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Playing the Loser's Game

HO HO HO! Merry Christmas

The Ruble’s Currency Crisis

Blood in the bourses of Moscow

The Commodity Flip NOT Flop Of 2014

Playing the Loser's Game

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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Forty years ago, Charles Ellis characterized active investment management as a “loser’s game.”  From the perspective of the mid-1970s, Ellis argued that since institutional investors had come to dominate the U.S. equity market, they could no longer generate market-beating returns by taking advantage of less well-informed amateurs.  Investment management had become a game played by professionals against other professionals, and the way to win was to make fewer mistakes than your competitors.  Since Ellis wrote, the trends he identified have continued in force — institutions’ share of assets has grown, portfolio turnover has increased, and managers have become more skillful.

This morning, John Authers of the Financial Times again characterized active management as a loser’s game, this time with special reference to the poor performance of most active managers in 2014.  There are three reasons why 2014 has been so challenging:

  • First, most active managers fail most of the time.  This is a consequence of what Sharpe called “The Arithmetic of Active Management,” and follows from the professionalization of the investment industry.  Since only half of the assets under management can have above-average returns before costs, and since active management costs more than passive indexing, the average active manager is at a disadvantage.
  • Second, there is little evidence of persistence in the success of active managers.  For example, the likelihood of finding a manager who will be above average for four consecutive years is about the same as the likelihood of flipping a coin and getting four heads in a row.
  • Third, active managers were especially challenged in 2014 because of the low level of dispersion in the U.S. equity market.  Dispersion measures the return differential between the average stock and the market index, and is a good proxy for the level of opportunity for active managers.  If dispersion is relatively wide, the opportunities to profit from stock selection are relatively large; when dispersion is narrow, the opportunities diminish.  And 2014’s dispersion may be a record low.

When Ellis wrote in 1975, the alternative to an unsatisfactory active manager was another (putatively-superior) active manager.  Since then, there has been dramatic growth in the availability of indexed investments.  In 2014 more than in most years, an investor who was willing to accept the market’s return outperformed a large majority of active investors.  One way to win the loser’s game is not to play at all.

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.

HO HO HO! Merry Christmas

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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How would you like some heating oil (HO) for Christmas?  Chances are you wouldn’t really like that too much, especially if you agree with this report posted on Morningstar.com that quotes, “Nobody would ever put oil in their house unless there was no gas on their street.”

Despite the S&P GSCI Heating Oil (spot return) losing 12.7% this month through December 18, it is the only commodity in the energy sector whose excess return of -11.5% is greater than its spot return.  With oil prices falling and heating oil in the index at its lowest since May 2010, how could the roll return (excess return – spot return) possibly be positive, indicating inventory pressure?

According to the International Energy Agency (IEA), saavy consumers are taking the opportunity to stock up on heating oil as prices fall. By October, German end‐user heating oil stocks reached 66% of tank‐fill (+1 percentage point m‐o‐m), their highest level since 2009. The impact is pairing excess return losses this month on heating oil compared to other petroleum constituents including WTI -18.1%, Brent -16.0%, unleaded gasoline -16.4% and gasoil -16.7% in the index.

The difference in roll return or term structures between the S&P GSCI Heating Oil and S&P GSCI Brent Oil has been increasing at an unprecedented rate.  Never in history has this difference increased for five consecutive months. There have been five times in history since 1999 with five consecutive months showing greater excess return in heating oil than Brent oil but not with the acceleration of today that reflects the stockpiling by the heating oil consumer.

Source: S&P Dow Jones Indices LLC. All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results.  Please see the Performance Disclosure at http://www.spindices.com/regulatory-affairs-disclaimers/ for more information regarding the inherent limitations associated with back-tested performance.
Source: S&P Dow Jones Indices LLC. All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at http://www.spindices.com/regulatory-affairs-disclaimers/ for more information regarding the inherent limitations associated with back-tested performance.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

The Ruble’s Currency Crisis

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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After sliding slowly down for most of the year, The Russian ruble dropped 20% in the last ten days. The slide began with the weakening Russian economy, sanctions imposed by the US and the EU last summer and falling oil prices.  All these factors were present for many weeks and none explain the sharp move seen at the right hand end of the chart where the ruble/dollar rate jumps.

There were two immediate causes. The first, and less important, was a bill passed by Congress authorizing additional sanctions.  While the President signed the bill, no instant action on more sanctions was expected. Second, at the end of last week Rosneft, the Russian oil company, offered a large ruble-denominated bond and the Russian central bank added the new issue to the list of securities it will accept as collateral for loans to local banks. Further, Russian banks were rumored to be the principal purchasers of the Rosneft bonds. Since Rosneft needs to refinance a large US dollar denominated loan from western banks, the markets assumed that, one way or another, the ruble proceeds from the bond issue or rubles from banks using the bonds as collateral with the central bank, would find their way into the foreign exchange markets and put downward pressure on the currency.  These fears sparked the run on the ruble this week.

So far this has played out according to the usual process: gradual economic weakening, rising inflation, large hard currency debts and external pressures on trade (cheap oil) creates nervousness and worry. Then some seemingly minor event like the Rosneft bond issue raises the fear level and leads to a run.

The response also followed the usual script except that for the moment it seems to be successful. First, the Russian central bank raised interest rates by 6.5 percentage points to 17%. Then it followed two days later by intervening in the foreign exchange market and buying rubles. The amount bought isn’t known but Russian foreign exchange reserves, estimated at $200 to $400 billion, don’t appear to be exhausted. Since Wednesday afternoon New York time, the ruble has traded near 60 to the US dollar without any large dips. Brent crude oil, the principal global oil benchmark, is also showing some signs of stability. It rebounded from under $59 yesterday to above $60.  For the moment the combination of relief from collapsing oil prices, the higher interest rates and the forex intervention may be stabilizing the ruble.

If the ruble can remain close to 60, the crisis will be over for the time being and the result will be far better than most past currency crises.  However, no one should assume everything is resolved. Interest rates at 17% and imports 50% more expensive than a year ago (see chart) impose huge stresses on the economy. Add to that the sanctions and the reluctance of European and American businesses to invest in Russian projects, and another currency crisis cannot be ruled out.

Tim Edwards, in an earlier post on this blog, noted that the trailing PE ratio on the S&P Russian BMI is four times, a deliciously low number.  It is either too early or too late: If the ruble holds near 60 or strengthens somewhat it may be too late to speculate in Russia; if the next move takes the Ruble close to 100, it is too early.  Unfortunately there is no way to know.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Blood in the bourses of Moscow

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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Things are not all well with Russian equities.  The S&P Russia Broad Market Index has lost more than half its value in U.S. dollar terms since the summer.  There is figurative blood on the streets.  If we were to follow the example of the founding members of the Rothschild banking dynasty, we would be lending money to Russian companies and buying up their shares.

The case for investing in Russia now is certainly thought-provoking.  At current prices, the Russian BMI is trading on a trailing price/earnings multiple of around four; the comparable ratio for the Global BMI is closer to twenty.  At roughly 58%, Russian equity volatility is in the 87th percentile of historical readings since 1997 and, to borrow a perspective from our recent whitepaper, periods of high volatility have historically identified beneficial entry points for Russian equities, as the chart shows:

Blood in the bourses

Source: S&P Dow Jones Indices LLC as of December 17th, 2014. Charts and tables are provided for illustrative purposes.  Past performance is no guarantee of future results.

So is Russia a “buy”?

There are two things to bear in mind.  First, somewhat obviously, patience may be required.  Historically, the short-term returns from purchasing at above-average volatility are inferior.   More importantly, the current geopolitical environment would suggest that things are as likely to get worse for Russian equities as they are to get better.

Secondly, the data in the chart above only go back to 1997. There is an obvious risk on relying too much on recent data.  There was no S&P Russia BMI index a hundred years ago, but no doubt if there had been its volatility would have been quite high in 1917; the subsequent destruction of all forms of private capital would provide a counter-example to the general rule of buying at periods of high volatility.

This, of course, is not 1917. Neither is it the turbulent times of the Napoleonic wars that so rewarded the Rothschilds’ historical adventures.  And despite the fact that recent periods of high volatility in Russian equities have represented attractive entry points, that may not imply anything about the current situation.  But historically, in the long term, fortune has favoured the brave, especially (or perhaps exclusively) the patient brave.   This is something to bear in mind as you consider the situation in Russia.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

The Commodity Flip NOT Flop Of 2014

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Six months ago, commodities looked like they were on the brink of a comeback. The S&P GSCI Total Return gained 7.4% YTD through June 20 at its high.  Back then, almost a record number of commodities, 12, were in backwardation, reflecting shortages in Brent Crude, Cocoa, Copper, Corn, Cotton, WTI Crude Oil, Feeder Cattle, Gold, Live Cattle, Natural Gas, Soybeans and Unleaded Gasoline.

Now, the S&P GSCI TR has lost 1/3 of its value, mostly coming from oil since taken together WTI and Brent make up about 40% of the index with a total of 62% in the energy sector. Energy is down 42.8% from its high in June, and at first it seemed the other sectors were sliding with it. Notice in the table below that in the S&P GSCI TR, all the sectors posted losses from June 20 through most of the summer, with precious metals ending its losing streak just in November.

Source: S&P Dow Jones Indices LLC. All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results.  Please see the Performance Disclosure at http://www.spindices.com/regulatory-affairs-disclaimers/ for more information regarding the inherent limitations associated with back-tested performance.
Source: S&P Dow Jones Indices LLC. All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at http://www.spindices.com/regulatory-affairs-disclaimers/ for more information regarding the inherent limitations associated with back-tested performance.

At some point the oil price slide decoupled from the other commodities since their fundamentals are different. From their respective bottoms, agriculture gained 11.8%, precious metals gained 7.3%, livestock gained 6.0% and industrials metals have been flat, gaining 60 basis points.  Nothing is overpowering Saudi’s oil supply in energy, but now energy seems to be on its own.  Below is the graph of the sector performance where energy’s lonely dropoff is clear.

Source: S&P Dow Jones Indices LLC. All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results.  Please see the Performance Disclosure at http://www.spindices.com/regulatory-affairs-disclaimers/ for more information regarding the inherent limitations associated with back-tested performance.
Source: S&P Dow Jones Indices LLC. All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at http://www.spindices.com/regulatory-affairs-disclaimers/ for more information regarding the inherent limitations associated with back-tested performance.

What’s changing? I have mentioned that low inventories are causing mean reversion that is likely to drive swings between winners and losers. These swings also show up in flipping term structures.  Over the summer through October the number of commodities that remained in backwardation dropped from 12 down to 4. Only WTI, Unleaded Gasoline, Copper and Feeder Cattle remained in backwardation. Today, WTI Crude Oil and Unleaded Gasoline have succumbed to the supply glut of oil so these commodities have lost their backwardated positions and are now in contango.

However, now, in December, the number of commodities that are in backwardation is TEN with six newly flipped commodities! This group includes Feeder Cattle, Heating Oil, Copper, Corn, Cocoa, Silver, Kansas Wheat, Lean Hogs, Coffee and Live Cattle.  News of hoarding from Vietnam of coffee, Russia with wheat and an export tax from India on sugar are supply issues that may be supporting this term structure.

 

 

 

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.