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

July 21, 2014

Timely perspectives from the 361 Capital research & portfolio management team

Written by Blaine Rollins, CFA


It was a sad week in the world and a volatile week in the markets; Janet Yellen’s stock valuation framework was the focus at the beginning of the week while geopolitical issues moved to front and center stage at the end of the week. But at Friday’s close, the markets managed to gain as better than expected earnings results dominated, and thoughts emerged that immediate Russian interests surrounding the Ukraine would calm followed by hopes for a successful cease fire in the Gaza.


Most important to the markets last week was the early slice of earnings releases. Google, Intel, JPMorgan, Goldman Sachs, and Citigroup all reported numbers better than expected and the stocks reacted with sharply higher moves. Bespoke showed the early earnings data as the best in 15 quarters, but this week will be another test as about a quarter of the S&P 500 will report. Earnings are the clear driver to stock prices right now so keep a sharp eye.


Inside of last week’s earnings releases you will find many comments like the following from Wells Fargo…

“While the economic recovery remains uneven, there are many indicators that economic growth is accelerating”

And one glance at last week’s Philly Fed New Order Index also showed you that the U.S. economy is shifting into a higher gear…


The Fed’s Fisher spoke on whether or not the Fed has overstayed its welcome…

I believe we are at risk of doing what the Fed has too often done: overstaying our welcome by staying too loose too long. We did a good job in staving off the deflationary and depression risks that were present in the aftermath of the 2007–09 financial crisis. We now risk falling into the trap of fighting the last war rather than the present challenge. The economy is reaching our desired destination faster than we imagined… should we overstay our welcome, we risk not only doing damage to the economy but also being viewed as politically pliant.

(Richard Fisher, Dallas Fed President)

GMO’s Jeremy Grantham sees an explosion of M&A as companies look to take advantage of low rates in an improving economy…

Mr. Grantham says the recent deal frenzy, which has gained steam this year with Comcast Corp’s $45 billion deal for Time Warner Cable, AbbVie ‘s $54 billion pact for Shire PLC and 21st Century Fox ‘s $80 billion offer for Time Warner, is just getting starting. He predicts every type of M&A record will be broken over the next couple of years, as companies take advantage of low interest rates and a recovering economy. “Don’ tell me there are already a lot of deals,” Mr. Grantham, co-founder and chief investment strategist of GMO, a Boston-based money management firm, wrote to clients on Friday. “I am talking about a veritable explosion, to levels never seen before.”


And according to the weekend papers, Banks are there to line up and help with the big deals…

Rupert Murdoch has lined up what would be one of the largest takeover loans ever written as the media mogul pushes forward with his $73bn bid to bring together his own 21st Century Fox with rival television and entertainment group Time Warner. Goldman Sachs and JPMorgan will provide a loan of about $25bn to fund the proposed deal, according to people familiar with the matter.


But the head of JPMorgan’s Private Bank sees increased risk in putting new money into fixed income…

Mary Callahan Erdoes , CEO of JPMorgan Asset Management, is concerned about retail investors continuing to invest in bonds despite the growing risks. “People who aren’t as informed are going into the bond market…. they don’t understand the effects of duration and convexity and what will happen eventually. That’s the most dangerous part of this,” Erdoes said at the Delivering Alpha conference presented by CNBC and Institutional Investor Wednesday. “It gives me great pause.”


Meanwhile, the U.S. Treasury is finally testing the waters to issue 30-50 year debt…

The U.S. Treasury asked big Wall Street brokerages on Friday if Washington should start borrowing money over extremely long periods, a move that would potentially help the government capitalize on current low interest rates. The Treasury released a quarterly questionnaire it circulates among large financial institutions that asked if it should “consider issuing a security with a maturity greater than 30 years.” Borrowing over longer terms helps insulate governments from future increases in interest rates. Sovereign bonds with a 50-year duration are not common, although China and Britain issue them. Some analysts think the Treasury is likely to hear requests for 50-year bonds.


Some fixed income investors are deciding now is the time to head for the exits in the Junk Bond markets…

@lcdnews: Largest Withdrawal In 11 Months: Retail-Cash Outflows From #HighYield Bond Funds Balloon

As most know, High Yield has been a great asset class to invest in. But keep an eye on flows and prices because pullbacks here usually find their way to the equity markets…

And then there is the small cap stock sector which had a tough week behind the Fed’s valuation call…

“Nevertheless, valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.” Yellen

The Fed is not the only one complaining of valuation in Small Caps as actual owners of the stocks have been reducing ownership for 4+ months now…

Since March 4, small caps have lost -4.7% while the S&P 500 has gained +5.5%. That 10% underperformance by the RUT is the worst since 2012 when the market was in the midst of the last downside correction.


Another chart shows the very even performance by market cap…


Besides a higher valuation versus historic, Small Caps have also had their earnings estimates cut more sharply in 2014 than Large Caps. Some of this is due to their larger U.S. exposure and the terrible Q1 weather we had. But bottom line is that the Small Caps need to put up some better than expected 2nd half earnings.

(Goldman Sachs)

As market cap and sector slices continue to put up different return streams, the correlations among equities continue to plunge…


Not much in the way of big moves week over week, but plenty of movement on a day to day basis…

Christopher Flowers tells you why global bank stocks are failing to keep pace with the current equity markets…

One of the biggest private equity investors in the banking sector has warned that regulation has depressed profitability so much that lenders will struggle to attract sufficient investors to survive the next financial crisis. “All the stuff that has happened and all the rules we’ve introduced have depressed profitability and that is a real vulnerability,” Christopher Flowers, the US private equity investor specializing in financial services, told the Financial Times in an interview. “Nobody is going to invest in an industry with returns of 5 per cent.”


Speaking of banks with unattractive returns, what price to book value would you pay for a mid to high single digit ROE?


Railroad earnings look solid. Remember when Berkshire Hathaway bought Burlington Northern in 2009? Makes you wonder if Warren & Charlie were even making a bet on the U.S. energy renaissance…


Speaking of Energy, here is a great long piece in the Financial Times regarding the rising U.S. importance in the world of energy and how if it wasn’t for the new technologies, we would likely be faced with another energy crisis…


One area of equities where Value investors are spending the most time = China…

China is drawing investors that bet on cheap stocks, an increasing rarity in the West, where U.S. equities are hitting record highs. The stocks of Asia’s biggest economy have fallen deep into the discount bin, trading at about 9 times the companies’ forecast earnings, compared with 11 times for the broader region and nearly 15 times for global stocks. Asian shares and particularly Chinese ones have lagged behind the rest of the world for years amid concerns over slowing, indebted economies and there is no certainty that gap won’t continue to widen. But investors who take long, sometimes painful bets on stocks they see as undervalued are having a good year in Asia. Value stocks are outperforming hard-hit growth shares this year at a pace “more persistent than during any other period in the last two to three years,” said recently. “If you are a global value investor and you don’t own anything in China, you have a lot of explaining to do,” said Brad Radin, who runs Toronto investment firm Radin Capital Partners Inc.


Richard Bernstein Advisors sees a broader opportunity in Equities…

Investors never fully embraced the bull market and remain very uncertain despite that the bull market is more than five years old.

Consider the following:

1) Credit Suisse data shows that US pension funds have their lowest equity allocations in more than 30 years.

2) BofAML’s “Sell Side Indicator” highlights that Wall Street strategists continue to underweight equities in their recommendations.

3) ISI’s hedge fund survey suggests that hedge funds are neutrally positioned.

4) ICI mutual fund flows have been negative for US equity funds for more than two months.

5) As mentioned, S&P 500® high beta stocks are selling at their cheapest relative valuations in nearly 30 years.


JPMorgan notes the characteristics of the current market to previous peaks…

UBS has correctly been Overweight risk assets. Last week they cut back on their Overweight. This is why they are taking some chips off the table…

Firstly we are concerned about valuations. We show that equity markets are stretched (e.g., more than 80% of the S&P rally since last year is due to re-rating), but we also find that the fixed income market has become quite rich (we have been overweight European peripherals for more than a year on valuation grounds, we show that this argument no longer holds), and the same is true of the credit market. Second because capital has been flowing rapidly into risky assets, we document that argument and here too find evidence that the market might be ahead of itself. We read the market reaction last week to the Portuguese news as a sign that the market is indeed too complacent and could correct rapidly.


Speaking of UBS, nice work to many of our friends at the Bank…

Swiss bank UBS saw 15.4 percent growth in its wealth management business for 2013, firmly securing its position as world leader in the sector, with close to $2 trillion of assets under management. If growth continues at its current rate, the bank – which currently runs $1.96 trillion – will become the first wealth manager to hit the $2 trillion “milestone”, according to wealth data firm Scorpio Partnership. This would mark a “transition in the scale of global wealth management”, Scorpio added.


One of the more interesting Investment visuals that I came across last week…


If you have to do a lot of writing in your personal or professional life, you will enjoy Vitaliy Katsenelson’s recent piece in Institutional Investor

I never thought I’d be giving writing advice. I was always the worst student in my literature class in Russia. I never received a grade higher than a C on any Russian essay I ever wrote. I have a theory that my teachers got sick of reading and grading my horrible essays, so they stopped and automatically gave me a passing grade out of pity. I don’t blame them. When I came to the U.S., my grades in English class in college were not spectacular either; in fact, English was the only class I failed in college and actually had to retake my senior year.


Worst Soccer Mom in the World…

“As you know, I’m no soccer fan,” said President Cristina Fernandez de Kirchner, while standing next to Messi and Argentina manager Alejandro Sabella. “I didn’t see a single match, not even the one yesterday (on Sunday). Even so, I called Alejandro (Sabella) because for me, and for 40 million Argentines, they had won the match.”


Tweet of the Week…


“Disney owns marvel.

Marvel owns Thor.

Thor is the son of a king.

Thor is now female.

Thor is now a Disney princess.”

Finally, if you like the ideas Blaine Rollins shares each week in the 361 Capital Research Briefing…

Then you should learn more about how he incorporates these ideas in the new mutual fund he is managing, the 361 Global Macro Opportunity Fund. Contact 361 Capital or your advisor for additional information.

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.

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