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More volatility expected as Fed rate rise looms – Cumberland Advisors’ David Kotok

Oct 1, 2014 17:54 UTC

David Kotok, Cumberland Advisors

David Kotok, Cumberland Advisors

A healthy dose of fear has re-entered financial markets in the final three months of the year. The Chicago Board Options Exchange VIX, a widely tracked measure of market volatility, rose to a two-month high on Wednesday.

Varying news reports offered threats from the Ebola virus and a stagnating European economy as tangential reasons. Perhaps another point is many investors view the U.S. Federal Reserve’s pending decision to raise interest rates as a rumbling train far off in the distance that they now hear headed their way. Closer to the horizon are headlines that can no longer lean on “Fed easing” to explain away rising asset prices and a rising stock market.

“We are in a new period of volatility and it's been developing for the last two or three months,” David Kotok, chairman and chief investment officer of investment advisory firm Cumberland Advisors told the Global Markets Forum on Wednesday. “When you suppress all interest rates to zero you dampen volatility and you distort asset pricing. Now the outlook for interest rates is changing so we are restoring volatility.”

The changes, he said, are evident in a rising U.S. dollar, falling commodity prices and the spread between the high yield and U.S. bond markets.

“These are examples of how things change when you return to more normal volatility and extract and stop monetary stimulus,” Kotok said.

Kotok, GMF moderator Jeanine Prezioso and Reuters Fed reporter Jonathan Spicer chat about bull and bear markets

Kotok, GMF moderator Jeanine Prezioso and Reuters Fed reporter Jonathan Spicer chat about bull and bear markets

Now comes a waiting game and a test of investors’ mettle to sift through the weeds as Fed policy moves closer to no longer supporting stock prices. The best stock pickers will resign themselves to flushing out those hit by a stronger dollar, those with exposure to commodities, as one example. The result of a stronger dollar on corporate earnings begin to show when companies report third quarter earnings, but more so in end-of-year earnings, Kotok said.

“We expect some downward guidance from companies that are seriously impacted by changes in the currency markets,” he told the GMF.

Kotok’s Cumberland has positioned itself in large cap stocks, which he says in his new book From Bear to Bull with ETFs  investors should seek out during bear markets while investing in small cap stocks in a bull run. The small cap Russell 2000 Index hit a five-month low on Wednesday.

Kotok in the Global Markets Forum

Kotok in the Global Markets Forum

“I am overweight large caps in my managed portfolios right now.”  Kotok said. “We are underweight small and midcaps, we have been for awhile. I have no way to know if we are in a corrective phase or if the bull market ended. But it's apparent that we have one of the two underway.”

Among other trades, Kotok looks at the VIX every day as well as the quarterly release of estimates of future interest rates assembled by the members of the Federal Open Market Committee.

“Look at the option markets which show the price of real money bets on the future of interest rates. They tell you every minute of every day what sophisticated investors collectively think an interest rate will be and when it will be there. That is a high frequency indicator that deserves continuous attention.”

Click here for the full transcript from the GMF interview: RTRS_David_Kotok_01102014

Inflated worries

Jordan Fraade
Jul 8, 2014 22:12 UTC

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After the European Central Bank’s July meeting Thursday, Mario Draghi announced the central bank would maintain its historically low interest rates — a 0.15% main lending rate and -0.1% on funds deposited at the ECB — to try to get inflation up to 2% from the current 0.5%. Draghi reiterated the ECB’s stance on quantitative easing: it’s in the toolbox, but it’s not coming out yet. Despite a report released last week by the Bank for International Settlements that urged austerity and higher interest rates, central bankers from Draghi to Janet Yellen to the Bank of England’s Jon Cunliffe seem united in their desire to keep rates low and push consumer prices higher.

David Wessel thinks the central bankers’ logic goes something like this: “There may come a day when our worries about financial stability will prompt us to hike interest rates, but rates are ‘the last line of defense.’ Not now.” That said, Wessel is skeptical about Yellen’s preferred methods to ensure stability — macroprudential tools (regulations, mostly) that attempt to guard against system-wide risk before crises can happen. They haven’t been tried enough for us to predict their success, he says, but he welcomes the bankers’ reluctance to raise rates quickly. The Economist points out that while some markets, such as housing in London, are starting to look frothy and overvalued again, “the excesses are still small, compared with those that brought down the global economy in 2007.” Since the eurozone economy is barely growing, raising interest rates “could push the economy back into recession and turn inflation to deflation.”

Leonid Bershidsky, though, says macroprudential policies are largely ineffective, and have led to a large shadow banking system in which investors try to avoid regulations. He thinks instead that the world’s central banks should start raising rates again, in line with the suggestions in the BIS report, because low interest rates could lead to foolish risk-taking and even a new asset bubble. Taking on Paul Krugman, who dismisses the idea that interest rates are artificially low, Bershidsky cites the Swedish central bank as a recent example of smart economic policy-making: The Riksbank hiked its interest rate, but he says there was no evidence that this led to substantial deflation or unemployment (to be fair, the Riksbank cut interest rates back to crisis-era levels last week).

The BIS and its head, Jaime Caruana, have been pushing for higher interest rates for years, and they’ve always been wrong, says Krugman. His assessment mirrors that of Martin Wolf, who mocks what he sees as the BIS’ Old Testament-style warnings about a coming inflation apocalypse. Tim Duy, reviewing the data, agrees with Joe Weisenthal that inflation is in finally coming, but not in a bad way: “It is simply difficult for me to become too worried about inflation given the history of the past twenty years — twenty years in which the US economy was at times substantially outperforming the current environment, no less. Underlying inflation simply has not been a problem.” — Jordan Fraade

On to today’s links:

Urban Planning
The fastest way to get around your city is…probably still by car. Or bike – Emily Badger

What’s causing the fails in the Treasury market? (It’s not QE) – Scott Skrym
Cash pools, Fed rev-repos, and the stagnationist future, part 1 – Cardiff Garcia

Real Estate
Foreign purchases of U.S. real estate increased 35% last year, and China leads the way – Nick Timiraos

The high salaries of Silicon Valley interns are totally justified – Jordan Weissmann

Home Ec
More and more, remittances are being sent without the help of banks – Tim Fernholz

Wall Street’s latest worry: A run on bonds from ETF investors – Nick Summers and Lisa Abramowicz

JOLTS are here! 4.6 million job openings in May, quits rate at 1.8% – BLS

Secular Declines
RIP easy middle class jobs – Chris Dillow

Carney in control

Jun 26, 2014 22:01 UTC

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Today, Bank of England governor Mark Carney announced two new rules implemented by the BoE to curb the possible risk of a UK housing bubble. Only 15 percent of new home loans made by mortgage lenders can be made at 4.5 times above the borrower’s income. Banks also “must decline loans to borrowers who fail a new stress test that assumes an immediate 3 percentage-point increase in the benchmark rate,” says Bloomberg’s Ben Moshinsky.

Earlier this month, the IMF warned the UK that rising housing prices and low economic growth posed a threat to the country’s economy, although Chief Secretary to the UK Treasury Danny Alexander told Bloomberg earlier this week that “people shouldn’t get carried away with the scale of the problem.”

Fast-increasing property prices in the UK are interesting, says Jeremy Hill, because it’s largely centered in London, and largely driven by foreigners (a quarter of London neighborhoods are unaffordable for 95% of the population). However, “a housing crash in London is not likely to happen absent a simultaneous housing crash in New York, Tokyo, Paris, etc. The BoE knows this and is reacting to the broader sense of the risk,” writes Hill. Further, Robert Peston points out that “much of the London market is being driven by cash buyers – and the Bank has no influence over their behaviour.”

This move is “a reminder that while UK house prices are surging, the flip side of the affordability calculation — wage growth — is the real problem,” says Mark Gilbert. Wages, he notes, haven’t kept pace with inflation at all since the Great Recession, with the exception of a brief period at the beginning of 2014 (which appears to be over, according to this chart).

Just two weeks ago, Carney gave a speech in which he warned that an interest rate hike from the historically low 0.5% “could happen sooner than markets currently expect.” Carney was questioned by the Treasury Select Committee this week and backtracked somewhat. “The exact timing of that [increase in rates] will be driven by the data,” he said. With regard to his forward guidance, MP Pat McFadden told Carney he was acting like “an unreliable boyfriend – one minute hot and one minute cold.” David Keohane quotes Citi’s Steven Englander wondering if “central bankers are actually just messing with us deliberately in order to exert some control on behaviour.” Which might, at least, be comforting. — Shane Ferro

On to today’s links:

Sovereign Debt Problems
Things are going to get really interesting with this Argentina situation - Joseph Cotterill

Raj Rajaratnam’s limousine driver is suing him - Courthouse News

The robots are stealing our jobs, diagnostics edition - Pacific Standard

Billionaire Whimsy
“I wouldn’t have moved for the taxes, but it is an interesting proposition,” says billionaire- Bloomberg
Chen Guangbiao invited 300 homeless New Yorkers to lunch, then only let 200 in -Business Insider

Long Reads
Tyler Cowen interviews Ralph Nader - The American Interest

Unintended Consequences
A herd of hippos that one belonged to Pablo Escobar are ravaging the Colombian countryside - BBC

MORNING BID – Europe and the bond market

May 16, 2014 12:43 UTC

The markets are in a bit of an odd spot right now, with the biggest quandary that of the bond market, where U.S. yields have gone into a dive in recent days to touch their lowest levels since October.

What’s unclear is how much to attribute to fears of a slowing economy, changing dynamics like reduced mortgage securities issuance or increased pension fund liability-driven purchases. There are also technical factors like the rallies in sovereign debt markets like Spain, Italy and Ireland, none of which have the credit profile of the United States, big short positions among those who still believe this can’t continue much longer, and the overarching “quantitative easing forever” stance out of the European Central Bank and Bank of Japan, to say nothing of a few other central banks that are still on an easing path. (Really, it’s not as if the U.S. Fed is all that stingy right now when it comes to stimulus. Yes, it’s pulling back, but it’s pulling back from negative territory, basically.)

Among those factors, rallies in overseas markets are an interesting part of this, and relates to the QE stance as taken by the ECB that’s likely to result in lower rates and extra stimulus in June and further on from that bank. April car sales were lousy in Europe, yet another data point supporting lower yields on the continent.

At one point on Thursday, Spain’s 10-year was only about 35 basis points higher than the U.S. 10-year, as that 10-year yield has dropped by more than 40 percent in the last year. That changed in the morning after some saber-rattling out of Moscow again, causing a quick selloff that widened the spread between the U.S. and peripheral European debt.

But it’s fair to say that many are confounded by the moves in bond markets, and the opinions vary between those who believe the sharp fall in long-dated yields speaks to increased concern about the economic outlook (with Appaloosa’s David Tepper on Wednesday night even saying the ECB is behind the curve), those who see it as supply and demand related, and those who think it’s an anomaly that will correct before long.

The opportunities in this market are varied for bond-fund managers, then, and a bit difficult to suss out. Long-dated Treasuries have been winners of late, of course, while the five-to-seven year area hasn’t been so much, but with yields dropping in the face of reduced Fed stimulus and economic data that would seem to suggest rates should be higher, expecting lots of people to pile into government debt at this point seems far-fetched.

A Citigroup survey conducted earlier this week showed their clients are looking to make money through roll-downs (when you buy one part of a yield curve to see yields fall and prices rise as they “roll down” in maturity to become shorter-dated debt; this works well when the yield curve is shaped pretty much as it is) and also in credit (where investors have been making hay for some time) and stocks.

Those ways – along with more dynamic hedging, if possible, depending on who you are – have been cited as more popular choices than simply going long, or worse, going short.

How this shakes out is unclear.

The U.S. economic figures are still on the mixed side – inflation does seem to be picking up, however modestly, but industrial production figures were weaker than expected and housing has become more of a thorn than a helping hand in the economy right now.

Retail sales aren’t all that exciting, unless you’re counting big auctions of art at the major New York houses, and that’s not exactly indicative of a broader economic upswing but ongoing stratification that usually ends with market debacles (in the U.S.) or heads on lances (in Westeros).

If the improvements noted in some indexes does prove to have staying power, then, as Heather Loomis of J.P. Morgan Asset Management told us, yields will go higher from here – though she now sees a 3.25 percent 10-year yield by year-end instead of 3.50 percent. For her part, Loomis said: “I do believe every round of quantitative easing has had a more diminished impact,” and if that holds true for the ECB, then those rallies in peripheral countries aren’t really something to hang on central bank largesse.

MORNING BID – Hi Janet, Here’s a Selloff.

Mar 20, 2014 14:06 UTC

Welcome Madame Chair, here’s a market selloff for you.

Fed Chair Janet Yellen made some news that she didn’t expect yesterday. She perhaps thought she was offering some clarity when she answered the question from Reuters’ Ann Saphir as to when the Fed might start raising interest rates. That’s not how it worked, although at least in this case she didn’t mouth off to Maria Bartiromo the way Ben Bernanke did eight years ago.

What we didn’t see in her answer on the distance between the end of QE3 and the first rate hikes of “six months” (or something like that), is whether we will start to see any kind of reaction from the primary dealers surveyed by Reuters yesterday.

Most still see the Fed not raising rates until late in 2015 although there were a couple of notable changes. Barclays moved up its expectations for the rate increases to the second quarter of 2015. There were still, however, four dealers that do not see rate hikes coming until 2016. This may, on some level, put the Fed behind the curve as interest-rates adjust, though it was notable to see several Fed members in the Fed’s projections believe rates should be at 1 percent by the end of 2015. (It wasn’t much of an adjustment, but somehow, the way it looked on the dot matrix chart the cool kids were talking about was enough to get the bond market in a lather. The stock market, of course, didn’t react until someone (Yellen) told it what to do.)

What is undetermined now, however, is what the Federal Reserve will be looking at when it decides whether to raise rates or not. The market has gotten awfully used to the idea of a threshold on the unemployment rate that made things easy. Without that, it reverts to looking at a number of indicators, although the Fed chair yesterday did say that she thought the unemployment rate was one of the best indicators.

It is perhaps to the markets’ credit that many commentators remarked on the Fed’s use of several indicators as worrisome. In years past, there was great praise for Alan Greenspan just because he used to discuss looking at various pieces of data in his bathtub or whatnot. Now the market finds such alchemy to be less comforting. That may at least be a sign of maturity. Or, perhaps, the Fed has through years of communication efforts changed the markets’ belief that the Fed chair should be this omniscient presence in the market. If so, that bodes well for what is usually an awkward transition between Fed chairs. This may make that much easier, regardless of what Yellen said.