FXIS Market Insights

There are a few versions of the old saying: “Sell in May and go away”.  That in itself isn’t much of a help unless you know when to get back in the game again.  The British used the term “Sell in May, then go away – come back on St. Leger’s Day”.  St. Leger is referring to a horse race in England which is scheduled to take place each year in September.  Let’s take this simple rule of thumb for a test ride and see if it could enhance returns if applied to investing in stocks.

Looking at monthly data of the S&P 500 since 1950, the straight Buy & Hold strategy of owning  say 10 units of the S&P 500 at a cost of $194.50 would have given you a final portfolio value of $10,894.  That is a total return of about 5500% with a compounded annual return of 7% as of May 28, 2010.  

We back-tested the same data by taking a position (10 Units of S&P 500) each year at the end of September and selling the same position at the end of May in the following year.  The “Sell in May” method did even better with a compounded annual return of 7.4% over the same time period.

The performance graph results look like this...

These results are encouraging but of course there are very few investors (left) who might have bought stocks on a buy & hold strategy since 1950 or let alone, have the tenacity and discipline to follow the “Sell in May” strategy over such a long period of time.  So let’s look at a shorter time frame to see if this method still makes sense.  The decade of the naughties (00’s) is often referred as “the lost decade” and indeed, stock market returns as per benchmark have been negative for a buy & hold investor.

Doing the same data analysis for the period of September 2000 until May 2010, a “Sell in May” strategy would not only outrank the “Buy & Hold” method but investors would actually come out slightly positive with an annualized return of 0.6%.

Here is the comparison in a performance graph ...

The method seems to have worked comparing these two specific time periods. However, shorter time frames can give results in varying degrees.  As luck would have it, the same strategy that worked so well for the “lost decade” would have resulted in a 21% loss during 2008/09, most of which would have been recovered by keeping the position until December 2009.  There are evidently periods when investors can miss out on strong market movements by staying out of the market.  We also examined different time periods by “staying out of the market” until October, November and December each year but found those performances actually resulted in weaker returns, even trailing the “Buy & Hold” strategy.

As with all backward looking hypotheticals, the caveat here too is that there is no guarantee that future performance can match previous results, something every investor needs to consider before implementing “Sell in May” each year.

For additional info and more details on our calculation methods please contact:   

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Noteworthy... 
• Fitch downgrades Spain's AAA credit rating down a notch to AA+ (WSJ)
• US consumer savings jump to highest level since January (FT)
• US personal income in April 2010 increased 0.4% from March 2010 (ESA)
• US consumer sentiment at 73.6, up slightly from April's reading of 72.2 (Reuters)
• The OECD raised its forecast for global economic growth to 4.6% in 2010 (Economist)
• Revised numbers for real GDP in the US show a growth of 3.0% in Q1 of 2010 (BEA)
• Australian government might make changes in its proposed mining-profit tax (Bloomberg)
• China denies a rumor that it had plans to avoid Euro-zone assets (WSJ)
• Apple overtakes Microsoft as biggest tech-company measured by market value (Reuters)
• Sales of new single-family homes were up 14.8% over the revised March rate (ESA)
• US durable goods orders in April 2010 increased 2.9% from March, to $193.9 billion (ESA)
• Industrial new orders for March were up by 5.2% in Euro area (Eurostat)
• US National Home Price Index fell 3.2% in the first quarter of 2010 (S&P)
• US consumer confidence increased to 63.3,  up from 57.7 in April (Conference Board)

Weekly Market Barometers

Charts Of The Week  
An extremely volatile week ended with the US markets almost unchanged.  After the “fat-thumb” trading scare earlier this month, the S&P 500 dropped below the widely watched 200-day moving average but had a strong turn-around to close the week at 1,089.41.  In the US, this was the last trading day for May and as usual for this time of year, the old saying “sell in May then go away” comes to mind.  Traditionally, this has been a fairly good rule of thumb but of course it did not work out in 2009. Investors would have missed out on one of the strongest bear market rallies if they had sold in May of last year.

What’s it going to be then this time around?  Aside from the often heard V-shaped recovery theme, there are a number of varying opinions on the shape of the recovery from hereon.  Below are some of the more popular predictions  - take a pick as to which shape seems most likely...

S&P 500 below 200 day moving average		Nouriel Roubini: Double Dip (W)
James Altucher: Check Mark		George Soros: Square Root

Good luck and good investing!

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

We don’t typically cover individual stocks but today was quite an extra-ordinary event which may have gone somewhat unnoticed within the day’s market turbulence.  As of market close on May 26, 2010, Apple is worth $222.12bn and overtook Microsoft with a market cap of only $219.18bn.  The chart below illustrates how Apple slowly rose from the ashes and then started to distance itself significantly outperforming Microsoft year after year since.  What an amazing turn-around in the midst of the greatest recession global financial markets had experienced since WWII. 

Some of the traditional Apple users have compared the ongoing battle between Apple and Microsoft with the fight of the rebel alliance versus the evil empire a.k.a. the “dark side” in the movie Star Wars.  As of today, Apple is no longer trailing in the shadows of the dark side. Well done Mr. Jobs and congratulations on becoming the new master of the (tech) universe.

This week saw another mini-flight to safety.  The Euro was pushed down to the lowest point in about 4 years (before recovering), US Treasuries and other Bonds saw yet again an influx of scared money fleeing the global financial markets in drones.  But within this trend towards the illusive safety, many investors forget that US Treasuries and similar AAA rated sovereign debt instruments are not without risk.  I am not referring to pure credit risk but also to the inherent risk from the mechanics of Bond prices.  Although this is very basic, here’s a graphic reminder of the relationship of Bond prices to changes in interest rates.

The prices of Bonds, particularly the longer term Bonds (10, 20, 30 years), are rather sensitive to changes in interest rates.  Unless you hold a Bond to maturity, its price can fluctuate rendering your investment not all that risk-free after all.  Pension funds, Bond funds and Bond ETFs are not immune to this - something to consider before pouring all your money into the “safest of all” asset classes.

US short term rates are still at zero which makes it less likely that Bond prices could rise much further.  But let’s assume that the US will experience a multi-decade period of near zero short-term interest rates just like Japan since 1990.  What is the likelihood that longer-term Treasuries will retain their current ratings allowing them to continue to finance deficits at ultra-low rates?

IMHO, the Greek and Euro-zone crisis should serve as a wake-up call.  The long-held believe in the risk-free rate is beginning to fade.  Several US States, California being one of them, have budget deficits approaching Greek standards. Unfunded liabilities continue to rise, entitlement cuts are political suicide and therefore they cut the lowest hanging fruit first, education being one of them. 

For California, the proposed budget cuts in education have been so drastic that Bond ratings agencies are now concerned about the long-term impact of these measures.  California and other US States are slowly approaching a tipping point of being no longer economically viable.  In order to assess the credit worthiness of say a 30-year municipal Bond, ratings agencies must now consider whether California will have an educated enough labor pool to continue generating enough middle-class earners for the much needed tax revenues. By cutting education to the bone, governments dumb down society as a whole rendering their own state or country unable to get out of the debt spiral. For now, the ratings agencies are merely concerned that their clients might actually be paid back in 30 years.  But with further cuts in education and other areas which contribute to the long-term economic viability of society, we should not only be concerned as long-term Bond investors.  Instead of cutting education, research & development programs for new and alternative energy, California as well as other States should heed the wake-up call from Greece. They must come up with cost-cutting measures for programs that do NOT contribute to sustainable long-term growth i.e. ridiculous pension and entitlement programs or building bridges to nowhere.  If they don’t, the consequences are also clear.  Long-term financing at ultra-low rates will become increasingly difficult not just for California, Michigan and New York but it will affect US Treasuries, the mother of “all risk-free” investments.

Noteworthy... 
• US Senate approves sweeping Wall Street reform bill (Reuters)
• Number of banks on FDIC's "Problem List" rose to 775, from 702 at the end of '09 (FDIC)
• Shanghai's stock index is down more than 21% so far this year (Business Week)
• Germany's parliament approves Euro-zone rescue bill (WSJ)
• The Shanghai Composite Index is Asia’s worst-performing stock index so far this year (Economist)
• Dubai World has agreed with its main creditors to restructure $23.5B of debt (Bloomberg)
• The Leading Economic Index for Germany Increased 1.5% in March (Conference Board)
• FOMC members expect real GDP growth of between 3.2% and 3.7% (FOMC Minutes)
• The Leading Economic Index (LEI) for the US declined 0.1% percent in April (Conference Board)
• Oil futures traded at $68 the lowest intraday price since Sept. 30 (Bloomberg)
• On a seasonally adjusted basis, the US Consumer Price Index (CPI-U) declined 0.1% in April (BLS)
• Euro falls to a four-year low of $1.2145 against the US Dollar on Wednesday (WSJ)
• Germany announced a ban on naked short selling and naked CDS of EU government bonds (FT)
• US Producer Price Index declined 0.1% in April, seasonally adjusted (BLS)

Chart Of The Week

Prof. Robert Shiller has been tracking the cyclically adjusted price earnings ratio (CAPE) of the S&P 500 all the way back to the late 1900’s.  This ratio does not fare too well as an indicator of short-term market performance however, over a longer time horizon, it is a good assessment of whether stocks are priced relatively expensive or relatively cheap.  The S&P 500’s CAPE is currently about 19x.  Based on the typical mean reversion, the stock prices are currently about 20% above the long-term average of 16.36.  Stocks, on average, are still expensive despite the over 4% market drop this week.

 

Weekly Market Barometers

Good luck and good investing!

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Angela Merkel’s phone must have been ringing off the hook in the past 24 hours.  It is fair to assume that leaders from other Euro-zone countries, lobbyists and financial heavy weights did a bit of arm twisting after Germany’s limited ban on naked short sales of government bonds and bank equities was enacted yesterday.  That announcement not only angered European counterparts was seen as a further loss of confidence in European financial markets sending the Euro to a new four-year low.

Today saw an announcement of a different kind, reversing many short sellers’ fortunes. Reuters reported: Germany and France are to coordinate Euro support plans.

Germany and France have agreed to coordinate efforts to support the euro zone and the single currency and prepare for upcoming summits together, German Chancellor Angela Merkel said through a spokesman on Thursday.

This may be the first real signal that Europeans have become uncomfortable with the pace of the Euro decline. For short-term traders, it was a violent move to the upside which left many “naked” short sellers truly exposed.  A brief spell of profit taking among the faster acting currency traders propelled the Euro back up nearly three cents within just two hours.

The contrarians have won the day but the Euro woes seem far from over.  Historically, Central Banks have had only limited success in talking up a currency.  Best example: The Federal Reserve and US Treasury.  Today’s short-term move just popped the Euro back into the medium-term trend channel.  That channel however is still pointing downward for now.

Here is the latest issue of Market Insights.  For your convenience, can also follow us on Facebook and Twitter.  In case you have questions, comments or suggestions please email: . 

In This Week's Issue
• Weekly Snapshot
• Chart Of The Week
• Weekly Barometers 
• Are We Approaching The End-Game Of The Euro?
• Finding Salvation In Gold
• Recommended Video 

Weekly Snapshot
• Gold prices hit a new all-time high climbing to $1,249 per ounce on Friday (Reuters)
• The Euro fell to 1.2359 against the US Dollar, lowest  level since November 2008 (AP)
• US Michigan consumer sentiment index rose to 73.3 in May (Bloomberg)
• US Industrial production increased 0.8 percent in April after having risen 0.2 percent in March (NBER)
• Retail and food services sales in April 2010 increased 0.4% to $366.4 billion from March (ESA)
• US Rates on 30-year mortgages hit 4.93%, lowest level in 2010 (AP)
• Euro area and EU27 GDP up by 0.2% in the first quarter of 2010 (Eurostat)
• Industrial production is up by 1.3% in the Euro area (Eurostat)
• US trade deficit in goods and services in March 2010 increased 2.5%, to $40.4 billion (ESA)
• US Senate votes 96-0 to audit Federal Reserve (LA Times)
• The US The Securities and Exchange Commission asks exchanges to devise new trading rules (Reuters)
• SEC: No evidence of a "fat finger" error by one trader that caused last week's market plunge (MarketWatch)
• Fannie Mae reported an $11.5B Q1 loss, and asked the government for another $8.4B in aid (WSJ)
• EU sets up €750bn ($1 trillion) Eurozone/IMF defense package to protect Euro from disintegration (AP)

Charts Of The Week
The Gold bulls are not just alive - they are kicking again.  Gold futures reached an all-time high of $1,249 per ounce.  Just how significant the recent rise in the Gold price has been is best seen when converting the Gold price to Euros.  On Friday, Gold broke through the €1,000 barrier for the first time ever.

Gold Price in US Dollars		Gold Price in Euro

Weekly Barometers

Are We Approaching The End-Game Of The Euro?
The demise of the Euro is just about upon us; that is the impression one can get from reading the financial news where the overall majority of economic commentators have been hammering the Euro to the proverbial death-bed.  Indeed, it has become more and more difficult to find supporters of the single currency in recent weeks.  The easy culprit is of course Greece and some of its Mediterranean neighbors who are at the center of this sovereign debt crisis which has been dragging the Euro lower and lower. 

Ultimately, the markets will decide whether the Euro is “toast” or not.  In the meantime, there are a few considerations however and before completing writing off Europe and its single currency, let us remember that every crisis also creates an opportunity.  One of these potential opportunities from a declining Euro can be seen in this week’s performance of the German Stock Market.  The DAX is up nearly 6% for the week.   Since this is so relevant and rather timely, I wanted to share some of my sentiments towards the current Euro trashing.  The following is part of an email I sent to a friend this week:

The EU certainly has its problems but I am somewhat amazed how all eyes are on Greece when our very own backyard is such a mess too. I have a long list of issues with the whole market mess but just briefly...

California is in a pile of @#$% and other states and municipalities are in big trouble too. I am also slightly amused that New York still has a AAA rating.

The Euro hit a low of 1.2359 today and it looks like will be testing the 1.2300 area which was the lowest it reached during the financial crisis. I attended a panel discussion yesterday about the very same subject.  Concerns about further bad news especially from Spain and Portugal are making it more likely that speculators will continue to push down the Euro.

But just from a trader's gut perspective, we're now approaching a hugely oversold territory on the Euro. While I'm still holding my horses, there might be an opportunity on the horizon.  When the sentiment is so bad and everyone is talking about the certain demise of the Euro, that's probably a good time to put on your contrarian hat. It was not long ago when everyone on the street said the US$ was "toast";  we know what happened since...

Looking at things from a different angle, a lower Euro bodes well for the export oriented countries in Europe not just towards the US, but also towards China.  By contrast, China's currency being pegged to the US Dollar has a slightly harder time now in terms of exporting their products to Europe at competitive prices.  The Euro fell almost 20% against the US Dollar in the past 6 months but that means the Chinese Yuan appreciated against the Euro by the same amount. 20% is a fairly big hit in terms of pricing products competitively. 

Yet another thought, China is sitting on somewhere around $2 trillion worth of US$ denominated assets (presumably much more than that as I don't trust those official stats) which are mainly in US Treasuries but also in a vast pool of foreign currency reserves.  These reserves are a problem for China and their Central Bank has been actively looking for ways to diversify such a huge one-sided risk.  The Euro at these beat-up levels is slowly looking attractive for a long-term play.  It may not be in the form of an outright currency purchase; the safer option for them might be German Bunds or Equity.

While this Euro slaughtering is going on, it may be a good time to look into other currencies which are somewhat isolated from general sovereign debt concerns.  The typical commodity currencies like Candy, Aussie and Kiwi come to mind with the Aussie Dollar leading the way in terms of a positive interest yield - central bank rates in Australia are at 4.5% now as opposed to 0.25% in the US.  But one could also look into other countries which are fundamentally in better shape possibly Norway and Singapore, maybe Korea (although I must do more homework on that).  All those are not without risk of course especially if global demand dries up. But for now, they seem a bit more attractive than a pure Euro/USD currency play.

In terms of trading these via ETFs, the major currencies are available and can be traded just like stocks.  So you don't have to lever up 100:1 and trade futures or spot currency contracts.  You can trade currency ETFs just like any other ETF via your typical online stock broker.

FXE = Euro, FXA = Aussie Dollar, FXC = Canadian Dollar to name a few.

To my knowledge, there are no ETFs for Singapore $, Norwegian Krona or Korean Won on US Exchanges (found some in the UK though), but there are entire country ETFs for Singapore (EWS) and Korea (EWY); those would be equity plays with some currency exposure built in.

It is definitely a challenge to try and make some sense of global markets these days.  Very poor visibility and plenty more volatility are almost forcing you to stay on the defense for now. Until we see some of the "fog" clearing up it's best to keep your seat belt fastened...

Finding Salvation In Gold
Not all that glitters is Gold but the most precious of all metals continues to exude its luster upon the investment community.  Volatility in financial markets, the fear of further sovereign debt issues in Europe and the possibility that the sovereign debt crisis might spread across the Atlantic has been driving up the price of Gold to new record levels this week.  As long as economic uncertainty prevails, investors will flock to the perceived safe haven assets, Gold being one of them. 

Henry Blodget of Business Insider acknowledges the great run gold has had in the past 10 years but he also expresses concern that some investors may climb on board this late in the game hinting at the precipitous gold run of the 1980’s and its sharp decline after the gold bubble burst.  As he calls it,  Gold has been “the most well advertised trade in the world”.

"But let's remember people love investments that have done well in the recent past and gold has had this tremendous run," Henry says in the accompanying segment, expressing concern about the onslaught of "buy gold!" investment ads on radio and TV.

 

Where do we stand now?  Are we near the end of the gold bull run or is this just the beginning of a much longer and more massive long-term price appreciation leading to $2,000 or even $5,000 an ounce?

Let us go back in time and look at the gold price of the past 4 decades to get a better reference point.

A few things to note here.  Unlike some Gold bugs may have you believe, Gold does not have a good track record as an inflation hedge.  For more than two decades, it essentially stayed in the same narrow price range generating a loss of real value compared with average inflation rates.  It was only after 2002-2003 when the precious metal took off and appreciated in value while stated inflation in the US was benign.

Let me throw in some numbers (please note these are rough averages):

The 1972 average Gold price in today's money was just under $300 whereas the 1980 average Gold price in today's money was about $2,000.  The 1990 average Gold price in today's money was $660 but it was only $370 for the year 2000.  Not much of an inflation hedge after all...

A slightly different picture emerged in the past ten years when Gold started to take off. The Gold run since 2002/2003 has been more gradual and much longer than the Bullion craze of the 1980’s.  That could hint at a more sustainable price development this time around.

Then there’s the debate about the inflation adjusted price of gold.  In today’s Dollars, the 1980’s price would be about $2,000 which is used by the Gold bugs as a rationale for the next major target; they suggest that Gold will reach at least $2000 an ounce within this decade just to be on the same page with inflation as compared to the 80’s.

Opponents of a continued Gold  rally claim the same Price Spiel in explaining the lousy track record as an inflation hedge.  Despite the worst financial crisis since the Great Depression and continued concerns over ballooning government deficits, so their argument, Gold has not provided enough of a risk diversification, all things considered. 

Last not least, there is the cost of holding gold; not a substantial one (e.g. the Gold ETF “GLD” has an expense ratio of 0.4%) but that cost also tends to rise in periods of higher inflation and higher interest rates.  Short of buying gold bullion, the cost of holding gold over the long-term can eat substantially into the inflation-hedge aspect of Gold which is something many gold buyers motivated by inflation concerns do not factor in.

For a trader, Gold has always been and continues to be an attractive commodity and “commodity” is the key word here.  Gold is not a substitute for currencies nor could governments truly go back to the traditional gold standard wherein currencies are backed by an equivalent amount of Gold.  Just to play with the numbers a bit more, the US was holding 8,133.5 tons of Gold at the end of 2009.  That amount is worth about $313bn and represents only about 2% of the US GDP - hard to imagine a gold price at which the US Dollar could truly be backed by... 

Having said that, one should consider Gold and other commodities as well as some select currencies as part of a well diversified portfolio.  How much of a percentage depends on numerous factors including personal risk profile, investment experience, net worth and investment horizon.  The average investor who is holding a substantial amount of his portfolio in typical mutual funds or market tracking ETFs such as VTI or SPY already has some exposure to Gold, commodities and currencies through companies whose profits rise and fall with the prices of these assets.  Simple examples are Oil companies or Gold Mining companies. 

In addition to the inherent exposure from the overall benchmark one should still consider these types of asset classes separately with the view of fine-tuning a balanced and well-diversified portfolio. But as Henry Blodget suggests, be careful with the “most well-advertised trade in the world”;  recalling the “Buy Land In Florida Ads” one should not blindly buy Gold thinking it could continue to rise forever.

Recommended Video 
Please consider this interesting video, a glimpse into the future of real-time research and investing.  This  new development in online technology allows you to search for specific events in the present, the past AND in the future... Enjoy!

Good luck and good investing!

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

After the €750bn loan package has been put together by EU leaders and the IMF in support of the Eurozone countries, its flagship, the Euro, has found some support in the currency markets.  However, there are still many who question the ongoing viability of the Euro and recent positions in currency futures markets reflect that fear of uncertainty quite clearly.  The chart below shows the commitment of traders (COT) below the futures prices of the Euro.  It indicates a widening gap between commercial hedgers (green line) and large traders i.e. the speculators (red line) which started about 6 months ago coinciding with the rapid decline of the Euro since then.  At present, there is no sign that the speculators believe in a positive outcome of the European debt crisis, something which may or may not change in coming weeks. 

Given this narrative, one might get the impression that currency markets have been and continue to be incredibly volatile.  They are in a way but in terms of comparing price volatility and market risk with other markets, I beg to differ.

For instance, oil futures dropped almost $12 or about 13% last week, which in view of the unresolved Oil leak in the Gulf of Mexico and the possibility of an end to further off-shore oil drilling on America’s coastlines, still leaves me slightly confused.  In the absence of other economic factors, these types of events would typically boost oil prices.  The fact that it didn’t means that a lot more price volatility, possibly in either direction, is on the horizon.

Stock markets around the world fell over 6% last week, notable exceptions were Hong Kong (-5.6%) and India (-4.5%).  As of Friday last week, the major US Indices have been slightly in negative territory for the year – who would have thought...

But the US is holding up better than the rest of the world thus far.  European stocks have been hammered since the Greek crisis.

And emerging markets have not been spared either.  Last week, China’s Shanghai Composite Index was leading the pack with a 17.6% drop for the year.

How does that compare to currency movements?

The Euro clearly took a beating this year having lost about 11% against the US  Dollar until Friday.  Other currencies however did not fare too badly versus the US Dollar and also held up well compared with the returns of the S&P500.

Examining a measure of risk as expressed in daily volatility, the major currencies (including the Euro) have generally been far less volatile than the broad stock market index S&P500 during almost every period in the past few years (our comparative data go back to 2007 only). 

2009		2008
2007		2007 – May 7th 2010

I do not suggest that investing in currencies would be more profitable than investing in stocks.  But given the same amount of leverage, for instance by using the standard ETFs for the various markets, the major currencies provided a far less bumpy ride than the US stock market in terms of the average daily returns. Given the high correlation of most international stock markets in recent years, the notion of diversification to mitigate risk should be carefully re-assessed.  As Douglas Short of www.dshort.com puts it:

Diversification works – Until it doesn’t!

In the above chart and in many asset allocation models, currencies are typically not included.  They are somewhat implied with international equity and bond exposure. I believe however, given appropriate balancing, currencies should be considered a separate asset class and be part of every investor’s portfolio if an inclination to some international diversification is present.  Done correctly, currencies can help mitigate overall risk and generate some balance for your returns.  The sample portfolio below is just one basic example to give you an idea how a simple allocation could be structured.  In the same time frame as above, a basic 40% Bond, 20% Currency and 40% Equity allocation not only provides better returns than the S&P500 but it also results in less than half the volatility and substantially lower risk. 

(Please note that the chart above is just one example of a hypothetical portfolio allocation.  We do not suggest that you should use these exact percentage allocations or any other allocation for that matter.  If you would like more information on how to include currencies within your portfolio, please email: for a more comprehensive assessment of your specific investment objectives.)

Good luck and good investing!

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Here is the latest issue of Market Insights.

You can now get the latest from FXIS by following us on Facebook , Twitter , Business Insider , Seeking Alpha and as always, directly via our Blog FXIS Market Insights. 

In case you have questions, comments or suggestions please email: . 

In This Week's Issue
• Weekly Snapshot
• Chart Of The Week
• Weekly Barometers 
• A Trading Glitch - Really?
• Is The Glass Half Full Or Half Empty?
• A Wake-up Call From Greece
• A Word On Currency Volatility
• Recommended Read 

Weekly Snapshot
• US unemployment rate edged up to 9.9%, and the labor force increased sharply (BLS)
• US nonfarm payroll employment rose by 290,000 in April (BLS)
• German lawmakers approve Greek bailout (NYTimes)
• Nasdaq plans to cancel trades of 286 securities that fell or rose more than 60% (Bloomberg)
• The SEC and CFTC to review “unusual trading” that contributed to Thursday's market crash (AP)
• The VIX Index (Volatility) jumps more than 50% in one day, closes at 32.80 on Thursday (Yahoo)
• Dow drops nearly 1000 points before recovering to close at 10,520.32 on Thursday (Reuters)
• European Central Bank on Thursday left its benchmark interest rate unchanged at 1% (NY Times)
• Spanish two-year rates are now six times as high as Germany’s (Eurointelligence)
• Australia raises interest rates to 4.5%, the sixth time in 7 months (NY Times)
• US manufacturing activity expanded in April at its fastest rate since June 2004 (FT)
• US personal income in March increased 0.3%,  personal consumption expenditures rose 0.5% (ESA)
• China tightens money supply by raising banks' reserve requirements for the third time this year (NY Times)
• Australian mining firms to pay 40% tax on profits from extraction of renewables starting in 2012 (WSJ)
• Euro-zone and the IMF approved an unprecedented €110B rescue package for Greece (Bloomberg)

Chart Of The Week
This is how Thursday looked like – a sea of red as far as the eye can see...

Source: www.finviz.com

Weekly Barometers

A Trading Glitch - Really?
Another roller-coaster week in financial markets.  It brought back some vivid memories of 2008 when many traders were shaking their heads and asked:  What the heck just happened?  At the worst moment on Thursday, the Dow Jones Industrial Index was down nearly 1000 points and plenty of stories were floating around as to why the massive sell off occurred. Reuters reported that Stocks plunge as trading glitch suspected:

The Dow suffered its biggest ever intraday point drop, which may have been caused by an erroneous trade entered by a person at a big Wall Street bank, multiple market sources said.

To get an idea of how close we were to even more hysteria, please consider the current NYSE rules on Trading Halts Due to Extraordinary Market Volatility.

The SEC and the Commodity Futures Trading commission said they were in the process of reviewing the “unusual trading activity” to determine how much of an impact an alleged glitch or trading error had on the market drop. Whether this was a glitch or simply a nervous sell-off, one thing seems certain: the market is telling us “Complacency no more.”  And it was exactly that complacency which caused us to be concerned when we wrote about the make-up of the recent economic data in FXIS Market Insights 24 April 2010:

We also believe that the stock market may have run a fair bit ahead of itself.  The Price/Earnings ratio of the S&P 500 currently has a multiple of 22.04, on a cyclically adjusted basis.  That value is about one third above its long-term historic average of 16.36.  Further, through a combination of near zero interest rates and a general sense of “the worst is over”, risk appetite has returned to the markets.  The volatility index, a.k.a. the fear index, has been back at pre-crisis levels for a few weeks now.  Too much complacency?

Take a look at the VIX index’s massive rise on Thursday to get an idea of how fast fear came back to the market. 

Friday was somewhat tamer, but volatility increased yet again by almost 25% to close the week at 40.95, clearly reminding us of the levels last seen during the credit crisis.  Certainly not a time to be complacent!

 

Is The Glass Half Full Or Half Empty?
In a number of previous articles, we made the point that any real and sustainable US economic recovery depends to a large extent on the creation of new jobs.  The US Bureau of Labor Statistics employment report for April 2010 finally looked like some form of a real recovery might be on the way:

Nonfarm payroll employment rose by 290,000 in April, the unemployment rate edged up to 9.9 percent, and the labor force increased sharply, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in manufacturing, professional and business services, health care, and leisure and hospitality. Federal government employment also rose, reflecting continued hiring of temporary workers for Census 2010.

In addition to that, the revised numbers for March and February show an additional net gain of 121,000 jobs. That’s all good news.  But let’s look a little closer to see what’s under the hood.

Census 2010 hiring by the NSA was 66,000  in April. This is a temporary measure, courtesy of the US taxpayer and should therefore be excluded from the report.  Hence there were only 224,000 new jobs created.

A growing concern is the number of long-term unemployed which increased to a record 6.7 million about 4.3% of the civilian workforce. 

The unemployment rose to 9.9% but a broader measure of unemployment, the U-6 rate is now back above 17%.

Employment remains the most critical factor for a sustainable recovery of the real economy.  The picture looks better, possibly half full, but we are not quite there yet.

Charts are courtesy of www.calculatedriskblog.com

 

A Wake-up Call From Greece
The sovereign debt crisis in Greece had a brief respite when Euro-zone member countries and the IMF agreed on a €110bn rescue package last week-end.  However, the financial markets wanted nothing of it, dragged the world stock markets lower and drove the Euro to its lowest level in 14 months. 

Market sentiment is clearly against the Euro right now; rumors of contagion and a possible eviction of Greece from the Euro-zone are increasingly coming to surface.

The scale of the violent protests against the planned austerity measures which include a freeze on government salaries, the elimination of the standard bonuses for government workers (13th and 14th months pay) and an increase in the retirement age to 63 by 2014 seem completely out of whack considering the miserable state of the Greek government’s finances. 

The Greek crisis and the populist backlash are a wake-up call, not just for Greece and Europe but also for the US and most other developed nations.  The current government budget deficits and the overall debt burden may be frightening but they pale in comparison to the scale of unfunded liabilities for pensions and healthcare.  Temporary measures for bailouts and economic stimulus packages are one thing but without drastic measures, ongoing government deficits are simply not sustainable for the simple fact that people live longer and there are not nearly enough young people joining the work force to generate sufficient government revenues and to support the growing unfunded liabilities.

In my view, the root of the problem (in addition to the obvious irresponsible spending habits of most government officials) is demographic in nature; the easiest way to hint at the scale of the predicament is to look at projected population charts.

Greek Population: 2000		Greek Population: 2050

If Greece has problems based on current demographics, the projections for 2050 look even more devastating.

US Population: 2000		US Population: 2050

The US projected demographics are not nearly as bad as Greece but the thought of having 13% of men and 17% of women over the age of 70 makes the current US retirement age a near impossible proposition.

Japanese Population: 2000		Japanese Population: 2050

A completely untenable development is under way in Japan.  Currently, almost 10% of all men and 14% of all women are 70 and older.  By the year 2050, those figures are forecasted to reach 24% (men) and 33% (women).  If those projections are somewhat close to reality, the current fiscal imbalances are child’s play.

For this very reason, politicians need to address these issues not just with temporary band aids but with real measures to control spending and to put the economy on a path to sustainable economic growth.  Yes, meaningful measures will be painful and there will be much more at stake than seemingly silly programs like 13th and 14th month salaries.  Politically, this may be an extremely risky endeavor as most politicians tend to play to the mood of the latest opinion polls.  Granted, there are no easy answers but something’s go to give if we want to avoid the obvious path towards the bankruptcy of many nations.  Greece must be viewed as an important wake-up call. Mr. Obama, Mr. Brown (Mr. Cameron?), Frau Merkel, Mr. Hatoyama, Mr. Sarkozy et. al, have your phones been ringing lately?

A Word On Currency Volatility
After all the crisis talk about Greece and the impending contagion to other Southern European countries, one could fear for the worst and question the ongoing viability of the Euro.  In terms of price and market risk, one might also get the impression that currency markets are incredibly volatile.  I beg to differ from the perspective of comparing them to other markets.

Oil futures dropped almost $12 or about 13% this week, which in view of the unresolved Oil leak in the Gulf of Mexico and the possibility of an end to further off-shore oil drilling on America’s coastlines, leaves me slightly confused.  In the absence of other economic factors, these types of events would typically boost oil prices.  This feels and smells as if a lot more price volatility, possibly in either direction, is on the horizon.

Stock markets around the world fell over 6% this week, notable exceptions were Hong Kong (-5.6%) and India (-4.5%).  After this sell-off, the major US Indices are now slightly in negative territory for the year – who would have thought...

But the US is holding up better than the rest of the world thus far.  European stocks have been hammered since the Greek crisis.

And emerging markets have not been spared either.  In fact, China’s Shanghai Composite Index is now leading the pack with a 17.6% drop for the year.

How does that compare to currency movements?

The Euro clearly took a beating this year having lost about 11% against the US  Dollar so far.  Other currencies however did not fare too badly versus the US Dollar and also held up well compared with the returns of the S&P500.

Examining a measure of risk as expressed in daily volatility, the major currencies (including the Euro) have generally been far less volatile than the broad stock market index S&P500 during almost every period in the past few years (our comparative data go back to 2007 only). 

2009		2008
2007		2007 – May 7th 2010

I do not suggest that investing in currencies would be more profitable than investing in stocks.  But given the same amount of leverage, for instance by using the standard ETFs for the various markets, the major currencies provided a far less bumpy ride than the US stock market in terms of the average daily returns. Given the high correlation of most international stock markets in recent years, the notion of diversification to mitigate risk should be carefully re-assessed.  As Douglas Short of www.dshort.com puts it:

Diversification works – Until it doesn’t!

In the above chart and in many asset allocation models, currencies are typically not included.  They are somewhat implied with international equity and bond exposure. I believe however, given appropriate balancing, currencies should be considered a separate asset class and be part of every investor’s portfolio if an inclination to some international diversification is present.  Done correctly, currencies can help mitigate overall risk and generate some balance for your returns.  The sample portfolio below is just one basic example to give you an idea how a simple allocation could be structured.  In the same time frame as above, a basic 40% Bond, 20% Currency and 40% Equity allocation not only provides better returns than the S&P500 but it also results in less than half the volatility and substantially lower risk. 

(Please note that the chart above is just one example of a hypothetical portfolio allocation.  We do not suggest that you should use these exact percentage allocations or any other allocation for that matter.  If you would like more information on how to include currencies within your portfolio, please email: for a more comprehensive assessment of your specific investment objectives.)

Recommended Read
Bill Gross, the Co-CEO of Pimco is not only one of the most successful fund managers, he also has a way with words.  Please consider his entertaining yet quietly sobering Investment Outlook for May 2010.  His remarks about ratings agencies are timely considering our most recent rant: Why Are Ratings Agencies Still Relevant?

Here’s a good tidbit from his letter:

Tramp stamp and hooker heels do not begin to describe the sordid, nonsensical role that the rating services performed in perpetrating and perpetuating the subprime craze, as well as reflecting the general deterioration of investment common sense during the past several decades. Their warnings were more than tardy when it came to the Enrons and the Worldcoms of ten years past, and most recently their blind faith in sovereign solvency has led to egregious excess in Greece and their southern neighbors. The result has been the foisting of AAA ratings on an unsuspecting (and ignorant) investment public who bought the rating service Kool-Aid that housing prices could never really go down or that countries don’t go bankrupt. Their quantitative models appeared to have a Mensa-like IQ of at least 160, but their common sense rating was closer to 60, resembling an idiot savant with a full command of the mathematics, but no idea of how to apply them.

Good luck and good investing!

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