March 06, 2010

Market Insights - 6 March 2010

Here is the latest issue of Market Insights. As always, please email any questions to: . 

In This Week's Issue
• Weekly Snapshot
• Chart Of The Week
• Weekly Barometers 
• Recommended Video 
• Financial Services Reform – Who Are They Kidding?
• All Eyes Remain On The Euro
• Keeping A Perspective On The Euro Weakness
• How Badly Do We Need China To Buy Our Debt?
• ETF Investing For The Greater Good 

Weekly Snapshot
• US unemployment rate remains at 9.7% (BLS)
• US Nonfarm payrolls in February declined by 36,000, better than expected (Bloomberg)
• Prudential to buy the Asian life-insurance business of AIG for $35.5 billion (Economist)
• ECB left rates at their record low of 1% and will do so for the foreseeable future (Reuters)
• Bank of England left interest rates at a record low of 0.5% (AP)
• Euro area and EU27 GDP up by 0.1% (Eurostat)
• Industrial producer prices up by 0.7% in Euro area (Eurostat)
• Pending home sales in the US fell 7.6% in January (Bloomberg)
• US auto sales rose 13% from previous year Ford outsold GM for the first time in over a decade (WSJ)
• The Reserve Bank of Australia raised its cash rate target by 0.25 percentage points to 4.0% (WSJ)
• The Bank of Canada left interest rates unchanged at 0.25% on Tuesday (Reuters)
• Euro area unemployment rate at 9.9% (Eurostat)

Chart Of The Week
Financial markets reacted positively on some recent austerity measures announced by the Greek government.  On Thursday, Greece was able to sell €5bn in a 10-year bond issue, although for a yield of 6.25%.  At these yields Greek Bonds come closer to junk status as some analysts noted this week.  This then begs the question: If a Greek 10 year bond at 6.25% is viewed close to junk bond level, what are other sovereign debts such as Brazilian government bonds?


Weekly Barometers  (click on chart for larger image)

Stocks-2010-0305   FX-2010-0305

Recommended Video
If you haven’t had enough of the Greek crisis and/or Goldman Sachs’ entanglements in questionable government deals yet, please consider this excellent interview with Martin Wolf, chief economics correspondent at The Financial Times.  

Financial Services Reform – Who Are They Kidding?
In light of renewed discussions about a Consumer Protection Agency and the ongoing disputes between US House Financial Services Committee Chairman Barney Frank and members of the senate, let us revisit an earlier article by the New York Times: Struggling Over a Rule for Brokers

“While most of the debate about financial overhaul legislation has focused on the impact on how big banks do business, one piece that would affect consumers directly has received little public notice: a requirement that stock and insurance brokers act in their customers’ best interest. And that provision may not make it into the final overhaul plan.”

Investment advisers are held to the standard of fiduciary duty in that they must always act in the best interest of clients.  In practice that would mean recommending an investment that may not be lucrative for the adviser (he may not make any or much less commissions) but would clearly be most beneficial to the client. 

Stock and Insurance Brokers are held to a (lesser) standard known as suitability, which requires them only to direct their clients to investments which are considered “suitable.”  The difference of these two standards is not just one of semantics but a conceptual distinction so fundamental that it hits at the very existence of the financial services industry.  As long as Brokerage and Insurance firms’ core revenues are coming from the sale of financial products and as long as the brokers have to primarily rely on commission income for their livelihood, this apparent conflict of interest will not go away.  Chances are therefore we might see a rather watered down financial services reform.  We can expect massive lobbying efforts and stiff resistance from the major players in the brokerage and insurance industries.

All Eyes Remain On The Euro
Severely tested by Greek sovereign debt concerns and an increasingly bearish mood among big hedge fund traders, the Euro has been loosing a lot of steam versus the US Dollar in recent months.  Most eyes have been on the EUR/USD currency pair and expectations were high this week that the Euro might slip further against the Greenback.  Some traders in the hedge fund community even seem to be banking on a return to parity in coming months.

While the bearish Euro sentiment continues to focus on the major currency pair EUR/USD, unbeknownst to many eyes, the Euro weakness has been much more apparent versus other currencies, most notably the Australian Dollar. The Euro weakness has been equally apparent when pricing certain commodities in Euros.  For instance, Gold priced in Euro hit an all-time high of €836.67 this week.

On the back of the Australian 0.25% rate hike early Tuesday, the Euro fell to a low of 1.4966 against the Aussie $, a level not seen since 1997.  The currency pair is now trading only about 1 cent (1000 points) away from the all-time historic low of just above 1.4.  More importantly, as the chart below illustrates, the Euro has lost 25% in the past 12 months and it has done so in a rather concerning one-way move to the down-side.


Against the backdrop of all this negative sentiment, it has become difficult to find a compelling reason to be bullish on the Euro.  However, the longer-term trend versus the US Dollar is still far above some major bullish trend lines.


In assessing further Euro weakness, I think it is important to keep a closer eye on the EUR/AUD rather than EUR/USD.  The fundamentals in Australia appear to be stronger than those of the US as well as the European Union.  Considering the recent rate hike, a bigger interest rate differential is very tempting for further carry trades.  Beware however, that the Australian Dollar, being a commodity currency, trades more volatile than many other major currencies.  Assessing risk-reward scenarios is important as always!

Keeping A Perspective On The Euro Weakness
When everyone was trashing the US Dollar in 2009 it helped, in hindsight, to keep a perspective on things.  As the world’s only true reserve currency, the greenback wasn’t going away that fast.  Similarly, in the midst of doom and gloom, it is important to step back and take a look at the journey of the Euro to get somewhat of a reference point.  Price history, as well as performance history are no indication of future results, you can read that much in every investment advisory disclaimer.  Yet, as the historic chart below illustrates, one cannot ignore the apparent, albeit erratic, up-trend in the value of the Euro versus US Dollar.


Regardless of where you might draw your long-term trend lines and whatever sophisticated technical indicators you may choose to employ in your analysis, the fact remains that the Euro today is still significantly higher versus the US$ than a decade ago when it was first introduced.  Further still, one can look at implied Euro rates from previous decades all the way back to 1972 and notice that, on average (using a simple 12 month moving average), the single currency is still higher than any of the average high-points of previous decades (see orange reference lines).


If we can agree that the Euro has been moving upward, one could surmise that it is approaching a half-way point in this rather wide channel marked by the blue trend lines.  Suppose that the Euro approaches this half-way point at around 1.3000, this then begs the Million Dollar question: “Is the glass half full or half empty?”

How Badly Do We Need China To Buy Our Debt?
The Department of US Treasury announced the revised numbers of major foreign holders of US Debt in their most recent update.  Based on the new data, China - not Japan - was indeed the number one holder of US Treasuries holding a total $894.8 billion worth of US Treasury securities at the end of December 2009.  Japan in second place held a total of $765.7 billion, $129 billion less than China.  See both data for current and previous versions in the charts below.

     Updated Chart     Previous Chart
Tr-Holdersupdate-2010-0226 Tr-Holdersprev-2010-0216

We have previously wondered what, if any, impact a decline in Chinese holdings of US Treasuries would have.  We also considered whether the recent hike in the discount rate would be some sort of a token gesture to the Chinese that potentially higher yields may be an incentive to keep buying those Treasuries.  While the revised US Treasury data show that China is indeed still holding the largest amount of US Treasuries, there is somewhat of a trend, albeit minute thus far.  Both data sets show that China has been reducing its US Treasury holding by $45 billion since last summer.  But it is far to early to assume that significant changes in Chinese holdings may take place.  Comparing the recent data with a longer-term view (end of year data), it does however show where China came from and what a potentially devastating effect on Bond markets could ensue if China were to reduce these US Treasury holdings to anywhere close to a level from a decade ago.


ETF Investing For The Greater Good
The thirst for new and innovative financial products has been apparent in the rapid rise of the number and complexity of Exchange Traded Funds (ETFs).  Ever more “interesting” and sophisticated ETF products are appearing on the radar screen of individual investors these days.  Many of these new ETFs, among them leveraged (2x or 3x) and inverse ETFs, have very little to do with the traditional pure index trackers such as the original ETF SPDR (Ticker SPY) which tracks the S&P 500 index at very low costs.  The newest and more complex ETF products are much more akin to Mutual Funds – best evidence for that are the expense ratios which are nearer to 1%, the realm of Mutual Funds.

Among the more recent developments we have noticed Green, Alternative and SRI (socially responsible investing) ETFs giving investors yet more choices to create a very selective investment portfolio.  The latest gimmick in this space are faith-based ETFs – I kid you not!  Under the umbrella of Faith Shares, 5 new ETFs have been created allowing you to put a religious touch on investing.  You can now invest in Baptist Values (FZB), Catholic Values (FCV), Christian Values (FOC), Lutheran Values (FKL) or Methodist Values (FMV).

I don’t mean to question or criticize religion and faith-based life and investment decisions in any way; nor do I wish to belittle any of the newer and more complex ETFs.  They would not have been created if there wasn’t any investor demand.  Instead, my caveat as with any new financial product or service is of a more general nature and very simply states:  Know what you’re buying! 

For starters, one can read the prospectus but that is typically nothing but an accumulation of legaleeze.  Most non-lawyers get dizzy and are left more confused about the true nature of the fund.  At the same time, the typical labels and brief fund profiles are not adequately describing the potential risks and investment policies either.  My first glance therefore goes to the fund holdings.  Those often reflect the true nature of the fund’s investment objectives better and clearer.  According to the brief description of FCV:

the FaithShares Catholic Values Fund investment objective is to track the performance, before fees and expenses, of the FaithShares Catholic Values Index, a custom index by FTSE/KLD.”

On closer look however, the Fund manager selects only 100 stocks from the pool of the 400 pre-screened companies of the FTSE/KLD Index that meet their “Catholic” value metrics.  Examining the Top 10 Holdings of the FaithShares Catholic Values ETF (see table below), the inquiring mind is curious as to what kind of investment, asset or company could be in line with “Catholic” values? 


    Data as of March 3, 2010 Source:

What makes large international companies like Starbucks or American Express faith-based organizations?  Dig a little deeper and you learn that the metrics are not active but rather passive screens.    That means if a company has no declared position e.g. on abortion, it could theoretically meet one of the criteria of Catholic values.  There are many other metrics which filter through the original pool of 400 pre-screened companies, many of which probably elude my understanding.  Notwithstanding these screening methods, there are other considerations you should take into account including your own risk profile, true correlation to the underlying as well as liquidity concerns for some of the smaller funds.  For instance, the total market value of FCV as of today is only about $2.6M, hardly a liquid fund by any measure. 

Lastly, please note that per website info, “FaithShares Advisors, LLC, the Fund's advisor, has committed to donating 10% of the net income derived from each Fund back to a ministry or charity supported by that Fund's denomination.”  This is very noble indeed and presumably a major factor in considering faith based ETFs in the first place.   But as with any new investment product, you should do your homework and try to understand how these new ETFs operate rather than listening to a sales pitch of your broker.  If in doubt, contact the fund directly, they usually have staff available to answer investor questions.  Alternatively, you could simply invest in a low-cost index fund and donate to your preferred charities directly.  It could net your charity an extra 0.85%, the amount that you would have otherwise paid in annual fees...

Good luck and good investing!

Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

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