Sideways

·

The yield curve is flattening in a big way. The spread between the 5 and 30 year treasury bonds is 168 basis points, compared to 250 last November. We have been expecting a flatter yield curve –it is an important sign of normalization. But investors seem to have been caught off guard by the strength of long term bonds. Treasuries with maturities of 20+ years have been among the best performers in the market, generating over 11% returns year-to-date. Not too shabby, especially given that rates are supposed to be moving higher.

Of course, rates will be moving higher – the Federal Reserve has made that perfectly clear. But not quite yet, and they’re only talking about short term rates. So the curve that is taking shape is significantly flatter, and at least right now it looks like higher rates will mostly be felt inside of 5 years. The long end tells a very different story, and for Credit, the story unfolding suggests a pretty benign, if uninspiring outlook. Looking back to the last credit cycle, when the curve finally started to flatten, credit spreads largely moved sideways for several years, in a range of about 10 basis points.

Looking at the past week, spreads were a little tighter, and for the month of April, generated positive excess returns of 41 basis points. The long end outperformed strongly, with total return for the month of 2.24%, and 62 basis points of excess return. Supply for the week came in at $32 billion, driven by the Apple deal. The market had been anticipating this deal following Apple’s announcement on April 23rd that it would be issuing bonds to fund share buybacks, but the deal was much smaller than expected – just $12 billion instead of $20 or more. The deal was well received (with the exception of the 10 year – the only tranche that moved wider on the break) and spreads for existing Apple bonds tightened.

The market as a whole right now has a complacency that leaves us wondering what else is going on out there. It feels a lot like middle age – reviewing where we’ve been, wondering if we’ve done enough, and when it all falls apart. The signs of middle age for the market are definitely there – a flatter yield curve, modest movement in credit spreads, modest economic growth. Now I guess we’re just waiting for someone, somewhere in the market to push things a little too far. It always seems to happen in middle age. The risk is greatest when we are no longer content with moving sideways.

The Power of Observation

· · Leave a comment
Tom Brakke, CFA

How do you process the torrent of information that comes your way as an investment decision maker? On April 29, Gregg Groechel of Inferential Focus gave a presentation to CFA Society Minnesota that challenged the attendees to see their information gathering and decision processes in a new way.

The talk was titled, “Identifying Meaning Versus Noise: Getting Past Biases and Seeing What is Actually There.” We all can agree that is a lofty goal.

Groechel, a Twin Cities charterholder, led the group through a series of exercises to show how hard it can be to put things into context. He used photographs to illustrate how background and foreground information can be difficult to separate – and how meaning can be obscured.

A couple of key questions from him: “How do you set up an intentional way of operating? How do you open up the organization [to process information effectively]?”

The mission of Inferential Focus (website; Twitter feed) is to “make sense of a changing world” for its clients, which include investment firms of all types, corporations, and governmental organizations. Groechel walked through some of the firm’s principles and its process.

What does the firm do? The start of the process involves intensive, far-reaching, and unusual reading. Unusual in the sense that most of the reading is done from paper (because the processing of the information is better in that form) and the Inferential Focus team is designed to look for information in a very specific way.

The members of the team are all generalists, reading across disciplines and avoiding the specialization that characterizes research efforts in most organizations. In addition, they are looking to glean specific kinds of information from the materials that are read.

The firm believes that there is a hierarchy of information, with events most important and then facts. What aren’t very important are opinions and commentaries. Groechel deconstructed an Economist article to show that a very large part of was made up of that relative fluff, with very few events and facts referenced.

Think about the typical investment report or presentation. A high percentage of the content is made up of opinion and prognostication. The percentage is even higher in many of the stories in the financial media.

Inferential Focus ignores that and focuses on what is actually happening, piecing together developments from an array of sources to observe a context through which it can help its clients see economic, political, social, and technological changes. It then communicates the ideas in written materials and in-person meetings.

To provide an example, Groechel distributed to the attendees one of the firm’s “packets,” a collection of the source material that it uses to support its observations and its communications with clients. In this case, the readings concerned China, specifically a variety of hurdles being erected by China to impede the success of foreign consumer brands while simultaneously buttressing the competitive position of its domestic firms.

It was a good example, in that the information came from a variety of different publications, was focused on facts and events, and pertained to a variety of companies. In considering the prospects for firms in China, most observers are either focused on their own narrow specialty (and making predictions in that regard) or speculating on the level of Chinese GDP (and assessing the prospects for firms in relation to that). Each approach, according to Groechel, is missing the essential context: There is a general headwind to most foreign consumer brand companies doing business in China that wasn’t there before. On balance, that is likely to make results worse than will otherwise be expected.

As investment professionals, we are immersed in information and our greatest challenge is in deploying our powers of observation in a differentiated and advantageous way to the benefit of our clients. Inferential Focus’ approach stands apart from that of most organizations, in that it is slower, more selective, more structured, and focused on identifying the big, important changes before others do.

Could it work for you? As Gregg Groechel said, this “consulting think tank looks at change through a different lens.” If nothing else, its divergent approach should make you think about how your own organization processes information and makes decisions.

 

Disclosure: I have known the Inferential Focus organization for thirty years. I have been a client and have also worked with the organization on some projects. Therefore, I have seen “the sausage being made” and have relationships with the principals of the firm. I have previously written about IF in a posting about a 1983 book that stemmed from its work (“The Tao Jones Averages,” long out of print but now available as an ebook) and in a piece that was inspired by an April 2013 IF report on applications of virtual reality that included a look at Oculus Rift, which was recently purchased by Facebook. (My essay focused on applications of the technology in the investment world.)

Member Social with a Twist Notes: Using Social Networks like Twitter for Investment Research

· · Leave a comment

We recently held a member social at Lyons Pub on April 17 where we informally discussed if social networks such as Twitter serve a purpose for investment research and if so how is it used? Here are some of the key points that were gleaned from our discussion.

  • Twitter and other social networks work well if you follow a wide variety of opinions and markets.
    • You should attempt to follow a variety of investment worlds, such as equities, fixed income, alternative investments, and the like.
    • However, larger firms usually are not a good repository for information—it’s overly scripted and regulatory considerations dilutes the voice and therefore the impact.
  • Are social networks a serious part of the due diligence process or is it just a way to delineate short-term trends?
    • It actually does both, but where you often get good information are from the links various posters provide.
    • Others mentioned that it can be used to challenge your investment thesis and keep you from investing in something you will later regret.
  • Sites that do a good job of curating links and information were popular with the group.
  • Twitter and other social networking sites are great for timeliness of information.
    • It works for finding out about a security that is moving strongly, as Twitter usually has the information well before the mainstream press.
    • For example one person found out why a biotech stock was moving because of a publication in a relatively obscure German scientific journal that was referenced on Twitter.
  • Many people in the conversation watched how many followers a person or company has and look at the trend analysis—are they getting more or less followers. However be careful of sponsored sites (i.e. sponsored sites usually get revenue if you “follow” them or visit their site), they are not as useful and their trend analysis is less meaningful.
  • One person thought that it was interesting that more sell-side analysts follow Twitter closely, but often are not followed as much for their opinions themselves.
  • Regulatory issues with Twitter and others?
    • Legally one can talk about general investing issues but not anything specific, like opinions on companies—especially on the sell side. Investment managers need to be very careful to avoid advertising issues with their firms.
    • One could be tempted to use a pseudonym, but firms do check cell phones, computers, etc. Investment managers should assume that all correspondence and communication can be monitored by their compliance department or securities regulators.
    • Can people tweet about their participation as a patient in a clinical trial? This concept is being discussed legally. The concern being that a sponsor of a clinical trial would not want participants leaking information about the trial before the sponsor could publish or announce the results to the entire market or scientific community. Leaks of results could create insider trading issues.
    • The key is knowing if the person is being paid for this information or not
    • Social sites might be difficulty to regulate in practice.
    • Higher level executives usually know when they are in possession of material nonpublic information and know not to tip such information to parties who might trade or tip such information to others who might trade or engage in social media or chatroom commentary. Lower level employees of organizations might not know that they possess material nonpublic information and might not know that they have a duty not to disclose company information on social media sites.                             .
  • One person said there are some that use Twitter as a weapon against companies but many thought that at times it is easy to determine where those tweets are coming from, decreasing their impact.
  • There are even social network sites that have aggregated company estimates from users, such as estimize.com.
  • Someone mentioned that Twitter and other sites would be better for option investors as these sites do a good job in assessing volatility, which could translate into assessing option volatility.

Here’s a list of people and organizations that some follow on Twitter:

Stocktwits, Zerohedge, SeekingAlpha, NotableCalls, and here’s a good site listing interesting Twitter feeds.

 

To Buy or Not To Buy

·

Investment Grade new issue was dominated by bank and finance this week. The primary market saw $26.5 billion in supply, over 50% of which came from financial issuers – and within that, 5 year bank paper was the most popular. USBank, Capital One, Fifth Third Bank, and Suntrust all came to market with 5 year bonds post-earnings. That seemed to put a bit of pressure on financial spreads. Overall, spreads were relatively unchanged all week, but bank names were a touch weaker as accounts were trading positions to make room for supply.

Away from 5 year space, Morgan Stanley had one of the week’s larger transactions, with a $3 billion new issue 10 year bond. It priced at +130, and seemed to be well received, but is now trading a few basis points wide vs new issue levels. Spreads in general gave up some ground on Friday in the face of Russia/Ukraine, heavy supply, and what feels like a real lack of conviction about market direction.

And this brings us to the crux of the matter. Investment Grade credit spreads are trading at their post-crisis tights – still a bit wide compared to pre-crisis levels, but for some very good reasons. We find it hard to support a significant move tighter. On the other hand, spreads remain well-supported by fundamentals, and market appetite has been insatiable. The economy is in solid shape, interest rates are under control, and volatility is low. This period of tight spreads could easily carry on for many months. Going short credit seems like a suicide trade. But it is the dread of something after the spread tightening comes to an end that causes us to raise the question.

Computer Forensics Help Fall Accused Insider Trader

· · Leave a comment

Guest Contributor: Mark S. Enslin

A former Bristol-Myers finance executive pleaded guilty earlier this year to an insider trading charge, admitting to buying stock options in a biotech company that Bristol-Myers was preparing to buy. As part of the plea, the executive agreed to forfeit $311,361 in allegedly illegal profits, and he now faces a maximum of 20 years in prison and $5 million fine when he is sentenced later this year.

This relatively innocuous insider trading case is interesting for at least two reasons. First, it’s a good reminder that insider trading remains a high priority for the SEC and other regulators. In fact, over the past three years, the SEC has filed more insider trading cases than in any three-year period in the agency’s history. Many of these actions involved registered representatives, hedge fund managers, corporate insiders, and other financial professionals who conspired in various forms to trade on non-public information.

The second interesting aspect of this case is what investigators revealed was one of their key pieces of evidence: they were able to trace the fact that the executive had run a series of Internet searches on insider trading detection just prior to some of his trades, including a review of an article entitled “Ways to Avoid Insider Trading.” Technology continues to evolve at an astounding pace, and the effects of that evolution on the securities industry will continue to be significant. When the SEC is able to utilize such technology on the back end to apprehend those who violate the securities laws, it’s only a matter of time before the SEC and other regulators will expect those in supervisory positions to utilize that same technology on the front end to attempt to stop the violations before they occur. Supervision of Internet usage, so called “social media” websites, and other electronic media remains a “hot button” issue and will only continue to grow in importance.