PrefBlog

Russia is intervening in the currency markets:

Russia’s central bank sold $420 million of foreign currency in its third day of interventions this month to slow the ruble’s world-beating decline.

The monetary authority spent the funds on Oct. 6 to shore up the ruble, the latest data on its website showed today. The bank also said it shifted the upper boundary of the currency’s trading band by 5 kopeks yesterday. The exchange rate was little changed at 44.6979 versus the dollar-euro basket as of 10:12 a.m. in Moscow today.

Bank of Russia will probably need to spend as much as $30 billion by year-end to slow the decline in the ruble, which lost 14 percent against the dollar last quarter, according to UralSib Capital.
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Demand for dollars and euros is growing among Russian companies as they contend with $54.7 billion of debt repayments in the next three months, according to central bank data.

A little bird asked me to comment on a paper by Pablo Fernandez of University of Navarra – IESE Business School titled CAPM: An Absurd Model:

The CAPM is an absurd (having no rational or orderly relationship to human life; contrary to all reason or common sense) model because its assumptions and its predictions/conclusions have no basis in the real world. The use of CAPM is also a source of litigation: many professors, lawyers… get nice fees because many professionals use CAPM instead of common sense to calculate the required return to equity. Users of the CAPM make many illogical errors valuing companies, accepting/rejecting investment projects, evaluating fund performance, pricing goods and services in regulated markets, calculating value creation…

According to the dictionary, a theory is “an idea or set of ideas that is intended to explain facts or events”; and a model is “a set of ideas and numbers that describe the past, present, or future state of something”. With the vast amount of information and research that we have, it is quite clear that the CAPM is neither a theory nor a model because it does not “explain facts or events”, nor does it “describe the past, present, or future state of something”.

It is important to differentiate between a fact (something that truly exists or happens: something that has actual existence; a true piece of information) and an opinion (what someone thinks about a particular thing). The CAPM could be described as an uninformed opinion, and not as a sensible opinion.

We all should try to explain a portion of “the world as it is”, not of “the world according to a wrong theory” nor of “the world if men were not men”. Ricardo Yepes, professor of philosophy of my university, wrote: “Learning means being able to keep perceiving reality as it truly is: complex – and not trying to fit every new experience into a closed and pre-conceived notion or overall scheme”. We may find out an investor’s expected IBM beta and expected market risk premium (MRP) by asking him. However, it is impossible to determine the expected IBM beta and the expected MRP of the market (for the market as a whole), because these two parameters do not exist. Different investors have different cash flow expectations and use different expected (and required) returns to equity (different expected market risk premium and different expected beta). One could only talk of the beta and the market risk premium if all investors had the same expectations. But investors do not have homogeneous expectations.

Sections 11 and 12 show how to calculate required returns in a sensible way and how to use betas being a reasonable person.
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Just an example: calculation of the beta of electrical companies done by a European Electricity Regulatory Commission. “We calculate the betas of all traded European companies. Leveraged betas were calculated using 2 years of weekly data. The Market Index chosen was the Dow Jones STOXX Total Market Index. There is a great dispersion (from -0.24 to 1.16) and some odd betas (negative and higher than one). We decided to maintain all betas… To unlever the betas, we assumed that the beta of the debt is zero for all companies. Then, the Commission calculates the average of the unlevered betas and relever it using an objective debt to equity ratio based on the average debt to equity ratio of comparable companies. The levered beta proposed by the Commission for the transport activity is 0.471870073”

The Commission acknowledges that calculated betas have a “great dispersion (from -0.24 to 1.16)” but calculates the average of all of them and finally provides betas with a precision of 9 figures after the decimal point!
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According with the CAPM “the market” assigns a beta to every company and that beta may be calculated with a regression of historical data. Of course, every investor should use this “market beta”. As we have already mentioned, the first problem is that this “market beta” does not exist.

When we calculate betas using historical data we encounter several well-known problems:
1. They change considerably from one day to the next.
2. They depend very much on which stock index is used as the market reference.
3. They depend very much on the historical period (5 years, 3 years…) used.
4. They depend on what returns (monthly, yearly…) are used to calculate them.
5. Very often we do not know if the beta of one company is lower or higher than the beta of another.
6. Calculated betas have little correlation with stock returns.
7. β = 1 has a higher correlation with stock returns than calculated betas for many companies
8. The correlation coefficients of the regressions used to calculate the betas are very small.
9. The relative magnitude of betas often makes very little sense: companies with high risk often have lower calculated betas than companies with lower risk.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 1bp, FixedResets off 7bp and DeemedRetractibles down 8bp. Volatility was low (Floaters don’t count!). Volume was low.

PerpetualDiscounts now yield 5.16%, equivalent to 6.71% interest at the standard equivalency factor of 1.3x. Long corporates are now at about 4.2%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 250bp, a widening from the 240bp reported September 10.

Europe isn’t looking very good:

U.K. 10-year government bonds rose with their German counterparts as a report showed factory orders in Europe’s largest economy plunged the most since 2009 in August, underlining risks to the euro area’s recovery.

Five-year gilts advanced for the fifth time in six days. The yield fell last week to the lowest level since February as reports signaled the U.K. economy was losing momentum, fueling speculation the Bank of England will delay interest-rate increases. The pound declined versus the euro as Business Secretary Vince Cable said Britain’s currency was still too strong and stifling exports.
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U.K. house prices fell for the first time in almost a year and a half in September, Nationwide Building Society said on Sept. 30, while a Markit Economics report on Oct. 3 showed services growth cooled more than economists forecast, further signs that the recovery may be losing enough momentum for the Bank of England to refrain from increasing borrowing costs. That has fueled gains in government bonds and slowed the rally in the pound.

… and there are renewed deflation fears:

Inflation in the euro area has fallen yet again and now stands at 0.3 percent. Prices are already falling in several of the European Union’s weaker economies. Even so-called core inflation, which excludes temporary factors and reveals the underlying trend, stands at less than 1 percent, a full percentage point below the ECB’s target.

… which is causing some to criticize Draghi and the ECB:

European Central Bank President Mario Draghi has disappointed investors and economists by failing to detail the size of the expansion he’s seeking in the central bank’s balance sheet. This much is clear from today’s investment bank research reports. Parsing Draghi’s comments from yesterday, as his favorite inflation measure fell to a record today, raises the chilling prospect that it may already be too late to avert deflation in the euro region — and that he knows it.

For the first time, Draghi has abandoned the incantation he’s used for months against the perceived evils of falling prices: “Inflation expectations for the euro area over the medium to long term continue to be firmly anchored.” That’s how he put it in his opening remarks at the August monetary policy press conference, and then followed it up, at the question-and-answer session, with, “Long-term expectations remain anchored at 2 percent.”
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Yesterday, in addition to dropping the mantra from his speech, Draghi also demurred when he was directly asked if he thought inflationary expectations were anchored:

Well, first of all, the inflation expectations — first of all, we don’t use — let me get this clear, because there has been a certain amount of misunderstanding in the last few weeks — we don’t use one single measure of inflation expectations. We use a broad range of indicators. And our inflation expectations measures have gone down especially on the short horizons and are now around 8 points below 2 percent on the five-year on five-year, and so we look at that with — definitely with great attention. I would say that the measures we’ve taken have been determined exactly because our medium-term outlook on inflation expectation has worsened and we see that the risks have increased.

Lena Komileva, the chief economist at G Plus Economics in London, a research company, interpreted the absence as a sign the ECB is aware that the euro region risks what she calls “Japanification.” Annual inflation was just 0.3 percent last month; it hasn’t touched 2 percent since January 2013.

All this gloom had an effect:

Stocks tumbled and bonds rallied, sending yields to the lowest since May 2013, as the International Monetary Fund cut its global outlook and German industrial production plunged. Oil slid to a 17-month low.

The Standard & Poor’s 500 Index (SPX) fell 1.5 percent to 1,935.10 at 4 p.m. in New York, the lowest level since Aug. 12. The Dow Jones Industrial Average lost 1.6 percent, the most since July. The yield on 30-year Treasuries retreated 8 basis points to 3.05 percent as investors sought safety. Oil tumbled 1.7 percent to the lowest since April 2013, while gold futures climbed 0.4 percent. Volatility rose, with the VIX jumping to the highest since March.

The IMF cut its outlook for global growth in 2015 and warned about the risks of rising geopolitical tensions and a financial-market correction as stocks reach “frothy” levels. German industrial production dropped 4 percent in August in the biggest decline since 2009.

With Hallowe’en fast approaching, I would be remiss if I didn’t alert Assiduous Readers to the BEST PRANK EVER:

A lewd statue of the devil that seemingly popped up overnight in East Vancouver has been taken down by city officials after raising eyebrows — among other things.

The statue stood about eight to nine feet tall on a pedestal near the intersection of 4th Avenue and Clark Drive for several hours Tuesday.

It was removed by city crews at around 3:15 p.m.

The statue also appeared to sport a full erection, a detail that likely raised hell with some of the commuters who use the station.

Click for … um … big

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts winning 18bp, FixedResets gaining 1bp and DeemedRetractibles up 2bp. Volatility was minimal. Volume was low.

Nothing happened today, but there was a nice column from Megan McArdle of Bloomberg regarding the Intregity case before SCOTUS that I mentioned on October 3:

But the law is never simple and intuitive, in large part because case law is made by the difficulty of hard corner cases. The briefs run through some of this history. For example: Does your employer have to pay you for your commuting time? That doesn’t seem reasonable; employees could relocate to the far exurbs and get themselves time and a half for hours spent driving and singing along to “Free Fallin’.” Okay, but what if you work in an airport, and at the end of your commute is a lengthy trip through the Transportation Security Administration lines? Should you get paid for what is essentially a mandatory 15 minutes added to your commute? A court said no; the TSA line is not part of your primary duties. Okay, how about if you work in a nuclear power plant, where, for the sake of the neighbors, everyone is rigorously searched and subject to radiation screenings? I can see the workers’ argument there, but a court ruled against them.

The workers’ brief tries to distinguish those cases from the Amazon case. The TSA case seems pretty easy: The security screening is not there for the benefit of the employer; it’s there because it’s required by law. You can’t demand that your employer pay you for commuting just because they’re located in the middle of an extended 15-mph zone. The security checks at the Amazon warehouse, on the other hand, are exclusively for the benefit of the employer, who is trying to prevent theft.

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts winning 11bp, FixedResets gaining 3bp and DeemedRetractibles up 5bp. Volatility was minimal. Volume was very low.

Interestingly, due to microscopic pricing changes, the median YTW-Duration (the YTW-Duration is the duration of the Yield-to-Worst scenario) of the FixedReset subindex is now in the ‘perpetual’ range, for the first time since April, 2009. After recovering from the pricing slump that gave rise to that scenario, there followed a long period during which the bulk of the issues in the index were the huge-spread bank FixedResets, which reduced their expected term by one day every day. In May, 2012, new issuance started making things more interesting with a series in the range of four (median expectation was a call of a relatively new issue at the first opportunity), a series starting at eight and declining to about 6.5 (median expectation is the Deemed Maturity of a bank issue 2022-1-31) and a third, relatively recent series at about 8.5 (median expectation is the Deemed Maturity of an insurance issue, 2025-1-31). And today … continued low yields for the Government of Canada 5-year bond, massive issuance of relatively low-spread FixedResets and calls of the higher-spread issues have tipped the balance to perpetuity. Fun times! This median YTW-Duration figure will almost certainly be volatile for the next year or so.

Click for Big

For those who are obsessive about such things, the median issue is BAM.PF.F, which at its bid of 25.25, HIMIPref™ calculates as having a 4.32% yield to Call 2019-9-30 and (given a GOC-5 yield of 1.58%), has a yield to perpetuity of 4.31%. At its closing bid of 25.26 on Friday, its YTW scenario was the call 2019-9-30 to yield 4.30%; I was using 1.61% as the GOC-5 yield on Friday. I told you the changes were microscopic!

Jobs, jobs, jobs!

A surprisingly powerful surge in hiring pushed unemployment to a six-year low of 5.9 percent in September as the U.S. labor market showed renewed vigor.

The 248,000 gain in payrolls followed a 180,000 increase in August that was bigger than previously estimated, the Labor Department reported in Washington. Revisions boosted the job count by 69,000 over the previous two months. The jobless rate fell from 6.1 percent to the lowest level since July 2008.
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Another report today showed the U.S. trade deficit shrank in August to the lowest level in seven months as exports edged up to a record. The gap decreased 0.5 percent to $40.1 billion, the smallest since January, from $40.3 billion in July, the Commerce Department reported.

The narrowing deficit prompted economists at Barclays PLC in New York to boost their tracking estimate of third-quarter gross domestic product to a 3.3 percent gain at an annualized rate from 2.7 percent.

Also today, another report showed service industries grew in September to cap the strongest quarter of expansion in more than 10 years. While the Institute for Supply Management’s non-manufacturing index fell to 58.6 from the prior month’s 59.6, the third-quarter average was the highest since the first three months of 2004, the Tempe, Arizona-based group said.

The quarterly average for the group’s factory index was the highest since early 2011, a report showed earlier this week.

Meanwhile, in Canada:

Canada swung to an unexpected merchandise trade deficit in August as imports surged to a record and exports fell for the first time in four months.

The C$610 million ($543 million) deficit followed a July surplus that was pared to C$2.20 billion from the initial C$2.58 billion estimate. None of the 14 economists in a Bloomberg survey predicted that Ottawa-based Statistics Canada would report a trade deficit today, and the median estimate was for a C$1.6 billion surplus.

The report is another setback in a week that saw Statistics Canada report the world’s 11th-largest economy stalled in July after a second-quarter expansion that was led by a jump in exports. Bank of Canada Governor Stephen Poloz said last month he saw early signs of a needed rotation toward growth led by exports and business investment.

And problems in moving exportable goods don’t seem to be getting any better:

Even with a grain harvest falling below last year’s record, Western Canadian farmers can’t find enough rail cars in the right places to move their crops.

Wet, cool weather across parts of the Canadian prairies has reduced the amount of high quality grain available, helping to fuel another showdown between shippers and the nation’s largest railways. While the crop is 20 percent smaller than last year’s, it will be harder to find and move the right grades to match export sales.

Grain shippers said railways haven’t been supplying enough cars, and about 24,000 orders for transport on the prairies haven’t been filled. Canadian National Railway Co. (CNR), facing a fine for failing to meet its minimum weekly grain shipping target, said farmers haven’t been delivering enough grain to country elevators to comply with the government order.

People are borrowing for more than just houses:

If stock investors are any guide, the $1.3 trillion U.S. junk-bond market is being inflated by a growing amount of leverage being used by buyers.

Both stock and junk-bond managers tend to deploy more leverage when markets are booming, and more than ever is being used to purchase U.S. equities, based on levels of margin debt on the New York Stock Exchange, according to UBS AG (UBSN) analysts. That suggests junk-debt buyers are engaging in similar financing activities.

As investors use more borrowed cash, they increase the potential for bigger losses in a downturn. This trend adds to concern that six years of unprecedented Federal Reserve stimulus has produced a bubble in the junk-bond market — and one that will be all the more painful when it eventually pops.
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Margin debt has surged to more than 2.5 percent of U.S. gross domestic product, about the highest level in data going back to the early 1990s, the UBS analysts [Stephen Caprio and Matthew Mish] wrote. The measure of leverage tends to be a leading indicator of relative yields on speculative-grade bonds, with a rising level of margin debt increasing the odds of future spread widening.

Investors are demanding 4.42 percentage points more than benchmark rates to own dollar-denominated high-yield bonds, compared with 5.9 percentage points on average over the past decade, Bank of America Merrill Lynch index data show.

… and Rob Carrick writes about Corporate bond ETFs: More than meets the eye:

Determined to avoid future catastrophes, the world’s regulators, central banks, investment strategists and money managers are asking questions and raising concerns about all kinds of investment trends and products. One of the latest to be scrutinized is a useful and seemingly innocuous category of exchange-traded fund that holds corporate bonds.

The concern starts with a lack of liquidity in the corporate bond market today. A liquid asset can be easily traded, without concern that you’ll have to pay a premium to acquire it or accept a discount when selling. Corporate bond liquidity has been negatively affected by a combination of a changing regulatory environment for the banks that dominate trading of these securities, and strong demand for these bonds from investors.

Today, the lack of liquidity means investors have to pay up to buy corporate bonds. When interest rates rise, it could mean they’ll take a hit if they sell. ETFs, which hold baskets of corporate bonds, complicate things. If investors dumped corporate bonds en masse, would these ETFs be able to efficiently sell their holdings as needed?

He then spoils this excellent question by allowing disingenuous salesmen to slip off the hook really easily:

If you did submit a sell order for your corporate bond ETF, it would be matched with a buy order from another investor. Even if corporate bonds turn toxic, there are investment dealers designated to maintain an orderly market in ETF trading. They’re supposed to put in a bid for the ETF units you’re selling, even if the price would reflect prevailing market conditions.

These dealers would have the option of exchanging the ETF units they’ve accumulated for the underlying securities. At BlackRock Canada, they say that’s not a problem. “You can’t make an ETF if you don’t have liquid underlying [investments],” said Noel Archard, the company’s head and managing director.

Alfred Lee, vice-president and portfolio manager at BMO Mutual Funds, said corporate bond ETFs give investors more liquidity than if they tried to sell an individual bond. “Given a liquidity event, liquidity is not going to be as good as in a normal environment. But we’re going to be owning the most liquid bonds out there.”

To sum up, problems in the corporate bond market will be reflected in the price of bond ETFs. However, ETF industry people say their funds will not exacerbate things.

(The article is also spoilt by the inclusion of the old nonsense about how risk and return are magically changed by putting the raw materials into a box.[ETF] Disadvantages: No maturity date, which means prices subject to interest rate trends. See Bond ETFs demystified for an explanation of what is really going on.)

Anyway, I hope that Noel Archard was misquoted, or quoted out of context, or severely shortened, or something, because his statement is nonsense. Synthetic ETFs can be a threat to financial stability; I’ll agree that there aren’t many of these in Canada, but we do have some, we could have more, and the underlying investments can be illiquid.

Alfred Lee also evades the question, by claiming that his firm (? Does this mean BMO ETFs? BMO Mutual Funds? BMO as principal?) will ‘be owning the most liquid bonds out there’. Who cares, in a crisis (and, I might ask, does he have a mandate to focus on liquidity?)? The issue is the price sensitivity of these bonds.

There are three main problems that I see:

• Firstly, in a crisis, people are going to want to get out faster than they got in; i.e., we could see one month’s redemptions equal to X month’s current purchases. This will pressure dealer inventories and hence prices.
• Secondly, we can expect risk aversion to increase in a crisis, which will increase the price sensitivity to this picked up selling, and
• Thirdly, there is the structural issue … ETFs are meant to increase the liquidity of an investment in their underlying. That’s their whole point! The implication is that you have investors in a particular asset class (e.g., the corporate bonds currently being discussed) whose holdings would be reduced, or non-existent, if they had to invest directly in the underlying (i.e., the liquidity provided by the ETF is a critical contributor to their decision to invest in the asset class). Therefore, on top of the increase in risk aversion due to the crisis, you’ve also got a structural increase in risk aversion.

It could be ugly, by which I mean a beautiful time to be trading.

There’s a strange story on US employment law:

On Oct. 8 the Supreme Court will hear arguments about whether that time counts as work. In 2010 two former employees of Integrity Staffing Solutions, a temp agency that supplies workers at many of Amazon’s U.S. warehouses, sued the company demanding back pay for the time they spent in security lines after clocking out at Amazon warehouses in Nevada. The security checks, the plaintiffs argued, were required by Integrity and therefore part of the job. (Amazon-employed workers go through the same checks.)

At issue is the scope of a 1947 amendment to the Fair Labor Standards Act that says employers don’t have to pay for time spent on work-related activities like getting to or from the office. Nine years later, the Supreme Court established in a pair of rulings that the key is whether the activity in question is “integral and indispensable” to the principal activities workers are paid to do. Butchers at a meatpacking plant, the court found, had to be paid for time spent sharpening their knives, and workers at a battery plant deserved compensation for time spent showering after work to wash off traces of sulfuric acid and lead.

The question in the Integrity case is whether security checks are more like those showers or more like commuting. With screenings increasingly common, the case could have implications for a wide range of workplaces….

Integrity says it doesn’t owe the workers money because the screenings weren’t directly related to their jobs. “No court has ever held that ‘not breaking the law’ is a principal job activity for which compensation must be paid,” the company’s lawyers wrote in a brief last May.

To me, this is open and shut. Of course time spent going through a security check should be compensated, if the employer insists you do it. I can reduce my commute by living in a tent at the warehouse’s front door, but reducing the time spent proving I’m not a crook is beyond my power (unless I quit my job, which I would). But not only has this case made it to the Supreme Court, but the Comrade Peace Prize administration is supporting the employers!

The Departments of Justice and Labor also submitted on Integrity’s behalf. There is, Solicitor General Donald Verrilli Jr. wrote, “no clear-cut distinction—either in terms of purpose or effect—between petitioner’s screenings and those that are routine at countless government and private-sector buildings.”

Crazy world. The forces of fear have won.

As an aside, I went to hotair.com to see what this week’s official Republican talking points on the issue are, but couldn’t find a mention of the SCOTUS Integrity case. I did find this complaint about a subtraction algorithm in the Common Core, though; as I often am when reading HotAir, I was perplexed by the level of annoyance shown. I use this algorithm all the time when doing mental subtraction. What’s the big deal?

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 5bp, FixedResets off 1bp and DeemedRetractibles down 4bp. Volatility was minimal. Volume was low.