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from Global Investing:

Pension funds cover the table

As gloomy first paragraphs go, you'd have to go some to top Schroders' Jonathan Smith's introduction to a report touting his firm's momentum investing offering.

"As the global economy continues to de-leverage, the next decade looks likely to be a period of weak growth and low interest rates, punctuated by bouts of heightened instability and crisis."

Oh but hang on!, here's Legal & General Investment Management having a go.

"The global economy continues to grind onward, but we don’t see this as a sustained trend: growth is fragile and remains vulnerable to shocks."

Hmm.. too similar, call it a draw. And anyway, both are cribbed from the popular, and I think unattributed, quote that "war is long periods of boredom punctuated by moments of sheer terror."

So how do you prepare to battle this unpredictable lost decade (aside from taking the hint and calling the Schroders and LGIM sales teams at the earliest opportunity)?

Well there comes some confirmation of sorts that longer-term investors are making some fresh moves to tackle inscrutable markets. Barings has found evidence of managers scurrying anew to spread their risk; diversifying assets and stepping up portfolio reviews in an effort to deal with volatility.

from Global Investing:

Time for a slice of vol?

As the global markets consensus shifts toward a "basically bullish, but enough for now" stance -- at least before Fed chief Bernanke on Monday was read as rekindling Fed easing hopes -- more than a few investment strategists are examining the cost and wisdom of hedging against it all going pear-shaped again. At least two of the main equity hedges, core government bonds and volatility indices, have certainly got cheaper during the first quarter. But volatility (where Wall St's Vix index has hit its lowest since before the credit crisis blew up in 2007!) looks to many to be the most attractive option. Triple-A bond yields, on the other hand, are also higher but have already backed off recent highs and bond prices remain in the stratosphere historically.  And so if Bernanke was slightly "overinterpreted" on Monday -- and even optimistic houses such as Barclays reckon the U.S. economy, inflation and risk appetite would have to weaken markedly from here to trigger "QE3" while further monetary stimuli in the run-up to November's U.S. election will be politically controversial at least -- then there are plenty of investors who may seek some market protection.

Societe Generale's asset allocation team, for one, highlights the equity volatility hedge instead of bonds for those fearful of a correction to the 20% Wall St equity gains since November.

A remarkable string of positive economic surprises has boosted risky assets and driven macro expectations higher but has also created material scope for disappointment from now on. We recommend hedging risky asset exposure (Equity, Credit and Commodities) by adding Equity Volatility to portfolios.

from Unstructured Finance:

UF’s Weekend Reads

Here is the latest edition of Weekend Reads courtesy of Sam Forgione. Enjoy.

From Barron's:

The managers of hedge fund Cassiopeia are teaching a lesson or two on trading volatility.

From Bloomberg Businessweek:

Matthew Philips addresses regulatory efforts to catch up with the glitch mob known as high-frequency traders.

from Global Investing:

Retreat of Tail-Risk Trinity

Until this week at least, one of the big puzzles of the year for many investors was squaring a 10-15% surge in equity indices with little or no movement in rock-bottom U.S., German and UK government bond yields. To the extent that both markets reflect expectations for future economic activity, then one of them looks wrong. The pessimists, emboldened by the superior predictive powers of the bond market over recent decades, claim the persistence of super low U.S. Treasury, German bund and British gilt yields reveals a deep and pervasive pessimism about global growth for many years to come. Those preferring the sunny side up reckon super-low yields are merely a function of central bank bond buying and money printing -- and if those policies are indeed successful in reflating economies, then equity bulls will be proved correct in time. A market rethink on the chances for another bout of U.S. Federal Reserve bond-buying after upbeat Fed statements and buoyant U.S. economic numbers over the past week also nods to the latter argument.

But as we approach the final fortnight of the first quarter,  more seems to be going on. Much of the whoosh of Q1 so far has merely been a reversal of the renewed systemic fears that emerged in the second half of last year. In fact, gains in world equity indices of circa 13% are an exact reversal of the net losses suffered between last June and the end of 2011.  And if those gains are justified, then much of the extreme "tail risks" that scared the horses back then must have been put to rest too, no? Well, the two mains tail risks -- a euro zone breakup or collapse and a lapse of the U.S. economy into another recesssion or depression -- do look to have been been put to bed for now at least. The ECB's mega 3-year cash floods in December and February and the "orderly" Greek debt default and restructuring last week have certainly eased the euro strain. The remarkable stabilisation of U.S. labour markets, factory activity, household credit and even retail sales has also silenced the double-dippers there for now too.

The net result seems to have been this week's synchronised retreat in three of the main "catastrophe hedges" -- gold, AAA-government bonds and equity volatility indices -- and this move could well mark a critical juncture. Gold is down 8% since its 2012 peak on Leap Day,  10-year U.S., UK and German government bond yields are up 25/30 basis points since Monday alone, and equity volatility gauges such as Wall St's ViX have dropped to levels not seen since before the whole credit crisis exploded in the summer of 2007.  If extreme systemic fears are genuinely abating and the prevalence of even marginal positioning like this in investment portfolios is being unwound, then there may well be some seismic flows ahead that could add another leg to the equity rally.  The U.S. bias in all this is obvious with the rise of the dollar exchange rate index to its highest since January. That has its own investment ramifications -- not least in emerging markets. But the questions for many will remain. Is the coast really clear? Are elections over the coming weeks in France and Greece and an Irish referendum on the euro fiscal pact just sideshows? Is the global economy sufficiently repaired to bet on renewed growth from here and will corporate earnings follow suit? Has bank and household deleveraging across the western world halted? Are the oil price surge and geopolitical risks in the Middle East no longer a concern? And if you've made 10-15% already this year, are you going to go double or quits?  The chances are there will not be 10-15% equity gains in every quarter this year.

from Global Investing:

Currency hedging — should we bother?

Currency hedging -- should we bother?

Maybe not as much as you think, if we are talking purely from a equity return point of view -- according to the new research that analysed 112 years of the financial assets history released by Credit Suisse and London Business School this week.

Exchange rates are volatile and can significantly impact portfolios -- but one can never predict if currency moves erode or enhance returns. Moreover, hedging costs (think about FX overlay managers, transaction costs, etcetc).

For example, the average annualised return for investors in 19 countries between 1972 (post-Bretton Woods) to 2011 is 5.5%, hedged or unhedged. For a U.S. investor, the figures were 6.1% unhedged or 4.7% hedged (this may be largely because only two currencies -- Swiss franc and Dutch guilder/euro -- were stronger than the U.S. dollar since 1900).

"The impact of hedging on returns (as opposed to risk) is a zero sum game. The profit a German investor makes on Swiss assets if the franc appreciates is offset by the loss the Swiss investor incurs on German assets... Averaged over all reference currencies and countries, the mean return advantage to hedging both equities and bonds was zero, both over 1900-2011 and 1972-2011.

LBS' Elroy Dimson and Paul Marsh, who presented the report at a briefing this week, were keen to emphasise hedging has its use. Mainly, it does reduce volatility, hence risk.

However, the study showed that the benefits of hedging on volatility did shrink; On average, hedging reduced equity volatility by 15% over 1900-2011, but by only 7% over 1972-2011. For bonds, the figures were 36% and 30%.

from Global Investing:

Calculating euro breakup shocks

Euro breakup risks, although subsiding, are still high on investor minds.

Almost one in two fund managers surveyed by Bank of America Merrill Lynch last month said they expect a euro zone country to leave the monetary union.

Technology services company SunGard, which has modelled different euro breakup scenarios, says the departure of Greece and Portugal will lead to a 15 percent rise in the euro against the dollar, a 20 percent fall in euro zone yields, a 15 percent fall in euro zone equities and a 20 percent increase in credit spreads.

Below are other findings:

• If all PIIGS left the euro, the single currency would rise 25% and regional equities would fall 20%. U.S. stocks would drop 15 percent. European banking stocks would fall by 25% and ITRAXX Financials credit spreads would increase by 100%, which would imply losses of up to 20% in high-grade corporate debt. VIX would be over 50.
• A total collapse scenario would see European equities down 40%, U.S. and global equities down 30%, euro yields down 75% and ITRAXX Europe and ITRAXX Financials credit spreads up 150% and 200%respectively.
• Oil would fall across the scenarios, ranging from 5% from a Greece departure through to a 50% decline from a complete breakup.
• Sterling would strengthen against the Euro by between 5-25% across the scenarios.

The results seek to model the impact of each scenario over three months, looking eight weeks before and six weeks after the shock to form a balanced picture.

from Global Investing:

Deutsche’s investment themes for 2012

We just finished our three-day Reuters 2012 Global Investment Outlook summit in London, New York and Hong Kong, where prominent money managers have discussed their outlook for next year. (For more click here)

Deutsche Bank Private Wealth Management (whose official was also a guest at the summit) is telling its clients the following 10 investment themes for next year.

1. Safe may not be safe Don’t react to uncertainty by automatically taking refuge in traditional safe havens such as cash, sovereign bonds, real estate or precious metals as they may prove less safe than they appear.

2. Walk before you run Build up holdings gradually, first focusing on “equity lite” type holdings

3. Ready, steady... go? When we get some clarity on euro zone resolution, not only equities and bond markets will start to have a different momentum.

4. Be nimble, but with a safety net Consider resorting to regular, dynamic portfolio rebalancing to adjust to economicand market developments.

5. Reason should dominate emotion Avoid an emotion-driven response that is likely to result in wrong investment decisions, andwrong timing, and make sure that reason always dominates the decision-making process.

from Jeremy Gaunt:

When things stagnate

Goldman Sachs researchers have been hitting the history books again, trying to divine what happens to currencies when economies stagnate. Answer:  Not as much as you might think

Looking at exchange rates for years before and during "stagnation", Goldman found that year-to-year FX volatility in such periods is lower than in normal periods. But a lot of it depends on the type of stagnation.

First, an average stagnation -- a period of sub-par economic growth lasting for at least six years:

On average, the run-up to stagnations (and the early years into an episode) tends to be characterised by moderate FX appreciation. Later on, FX remains flat for a while and gradually assumes a depreciation trend during the last years of stagnation. The average initial appreciation hovers below 5%, while the ultimate depreciation tends to be smaller than 10%.

Next, a "Great Stagnation" -- a period lasting for 10 years or more:

The initial appreciation can reach more than 20% (computed from the years prior to the stagnation) and the posterior depreciation can surpass 10 % .

What does this mean? Well is it not particularly good news for the United States.

from Eric Burroughs:

Big risks everywhere

The market volatility of the past two weeks has been astounding. While the broad factors are obvious, markets are not beasts that lend themselves to easy analysis and the nuances really matter here. A few broad factors at play are feeding off each other. All have been discussed and debated, but here's a rundown on the interplay I see taking shape.

1) Euro breakup not so far-fetched

How do you hedge against the potential collapse of a single currency used in a $13 trillion economic zone plus trillions more of securities and derivatives? Not easily. A splintering or breakup of the euro has gone from unimaginable to a risk that can't be ignored altogether.  Europe's inability to get ahead of the crisis now means a sovereign debt crisis is fast becoming a banking one. The solutions -- a super sized EFSF rescue fund, Eurobonds, a commitment to fiscal union -- are there to be had. But the political will is lacking.

Back to the hedging. The options market is the obvious place to turn, especially deep out-of-the-money options that typically mean you don't have to pay a lot upfront to protect against a doomsday scenario. For the euro, this has been most apparent in the euro/Swiss franc FX options market where the hedging for downside protection against the euro has been intense. The extreme implied vol skew towards EUR/CHF puts reflects big demand for such protection. The Swiss franc is bearing the brunt of the selling not just because of the franc's perceived safe-haven status, but also because Asian central bank diversification of dollar holdings has kept euro/dollar surprisingly high for all the single currency's worries. (So in some ways, the Swiss National Bank can blame its counterparts in Asia for making the pressure on the franc so acute. ) The franc is the Alpine haven as the European project threatens to tear apart at the seems, and the SNB's attempts to get extremely unconventional in fighting this battle -- flooding liquidity and creating negative short-term interest rates -- are only partially working. The below surface now shows more demand for short-term EUR/CHF calls in case the SNB succeeds, but the steep skew towards out-of-the-money puts is one of the best gauges for showing the extreme nervousness over what the endgame really is in Europe. When the skew starts to normalize, then the market may be convinced that Europe is getting a handle on this crisis. We are far from that point.

2) U.S. GDP shock, G7 stagnation and tightening fiscal policy

The debate over the S&P downgrade of the USA's AAA rating masked the bigger even that occurred at about the same time -- the shock downward revisions to U.S. GDP. By showing a much weaker recovery coming out of the crisis, the revisions overturned many growth assumptions that fed into many other forecasts made by funds, from interest rates to earnings.  That is the main reason why the stock market reaction was so big: what looked like a relatively healthy recovery was a mirage, and the data pointed to stagnation and a higher risk of a double-dip recession ahead. Earnings expectations were the most at risk from such major revisions, and that's why consumer and technology related stocks were the most hit in the initial selloff. At this point, the share slide has helped better align prices with expectations for earnings. But the downgrade to earnings is only just kicking in. This wholesale reassessment may have more room to run, and in the process drag shares down further. In historical and forward p/e ratios, the denominator will be falling as fast as the numerator.

from Eric Burroughs:

What market volumes and vols are saying

For what has been a fairly tumultuous month across markets, many equity indexes have seen volumes only whither as the month of May has worn on. Away from the speculative maelstrom in commodities, only U.S. Treasuries have seen decent volumes this month when compared with one-month averages. The lack of volume in these moves, and the sideways action in many equity markets, suggests that many investors are happy to sit on the sidelines until some of the noise settles down and signals start to emerge. What kind of noise? Think of the litany of reasons blamed for market moves this month: fears of a U.S. and/or global slowdown, fears of a China slowdown on TOP of fears of more China tightening, fears of Greek debt restructuring in the latest wave of the euro zone crisis (what European bank hasn't had time to hedge Greek credit exposure by now?), Asia central bank tightening, etc. At the end of the day, none of them is all that compelling. What we've seen is a shakeout in some frothy markets, mainly commodities, that has prompted a broad wave of risk reduction across assets. But looking at volumes, this is no rush for the exits -- just a natural paring of positions. It does suggest that we could be in for a choppy summer as market players grapple with the end of QE2, the U.S. debt ceiling debate and fuzzier economic data. At the same time, many gauges of implied volatility are also subdued. The moves in equities show signs of markets being in balance. On the flipside, the rush into Treasuries as yields have fallen point to a market that may be getting ahead of itself, just as implied volatility on T-note futures suggests complacency. So watch Treasuries closely in coming weeks - either an acceleration of the trend, or a sudden reversal, may be the key gauge on how to think about the risk trade.

Starting with the U.S. stock market, volume has only eroded -- both during the market runup to three-year highs this month and the subsequent turn down on the commodities rout and some mixed signs on the economy. Looking at New York composite volume (NYSE total), the biggest volume day of late was on May 4 -- two days after the market peaked and turned, and showing some nervousness. Still, it's hard to conclude that there is much axiety out there. I like to look at volumes in the context of a 20-day (one-month) moving average, so relative to the near-term trend. Spikes through that rolling average signal stronger conviction, whatever the market direction. The simple fact is that we have not seen very strong volumes, and in fact the 20-day average itself is at the lowest levels coming out of the crisis. That suggests a lot of market players are simply unwilling to step in at this stage: so not too worried about a selloff, but not wanting to chase the market higher here. Thus a fairly balanced market, and so the VIX and S&P implied vol flatline.

Here in Hong Kong, we have also seen pretty weak turnover on the HKEx main board thanks to the painful range in place for more than a year now. Even some signs of a technical breakdown failed to materialize, and the Hang Seng is stuck in a rough 22,000 to 25,000 range in place since the May 2010 Flash Crash. The picture is more complicated in Hong Kong thanks to the array of new IPOs hitting the market over the past year, including AgBank and lately Glencore. That has tended to both drive up turnover AND keep a lid on the market, given the money being sucked into the new shares from existing holdings. Still, over the past year the clear signs of surging volumes have come when the market has reached highs in this broad range, such as October last year and April this year. It's a similar picture in Shanghai. Another clear sign that investors are more eager to chase the market higher rather than lower, and thus are not particularly nervous.