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

March 17, 2014

Timely perspectives from the 361 Capital research & portfolio management team

Written by Blaine Rollins, CFA

(Friendship/ErrysWiskan)

Plenty for the market to chew on this week:

1) Continuing Russian aggression towards the Ukraine

2) Further slowing data points in China and now Chinese corporate bond defaults

3) U.S. Political instability as the GOP wins a surprise Congressional seat in Florida

4) Further breakdowns in key Equity market sectors and geographies

The Ukraine Question…

“President Putin has a choice about what he’s going to do here. Is he going to continue to further isolate himself, further hurt his economy, further diminish Russian influence in the world, or is he going to do the right thing?”

(Dan Pfeiffer/The White House)

@ReformedBroker: The Crimea referendum is in: 97% would like to become Americans.

As Russia decides how to proceed in the Ukraine, the financial markets have declared war on Russian assets…

Tension continues to build as Russia remains in control of the Crimea region of Ukraine and has not shown signals of backing down despite threats of sanctions from the U.S. and EU. The Russian ruble has continued to depreciate and government bond yields have begun to move up substantially, potentially stressing the Russian financial markets. The threat of sanctions between the EU and Russia could hang over markets until the situation is resolved.

(Steven Pytlar/PrimeExecutions)

While Russian stocks, bonds and the currency go on sale, the most important commodity in their economy also sells off…

“It is hard to overemphasize the importance of energy to the Russian economy,” writes Ed Hyman’s team at International Strategy and Investment. “In 2013, it was the largest oil producer in the world. Oil and gas account for 20% of [gross domestic product], over 70% of exports, and 52% of federal revenues.”

(Barron’s)

I would agree that Russian stocks look to be the cheapest in the world, but what might it be worth if any companies get nationalized…

(UBS/BusinessInsider)

For Russia, this will all come down to their ability to deal internally with the Economic sanctions that are going to be bestowed on them. There are many Billionaires in Russia. Will they put up with their foreign assets being restricted or even seized? And if they retreat those assets into Russia, will they be happy with the falling value of those assets. Russia also imports more than it exports and what they export is mainly gas/oil. So if the world continues to flood the market with cheap fuel and energy prices fall, there could next be unrest from inside of Russia’s borders. Will the Crimean’s ask for a recount in the future?

@zerohedge: JAPAN CONSIDERS SANCTIONS AGAINST RUSSIA, NIKKEI SAYS. Oh, so Japan doesn’t need that LNG after all

And then there is Japan which chose a bad time to eliminate their Nuclear power and replace it with Natural Gas. How long until the North American LNG facilities are sizable enough to replace their Russian purchases?

As expected, Russia and those dependent upon its energy (Germany, Japan) have shown significant declines…

Vladimir Putin & the Russian Bear also have the Volatility Index popping. Is a 20.0 VIX on the horizon again?

And while the VIX surges, flights to safe harbors benefit: Bonds, Gold, Utility Stocks, REITs…

For those keeping score at home, Gold is UP in 11 of the last 12 weeks…

And the Utility Stock index has shaped up very nicely. Warren Buffett’s last Berkshire Hathaway letter helped to fuel some potential M&A speculation here also…

I was disappointed to see the recent pullback in High Yield performance relative to Treasuries. We will now return to calling Junque Bonds, Junk Bonds. And the outlook for Equities gets another yellow flag for it.

For the week, it was all lower except for the flight of safety into Utility stocks…

More broadly, Gold, the Miners, Bonds and their proxies posted the gains while all Risky assets sold off on the week. Interesting to continue to see Small Caps outperform Large Caps. This is likely due to the Small Caps lesser International exposure.

A good paper by Vanguard showing how Advisers can add 300bps to a client’s performance. Keeping them calm during times of market stress is a major value add…

Advisers looking to quantify their worth in terms of the added return they can provide clients are being offered a concrete answer of 3 percentage points in a new report from The Vanguard Group Inc. The first of five factors influencing this extra return has to do with behavioral finance. Keeping clients focused on the long term and making them stick to a regular investing plan can add 1.5% or 150 basis points, according to the report, “Putting a Value on Your Value: Quantifying Vanguard Advisor’s Alpha,” which was released Monday. Two of the most significant behavioral factors that derail investor performance are “the allure of market-timing and the temptation to chase performance,” said the report by Vanguard, which manages $2.5 trillion in mutual fund assets. “Advisers as behavioral coaches can act as emotional circuit breakers by circumventing clients’ tendencies to chase returns or run for cover in emotionally charged markets.”

(InvestmentNews)

Jeremy Grantham had a big piece in Barron’s this weekend. Here is GMO’s updated asset class forecast…

(ValueWalk)

If Team GMO is correct, the majority of Municipal Pension Plans are in dire straits. Chicago Mayor Rahm Emanuel is not waiting for better markets. Instead he is looking to double its citizen’s property taxes now…

Public pension funds have posted double-digit gains four of the last five years, and asset levels have never been higher. Yet government pension costs are soaring as the bills that politicians postponed during the hard economic times come due. No less than Warren Buffett warned this week that “local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford.” Moody’s last month advised investors that “contribution requirements for pensions will remain high and trending upward in most cases.”

Perhaps the biggest pension landmine outside of Detroit is Chicago. The Windy City next year must make a $1.07 billion balloon payment—equal to a third of the city’s operating budget—on $19.4 billion of pension debt. The pension payment could cover salaries for 4,300 police officers or the resurfacing of 16,000 blocks of road, and Mayor Rahm Emanuel has warned that property taxes may have to double to pay the bill.

Meantime, the required pension contribution for Chicago schools this year is tripling to $613 million. Chicago unions are pressing the state government to raise property, sales, income and corporate taxes to bail out worker pensions. Chicago’s pension funds are only half as well-funded as even Detroit’s, if you can believe it, and could run dry by 2020. With state politicians up for re-election this November and Chicago’s mayoral race next February, it’s more likely that investors will foot the bill.

(WSJ)

Adding to U.S. political uncertainty, the 1st data point for the midterm elections went to the GOP last week…

CLEARWATER BEACH, Fla. (AP) — Republican David Jolly defeated Democrat Alex Sink on Tuesday in a Tampa-area House district where President Barack Obama’s health care overhaul got its first test ahead of November’s midterm elections and both sides spent millions auditioning national strategies. With almost 100 percent of the vote counted, Jolly had 48.5 percent of the vote to Sink’s 46.7 percent. Libertarian Lucas Overby had 4.8 percent. The election was to replace 42-year Republican Rep. CW Bill Young, who died in October of cancer, and the evenly divided district had been considered a toss-up… The battle for Florida’s 13th District seat was a prequel of sorts to the national fight this year over who controls Congress in the last two years of Obama’s final presidential term. The House is expected to remain under Republican control. But in the Senate, Republicans are hoping to leverage Obama’s unpopularity and his health care law’s wobbly start to gain the six seats required to control the 100-member chamber. That made the race in Florida a pricey proving ground for both parties heading into November elections.

(RealClearPolitics)

A Political Pro-Tip for the Midterm Elections: Talk to Japan & Europe then get behind Liquefied Natural Gas in a very big way…

Speeding up U.S. natural gas exports was a good idea even before the crisis in Crimea, but it’s an even better idea now. It’s not as if U.S. exports are going to undermine Vladimir Putin’s imperialistic designs in the short term. Ukraine would love to be less dependent on Russia for natural gas, but the export infrastructure in the U.S. for liquefied natural gas (LNG), particularly in terms of ports, isn’t ready. Indeed, the earliest that an export terminal is expected to come on line is in late 2015, with other terminals becoming operational perhaps a couple of years later. For that matter, the government doesn’t direct where exports go. If the price in Asia for LNG is higher than in Europe, U.S. exports will tend to wind up there.

(TheDenverPost)

Sports Headline of the Week…

(@GoldAndOrSmith)

Why the Under-25 Category will soon have the lowest Unemployment Rate…

“I equate coding to reading and writing and basic literacy,” says Adam Enbar, founder of New York’s Flatiron School, which offers 12-week, $12,000 programs to turn novices into developers. “Not everyone needs to be Shakespeare, just as not everyone needs to be an amazing developer,” he says. “But…we’re entering a world where every job if not already, will be technical.” Programming languages vary in popularity and difficulty, and it takes hundreds of hours to become even a junior developer. But understanding what “code” is and knowing what’s possible and what’s not, when working with an IT team, is generally more important than being able to make apps yourself… Co-founder and CEO Jake Schwartz says that coding is important because it teaches a different way of thinking. “Programming teaches logic, higher-level math and learning concepts that make you smarter and are useful no matter what,” he says.

(WSJ)

And finally…

A pharmacy in North Dakota has put a little girl’s fears to bed, prescribing a bottle of “Monster Spray” to help keep at bay all the things that go “bump” in the night. Austin Johnson, a pharmacy technician at Barrett Pharmacy in Watford City, told The Huffington Post she was at a friend’s house when she noticed her friend’s 6-year-old daughter didn’t want to go to bed because of the “monsters” in her bedroom. The girl’s mother said the child had been having trouble sleeping the past few nights. “I was telling her mom about this thing the pharmacy had done for another kid when I started working there. So I asked if she wanted me to write up the prescription,” Johnson said, referring to the Monster Spray bottle…The girl sprayed the prescribed Monster repellent for three nights before finally becoming convinced that she’d gotten rid of them. As for what’s really inside Barrett Pharmacy’s Monster Spray: Unfortunately, it’s a closely kept secret.

(HuffingtonPost)

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

361 Capital Research Briefing Archive

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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.