Monthly Archives: October 2015

Covenant Weekly Synopsis as of October 23, 2015

October 26, 2015

Following a fourth consecutive week of equity market gains, October is shaping up to be a very strong month with developed and emerging markets up 8% or more thus far (additional market detail can be found here). Once again, much of the impulse for equity markets to move higher was delivered by central banker largesse. First, European Central Bank head Mario Draghi strongly hinted at additional quantitative easing for the Eurozone later this year. Then, on Friday the People’s Bank of China reduced bank reserve requirements and implemented another round of interest rate cuts (the sixth cut since last November).

Against this backdrop, Chairman Yellen and the rest of the Federal Open Market Committee are meeting this week to discuss domestic monetary policy. No one expects the Fed to hike rates this time around, or even in December when they meet for the final time in 2015. The Fed has a real problem on their hands because in the midst of sputtering economic growth, complicated by easy monetary policies elsewhere, raising interest rates will drive up the value of the US Dollar and put further pressure on an already struggling domestic manufacturing sector. I bet former Fed Chairman Ben Bernanke is very glad to be focusing his efforts on promoting his memoir The Courage to Act – an ironic title given the Fed’s current conundrum.

Housing Market – During a recent meeting with a mortgage derivatives hedge fund manager, we discussed if banks were loosening their mortgage lending standards. The answer was “yes, but not dramatically”:

  • Debt / Income ratios have drifted up to 37%, after bottoming-out at 33% in 2010
  • Average FICO scores of borrowers topped out in the 740’s and are now down to 727;
  • Loan-to-values for mortgages are up to 83% from the high 70% level.

Also, first time buyers beginning to come back to the market as Millennials are getting married, having children (and moving out of their parents’ homes).  Looser lending standards, even modest ones, will help keep the housing market’s growth on track and support the slow, but positive, economic expansion in the U.S.

Self-Reflection – “The key is not to believe our own B.S. too much” quipped the quant describing how he and his team went through a painstaking analysis of their portfolio optimization algorithms. As a systematic, short-term trader, trading costs are one of the largest drags on overall performance so they decided to attack the problem by reducing the total number of trades in the portfolio optimization process. They theorized that by determining the probability that the market would move to their current positioning at any point in time, rather than constantly trading toward the “optimal portfolio” they could cut costs and improve performance. He admitted this was a difficult intellectual concept to pursue because they knew that reducing the trading frequency would negatively impact their back tested results. However, after thoroughly researching and testing the new optimization algorithms, they took an informed “leap of faith” and implemented the change. The results were a resounding success. In live trading they have reduced trading volume by about 1/3 without any degradation to the strategy and added back more than 5% annually to performance through savings on trading costs. In the hyper-competitive hedge fund industry this manager is a rare one, having navigated markets (and ever changing investor demand) for more than 15 years. His willingness to challenge what he holds sacred is a big reason for his firm’s longevity and a valuable lesson to everyone.

Economic Wrap-Up – Retail sales in September grew a disappointing 0.1% month-over-month(m/m) and previous estimates for August and July were also revised downward.  In the month of September, annualized headline CPI Inflation dropped to 0.0%, due to a 9% decline in the price of gasoline. Core CPI edged higher though to 1.9%, just below the Fed’s target inflation rate. Preliminary Purchasing Managers Indices (PMI’s) released last week indicate developed economies (US 54, Japan 52+, and Euro-zone 52) continue to expand, albeit it at a modest pace consistent with the rate of growth seen over the last few years.

Be good,


Covenant Weekly Synopsis as of October 9, 2015

October 12, 2015

After the worst quarter since 2011, equities rebounded to post their best weekly performance of 2015. The S&P is now up nearly 8% from its recent lows and only about 5.5% from the all-time high set in May of this year. International developed and emerging market equities rose sharply and even beaten down commodities and high yield debt were invited to the rally party. Unsurprisingly, traditional fixed income securities declined on the week as investors pulled capital from safe haven assets. In spite of last week’s rally, it is worth noting that most regional equity indices are in negative territory for the year (with the exception of Europe and Japan) as are commodities. Additional market detail can be found here.

Bad Mood Investor sentiment has long been viewed as a contrarian indicator. Overly bullish or bearish views on the market often mark a turning point as all of the good/bad news has been priced in. The market swings (primarily the declines) over the last two months have been unnerving and impacted the short-term psyche of investors. According to Ned Davis Research, investor sentiment is at extreme lows with only 46% of surveyed investors reporting they are bullish. Historically, when the bullish investor level declines below 55% it has been a good time to go against the crowd and be a buyer.

Fight Club – The first rule of currency wars is that you don’t talk about currency wars. On Friday, the International Monetary and Financial Committee (a gathering of 25 International Monetary Fund member nations) committed to avoid “all forms of protectionism and competitive devaluations”. This announcement follows a similar proclamation by the G20 in early September, and combined the statements bring to mind a quote from Shakespeare’s Hamlet “…thou doth protest too much, methinks”. As we’ve mentioned in previous communiqués, a covert currency war has in fact been an ongoing feature of the recovery from the Financial Crisis. In an era of slow global growth central banks are scrapping for what little opportunity exists to bolster their respective economies and a cheaper currency makes exported products more attractive. The problem with this approach is that it creates a positive feedback system of competitive devaluations since currency devaluation is a zero sum game – for one currency to decline at least one other currency has to appreciate, potentially prompting action by the central bank in charge of the rising currency. I am skeptical that central bankers will honor this commitment and as a result monetary policy will continue to be the tool of choice for spurring local growth amongst competing central bankers.

Economic Wrap-Up: The September ISM Non-Manufacturing Index declined to a three-month low of 56.9, though it continues to indicate expansionary conditions (delineated as a reading above 50). Thus far this year, the non-manufacturing sectors have been the primary source of domestic growth, offsetting slower growth in the manufacturing sectors due to weak global demand and a strong USD. Weekly Initial Jobless Claims were lower than expected, while Continuing Claims remain elevated. Consumer Credit expanded at a slower pace than expected in August.

Be good,


P.S. Due to my travel schedule, there will not be a Weekly Synopsis next week.

Covenant Weekly Market Synopsis as of October 2, 2015

October 5, 2015

Although last week saw positive moves across most asset classes, the third quarter served as a reminder that risky assets are risky. As concerns around China’s growth rate and uncertainty about the timing of a Fed rate hike competed for top billing in news headlines, risky asset classes sold off and at the sub-asset class level recorded some of the worst quarters since 2011:

Q3 2015 Performance

Emerging Market Equities   -18%
Commodities   -14%
Small Cap   -12%
EAFE Equities   -10%
S&P 500   -6%
High Yield   -4%
REITS   +1%
Barclays Aggregate Bond Index   +1%

Additional market detail can be found here.

The volatility in Q3 was elevated, though it was not unprecedented. Moreover, the uncertainty resulting from divergent central bank monetary policies and tepid global growth will likely provoke heightened volatility levels for the foreseeable future. The good news is that volatility can produce investment opportunity; the bad news is that most people are overly reactive to volatility and end up making poor investment decisions. 

Intentional Investing: In today’s world of ceaseless sound bites and 24/7 news cycles, it is very easy for investors to get “caught in the moment” leading to emotional, rather than rational, investment decisions. Now, more than ever, it is important to think fast and slow to identify the signal from the noise in the information flow and avoid emotional decisions. Successful investing in this new era of voluminous and rapid information flow requires having a plan (including a diversified portfolio with exposure to multiple asset classes) and sticking to it, lest you end up as a statistical casualty like the average investor in the Fidelity Magellan fund between 1977 – 1990. Over this 14-year timeframe, portfolio manager Peter Lynch delivered remarkable performance averaging 29% per year. Unfortunately, the average Magellan investor actually lost money succumbing to emotional impulses in which they bought at the highs and sold at the lows.

Economic Wrap-Up: In August, Real consumption increased 0.4% month-over-month (m/m) and is on track to match the 3.6% annualized growth rate recorded in Q2. However, inflation remains AWOL, with annual core inflation rate at 1.3% (well below the Fed’s target rate of 2%). U.S. Consumer Confidence rose to 103 (from 101.3). The September ISM manufacturing index fell to 50.2 (from 51.1 – a level above 50 indicates expansion), as the strong US dollar continues to put downward pressure on foreign demand. September payroll data was weak as only 142,000 jobs were added (vs. a consensus estimate of 200,000) and the average annual earnings growth remained flat at 2.2%. Taken together this data confirms our long-held view that the U.S. economy, while expanding, is unable to hit on all cylinders in a low global-growth environment.

Be good,