Stock market correlation leads to ‘closet’ indexing – InvestmentNews 09-30-12

Salient to Investors:

A fund is highly correlated to its benchmark index if its R-squared reaches 90: at 95, it is considered a ”closet” index fund.

The steady rise in correlations among all stocks is making it more difficult than ever for actively managed funds to differentiate themselves from their benchmarks.

Morningstar said that the 10 largest actively managed stocks fund in the world have an average three-year R-squared of 97, up from 83 in 2007. The average large-cap-blend fund has an R-squared of 99.7.

Brendan Clark at Clark Capital Mgmt said the underlying condition of the market is creating closet indexers.

Over the past 3 years, almost $150 billion has flowed into passive stock funds and more than $300 billion has been withdrawn from actively managed stock funds.

Kevin McDevitt at Morningstar said that while traditionally, investors want active managers to outperform the market, the differentiation from a benchmark should be more about downside protection – passive funds can’t defend themselves when the market is falling.

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Threats to a fulfilling retirement – InvestmentNews 09-30-12

Salient to Investors:

The traditional move to fixed-income-heavy asset allocation in retirement planning poses risks and limitations, especially given expanding life expectancy. 

First, today’s unconventional monetary policy raises the inflation risk. Second, long-duration government bonds and high-grade debt carry the risk of capital loss.

A 10-year Treasury and similar debt could decline more than 25% if long-term rates reverted to levels of the early 2000s.

Retirees should consider capital appreciation as an investment objective in addition to income generation, highlighting the role of equities alongside fixed income.

Dividend-paying equities, in particular, are well-suited to a portfolio managed for both capital appreciation and income.

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Don’t look down: Ignore the fiscal cliff, buy now – Investment Bews 09-30-12

Salient to Investors:

David Kelly at J.P. Morgan Funds recommends a balanced portfolio because most investors are very conservative, bonds are expensive, and stocks are cheap. Kelly said:

  • Valuations are extreme, which only makes sense if you believe we are on the brink of a financial disaster. All we have to do is avoid the worst consequences of fiscal mismanagement.
  • The chances of a full fiscal cliff are extremely rare.
  • A too rapid drop in reducing the deficit will lead to recession.
  • Consumer discretionary and consumer cyclical sectors will be the biggest beneficiaries of any reduction in the full impact of the fiscal cliff because the effects will be felt first in the U.S. economy. Sectors more tied to the global economy, including industrials, materials and technology, will enjoy less of a boost from fixes to the cliff.

Stocks are too cheap to ignore. The forward P/E ratio of the S&P 500 is 14 versus 27.4 at the peak in December 1999 and the 15-year average of 17.4.

Tim Leach at US Bank Wealth Management expects GDP to grow 2% over the next year, which helps support earnings. Leach says the fiscal cliff comprises 2.5 percent of tax increases and 1 percent of spending cuts, with more give on the tax increase side – Less-than-full fiscal cliff means US equities will fare reasonably well. Leach expects enough active compromise after the election to lessen the full impact of the fiscal cliff.

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Sold in May? Wish that could go away – MarketWatch 09-29-12

Salient to Investors:

A record number of investors bet on the “Sell In May and Go Away” adage this year, but so far year the indexes are up.

Since 1896, this six-month period has done at least just over half the time as well as it has this year so far. October historically has been the month for stock market crashes have occurred.

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Jobs in focus as stocks enter 2012’s final quarter – MarketWatch 09-29-12

Salient to Investors:

Nigel Gault and Paul Edelstein at IHS Global Insight expects payroll growth won’t be enough to reduce the unemployment rate.

Doug Roberts at Channel Capital Research said most of the rally is being driven by QE.

Wasif Latif at USAA Investments said Spain will need to accept the offer from the ECB.

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As Money Pours Down, It’s No Wonder That Stocks Are Up – The New York Times 09-29-12

Salient to Investors:

Ethan Harris at Bank of America Merrill Lynch said central bank actions have clearly been a major factor in the market rally.

Larry Kantor at Barclays said a modestly growing economy with depressed cyclically sensitive sectors is a relatively stable and safe environment, and when combined with a central bank committed to aggressively supporting growth through higher asset prices, makes for a very attractive environment for taking risk.

Lakshman Achuthanat the Economic Cycle Research Institute says the US is already in recession, and Fed actions won’t change that – the economy is going to have to ride out the business cycle. Achuthan said Fed actions have been increasingly ineffective and the relationship between the economy and the stock market is complex – it’s not always clear whether the market is predicting the economy, reacting to it, or responding to other factors.

Robert Rodriguez at FPA says the market is overextended and is reducing its stock exposure, and says another credit bubble is likely if the central banks persist in trying to prop up the global economy. Rodriguez says the fundamental problem in the US can’t be solved by the Fed.

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Wealthy Americans Gain Even as Republicans Decry Redistribution – Bloomberg 09-28-12

Salient to Investors:

The Census Bureau Gini Index shows income inequality reached a new high in 2011. Quarterly corporate profits have almost doubled since the end of 2008, while workers’ inflation- adjusted average hourly earnings have declined.

Anne Mathias at Guggenheim Securities said said fifty years ago it was how the other half lived, and now it’s the other 1 percent. Mathias expects a successful push to tax the rich during post-election budget talks.

The Congressional Budget Office calculations show inequality in 2009 wasn’t much worse than in 2003 – it includes the value of employer-provided health insurance, taxes and government benefits.

Dean Baker at the Center for Economic and Policy Research said government affects income distribution through other channels, including minimum wage, collective-bargaining rules, stimulus spending and allowing certain types of foreign workers into the U.S.

Emmanuel Saez of the University of California, Berkeley said the top 1 percent of families garnered 93 percent of the income gains in 2009 and 2010.

A Congressional Research Service study concluded that previous rate-cutting had little association with saving, investment or productivity, but did exacerbate the rich-poor gap.

Citizens for Tax Justice says the U.S. tax system is a mix of a progressive federal income tax and regressive state and local taxes.

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Japan-China Politics Risk Prolonging Worst Ties Since 2005 – Bloomberg 09-28-12

Salient to Investors:

It’s unlikely the leaders will allow any escalation into open conflict.

Richard Samuels at MIT said the conflict is due to domestic political considerations as the whole region is roiling amid uncertainty over leadership. Samuels says there is always the danger of miscalculation which is why Japan patrols with the Coast Guard and not naval vessels.

Feng Wei at Fudan University said Noda is having a difficult time at home and fanning the Diaoyu islands issue is the only card he can play, while anti-Japanese sentiment serves as the glue and ideology that can bring the Chinese together.

Chen Yuluic adviser to the People’s Bank of China, told reporters in Beijing that the island dispute threatens Tokyo’s future as an offshore yuan center.

Brad Glosserman at Pacific Forum CSIS said both sides need to take their egos and nationalist instincts offline, but neither country can afford to back down because of both their extreme nationalistic pressures.

Kunihiko Miyake at Ritsumeikan University sees a need to reset ties which requires a change of players.

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Copper Bulls Retreat on Concern Stimulus Not Enough: Commodities – Bloomberg 09-28-12

Salient to Investors:

Copper bulls retreated for a third consecutive week on concern about weaker manufacturing from Europe to China.

Christine Lagarde at the IMF expects weaker global growth than forecast in July.

Filip Petersson at SEB says it will take time for stimulus to impact real demand, and sees poor data globally – industrial-metals will have a very hard time recovering without the Chinese at least stabilizing.

Barclays says weakening global growth means central banks actions won’t be a game changer for many commodities – copper supplies will exceed demand by 160,000 tons in Q4, the first surplus in 2012.

Macquarie Group said copper is the metal most likely to benefit from infrastructure spending in China.

Ross Strachan at Capital Economics said the significant recent steps from many countries will in due course help to alleviate the worst fears of hard landings, particularly in China. Strachan said the global economy is slowing down and things will significantly worsen for commodity prices.

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