Here are this week’s reading diversions for your personal enlightenment. Have a super long Victoria Day Weekend!

24 Signs You Went To Catholic School
24 Signs You Went To Catholic School

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Women’s College Hospital – Improving care for women with BRCA1 and BRCA2 mutations

Mutations in BRCA1 and BRCA2 increase a woman’s lifetime risk of breast cancer as well as ovarian and fallopian tube cancer. Women with a family history of cancer are often screened for mutations in these genes. If they are found to carry a mutation, they often choose surgical treatments to reduce their risk of cancer.

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This Blog May Be a Lifesaver: BRCA and You | The Oz Blog

Genes, of course, are the parts of each cell that contain hereditary information that determines if you are destined to inherit your mom’s curly hair and your dad’s high cholesterol. Every gene has a job. The job of a normal BRCA gene is to stop cancer. A mutation is a misspelling of the gene that changes its function. If a BRCA mutation occurs, the gene can no longer do it’s job, and cancer, specifically breast and ovarian cancer, is free to grow. Like any other gene, BRCA mutations can be passed on to subsequent generations.

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Best Exercises For Love Handles: 5 Ways To Lose Belly Fat For Summer

“Most people think that doing crunches will get rid of love handles, but they are misinformed,” Keigher says. When done properly, crunches do tone muscles, but the problem is, love handles don’t contain an ounce of muscle. They’re fat, and to burn fat you need a healthy diet and a rigorous cardiovascular program, he explains.

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10 Foods You Can Still Eat Safely Past the Due Date | Food For Thought

Raw chicken that’s expired is one thing, but that jar of mayonnaise that’s a week past due, would you chance it?

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Women Tolerate Pain Better than Men – Science News – redOrbit

She gets a tooth pulled, then drives herself home, makes dinner for four, does the laundry and helps the kids with their homework.

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Cardiovascular Risk In Middle Age Linked To Body Fat – Health News – redOrbit

Young adults with more body fat had less stiff arteries, they discovered. However, after the age of 50, increasing body fat was linked to stiffer arteries in both male and female study participants. Furthermore, body fat percentage was more closely related to arterial stiffness than body mass index. On average, men were approximately 21 percent fat while women were an average of 31 percent fat, the MRC team reported.

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Strawberry Aroma Under The Microscope – Science News – redOrbit

It’s easy enough to simply recognize that something smells like a strawberry, but it’s much more difficult to understand why something smells that way. Scientists from the Technische Universität München (TUM) set out to get to the bottom of the strawberry smell in order to understand a little more about scents and how our brains understand which scent and taste belong to which foods.

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Popcorn Ingredient Bad For Brain – Health News – redOrbit

Although often touted as a low-calorie snack for those looking to watch their food intake, popcorn is not exactly a health food. Now, according to researchers at the University of Minnesota, one ingredient in the puffy, steaming bag may actually be harmful to your brain.

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Watch “Rupinder Bains: Living with Crohn’s disease” Video at TED2013 #TEDTalentSearch

Rupinder Bains is making it her goal to put a face to Crohn’s. Diagnosed last year, Bains believes that doctors and healthcare professionals do not adequately convey the experience of having the disease.

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8 Of The Healthiest Breakfast Foods Ever

In fact, a number of breakfast foods you’re probably already eating (or drinking — hello, coffee!) pack big-time benefits for your health.

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The Best Foods for Your Teeth | Men’s Health News

In fact, a lack of tooth wear (caused by eating soft foods too often) could actually deteriorate your teeth’s enamel, the researchers say.

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The Difference Between Allergies and the Common Cold | Men’s Health News

Warning: Researchers say this year’s allergy season could be the worst on record—and that allergy seasons are getting longer and more intense every year. But is that what’s behind your sudden sneeze? Maybe not.

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The Eclectica Fund – Q1 Review 2013

The Fund returned 3.5% (net) in Q1. The main positive contributors to this performance were equities and FX. There were gains from long positions in consumer staples and Japanese stocks, as well as gains from shorts in industrial commodity related stocks. In FX, the Fund profited from being long the US dollar. Offsetting losses came primarily from long positions in commodity futures, spread across gold, oil and softs.

Long Consumer Staples

Given our longstanding caution regarding the prospects for the global economy we have looked to express equity risk by being long cash generative businesses with the strongest balance  sheets and the least economic sensitivity. This served us well in the first quarter when the performance of the S&P consumer staples index defied recent convention. Such stocks tend to under-perform their industrial brethren given the seasonal optimism that tends to surround the global economy at that time of year.

This time around however they out-performed by rallying 13.8%. But with the annualised Sharpe ratio on our basket looking unsustainably high, we took a tactical decision to realise profits towards the end of March. An unresolved but pertinent question is whether this price action might mark the start of the next asset bubble? Consider the plight of a conservative investor: concerned about the risks to the global economy and hence cyclical equities; fearful of financial repression in Treasuries; trapped (possibly unfairly) by the prejudice of the ten-year bear market in US dollars; scared that governments may have to haircut his savings account in the bank; and now terrified by the sudden price collapse in gold. It could be argued that for such an investor all roads lead to the safest, least volatile, most liquid consumer non-discretionary blue chips on Wall Street, which provide a 3%dividend income payable in dollars.

Long US Dollar

The second of our major investment themes is the likely durability of the US economy relative to the rest of the world,and the impact this may have on the US dollar. Unlike the rest of the world, America has dealt with the overhang of bad debts from the housing bubble through a vicious house price correction and resulting bust and the recapitalisation of its banking system. Wages have come down sharply relative to Asia, the shale gas boom means energy is now far cheaper as well, and the resulting lower cost base is allowing the US to reclaim market share within the global economy. As such, US real GDP is 3.3% above the pre-crisis high of Q2 2008,whereas the European economy is still languishing 3.1%below the all-time high recorded in Q1 2008.x As measured by the DXY Dollar Index, the dollar gained 2.5%for the first quarter, and seasonally recorded one of its best monthly performances on record for the month of February. This strength was partly attributable to investors’ perception that American economic conditions are improving, and also partly helped by the continuing crisis in Europe. Perhaps more interesting was another break from recent tradition, as the US dollar proved less negatively correlated to the performance of the stock market. It is early to draw anything firm from this, but the sight of the stock market and the dollar rising in tandem looks more like the regime which accompanied the last two dollar bull markets of 1980-85 and 1995-2001.

Long Japanese Equities

Another investment theme we have been leaning toward ever since the end of 2012 is a long position in Japanese equities.Back in 2008, we purchased a ten year 40,000 Nikkei one-touch call option. We had been struck by the historical observation that it had taken the Dow Jones Industrial Index twenty five years to recover from the nominal price losses of the Great Crash of 1929 and make new price highs. The gold price had required twenty-seven years to overcome its previous bubble high. Was Tokyo somehow different or would the persistent inflationary threat of a fiat currency and social democracy’s abhorrence of deflation be such that dire economic circumstances could once more persuade them to elect public officials intent on repealing the nominal loss?In order to turn bullish, we had to see a further deflationary shock. And as we examined Japan’s economy we conceived of a catalyst. As a consequence of the mercantilist policy of seeking an external surplus with the rest of the world through resisting the yen’s strength, the Japanese economy had built up a huge short position against its own currency. This left them, we reasoned, vulnerable to exogenous shocks similar in nature to the Lehman crisis, when the currency strengthened as foreign denominated assets had to be sold to make good yen losses registered back home. We reasoned that further exogenous shocks were likely to produce yet more yen strength.2011 saw not one but two huge shocks. The global economy weakened as a result of the European crisis, and Japan was struck by a catastrophic earthquake. The yen strengthened sharply. We had posited that further FX strength would create duress at the corporate level and sure enough credit spreads soon widened. By the start of 2012 we had witnessed the nation’s two largest manufacturing debt restructurings, and atone point it seemed that the impossible was becoming a reality as household names such as Sharp, Panasonic and Mazda looked likely to go bust. Even Sony only just managed to hold it together by issuing a large and very dilutive convertible.

We reasoned that such was the corporate pain that the political class would be forced to intervene more directly in the policies of the Bank of Japan. And, sure enough, as the economic conditions worsened last year, we saw a newly elected government fire the institution’s two most senior decision makers and embark on a policy shift on the scale of the Plaza Accord. This dramatic regime shift and the resulting 20% depreciation of the yen is very bullish for Japanese assets(denominated in yen terms) and so with our catalyst in place we started buying TOPIX index futures and shares in Japanese property companies.

Receive Rates

However, we also caution that Japan’s monetary pivot towards QE will not create economic growth out of nothing. Instead it seeks to redistribute global GDP in a manner that favours Japan versus the rest of the world. This is the last thing the global economy needs right now. For as we have moved into spring, business activity appears to be slowing as the inventory cycle brought about by
Draghi’s speech and the re-opening of Chinese liquidity taps last year fades away. Reported PMIs are rolling over, and a destocking cycle combined with a resurgent and competitive Japanese export industry does not bode well for economies in Europe and the rest of Asia.This slowdown is occurring at a time when better global economic statistics over the last six months had served to enrich the risk premium available at the front end of sovereign bond curves, US dollar 3y1y rates backing up from 95bps to150bps as an example. We judged that the combination of richer rates and weaker economic data justified a much greater and wider fixed income exposure. Accordingly, since the end of the quarter, we have initiated positions split geographically across Australia, Europe, Korea, Switzerland and the US.

Conclusion

In summary, as we move into the second quarter the key elements of our portfolio are as follows: long the Tokyo stock market trading just barely greater than its 50 year moving average (comparable to where gold traded ten years ago and where the Dow Jones traded shortly after the attack on Pearl Harbour in 1941), long low variance US equities, long the US dollar and receiving fixed income at the short end sovereign curves.

Hugh Hendry, CIO

Q1 Review 2013 Hendry by ValueWalk.com

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Today’s chart looks at the market from a technical perspective. While there are a plethora of Wall Street analysts calling for much higher levels for the S&P 500; most of these calls are based simply on the belief that the current trajectory must continue indefinitely. While you certainly cannot “fight the Fed” the underlying fundamentals and economics that support the markets long term are not present for the party. What is very important to understand, and can be clearly seen in the chart below, is that despite repeated calls for “ever rising” stock markets in the past eventually left investors devastated. Markets do not, and cannot, continue indefinitely in one direction.

Market prices are subject to gravity (the long term moving average) and the longer the duration of the moving average the greater the “gravitational pull” that exists. One way to measure extremes of price movement is through the use of standard deviation. One standard deviation from the mean (average) encompasses 68.2% of potential outcomes within a given distribution of data which, in this case, are market prices. Two standard deviations encompass 95.8% of all potential outcomes while three standard deviations encompass 99.8% of all potential outcomes.

The chart below shows a MONTHLY chart, which is a very slow moving analysis, of the S&P 500 overlaid with Bollinger Bands which represent 2 and 3 standard deviations of a very long term (34 month) moving average.

At the peaks of the “Internet Bubble” and the “Credit/Housing Bubble” the market never got significantly above 2-standard deviations. Today, we are encroaching well into 3-standard deviation territory. Standard deviation analysis tells us that roughly 99% of the potential movement in prices, from the bottom of the correction in 2011, has been achieved. Furthermore, the extension of the market above the long term moving average is also at levels that have previously been associated with major market tops.

The top graph is a very long term (150 month) measure of overbought and oversold conditions. It is also warning that the current market environment is stretched very far and that further gains are likely to be limited without a correction first.

However, therein lies the potential problem. Looking back at the markets during a bullish trend the market is usually contained between the long term moving average and 2-standard deviations above the mean. However, when the extension is above the long term mean subsequent corrections are generally more associated with mean reversions. A mean reversion is where prices fall an equal distance in the opposite direction or well below the long term moving average.

The current level of overbought conditions combined with extreme complacency in the market leave unwitting investors in danger of a more severe correction than currently anticipated. A correction to the long term moving average (currently around 1350) would entail an 18.5% correction. A correction to 2-standard deviations below the long term moving average (which is most common within a mean reversion process) would slap investors with 33% loss.

If you don’t think a 33% loss is possible you should be aware that that is about the average draw down of the markets during a normal recessionary cycle. Not only is such an event possible – it is probable when, not if, the economy slips into an eventual recession.

IMPORTANT: We are currently invested in the market and I am not suggesting that you sell everything and move to cash. What I am saying is that the market is very extended and the risk of a correction of some magnitude has increased significantly this year. Therefore, if you are close to retirement, or simply just can’t afford the risk of a major market correction, then you may want to start reducing some of your portfolio risk and begin to build in some hedges against an unexpected event. Whatever eventually trips up the market will be “unexpected.”

Currently, it seems that most of the world’s concerns have been put behind us due to the massive injections of liquidity being injected by the Federal Reserve, BOJ, ECB and China. The Eurozone crisis has disappeared, recessions in the Eurozone and weak US economic data are of little concern, declining revenue and earnings are readily dismissed as the primary driving force for investors is Fed interventions. However, it is within this complacency, that an unexpected turn of events can pull the rug from beneath the markets and send money racing for the sidelines. Unfortunately, for most individuals, by the time they realize what is happening it will likely be far too late to act.

Some additional color from Lance on the Taper…(via Bloomberg)

“If I was Ben Bernanke, there would be two things I’ve got to be concerned about,” Roberts said in phone interview today “One is creating asset bubbles: If you look at yields on junk bonds, they are at historic lows. The other is the margin on NYSE stocks, which is the amount of leverage investors have taken on. Markets have gone virtually parabolic”

“What the Fed has got to figure out is if it’s solely because of what it is doing or because of the economy and underlying fundamentals”

“At the next meeting, I would start to put out language that says, ‘At some point in the future we’re going to see some tapering,’ and see how the market reacts. If the market reaction is fine, I would start doing that behind the scenes and announce it later”

“It’s very possible we’ll see hints come before the next meeting. It wouldn’t surprise me to see more articles and more Fed officials talking about Fed tapering before June so there won’t be a shock to markets”

“If you look at financial markets, they are extremely susceptible to a sharp, rapid correction. It would kill everything the Fed has put together. Bernanke will condition markets long before he takes action. We may see tapering occur prior to the Sept. meeting”

“I’m predicting nothing specific in the next few months. But in Sept., around the Fed’s Jackson Hole event, we could get specific numbers”

Roberts said he expects Fed to announce in Sept. tapering of QE to ~$65b/mo. from $85b/mo., with $10b taken off MBS and Treasuries each, followed by another similar reduction later.

“Here’s the problem. Some of the economic data is not improving. If you taper off now and we don’t have economic strength, the economy is likely to start to slip into a recession quickly. There are also questions of whether the Fed has reached the limit of its abilities to purchase bonds, and why the boost to asset prices hasn’t translated into the real economy. Clearly, there’s a broken transmission system.”

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As a gentle reminder, the reason why nobody anywhere trusts this particular bubble – the biggest in history – is not because speculators are not greedy (they are), or because everyone knows the market is always one central planner wrong move away from a collapse which would make the 2009 lows seem like amateur hour (it is), but because, as Seth Klarman explained two weeks ago, it is the Fed itself which by pushing on a string and the economy constantly deteriorating, proves it has no idea how to make things better: “When you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed’s balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else–even, or perhaps especially, the  policymakers—does either.”

And today from Bill, on the reason why QE is not working as intended, and why the Fed’s channels are not only clogged but never worked as intended in the past four years: “Does it mean it is a good thing that capitalism should thrive under this quantitative easing posture on the part of central banks that distorts markets and this court’s capitalism and promotes a zombie corporations and lowers net interest margins and destroys business model? All of that is the negative aspects of quantitative easing. Can we live with? I do not think this will be with us for a long time.”

One can hope.

Some other observations from Gross:

On how distorted the bond marker is:

“It is easy on the bond side. We speak to an epical bond/bull market, not the beginning of a bear market but the ending of an epical bond/bull market show it in terms of a smiley face. It has been the investment committee. The bright side of the smile is the thirty year bull market in which prices rose exceeded what rationally could have been expected. We are at the bottom basically of this smiley face and our opinion on a long-term basis. That means with treasury yields and credit spreads, importantly and here is the key to the bond market statement: treasuries are 80 basis points, credit spreads are 70 basis points, put them together, 150 basis points in combination. In our opinion, absent of an additional amount of quantitative easing treasuries will go down in yield because of slowing economy, but that will make spreads go up. This suggests a 20-Month time ahead in which treasury, corporate, and high yields do not move much. The end of the smiley face all market run in terms of higher yields and lower prices is over.

On whether the conditions today are reminiscent of what we saw in 1992 and 1993:

“I do not think so, because in 1994 the FED raised funds dramatically to 200 basis points to basically slow things down. If the FED did that this time, I think they know with this amount of leverage there is two to three times more leverage in this economy this time than in 1994, the FED does not dare move in 200 basis point increments. That kind of market to our way of thinking is not in store for us. Does it mean it is a good thing that capitalism should thrive under this quantitative easing posture on the part of central banks that distorts markets and this court’s capitalism and promotes a zombie corporations and lowers net interest margins and destroys business model? All of that is the negative aspects of quantitative easing. Can we live with? I do not think this will be with us for a long time. For the next 12-24, perhaps.

On when the Federal Reserve will start to taper the billions of dollars in bond purchases:

“It is almost a day-to-day thing in terms of the market but certainly not in the terms of the FED. They had objectives in terms of 6.5% unemployment and importantly, 2.5% inflation. We’re down to 1 percent inflation in terms of the PCE which is their target for inflationary measure. To think the fed would begin to pull back in terms of tapering when inflation is approaching the Japanese levels of the lost decade is a big stretch. I do not think they change much. I think they have to be concerned about what happens in asset markets. Up until this point the chairman has done an Alan Greenspan and said cannot really relieve him as such but will monitor them in terms of potential regulation. However, having said that, I think the FED basically is on hold for a long time until unemployment and more certainly, inflation moves higher to the 2.5% target.

On the implications of the end of the 30-year bull market in treasury:

“It is not just treasuries. Treasuries, corporates, high-yield. We actually saw the end of the treasury market about six months ago. I think only a few weeks ago when you put the whole enchilada together, what does it mean going forward? It means as interest rates eventually go up, we do not think they are going up for 12 months or so, that the cost of interest for them move forward. And the portly, households will increase as well. Because of the lag effect in terms of the average cost of debt for corporations, and even government, there is a fair amount of room in terms of timing, even as interest rates move back up. Treasury yields on average are above 2%. In terms of what they’re issuing it is closer to 1%. Same thing in terms of relative magnitude on the front of corporatations and households. It will be a while until this “smiley face” where higher interest rates begin to affect corporations and the credit sector as well as the government sector in terms of the cost of leverage in the cost of borrowing. Eventually, a net interest margins narrow on the part of corporations because they will hire in terms of interest. Same things for households they pay higher for mortgage loans. That is two to three, four years out. We don’t have to worry about it yet, but we have to worry about it.

On the great experiment and what is happening in Japan right now in the shift:

“We want to be able to monitor in the Tokyo office. They are in touch with the institutions in Tokyo. We want to be able to monitor where the money is going. Our sense is not much of it, some of it, is going outside the country. The metaphor for the Japanese small investor, Mr or Mrs. Watanabe, when she or he begins to sense there are more attractive yields outside of Japan and the Japanese Yen moving lower in the yields and lower in price that they can capture a higher total return by moving outside that is where they will go. We want to get in front of them so to speak. Where will they go? Typically they went to the Euro and bought a lot of France and Germany. Those markets we think our extended close to zero. Italy and Spain perhaps at the periphery. And back to the good ol’ United States. We think it will buy treasury bonds at 80 basis points above the five-year and close to 1.90 or so for the 10-year treasury. It does not sound like a deal, but a much better field in Japan.

* * *

So to summarize: the great bond bull market is over, but Japan will buy everything about 1.90% on the 10 Year. Perhaps this is why, somewhat counterinuitively, Pimco has been buying up every Treasury it could find in the past 6 months, or around the time Pimco “saw the end of the treasury market about six months ago.” Just in case someone takes Bill a little too literally.

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From Seth Klarman of Baupost:

Is it possible that the average citizen understands our country’s fiscal situation better than many of our politicians or prominent economists?

Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one. They are wary of believing promises by those who failed to predict previous crises in housing and in highly leveraged financial institutions.

They regard with skepticism those who don’t accept that we have a debt problem, or insist that inflation will remain under control. (Indeed, they know inflation is not well under control, for they know how far the purchasing power of a dollar has dropped when they go to the supermarket or service station.)

They are pretty sure they are not getting reasonable value from the taxes they pay.

When an economist tells them that growing the nation’s debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem, this simply does not compute. They know the trajectory we are on.

When politicians claim that this tax increase or that spending cut will generate trillions over the next decade, they are properly skeptical over whether anyone can truly know what will happen next year, let alone a decade or more from now.

They are wary of grand bargains that kick in years down the road, knowing that the failure to make hard decisions is how we got into today’s mess. They remember that one of the basic principles of economics is scarcity, which is a powerful force in their own lives.

They know that a society’s wealth is not unlimited, and that if the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse. For if you must rescue everything, then ultimately you will be able to rescue nothing.

They also know that the only reason paper money, backed not by anything tangible but only a promise, has any value at all is because it is scarce. With all the printing, the credibility of our entire trust-based monetary system will be increasingly called into question.

And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed’s balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else–even, or perhaps especially, the  policymakers—does either.

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SIA Charts Daily Stock Report (siacharts.com)

The SIA Daily Stock Report utilizes a proven strategy of uncovering outperforming and underperforming stocks from our marquee equity reports; the S&P/TSX 60, S&P/TSX Completion and S&P/TSX Small cap We overlay these powerful reports with our extensive knowledge of point and figure and candlestick chart signals, along with other western-style technical indicators to identity stocks as they breakout or breakdown. In doing so we provide our Elite-Pro Subscribers with truly independent coverage of the Canadian stock market with specific buy and sell trigger points.

Note: Subscribers can screen all Canadian and U.S. stocks and mutual funds, or as components of equally weighted mutual fund sectors indices (e.g. Income Trusts, Precious Metals), and fund groups by issuer (eg. AGF, Dynamic, Franklin Templeton), all Canadian ETFs, ETF Families by issuer (iShares, Horizons, BMO) or as components of Equally Weighted ETF Sector Indices (e.g. 2020+ Target date, Cdn Equity Lg Cap), and create and monitor their own, or SIA’s existing model portfolios. Finally, subscribers benefit from being able to generate BUY-WATCH-SELL Signals on demand with SIA Charts proprietary Favoured/Neutral/Unfavoured, SMAX scoring algorithm (see green-yellow-red graph 1 below).

SPDR GOLD TRUST (GLD) AMEX – May 17, 2013

GREEN – Favoured / Buy Zone
YELLOW – Neutral / Hold Zone
RED – Unfavoured / Sell / Avoid Zone

SPDR GOLD TRUST (GLD) AMEX – May 17, 2013

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Morningstar recently reported the number of bond funds buying or holding stocks is at the highest level in 18 years. The below chart from Charles Schwab details data over the last ten years. Schwab/Morningstar note the percentage of bond funds holding equities has remained stable over this time period though. Nonetheless, more bond funds are buying equities in an effort to find higher yielding securities than currently available from bonds.

Source: Charles Schwab

In addition to bond funds jumping into dividend yielding stocks, Schwab reported the following from a survey of the central banks around the globe:

“Last month, Central Bank Publications and Royal Bank of Scotland Group Plc conducted a survey of 60 central bankers. Nearly 25% of respondents said they own stock shares or plan to buy them. The Bank of Japan, featured heavily in the news recently and holder of the world’s second-largest level of reserves, said it will more than double investments in stock exchange-traded funds by 2014. The Bank of Israel bought stocks for the first time last year, and the Swiss National Bank and Czech National Bank have upped their holdings to at least 10% of reserves.

Of the 60 banks surveyed, 14 said they’d already invested in stocks or would do so within five years. In fact, this is the first time ever the question about stocks has been in this annual survey.

Behind the heightened interest in stocks are growing central-bank reserves requiring increased diversification. In US dollar terms, the four largest central banks have expanded their balance sheets to more than $13 trillion, compared to only $3 trillion 10 years ago. Most central banks have had heavy and consistent reliance on fixed-income securities, but with yields low (and falling) in many countries, keeping all reserves in fixed income risks a declining value of reserves.

However, 70% of the central banks in the survey (including the US Federal Reserve) indicated that stocks remain “beyond the pale.” A few central banks, including the Fed and the Bank of England, have no mandate to purchase stocks directly.

Jim O’Neill, chairman of Goldman Sachs Asset Management, weighed in: ‘I don’t think people should worry about (central banks owning stocks). Frankly, it makes a huge amount of sense in a world of floating exchange rates and such incredible opportunity, why should central banks keep so much money in very short-term, liquid things when they’re not going to ever need it?’”

 

Copyright © Horan Capital Advisors

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Abenomics for Europe

The devaluation of the Japanese yen may lead EU policymakers to implement measures that will help the economic situation in the single currency zone.

by Scott Minerd, CIO, Guggenheim Partners LLC

The monetary policies pursued in Japan, informally known as “Abenomics,” may indirectly save the European Union. Japan, which is a direct export competitor with Germany, has devalued the yen by approximately 30% since last September. The euro, on the other hand, is currently overvalued by roughly 20% on a purchasing power parity basis. This means German goods have become relatively more expensive and German export data has begun to slow as a result of this.

This dynamic could lead the European Central Bank to act more aggressively in devaluing the euro, which would help the periphery. Importantly, the measures could be carried out under the banner of stimulating economic growth through boosting exports in Germany and France, thereby avoiding the political backlash from the core, which is reluctant to provide help to the periphery. This development, combined with the recent announcements that the European Union is not likely to implement any further austerity measures, can be interpreted as evidence that Europe could return to modest economic growth within the next 6-12 months.

Economic Data Releases

Better Retail Sales and Small Business Sentiment

• Retail sales rose 0.1% in April, with core retail sales rising at the fastest pace in four months. Nine out of the thirteen major categories saw growth in April.
• Initial jobless claims fell for a third straight week to 323,000, the lowest since January 2008.
• The NFIB small business optimism index rose to 92.1 in April, the highest since October 2012.
• Import prices fell for a second straight month in April, led by falling fuel prices.
• Wholesale inventories increased 0.4% in March after falling in February, while wholesale sales fell by the most in four years.

Improving Production Numbers in the Eurozone, Chinese Data Rebound Modestly

• Industrial production in the eurozone had the largest monthly gain in 20 months in March, rising 1.0%.
• German industrial production gained 1.2% in March, the second consecutive increase. Production in Italy fell more than forecast, while the U.K. saw a 0.7% rise.
• The ZEW survey of economic expectations in Germany ticked up to 36.4 in May from 36.3, a less-than-forecast increase.
• Germany’s trade surplus widened for a third straight month as exports grew 0.5%.
• China’s exports rose 14.7% from a year earlier in April, a better-than-expected increase.
• Chinese industrial production rose 9.3% year-over-year in April, rebounding from 8.9% in March.
• Chinese retail sales growth also rebounded in April, in line with forecasts of 12.8%.
• Japanese M2 money supply grew 3.3% year-over-year in April, the fastest 12-month growth since November 2009.

Chart of the Week

Recession in the Eurozone Ending in 2014?

The eurozone’s economy is expected to return to growth in 2014, according to official projections. The region’s most drastic fiscal cuts have already been implemented, meaning the public sector may cease to be a drag on growth over the next few years. Additionally, the private sector should respond favorably to the cessation of government austerity, which will further propel economic recovery.

Source: EU European Economic Forecast Spring 2013, Guggenheim Investments. *Note: 2013 and 2014 are forecasted projections. Core countries include Germany and France; Periphery refers to Italy, Spain, Ireland, Greece, and Portugal.

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2013, Guggenheim Partners. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Copyright © Guggenheim Partners LLC

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On New Criteria, Berkshire Hathaway Inc. Downgraded To ‘AA’, Core Ins. Subs Affirmed At ‘AA+’, Senior Debt Rated ‘AA’

Overview

• Under our revised group methodology criteria, we are lowering our counterparty credit rating on BRK to ‘AA’ from ‘AA+’. At the same time, we are affirming our ‘AA+’ counterparty credit and financial strength ratings on BRK’s core operating insurance companies.
• The ratings reflect our view of the group’s excellent business risk profile and very strong financial risk profile based on an extremely strong competitive position and very strong capital and earnings.
• The negative outlook reflects the U.S. sovereign ratings cap and our view that the group’s capital adequacy per our capital adequacy model could deteriorate relative to its risk profile.

Rating Action

On May 16, 2013, Standard & Poor’s Ratings Services lowered its counterparty  credit rating on Berkshire Hathaway Inc. (NYSE:BRK; AA/Negative/A-1+) by one  notch to ‘AA’ from ‘AA+’ and affirmed its ‘AA+’ insurance financial strength  ratings on BRK’s core subsidiaries following release of our revised Insurers  Rating and Group Rating Methodology, released on May 7, 2013. The outlook on all ratings is negative. At the same time, we assigned our ‘AA’ senior debt rating to Berkshire Hathaway Finance Corp.’s (BHFC) $1.0 billion senior
unsecured notes. BHFC has issued the notes in two tranches: $500 million 1.3% senior unsecured notes due May 15, 2018, and $500 million 4.3% senior unsecured notes due May 15, 2043. The company used the proceeds of this issue to repay $1.0 billion of senior notes maturing on May 15, 2013.

Rationale

BRK fully guarantees BHFC’s new note issuance. BHFC’s borrowings are used to fund the finance operations of Vanderbilt Mortgage & Finance Inc., a wholly owned subsidiary of Clayton Homes Inc., a vertically integrated manufactured housing company. We treat these borrowings as operating leverage, so we exclude the debt, interest expense, and pretax operating income of these operations from our calculations of financial leverage and coverage for BRK.

The lower credit rating on BRK better reflects our view of BRK’s dependence on its core insurance operations for most of its dividend income. Its non-insurance business segments generate a majority of BRK’s operating income, but aside from the insurance subsidiaries only Burlington Northern Santa Fe LLC (BNSF) has provided a significant portion of the total dividends paid from the operating companies to the holding company. BRK’s adjusted leverage and coverage metrics are more consistent with those of ‘AA’ rated issuers rated under our comparable corporate criteria.

BRK’s adjusted debt-to-EBITDA ratio of 1.6x as of year-end 2012 was slightly less than the ‘AA’ U.S. corporate median (three-year average) of 1.2x, while its adjusted EBITDA fixed-charge coverage ratio for 2012 was about 23x, when evaluated against the ‘AA’ U.S. corporate median (three-year average) of 19.6x. As of year-end 2012, adjusted financial leverage was about 12%. The vast majority (close to 80%) of the insurance group’s dividend capacity is from insurers domiciled in one state. Therefore, dividends are subject to the applicable statutory limitations on the amount of dividends an insurer is permitted to pay without receiving special approval from the state insurance commissioner, in this case the Nebraska Department of Insurance. Nevertheless, BRK continues to benefit from nonstandard notching and is the only interactively rated insurer that has an issuer credit rating less than two notches below the core insurance company ratings. This reflects our view of the diversity of businesses and the substantial amount of cash and investments at the holding company.

The ratings reflect our view of BRK’s excellent business risk profile (BRP) and very strong financial risk profile, built on an extremely strong competitive position and very strong capital and earnings. These factors are offset to some extent by BRK’s high tolerance for equity investments, which has resulted in volatility in the company’s insurance subsidiaries’ statutory capital, capital adequacy of the insurance operations being less than what we typically expect for the rating category, and adequate enterprise risk management. Management succession at BRK is also an offsetting factor. We assess a one-notch uplift to the BRP to reflect our view of the low-risk nature of its non-insurance operations, which comprise approximately 60% to 70% of total earnings. In addition, we apply a holistic adjustment because BRK, on a consolidated basis, continues to outperform its insurance and non-insurance peers with respect to operating and financial performance, such as underwriting and cash-flow generation. For first-quarter 2013, pretax operating income was $5.9 billion, up 36% from the same quarter in 2012, with most of the improvement stemming from the insurance segment of BRK. Shareholders’ equity rose to $198.1 million from $187.6 million as of year-end 2012, mostly driven by $5 billion of net income in the quarter and the appreciation of unaffiliated equity securities.

Outlook

The outlook is negative for two reasons. One is the sovereign rating cap of ‘AA+/Negative’, which applies to the obligations of the U.S. government, government-related enterprises, and U.S. financial services firms. The second reason is that we could lower the rating if the capital adequacy according to our capital model of BRK’s insurance operations relative to its risk profile deteriorates as a result of a material increase in investment risk exposure or the funding of a large acquisition by the insurance companies. The negative outlook reflects our sovereign rating cap and our view on the group’s capital adequacy per our proprietary capital model. We also expect the group to maintain operating performance consistent with our base-case scenario, and at least a very strong competitive position.

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