Monday, October 5, 2015

The Courage To Act?

Ben Bernanke, the former chairman of the Federal Reserve, wrote a comment for the Wall Street Journal, How the Fed Saved the Economy:
For the first time in nearly a decade, the Federal Reserve is considering raising its target interest rate, which would end a long period of near-zero rates. Like the cessation of large-scale asset purchases in October 2014, that action will be an important milestone in the unwinding of extraordinary monetary policies, adopted during my tenure as Fed chairman, to help the economy recover from a historic financial crisis. As such, it’s a good time to evaluate the results of those measures, and to consider where policy makers should go from here.

To begin, it’s essential to be clear on what monetary policy can and cannot achieve. Fed critics sometimes argue that you can’t “print your way to prosperity,” and I agree, at least on one level. The Fed has little or no control over long-term economic fundamentals—the skills of the workforce, the energy and vision of entrepreneurs, and the pace at which new technologies are developed and adapted for commercial use.

What the Fed can do is two things: First, by mitigating recessions, monetary policy can try to ensure that the economy makes full use of its resources, especially the workforce. High unemployment is a tragedy for the jobless, but it is also costly for taxpayers, investors and anyone interested in the health of the economy. Second, by keeping inflation low and stable, the Fed can help the market-based system function better and make it easier for people to plan for the future. Considering the economic risks posed by deflation, as well as the probability that interest rates will approach zero when inflation is very low, the Fed sets an inflation target of 2%, similar to that of most other central banks around the world.

How has monetary policy scored on these two criteria? Reasonable people can disagree on whether the economy is at full employment. The 5.1% headline unemployment rate would suggest that the labor market is close to normal. Other indicators—the relatively low labor-force participation rate, the apparent lack of wage pressures, for example—indicate that there is some distance left to go.

But there is no doubt that the jobs situation is today far healthier than it was a few years ago. That improvement (as measured by the unemployment rate) has been quicker than expected by most economists, both inside and outside the Fed.

On the inflation front, various measures suggest that underlying inflation is around 1.5%. That is somewhat below the 2% target, a situation the Fed needs to remedy. But if there is a problem with inflation, it isn’t the one expected by the Fed’s critics, who repeatedly predicted that the Fed’s policies would lead to high inflation (if not hyperinflation), a collapsing dollar and surging commodity prices. None of that has happened.

It is instructive to compare recent U.S. economic performance with that of Europe, a major industrialized economy of similar size. There are many differences between the U.S. and Europe, but a critical one is that Europe’s economic orthodoxy has until recently largely blocked the use of monetary or fiscal policy to aid recovery. Economic philosophy, not feasibility, is the constraint: Greece might have limited options, but Germany and several other countries don’t. And the European Central Bank has broader monetary powers than the Fed does.

Europe’s failure to employ monetary and fiscal policy aggressively after the financial crisis is a big reason that eurozone output is today about 0.8% below its precrisis peak. In contrast, the output of the U.S. economy is 8.9% above the earlier peak—an enormous difference in performance. In November 2010, when the Fed undertook its second round of quantitative easing, German Finance Minister Wolfgang Schäuble reportedly called the action “clueless.” At the time, the unemployment rates in Europe and the U.S. were 10.2% and 9.4%, respectively. Today the U.S. jobless rate is close to 5%, while the European rate has risen to 10.9%.

Six years after the Fed, the ECB has begun an aggressive program of quantitative easing, and European fiscal policy has become less restrictive. Given those policy shifts, it isn’t surprising that the European outlook appears to be improving, though it will take years to recover the growth lost over the past few years. Meanwhile, the United Kingdom is enjoying a solid recovery, in large part because the Bank of England pursued monetary policies similar to the Fed’s in both timing and relative magnitude.

It is encouraging to see that the U.S. economy is approaching full employment with low inflation, the goals for which the Fed has been striving. That certainly doesn’t mean all is well. Jobs are being created, but overall growth is modest, reflecting subpar gains in productivity and slow labor-force growth, among other factors. The benefits of growth aren’t shared equally, and as a result many Americans have seen little improvement in living standards. These, unfortunately, aren’t problems that the Fed has the power to alleviate.

With full employment in sight, further economic growth will have to come from the supply side, primarily from increases in productivity. That means that the Fed will continue to do what it can, but monetary policy can no longer be the only game in town. Fiscal-policy makers in Congress need to step up. As a country, we need to do more to improve worker skills, foster capital investment and support research and development. Monetary policy can accomplish a lot, but, as I often said as Fed chairman, it is no panacea. New efforts both inside and outside government will be essential to sustaining U.S. growth.
Mr. Bernanke is a devastatingly brilliant economist who is promoting his new book, The Courage to Act. I agree with the thrust of his arguments above, given how dysfunctional Washington is, the Fed had to step up to the plate in 2008 to save the U.S. economy from another Great Depression.

But Bernanke ends his comment by stating "monetary policy can no longer be the only game in town" and here is where agree and disagree with him. In a perfect world, those politicians in Washington would all get together and pass laws by compromising on their proposals, ensuring fiscal policy would support long term growth.

Unfortunately, I just don't see this happening any time in the near future. In fact, I see the politics of division and inaction gripping Congress and the Senate becoming worse which is one reason why we're witnessing the extraordinary rise of non mainstream candidates from all sides of the political spectrum.

If someone told you we would be talking about Donald Trump, Ben Carson and Bernie Sanders as serious presidential contenders a year ago, you would have scoffed at them. Even though they don't share the same ideological views, they've been able to capitalize on the growing frustration with politics as usual in Washington.

Why am I bringing this up? Because if fiscal policy doesn't support the economy, then the only game in town by default will be monetary policy which is why Bridgewater's Ray Dalio is increasingly worried about the next downturn, and he's not the only one.

On Friday, DoubleLine Capital co-founder Jeffrey Gundlach, the current bond king, warned of 'another wave down' after the weak jobs number on Friday that the U.S. equity market as well as other risk markets including high-yield "junk" bonds face another round of selling pressure.Gundlach joins Bill Gross, the former bond king, in warning of a rout in stocks and other risk assets.

With all due respect to Ray Dalio, Jeffrey Gundlach, Bill Gross and Carl Icahn who recently warned of a looming catastrophe ahead, it remains to be seen who gets the last laugh on stocks. As I discussed in my weekend comment, with the Fed out of the way for the remainder of the year, the October surprise won't be a market crash but a huge liquidity rally in risk assets that could last well into 2016.

There is something else that happened over the weekend that received little attention as everyone was talking about Ben Bernanke's new book and how he thinks more execs should have gone to jail for causing Great Recession.

Alister Bull and Matthew Boesler of Bloomberg report, Korcherlakota Says Low Inflation Warrants Further Fed Stimulus:
Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the U.S. central bank would have been “totally justified” if it had increased policy stimulus to combat low inflation when it met last month, adding that negative interest rates could be a useful policy tool.

Speaking in an interview Sept. 29 with Arthur Levitt on Bloomberg Radio, the Fed’s most outspoken policy dove declined to say if he had recommended negative interest rates in projections submitted for the Sept. 16-17 meeting of the Federal Open Market Committee. He did say, however, that more aggressive Fed policy was warranted than the current setting of near-zero rates.

“Given the inflation outlook, given how low inflation is expected to be, to ensure the credibility of our inflation target, taking a more accommodative stance in September would have been totally justified,” Kocherlakota said in the interview, broadcast Saturday. He steps down from the Fed on Dec. 31 and is not a voting member of the FOMC this year.

The FOMC decided last month to hold rates near zero, though Chair Janet Yellen said Sept. 24 that she expected that the central bank’s first rate increase since 2006 would be warranted later this year. Kocherlakota has repeatedly argued for a delay in rate liftoff.
Accommodation Time

“My main point -- this is a time to think about adding accommodation, not a time to be thinking about taking it away,” he said.

Policy makers submit quarterly economic forecasts including their projections for the appropriate future path of the federal funds rate, which has been held near zero since December 2008. Displayed as dots on a chart, forecasts on the so-called “dot-plot” released Sept. 17 showed that one official viewed the appropriate rate at the end of this year and next to be slightly less than zero.

Kocherlakota said he was prevented by the Fed’s rules of confidentially from disclosing if this was his dot, though he expressed interest in the decision of central banks in Sweden and Switzerland to drive rates below zero.

“I think it’s another useful tool in our toolkit that we should be surely thinking about,” he said, in response to the question of whether the Fed should consider doing likewise if officials decided there was a need to stimulate the economy more aggressively.

“It’s been very interesting what the European central banks have been able to do in terms of actually provide more stimulus than I would have expected, by driving interest rates below what economists used to call the zero lower bound,” Kocherlakota said.

Yellen was asked about the negative dot in the Fed’s Summary of Economic Projections during a post-FOMC press conference on Sept. 17. She said “negative interest rates was not something that we considered very seriously at all today.”
In my opinion, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota is way ahead of his colleagues in understanding the Fed's deflation problem. He understands the real risks of deflation coming to America and I think he has been instrumental in the sea change at the Fed which impacted its big decision to stay put on rates.

Will the Fed consider negative rates any time soon? I doubt it but if inflation expectations keep sinking to record lows, this option might be considered and so will more quantitative easing (Bridgewater went on record to state more QE will come before a rate hike).

Right now, this isn't something which worries me as I believe global growth will recover in the short run, or at least that's what the stock market is indicating to me as investors bet big on a global recovery (click on image):

Is this just another countertrend rally which will fizzle out or is this part of a meaningful sector rotation back into commodities and energy following Friday's tepid jobs report? I don't know but the huge reversal on Friday may signal a change in risk appetite and you have to pay close attention to emerging markets (EEM), Chinese (FXI), Energy (XLE), Oil Services (OIH), Oil & Gas Exploration (XOP), Metals & Mining (XME) and solar (TAN) shares to see if this is part of a much bigger move.

As far as large (IBB) and small (XBI) biotech ETFs, they are down late Monday morning after popping at the open but this didn't surprise me as I expected both these indexes might retest their 400-day moving average before moving back up (click on image):

A lot of traders are fretting about the "death cross" on biotech but I never took these 'death crosses' too seriously, especially in the volatile biotech sector which unlike energy and commodities is still in a secular bull market and has the potential to surge higher and make new highs.

Below, former chairman of the Federal Reserve Ben Bernanke tells USA Today's Susan Page that more corporate executives should have gone to jail for their misdeeds. Bernanke also appeared on CNBC on Monday where he stated he sees no reason why central bank policymakers should rush to increase interest rates.

I agree with him but historic low rates are fueling inequality and the buyback binge, which is very deflationary. Still, unlike Greenspan who sent out a dire warning on bonds in August, Bernanke is very cautious as he sees many risks to this tepid recovery. No wonder he's now advising Ken Griffin, the reigning king of hedge funds, the man is brilliant and very careful in his analysis.

Friday, October 2, 2015

The October Surprise?

Akin Oyedele of Business Insider reports, Huge Miss on Jobs Report:
The US economy added 142,000 jobs in September, fewer than forecast.

Economists had been expecting the economy to add 200,000 jobs.

The unemployment rate held steady at 5.1%, a seven-year low.

Average hourly earnings were flat month-over-month in September, below expectations for 0.2% growth.

Ahead of this report, economists had noted that August and September nonfarm payrolls prints had been revised higher most of the time over the past decade. The August print, however, was revised lower to 136,000 from 173,000 in Friday's report.

Economists had noted that the broad-based slowdown in the manufacturing sector, partly because of the strong dollar and slower exports, would most likely show up in this report. Manufacturing employment fell 9,000 in September, versus expectations for no change.

Mining employment also fell, as healthcare and information added more jobs, according to the Labor Department.

The labor-force participation rate, which measures the share of Americans over 16 who are working or looking for a job, fell to 62.4%, the lowest since October 1977.

The year-over-year projection for hourly earnings growth, at 2.4%, was the most bullish forecast for wages in this economic cycle. Wages missed, at 2.2%.

In September, the Federal Reserve held off on raising its benchmark rate for the first time in a decade, citing global growth concerns and a labor market that needed further improvement. After the jobs report, Fed fund futures reflected only a 30% chance that the Fed would lift rates in December and a 52% probability for March.

Stock futures nosedived after the report — all three major indexes lost more than 1%, and Dow futures shed as many as 200 points. The yield on the 10-year benchmark Treasury note fell below 2% for the first time since the market sell-off on August 24.

Here's what Wall Street was expecting for the jobs report:
  • Nonfarm payrolls:+200,000
  • Unemployment rate: 5.1%
  • Average hourly earnings, month-over-month: +0.2%
  • Average hourly earnings, year-over-year: +2.4%
  • Average weekly hours worked: 34.6
I don't know why economists are so shocked to see the pace of job growth in the United States is decelerating. The mighty greenback, the rout in commodities and China's big bang are all weighing on the U.S. economy. Moreover, when a record 94.6 million Americans are not in the labor force, it's not a sign of economic prosperity and strength.

Although some think the weak jobs numbers are masking a strong economy, the truth is the jobs picture is even worse than you think. The U.S. economy may be in relatively better shape than the rest of the world but it's far from firing on all cylinders and the risks of another downturn are high which is why Bridgewater's Ray Dalio is worried about what happens next. In my opinion, the Fed's big decision a couple of weeks ago has been vindicated and it's right to fear deflation coming to America even if it will never publicly admit it (I warned you about this possibility a year ago).

As far as stocks, bonds and commodities, the knee-jerk reaction following the September jobs report was swift (click on image):

Stock futures reversed course and got slammed, the yield on the 10-yield Treasury fell below 1.94%, the US dollar declined spurring commodities like oil higher. Gold rallied partly because the US economy isn't doing as well as anticipated and some big investors think the Fed's next big move will be more more quantitative easing (QE), not a rate hike.

What do I think of all this? To be honest, not much. I maintain my views which I clearly outlined in my recent comments on a looming catastrophe ahead and who gets the last laugh on stocks.

If anything, I'm now more convinced than ever that the Fed won't make the monumental mistake of raising rates this year and that now is the time to load up on risk assets, especially biotech which got massacred last month, hitting major indexes and the healthcare sector very hard.

I want you all to stop listening to investment gurus scaring the crap out of you and start paying attention to markets, focusing on the sectors that have been leading us higher because they are in a secular bull market. If you look at the charts of healthcare (XLV) and biotech stocks (IBB and XBI), they got hit very hard in September but are coming back strong (click on images below):

Notice how the large (IBB) and small (XBI) biotech indexes have already crossed above their 400-day moving average and the smaller biotech shares are rallying hard on Friday as they are the ones that got clobbered the most in September. The healthcare index (XLV) is also close to crossing over its 400-day moving average (healthcare is a mix of big pharma, big insurance plans, big biotech and medical equipment stocks).

Again, this to me is very positive and if this momentum continues, it represents a change in market sentiment and risk-taking behavior. Importantly, with the Fed out of the way for the remainder of the year, I would ignore Carl Icahn's dire warning and load up on risk assets right now. Just make sure you pick your spots carefully as some sectors will rally and fizzle quickly or not participate while others will surge higher and make new highs (mostly tech and biotech).

I could be wrong, markets are crazy in October (or so everyone is conditioned to believe) but I think the big October surprise will be a huge rally that continues into the first half of next year. The bears love talking about "bull traps" but if you ask me, September was a huge "bear trap" and all these short sellers shorting this market and sectors like biotech are in for a lot of pain in the months ahead.

In fact, as I'm ending this comment, markets are staging a dramatic reversal on Friday and the small biotech companies I trade are surging higher (click on image):

Admittedly, I got clobbered in September along with many other biotech investors but I didn't panic, added more to my core positions and I'm sitting tight here (I'm better at buying the big dips than selling the big rips!).

But it's not just biotechs taking off on Friday. Check out the big moves in emerging markets (EEM), Chinese (FXI), Energy (XLE), Oil Services (OIH), Oil & Gas Exploration (XOP), Metals & Mining (XME) and solar (TAN). Below, a list of ETFs I track and how they performed on Friday (click on image):

It's clear that with the Fed out of the way, smart money is betting big on a global recovery (click on image below):

All of the stocks above are still in a downtrend but they can bounce big from these levels if market sentiment shifts and risk appetite increases (could be a violent countertrend rally).

Below, Rich Ross of Evercore ISI explains why biotech stocks are on their way back up from a recent plunge. And Len Yaffe, Stoc*Doc Partners, discusses key areas in the biotech industry, and his top stock picks.

Third, Jim McCaughan, Principal Global Investors CEO, says buying on setbacks is a promising strategy in U.S. equities. McCaughan is more cautious on emerging markets in the near term.

Lastly, Scott Minerd, CIO with Guggenheim Partners, discusses the jobs number and the markets and gives his best investing ideas, including investing in Spain (EWP) and Brazil (EWZ). Great comments on global liquidity trends, listen to this discussion.

We shall see what positive or negative surprises October has in store for us but one thing you should all be made aware of is James Bond is ditching his classic, straightforward martini for a dirty martini, combining vodka, dry vermouth, a muddled Sicilian green olive, and a measure of the olive’s brine (great choice!).

Hope you enjoyed this comment and wish you all a great weekend! Please remember to kindly donate and/or subscribe to this blog at the top right-hand side and support my efforts to bringing you the very best insights on pensions and investments. Thank you!!

Thursday, October 1, 2015

Why Is PSP Suing a Hedge Fund?

Ted Ballantine of Pension360 reports, Canada Pension Sues Hedge Fund Over Alleged Pricing Manipulation:
The full story was reported by Saijel Kishan and Katherine Burton of Bloomberg in their article, Boaz Weinstein's Revival of Saba Challenged by Pension's Lawsuit:
For Boaz Weinstein, whose credit fund had hemorrhaged money and investors over the past three years, April seemed like the turnaround moment.

The fund produced the best monthly return in its six-year history, a 10 percent jump that wiped out the pain of March when it suffered its biggest loss ever. From April on, there were no more losses, and he outpaced his rivals as volatility picked up in credit markets. Then on Friday, one of Canada’s largest pension plans and an erstwhile investor, said cheating may have contributed to the big swing -- allegations that Weinstein soon called “utter nonsense.”

In a suit filed by the Public Sector Pension Investment Board, once one of the biggest investors in the $1.6 billion Saba Capital Management, the pension fund accused Weinstein of “shortchanging” it by marking down a “significant” portion of the fund’s assets after the retirement plan asked that all its money be returned at the end of the first quarter. The next month, after the pension’s exit, Saba raised the value of the holdings, according to the lawsuit.

Whatever the outcome of the dispute, the accusations could curtail future money-raising for Weinstein, 42, as he seeks to rebuild his business, which has been hit by a 20 percent loss from the beginning of 2012 through last year. The tumble caused clients to pull billions, and employees, including three long-time executives, to leave the firm that once managed $5.5 billion.

‘Fully Vetted’

“Any suit of any nature against a fund manager will be a negative on a due-diligence checklist even if the suit is dismissed,’’ said Brad Balter, head of Boston-Based Balter Capital Management. “It’s not insurmountable, but it will be a hurdle to getting new investors.”

In a statement Sunday, Weinstein said he takes the allegations very seriously, even though they relate to only a “tiny portion” of the pension fund’s investment. “The valuation process was transparent, it was appropriate, it was fully vetted by auditors, counsel and others, and it was entirely fair,” he said. “The suggestion that I manipulated the valuation of two bonds for my personal gain is utter nonsense.”

The court fight could invite scrutiny from the Securities and Exchange Commission, which has cited valuations as one of its priorities this year and anticipates bringing cases involving pricing of portfolios.

SEC’s Concerns

“The SEC has several key concerns and valuation is one of them,’’ said Ron Geffner, a former SEC lawyer. In investigating cases of potential misvaluation, the SEC will look to see if a firm followed the methodologies disclosed in offering documents, its written policies and procedures and other client communications, said Geffner, now at Sadis & Goldberg LLP. If the investment manager deviated from its usual methods, the SEC will ask why the change occurred, he said.

John Nester, a spokesman at the agency, didn’t respond to a message seeking comment outside business hours.

The C$112 billion ($84 billion) pension fund, which oversees the retirement savings of Canadian federal public servants, said it was the Saba Offshore Feeder Fund’s largest investor, having invested $500 million over the course of 2012 and 2013 and accounting for 55 percent of the fund’s assets. The plan said it had asked Saba for its money back early this year, saying Saba’s 2014 losses appeared to be “unrelated to any market development that could or should have adversely affected the fund’s performance had the fund been properly managed,’’ according to the lawsuit.

McClatchy Bonds

Saba couldn’t adequately explain the losses, the Montreal-based pension fund wrote. The pension said it rejected a request by Saba to return capital in three installments, a move that allegedly would hide the redemption from other clients. By late January, clients accounting for 70 percent of the assets in the offshore fund asked for their money back.

The suit filed in Manhattan state court centers on hard-to-sell McClatchy Co. bonds owned by Saba. Between late January and the end of the quarter, there was only one trade done in the bonds that was for greater than $500,000 in notional value. Weinstein was looking to sell about $54 million in the bonds, according to a person familiar with the firm.

Normally, the hedge fund used independent pricing services or brokers who regularly traded the bonds, and these sources valued them at 50 cents to 60 cents on the dollar at the end of the first quarter, the pension plan said. When the pension asked for its money back, Saba used a different process called “bid wanted in competition,” a sort of auction used to trade a block of securities. That method valued the bonds at 31 cents as of March 31. Saba did not sell the bonds, and within a month, returned to its usual pricing methodology, marking the bonds in the 50s, the pension plan said.

Weinstein’s Response

“They did so to stanch further investor defections from the fund and to directly benefit themselves by boosting the residual value of their investments in the fund and other affiliated hedge funds with exposure to the same bonds,” according to the lawsuit. The pension plan, which is represented by law firm Skadden Arps Slate Meagher & Flom LLP, is asking for unspecified compensatory damages and disgorged profits.

Weinstein denied that he changed his pricing methodology in April. “We continued to use the auction to price those (and other) bonds in the second and third quarters of 2015,” he said in the statement. “PSP could have corrected its mistake with a one-minute phone call to me.”

Weinstein said he used the same auction process to sell 29 other bonds, prices that the pension fund didn’t challenge. “We couldn’t discard two of the prices resulting from the auction simply because PSP was unsatisfied with the outcome; to do so would have been improper and unfair to every other Saba investor,” he said. “I am 100 percent committed to treating all of my investors fairly, and I did exactly that in connection with PSP’s redemption."

‘Price for Liquidation’

Weinstein started Saba -- Hebrew for grandfather -- in 2009, after he stepped down as co-chief of the credit business at Deutsche Bank AG, where in 2008 he lost at least $1 billion. It was his only losing year out of 11 at the bank, a person with knowledge of the matter said at the time. At Saba, where he trades on price discrepancies between loans, bonds and derivatives, he initially produced strong profits, gaining 11 percent in 2010 and 9.3 percent the following year. Then he struggled as as central banks embraced quantitative easing that reduced volatility in credit markets.

Saba returned 7.6 percent this year through Friday.

Uzi Zucker, an early investor in Saba who pulled some of his money in the first quarter, called the suit unprofessional. “It’s just sour grapes,” he said. “He had to price for liquidation. I never questioned his judgment.”

The case is Public Sector Pension Investment Board v. Saba Capital Management LP, 653216/2015, New York State Supreme Court, New York County (Manhattan).
Antoine Gara of Forbes also reports, Canadian Pension Fund Says It Was Cheated By Boaz Weinstein's Saba Capital:
The Public Sector Pension Investment board, a pension fund for the Royal Canadian Mounted Police and the Canadian Forces is accusing Boaz Weinstein’s Saba Capital of incorrectly marking assets this year as it sought to redeem a $500 million investment in the hedge fund. PSP said in a Friday lawsuit filed in the New York State Supreme Court Saba and its founder Weinstein knowingly mis-marked assets during the redemption in order to inflate the value of the hedge fund’s remaining assets for investors, including top executives.

Weinstein, a former Deutsche Bank proprietary trader who lost nearly $2 billion for the German bank during the worst of the financial crisis, created Saba Capital in 2009 and quickly took in billions in assets from investors around the world. At its peak, Saba Capital held over $5 billion in assets under management. One of the firm’s most profitable trades was taking the other side of JPMorgan Chase’s so-called London Whale trading debacle in 2012, which cost the bank over $6 billion, but earned Saba significant profits.

When PSP made its $500 million investment in Saba in early 2012, the hedge fund had nearly $4 billion in assets under management. However, in recent years Saba’s assets quickly dwindled amid the fund’s poor performance. By the summer of 2014 Saba’s assets had fallen to $1.5 billion, PSP said in its lawsuit.

In early 2015, PSP reevaluated its investment in Saba and decided to redeem 100% of its Class A shares. At the time, PSP, a $112 billion fund, was Saba’s largest investor. To mitigate the impact of such a large redemption, Saba asked that PSP take its money back in three installments, however, the public pension fund refused.

Saba eventually agreed to a full redemption. PSP alleges that Saba knowingly manipulated its assets to depress their value during the redemption process, thus minimizing its payout.

According to its complaint, PSP accuses Saba of arbitrarily recorded a markdown on some of its bonds during the March 2015 redemption. A month later, Saba then marked its assets upwards. “As a result of defendants’ self-dealing, the Pension Board incurred a substantial loss on its investment in the Fund, for which defendants are liable,” PSP’s lawyers at Skadden, Arps , Slate, Meagher & Flom said in the complaint.

Specifically, Saba is accused of valuing bonds issued by The McClatchy Company using a bids-wanted-in-competition (BWIC) process that created depressed bidding prices that the hedge fund used to value PSP’s investment assets. Other measures from external pricing sources, which the hedge fund had used previously, put the McLatchy bonds at far higher values. Once the redemption was complete, Saba immediately moved away from BWIC valuations and back to those that could be gleaned from external pricing sources.

“[D]efendants used the BWIC process in a bad faith attempt to justify a drastic and inappropriate one-time markdown of the MNI Bonds held by the Master Fund, thereby depriving the Pension Board of the full amount it was entitled to receive upon redemption of its Class A shares of the Fund as of March 31, 2015. By reason of defendants’ unlawful conduct, the Pension Board has suffered substantial damages,” the fund said in its complaint.

In recent weeks Saba partners including Paul Andiorio, George Pan and Ken Weiller were reported by Bloomberg to have left the hedge fund.

Jonathan Gasthalter, a spokesperson for Saba Capital, relied with this comment:

“Saba Capital is disappointed that the Public Sector Pension Investment Board (“PSP”) has chosen to file a meritless lawsuit over the valuation of two securities out of well over a thousand. The difference in value at issue amounts to merely 2.6% of the total of PSP’s former investment with Saba.

As was explained to PSP in writing earlier this year, these two securities were priced using an industry-standard bid wanted in competition (BWIC) process, soliciting competitive bids from every leading broker and dealer in the relevant securities. The BWIC process was fully consistent with Saba’s valuation policy, and was carefully vetted and approved not only by Saba’s internal valuation committee, but by at least four external advisors: auditors, outside counsel, fund administrator, and Saba’s external members of its board of directors.

Contrary to the allegations in PSP’s complaint, Saba did not use the BWIC prices for a single month and solely for purposes of PSP’s redemption, but rather continued to use BWIC pricing as appropriate in the second and third quarters of 2015. Moreover, the results of the BWIC process were accepted by PSP more than 90% of the time, for dozens of securities. In only two instances–the two at the center of PSP’s lawsuit–did PSP take issue with the prices obtained by the BWIC process. PSP’s cherry-picked objection to these two prices has no legal merit.

Saba Capital took great care in redeeming PSP’s investment on a time-table dictated by PSP, including by finding fair and accurate market prices for extremely illiquid positions. Saba Capital looks forward to vindicating its position in court.”
This is an interesting case on many levels. Let me quickly share some of my thoughts:
  • First, PSP made a sizable investment in Mr. Weinstein's hedge fund, having invested $500 million over the course of 2012 and 2013 and accounting for 55 percent of the fund’s assets when it redeemed. I understand scale is an issue for the PSPs and CPPIBs of this world but whenever you make up over 25% of any fund's assets, you run the risk of significantly influencing the performance of this fund or its ability to garner assets from other investors who aren't going to invest knowing one investor makes up the bulk of the assets.
  • Second, why exactly did PSP invest so much money in this particular hedge fund and what took it so long to exit this fund? Saba Capital Management suffered losses over the past three consecutive years! I would love to know the due diligence PSP's team performed, especially on the operational front, and understand their rationale after reviewing the people, investment process, operational and investment risks at this fund. It looks like PSP was lulled by the fund's decent performance in 2010 and 2011 but investing $500 million with a manager who lost $1 billion back in 2008 is crazy if you ask me. There certainly wasn't a lot of backward or forward analysis on PSP's part in making such a sizable investment to this hedge fund.
  • Third, on the operational front, did PSP perform a due diligence on this fund's administrator (one that has the expertise to rigorously analyze the fund's NAV) and was the way the fund prices bonds clearly spelled out in the investment management agreement (IMA)? This lies at the heart of the issue. When you're investing in a quant/ credit hedge fund that invests in illiquid bonds or derivatives, you need to understand the method it prices these investments and you better be comfortable with it before you sign off on such a sizable allocation. If Mr. Weinstein violated the IMA in any way, then PSP is absolutely right to sue him. If not, PSP will lose this case no matter what it claims. It's that simple.
  • Fourth, this case also highlights why more and more institutional investors are moving to a managed account platform when investing in hedge funds. Go back to read my comments on Ontario Teachers' new leader and on his harsh hedge fund lessons. Following the 2008 debacle, Teachers' moved most of its hedge fund investments onto a managed account platform to mitigate operational risk and more importantly, liquidity risk which is currently a huge concern. But even if you have a managed account platform and have transparency, it's useless unless the underlying investments are liquid. And again, did the manager violate the IMA? That's the key issue here.
  • Fifth, this lawsuit is a black eye for Saba Capital Management which has suffered from redemptions and key departures. As one investor stated in the article, it's a negative for a due diligence checklist and it will be a hurdle to getting new investors. But the lawsuit also reflects badly on PSP Investments and it will make it harder for this organization to approach top hedge funds which can pick and choose their investors in this tough environment. Nobody wants a litigious pension fund as a client and win or lose, this lawsuit is a lose-lose for both parties involved in the case. Mr. Weinstein claims “PSP could have corrected its mistake with a one-minute phone call to me.” If this is true, then why didn't PSP call him to rectify the misunderstanding or why didn't Mr. Weinstein reach out to PSP to make this suit go away?
  • Lastly, I would love to know which other pension funds invested in this hedge fund and how this lawsuit and recent redemptions are impacting their impression of the fund. 
Those are my brief thoughts on this case. One expert I reached out to shared this with me on this case: 
"The situation may have been averted if the proper controls were in place to monitor the fund's pricing and ongoing monitoring of funds redeeming from it. In this case, it's a credit hedge fund investing Level 2 assets. The price was most likely derived from broker prices. However, if the controls were put in place, then PSP may have a point and the manager may be at fault."
There is nothing that pisses off institutional investors more than operational mishaps or fuzzy pricing when they are redeeming from a hedge fund. I remember when I was working at the Caisse investing in hedge funds and we had trouble with a CTA as we wanted to move from a highly levered fund to one of his lower levered funds. It took forever for this manager to execute a simple request and here we are talking about a CTA who invests in highly liquid instruments! I called him a few times and warned him that we weren't pleased at all and he gave me some lame excuse that the funds were tied up with his administrator.

News flash for all you overpaid hedge fund Soros wannabes out there. When an institutional investor wants to redeem, please stop the lame excuses on your pathetic performance and don't get cute on pricing. In fact, you should be bending over backwards to accommodate these investors on the way out just as hard as when you were schmoozing them when you wanted them to invest in your fund.

As always, if you have anything to add on this case, you can email me at Let me end by plugging a couple of Montreal firms that specialize in operational due diligence for hedge funds, Castle Hall Alternatives run by Chris Addy and Phocion Investments which is run by Ioannis Segounis, his brother Kosta, and David Rowen (Phocion specializes in performance, operational and compliance due diligence. In fact, performance analysis is Phocion's bread and butter which gives them a real edge over their competitors).

As far as a managed account platform, Montreal's Innocap is still around and provides excellent services to institutional investors looking to gain more transparency on their hedge fund investments and significantly mitigate their operational and liquidity risks (for a small fee, of course, and Innocap also makes sure the hedge fund managers are properly pricing all their investments on a daily basis and raise flags if they see discrepancies in the pricing).

Below, an older Senate Banking Committee (1998) where you will hear testimony from Brooskley Born, the former head of the CFTC discussing operational risk at large hedge funds investing in the OTC derivatives market. It's too bad President Clinton, Alan Greenspan and Robert Rubin never heeded her warning and foolishly marginalized her. She would agree with me and tell all investors to beware of large hedge funds, now more than ever.

Wednesday, September 30, 2015

Who Gets The Last Laugh on Stocks?

Myles Udland of Business Insider reports, Bill Gross is literally laughing at the stock market:
Bill Gross is literally laughing at the stock market.

In a tweet on Tuesday morning, Janus Capital's Bill Gross said: "Stock market refrain from a few months ago: "Where else are you gonna put your money?" LOL ... Ever considered cash?"

Put another way, Gross is laughing at people who invested in the stock market because there was nothing else to invest in.

Folks who have been reading Gross' investment updates over the past year or so most likely know that Gross would prefer holding cash to being invested in the stock market — or almost anything else.

Early in September, Gross' monthly missive basically said everything sucked.

Gross wrote:
Global fiscal (and monetary) policy is not now constructive nor growth enhancing, nor is it likely to be. If that be the case, then equity market capital gains and future returns are likely to be limited if not downward sloping. High quality global bond markets offer little reward relative to durational risk. Private equity and hedge related returns cannot long prosper if global growth remains anemic. Cash or better yet "near cash" such as 1-2 year corporate bonds are my best idea of appropriate risks/reward investments. The reward is not much, but as Will Rogers once said during the Great Depression – "I'm not so much concerned about the return on my money as the return of my money."
Early Tuesday, stocks were falling after getting crushed on Monday.
I guess we can add the former bond king to a growing list of investment gurus warning of a looming catastrophe ahead. The only problem is the stock market is laughing right back at Bill Gross and other doomsayers.

In fact, ever notice how every time we get a big pullback in stocks you get all these dire warnings from gurus that the worst is yet to come? Sure, stocks are getting clobbered and some sectors like biotech just experienced a real drubbing in Q3 but if you ask me, it's better to ignore these dire warnings from eminent "investment gurus" and remember the wise words of the late comic genius George Carlin: "It's all bullshit and it's bad for you!".

That's right folks, there is so much nonsense and misinformation being spread out there from informed sources that it's no wonder many retail and institutional investors are having a hard time navigating through these volatile markets. And some of the best and brightest are taking a real beating this year.

Take the time to read my recent comment on the looming catastrophe ahead.  I cleaned up some typos and dates I got wrong but my message remains the same. In fact, I was listening to Jim Cramer on CNBC this morning (cynics call him the king of bullshit but he has spurts of great insights) and he made a few excellent points on how Tuesday was the fiscal year-end for mutual funds and many sold stocks for tax reasons and how these markets are highly illiquid, exacerbating downside moves.

What else? Tim O'Neill, Goldman Sachs' partner and global co-head of the investment management division, has a warning: If passive investing gets too big, then the stock market won't work.

I should know, I trade biotech stocks and have seen huge and unbelievable downside moves which makes me highly suspicious that either Fidelity (the biggest biotech investor in the world) is playing games here to "shake out weak hands" or there was some big hedge funds suffering from redemptions and forced to close out their big leveraged biotech bets. Either way, I'm not panicking here and prefer to sit tight and ride out this storm.

On Wednesday, things are looking much better. Sure, we're heading into the dreaded month of October but I'm confident the worst is behind us, especially in the biotech sector which everyone now loves to hate. Pay close attention to the iShares Nasdaq Biotechnology (IBB) and the SPDR S&P Biotech ETF (XBI) as I think they are going to bounce big from these way oversold levels once these markets stabilize (click on images):

Keep in mind the former is made up of large biotech stocks and leads the latter which is made up of smaller biotech stocks and is thus a lot more volatile. The same goes for the ALPS Medical Breakthroughs ETF (SBIO). It too is made of small cap biotech shares which swing like crazy (all biotech stocks are definitely not for the faint of heart).

Below, I list a few small biotech companies I track and trade. Some are way oversold and look terrible from a technical point of view but I'm confident many will recover from the latest biotech bloodbath (click on image):

There are plenty more but the truth is this sector just experienced a good thrashing and it scared the crap out of many investors. Still, if you think the rout in biotech is awful, check out the carnage in energy (XLE) and metals and mining shares (XME) or even in top hedge fund picks like Sun Edison (SUNE). OUCH!!

Below, CNBC's Brian Sullivan looks at how much market cap has been lost by the big oil companies during the commodities crush. In his latest comment, We’ve Seen This Picture Before—–Global Markets Down $13 Trillion Already, David Stockman warns the worst is yet to come.

I prefer listening to the ageless wisdom of George Carlin than all these so-called investment experts.  He nails it in the clip below and if you need a good laugh to get your mind off markets, watch it.

Tuesday, September 29, 2015

Ontario Teachers’ Eyes London Expansion?

Joseph Cotterill of the Financial Times reports, Ontario Teachers’ eyes London expansion:
Ontario Teachers’, the Canadian pension plan that owns the UK’s High Speed One railway and its National Lottery operator, is planning to expand further in London, tripling the size of its European investment team.

It revealed on Thursday that it aimed to grow its private equity arm by adding staff in infrastructure and in what it calls “relationship investing” — investing in public or nearly-public companies and working closely with the managers.

Teachers’, which has $160bn in assets, this month moved from Leconsfield House, MI5’s former haunt, into a bigger steel-and-glass building overlooking Marylebone’s leafy Portman Square.

Its expansion is expected to lead to further purchases in the UK, where it also owns Birmingham and Bristol airports.

“We own four airports, so why wouldn’t we look at London City Airport?,” says Jo Taylor, Teachers’ European head, highlighting one asset that is coming to the market. (Teachers also owns Brussels and Copenhagen airports.)

“If an asset like London City became available, or an asset like HS2 [HS1’s potential successor] became available for funding, clearly we would be interested,” he adds.

Ontario Teachers’ is one of a rare breed of pension fund investors — many of them Canadian — that are using in-house teams to find and buy assets independently, or alongside buyout firms, as well as paying fees to traditional third-party funds.

They are increasingly seen by some buyout managers as rivals in a market where prices are high and deals scarce.

“They’re the poster boy, the role model if you like, for increasingly active investors in private equity,” says Stephen Gillespie, a partner at Gibson Dunn.

Mr Taylor, a veteran of 3i, the British buyout firm, prefers to talk about partnership.

Expanding in London, in a timezone where the fund can quickly give feedback on investment offers, provides “the ability for us to develop strategic relationships for the plan over the long term”, he says. “Teachers’ is very much focused on partnering.”

Last year it invested in CSC, a coin-operated laundry machine company owned by Pamplona Capital Management. Last week it continued the relationship, buying a stake in Pamplona’s OGF, France’s biggest operator of funeral parlours.

The nature of these businesses — unglamorous, but with inflation-busting cash flows — is not the private equity norm.

Part of the reason Teachers’ has become a large investor in infrastructure — typically a long-term investment — is that its private market returns have to protect future payouts to its more than 300,000 pension members. Public-sector pension plans must be fully-funded under Canadian law. (LK: this is false, only true in the Netherlands)

Ron Mock, chief executive, says the UK is the “model that the rest of the world follows” on infrastructure investment policy.

“It’s about clarity of outcome, it’s the regulatory environment,” he adds. “There’s not a lot of, or hardly any, renegotiation after a deal is done.”

But in both infrastructure and private equity, asset prices are high, as capital is flooding into what are inherently scarce assets from low-yielding public markets.

In buyouts, some question whether Teachers’ edge is simply overpaying and reducing its future returns.

Teachers’ view is that it takes a different perspective to traditional private equity firms by holding investments for the longer term.

Private equity firms can often own businesses for half a decade or more — but the limited lives of funds means they have to sell within a set period.

The nature of leverage, used to juice returns, can also make funds unwilling to inject more capital after the first investment.

“We can provide multiple subsequent rounds of capital,” Mr Taylor says. “We can hold an asset for seven, 10, 12 years . . . we look at these projects with a conservative approach. We’re more likely to apply lower levels of debt.”

In terms of Teachers’ returns, Mr Taylor says the fund has a 24-year record in private equity of 20 per cent net returns.

There is some academic evidence to back this up. In 2014 a Harvard Business School paper found ‘solo’ direct investments in private equity by seven anonymous large institutional investors returned more than public markets between 1991 and 2011.

Although these deals fared better than co-investing in companies alongside private equity managers, their outperformance versus investing in buyout funds was more mixed.

“While direct investments consistently outperform the market, they do not regularly outperform other private equity investments,” the paper argued.
This is an excellent article but let me go through some of my thoughts. First, unlike the Netherlands, there are no laws forcing public sector pension plans in Canada to be fully-funded. It's too bad because I think everyone should be going Dutch on pensions, including our much touted Canadian funds which are global trendsetters.

Second, I have mixed feelings about Canadian pension funds opening up offices in London, New York, Hong Kong or elsewhere. On the one hand, I understand why they need "boots on the ground" but is it really necessary, especially if they have solid partners in these regions to work with? I'm not convinced about opening up foreign offices and paying people a lot of money for a job that can be done by pension fund professionals in Canada working with solid partners (here I prefer PSP's approach than CPPIB's and Teachers'). But if it works and helps reduce fees, maybe there is a rationale for such an approach.

Third, while direct investments in private equity do not regularly outperform other private equity investments, more and more private and public companies are looking for a long-term partner like Ontario Teachers' when it comes to improving their operations. Even private equity funds are thinking long-term these days, emulating Buffett's approach.

But don't kid yourself. Mark Wiseman, president and CEO of CPPIB, told me a few years back that Canada's pension fund invests and co-invests with top private equity funds because he "can't afford to hire a David Bonderman." However, in infrastructure, he told me CPPIB goes direct like most of Canada's large pension funds.

Fourth, Ron Mock, the president and CEO of Ontario Teachers', sounded the alarm on alternatives in late April. He knows the current environment is extremely difficult for liquid and illiquid investments but he and his team are always on the hunt for reasonably priced prize assets, especially in infrastructure.

In fact, Ron clearly explained OTPP's asset-liability approach to investing when we chatted about the plan's exceptional 2014 results. Everything at Teachers' is about matching assets to liabilities. So, when I read that Teachers' recently bought a stake in a French funeral business, I wasn't surprised. These type of businesses aren't glamorous but they provide steady cash flows over a long period, just like infrastructure.

Let me end this comment by plugging a firm in Toronto, Caledon Capital Management. I recently met three partners -- David Rogers, Stephen Dowd and Jean Potter -- here in Montreal and was thoroughly impressed with their approach in helping small and medium sized pension plans and family offices gain a foothold in infrastructure and private equity.

Prior to founding Caledon, David was the SVP at OMERS' Private Equity and Stephen was the SVP, Infrastructure and Timberland, at Ontario Teachers' before he joined Caledon last year. Together, they have years of experience working at public pensions which gives them an advantage when they assist their clients on board investment committees, helping them invest in these alternative asset classes.

[Footnote: David Rogers is one of the nicest guys I ever met in the pension fund industry and he helped Derek Murphy, PSP's former SVP of Private Equity, and I a lot when we prepared the board presentation on private equity back in 2004. Derek, if you're reading this, contact David at

Also worth noting that Guthrie Stewart joined PSP Investments in September 2015 as Senior Vice President, Global Head of Private Investments. He will be replacing Derek Murphy in this new role and you can read about him here.]

Below, I embedded a May 2015 Bloomberg interview with Ron Mock, CEO of Ontario Teachers'. Listen carefully to his comments as you track the latest moves from this exceptional pension plan.

As always, please remember to subscribe and/ or donate to this blog via PayPal at the top right-hand side and support my efforts in bringing you the very best insights on pensions and investments. I thank all of my institutional supporters who value the work I provide them with.

Monday, September 28, 2015

A Looming Catastrophe Ahead?

Caroline Valetkevitch of Reuters reports, Wall Street braces for grim third quarter earnings season:
Wall Street is bracing for a grim earnings season, with little improvement expected anytime soon.

Analysts have been cutting projections for the third quarter, which ends on Wednesday, and beyond. If the declining projections are realized, already costly stocks could become pricier and equity investors could become even more skittish.

Forecasts for third-quarter S&P 500 earnings now call for a 3.9 percent decline from a year ago, based on Thomson Reuters data, with half of the S&P sectors estimated to post lower profits thanks to falling oil prices, a strong U.S. dollar and weak global demand.

Expectations for future quarters are falling as well. A rolling 12-month forward earnings per share forecast now stands near negative 2 percent, the lowest since late 2009, when it was down 10.1 percent, according to Thomson Reuters I/B/E/S data.

That's further reason for stock investors to worry since market multiples are still above historic levels despite the recent sell-off. Investors are inclined to pay more for companies that are showing growth in earnings and revenue.

The weak forecasts have some strategists talking about an "earnings recession," meaning two quarterly profit declines in a row, as opposed to an economic recession, in which gross domestic product falls for two straight quarters.

"Earnings recessions aren't good things. I don't care what the state of the economy is or anything else," said Michael Mullaney, chief investment officer at Fiduciary Trust Co in Boston.

The S&P 500 is down about 9 percent from its May 21 closing high, dragged down by concern over the effect of slower Chinese growth on global demand and the uncertain interest rate outlook. The low earnings outlook adds another burden.

China's weaker demand outlook has also pressured commodity prices, particularly copper.

This week, Caterpillar slashed its 2015 revenue forecast and announced job cuts of up to 10,000, among many U.S. industrial companies hit by the mining and energy downturn. Also this week, Pier 1 Imports cut its full-year earnings forecast, while Bed Bath & Beyond gave third-quarter guidance below analysts' expectations.

"We are continuing to work through the near-term issues stemming from our elevated inventory levels and have adopted a more cautious and deliberate view of the business based on our first-half trends," Jeffrey Boyer, Pier 1 chief financial officer, said in the earnings report.

On the other hand, among early reporters for the third-quarter season, Nike shares hit a record high after it reported upbeat earnings late Thursday.

Negative outlooks from S&P 500 companies for the quarter outnumber positive ones by a ratio of 3.2 to 1, above the long-term average of 2.7 to 1, Thomson Reuters data showed.

"How can we drive the market higher when all of these signals aren't showing a lot of prosperity?" said Daniel Morgan, senior portfolio manager at Synovus Trust Company in Atlanta, Georgia, who cited earnings growth as one of the drivers of the market.

To be sure, the vast majority of companies usually exceed their earnings forecasts when they report real numbers.

"This part in the earnings cycle is typically the low point for estimates," said Greg Harrison, Thomson Reuters' senior research analyst. In the first two quarters of 2015, companies went into their reporting season with analysts predicting a profit decline for the S&P 500, and in both quarters, they eked out gains instead.

In the last two weeks, analysts have dropped their third-quarter earnings predictions by about 0.3 percentage point. There was no change in estimates in the final weeks of the quarter in the first two quarters of 2015.

And companies may be snapping their streak of squeezing profits out of dismal revenues. For the first time since the second quarter of 2011, sales, seen down 3.2 percent in the third quarter from a year ago, are not projected to fall as fast as earnings. Companies have been bolstering their earnings per share figures by buying back their own shares and thus reducing their share counts, and that may happen again this quarter.


Even with the recent selloff, stocks are still expensive by some gauges. The S&P 500 index is selling at roughly 16 times its expected earnings for the next 12 months, lower than this year's peak of 17.8 but higher than the historic mean of about 15. The index would have to drop to about 1,800 to bring valuations back to the long-term range. The S&P 500 closed at 1,931.34 on Friday.

Moreover, forward and trailing price-to-earnings ratios for the S&P 500 are converging, another sign of collapsing growth expectations. The trailing P/E stands at about 16.5, Thomson Reuters data shows. Last year at this time, the forward P/E was also 16 but the trailing was 17.6.

The last period of convergence was in 2009 when earnings were declining following the financial crisis.

The 3.9 percent estimated decline in third-quarter profits - down sharply from a July 1 forecast for a 0.4 percent dip - would be the first quarterly profit decline for the S&P 500 since the third quarter of 2009.

Energy again is expected to drag down the S&P 500 third-quarter forecast the most, with an expected 64.7 percent decrease in the sector. Without the energy sector, the forecast for third-quarter earnings shows a gain of 3.7 percent.

Earnings for the commodity-sensitive materials are expected to fall 13.8 percent, while industrials' earnings are seen down 3.6 percent.
No doubt, stock market investors are bracing for an earnings recession or possibly worse. Akin Oyedele of Business Insider reports, A radical shift is coming to the markets:
The days of double-digit returns are over.

Lisa Shalett, head of investment/portfolio strategies for Morgan Stanley Wealth Management, said at a press briefing on Tuesday that since the end of the financial crisis, investors have enjoyed healthy returns on stocks and bonds, partly because of the Federal Reserve.

But that's about to change.

Shalett said:
"Over the last six and a half years, the S&P 500 has compounded roughly 15%, at the same time that the US bond market has compounded at 9% ... So if you had a balanced portfolio of stocks and bonds, you experienced superior returns, and that portfolio had double-digit returns.

Our outlook is that that balanced portfolio that delivered those double-digit returns probably over the next five to seven years is going to return something a lot closer to four to six percent. "
The Federal Reserve's bond-buying program, known as quantitative easing, together with low interest rates, made it easy for corporations to borrow money and encouraged investors seeking higher returns to invest in riskier assets like stocks.

Now that the stimulus is gone and the Fed is in a "tightening bias" — implying that even if the Fed isn't raising rates it isn't making policy any more friendly for businesses — asset prices could begin to reflect a value that is unsupported by monetary policy.
Indeed, last week was another ugly one hitting many sectors, including high-flying biotech shares which got clobbered on Friday, dragging down the Nasdaq and S&P 500.

Below, I'm going to go over a few sectors and wrap it all up at the end with some thoughts. First, let's look at some ETFs I regularly monitor (click on image):

As you can see, apart from the iPath S&P 500 VIX ST Futures ETN (VXX) and government bonds (TLT), all sectors are now in a downtrend (relative to their 200-day moving average). This doesn't portend well for the overall market and it hardly surprises me that analysts are revising down their earnings estimates as they tend to react to price action, not lead it.

Let me go over some of these sectors below, beginning with the biotech sector since it got slammed the hardest last week weighing down major indices.

Biotech: It was a bloodbath in biotech last week. The week didn't start well with Democratic candidate Hillary Clinton crushing biotech stocks after tweeting  she promised to unveil a plan on Tuesday to take on "outrageous" price increases, referring to this New York Times article.

If you ask me, after hearing her speak, that was much ado about nothing. Still, biotech shares kept getting slammed and it was particularly ugly on Friday afternoon as I watched over 200 biotech shares getting clobbered. Below, I provide you with a list of some of the hardest hit biotech stocks as of Friday (click on image):

Interestingly, among the biggest movers on Friday were two biotech stocks, Bellerophon Therapeutics (BLPH) and Prima Biomed (PBMD) and the short biotech ETFs, namely, the ProShares UltraPro Short Nasdaq Biotech (ZBIO), ProShares UltraShort Nasdaq Biotech (BIS)
and the Direxion Daily S&P Biotech Bear 3X ETF (LABD).

There were plenty of bearish articles pointing out that biotech stocks have fallen into bear market territory as the Nasdaq Biotechnology Index is down more than 22% from its peak in July. The decline is roughly double the losses of the S&P 500 and the Nasdaq over the same period.

If you look at the chart of the Nasdaq Biotechnology Index (IBB), you will see how after it hit an intra-day low of 284 a month ago, it surged higher to its 50-day moving average and then started sinking again, going below its 200-day moving average and it might even go below its 400-day moving average this week which I use to gauge the longer trend (click on chart):

The huge drop in biotech shares is also weighing down the Health Care Select Sector SPDR ETF (XLV) which was one of the outperformers this year but is now in bear territory (click on image):

Despite the vicious selloff, I'm sticking with my call from a month ago, namely that now is the time to load up on biotech. However, I'm looking at that 284 low the biotech index made a month ago and I realize this sector is extremely volatile especially in these Risk On/ Risk Off markets dominated by algorithmic trading (Cramer was right, China could cause biotech stocks to plunge) .

Still, if you ask me, in a deflationary environment, there's a lot more risk in energy and commodity stocks than biotech stocks and even though it's counterintuitive, I'm more comfortable buying the big dips in biotech than bottom fishing in energy and commodities. Despite huge volatility, the former sector is still in a secular bull market while the latter two are already in a deep bear market.

Energy, commodities and emerging markets: These sectors are all inter-related and it's pretty much a China story. Regular readers of my blog know I'm not bullish on emerging markets (EEM), Chinese shares (FXI), energy (XLE), oil services (OIH), metal and mining stocks (XME) and have warned my readers that despite counter-trend rallies, they are better off steering clear of these sectors.

Have a look at the charts of these below which paint an ugly picture as most are already in a deep bear market (click on images).

Emerging Markets (EEM)

iShares China Large-Cap (FXI)

Energy Select Sector SPDR ETF (XLE)

Market Vectors Oil Services ETF (OIH)

SPDR S&P Metals and Mining ETF (XME)

As bad as these charts look, there are plenty of investors betting big on a global recovery. Over the weekend, I read that hedge funds are primed for an oil rebound, increasing their bullish bets. If I were them, I'd pay close attention to what Pierre Andurand is saying as he sees crude prices falling below $30 a barrel.

And if you look at the stocks I posted in my comment on betting big on a global recovery, you will see most keep making new 52-week lows (click on image):

This is why I keep telling you it's better to wait for a turnaround in global PMIs before you stick your neck out and bottom fish in these sectors. If the global economy, especially China, starts showing signs of a turnaround, you will see a major countertrend rally in all these sectors.

Industrials: This sector is also related to China and others mentioned above. In an ominous sign of the times, Caterpillar Inc. (CAT) slashed its 2015 revenue forecast last Thursday and said it will cut as many as 10,000 jobs through 2018, joining a list of big U.S. industrial companies grappling with the mining and energy downturn.

Have a look at the charts of  Caterpillar Inc. and the Industrial Select Sector SPDR ETF (XLI) below and you will see pretty much the same weakness as the sectors above (click on images):

Financials: Interestingly, financial shares (XLF) fared pretty well last week, especially on Friday following news that the Fed might raise rates but on Monday they resumed their downturn and the way markets are heading, I strongly doubt we will see a Fed increase this year which is why I see continued weakness in this sector (click on image):

Related to financials is the retail sector (XRT) which remains relatively weak as most consumers are debt-constrained and petrified of losing their job, putting off spending (click on image):

There is one bright spot for financials, however, and that is housing. If you look at the SPDR S&P Homebuilders ETF (XHB), you will see it's holding up relatively well (click on image):

But Wall Street's big bet on housing isn't paying off and this sector is vulnerable to a rate increase and more importantly, to rising unemployment. So far, the U.S. economy is doing relatively well but that can all change abruptly, especially if we get a market crash.

[Update: The SPDR S&P Homebuilders ETF (XHB) is down almost 5% on Monday after pending home sales tumbled in August.]

Utilities, REITS and dividend yielding sectors: These sectors are sensitive to interest rates and tend to do well as long as the Fed stays put. But even their chats don't inspire much confidence in these markets and they are vulnerable to any good news on the global economic front (click on charts).

As you can see, consumer staples (third chart; ticker is XLP) are doing relatively well in a tough market but in my opinion, this is more of a Risk Off and flight to safety trade than conviction buying.

Bonds: Good old government bonds (TLT) continue to do relatively well and provide investors with the ultimate hedge against deflation and the ravages of markets (click on chart):

What isn't doing well is the high-yield corporate bond market (HYG) and that concerns many investors, including the bond king, Jeffrey Gundlach who has warned the Fed to stay put as long as the junk bond market remains weak (click on image):

Gold will shine again?: If you've been reading Zero Hedge and firmly believe the world is coming to an end and that we're heading to "QE Infinity", then now might be a good time to load up on gold shares (GLD). But I'm not in that camp and think that the latest rally in gold will peter out again once markets stabilize following some good economic news (click on chart):

In fact, as you watch all the gloom and doomers parading on television, pay close attention to this chart on volatility (VXX) below as I think we're in for a bit more pain but things will reverse course fast once it hits its 400-day moving average (click on image):

Conveniently and not surprisingly, this selloff is happening at quarter-end. I would be very careful here not to overreact to what's going on in markets, especially in extremely volatile sectors like biotech which experience sharp selloffs followed by huge rallies.

In the short-run, I expect to see a rally in the S&P 500 (SPY) right back up to its 400-day moving average (click on image):

Whether or not it goes higher remains to be seen as the overall market is weak and there's a risk we will see a major bear market if things go awry from here on.

Below, CNBC's Scott Wapner reports on billionaire investor Carl Icahn's warning of a potential looming catastrophe. Wapner shows an extract of the video going over 5 things that keep Carl Icahn up at night (second clip).

Icahn also spoke with Andy Serwer of Yahoo Finance stating it's going to be a real bloodbath and going over a policy paper on income inequality that the billionaire financier recently sent to Donald Trump and others on Wall Street and in Washington.

In the paper, Icahn warns of “dangerous systemic problems that will affect each and every American in the coming years.” The five and a half page paper has some similarities to the video that Icahn is releasing on, but focuses more on imbalances in our society.

While I agree with Icahn on the buyback bubble exacerbating inequality, take these ominous warnings on markets by hedge fund gurus with a shaker of salt and pay attention to their portfolios, not what they're warning of on CNBC. Icahn is betting big on a global recovery and he's right to hedge as he's losing his shirt on energy and commodity shares.

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