Tuesday, August 30, 2011

Did Bonds Just Peak?

One of my favorite strategists, Jim Bianco of Bianco Research, was on Yahoo Breakout on Tuesday urging caution as he expects more losses to come:

A week ago the market was gripped with fear and talk of a "retest" of the August lows of 1100 filled the airwaves. Today, markets are surging and the bulls are giddily predicting a run to S&P 1250, 1300 and beyond.

Building on last week's 4.7% gain, the S&P was recently up 2.83% to 1210 while the Dow was higher by 2.26%.

Bucking the rising trend, Jim Bianco of Bianco Research says investors should take a "risk-off attitude."

While most observers (and investors) focus on the equity market, Bianco is focused on the credit markets, which he notes "continue to worsen" and are "not confirming a bottom in stocks."

Clearly, there's not nearly as much stress in credit markets today as in 2008, but Bianco sees similarities between the current environment and the summer of 2008, when the stock market was "attempting rallies" even while the credit market worsened. "Eventually, the stock market gave it up and corrected back to the credit markets," he recalls.

While Bianco is not predicting the kind of "calamity" that befell stocks in 2008 and early 2009, he expects the stock market will soon revisit its August lows, and possibly break below them with risk to S&P 1070. This negative view is buttressed by a forecast the economy will soon slide into another recession, meaning "the $100 per share earnings consensus estimate for the S&P 500 might be 30% to 40% too high."

In sum, Bianco believes investors are better off selling this rally and positioning themselves for another downdraft by sticking with defensive stocks like utilities. "There isn't a safe place [to hide]," he says. "I expect more losses to come. Returns between now and year-end will have a minus sign."

Given that fairly dire outlook, Bianco continues to recommend short-term Treasuries, even at today's miniscule yields. "You're not getting any return but there's no downside risk," he says.

Jim is a great guy and I absolutely love his research. He might be right, credit markets have led the stock markets so this rally could fizzle or remain range-bound (perfect for traders). Having said this, don't be surprised if stocks keep grinding higher, especially large cap tech stocks which just clobbered in the first two weeks of August. I also wouldn't be surprised to see credit spreads come in the next few months as investors dive into corporate bonds and the US economy slowly improves.

Another thing that caught my attention was Bill Gross's mea culpa, prompting Brett Arends of MarketWatch to ask, Did bonds just peak?:

They say the time to sell is when the last bear turns bullish.

When it comes to U.S. Treasury bonds, did that just happen?

Bill Gross, the world’s most famous bond manager, has now fessed up that he made a blunder when he turned bearish on the bonds last winter. Gross says his bet against Treasurys was a “mistake” and that he had been “losing sleep” over it this summer. Read the story about Gross losing sleep on the Wall Street Journal web site.

Treasury bonds have been booming to higher and higher prices for months, as fears have grown of a new recession and a deepening financial crisis.

Bonds work like a seesaw, so when the prices go up, the yield, or interest rate, goes down. Today the interest rate on 10-year Treasury notes (ICAPSD:10_YEAR) has plummeted to just 2.2%. The 30-year bond (ICAPSD:30_YEAR) pays a mere 3.5%. These are at, or near, historic lows.

The “real yield” on inflation-protected Treasuries, known as TIPS, has collapsed as well. Short-term TIPS now lock in a guaranteed loss of purchasing power. Even long-term TIPS don’t pay you much over inflation.

In the circumstances, it’s easy for commentators to throw rotten eggs at Gross.

But successful investment management is like successful poker playing. It isn’t about predicting the future. It’s about understanding the odds — and the other players. And when Gross got out of Treasuries he was making a reasonable decision, based on the prices at the time and the scenarios in front of him.

Uncle Sam is basically broke. The national debt, which was $3 trillion a generation ago, is up to about $15 trillion. Within five years it is forecast to pass $20 trillion.

More importantly, our political system has become a farce. Neither party has any serious intention of dealing with the deficit. Witness the childish and surreal attitudes toward taxes and the Pentagon.

The “super committee” created a month ago is just a feel-good bedtime story you tell to children, which is who we now are.

In the circumstances the only recourse left is for Ben Bernanke to clip the coins — in other words, to print more dollars to cover the shortfall.

Sooner or later that is going to smoke bondholders. It has already trashed the U.S. dollar.

Why would anyone lend to such an entity for 30 years at 3.5% interest? Or even for 10 years at 2.2%?

As the late Herbert Yardley once wrote, in the classic “Education of a Poker Player,” I wouldn’t bet on that hand with counterfeit money. You’re taking on the risk of a big loss in return for the hope of a small gain.

If you’re playing your hand on behalf of widows, orphans and other bond-fund investors, you don’t try to bluff too often. And you don’t draw to an inside straight.

Why have Treasuries boomed?

I suspect there are three reasons.

First, investors around the world still believe in the American Empire. They haven’t worked out that the game is up. And so when they smell crisis they still run to the Treasury market.

Second, many investors here are still hung up on Modern Portfolio Theory, which tells them aging Baby Boomers should be buying more bonds, regardless of the price. Every month they sock more money into their bond funds, merrily trusting that “bonds are safe.” Tell that to anyone who bought government bonds in the Fifties, before the great inflation. Tell that to anyone who has lent money to any number of European governments — from Greece to Ireland to Italy.

The third reason? Many private investors are succumbing, once again, to the biggest single mistake in the markets — performance chasing. In effect they are saying: “Look — bonds have done really well, so we should get on board!” You may be surprised that anyone could be so foolish, but believe me, an amazing number of investors really do think that way. The momentum can even make them look good — for a while.

Diehard bears argue that US Treasurys will keep rising, just as Japanese Government Bonds did in the Nineties, to the point where long-term yields fell below 1%.

But there are problems with that analogy. Yes, the Japanese government ran huge deficits while its bonds boomed. But Japanese society didn’t: The country ran a trade surplus every year, and households saved and saved. The contrast with the ailing American Empire could scarcely be more stark.

If you want to own government bonds, you’re probably better off buying them from a country with a grown-up political system. Norway’s bonds actually pay a higher rate of interest than Treasuries — and Norway has a balanced budget, and no national debt. No kidding.
I got nothing against Norwegian bonds as Norway's new oil finds shield it from economic gloom. But the article above is fraught with mistakes. First, I don't care about what any credit agency says, the United States of America isn't broke, will never be broke and will never default on its debt. The tea party wanted this t happen but it won't.

Second, don't fight the Fed. Ever heard of that mantra? Even the biggest and most aggressive hedge fund in the world is no match for the Fed. The Fed doesn't collect 2 & 20, but their job is to make sure banks make a killing by borrowing at zero at the short end, investing in bonds, locking in spread, and trading risk assets all around the world.

Just look at the OCC's latest quarterly report on bank trading and derivatives activity for Q1 2011. Here are the highlights:
  • U.S. commercial banks reported trading revenues of $7.4 billion in the first quarter, 10% lower than $8.3 billion in the first quarter of 2010. Trading revenues in the first quarter of 2011 were 113% higher than in the fourth quarter of 2010.
  • Trading risk exposure, as measured by value-at-risk (VaR), has declined for each of the five major dealers on a year-over-year basis. Aggregate average VaR at these banking companies has fallen 21%, from $852 million in the fourth quarter of 2010, to $677 million.
  • Credit exposure from derivatives decreased in the first quarter. Net current credit exposure fell 6% or $23 billion from the fourth quarter of 2010, to $353 billion.
  • The notional value of derivatives held by U.S. commercial banks increased $12.8 trillion, or 5.5%, from the fourth quarter of 2010 to $244 trillion. The notional value of derivatives is 12.7% higher than a year ago.
  • Derivative contracts remain concentrated in interest rate products, which comprise 82% of total derivative notional values. Credit derivatives, which represent 6.1% of total derivatives notionals, increased 5.3% to $14.9 trillion.
Unfortunately, the second quarter report has yet to appear but trading revenues were down. And keep this in mind, banks couldn't care less about lending money to small & medium-sized businesses (SMEs). Loans are long-term and illiquid. They want their investment bankers and prop traders to crank it up and start producing trading and investment banking revenues. The Fed is supporting them, giving the banks a 2-year green light to keep trading, trying to reflate risk assets and introduce mild inflation in the system.

Finally, and most importantly, in this environment, the main threat remains deflation, not inflation. In January 2009 I openly criticized this ridiculous notion that there is a bubble in bonds and continue to warn investors that this is the biggest misconception out there. If debt deflation grabs hold, you'll be lucky to lock in your money at a little over 2% over the next 10 years. And all those pensions piling into alternative investments are going to get clobbered as bonds outperform every other asset class. Below, I embedded the Jim Bianco interview. I doubt he buys the argument that bonds have peaked, but at least he doesn't see a second wave of the financial crisis any longer.

Monday, August 29, 2011

AAA: Pensions Turning to Alternatives

Online PR Media reports, AAA: Pensions Portfolios Turning To Alternative Investments:
The results of a new poll indicating that more pension portfolios are investing in alternatives has been welcomed by Alternative Asset Analysis (AAA).

The recent SEI Quick Poll shows that the percentage of executives from pension funds claiming to have investments in alternatives has increased to 78 per cent, from 51 per cent in 2008. This percentage rose to 53 per cent in 2009 and to 65 per cent last year.

Anthony Johnson, an analysis partner for AAA, an alternative investment advocacy group, said, “These figures show an impressive increase in the past year, compared with the increases measured over the previous few years.

“This seems to support our suggestions that more pension funds are moving toward alternatives this year as they offer a safer haven in light of current instability on the stock markets.”

Chief Actuary at SEI’s Institutional Group, John Waite, said, "Alternative investments continue to be integrated into pension portfolios as another channel for mitigating risk, while providing additional return apparently.”

He added, “Ongoing volatility of interest rates continues to put liability risk as a primary concern for plan sponsors.”

He also stated that many fund managers seem to be slightly confused as to what the best investment strategy is during the current economic climate and are opting for a highly diversified approach. Many are investing in asset classes such as gold, antiques and forestry, which have all been performing well compared with traditional equities.

Forestry is a particularly interesting option for pension funds as there are often choices to invest in funds themselves or to buy forested land directly and gain returns when the trees in the timber plantation reach maturity and are sold off. Greenwood Management has several timber plantations in Brazil, where there is growing demand for non-native timbers for the domestic steel industry and for export to Asia, where markets for timber and forestry products are extremely strong and growing.

I cringe every time I read these polls about pensions moving into "safer," illiquid alternative investments. It is complete and utter nonsense to claim that alternative investments should be "integrated into pension portfolios as another channel for mitigating risk, while providing additional return.” If pensions don't know what they're doing, they're going to get clobbered with these alternative investments.

I know, those smart pension consultants are busy checking off the list, fitting you in a box. They'll shove you in private equity, infrastructure, real estate and now timber. These "geniuses" know nothing more than a one-size-fits-all approach for all their clients, even if in many cases it simply doesn't make sense.

Oh, and what about those volatile stock markets? So what? Big deal! If pensions are smart, they'll follow CalPERS' lead and ride out the big waves, buying the dips, especially in large cap risk stocks. That's exactly what I did in my personal portfolio over the last few weeks, trading each dip, and I couldn't care less what any pension consultant is recommending. I'll take my liquid approach over theirs any day of the week. Most of these pension consultants are clueless about why markets are so volatile.

If they actually did their homework, they'd figure out the extreme volatility was caused by high-frequency trading algorithms which made markets more volatile this summer, scaring investors away. It's all a bunch of nonsense, but pensions can hide in illiquid alternatives and claim they're "managing risk." This is pure rubbish. They're actually taking on illiquidity risk, and will end up paying a high price for their herd mentality. Now I understand why they call it "dumb money." They blindly scoop up whatever garbage pension consultants throw their way.

Sunday, August 28, 2011

Hedge Funds Surviving the HFT Hurricanes?

If you've been reading my blog religiously over the last few years, you probably noticed that even though I am pro hedge funds, there's a lot more smoke and mirrors in this industry than true alpha. I've warned all my readers not to get caught up in the hedge fund hype.

A while back, Bridgewater wrote a comment on how hedge funds are selling beta as alpha. I agree, most hedge funds are nothing more than huge asset gatherers, charging 2% management fee and a 20% performance fee but adding little to no alpha. It's all beta. Just look at Long/Short Equity, one of the more popular strategies, where most managers go long small cap stocks and short large caps. Why would a sophisticated institution pay 2 & 20 for something that they can synthetically manufacture internally? If it's a niche strategy worth paying fees for, fine, otherwise, forget it.

When I trade markets, I use my knowledge of hedge funds to understand violent moves to the upside or downside. For example, when hedge funds deleverage, sell small cap stocks, you can see a massive rush out of illiquid stocks, and violent downside moves -- sometimes as much as 80% in a few days. That's why oversold can become extremely oversold, especially in the summer when people are on vacation and trading is light. Totally irrational but that's the way this wolf market operates. Great for traders, terrible for buy & hold types waiting to make a decent return on their investments.

Moreover, when hedge funds go long a sector or stock, they have position and sector limits they must adhere to, but I don't. A long time ago, I wrote a comment on why small is beautiful in this market. It is so volatile that it's better to be small and nimble, making decisions quickly, than having to be a large pension fund that has to get approval by some investment committee to take sizable opportunistic bets.

I pay attention to hedge funds. Most are wrong but the elite ones are the best of the best and unlike other asset managers, they all have skin in the game. But even they are poor market timers. I like to spy on elite funds, whether they're long-only or hedge funds, and start from there to build a portfolio of stocks across all sectors that I put on my radar list, stocks that are ripe for trading.

I also realize that when too many hedge funds own the same basket of stocks, or are on the same side of the trade, this is usually a signal to bet against them. Again, the large majority of hedge funds are awful and don't deserve an allocation. if you keep that in back of your head, you'll do fine trading these markets.

So let's take a quick whirlwind tour of what's going on with hedge funds:
  • Reuters reports that August was shaping up as one of the worst months ever for some top hedge fund managers like John Paulson, but Warren Buffett may have changed that. According to Bloomberg, Paulson who is betting on an economic recovery by the end of 2012, has lost about 14 percent this month on a merger arbitrage hedge fund.
  • WSJ reports when hedge-fund honchos drop their fees, sometimes they don't give their clients much of a break. Billionaire investor Paul Tudor Jones II has decided to lower some fees charged by his largest hedge fund after years of grumbling by some clients, according to people close to the matter. But Mr. Jones, who runs hedge-fund firm Tudor Investment Corp., is raising other key fees charged by the fund.
  • One reason the high fees may not deter investors: Mr. Jones has managed to make money amid the market's recent tumble, scoring gains of more than 3% so far this month, according to investors. The reason: Mr. Jones has held a large slug of gold-related investments as well as bearish positions on stocks.
  • Reuters reports that hedge funds run by sophisticated computer programs are profiting from large falls in stock markets and a rocketing gold price this month, even as funds managed by human beings struggle to cope with high market volatility.
  • These "black box" funds are up 4.2 percent so far this month, according to Hedge Fund Research's HFRX index, while the average hedge fund is down 4.0 percent and managers betting on rising and falling stock prices have lost a hefty 7.3 percent on average.
  • The FT reports that event-driven is one of the least recognised hedge fund strategies and yet, over the long term, 25 per cent of hedge fund assets are allocated to it. Its diversification benefits from mainstream indices are the principal reason for its prevalence in hedge fund portfolios.
  • However, the article also quotes Stephen Harper, chief executive of Saguenay Strathmore Capital (SSC), a fund of hedge funds manager, as cautious, stating: “We like the strategy in principle but we started getting out of it in 2007 and early 2008. We were concerned about lurking beta in the strategy and the low M&A volumes so far this year have not changed our view.” SSC has reduced the event-driven portion of its multi-strategy funds to just 1-2 per cent.
  • Reuters reports, hedge funds, wary of more intervention by European stock market regulators, are being forced to rethink investment strategies as authorities decide whether to extend short-selling bans.
  • Finally, Bloomberg reports that speculators increased bullish bets on agricultural commodities to the highest level since early May after adverse weather eroded yield prospects for corn and soybean crops in the U.S., the world’s top grower and exporter.
  • Hedge funds and other speculators raised their net-long positions across 11 agricultural futures and options by 15 percent to 776,774 contracts in the week through Aug. 23, government data compiled by Bloomberg show. That’s the highest since May 6. Funds became bullish on wheat for the first time since June and wagers that soybeans will gain rose 64 percent.
What does all this tell me? Nothing really new except that most hedge funds are underperforming because they have way too much beta in their portfolio. Just like pension funds, mutual funds, and endowment funds, they too are suffering and licking their wounds as this summer's high-frequency trading (HFT) hurricanes have wreaked havoc on financial markets.

Finally, below, Alain Bokobza of Societe Generale, talks about how hedge funds' bearish bets against the Standard & Poor's 500 Index increased to the highest level since 2008 after this month's stock slump raised concern that economic growth is slowing. Remember what I said above, when hedge funds are all on the same side of the trade, expect a counter-reaction, which could mean violent bear market rallies.

It is my belief that all these institutions have to make up for August's savage losses. And how are they going to do it? By cranking up the risk dial, especially in liquid, large cap technology stocks. Markets will remain volatile, perfect for traders, but I remain long risk assets, short gold, and short volatility.

Saturday, August 27, 2011

Honoring "Grandpa Jack"

The Globe and Mail reports, Final tribute to Jack Layton celebrates his message of hope, optimism:
Jack Layton’s friends and supporters paid him fitting tribute Saturday afternoon. But again and again, his loved ones urged mourners to move on in his spirit, issuing a call to build real change out of his legacy.

That was Mr. Layton’s wish, planned before he succumbed to cancer in the early hours of Monday morning. And it came through loud and clear from his wife, Olivia Chow, who was not among the service’s eulogists but appeared instead in a video tribute played during the ceremony (see video below).

“Yeah I'm sad, we’re sad. But let us not look behind us, let us look forward,” Ms. Chow said in the video, while she watched from the front row. “I think that's a good way to celebrate his life.”

As much as ever, crowds followed the late NDP leader’s message of hope and optimism, both figuratively and literally. Groups of mourners ran alongside the hearse carrying his casket as it moved through downtown Toronto, led by a brigade of pipers and flag-bearers.

They came in droves, many dressed in orange, and cheered him as he went. Some wore “Thank You Jack” t-shirts, and others carried treasured objects Mr. Layton had given them years earlier.

Inside Roy Thomson Hall, some 1,700 invited guests and dignitaries and another 600 members of the public applauded gently as the casket was carried in.

The ceremony began in sombre fashion, and never lacked for tears. But it had moments of laughter as well, beginning with officiant Rev. Dr. Brent Hawkes pointing out his robes were red, not orange. Mr. Layton’s daughter Sarah rhymed off a list of ways her father had charmingly embarrassed his family - including “your fashion sense in those early years”.

Those in attendance at the funeral routinely rose to their feet for a series of standing ovations. And the ceremony was full of music – one of Mr. Layton’s passions – starting with a movement of G.F. Handel’s Messiah through a sparing but moving rendition of Leonard Cohen’s “Hallelujah” sung by Steven Page. Singer Lorraine Segato’s performance of “Rise Up” had spectators dancing outside in David Pecaut Square.

Stephen Lewis, who gave the first of three passionate eulogies, noted the way Mr. Layton died – “so suddenly gone, cruelly gone, at the pinnacle of his career.”

“Jack simply radiated an honesty,” Mr. Lewis said, something “we’ve been thirsting for.”

The service also paid tribute to Mr. Layton’s trademark stubbornness in pursuing his favourite causes, from homelessness and environmentalism to gay rights and HIV/AIDS campaigns. His son, Toronto city councillor Mike Layton, recalled his father’s refusal to turn back on disastrous father-son biking and sailing trips.

“This is how my father lived his whole life. ... He’d pour everything into achieving a goal,” the younger Mr. Layton said. “‘You can wait until you have perfect conditions,’ he said, ‘or you can make the best of what you’ve got now.”

Several of Mr. Layton’s political allies and opponents noted the spirit of the occasion had allowed old foes to stand together.

Dr. Hawkes tearfully recounted sitting with Mr. Layton the night before he died, and hearing the politician profess that “I’ve had a great and blessed life, but it has been far from perfection – I have made some mistakes.”

“He was in awe of the trust given to him of late,” when voters launched him into the Official Opposition in Parliament, Dr. Hawkes said.

But Mr. Layton also wanted desperately to help bring about an inclusive movement that would make Canada a more generous place, Dr. Hawkes said. Differing opinions would be welcome, but people would work with respect, with optimism in the face of defeats, and assuming the good intent in each other.

“If the Olympics can make us prouder Canadians maybe Jack’s life can make us better Canadians,” Dr. Hawkes said, before emerging from behind the lectern and pointing his finger at the thousands of mourners facing him.

“May we rise to the occasion, because the torch is now passed. The job of making the world a better place is up to us,” Dr. Hawkes concluded.

Following cremation, Jack Layton’s ashes will be spread in three different locations – one in Quebec, honouring his birthplace and site of the NDP’s political breakthrough, and two in his home city of Toronto.

The late Opposition Leader’s principal secretary Brad Lavigne, who is also an honourary pallbearer at Saturday’s state funeral, told The Globe a portion of the ashes will be planted with a memorial tree at the Wyman United Church cemetery in Hudson, Que., where Mr. Layton grew up.

Another portion will be scattered on the Toronto Islands, where Mr. Layton and Olivia Chow were married in 1988, and where a memorial tree will also be planted. The third portion of his ashes will be buried at St. James Cemetery in the city’s downtown.

After graduating from McGill in Montreal, Mr. Layton moved to Toronto to do his PhD at York University, later teaching political science at Ryerson. He served for many years as a municipal politician and was elected as the MP for Toronto-Danforth in 2004.

I watched some of the service today, including Stephen Lewis' incredible eulogy ("tough act to follow" indeed), and the moving eulogy of his daughter, Sarah, and son, Mike. Must admit, choked up and teared like crazy when Sarah spoke about "grandpa Jack." I felt her grief and love for her father and thought about my aging humble father who worries about me.

I will also openly admit that even though I never voted NDP in my life (came close last election but exercised my right not to vote instead), I always admired Jack Layton's authenticity and the generosity he radiated. He was a man of conviction and principles, a rare politician in an age of political cronyism.

My problem is that even though I'm a fiscal conservative and would introduce cuts to the federal government and amalgamate Crown corporations that would make Prime Minister Harper blush, I'm a fierce social liberal who believes in fighting for justice, especially for the poor, elderly, and disabled. I fundamentally believe that Canada has ways to go before we can truly call ourselves a "just nation." Unfortunately, the real unemployment scandal is thriving right here in good old Canada.

How do I know? Because I'm part of those unemployed and worse still, continuously struggle with discrimination based on the fact that I suffer from Multiple Sclerosis (MS). I don't let it get to me but I worry about our society and the hundreds of thousands of other disabled who aren't as blessed as I am and have been marginalized and castigated to a life of poverty.

I also think about pension poverty, an issue that I have championed through this blog with the help of others, and will continue to push hard on. I think the NDP and Liberals got it right with expanded CPP, and the Conservatives got it wrong pandering to banks and insurance companies. If you don't understand why the fuss over pensions, then you simply don't understand Jack Layton's vision of social justice. I think Jack would agree with me on this: why shouldn't all Canadians receive the same pension guarantees as the MPs and Ministers in Ottawa? Are we too stupid to see that we're heading down a road that leads to pension poverty?

As I watched the state funeral honoring this great Canadian, I noticed Charles ('Chuck') Taylor, in the crowd. Professor Taylor is a humble giant in political philosophy and he had a profound intellectual influence in my life. At McGill University, I used to take his courses as electives and audit others for pure intellectual stimulation. Through him, I learned all about the beauty and shortcomings of political liberalism, and the social justice he, Michael Walzer, Alasdair MacIntyre and other "communitarians" envisioned based on the timeless writings of Aristotle and other great thinkers. I miss those McGill days where I can walk into the classroom and listen to Chuck's lecture on political philosophy.

Finally, I think the best way to honor someone like Jack Layton is to just be a good Canadian citizen and show our love for this great country by doing our small part in making it a better place to live. My small part is called Pension Pulse, and as long as I'm healthy, hope to continue blogging on pensions and markets for many years to come. Below, a moving tribute to "grandpa Jack as well as Stephen Lewis' and Sarah Layton's moving eulogies." Canadians will miss you, Jack.


Friday, August 26, 2011

Passing The Baton?

The Economist Free Exchange blog laments, Passing the baton (HT: Frank):
In his Jackson Hole speech a year ago, Ben Bernanke wanted to leave no doubt that the Federal Reserve could and would act more aggressively to boost America’s flagging economy. This year he wanted to leave no doubt that the politicians could and should do more.

The most highly anticipated central banker’s speech in months gave no hint of bold new initiatives from the Fed. He repeated the mantra that the “Fed has a range of tools that could be used to provide additional monetary stimulus”, but there was no discussion of them and not a whiff of imminent QE3, a third round of bond buying. Mr Bernanke promised that the Fed’s policy-setting committee would have a “fuller discussion” of other tools it could use at its September meeting, which has been extended a day. But he chose to use this speech to give Washington a lecture on fiscal policy, arguing that while America urgently needed a credible plan to reduce long-term deficits, it shouldn’t overdo the short-term tightening.

For investors who had been hoping for a repeat of August 2010, when Mr Bernanke’s signaling of QE2 sent stocks soaring, the speech was surely a disappointment. But it was hardly unexpected. The hints from the Fed in recent days were well-telegraphed and unambiguous: Mr Bernanke wouldn’t be signaling new actions in Jackson Hole.

From Mr Bernanke’s perspective, there is a clear logic to his reticence. Although there are economic parallels between this year and last (things starting to look a lot worse during the summer), the central bank is in a rather different position. A year ago the Fed had taken relatively little action in response to the weakening economy. This year the central bank has only just signaled that short-term interest rates are likely to stay at zero until at least 2013. Since Mr Bernanke has already laid out other steps the Fed could take (for instance, in last year’s speech), discussing them again in detail now could be tantamount to launching them. That’s why he chose buy time by promising a fuller debate in September. Tactically at least, that is understandable. Strategically, given the weakness of the economy, it may be a timid choice.

Mr Bernanke’s decision to weigh in on fiscal policy is more obviously right. The Fed’s task is made considerably more difficult by Washington’s fiscal choices. America’s current trajectory—virtually no progress on medium-term deficit reduction and a hefty tightening next year unless temporary tax cuts are extended—is daft. And though he put it far more politely, Mr Bernanke’s basic message was just that. “Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence disregard the fragility of the current recovery”, he said, adding that “the country would be well served by a better process for making fiscal decisions”.

All eminently sensible. Nonetheless there is something a little disconcerting about the Fed chairman talking to a gathering of the world’s top central bankers at a time of extraordinary uncertainty and focusing on fiscal policy. “Don’t rely on us alone” may be an accurate and important message to send, but given Washington’s recent record on fiscal negotiations, it is hardly a comforting one.

Even more unnerving was the dissonance between Mr Bernanke’s focus and tone, and the palpable sense of nervousness amongst the Jackson Hole attendees. The mood in the meeting’s corridors is grim, largely thanks to the mess in the euro-zone (of which more in later posts). It’s not uncommon to hear that today’s situation is more dangerous, and intractable, than 2008. Mr Bernanke said virtually nothing about the financial risks from Europe. “I have confidence that our European colleagues fully appreciate what is at stake in the difficult issues they are now confronting and that, over time, they will take all necessary and appropriate steps to address those issues effectively and comprehensively”, he said. He might just as well have said, “It’s a big mess and I’m crossing my fingers that they can sort it out”.

I don't know about you, but it doesn't exactly inspire confidence when the most powerful man in global finance is quoted saying “It’s a big mess and I’m crossing my fingers that they can sort it out”. The Fed, the ECB, US and European politicians better be on the same page and sort this European mess out as quickly as possible or else Soros is right, we're heading into a global depression.

Of course, the Fed is just hedging here. I have a feeling things aren't as dire and drastic as the folks over at Zero Hedge and all their short selling supporters make them out to be. Maybe the Fed sees an improvement in the financial system which is why he wasn't in a rush to dole out more goodies to traders in the form of QE3. As I predicted, after initially selling off, stocks took off and the VIX plummeted after the speech as most traders bought the dip. High beta stocks really took off. It was a RISK ON day and why not? Nothing new or unexpected came out of Jackson Hole speech.

The Fed has already given prop traders at big banks and hedge funds a long green light to trade risk assets. They have two years before the Fed raises rates again. So while everyone is bracing for Hurricane Irene, I plan on having fun this weekend looking at high beta stocks that are ripe for trading. In this wolf market, if you can't beat the wolves on Wall Street, you're better off joining them (see video below). Have a great weekend.

Thursday, August 25, 2011

AIMCo vs. CPPIB: Diverging Views on PE?

Wellington Financial posted an interesting comment on their site, AIMCo’s take on PE marks stark contrast to CPPIB:

Diverging views – that’s what makes a market!

Thanks to the good folks at AltAssets, we have some new insight into what AIMCo CEO Leo de Bever sees in the world of private equity buyout these days. AIMCo manages $70B of assets for various Alberta-based public pension plans. You’ll notice that his take on the PE situation is markedly different than what we’re seeing at CPP Investment Board. Not that there’s anything wrong with that, but if you are a member of both plans, you could be forgiven for wondering why you appear to be on both sides of the trade, so to speak.

Here are some relevant highlights of the interview:

What is the current appetite for private equity investment amongst your clients?

Our clients bought into the asset class during the 2005-2008 period at too high a price and a very high external fee structure, a side effect of a limited internal management budget prior to AIMCo’s creation in 2008. Net returns had been disappointing, so some clients are doing some soul searching as to whether they want to keep investing in private equity.

To give you a better idea of our starting position, the average ongoing private equity management fee burden was over three per cent, largely because the money committed in 2005-2008 was less than half invested. Initially, I was getting client pressure to rush and fill the remaining private equity allocation. However, filling asset class buckets only makes sense if there are good opportunities. Private equity only has good returns when one can improve the performance and value of a company by strengthening the management and capital structure or improving the economics of the business.

We are still of the view that if you do this well, have patience, and keep management costs in line, you can do better than the public market by five per cent after costs, but you have to work for it. There is considerable pressure on pension funds and endowments to perform well and that is why our clients raised their allocation to [direct] private equity. It is not radically high, and is remaining steady while we try to find the right assets.

How have your GP relationships and strategy changed since you have come on board in 2008?

The initial 46 private equity fund investments were unwieldy. How can you manage 46 relationships? My team cut that to 15, a number we feel we can work with.

Small allocations to 46 firms meant that any views we may have had were not heard. We were told politely that we didn’t matter. I never liked that. Even a ‘limited’ partner should be able to have a discussion that can help the relationship along. With 15 or fewer relationships that becomes possible.

We are working through a big J-curve issue due to the rising allocation in the years between 2005 to 2008 and we are also controlling costs by bringing the skills in-house that allow us to go more direct. The direct deals are out there, and of course we are part of it.

But like anything else, we will only do things ourselves if we have the skills. Unless you have the expertise this is a case of ‘don’t try this at home’. GPs are now starting to provide better terms, often in the form of co-investment opportunities, which brings down our average management costs.

When we look where to invest, we start at the original premise of private equity, which is not high leverage or financial engineering, but taking a company out of the limelight of quarterly earnings to help it create more value for shareholders. Pension funds have the required cash and patience because of their long time horizon.

Those are pretty strong views, which won’t come as a surprise to anyone who has heard Mr. de Bever speak at an industry conference. Like Michael Nobrega of OMERS, Mr. de Bever has considered opinions, and he thinks it is his job to share them as a steward of capital.

If you’ve been following this space over the years (see representative post “How are we doing on SunGard after 5+ years?” April 13-11), you’ll understand what I mean when I point out that if Mr. de Bever ran CPP Investment Board, things would be dramatically different at that $153B entity. Under the watchful eye of CPPIB EVP Mark Wiseman and the now departed John Breen (see prior post “Dust off your resume: CPPIB’s hiring” July 15-11), CPPIB committed C$21.8 billion to third party private equity funds between 2005 and 2008. The period of time that Mr. de Bever says was marked by “too high a price and a very high external fee structure”. With an average commitment of C$272 million across 80 different funds during that timeframe, CPPIB definitely has more say than AIMCo when it comes to negotiating deal terms and side letters. But our ultimate return experience shouldn’t be any different if those vintage years are as poor as Mr. de Bever anticipates.

The fact that CPPIB has committed to just ~10 additional private equity funds since the beginning of 2009 (the 20 funds a year pace is now just 4/yr) may well mean they are starting to come around to Mr. de Bever’s point of view. But it could also reflect the fact that by the end of 2008, CPPIB had found all the global managers they intended to partner with over the coming years.

If CPPIB is right, and global buyout is the place to be (see prior post “Doubling Down on Private Equity at CPP Investment Board” Feb 20-09), then AIMCo beneficiaries may well be missing the boat. If Mr. de Bever is proven correct, then Canadian taxpayers are in for many more years of net flat returns, at best, in CPPIB’s C$29 billion external private equity program.

I recommend my readers carefully go over AIMCo's 2010-2011 Annual Report. On page 12, you'll notice all the benchmarks AIMCo uses for its public and private investments. AIMCo’s total fund return was 8.2% for the year ended March 31, 2011, marginally better than the AIMCo Total Fund Benchmark. Most listed assets earned a higher than market return, but that was offset by lower than market returns in unlisted assets. The return on pension and endowment assets was 10.3%.

Indeed, Private Equity returned 9.2% for FY2011, underperfoming its benchmark by 3.4%. On page 30 of the Annual Report, this explanation was given:
AIMCo inherited a globally diversified private equity portfolio that had generally underperformed its peers and was operating at a loss as at December 31, 2008. It was composed of approximately 70% funds, 12% fund-of-funds and 18% co-investments, by net asset value. Since that time, a new private equity team has been formed to execute a restructuring of the program. They have been transitioning it toward more opportunistic direct and co-investments, a cost-efficient and flexible platform, while maintaining a smaller, select relationship-oriented fund portfolio.

Given the illiquid nature of private equity, this transformation will occur over the next five years. Last year’s results have been impacted by the $35 million cost of selling some underperforming fund investments to free up capital for direct placements and save $16 million in annual fees.

In 2010/11, we also expanded the portfolio to target the growing number of pre-IPO start-ups that are trying to capitalize on disruptive innovation in energy, materials and agriculture. Our investments in this area have been focused on clean and renewable energy companies that are well along the path to grow to commercial scale.
Mr. de Bever is very cautious. He knows things can get out of whack in both public and private markets. He warned people on my blog last October to watch out when the music stops. He was underweight equities in FY2011 and it cost him some return but he probably made it all back in the last few weeks as markets sold off.

As far as the Wellington article above, I agree that CPPIB has too many fund stakes but they're huge and still they've landed some home-runs in private equity, including the Skype deal in FY2011. Of course, no pension fund in Canada publishes its direct investing results relative to fund investments, so we don't really know how to interpret those overall performance figures. All I know is that public equities lead private equities, and as long as stock markets around the world remain weak, you can forget about strong PE returns. Will Fed Chairman Bernanke rescue public markets and PE on Friday by injecting more liquidity into the system? Stay tuned.

UPDATE: A senior pension fund manager shared these thoughts with me:
For the sake of long term credibility, AIMCo should identify the performance of the run out of the old assets separately from the new, so we can accurately measure the view of the 05-08 vintage and the new concentrated bet approach. The reality is the leadership won't be around to see either opinion actually proven out. So, nothing to learn here, other than how institutions fail in the short term, fire some people, and start over again, without much consequence to the institution. This is why there should be many medium sized pension funds, and lots of diversification of management, rather than large mega pools of capital.
Someone on Twitter (follow me @PensionPulse) reminded me "just cause you have a pool of capital that qualifies you for PE involvement, doesn't mean you have brain/method suitable for same."

That reminds me of Tom Barrack's famous quote when he got out of real estate right before the crisis hit: "There's too much money chasing too few good deals, with too much debt and too few brains."

At the time, I sent out an article to PSP's senior managers, I'm Tom Barrack and I'm getting out, pissed off our head of real estate (good!!!) and I was castigated for being "too negative." The rest as they say, is history. -:)

Finally, watch this interview below with Holland Balanced Fund President Michael Holland who doesn't expect much from the Fed and argues investors should not be concerned with the market's recent volatility.

Wednesday, August 24, 2011

Is Bank of America "Rotted to the Core"?

Yahoo Daily Ticker reports, Henry Blodget vs. Bank of America: “Rotted to the Core”:

A major controversy has erupted in the blogosphere over the value of Bank of America's balance sheet, and whether the bank will be forced to raise capital in the near future.

At the center of the debate is my colleague Henry Blodget, who touched off a maelstrom Tuesday with a blog that concluded Bank of America might need to raise up to $200 billion in capital.

"The trouble is that the market doesn't believe Bank of America's assets are worth anything close to what Bank of America says they are worth," Henry writes, citing the following items other observers think should or will be subtracted from the bank's $222 billion of book value:

  • $15-$20 billion in Increased mortgage-litigation reserves. Zero Hedge thinks BOFA is understating the liability for mortgage litigation costs by this amount. See explanation here.
  • Some percentage of $80 billion of "second mortgages." Yves Smith thinks these should probably be written down by 60%, or $48 billion. You can pick your own number.
  • Some percentage of $47 billion in commercial real estate loans.* The "extend and pretend" game in commercial real-estate is even more pronounced than in residential real estate. So as Yves Smith observes, there's almost no chance those loans are actually worth $47 billion. (UPDATE: Our original post said BOFA's CRE exposure was $182 billion, which was a number cited by Yves Smith. BOFA said this number was off "by a factor of 4." Yves has since rechecked the filings and realized that she made a mistake. I apologize for relaying it.)
  • A healthy percentage of $78 billion of "goodwill." Bank of America built itself by acquisition. "Goodwill" is what's left over when management overpays for something. As Yves Smith observes, Bank of America's former CEO Ken Lewis loved overpaying for things. He overpaid for Countrywide, for example, which has since been written off to zero, and Merrill Lynch, which he could have had for free by waiting a couple more days.
  • Untold amounts of exposure to collapsing European banks and sovereign debt.* Yves Smith says Bank of America says its European exposure is $17 billion. (UPDATE: Bank of America issued a statement clarifying that its "sovereign" exposure--to the debt of PIIGS countries--is $1.7 billion. The overall European exposure is $17 billion. But the big concern here is not just sovereign exposure--debt of countries--but bank exposure. Along with the associated derivatives.) Really? Has the firm not written any credit default swaps protecting customers in the event that European banks or countries go belly up? Might the firm have to post some cash "collateral" to satisfy these contracts? That's what Lehman had to do, after all. And that's what made Lehman go from "having plenty of capital" to being broke overnight.

"The market also doesn't believe that Bank of America has reserved anywhere near enough to pay the costs of litigation surrounding its mortgage behavior during the housing boom," for which it has already paid $13 billion in settlements, Henry added.

Bank of America's response was quick and ruthless: "Mr. Blodget is making 'exaggerated and unwarranted claims' which is what the SEC stated publicly when he was permanently banned from the securities industry in 2003," the bank declared.

Shoot the Messenger

The bank took umbrage with Henry's figures on its exposure to sovereign debt and commercial real estate (which were corrected from as noted above) as well other conclusions and the motivations of some of his sources. "The mortgage analysis was provided by a hedge fund that has acknowledged it will benefit if our stock price declines," BofA said. (For the record, Henry is long Bank of America stock and thus has no incentive to drive the shares lower, as some critics contend.)

Some bank analysts, including Dick Bove and Meredith Whitney have come to Bank of America's defense. "There's no reason for the bank to have to out and raise capital whatsoever," Bove told Bloomberg TV.

Meanwhile, JPMorgan upgraded BofA stock to neutral from underweight, and Bank of America shares were rallying sharply midday Wednesday, albeit from depressed levels. Bank of America, meanwhile, dismissed a rumor that it was in talks to be acquired by JPMorgan.

On the other hand, several high profile bloggers and financial writers such as Barry Ritholtz, Chris Whalen, Yves Smith, Michael "Mish" Shedlock and Zero Hedge have entered the fray in support of Henry's critique.

As Henry and I discuss in the accompanying clip, the whole Blodget and the Bloggers vs. Bank of America debate may make for a good Twitter-spat, but obscures the much bigger issue: Nobody really knows what's one the bank's balance sheet and BofA didn't take the opportunity to offer more clarity in its spirited defense yesterday.

Meanwhile, Bank of America shares have fallen nearly 50% in the past month and the price of insurance against default has surged to record levels.

"I'm sorry if BOA thinks the market is stupid," Henry says. "We went through this in 2008; all the banks said 'we're perfectly capitalized, we're in great shape'; three months later they were revealed to be rotted to the core. The concern is that's what's going on here."

For the record, I reached out to BofA's representatives for comment and will update the story if and when they respond. We've also extended an open invitation to CEO Brian Moynihan to appear on The Daily Ticker and address these and related issues.

Not one to shy away from controversy, let me weigh in with my thoughts. The comments you will read below are blunt and to the point, which is exactly my style of expressing myself.

First, and most importantly, I couldn't care less what Henry Blodget, Yves Smith, Tyler Durden, or any other frigging clueless analyst with no significant skin in the game thinks about Bank of America. I only pay attention to what elite funds are buying and selling. That's it, that's all. Everything else is just noise (doesn't mean these elite funds are always right or good market timers!)

I invite you to carefully go over the detailed institutional holdings of Bank of America (BAC) for Q2 2011. In particular, click on change in shares column and you'll see top funds like Wellington and Kingdon Capital increased their purchases in Q2 (click on image to enlarge):

If you then click on page 2, you'll notice another top fund Dodge & Cox, significantly increased its position in Bank of America. Also worth noting, two large Canadian pension funds, the Caisse and OMERS, significantly increased their position in Bank of America during Q2 (click on image to enlarge):

Here are some other elite funds that increased their BAC holdings: Citadel, Shumway Capital, Jabre Capital, Marathon Asset Management and SAC Capital (albeit, they didn't report a significant stake). I did however see Paulson & Co. decrease their holdings in Bank of America and Citigroup in Q2. Maverick Capital, another elite fund, significantly increased its holdings in Citigroup.

Second, and equally important, I'm growing increasingly weary of Tyler Durden and Yves Smith. I flat out don't trust either of them and think they have hidden agendas on their blogs where short sellers feed them a bunch of doom & gloom bullshit and their readers lap it up. In particular, I would like Tyler Durden of Zero Hedge and Yves Smith of Naked Capitalism to publicly state that they receive no financial support from hedge fund managers like George Soros (Naked Capitalism) or Eric Spott (Zero Hedge). Just read the dribble Tyler posted on this controversy and read the comments (I can't comment any longer because Tyler blocked my account. His way of silencing the sole bullish voice on Zero Hedge!).

I trust few in the blogosphere and will flat out tell you that I pretty much kill whatever I eat and will always publish the truth no matter who is funding me. If they don't like what I'm publishing, tough luck! No hedgies funding me, not even those who I recommended multi-million dollar investments (cheap bastards are collecting 2 & 20, gathering assets, selling beta as alpha to stupid pension funds). I bust my ass every day trading and blogging, stick my neck out and hardly anyone has given me a penny. Everyone wants a free lunch (my way of saying stop being cheap and donate to Pension Pulse!!!).

Finally, I am currently long JDSU and RIMM and remain neutral on Bank of America. I think it's way oversold and due for a nice bounce (it was up 11% on Wednesday), but financials are getting clobbered as leading economic indicators point to a double-dip recession (not convinced yet). Having said this, Bank of America and financials have a powerful ally in Fed Chairman Bernanke who basically gave them the green light over the next two years to borrow at zero percent, invest in Treasuries locking in spread, and then trade risk assets all around the world in search of yield. This allows big banks to make enormous trading revenues and shore up their weak balance sheets.

If you ask me, only fools would short Bank of America, Goldman Sachs, Citigroup or other financials in this environment. There will be more dips, but I'd be loading up on them. Below, watch a few clips on the controversy, and remember, even though I'm not always right, I have no hidden agenda and will always deliver the straight goods. No bullish or bearish screen savers on my computer and no big hedge fund managers backing me up (couldn't care less, don't need them). If you appreciate my work, please donate to my blog by clicking on the PayPal "DONATE" button under the pig at the top of the page. Thank you.

UPDATE: BAC shares are up 9.5% Thursday following the news that Warren Buffett's conglomerate Berkshire Hathaway will invest $5 billion in Bank of America. That's why he's the one of the best investors in the world because he knows a deal when he spots one and isn't afraid to put his money where his mouth is.

A buddy of mine, a broker, sent me this comment:

If my memory is correct....

Warren Buffet made a big investment in Goldman Sachs around $115 per share back in 2008/2009 - during the days of the financial crisis. Stocks rallied big time on the news.

Then, the market got over the excitement and resumed its decline. GS finally bottomed around $55 before it was all over.

Watching CNBC this morning, you'd think Buffet just saved the world again with his investment in BAC. I'm wondering if maybe he's a little early again.
Of course, Buffet doesn't buy in open markets like you and I, he bought preferred shares. But he's not investing $5B because he thinks Bank of America will go bankrupt. If it goes lower, he'll probably increase his stake. It was a great stock to trade this week. Period. Nice 30%+ bounce. And according to Bloomberg, Buffet already made $ 1.3 billion on his first day.

As I stated, traders will likely sell the Fed's news tomorrow no matter what it is. We shall see. If they do, just keep buying the dips.




Tuesday, August 23, 2011

Will Baby Boomers Sink the Stock Market?

Michael S. Derby of the WSJ asks, Will Baby Boomers Sink the Stock Market? (HT: Frank):

The next quarter century or so could be a tough one for the stock market, researchers at the Federal Reserve Bank of San Francisco warn.

In a paper released by the institution Monday, two of its staffers said the retirement of the Baby Boom generation stands to strip away from equities a key source of support.

The ongoing wave of retirees won’t crater the market, but they may well be “a factor holding down equity valuations over the next two decades,” Zheng Liu and Mark Spiegel write.

As they see it, what the Baby Boomers have given to the market is something like what they will be taking away.

“U.S. equity values have been closely related to demographic trends in the past half century” across several key metrics, the economists write.

“In the context of the impending retirement of baby boomers over the next two decades, this correlation portends poorly for equity values,” Liu and Spiegel write.

As much as it is a problem for the market over the long haul, as retirees sell stocks to try to maintain their lifestyles, the “well known” nature of the troubles is also a problem for markets now. Indeed, if current investors start pricing in the coming Baby Boomer headwind, they may “depress” stock prices.

“These demographic shifts may present headwinds today for the stock market’s recovery from the financial crisis,” the paper said.

Liu and Siegel allow that considerable uncertainty surrounds their work. Other important influences on the outlook for stocks are the performance of the bond market, as well as the appetites of foreign buyers. They cited China as one potential wild card, saying that nation and other emerging economies “may relax capital controls, which would allow their nationals to invest in U.S. equity markets.” That could counter some of the drag generated by U.S. retirees.

I take all these demographic studies with a shaker of salt. Apart from the potential of foreigners buying US stocks as baby boomers retire, there is the potential that baby boomers will live longer, more healthy lives and many will push back retirement as far as possible. Just today, I read exciting news about researchers finding the common cause for ALS, a discovery could have a broader impact on treatment of other neurodegenerative diseases also characterized by the irregular accumulation of proteins, like Parkinson's, Alzheimer's disease and other dementias. Closer to me, researchers are now starting trials using adult stem cells to treat MS.

This is all very exciting news and as more and more people adopt healthy lifestyle choices, I wouldn't be surprised to see a significant impact on lifespans. And this myth that people are going to sell all their holdings in stocks is way overdone. Besides, retail and institutional investors don't control the stock market, machines do. In this wolf market, multi-million dollar computers trading at ultra-high frequencies are creating fictitious volume, making a killing in up and down markets.

That's why even though I'm wasn't surprised to see risk assets rally on Tuesday, I don't get overly- excited about a rally based on stimulus expectations from the Fed's following this Friday's Jackson Hole meeting. This is the way I'm personally playing the Fed meeting: I remain long risks assets but expect traders to sell the news whether it's a stimulus or not. And if stocks sell off again, I'll be buying the dip. If they keep grinding higher, I will keep buying up. Others, like Chis Ciovacco, think that buying the dips here is lethal because numerous long-term bearish signals recently appeared on weekly and monthly charts.

Finally, watch the Bloomberg interview with Marc Faber below. Several gold bulls have warned that the gold rally is overdone and due for a pullback, but Mr. Faber is still long gold and he doesn't see the S&P making new highs. Who knows? I can make an equally persuasive argument as to why I see massive liquidity in the global financial system and how yield starving, momentum chasing institutions will run-up high beta stocks in the last quarter to make up for the savage losses they experienced over the last few weeks. And as I stated before, when it comes to bonds outperforming stocks over the next decade, never say never.

Remember, in these markets, you can move from extreme oversold levels to extreme overbought levels extremely quickly. Once performance anxiety sets in, greed takes over, and we're off to the races again and have to pay attention for new bubbles. Don't worry, baby boomers will be part of the next bubble, I guarantee it.

Monday, August 22, 2011

What's the Point of More QE?

Yahoo Daily Ticker had an interesting interview with Edward Dempsey, CIO of Pension Partners, asking what's the point of more QE?:

This week's financial and economic calendar culminates Friday with Federal Reserve Chairman Ben Bernanke's policy speech at the Fed's annual summer getaway in Jackson Hole, Wy.

Will he or won't he announce another round of quantitative easing? That's the big issue facing financial markets.

It was at this same conference last August that Bernanke cued in the markets about the second round of quantitative easing, which resulted in the Fed buying $600 billion of Treasury bonds between November 2010 and June of this year. In the first round of QE between Dec. 2008 and March 2010 - the Fed bought $1.7 trillion of debt, mostly mortgage securities.

I'm sure the Feds have "QE3 through 30 queued up and ready," says Edward Dempsey chief investment officer at Pension Partners. "However, I don't know how effective it'll be."

Though markets ticked higher after the Fed's August 9 announcement that it would keep rates "exceptionally" low through mid-2013, it's done little to quell the volatility and nerves.

Traders and 401(k)s may benefit from more Fed action as it may generate asset reflation, but Dempsey says QE3 is unlikely to relieve stress in the real economy, citing the impact of two QEs to date. "It has not done anything for house prices, it has not done anything for wage growth. It hasn't done anything for employment."

In fact, Dempsey is unclear if it's benefited anyone. "We are approaching zero yield," he says. "It's devastating on retirees, it's devastating on pensions and endowments" - his main focus of investing. Many pundits, including Jim Cramer, have been pushing dividend-yielding blue chips as a wise investment for those looking for income in their portfolio.

But "I would be very uncomfortable placing my capital at risk for a 2 or 3% yield," Dempsey says. As discussed in this previous clip, he's worried the 'summer crash' isn't over just yet.

In the meantime, savers will continue to be penalized until hopefully, the economy recovers to a point the Fed feels comfortable raising rates to forgotten "normal" levels of 1% or higher.

I've already stated that the Fed doesn't care about anything else but the banking system and reintroducing mild inflation into the global economic system. Quantitative easing is already pushing food and energy prices higher everywhere, including in emerging markets. And now the Fed has given a green light to big banks to trade like crazy for the next two years. Unfortunately, the volatility in the stock market is spooking homebuyers, pushing the housing recovery further away.

Last week, Steven Johnson of Reuters asked, Fed may have bullets left, but are they blanks?:

When Federal Reserve Chairman Ben Bernanke takes the podium next week at the central bank's annual meeting in Jackson Hole, Wyoming, his sense of deja vu may be overwhelming.

Stocks have been giving up gains won after last year's speech, when Bernanke hinted at plans to pump more money into the financial system. Oil prices are higher and there's been little improvement in the job market. Bond yields are down, though, because the economic outlook has deteriorated.

It's almost as if QE2, the Fed's $600 billion bond-buying program first mentioned at last year's meeting and designed to boost the struggling economy, never happened.

That's not to say investors doubt the central bank's resolve to act again if the U.S. economy keeps losing steam. Last week, it surprised markets with an unprecedented pledge to hold interest rates near zero until at least 2013.

But given questions about the efficacy of monetary stimulus to date and a growing political backlash against the Fed's policies, investors expect the U.S. central bank to keep its powder dry at this year's Jackson Hole symposium from Aug. 25-27.

"The Fed already shocked the world when it indicated its ultra-low interest rate policy would remain in place until 2013," said Fred Dickson, strategist at D.A. Davidson & Co in Lake Oswego, Oregon. "That telegraphed the economy is going to stay weak. But monetary and fiscal policies haven't worked very well, so I don't expect we'll get a QE3 announcement. That would really catch everybody by surprise."

It's not that the central bank doesn't have a few tricks left up its sleeve. Bernanke has previously detailed what he could do next. This includes buying long-dated Treasuries to push down long-term rates and cutting interest on bank deposits held at the Fed to encourage more lending.

Still, there's the problem of ever diminishing returns. The benchmark S&P 500 index rallied more than 4 percent when the Fed on Aug. 9 said it would keep rates low into 2013, but fell more than 4 percent the next day. At around 1,200, the index is off its Aug. 8 low but trading remains volatile.

Atlanta Fed President Dennis Lockhart has said the central bank could buy more long-term bonds to lengthen the duration of its portfolio, which would flatten the yield curve and allow homeowners to refinance at lower interest rates.

But with rates already low, the impact may be muted.

What's more, investors said lower 30-year bond yields could actually complicate life for insurance companies that have to match liabilities and assets.

POLITICAL BACKLASH

Then there's the limited impact the Fed's quantitative easing, or QE, has had on the broader economy, which ground to a halt in the second quarter and, some fear, is flirting with a slide back into recession.

Economists polled by Reuters now expect the economy to grow at just a 1.7 percent rate in 2011, well below the Fed's June forecasts of 2.7 to 2.9 percent.

Including QE2, which ended in June, the Fed has spent some $2.3 trillion in recent years to prevent a slide into deflation, more than tripling its balance sheet in the process.

"On one hand, QE2 added to the U.S. market. On the other, a lot of the liquidity fled and went into emerging markets and commodities, and those commodities, including oil, went higher in price," said Ashish Shah, head of global credit at AllianceBernstein, with $216 billion in fixed-income assets. "So you actually robbed consumers of purchasing power."

That has put the Fed in the line of fire of some politicians and voters -- so much so that some investors fear the growing politicization of Fed policy could curb its independence.

Texas Governor Rick Perry, a Republican candidate for president, even said he would consider it "treasonous" if Bernanke "prints more money between now and the election" in 2012.

William Larkin, fixed income portfolio manager at Cabot Money Management, dismissed Perry's remarks as "crazy talk," but did say the Fed faced increased political hurdles.

"The Fed is going to face a lot of push back," he said. "Keeping rates low has caused talk of financial repression --- stealing from savers and giving to debtors."

A weaker dollar, partly the result of the Fed's easing, also complicates things. While it in theory helps exports, it also makes imported goods more costly, putting more pressure on consumers. Against major currencies, the dollar is 11 percent weaker since the August 2010 Jackson Hole meeting.

"The Fed is being viewed as a political rather than financial actor, so their policy responses may have to be political as well as economic," said Boris Schlossberg, head of research at GFT Forex. "As they lose their credibility among a certain segment of the population, that whittles away the kind of independence they used to have."

Support for more easing isn't universal within the central bank, either. Dallas Fed President Richard Fisher, one of three policymakers who voted against keeping interest rates low until 2013, blamed "fiscal misfeasance in Washington" for the economy's woes.

MAKING SENSE OF IT ALL

None of this makes investing any more straightforward, money managers say. While stocks still look more enticing than low-yielding Treasuries, many portfolio managers have grown more defensive given the worsening economic outlook.

Dickson said he recommends clients increase cash and metals allocations just to be safe. But he still favors stocks over bonds, particularly multinational stocks that offer dividend yields above the 10-year Treasury.

He said a D.A. Davidson & Co portfolio of such stocks has held up better than the S&P, shedding about half as much as the broader market between mid-July and Aug. 8.

Another option for equities investors is high-yield corporate bonds that offer comparable returns but "half the volatility" of stocks, Shah said, noting U.S. corporations are sitting on piles of cash.

"But for people who want to preserve capital, there aren't a lot of choices," he said. "You're going to earn zero here."

There may be reason to hope that the Fed won't need to act again. The central bank's latest senior loan officer survey showed some easing in lending conditions, particularly for commercial and industrial loans to businesses.

If the trend persists, that could encourage more hiring.

Should things take a turn for the worse, though, investors had better bet on another round of QE, said Michael Cheah, senior portfolio manager at SunAmerica Asset Management in Jersey City, with $1.5 billion under management.

With inflation low and wage growth stagnant, he said the Fed has the leeway to pour more money into the system. That would boost stocks at the expense of bonds and stoke demand for higher-yielding currencies over the dollar.

"I think quantitative easing is only creating the illusion of prosperity but my job is to trade that illusion," he said. "That makes me bullish stocks."

Indeed, QE is creating the "illusion of prosperity," but it's bolstering trading revenues at the big banks, allowing them to essentially profit for free, and buying them time to shore up their balance sheets. That's what the Fed is gambling on, by bolstering banks' trading revenues, and introducing mild inflation into the economic system, they will be able to avoid a Japanese-style deflationary episode. And for all the critics of QE, think about this: what would have happened if the Fed did nothing and Washington remained polarized with diametrically opposed political views on the debt ceiling? It would have been a disaster. Like it or not, QE might have saved the system from total collapse.

But QE is creating more volatility, allowing high frequency traders to make a killing while retail and institutional players scramble for yield. In these volatile markets, you need to swing trade. Forget buy & hold, you will get killed. I have been spying on elite funds, watching what they've been busy buying and selling. Many elite funds have gotten killed in the latest market route but there are interesting stocks on my radar: RIMM, A, GLW, FSLR, JDSU, JNPR, ORCL, SYMC, EMC, C, BAC, MDT, MOS, SLV, LDK, YGE, are just a few of the symbols I'm tracking. But there is no rush to buy stocks yet.

Below, watch the clips I embedded with Edward Dempsey. He thinks we're going to head lower from here and he's still bullish on gold. I also embedded an interview with Axel Merk, founder of Merk Investments and manager of the Merk Hard Currency Fund, who says not only is it unwise for the Fed to commit to another round of QE, it's also unnecessary. "The Federal Reserve has managed to move the markets with words rather than action," he says, citing the Fed's announcement on August 9 to keep rates exceptionally low through mid-2013 and the drop in interest rates along the yield curve that followed. "Short-term cost of borrowing has pretty much gone to zero," he notes. "That is something that previously only been done through the purchase of securities." Excess printing by the Fed is why Mr. Merk is bullish on the euro.

My take: If the Fed does nothing, markets might initially sell off but I would be buying that dip hard, especially in financials and high beta stocks. There is plenty of liquidity to drive risk assets much higher. Stay tuned.