Posted in Newsclips, Samples

Value ETFs Riding High on Small Cap Outperformance



 A quick look at large cap value equity performance so far this year suggests a challenging time for value stocks. But this is an incomplete picture and performance among smaller cap value stocks has been very strong. We note that year to date returns in value ETFs, particularly those with higher exposure to small caps, are outperforming the broad index and their large cap peers. 


A client inquiry regarding the performance of value versus growth equities in the U.S. led us to an interesting discovery. The chart below shows a clear divergence in returns this year for growth versus value equities in S&P 500. 



We typically see returns in ETFs track underlying indices fairly closely. But this appears to be a case where broad ETF definitions can give misleading impressions about performance characteristics. The next chart shows that although the faster price appreciation has driven total assets in U.S. growth ETfs higher, U.S. value ETFs have also seen year to date growth exceed 10%. 



Looking at net 20-day flows into value and growth ETFs shows surprisingly similar flows given the wide disparity in performance. We had expected to see year to date underperformance drive move value investors out of the strategy. 



Now there is enough variety in the ETF space for broad definitions like value and growth strategies to include a range of different return profiles. But there appears to be much greater variation among value ETFs than their growth focused competitors. 

The chart below shows YTD returns for all U.S. growth equity ETFs. These range from 19-28%, reasonably close to the S&P 500 Growth Index total return of 16%. 



The universe of U.S. value ETF returns has a much wider dispersion, and much less resemblance to the S&P 500 Value Index. Year to date returns range from 18-37%, well above the 4.9% return of the index. Most of the variation is explained by exposure to small caps. The best performing funds focus on small caps or value sector of the Russell 2000. 

Still, the fact that none of these ETFs are within 12% of the total return for a widely used, if large cap specific, benchmark value index illustrates how widely performance can vary within a defined space. The outperformance of small cap value ETFs is helping maintain investor interest in value ETFs even as larger cap value stocks are under-performing. 



The underperformance of large cap value stocks does not paint a complete picture of the value space in U.S. equities. Small cap value stocks are outperforming and helping drive superior performance in the value ETF space. Given the high concentration of stock market performance in a handful of large cap technology names, the strong performance of small cap value may offer some under-appreciated diversification opportunities. 


Posted in Newsclips, Samples

The Rise Of Emerging Markets

  • The Financial Times – Seven charts that show how the developed world is losing its edge

    What is happening to the world economy? Here are some answers, in seven charts. They reveal a world undergoing profound changes. The most important transformation of recent decades has been the declining weight of the high-income countries in global economic activity. The “great divergence” of the 19th and early 20th centuries, when today’s high-income economies leapt ahead of the rest of the world in terms of wealth and power, has gone into remarkably rapid reverse. Where once there was divergence, we now see a “great convergence”. Yet it is also a limited convergence. The change is all about the rise of Asia and, most importantly, of China.


The interactive charts below offer a look at the rise of emerging market economies on the world stage. The first chart shows that, while the U.S. still accounts for the largest portion of world GDP, China is quickly closing in.

The second chart shows that, on a regional basis, East Asia & the Pacific actually account for a larger share of world GDP than Europe and North America.

Finally, the last chart shows a breakdown of contribution to world GDP based on income groups. High income economies still account for over 60% of world GDP.



Posted in Newsclips, Samples

U.S. Dollar Decline Looking Over-Extended

  • Financial Times – Dollar sinks on failure of healthcare reform
    US currency hits 10-month low as hopes fade for Trump economic stimulus
    The dollar has been a barometer of prospects for the Trump administration’s efforts to enact pro-growth policies of tax cuts and fiscal stimulus. As the administration has become bogged down in the past six months handling healthcare reform and dealing with the Russia scandal, the reserve currency has steadily retreated. Lacklustre economic data, notably a weaker tone for inflation and retail sales for June, have prompted the bond market to reduce the likelihood of further interest rate increases from the US Federal Reserve.

  • Wall Street Journal – Why a Weaker Dollar Is a Source of Market Strength
    The dollar is down. But that is good news for markets

    The WSJ Dollar Index has now unwound the boost it got from the election of Donald Trump in November, and is down about 6.5% this year. The greenback’s key counterpart, the euro, is up close to 10% in 2017. Early Tuesday, the euro rose above $1.15 for the first time since May 2016, reaching the top of the range it has been in since the start of 2015 under the influence of monetary-policy divergence between Europe and the U.S. The transformation in the dollar and euro’s relative fortunes in 2017 has been remarkable. The focus at the start of the year was on the U.S. Federal Reserve and its efforts to raise interest rates; now the European Central Bank has stolen the spotlight as it tacks gently away from ultraloose policy settings.

  • Wall Street Journal – Dollar Doldrums Mean Easier Money
    The Goldman Sachs Financial Conditions Index, a widely-watched gauge, was at its lowest since late 2014 this week. The lower the index, the looser the flow of money, based on factors like bond yields and the value of the dollar against its peers. Much of that is the result of a falling greenback. The WSJ Dollar Index, a measure of the U.S. currency against 16 others, is down 6.5% since the end of last year. The index was down another 0.6% Tuesday morning at its lowest level since October, before the presidential election spurred a big surge in the dollar.


Expectations for sustained weakening by the U.S. dollar seem to be fashionable lately. And there are many reasons why this could be the case. We discussed some of them yesterday as they related to potential tailwinds for emerging markets. But there are signs the dollar’s latest decline is over-extended, short-term outlook aside. The potential for sustained dollar weakness, which would mean persistently loose financial conditions, may complicate the Fed’s plans. 


Despite agreeing that medium-to-long-term influences point toward persistent U.S. dollar weakness, we see two signs that the short-term outlook is brightening. The first is a simple momentum indicator we use to highlight overbought and oversold conditions. The chart below shows oversold conditions (indicator below -0.5) beginning to appear. 



The second is that our 20-day forecast model is beginning to lean bullish for the dollar. The model estimates the probability that the Bloomberg U.S. Dollar Index will close higher in 20 days. The recent dollar selloff has seen this probability climb to 76.8%. You can read more about the model here

It’s important to note that the latest decline accelerated as the markets tried to gauge political consequences of a defeat to GOP-led health care reform. Deteriorating political risks would be well outside the scope of the model, which considers changes in changes in the yield curve, relative performance of global equities, global risk indices, economic data and gold. The volatile political environment in the U.S. is a risk fact for dollar weakness to continue or even worsen. 



Setting aside the short-term outlook for a moment, the potential for persistent U.S. dollar weakness will complicate discussions within the FOMC as they progress toward balance sheet normalization and consider further rate hikes in 2017. We have discussed how financial conditions do not necessarily tighten as the Fed is raising interest rates. And we’ve also discussed how uncertainty and financial stability concerns tend to accompany tighter financial conditions. But the second Wall Street Journal story above illustrates another point. 

The chart below from the Wall Street Journal story clearly shows just how influential the U.S. dollar weakness has been in driving financial conditions lower (looser). The potential for sustained dollar weakness means a potential medium-to-long-term bias for looser financial conditions. As we’ve mentioned before, New York Fed President William Dudley has promoted the Goldman Sachs Financial Conditions index within the Fed as a means to gauge policy effectiveness. We’ve noted that the influence of the stock market may be problematic if the Fed misses other signals like the yield curve. If the weaker dollar is clouding the signal in the index, the Fed risks tightening too quickly.



This is precisely the opposite challenge they faced as they marched toward the final tapering in late 2014 and the first rate hike in 2015. Both instances saw markets build a massive premium into the U.S. dollar as the Fed was the only central bank tightening policy. There is potential for this premium to be unwound as the Fed begins to slow its pace of tightening and other central banks converge on tighter policy stances. The Fed may be happy to see economic tailwinds from a weaker U.S dollar given recent weakness in economic data. But weighing these offsetting influences will make for complicated discussions and tricky communications in the months ahead. 


Despite valid reasons to expect persistent U.S. dollar weakness, we see some signs that this latest decline is getting over-extended. Firming expectations for more dollar declines are driving positioning across many assets, especially emerging markets. A near-term correction isn’t likely to derail medium-to-longer-term dollar weakening. An eventual return to dollar weakness, or continued dollar weakness despite oversold conditions, will complicate the Fed’s discussions about further tightening this year. 

Posted in Newsclips, Samples

The Market vs. The Fed Update

  • The Daily Reckoning – Jim Rickards: The Fed Has Hit the ‘Pause’ Button

    No rate hikes are coming at the July, September or November Fed FOMC meetings. The earliest rate hike might be at the December 13, 2017 FOMC meeting, but even that has a less than 50% probability as of today. I’ll update those probabilities using my proprietary models in the weeks and months ahead. The white flag of surrender came in two public comments by two of the only four FOMC members whose opinions really count. The four voting members of the FOMC worth listening to are Janet Yellen, Stan Fischer, Bill Dudley and Lael Brainard.


The market has 1.5 hikes priced in through the end of 2018 with no more hikes expected this year. The Fed’s June update to its Summary of Economic Projections predicted 1 more hike this year and three next year. The market and the Fed are once again on different pages. Go with the market as it has a better track record.


The Fed last updated their Summary of Economic Projections at the June FOMC meeting with an expectation for one more rate hike by the end of 2017 and an additional three by the end of 2018. This would leave the targeted funds rate at 1.375% as 2017 comes to a close and 2.125% by the end of 2018.



But, as the chart below shows, the market is not pricing in another hike this year. The odds of a hike at the September meeting are just 10% while the odds of a December hike are 42%.



Expressed another way, the market has 0.4 more hikes priced in for this year while the Fed expects one more hike. By the end of 2018, the market expects 1.5 more hikes while the Fed expects a total of four.

Posted in Newsclips, Samples

Market Not Convinced The Trump Trade Is Dead

  • Bloomberg View – Komal Sri Kumar: How Trump Could Puncture the Equity Bubble
    A delay in stimulus measures and the rise in global trade tensions could deflate valuations.

    Donald Trump’s appeal last November was linked to two factors. Both are now putting the valuation bubble in equities at risk. The first factor was his emphasis on stimulus — tax reform, infrastructure spending and fewer regulations — that has pushed markets to higher and higher levels. The new administration was targeting at least 3 percent annual growth in real gross domestic product, well in excess of levels that the U.S. economy has experienced since the financial crisis.  The second component of the Trump campaign presented the U.S. trade deficit as a sign that the country was being treated unfairly by its trading partners. The remedy was to impose higher tariffs on imports, with China and Mexico mentioned as specific targets. Fear that the trade restrictions the candidate threatened during the campaign would dominate the incipient administration was the reason U.S. equity futures plunged during the hours immediately after the election results were known. Retaliation by trading partners to new tariffs would have slowed global economic growth and demand, resulting in a headwind for equities.

  • The Wall Street Journal – The Last Market Still Betting on Trump

    Still, the market’s high valuation in the face of declining earnings growth and a tepid U.S. economy means some of the rally was likely driven by policy expectations. More than half of the respondents to a survey of nearly 1,100 clients conducted by Cornerstone Macro last month said they expected Congress to pass a significant tax bill before the 2018 midterm elections. The question to ask, says Cornerstone’s Andy Laperriere, is what would happen to stocks if all investors gave up on a tax cut? The answer: They would probably go down.


The Trump trade has three parts; healthcare reform, tax cuts and a business friendly environment. Healthcare reform is on life support, but not totally dead. Expectations are tax cuts, especially corporate tax cuts, can still happen. The massive reduction in regulatory activity is viewed as a big positive for markets. Sum it up and the Trump trade, or at least the hope of the Trump trade, will continue to be a tailwind for markets.


As we noted last month, the U.S. is experiencing an unprecedented drop in regulatory activity. This is in part due to Trump’s pro-business agenda.


In addition, the betting markets are not convinced that healthcare and tax reform are dead. As the next chart shows, the betting markets barely budged on yesterday’s news that Republicans were abandoning the current bill. Bettors have been giving less than a 50% chance of healthcare reform since May and have placed the odds near 20% in recent weeks. 



Regarding tax reform, bettors still place 51% odds on a cut to corporate tax rates. The odds the individual tax rate will be cut stand closer to 36%.



Posted in Newsclips, Samples

U.S. Banking Sector Lagging Despite Steeper Curve

  • Wall Street Journal – Bank Earnings Are Coming: Five Things to Watch
    Calm markets, the Fed and lighter lending are among the factors seen influencing second-quarter results
    The Federal Reserve’s decision to raise short-term interest rates in June, the fourth rate increase since December 2015, should boost banks’ lending income. The rates banks charge on credit cards, home equity lines of credit and other types of loans vary depending on the Fed’s target. Those higher yields will help push net-interest income at the median big U.S. bank up by 6.2% in the second quarter, according to analysts at RBC Capital Markets.


Recent steepening in the U.S. Treasury curve offers a brighter outlook for financials and especially regional banks, yet regional banks have lagged despite heavy inflows into the sector. Further steepening in the treasury curve could see regional banks outperform. 


As the chart in the health care block above shows, despite strong inflows in July, financials continue to underperform at only +5.2% for the year. We noted through the second quarter that U.S. bank equities looked vulnerable to further flattening in the Treasury curve. Interest rates were already well below forecasts and expectations for net interest margins were still tied to a steeper curve. Bank investors were granted some relief as the Treasury curve steepened over the past month. The chart above shows the U.S. 2y10y spread has steepened almost 20 bps since June 14. 

It appears that regional bank investors may now be too pessimistic about the outlook for net interest margins. The next chart shows 20 day change in the U.S. 2y10y spread (x axis) and U.S. regional bank total returns (y axis). The latest point is marked. Bank total returns are flat over the past 20 days even as the 2y10y steepened 17 bps. But past steepening moves greater than this have been heavily skewed toward stronger total returns for regional bank equities. 




ETF investors are flooding into financials despite continued under-performance. One potential headwind for the banking sector specifically has diminished as the Treasury curve steepened in the past month. Now regional bank investors appear wary of accepting the brighter outlook for profitability. We expect net interest margins to be in focus during earnings. Regional banks could be poised to outperform in the near term if the curve continues to steepen. 

Posted in Newsclips, Samples

The Fed’s Got a Fever and the Only Prescription is More Inflation

  • Bloomberg – The Study Europe’s Rate-Setters Should Read
    A new paper shows why the longer rates stay low, the fewer benefits they bring.
    A key argument for hurrying up with a monetary tightening is that negative rates have hurt bank profitability, restricting lenders’ ability to give credit to families and firms. But is it really the case? How low can interest rates go before they become a drag on the economy? A new way of thinking about this problem comes from a working paper by Markus Brunnermeier and Yann Koby at Princeton University. The two scholars believe there is a “reversal interest rate” below which a central bank prompts lenders to cut back on their lending, instead of increasing it. This boundary creeps up over time, setting a limit to how long central banks should keep interest rates low.
  • Bloomberg – The Fed Needs a Better Inflation Target
    A higher goal, with more public support, would benefit the central bank and the economy.
    Today, a group of economists published a letter urging the U.S. Federal Reserve to consider a monumental change in policy: raising its target for inflation above the current 2 percent.

    I signed the letter. Here’s why.

    The inflation target helps define how much stimulus the Fed can deliver when it lowers interest rates to zero (a boundary below which the central bank has been unwilling to go). In a higher-inflation environment, a nominal fed funds rate of zero results in a lower real, net-of-anticipated-inflation rate — the rate that economists typically see as most relevant for consumer and business decisions. If, for example, people expect inflation to be 3 percent, then a zero nominal rate translates into a negative 3 percent real rate — a full percentage point lower than the Fed could achieve if expected inflation were 2 percent.


We have two opposing perspectives in the articles above concerning further monetary stimulus. The ‘reversal rate’ suggests interest rate cuts can move from an accommodative to contractionary impact on lending. The research indicates balance sheet expansion increases this so called reversal rate, meaning interest rate cuts could more quickly become ineffective. In contrast, Kocherlakota continues his support for easier policy by signing a letter with fellow economists urging the Federal Reserve to increase its inflation target.

Who’s right? Unfortunately, the camp calling for continued accommodative policy has a difficult battle showing its ability to foster improved lending and ultimately economic/inflation growth. However, both perspectives appear to have value. We will explain.

The chart below shows two important components of financial conditions: 1) deposits and lending growth (orange line) and 2) leverage and volatility in the financial system (green line). Lower levels indicate expansion, while higher levels contraction. 

Financial leverage remains as elevated as ever and coupled with ultra-low volatility in market returns. Conversely, growth in deposits and lending has steadily retreated post-Great Recession to near average levels. We define values below the shaded green band as too expansionary and values above too contractionary. The Federal Reserve should likely aim for these financials conditions to remain near average (zero).



Prior to the Great Recession the changes in the fed funds rate led to better conditions (i.e. growth) for deposits and lending. The scatterplot below shows six-month changes in the funds rate versus changes in our composite of deposit and lending growth six months forward. More cuts (moving left in chart) were matched with accommodative conditions.


But this all changed post-Great Recession. Further easing actions were surprisingly often followed by diminishing growth in deposits and lending. Confusingly, recent hikes have had balanced-to-accommodative impact. We see some evidence of this ‘reversal rate’ suggesting cuts beyond a certain level can become contractionary. Is a rise in rates toward this ‘reversal rate’ actually good for the economy?



So the Federal Reserve’s steadfast committal to interest rate hikes may be the better path barring a significant shift in economic data. However the added pace of tightening created by balance sheet reduction may be better connected to a higher inflation threshold as suggested by Kocherlakota.

The chart below shows the impact of year-over-year balance sheet reduction on deposits and lending during varying rates of inflation. We are aiming to show the likelihood of the Fed going too far (i.e. mistake) when tightening. This model uses changes in major economic data releases to determine probabilities of balance sheet reduction forcing our composite of deposits and lending to exceed +1 standard deviation from the long-term average (above green band in the first chart above). For the probabilities below we have held constant current rates of economic growth and assumed a pace of hikes at 50 bps per year.

Current core inflation near 1.9% year-over-year (CPI ex-food and energy) shows the Fed has a higher probability of causing a contraction in deposits and lending at nearly any pace of balance sheet reduction. Inflation running above 2.2% indicates a better environment with lower probabilities of contraction.





The Fed will be taking a gamble with continued rate hikes in hopes economic growth remains stable and inflation rises. Losing this bet would likely force the U.S. Treasury yield curve flatter and flatter while demand remains high for longer-dated issues. We have recently shown the yield curve is on the precipice of flattening to quite unfavorable levels for banks and other financials. In this scenario, the Fed like Chistopher Walkin has a fever and the only prescription is ‘more inflation.’

Next Wednesday (June 14) we will see May’s CPI. We continue to believe inflation remains paramount to job growth as we reach full employment. 

Posted in Newsclips, Samples

Discussing The Six Stocks Leading This Rally


Net Positions – Why Are Six Stocks Leading This Rally?
In this Net Positions, Jim Bianco takes a look at the six stocks leading the rally.


There is not a single clean metric to show if the stock market’s returns are concentrated in a few stocks. That is why we use several charts above to show the S&P 500’s gains this year are the most concentrated since the tech bubble of 1995 to 2000.  

To illustrate, a portfolio holding 86% cash and a market weighting of the six FAANMG stocks in the other 14% would be up 2.60% this year. Many fully invested, highly diversified funds have done worse.

2017 investment committee meetings can be condensed into two topics:

  • What to do with FAANMG stocks as a group
  • What to do with the other 494 stocks in the S&P 500 as a group

Simply put, managers will have a very tough time outperforming the market unless they are correctly positioned in the FAANMG stocks. While this simplifies investment meetings, managers are essentially living and dying by these six stocks.

  • Bloomberg View – A Few Big Stocks Don’t Tell the Whole Market Story
    Investor nervousness over concentrated gains in the markets is nothing new. The FANG stocks — Facebook, Amazon, Netflix and Google — accounted for a large part of the S&P 500 gains in 2015, as well. AQR’s Cliff Asness looked at the impact of individual stocks on the S&P 500 from 1994 to 2014 and compared those results to the 2015 FANG-driven market. Asness showed what the impact on overall market performance would have been if you removed the best performing stocks each year
Again, as noted above, there is no single statistic that measures the concentration of returns. This story uses a different set of statistics and comes to a different conclusion.


Posted in Newsclips, Samples

OPEC’s Compliance Test


  • Bloomberg Graphics – OPEC Reality: Saudis Delivered, Non-OPEC Didn’t.

    Just under a week from now, the Organization of Petroleum Exporting Countries will meet in Vienna to decide whether to extend the first oil production curbs in eight years in order to eliminate a glut. The group will evaluate data, described below, that highlights two key details: First, Saudi Arabia is shouldering much of the burden. Second, non-member producers – who pledged reductions of their own – haven’t delivered in full.

  • Bloomberg – OPEC Wants to Carry on Pumping Less and Earning More
    Production cuts produce higher petrodollar revenues, IEA says

    At first glance, OPEC’s cuts haven’t worked — global oil inventories remain well above normal levels. But the policy’s made a difference where it really counts: juicing the coffers of finance ministries from Baghdad to Caracas. The resurgent flow of petrodollars explains why Saudi Arabia and Russia have largely convinced everyone else in the deal to extend the production cuts another nine months to the end of March 2018.

  • Wall Street Journal – Why OPEC Plans Oil Cuts Into 2018: Aramco’s Coming IPO

    Saudi Arabia is pushing the OPEC oil cartel and other big producers gathered here this week to extend crude production cuts for another nine months. The reason: the timing of the blockbuster IPO of Saudi Arabian Oil Co., people familiar with the matter said. The Saudis want higher oil prices well into 2018 to support the initial public offering of their state-owned oil company, Aramco, people familiar with the matter said. The initial offering of 5% of the company is being timed for some time in 2018 and has been billed as the biggest ever, with valuations reaching over $2 trillion.

  • Bloomberg – OPEC Close to Agreement to Extend Oil-Supply Cuts for 9 Months
    Other proposals will be discussed including even longer curbs

    OPEC and its allies were close to an agreement to extend their oil-production cuts for another nine months as they seek to prop up prices and revive their economies. While ministers gathering in Vienna still planned to discuss other options — a shorter deal for six months or curbs lasting for the whole of next year — consensus was building around an agreement that runs through March 2018.


We have written quite a bit on the U.S. shale oil production side of the global oil market drama and did a Net Positions (webcast) on this subject last week reviewing our expectations for U.S. production. But with the OPEC meeting finally coming tomorrow, it is time to shift focus to the potential weaknesses in the planned extension. 

Expectations for this meeting have been set quite high as the Saudis and Russians publicly agreed to extend production cuts well in advance of the formal decision. Whispers of deeper cuts in production of a longer extension have been floated as well. As the largest producer and largest exporter of crude oil respectively, Russia and Saudi Arabia have made as much noise as possible in an attempt to regain control of the narrative. But U.S. shale oil producers are not the only risk in their hopes for a drawdown in global oil supplies. 

The Bloomberg Graphics story above includes the visualization below. The squares are sized to production cut targets with shaded squares indicating if they were met (orange) or not (yellow). The top row is OPEC producers led by Saudi Arabia. The bottom row is non-OPEC producers led by Russia. Compliance among non-OPEC producers has faltered. Russia has yet to be in compliance with its agreed cuts and smaller producers have followed suit. Malaysia, Kazakhstan and South Sudan have increased production since the cuts.

The Saudis have earned more excess revenue since the production cuts despite cutting production by more than they agreed. Non-OPEC producers have happily continued pumping oil to sell at higher prices. Despite any public agreements, real declines in global inventories will continue to face headwinds if non-OPEC compliance keeps eroding. 



The Wall Street Journal story above highlights the Saudis big incentive to keep oil prices high ahead of its planned IPO for Saudi Aramco. It strikes us that this is a major benefit of higher prices that is accruing only to the Saudis. Will they have to give ground to other key producers who sense this imbalance? Iran is another risk factor in achieving a balanced market and may see an opportunity in the vulnerable IPO. 


U.S. tight oil production is not the only threat OPEC faces in its push for meaningful cuts in global oil production. Non-OPEC compliance with production cuts could be a growing problem and the pending IPO will leave the Saudis potentially vulnerable as they try to defend higher oil prices for another nine months. 

Posted in Newsclips, Samples

U.S. Small Cap Outflows


  • Bloomberg – Investors Just Pulled the Most Cash From Small Caps in a Decade
    Pain in smaller stocks has some readying for selloff
    Investors pulled $3.5 billion from the biggest exchange-traded fund that tracks the Russell 2000 Index last week, spooked by the steepest selloff in the domestically focused stocks since before Donald Trump’s surprise election win. The biggest outflow in 10 years comes less than a month after small caps roared to an all-time high on speculation Trump administration policies would supercharge growth in the world’s largest economy.


The last time Bloomberg noted a similar mass exodus by U.S. small cap equity ETF investors was on April 4. Net 5-day flows bottomed on April 7 at -$3.18 billion. We published an update on small caps and the reflation trade on April 12 when it seemed the tide had turned. The Russell 2000 dipped by another 1% before rallying 5.5% through April 26. 

This time it appears as if net flows may have already bottomed. The top panel of the chart below shows total assets in U.S. small cap equity ETFs have fallen 2.5% since May 15 and 5% since the April 26 peak. The bottom panel shows 5-day net flows for small cap ETFs. 5-day net flows bottomed on Friday (May 19) with $3.46 billion leaving small cap ETFs in the prior week. Total net flows for the past 5 days were -$1.92 billion. 

Though slightly larger in magnitude than recent outflows, we think the Bloomberg story overstates the severity of the outflows. 



Performance for U.S. small cap ETFs has been strong. On average, small cap ETFs are +4.7%. They are up 6.6% since Trump’s election. Small cap ETF investors are likely to continue the dip buying behavior as long as the post-election investments are profitable. 


Posted in Newsclips, Samples

What To Look For In The FOMC Minutes



As the chart above shows, the market has priced in a June rate hike as a virtual certainty. There is no need for the qualifying language used below. At this point, the market would only be shocked if the Fed failed to hike.


  • The Wall Street Journal – Fed Minutes to Offer Clues on Debate Over Path of Rate Increases|
    Federal Reserve officials left their benchmark short-term interest rate unchanged within a range between 0.75% and 1% at their meeting May 2-3, and minutes of that gathering could indicate whether they are preparing to lift it by a quarter percentage point at their next meeting June 13-14. The minutes, to be released 2 p.m. EDT Wednesday with the usual three-week lag, are likely to provide more detail on the internal debate over the path of rates. They also could shed light on evolving plans to shrink the Fed’s holdings of bonds and other assets. Here are five things to watch for.
  • Reuters – U.S. rate hike in June ‘a distinct possibility’ -Fed’s Harker
    “I think June’s a distinct possibility … quite possible,” Patrick Harker told reporters. But “if we get another surprise on inflation to the downside, that would worry me a little,” he said when asked what might delay that policy tightening.

Posted in Newsclips, Samples

The Problem With Trump’s Economics Forecast


  • The Wall Street Journal – Greg Ip: Nice 3% Target, Mr. Trump. How Will You Get There?

    Yet there are good reasons independent economists think the U.S. can’t return to its historic growth of 3%. The U.S. working-age population grew 1.2% a year from 1950 through 2000. With the baby boomers retiring and families shrinking, it will grow less than 0.3% a year over the next decade. To make a credible case for 3% growth, Mr. Trump has to identify some wellspring of workers or productivity, that is output per worker, that his predecessors have missed. Mr. Mulvaney thinks prodding many people off social safety-net programs and back to work will be good for them, and for growth. In principle, that’s true, but the magnitudes are doubtful. About half of household heads on food stamps and three quarters of those on Medicaid already work, says Robert Moffitt, an economist at Johns Hopkins University. At most, 13 million recipients of Medicaid and 6.5 million recipients of food stamps don’t work (and the two groups overlap). The growth of people on disability insurance can be slowed with tougher eligibility, but experience suggests getting existing recipients off is almost impossible.

Posted in Newsclips, Samples

What Is Trumponomics?

  • – Caroline Baum: What exactly is Trumponomics?

    Already we are hearing references to “Trumponomics.” But what exactly are the priorities or objectives of a president who seems to make things up as he goes along, who says one thing one minute and contradicts himself the next, and who is neither a policy wonk nor remotely interested in policy details? That isn’t to say President Donald Trump is wishy-washy about all aspects of economic policy. He has been a strong and unrelenting critic of “free trade” as far back as the 1980s, refashioning the accepted wisdom on trade as a win-win into a win-lose. And in his book — literally and figuratively — America has been on the losing end for decades. (Trump insists he supports free trade, as long as it is fair.) Trump has long been opposed to immigration, both legal and illegal, preferring a policy of America First and Only. Such nationalism may sell well in the Rust Belt, where many blue-collar workers are no longer able to earn a middle-class wage, but it deprives the U.S. of one key input to growth: young, able-bodied workers.

Posted in Newsclips, Samples

The 2/10 Spread Is At Its Lowest Level Since October


  • CNBC – Bond market warning? A closely watched economic indicator just hit a postelection low

    The short end of the yield curve is “rising on expectations of tighter monetary policy, while the low end is more correlated to growth … so I think the case could be made that the curve continues to narrow,” Oppenheimer technical analyst Ari Wald said Monday on CNBC’s “Trading Nation.” Yet this doesn’t worry Wald, who noted that the yield spread turned fully negative before each of the four most recent recessions. “We don’t think the flatter curve is a warning,” he said. “As long as banks can borrow short[-term debt] and lend long[-term debt], we think the economy can do just fine and the stock market can do just fine.” “The flattening ties into the fading of expectations for some kind of fiscal push this year,” Caron said Monday on “Trading Nation.” “This is the broader representation of a resetting of expectations, in the United States at least, and the expectation for maybe slower growth than what we expected just after the election.”

Posted in Newsclips, Samples

Pricing In Reflation


  • Blackrock Blog – Jeffrey Rosenberg: What the bond markets tell us about reflation
    We see stable global growth and inflation helping the Federal Reserve make good on its promise to Normalize normalization. Global developed bond yields appear vulnerable to further increases as French political risk fades, leaving improving fundamentals as a longer run driver for eventual global policy normalization. We remain overweight U.S credit for its income potential, but prefer investment grade debt given elevated credit market valuations. We are underweight European credit and sovereign debt amid tight spreads and improving growth.

Posted in Newsclips, Samples

Gaming Earnings

  • The New York Post – John Crudele: How companies lie about earnings to meet Wall Street expectations

    Everyone knows by now that companies can — and do — manipulate their per-share earnings to meet Wall Street expectations. But I’ve always worked on the assumption that corporate revenues were pure numbers — without much manipulation going on there. Well, it turns out that I was wrong. In the current issue of Accounting Horizons, put out by the American Accounting Association — I read it so you won’t have to — a story with the can’t-put-down title of “Revenue Benchmark Beating And the Sector Level Investor Pricing of Revenue and Earnings” details “the propensity of companies to exactly meet or slightly beat analysts’ forecasts in conformity with the priorities of investors.” Still don’t understand? Companies are fudging their revenues as well as their earnings. And that should make investors very nervous.


Gaming earnings is a topic we have covered extensively. Back in 2009 we offered the following explanation on how GE massages their earnings:

Let us quote from Jack, Straight From the Gut (2001 edition) by Jack Welch:

Page 224
I was getting ready to leave the office for a long weekend on Thursday night, April 14, 1994, when Mike [Carpenter, Head of GE Capital] called with one of those phone calls you never want to get. “We’ve got a problem, Jack,” he said, We have a $350 million hole in a trader’s account the we can’t identify, and he’s disappeared.

Jack continues:

I didn’t yet know who Joseph Jett was, but over the next few days I would learn more then I cared to about him. Carpenter told me that Jett, who ran the firm’s government bond desk, had made a series of fictitious trades to inflate his own bonus. The phony trades artificially boosted Kidder’s reported income. To clean up the mess we would have to take what looked like a $350 million charge against our first quarter earnings.

The quarter had ended and Jack was given the bad news that GE was going to miss its numbers. What was Jack’s response?

The news from Mike made me sick: $350 million, I couldn’t believe it. It was overwhelming.  I rushed to the bathroom, and my stomach emptied in awful spasms.

Let there be no surprise, the “GE culture” is all about beating the street’s quarterly estimates by a few cents. What makes the head of GE throw up? Products that kill? Laying off employees? Bad strategic decisions? Apparently not. What makes him throw up is missing street estimates by a few cents. His division heads understood this and would go to any length to prevent it from happening.  More from Jack:

Page 225
That Sunday evening, I called 14 of GE’s business leaders to deliver the bad news and apologize to each of them for what had happened. I felt terrible, because this surprise would hit the stock and hurt every GE employee. I blame myself for the disaster.

The previous year, 1993, when Jett’s phantom trades accounted for nearly a quarter of the profits made by Kidder’s fixed income group, Jett had been named Kidder’s “Man of the Year.” We had approved Mike’s request to give Jett a $9 million cash bonus, a huge award even for Kidder. Normally, I would have been all over this. I would have dug into how one person could have been so successful, and I would have insisted on meeting him.

The response of our business leaders to the crisis was typical of the GE culture. Even though the books had closed on the quarter, many immediately offered to pitch in to cover the Kidder gap. Some said the could find an extra $10 million, $20 million, and even $30 million from their businesses to offset the surprise.

Please re-read the last highlighted passage. It sure sounds like Jack just described SEC and FASB violations as an integral part of the GE culture. Didn’t we create Sarbanes-Oxley in 2002 to stop such cheating?


Posted in Newsclips, Samples

How ‘Buy-The-Dip’ Became A Learned Response Function


  • The Wall Street Journal – ‘Buy the Dip’ Is Becoming a Pavlovian Reflex
    Mr. Chan notes that five standard-deviation stock declines are happening more often. There have been three such declines in U.S. stock market in less than a year, a frequency nearly 20 times higher than the long-term average. One struck following the “Brexit” vote last June and the other hit on Sept. 9.  Here’s the buy-the-dip aspect: Not only are stocks abruptly falling, they rebound with atypical haste. The S&P 500 recouped the bulk of its 5.3% two-day post-Brexit decline in five days; it took nine trading sessions after September’s 2.5% one-session drop. In only three days, S&P 500 recovered nearly all of last week’s 1.8% drop, the second-fastest rebound following a five standard-deviation drop on record, according to Mr. Chan. “Market shocks have come to be viewed by investors as alpha opportunities rather than marking the onset of rising uncertainty,” Mr. Chan wrote. “Initially, a clearly visible and high strike Fed put taught the market to ’buy the dip’; now, however, this behavior has simply become a learned response function.”

Posted in Newsclips, Samples

More On Zillow’s Zestimate

  • The Upshot (NYT Blog) –  Angry Over Zillow’s Home Prices? A Prize Is Offered for Improving Them

    It’s one of the oldest tricks in an internet company’s playbook. Concoct a tool that gives the public new statistics on something — the quality of a restaurant or a toaster, say. Then watch visitors flock to the data and worry about accuracy later. Few such tools have been as controversial as ones that show people the market value of homes, using software algorithms to do the estimates. Homes are typically the most valuable asset in people’s lives, so emotions run hot when these estimates are seen as too high or too low. The best known of these tools — the Zestimate, from the online real estate website Zillow — began on the internet 11 years ago and has since amassed a huge audience of homeowners, shoppers and nosy neighbors. Sellers say unfair Zestimates can kill offers on their homes. About 171 million people visit Zillow each month, according to the company.


We wrote about Zillow’s home price estimates in a post yesterday:

Zillow’s estimate is providing buyers of real estate with a different anchor, and one that is arguably more objective than the seller’s asking price. We’re not surprised a home builder finds the new anchor too low for their taste (highlighted above). And there are certainly instances where Zillow’s estimate could be misleading. Nonetheless, Zillow’s predictive model for estimating the sales price reduces the anchoring power of the asking price and levels the playing field between buyer and seller.

Posted in Newsclips, Samples

Robert Shiller On The Markets


  • CNBC – Nobel winner Robert Shiller: Stay in the market because it ‘could go up 50 percent from here’

    Nobel Prize-winning economist Robert Shiller believes investors should continue to own stocks because the bull market may continue for years. CNBC’s Mike Santoli spoke with Shiller in an exclusive interview for CNBC PRO. Santoli asked Shiller about his market outlook. “I would say have some stocks in your portfolio. It could go up 50 percent from here. That’s what it did around 2000, after it reached this level, it went up another 50 percent. So I’m not against investing in the stock market when you consider the alternatives. But I think if one wants to diversify, US is high in its CAPE ratio. You can go practically anywhere else in the world and it’s lower,” Shiller said. “We could even set a new another record high in CAPE, that’s not a forecast.”