361 Capital Weekly Research Briefing

361 Capital portfolio manager, Blaine Rollins, CFA, previously manager of the Janus Fund, writes a weekly update looking back on major moves, macro-trends and economic data points. The 361 Capital Weekly Research Briefing summarizes the latest market news along with some interesting facts and a touch of humor. 361 Capital is a provider of alternative investment mutual funds, separate accounts, and limited partnerships to institutions, financial intermediaries, and high-net-worth investors.

361 Capital Weekly Research Briefing

May 12, 2014

Timely perspectives from the 361 Capital research & portfolio management team

Written by Blaine Rollins, CFA



If you thought steering the Financial Markets was difficult, try taking a seat in a Formula One race car…

(Wired)

One of the most debated red flags in the U.S. Equity Market is the current underperformance of Small Cap Stocks…

I have to admit that looking to the small caps for RISK sentiment is also a favorite indicator of mine. The new recent lows set by the Russell 2000 last week did not make me comfortable about my long positions. But as we know, Small Caps can be volatile and a double digit move in the opposite direction can always be on the horizon.

This month, The Leuthold Group studies that while Small Caps almost always underperform when market breadth weakens; the reverse is not always true. Small Caps can underperform without impacting the broader market and don’t forget that Small Caps will usually bloody both knees on the playground once a year…

(Leuthold Group)

The Leuthold Group also shows why Small Cap Managers and Analysts should take all of their vacation time between May and October…

And if you read their Monthly research, you will also find the Presidential market cycle will give Small Cap investors a further reason to pack a big suitcase for the Summer of 2014. (I would highly recommend The Leuthold Group’s research for any Financial Advisor or Portfolio Manager. Always a helpful read for your portfolios and thought process. You can contact them at www.leutholdgroup.com.)

(Leuthold Group)

If you are looking for another RISK Red Flag, the Nasdaq has tracked Small Caps exactly in this down leg…

(@stockchartscom)

And while Nasdaq’s new 52 week lows are now exceeding new highs, their contagiousness has not yet spread to the NYSE…

But remember, the NYSE is much more interest rate sensitive and Bonds and their proxies are trading near 52 week highs.

Speaking of Bond proxies, the highest dividend paying stocks are crushing those that don’t pay dividends…

The average stock in the Russell 1,000 is down 2.02% since March 5th, which was the date that marked a turning point for the market where the “high growth/no earnings” trade began to unwind. There are quite a few “high flyers” that are now down 40-60% from their recent highs, but as these stocks have been falling, low growth companies that pay dividends have been holding up well. In the Russell 1,000, there are 300 stocks in the index that pay no dividend. As shown below, these 300 non-dividend payers are down an average of 7.21% since March 5th. Conversely, the 300 highest yielding stocks in the Russell 1,000 are up an average of 2.11% since March 5th. Talk about a tale of two markets.

(BespokeInvest)

Don’t forget that recent tax law changes have given Dividends a significant tax advantage over Interest…

Dividends that are paid by corporations are taxed at a flat 15% income rate, for federal income tax purposes. (Note: not all dividends qualify; dividends from mutual funds and dividends from real estate investment trusts (REITS) are the most prominent exceptions.) To qualify for the dividend tax preference, the position in the underlying company must have been held for more than one year. For an investor in the top tax brackets of 35% or 39.6%, paying just 15% tax on a dividend means a savings of more than 20% in the after‐tax amount received. Since other income investments are taxed at 35%, those investments must pay a higher pre‐tax yield in order to have the same after‐tax amount. The following table illustrates how this savings can be significant.

Note: State income taxes are not considered in the above example. While Treasury bond interest payments are taxed at the federal level, they are not taxed at the state level. State income tax on dividends varies significantly by state and needs to be considered.

(Briefing.com)

Another active discussion in the markets is the recent bounce in Emerging Markets…

While Russia has been a top news item, its stock market has settled into a two month base. But more important for Emerging Market Equities has been the 2014 slide in the US$ combined with an ongoing appetite for EM Debt. With valuations for EM equities very attractive relative to the last 10 years, it is easy to see how the markets could continue to glide higher.

Speaking of valuation of Emerging Markets…

(Leuthold Group)

And finally helping Emerging Market Equities is how hated they are…


(Leuthold Group)

No doubt all the profits and returns of capital from private equity funds are being disbursed across many asset classes, including Emerging Markets…

U.S. pension funds face a dilemma that might be considered a nice problem to have: record amounts of capital flowing back from private-equity investments. Strong markets have given the private-equity firms backed by pension money the ability to sell companies, which generates cash for investors. These funds last year returned $134.6 billion to pension funds and other investors, according to Cambridge Associates LLC, topping 2012’s record of $115 billion.

(WSJ)

Meanwhile, it has been a brutal 10 weeks in Hedge Fund land…

Breaking Bread: “Hedge fund guys really need to get out more,” said the market’s top equity volatility trader. “Make new some new friends,” he continued, buying back a bit of his short vol position, late Friday afternoon. “They gotta stop having all these dinners together,” said Road Runner, having a fantastic year, dodging all these crowded catastrophes. “Isn’t it just amazing how often they all have exactly the same position?” he asked, looking both ways. “Beep! Beep!” And darted off.

(EricPeters)

But while some areas of Equities have shown extreme weakness, investors remain unfazed and continue to add to their mutual fund holdings…

For the week, Consumer Cyclicals were the worst, while Consumer Staples were the best. The market remains in a defensive mode…

More broadly, it was the less than developed international investments that took home the most points while the U.S. markets remained in a RISKOFF mode…

The next big thing in long only Asset Management will be Active ETFs. Their evolution will further slice the indexes up into vehicles that investors could only buy through high cost mutual funds or separately managed accounts. Expect the biggest players to be involved to keep/grow their AUM even at the cost of lower pricing and margins…

Implications for Money Managers: We believe one of the major impacts of these new ETFs on asset managers will be fee compression. Many of these ETFs have fees around 40 BPS. Investors will demand real alpha for the fees they are paying and they will also expect more consistency in alpha provided by the active managers as they will be compared not only to their selected benchmark, but also to the smart beta strategies. Active managers may consider creating concentrated portfolios to provide alpha to their clients. These concentrated portfolios will be different from many of the non‐market cap indexes and investors will be willing to pay for those investment portfolios as long as they provide consistent alpha. They should focus on expanding services to their client in the overall investment process e.g., Help a pension plan to make sure they are able to meet their cash flow needs.

(ISI Group)

And while few were anticipating it, the Wirehouses shifted their profits into 3rd gear, which is great news with Trading Profits down shifting…

@trhunnicutt: Lots of colors in these charts, but for wirehouses the 1 that matters is green

(InvestmentNews)

I am a big fan of this Morgan Stanley call on Large Cap Europe. Large Caps have an easy valuation argument so now all they need is a bit more momentum in the trade to capture more interest. Maybe an easing of Russian/Ukraine tensions and a June rate cut by the ECB will be the catalyst?

(ValueWalk)

If you are an investor in Equities or a beneficiary of a Pension Plan, you are likely going to own shares in Alibaba. Just so you have an idea of what you are owning, consider it the Chinese equivalent of all of the businesses below. In other words, this is a BIG company.

(Quartz)

If you need help valuing Alibaba, download Dr. Damodaran’s valuation framework and input your own assumptions. Here is his output…

The value of the operating assets in Alibaba, based on my assumptions, is $127.48 billion. Adding cash ($7,876 million), the value of cross holdings in other companies ($2,087 million) and Alipay ($3,000 million), netting out debt ($6,670 million) and the value of equity options granted to employees ($3,190 million) results in a value for equity of $130.59 billion. Finally, since this is an initial public offering that will raise money that is going to be kept in the firm (according to the prospectus), I added an estimated $15 billion (the rumored IPO target) to arrive at an overall equity value of $145.59 billion. Again, working with the 2368.67 million shares outstanding, including restricted stock units granted to employees, that works out to a value per share of $61.46/share.

(MusingsOnMarkets)

If you have Hotel exposure in your portfolios, congrats. If you need a hotel room for this summer, I am sorry…

In year-over-year measurements, the industry’s occupancy increased 7.5 percent to 67.4 percent. Average daily rate increased 5.6 percent to finish the week at US$116.41. Revenue per available room for the week was up 13.6 percent to finish at US$78.42. The 4-week average of the occupancy rate is solidly above the median for 2000-2007, and is at the highest level since 2000. The following graph shows the seasonal pattern for the hotel occupancy rate for the last 15 years using the four week average.

(CalculatedRiskBlog)

Given the tight occupancy, it may not be a bad idea to forward reserve your rooms for the Summer 2016 Olympics…

So worried are Olympic organizers by how far behind schedule the 2016 Rio Games has fallen, London has reportedly been asked, in secret, if it could host the event at the last minute. According to the London Evening Standard, an informal approach has been made by IOC chiefs to ascertain whether London’s 2012 Olympic venues could be brought back into use. The build-up to the Rio Games has been labelled a shambles, with every venue badly behind schedule, spiraling costs and accusations of negligence… A source told the Standard: “At a comparable planning stage in 2004 Athens had done 40 percent of preparations on infrastructure, stadiums and so on. London had done 60 percent. Brazil has done 10 percent – and they have just two years left.

(Telegraph)

A great graph showing how far the U.S. housing market has recovered…

@NickTimiraos: An interesting look at the average mortgage payments as a share of incomes, by state, today vs 2006 bubble peak

And if you want to know why the State of California is still red in the chart above…

SAN FRANCISCO (KPIX 5) — Realtors are using the words “overbid madness” to describe what’s happening in San Francisco’s housing market. One case in point is a home that was sold hundreds of thousands above the asking price. Shrouded in fog, and swimming in cash a two bedroom, modern home in the Glen Park neighborhood was just snapped up for $2.1 million. “That’s really unbelievable,” said Kendra Mastain of San Francisco. The sleek home on Bosworth sold for $600,000 over asking price. “I’m a RN, I make a decent living,” said Tammy Elder of San Francisco. “I don’t ever picture myself buying a house here.” Arrian Binnings of Christie’s / Pacific Union told KPIX 5, “That wasn’t even our highest offer.” Binnings said its supply and demand, with most homes for sale commanding 12 percent over asking.

“That is a red hot market,” he said. For sale signs a rare sight in San Francisco. Real estate agents said if new property stopped coming on the market, San Francisco would run out of homes for sale in just five weeks. There were eight offers on the home, but only one person can win. It has turned San Francisco’s real estate market into contestant’s row on The Price Is Right, making the losing bidders desperate.

(SFKPIX5)

No steering wheel needed on this ride. Only a stomach for Ups and Downs…

(TheBicaFunicularLisbonPortugal/RicardoBahutoFelix)

In the event that you missed a past Research Briefing, here is the archive…

361 Capital Research Briefing Archive

The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, 361 Capital is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of 361 Capital.

Blaine Rollins, CFA, is managing director, senior portfolio manager and a member of the Investment Committee at 361 Capital. He is responsible for manager due-diligence, investment research, portfolio construction, hedging and trading strategies. Previously Mr. Rollins served as Executive Vice President at Janus Capital Corporation and portfolio manager of the Janus Fund, Janus Balanced Fund, Janus Equity Income Fund, Janus Aspen Growth Portfolio, Janus Advisor Large Cap Growth Fund, and the Janus Triton Fund. A frequent industry speaker, Mr. Rollins earned a Bachelor’s degree in Finance from the University of Colorado, and he is a Chartered Financial Analyst.

Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Terms & Conditions page for a full disclaimer.

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