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

August 4th, 2014

Timely perspectives from the 361 Capital research & portfolio management team

Time For A Gut Check…

Written by Blaine Rollins, CFA

(KariPhotography)

With most of the major and minor equity indexes breaking through their 50-day moving averages, the market is now going to test your portfolio’s risk conviction. It was a very busy week with respect to financial data and analysis. The preliminary Q2 GDP of 4% was a hot data point despite inventory build contributing 100 basis points of this gain. The Fed slanted slightly more hawkish in their inflation talks on Wednesday, and Alan Greenspan threw up a potential market correction flag on Thursday, but, the Friday jobs data came in very Goldilocks-friendly (not too hot, not too cold) with a rising unemployment rate and a mild +209K nonfarm payroll gain. With no Fed talks for 2 weeks (Jackson Hole) and no Fed meeting until September, the markets could cool their rate hike angst from last week and recover some of the short term oversold condition. However, it is August, and most are thinking beach towels or hiking boots, so anything could happen in these thinly traded markets.

The Federal Reserve remains on a patient course as it weighs interest-rate increases following a roster of economic reports Friday pointing to steady U.S. job growth and firming—although, still low inflation and wages. A Commerce Department report showed the Fed’s favored measure of inflation—the personal consumption expenditure price index—up 1.6% in June, makes 26 straight months below the Fed’s 2% inflation goal; though still higher than 1% and below last year’s readings. Meanwhile, the Labor Department reported average hourly earnings of private-sector workers up 2% from a year earlier, unchanged from the range of the past few years. That could give Fed Chairwoman, Janet Yellen, leeway to stick to a plan to keep short-term rates near zero until well into 2015. Still, Ms. Yellen is facing increasing internal pressure from easy-money skeptics on her policy committee to move more quickly toward rate increases.

(WSJ)

Six straight consecutive monthly gains of 200,000+ jobs created…

(NYTimes)

The Q2 earnings season is now behind us with the majority of companies having reported. It was a good season for earnings beats…

If your hand was holding Russia and Golf exposures in Q2, then not even a World Cup wild card could help your earnings…

Adidas shares dropped more than 10 percent after it slashed its financial targets for this year and next. They warn that conditions in Russia and challenges in the US golf market were creating serious risks for the company… “The recent trend in the Russian ruble as well as increasing risks to consumer sentiment and spending from its current tensions in the region, points to higher risks in the short-term profitability contribution,” the company said, as it rushed out a headline for the second quarter figures, a week earlier than planned… While sales were up 10 percent on a currency neutral basis between April and June, Adidas said that revenues in its TaylorMade US golf division had slumped 18 percent.

(FinancialTimes)

Looking at the markets, investors continued to pare their Junk Bond exposures…

Retail-cash outflows from high-yield funds totaled $1.5 billion in the week ended July 30, with ETFs representing just 23% of the sum, or roughly $334 million, according to Lipper. The outflow is narrower than last week’s total of $2.4 billion, the largest one-week redemption in 13 months, and the ETF influence is down from 45% last week. With this latest withdrawal, the net outflows in July are shaping up at $5.4 billion, representing the largest one-month redemption in 13 months.

(Forbes)

Given less liquidity and smaller trading desks in the market, there has been a dramatic effect on Junk Bond prices…

…as well as High Yield spreads. But this is good for the Risk markets as High Quality spreads are sitting tight…

(BespokeInvest)

Over in Equities, one would think that an economic slowdown was on the horizon given the 2 week pullback in Industrial stocks; even transports took a pause last week which hasn’t happened since April…

Small Caps continue to underperform Large Caps and now the spread is reaching noticeable divergence…

Even the major press is writing about the “worst underperformance in 16 years”…

Small-cap stocks are on track to underperform their large-cap peers by the widest margin in more than a decade. The performance of the Russell 2000, a benchmark for small stocks, is trailing the S&P 500 by 8.1% this year, based on midday trading. If that trend holds, it will be the worst yearly underperformance in 16 years, according to Bank of America Merrill Lynch… Valuations in the sector won’t help either, he said. Even with the Russell 2000’s underperformance, it is trading around 19 times its expected earnings for the next year. The S&P 500 is trading around 15.7 times its forecast earnings, according to FactSet… Another cloud on the horizon is a slowing housing-market recovery, since small companies get 19% of their earnings from the housing market, compared to 10% for large-cap companies, Mr. DeSanctis said.

(WSJ)

If Small Cap companies get 19% of their earnings from the housing market, the IWM ETF might be doomed for a while longer…

Look no further for reasons why Residential Housing shares are out of favor…

@MatthewPhillips: Back to normal. US homeownership rate, 64.7% at the end of Q2. Data back to 1965.

For the last month, Tech was best and Utes were worst. This bar chart is eye candy to a Growth Stock portfolio manager…

My weekly ETF performance is ranked by Q3-to-date (or basically July). While many indexes were running with positive returns through most of July, last week quickly erased those gains. Will investors now look for an oversold bounce or shift toward better performing Technology and Emerging Market exposures? If a bounce occurs, watch closely as it will have a story to tell…

So why might a bounce occur? Thursday & Friday showed a big move in the Put/Call ratio signifying the willingness of investors to buy insurance against their portfolios. As shown in the past, this can be a good bounce point in the short term…

And on a near term basis, the market has become oversold with less than 20% of the S&P 500 stocks trading above their 20-day moving averages. Typically, this is a good bounce point…

Looking at higher risk Small Caps shows the last 3 times the ratio of SPY:IWM hit this level; Small Caps reversed their underperformance over the next month…

@WildcatTrader: Past three years the RUT has started to outperform the SPX in this range.

The Emerging Market chart shows not all is lost as one asset class is still outperforming…

In his recent piece, Byron Wien gives a detailed and thoughtful outlook on why he would be a buyer of this pullback in equities…

I continue to believe that real economic growth in the United States will move toward 3% during 2014, and S&P 500 profits will be up 7%, with a similar increase next year. As a result, I believe the S&P 500 will appreciate in the mid-teens this year. One condition that gives me pause, however, is the disappointing increase in revenues, which were only up 3% in the second quarter. At this point they should be growing 4%–5%. I see neither a recession nor a bear market in sight even though we are five years into the economic and market recovery. Let’s hope geopolitical turbulence doesn’t upset that outlook.

(ByronWien/Blackstone)

The green oil tanker below broke 40 years of banned trade last week…

A tanker of oil from Texas set sail for South Korea late Wednesday night, the first unrestricted sale of unrefined American oil since the 1970s… The Singapore-flagged BW Zambesi is the first of many ships likely to carry U.S. oil abroad under a new interpretation of the federal law that bars most sales of American oil overseas. Analysts say future exports appear wide open: as much as 800,000 barrels a day come from just one of the many U.S. oil fields pumping light oil. Though U.S. policy on oil exports hasn’t changed, production of this kind of oil, known as condensate, is surging. This early shipment “is the wedge that’s pushing the door open” for more ultralight oil exports, said Daniel Yergin, vice chairman of consulting firm IHS.

(WSJ)

Green-decked BW Zambesi is preparing to sail from Texas with an oil cargo destined for South Korea.

(DigitalGlobe/Microsoft)

Meanwhile, U.S. Energy production is no longer a growth business as it now underperforms GDP growth…

(WSJ)

Interesting: 4 of the 5 largest Canadian Bank CEOs have retired in the last year…

McCaughey is the–not kidding–fourth Canadian bank CEO to retire in the last year. RBC, TD, BNS, and now CIBC. And these guys are not that old. Late fifties, maybe. So it is clear what is going on here–they are cashing out on the highs. It is perfectly rational behavior. Come on–if you were a bank CEO, and you thought that your industry had years of upside left, would you get out? If you were 57? You would not. Let me say it again, more succinctly. 4 out of the 5 Canadian bank CEOs have retired in the last year. That is a complete sentence.

(JaredDilian/DailyDirtnap)

Southern California had buckets of rain over the weekend but California still looks like it needs Noah to build an ark in Dodger Stadium…

All of California is in “severe drought” (shown in orange), and 82 percent is rated “extreme drought” (in red). The agency’s highest drought rating–“exceptional drought” (crimson)–now covers 58 percent of the state, up from 36 percent a week ago. Exceptional drought is marked by crop and pasture loss, and water shortages that fall within the top two percentiles of drought indicators. The water reserves in California’s topsoil and subsoil are nearly depleted, and 70 percent of the state’s pastures are now rated “very poor to poor,” according to the USDA. Reservoir levels are dropping, and groundwater is being drained from the state as farms and cities pull from difficult-to-replenish underground caches. The state’s 154 reservoirs are at 60 percent of the historical average, or 17.3 million acre feet lower than they should be. That’s more than a year’s supply of water gone missing.

(Bloomberg)

And as Neel Kashkari found on his weeklong walkabout, the California drought makes it even more difficult to find a job…

The Fresno Community Food Bank is doing record business these days, serving food to 220,000 residents, including 90,000 children each month, up 340% from a few years ago, according to the food bank. Fresno is in the heart of California’s agriculture economy. With a third year of record drought, farmers don’t have enough water for their almond, cantaloupe, and other crops. The rising cost of water had forced farmers to idle about 500,000 acres of land. One young woman in line at the food bank said it simply: “There’s not enough water. Crops can’t be grown. My family works in the fields and they can’t get work every day . . . sometimes just on weekends.”

(WSJ)

If you are interested in public education, this book is a great read. I came away from it quite fired up that education systems can be changed to benefit students in years rather than decades. Of course parents, teachers, and governments must want to tackle significant changes at home and in the classroom. One Pro Tip to Parents: Read to your kids or with your kids EVERYDAY…

In a global quest to find answers for our own children, author and Time magazine journalist Amanda Ripley follows three Americans embed¬ded in these countries for one year. Kim, fifteen, raises $10,000 so she can move from Oklahoma to Finland; Eric, eighteen, exchanges a high-achieving Minnesota suburb for a booming city in South Korea; and Tom, seventeen, leaves a historic Pennsylvania village for Poland. Through these young informants, Ripley meets battle-scarred reformers, sleep-deprived zombie students, and a teacher who earns $4 million a year. Their stories, along with groundbreaking research into learning in other cultures, reveal a pattern of startling transformation: none of these countries had many “smart” kids a few decades ago. Things had changed. Teaching had become more rigorous; parents had focused on things that mattered; and children had bought into the promise of education.

(Amazon)

And finally, Happy 180th birthday to John Venn…

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

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