Weekend Reads

Summer is upon us, in case the nation-wide triple digit temperatures hadn’t already made that abundantly clear. The second quarter of 2012 is now behind us, making it a good time to reflect on the year so far. Friday’s rally showed that even minor progress out of Europe still possesses the power to send markets scurrying, as multiple markets put in their best trading day of the year (or for several years, in some cases). The ups and downs throughout the month didn’t do much to satisfy bulls or bears, though the mini-rally was definitely not what many CTAs were hoping for. All the big macro-economic fears are still in place (it’s not like anyone expected Europe to solve their debt woes anytime soon), so the direction of the rest of the summer is still anyone’s guess. As we head into the pre-4th  of July weekend (expecting picnics and barbecues aplenty), here’s our weekend reading material:

  • SEC brings fraud charges against Phil Falcone (Reuters)
  • JP Morgan’s “fail whale” trading losses may total $9 billion (New York Times)
  • 7 equations for managing your retirement money (MarketWatch)
  • Innovative tracking of the Colorado wildfire (Time)

And just for fun…

Risk On (The Atomic Green Rally, Part II)

June’s been sprinkled with a few too many of these sharp risk on rallies for our taste. When our screens turned neon green at the beginning of the month, we worried that this was the June snap-back we had hoped to avoid. Fortunately, the month contained plenty of give and take, and many of the short positions in our hypothetical trend following model remained open for most of the month. Today’s rally has brought even more of the short positions from our hypothetical trend following model close to their 100-day moving averages, the point at which the trades will be stopped out.  It’s not difficult to see why, when our Finviz screen is lighting up like a Christmas display that’s lost most of its red lights:

Disclaimer: past performance is not necessarily indicative of future results.

Should this rally hold through the end of the day, our trend following model will be starting July in a precarious position, with several trades just a short rally away from being stopped out for a loss. In the end, it was not quite the June we were looking for, but not quite as bad as we’d feared. Half of the year is now ink in the books, but we haven’t lost hope yet. With most of the short positions in our trend following model still open, a big downturn in July would still be welcome for trend followers.

Corn Escaping the Risk On/Off Trade?

We harp on the so-called “risk on/off” trade fairly often, and we feel like it’s worth a reminder of why this is so important. The risk on/off trade, when certain groupings of markets rise together or fall together, can make life difficult for CTAs. Diversification is as vital a risk management practice for managed futures as it is for individual investors. You wouldn’t bet your entire life’s savings on one company’s stock, and CTAs don’t bet the farm on just one futures market, either (at least, most don’t).

But diversification requires markets that are… well, diverse (think multiple asset classes like grains, metals, currencies, etc).  That is, it isn’t enough to be invested in different markets– the markets must behave differently, too. And that’s the rub – when the risk on/off trade is in full swing (multiple markets moving in unison), you could have several different investments all behaving in much the same way. Different, but not diversified.

That’s why we’ve been cautiously optimistic about the trend in the corn market of late (and, to a lesser extent, grains as a whole). The markets have been far more concerned with USDA crop reports and weather forecasts than with the overall direction of the economy – getting back to what we like to see. Take this morning, for instance: corn was up over 1%, while the indices, energies, and metals were are all down more than -1% (corn was flat by the afternoon, but you get the idea). The rolling 30-day correlation between corn and the market average shows corn hovering around zero (non-correlated) during June, much like its behavior in March:

Disclaimer: past performance is not necessarily indicative of future results.

Managed futures is not quite benefitting (yet, hopefully), in part due to the choppiness of the market. Last month we took note when corn volatility surged to new 2012 highs. That surge, however, didn’t end – volatility has remained high, recently climbing to yet another 2012 high:

Disclaimer: past performance is not necessarily indicative of future results.

The volatility that has accompanied the weather and crop reports has made it difficult for CTAs to latch onto a trend… but at least the risk on/off trading from May seems to have been left behind. If it’s not one thing, it’s the other… but we can always hope for both market trends and uncorrelated market behavior.

The Case for Continued Downward Trends

We made the argument at the beginning of June that this month would be particularly important for managed futures, pointing out that a dissolution of the downward trends most trend followers were riding out could erase the meager gains achieved by the asset class YTD. No sooner did we publish the newsletter than did we see an uptick in the markets, followed by a roller coaster that would change direction at the drop of a pin.

Not what we wanted to see.

As of June 26th, though, the Newedge CTA Index, while down 1.89% MTD, is still just barely positive on the year at .57%. (Disclaimer: past performance is not necessarily indicative of future results.) CTAs struggled this month- no doubt about that- but they aren’t dead yet. More significantly, using the trend following proxies we unveiled earlier this year as a snapshot of the trend following space, we see that the majority of the models, despite the whipsaw climate, have not been stopped out of their short positions. This is the nuance – the plot twist – that has us biting our nails headed into July. Managed futures, in our opinion, is literally standing on the precipice of a year (and maybe decade? Or we’re just being drama queens?) defining move. If the sideways gives way to a large downturn, we may have a new case in point for discussing crisis performance with investors. If not… well, go read our newsletter on June.

However, we tend to believe at this point that we should see downturns across the markets in the coming months. Not for a reason that we can mathematically demonstrate, of course; the markets are far from rational these days. We just see enough potential catalysts for the downturn on the near term horizon that it’s what we’re expecting.

  • The Euro Summit- This Friday, the leaders of the European free world are convening to save the world from Greece, Spain, Italy and the rest of the Eurozone that no one is worry about yet but probably should be. The general feeling for months was that there was no way such leaders would let the world go to hell in a hand basket, but after months of shenanigans and hijinx, such confidence has waned. Those with nothing on the line tend to believe that these leaders are functionally worthless, and that the meeting will fail to generate the results needed to prevent a complete collapse in Europe. Those with money on the line are forcing a smile and hoping they’re wrong for agreeing. Given that Merkel has patently rejected any chance of life for the measures that would probably be necessary to get things anywhere close to back on track, we’re sending early condolences to those with money on the line.
  • QE Disappointments- Big Ben got the world all kinds of excited when indicating an extension of actions intended to boost liquidity. It was exactly what so many people wanted to hear. Unfortunately, most people have selective hearing, because the decision and resulting commentary clarified two very important things: 1) Maybe does not mean yes, and with very little substantial economic data coming out between now and the August meeting, the odds of there being a strong enough trigger to push the Fed into being more aggressive are slim to none, and 2) even if the Fed does act, their ability to make a substantial impact, by their own admission, is definitely in question. Great skepticism write up here.
  • Political Tomfoolery- Hey, guess what? It’s an election year in the U.S. Guess what? We’ve only just begun. We haven’t even had our first debate yet. Things are going to get ugly. And in an era where complex policy issues are boiled down to 140 character barbs and jabs with little effort made to give the assertions context or support, the chances of the national political dialogue resembling anything productive are laughable. That’s sort of a problem, because there’s a lot of work to be done on Capitol Hill, particularly in terms of that fiscal cliff we’re dancing towards.

This is the next couple of months. It does not account for extremes in Europe (collapse of the Euro itself, for instance), hormonal-teenager-like reactions to Fed inaction, or political pitfalls we never see coming. All of that could happen as well, but even without, there is, in our opinion, enough coming down the pipes that should stop the sideways motion and push us further down this trend. If we hit one of those extremes, forget about it. If those markets go to zero, we’ll be very happy indeed (though probably in a minority). If not, then we absolutely give up on trying to use our publications as a form of psychological warfare against the gods and goddesses of market trends. Seriously.

Dear Mom…

Working in finance, you learn not to talk shop too much with family members. It’s a little easier for us to avoid typically. They ask us for a stock recommendation, we say we don’t do stocks, they get a blank look on their face, and we change the subject. But seriously, talking finance with family members can be the headache from hell when you’re working in it day in and day out. Take the following conversation one of the people in our office had with their under 50 mother – a necessary one, but facepalm status nonetheless:

Daughter: Mom, when was the last time you talked to your adviser?

Mom: We’re fine.

Daughter: Mom, seriously, when was the last time you went over your portfolio?

Mom: It’s ok- we’ve got plenty of time. Everything will work out over the long term.

Daughter: You’re young, you’re right, but that doesn’t mean you shouldn’t be diligent about these things. Do you know what’s in your portfolio?

Mom: Sure, it’s fine. Seriously- we’ve got all the time in the world.

Translation: she doesn’t really know what’s in there or why, so she’s just repeating the excuse given to her by her adviser. The excuse itself bears scrutiny, though: Time. Funny word, that. Unfortunately, most of us don’t have time, but will instead be forced to work overtime in the big picture just to make ends meet during retirement. US News and World Report states:

Most Americans no longer aspire to retire early. Workers are increasingly pushing back their desired retirement age and wondering if they will be able to retire at all.

The age workers expect to retire has increased from an average of 60 in 1995 to 66 in 2011, according to a Gallup poll. The proportion of people aiming to retire early has plummeted from 50 percent in 1995 to 28 percent in 2011. Most Americans now expect to retire at age 65 or later.

“It’s just not possible for people to work for 30 or 40 years and support themselves on their assets for another 20 or 30 years,” says Alicia Munnell, director of the Center for RetirementResearch at Boston College. “Many people saw their 401(k)s decimated by the recession, and many people also saw their house lose value.”

The recession has accelerated the trend of Americans pushing back their retirement date. Almost half (46 percent) of people age 50 and older say they now plan to retire at a later age than they did three years ago, and the reason is often because the value of their 401(k) and other retirement investments has declined, according to a recent Towers Watson survey. Unsurprisingly, workers depending on their 401(k)s to finance retirement are planning longer delays than people with a traditional pension.

All that time you thought you had? Well, you may have an additional ten to twenty to wait – not out of choice, but necessity. That’s not the kind of time you want to have.

The whole concept of having a lot of time before you retire feeds into the ideas guiding your investment portfolio. When you have time, the buy and hold strategy looks pretty attractive. But how, exactly, is that working out? Well, had you started using this strategy back between 1993 and 1996, it might have been a winning strategy for you over a ten-year period. However, if you look at the chart below, you’ll notice that the ten-year rolling return for an investment in the S&P 500, used here as an imperfect proxy for stock exposure, actually dipped into negative territory for a full two-year time period.

Disclaimer: Past performance is not necessarily indicative of future results.

The more interesting thing to note, though, is the blue line – managed futures performance per the Dow Jones Credit Suisse Managed Futures Sub-Index. Assuming a world where this index were investable (it’s not), you’d notice that managed futures rolling ten year returns are actually increasing relative to the same measure for stocks. In fact, the average 10-year rolling return for managed futures was 99%, while the average for stocks was 79%. And as a gloating aside – note that the managed futures line never once dipped into negative territory the way stocks did.

To be fair, past performance is not necessarily indicative of future results, and managed futures, because of the risks involved, is never going to be right for every investor. The illustration above is not a perfect representation – it’s just a snapshot that we hope makes you think about “time” and planning a little differently. It’s not that we don’t think you should look at investing over the long-term, because we do. Managed futures investments should have a minimum timeframe of three to five years, in our opinion. What we’re saying is that even when you do look at the long term, there are still potentially better options than the traditional investments you’ve been looking at. Even if you do want to invest with longer timeframes, you can do better than a traditional buy and hold approach.

Sigh. Oh, Parents. We’ve become them, in many ways – nagging them to look at their portfolios, chasing around rugrats of our own. We’re suddenly in a position to be giving them advice – just make sure you’re listening to the advice you dole out as well.

Bonds Winding Up?

The generational bull run in bonds has been something to behold. As US treasuries have climbed higher and higher, we’ve been watching with growing anticipation for the first sign that the eventual reversal is coming. Unfortunately, every time it’s looked like a big swing downward is on the way, it has bounced back and resumed that seemingly never-ending upward trek (see our over-anxious calls covered here).

But now bonds have taken on a new direction which is neither up or down – bonds have been quite noticeably sideways of late. After climbing in May on the backs of the big risk market Euro fueled selloff, US 30 Year Bonds have spent most of June trading in a narrow range:

Disclaimer: past performance is not necessarily indicative of future results.

What can we expect on the heels of a period such as this? Is this tight range-bound trading a windup for big rip higher in the bond market? How much higher can they even go? Or, is this just a frustrated fizzle on a backdrop of continued global ambiguity? We don’t have a crystal ball, but we can’t help but feel a little nervous/excited that something big (we hope on the downside) is brewing for bonds.

Giving Alternatives a Bad Name

People sometimes balk at the term “alternative investments” because to them, it can sound a little scary. “Alternatives” seems to bring to mind something bizarre or untested. We like to explain to such people that, in fact, managed futures has a long track record and hundreds of billions in assets under management. Futures trading is risky and it’s definitely not for everyone, but there are programs that have been at this for decades – not exactly some flash in the pan, and certainly no “get rich quick” scheme. Unfortunately, we know we’re fighting an uphill battle when we see articles like this one from Reuters (hat tip to Barry Ritholtz for bringing it to our attention) about hedge funds in search of new alternative investment opportunities. Apparently, some are turning to the “exotic” in search of returns… and we can only shake our heads:

One hedge fund investor at the conference said he had achieved double-digit returns from investing in a range of more esoteric funds, such as those involved in electricity arbitrage, where a manager tries to profit from fluctuating prices by buying and selling electricity, and those trading the volatility of option prices…

He also has money in funds shorting stocks of Chinese companies caught up in fraud scandals, and in funds involved in lending securities to borrowers for a fee.

If the idea of shorting scandal-ridden Chinese companies doesn’t make you flinch, you’ll be glad to know that this is not even the worst example of exotic alternatives out there. Head on over to CNBC and check out their coverage of alternative investments (if you dare). You’ll find tips for getting in on the diamond trade, learn the best time to invest in wine, or learn about the opportunities for investing in racing horses. The scope of the list is pretty breathtaking – frankly, we’re a little surprised that the blackjack tables at Vegas didn’t make the cut. This is just the sort of thing that makes some people raise an eyebrow at the term “alternatives.” There’s even a poll:

If you could choose only one alternative investment, which of the following would it be?

  • Art
  • Automobiles
  • Coins
  • Horses
  • Wine

A poll about alternative investing, and these are the choices? The stupid… it burns…

“Alternatives” is a pretty broad umbrella, covering just about everything that isn’t named stocks, bonds, or cash. But that’s no excuse for the financial media emphasizing novelty investments rather than well-regulated and time-tested options. Big money hedge funds or proprietary trading desks might be able to get away with exotic investments, but unless you’re named Goldman Sachs, you probably want to shy away from credit default swaps, barge leasing, and cranberry bog harvesting. Alternative investing isn’t right for everyone, but it’s a shame when investors have a negative opinion of alternatives because of the poor coverage out there.