStar.com
China is now in pole position as the world's largest gold mining producer. Much if not all of Chinese domestic gold mining output is refined into standard gold by Shanghai Gold Exchange (SGE) approved refiners and then sold through on the SGE. A lot of recycled gold in China also flows through the same refineries and is sold on the SGE. As of 2013, there were at least 35 refiners across China accredited by the SGE to deliver gold ‘Ingots’ (bars of weights 12.5 kg, 3 kg and 1 kg) on the Exchange. The list is probably longer now, and although the sheer scale of the Chinese gold refining sector is hard to keep track of, you get the picture as to its size.
It was therefore surprising that recently, while working on a particular task that required images of gold bars produced by Chinese refiners, I found that the selection of Chinese branded gold bar images on ‘the web’ (i.e. Google.com) seemed extremely limited. As it turns out, there are a vast number of images of Chinese brand gold bars on the wider web, you just need to know how and where to look. Nearly all of these images have never been picked up before in “Western search engines”.
Some of the large Chinese gold refineries are owned by, or affiliated with, large Chinese gold mining companies. These gold mining companies are:
The 3 next biggest Chinese gold mining companies, in no particular order, are as follows:
There are 9 Chinese gold refineries accredited to the London Bullion Market Association’s (LBMA) Good Delivery List for gold. This list, which is analogous to an A-List, includes gold refiners around the world which produce large gold bars (400 oz), and whose production meets the very high quality standards laid down by the LBMA. Only Japan, with 11 gold refineries on the LBMA list, has a higher number than China. Russia has 8 of its gold refineries on the LBMA gold list. The above refineries of Zhongyuan, Zijin, Shandong Gold, and Shandong Zhaojin are on this LBMA Good Delivery list.
Cross-referencing these names with a list such as the top refinery suppliers of gold bars to the Shanghai Gold Exchange (see table below) also validates that the refineries of (Henan) Zhongyuan, Zijin Mining, Shandong Gold, and Shandong Zhaojin are amongst China’s largest gold refiners, with Zhongyuan, Shandong Gold, and Shandong Zhaojin in the top 3, and Zijin a bit further down, at least in 2011 when this table was produced.
Shanghai Gold Exchange – 2011 Top 10 gold refiners supplying SGE
With 4 accredited refineries on the LBMA list, one might think that photos / images of the gold bars output by these refineries are easy to find. Next step is to see if any images of these refiners’ gold bars are available “on the web”. The short answer is that a few images are available (see below), but they seem to be very rare and not saved very widely ‘on the web’ (Google.com).
LBMA bar mark description – “Current Bar Mark: Circular logo round Chinese character with CHN GOLD below.“
‘China Gold’ brand bars (i.e. Zhongyuan Gold Smelter bars) are not widely found by Google image search. The above image that Google does find is sourced from page 10 of a Gold Bars Worldwide brochure, which is titled “Shanghai Good Delivery Gold Ingots and Bars“, published by Grendon International Research Pty Ltd in November 2014.
LBMA bar mark description – “Current Bar Mark: Double crescent logo with ZIJIN MINING in Roman and Chinese characters. Circular assay mark with ZIJIN MINING in Roman and Chinese characters.“
This image is a ZIJIN ‘double cresent’ bar. Notice the SGE marking. Again, Google finds this image by sourcing it from page 10 of the same GoldBars Worldwide brochure here, as it only seemed to be found by Google.com at that source. The photographs in this brochure were actually supplied to Grendon by the refineries, so without this brochure, Google would not even have found this image.
Note: if you look in the pdf in the above link, the Gold Bars Worldwide brochure actually labels this bar image as a Henan Zhongyuan bar which looks wrong. The double crescent insignia shows that it’s actually a ZIJIN bar, as per another Zijin bar on page 9 of the same brochure.
3. Shandong Gold Mining Company
LBMA bar mark description – “Current Bar Mark: Circle surrounded by TAISHAN in Roman and Chinese characters within a square comprising four stylised S’s.”
During the test, Google didn’t find any images of Shandong Gold Mining gold bars, However, conveniently, a Shandong Gold bar is on the BullionStar site here, which Koos Jansen used to illustrate SGE bar markings.
Notice the circle, the SGE marking, and the ‘Taishan’ marking in the above image.
4. Shandong Zhaojin Gold
LBMA bar mark description – “Current Bar Mark: Triangle with two interlocking half circles and ZHAOJIN in Chinese characters within the triangle.”
The only images I could find of Shandong Zhaojin gold bars using Google.com were these ones, which are on the actual Shandong Zhaojin Import and Export Co Ltd website.
Notice the SGE markings. Notice also the Shandong Zhaojin bar logo is the same as the Shandong Zhaojin company logo.
Note that since the publication of this article that you are reading, Google has started to find the images that you see here and the images listed below. That’s the beauty of the web, in that the more links to pages and images that exist, the easier it is for web bots to find and index said pages and images. Therefore, if you test Google.com now for these gold bar brands, Google is now finding more gold bar images of the refineries described here, precisely because they are in profiled here.
The ‘Motherlode results’ Search – Baidu.com
The very limited search results above suggested a different approach was needed. Like a lot of people, I’d heard about the Google Chinese site http://www.google.cn, and its re-consolidation to operate from http://ift.tt/gHQ051 a few years ago, as Google scaled back its CHinese presence. I had also vaguely heard of Baidu.com, the Chinese search engine, but I had never had the need to use it before.
The first port of call was to consult with Koos Jansen, resident China gold expert at BullionStar. Koos advised the following approach: “Get the Chinese names of the refineries, and search Baidu“. Seems pretty obvious in hindsight…:)
For non-Chinese speakers, there are 2 ways to establish the Chinese names of the refineries. The first is to use a refinery’s website. This works most conveniently with dual-language websites (since you can toggle between the Chinese and English names of the company to establish what the Chinese characters are), and it goes without saying that it only works if the Chinese refinery (or mining company) actually has a website, which isn’t always the case. The second approach is to use a Shanghai Gold Exchange list of SGE members names which includes their English names alongside the Chinese names (in Chinese characters). Such a list can be seen here.
Not to put too fine a point on it, but the results of using this approach in Baidu are astounding compared to using Google.com. There are huge amounts of gold bar image results for the Chinese refiners. Here’s a flavor:
Zhongyuan Gold Smelter – owned by Zhongjin Gold
LBMA description – Circular logo round Chinese character with CHN GOLD below
Note that 'China Gold' operates retail outlets in China, through which a lot of its gold bars are sold to the public.
Zijin Mining
LBMA description – Double crescent logo with ZIJIN MINING in Roman and Chinese characters.
Searches for Zhongyuan Gold (China National Gold), Zijin Mining, Shandong Gold and Shandong Zhaojin using Google Hong Kong (English version) bring back very limited bar image results, which are mostly images from the ‘Gold Bars Worldwide’ brochures.
The Chinese equivalent name searches in Google Hong Kong (Chinese language) bring back reasonable gold bar image results for each of the 4 refiners above, but not nearly as many image results as retrieved from Baidu. For example, Google Hong Kong (Chinese version) finds the below Zhaojin image in a directory called http://ift.tt/2cjrV9h. But Google.com draws a blank on this directory.
Based on this relatively brief overview, it would appear that Baidu provides the most comprehensive results for gold bar images of Chinese gold refiners.
via http://ift.tt/2cqZKYz BullionStar
There was a burst of righteous populist anger anger last week, when it emerged that Wells Fargo had engaged in pervasive, “massive” fraud since at least 2011, including opening credit cards secretly without a customer’s consent, creating fake email accounts to sign up customers for online banking services, and forcing customers to accumulate late fees on accounts they never even knew they had. For this criminal conduct, Wells was fined $185 million (including a $100 million penalty from the CFPB, the largest penalty the agency has ever issued). In all, Wells opened 1.5 million bank accounts and “applied” for 565,000 credit cards that were not authorized by their customers.
As “punishment” Wells Fargo told CNN that it had fired 5,300 employees related to the shady behavior over the last few years. The firings represent about 1% of its workforce and took place over several years. The fired workers went to far as to create phony PIN numbers and fake email addresses to enroll customers in online banking services, the CFPB said. What was hushed away is that not a single employee will go to prison, and that ultimately it will be Wells Fargo’s shareholders – such as Warren Buffett – who will end up footing the bill.
What Wells did not disclose publicly to anyone is that the head of the group responsible for Wells’ biggest consumer fraud scandal in years, is quietly leaving the bank with a $125 million bonus, a bonus which as Fortune’s Stephen Gandell writes today will not see even one cent clawed back as part of the dramatic revelations.
As Gendel writes, Carrie Tolstedt, the Wells Fargo executive who was in charge of the unit where employees opened more than 2 million largely unauthorized customer accounts—a seemingly routine practice that employees internally referred to as “sandbagging”— is leaving the giant bank with an enormous pay day, some $124.6 million.
Carrie Tolstedt
Tolstedt is walking away from Wells Fargo with a very full bank account, and praise: in the July announcement of her exit, which made no mention of the soon-to-be-settled case, Wells Fargo’s CEO John Stumpf said Tolstedt had been one of the bank’s most important leaders and “a standard-bearer of our culture” and “a champion for our customers.” In light of the record fine levied by the CFPB for the unit which Tolstedt headed, we wonder if Stumpf would like to retract his statement.
What is just as troubling is that despite beefed-up “clawback” provisions instituted by the bank shortly after the financial crisis, “it does not appear that Wells Fargo is requiring Tolstedt, the Wells Fargo executive who was in charge of the unit where employees opened more than 2 million largely unauthorized customer accounts—a seemingly routine practice that employees internally referred to as “sandbagging”—to give back any of her nine-figure pay.”
As a reminder, on Thursday, Richard Cordray, the head of the CFPB, said, “It is quite clear that [the actions of Tolstedt’s unit] are unfair and abusive practices under federal law. They are a violation of trust and an abuse of trust.”
However, cited by Gendel, a spokesperson for Wells Fargo said that the timing of Tolstedt’s exit was the result of a “personal decision to retire after 27 years” with the bank. The spokesperson declined to comment on whether the bank was considering clawing back Tolstedt’s back pay.
In a statement following the settlement, Wells Fargo said, “Wells Fargo reached these agreements consistent with our commitment to customers and in the interest of putting this matter behind us. Wells Fargo is committed to putting our customers’ interests first 100% of the time, and we regret and take responsibility for any instances where customers may have received a product that they did not request.”
In other words, this has become yet another instance where bank subordinates were engaged in activity that seemingly none of their supervisors was aware of. While Fortune writes that it is not clear how closely, Tolstedt was responsible for or even aware of the widespread abusive tactics at the bank, it is a fact that Tolstedt ran the community banking division of the bank, which included its retail banking and credit card divisions, during the entire period in which the customer abuse was alleged, which goes back to 2011. The CFPB said about three quarters of the unauthorized accounts opened by employees of Wells Fargo were bank deposit accounts. Another 565,000 were unauthorized credit card applications. Tolstedt took over the division in 2008, after Wells Fargo merged with Wachovia during the financial crisis.
Ironically, Tolstedt was a regular on Fortune‘s Most Powerful Women list. She was replaced on this year’s list by Mary Mack, who is taking over her job at the bank.
Tolstedt was regularly praised for her unit’s ability to get customers to open numerous accounts. For a number of years, Wells Fargo’s proxy statement, which details executive pay, cited high “cross-selling ratios” as a reason that Tolstedt had earned her roughly $9 million in annual pay. For instance, in Wells Fargo’s 2015 proxy statement, the company said that its compensation committee had authorized Tolstedt’s $7.3 million stock and cash bonus that year, because “under her leadership, Community Banking achieved a number of strategic objectives, including continued strong cross-sell ratios, record deposit levels, and continued success of mobile banking initiatives.”
However later in 2015, the L.A. City Attorney’s office sued the bank because of its sales tactics, saying that many of the abusive practices came from intense pressure on Wells Fargo’s employees to get customers to open up numerous accounts. A separate class action of former employees alleges they were fired for not meeting cross-selling goals, or going along with the aggressive sales tactics.
Meanwhile, the awards for Toldstedt continued piling in, and earlier in 2016, when Wells Fargo released its annual proxy statement, it once again said that in order to justify her multimillion dollar bonus, Tolstedt’s division had “achieved a number of strategic objectives.” But this time, for the first time in years, cross-selling wasn’t listed as one of them.
While one can speculate if Tolstedt decided to leave in advance of the CFPB crackdown on her division, one thing that is certain is how much money she is taking with her: according to Gendell, when Tolstedt leaves Wells Fargo later this year, on top of the $1.7 million in salary she has received over the past few years, she will be walking away with $124.6 million in stock, options, and restricted Wells Fargo shares. Some of that hasn’t vested yet. But Tolstedt gets to keep all of it because she technically retired. Had she been fired, Tolstedt would have had to forfeit at least $45 million of that exit payday, and possibly more. It is safe to assume that had she waited until after the CFPB settlement, that her parting present may have been one third smaller, and that she could have been the bank’s scapegoat, fired to placate regulators.
Alas, now we will never know what “could”have happened, which means that the only recourse Wells and its shareholders have – if they feel like bothering – is to try to recoup some of her ill-gotten bonus. As Fortune concludes, “the bank’s proxy statement says that the bank has “strong recoupment and clawback policies,” and that the bank will revoke bonus pay if it is found that the conduct of an executive resulted in representational harm to the bank, or that the executive was not able to “identify or manage” risks in his or her division. But there is no sign that Wells Fargo is going to ask Tolstedt to return even a sliver of her stock jackpot.“
As we pointed out last week, when we observed that yet again nobody is going to prison, Gendel’s parting assessment is similar: “on Wall Street, the carrots are still widely handed out. The sticks, however, remain out of sight.”
This also means that the biggest crime on Wall Street remains a more prosaic one: getting caught.
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The government is giving what The New York Times described as a “$2.45 billion loan” to Amtrak to buy new Acela trains to replace the ones that currently ride the rails between Washington, New York, and Boston. The first set of Acela trains, deployed about 15 years ago, cost about $1.2 billion; the new set will cost about twice that.
If Acela is such a great business, writes Ira Stoll, why does the federal government need to loan it money? Why can’t it raise funds the way other, competing, businesses, like airlines do, by selling bonds or issuing stock? Instead what’s happening is the government is backing one competitor in the market for travel between Boston, New York, and Washington.
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Submitted by Michael Lebowitz via 720Global.com,
In “What Me Worry” we noted that the closely watched equity volatility index (VIX) was at a level of investor complacency rarely seen, not only in election years but over decades of market history. We also mentioned anxiety surrounding the upcoming election is palpable, and that equity valuations are at rarefied levels without supporting earnings and economic data. Given these factors we ended the article with the following:
“The market, courtesy of complacent investors, is offering very cheap insurance for an event that has the potential to induce extreme volatility via VIX options and futures. Even if the next eleven weeks leading to the election prove to be uneventful, the VIX at current levels, as shown earlier, has been a prudent place to own protection. We recommend you consider this opportunity as a protective measure”.
Unfortunately, most professional investment managers are not adept and/or able to trade VIX futures, options or volatility in other forms to hedge their client’s equity positions. More often than not, concerned managers will instead reduce perceived risk by selling a portion of their equity holdings and increasing cash positions and/or shifting portfolio allocations from equities to fixed income. It is in this vain that we discuss how the latter option, shifting money from equities to fixed income, has risks that were not as evident during the 2000 tech crash and the 2008 financial crisis.
Harry Markowitz developed the Modern Portfolio Theory (MPT) in the 1950’s. Simply put his theory argues that portfolio risk can be reduced by holding combinations of different securities and asset classes that are not positively correlated. We agree with the theory that there are benefits to diversification but we do not subscribe to MPT. Diversification makes sense when you buy uncorrelated assets that are undervalued. Buying assets for the sake of diversification without regard for valuation is fraught with risk regardless of how many different securities and asset classes one may hold. In the words of Warren Buffett “diversification is a protection against ignorance. It makes very little sense for those that know what they are doing”. To paraphrase Warren Buffet, diversification is for those that do not know what they are doing.
The truth of the matter is that blind diversification does not work simply because it does not take into account the effects of volatility on asset prices. Chris Cole from Artemis Capital, one of the clearest thinkers on the importance of volatility as an asset class, highlights this point in the following graphic.
Contrasting the perception of a well-diversified portfolio with the reality of embedded volatility, the graph reflects enormous concentration risk in short volatility. Importantly, this risk matters most at the exact point in time when one expects – hopes – their strategy of diversification will protect them. Unfortunately, the well-diversified portfolio (left side) turns in to the short volatility-concentrated portfolio in periods of extreme market disruption. Mr. Cole’s analysis may be best summarized with the popular statement that correlations on many assets go to one during a crisis.
Without regard for Mr. Buffett’s or Mr. Cole’s perspectives, many investment managers tend to hold “diversified” portfolios of stocks and bonds in various forms and strongly believe that such diversification will protect their portfolios in the event of a serious market correction. Unfortunately, many investors are not basing this diversification strategy on a fundamental analysis of bonds but largely on a blind assumption that bond prices will rise – yields will fall – in the event of trouble in the equity market.
Sovereign bond markets around the world are trading at their lowest yields in decades and in some instances, including in the United States, in centuries. In fact there are approximately $13 trillion worth of global bonds that have negative yields.
Bond investors today are faced with a unique problem resulting from these low yields. The potential for price increases versus price decreases is grossly asymmetric. In other words there is a lot more money to lose in bonds than can be made. To illustrate this consider a ten-year U.S. Treasury note maturing in August 2026, with a coupon of 1.50% annually, a price of 99.25 and a yield of 1.58%. The chart below shows a range of potential one-year total returns for various yield levels in the ten-year note described above. As a frame of reference the average yield during the 2008 crisis was 3.43%. If the yield on the current 10-year note were to rise to that level in a year an investor would suffer a loss of 14%.
With the poor risk/reward skew in mind we turn back to the idea of using bonds to hedge against an equity market correction. If such a strategy is going to work, bond yields must fall further into record territory. Can this happen? We do not have the answer, nor does anyone else. Yields have already dropped well beyond the point that most professionals thought possible and given the potential for a deflationary economic recession, they may decline further. Additionally, the Federal Reserve will almost certainly employ bond friendly actions, as they have in the past, to quell equity market and economic turmoil. If Japanese and German ten-year notes are indications, U.S. Treasury yields can certainly go negative.
The question you must consider is, given extremely low yields and seemingly limited room to decline, do you have confidence that, in the event of an economic recession and severe equity market correction, yields will drop further? If so, then to what extent will such a decline protect you?
If one is to hedge with Treasury securities, they must also consider what happens if yields do not decline during a market correction. What if “safe-haven” securities traditionally used for hedging purposes were to lose 5% to 10% or even 20% or more?
Below is a list of circumstances that could lead to rising bond yields, in a departure from prior major market corrections:
Current yield levels alter the traditional protection U.S. Treasuries and other bonds now afford. As James Grant of Grant’s Interest Rate Observer has stated, instead of risk-free return, one gets return-free risk. In other words, the past may not be prologue to the future. The hedging benefits that bonds have provided in the past do not appear to offer the same protection of prior periods. This analysis implies an important message for those looking to take a traditional equity hedging approach: the margin of error is quite small for anyone assuming that tomorrow will be like yesterday.
Recent history has favored those that used fixed income, especially U.S. Treasuries to hedge equity market drawdowns. That however does not take away one’s responsibility to question whether the current risk/reward proposition is still applicable. In a world of declining inflation, stagnating global economic growth and aggressive central bankers, such a hedging strategy may still make sense. However, we would be remiss if we did not reiterate a point made earlier – diversifying for diversification’s sake makes little sense if you are not buying assets that offer value.
There is relatively little upside for Treasury prices and a number of legitimate reasons yields could defy the pattern of the past 35 years and actually increase. Accordingly, one looking for true diversification should consider increasing cash positions, hedging with volatility instruments and/or options, and adding alternative assets such as precious metals.
Finally, we were gratified to see this news clip posted from Bloomberg as we were finalizing this article.
via http://ift.tt/2cfVsWA Tyler Durden