Monday, December 28, 2015

The Year Nothing Worked?

Lu Wang of Bloomberg reports, The Year Nothing Worked: Stocks, Bonds, Cash Go Nowhere:
The idea behind asset allocation is simple: when one market struggles, it’s OK because an investor can jump into another that is thriving. Not so in 2015.

In fact, if you judge the past year by which U.S. investment class generated the largest return, a case can be made it was the worst for asset-allocating bulls in almost 80 years, according to data compiled by Bianco Research LLC and Bloomberg. With three days left, the Standard & Poor’s 500 Index has gained 2.2 percent with dividends, cash is up less, while bonds and commodities are showing losses (click on image below).


After embracing everything from Treasuries to high-yield bonds and technology shares amid seven years of zero-percent interest rates, investors found themselves with nowhere to run at a time when the Federal Reserve’s campaign of stimulus drew to an end. Normally it isn’t like this. Since 1995, practically every year has seen some asset deliver returns exceeding 10 percent.

“It’s been challenging from the point of view that the equity market and bond market are probably more joined at the hip than normal,” said Hayes Miller, the Boston-based head of multi-asset North America who helps oversee $35.8 billion for Baring Asset Management LLC. “We’ve had high cash exposure relative to norm because we felt cash provides one of the only good diversifiers against the risk-off trade.”

Bianco Research keeps track of the S&P 500, 30-year U.S. Treasury bonds, 3-month Treasury bills and the Thomson Reuters/CoreCommodity CRB Commodity Index to gauge performance in stocks, bonds, cash and commodities. The four are the most common asset classes considered by investors when an allocation strategy is designed, according to Jim Bianco, the founder.

While the depth of losses in equities and commodities is nowhere near as bad as in 2008, the correlation of declines highlights the challenge for money managers who seek to amplify returns by rotating among assets. Among other things it’s a recipe for pain among hedge funds, according to Bianco. The industry is heading for its worst annual performance since 2011, with closures rising, data compiled by Bloomberg and Hedge Fund Research Inc. show.

“The Fed stimulus lifted all boats, and then the Fed withdrawing the stimulus is holding the boats down,” Bianco said by phone. “If the argument is right that the economy is going into 2016 weak and earnings are negative, those conditions will continue and therefore on the asset allocation level, I don’t expect anything to break out just yet.”

S&P 500 futures slipped 0.2 percent and commodities fell at 9:56 a.m. in London, while Treasuries were little changed.

With nothing going up, exchange-traded funds that invest in different asset types as a way to diversify risk have struggled. Among 35 such ETFs tracked by Bloomberg, the median loss for 2015 is 5 percent. The iShares Core Growth Allocation ETF, which has a mix of 60 percent in stocks and 40 percent in bonds, has slipped 0.5 percent, and the First Trust Multi-Asset Diversified Income Index Fund is down 7.4 percent.

Uncertainty over the timing of the Fed’s first interest rate increase in almost a decade and its potential impact on the economy weighed on markets throughout 2015, according to Michael Arone, the Boston-based chief investment strategist at State Street Global Advisors’ U.S. Intermediary Business. Policy makers signaled the pace of subsequent increases will be “gradual” when finally tightening this month.

“The Fed has finally broken that cycle by beginning policy normalization, and hopefully this will provide the market some clarification and resolve in a more solid direction,” Arone said by phone. “If the market feels comfortable at the pace of which the Fed moves interest rates and the economy is recovering, risk assets like stocks could perform well.”

The S&P 500 has made little headway in 2015, adding 0.1 percent without dividends. Equities fared worse in dollar terms outside the U.S., with the MSCI EAFE Index dropping 3.1 percent while the MSCI Emerging Markets Index sinking 16 percent.

Commodities have fallen to a decade low as tepid global inflation dimmed the allure of precious metals, weak Chinese demand hurt raw-materials prices and a global supply glut sent crude oil tumbling. In the bond market, high-yield corporate debt is heading for first annual decline since 2008 amid a flood of investor redemptions from junk bond funds and concern rising borrowing costs will threaten corporate solvency.

According to Bianco’s study, gains from the best-performing assets had surpassed 10 percent in all but one year since 1995. During the last nine decades, 23 years, or a quarter of the total, saw at least one asset class returning more than 30 percent, and only four ended with gains smaller than 4 percent.
Let's face it, 2015 has been a brutal year, especially for hedge funds which just had their worst quarter since the crisis. I've been harping on hedge funds all year as many top funds have experienced serious losses and if you ask me, this latest hedge fund shakeout is far from over.

I mention this because I saw something on LinkedIn from UBS on hedge funds offering "superior risk-adjusted returns" over the next 5-7 years that made my eyes roll (click on image):


Amazingly, 145 people liked this chart. I just couldn't resist commenting on it: "What a joke, when are you all going to stop the hedge fund lovefest and just admit the bulk of hedge funds absolutely stink. They're nothing more than glorified leveraged beta chasers. It's ok, I expect a long period of debt deflation will wreak more havoc on the industry and weed out 3/4 of the funds over the next five years."

By the way, I'm not kidding, I expect the Fed's deflation problem to only get worse in 2016 and this will wreak more havoc on hedge funds and private equity funds which also have dim prospects going forward. There will be a shakeout in private equity too but I doubt it will be as brutal as the one hedge funds are experiencing (then again you never know).

The most important thing asset allocators need to understand is the macro environment. In particular, there's no end to the deflation supercycle and the ongoing global jobs crisis, pension crisis, and demographic time bomb keep weighing on inflation expectations. The Martingale casinos aren't about to go bust but there's an uneasiness out there that the Fed is committing a major policy blunder and that in the not too distant future, negative interest rates will rule the day.

Fears of deflation have prompted many large hedge funds and speculators to wisely abandon their short Treasuries positions a year after setting up their biggest bets against bonds (they would have been wiser to short the high yield market instead of government bonds).

The global deflation overhang has been particularly brutal on equities, especially in some sectors like emerging markets (EEM), Chinese (FXI), Energy (XLE), Oil Services (OIH), Oil & Gas Exploration (XOP), and Metals & Mining (XME), all of which are plays on global growth.

Not surprisingly, if you look at the worst performing S&P 500 stocks of 2015, you'll see names like Chesapeake Energy (CHK), Southwestern Energy (SWN), Consol Energy (CNX), Freeport McMoran (FCX), Kinder Morgan (KMI), Range Resources (RRC), Ensco (ESV) and Devon Energy (DVN). These stocks and many other stocks in energy and commodities are all down huge this year (anywhere between 50% to 80%++).

This is why I kept telling my readers to steer clear of energy and commodity stocks in 2015 and use any countertrend rally to get out or short them. And while some global funds are now betting on reflation and Canada's large pensions are betting on energy, I remain very cautious on energy and commodity stocks and would avoid them or trade them very tightly (ie. there will be countertrend rallies if people think global growth is coming back but these rallies will fizzle quickly once people realize global deflation is getting worse, not better).

But it's not just energy and commodity names that got hit in 2015.  A lot of retail stocks (XRT) like Macy's (M), Michael Kors (KORS) and Wal-Mart (WMT) also got clobbered in 2015 and this despite the huge drop in oil and gas prices. This is particularly worrisome because it means Americans are spending less, saving more and paying off their huge debts (all of which reinforces deflation coming to America). Stocks like Amazon (AMZN) soared in 2015 because in a deflationary world, price and convenience matter more than ever (still, be careful with this high flyer, as a pairs trade, I would short Amazon and go long Wal-Mart in 2016!!).

As far as large (IBB) and small (XBI) biotech, which remains one of my favorite sectors, 2015 was very volatile and brutal, especially if you were in the wrong stock. Here too, China's Big Bang not Hillary Clinton, was the culprit for the decline in this sector as investors and speculators feared the worst and took a RISK OFF approach. Still, I recommended buying the huge biotech dip in late August and stick by that call even if I know it will be very volatile.

But while nothing worked well in 2015, some short sellers made a killing and some of them are increasing their bets on major oil stocks. I think the best hedge funds are going to be the ones that are going to be the best stock pickers on the long and short end but in my experience, most hedge funds stink and are unable to deliver alpha, especially in their short book.

Anyways, hope you enjoyed this comment. I'm still in vacation mode, enjoying my holidays but think it's important to go over some end of year items as I prepare my Outlook 2016 next week. The bottom line is that global deflation matters a lot and that 2016 might be worse than 2015, especially if the Fed exacerbates its deflation problem by raising rates too aggressively (or even just raising them gradually!).

As always, please remember to donate and/ or subscribe to this blog at the top right-hand side and support my efforts with your wallet, not just your kind words. Most of you are freeloading off the generosity of a handful of individuals and that irks me off to the point where I'm considering going private in 2016 and sending my blog comments to people who actually take the time to subscribe.

Below, a Bloomberg panel discusses why nothing worked in 2015. A very interesting discussion which I recommend you listen to carefully bearing in mind my comments above.

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