Sunday, August 18, 2013

Abenomics

Abenomics (= Abe + Economics) is the term used to describe the economic policy proposed and executed by the administration of the current Japanese Prime Minister Shinzo Abe who was re-elected in December 2012.  Japan’s economy has suffered prolong recessions since mid-1990s and deflations for at least a decade. So, the new economic policy includes the three parts, also called the Three Arrows of Abenomics: a massive fiscal stimulus, more aggressive monetary easing from the Bank of Japan, and structural reforms to boost Japan’s competitiveness. 
The First Arrow of fiscal stimulus is to increase government spending by 2% of GDP, which is worth 10.3 trillion JPY or 116 billion USD.  However, this level of spending is likely to raise the deficit to 11.5% of GDP for 2013 (For comparison, the current US deficit to GDP ratio is 5.7%).  The current public debt to GDP ratios are 105% for the US and 240% for Japan.  To offset this huge spending, the consumption tax will be raised from the current 5% to 8% in 2014 and to 10% in 2015.  However, the tax hike will definitely encourage consumption and slow down the economic growth. 
The Second Arrow of monetary easing is to target the inflation rate at an annual rate of 2%, and to correct the excess yen appreciation, to set negative real interest rates, and to commit to radical quantitative easing of buying construction bonds.  At one time, yen has depreciated to 102 JPY/USD from 80 JPY/USD. The Third Arrow of structural reforms, which should be the most important arrow among the three, was announced on June 3, 2013, which disappointed the market due to its small scale.
In general, the market reactions to the Three Arrows were positive:  The NIKKEI index showed the sign of great improvement after December 2013.  However, it is still very small in term of its 30-year trend; maybe it is still too early to tell.  The recent GDP growth showed a good sign, too, but it was still insignificant judging from the trend of recent 10-year data.  The unemployment was trending down, but it has happened since 2010.
There are many criticisms of Abenomics.  It may result in a drop in real wages if jobs and salaries do not increase significantly. Government interference and pressure on the Bank of Japan endangers its independence and may lead to currency wars.  Some also criticize the policy focusing too much on the demand side of its economy, not on the supply side.  The real problem on the supply side is Japan’s aging population; its shrinking workforce cannot sustain the current economic output in the future.  Also, the government commitment in spending on pensions, medical expenses and social security will continually act a substantial burden to the already indebted country.

Sources:
  1. 1.      en.wikipedia.org/wiki/Abenomics
  2. 2.      The Economist, May 18th-24th 2013
  3. 3.      Yahoo Finances for NIKKEI indexes and Yen historical exchange rate.
  4. 4.      www.tradingeconomics.com for other Japan’s macroeconomic data.

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Friday, August 16, 2013

Why Detroit’s Bankruptcy Could Detonate a $3.7-Trillion Muni Bond Bomb

From Moral Obligation to Moral Hazard
Before we get to the current situation at hand, it’s important that we have a historical understanding of municipal bonds.

  The first officially recorded municipal bond was issued by the City of New York for a canal in 1812. It was a general obligation bond, meaning the city pledged every available resource – most notably, tax revenue – to repay the debt. So, in theory, unless the city lost its legal ability to levy taxes, which it never would, investors would be repaid. That’s key because every single general obligation muni bond issued since that time has carried the same level of implied safety.

If Kevyn Orr succeeds

Just like we witnessed during the real estate collapse when homeowners started walking away from their mortgage obligations without any recourse, other cash-strapped municipalities are destined to follow Detroit’s lead and try to renege, too.

Three More Reasons to Be Wary of Muni Bonds

•Muni Bond Threat #1: Misguided political proposals
•Muni Bond Threat #2: Market forces
•Muni Bond Threat #3: A less-than-robust recovery

TOXIC MARKETS

In terms of specific cities, I’d be most concerned about Chicago and Cincinnati. Much like Detroit, they’ve suffered a mass exodus of citizens.
  Based on the last census, Chicago’s population checks in at 2,695,598 people, down 25% from its peak of 3,620,962 people in 1950. Meanwhile, Cincinnati’s population of 296,223 people has dropped 41% from its peak population of 503,998.
  And overcoming financial obstacles becomes increasingly difficult when your tax base contracts.

What is the Intuition?
All it takes is a crisis of confidence to undermine a supposedly “safe” muni bond investment. And there are definitely enough headwinds in the market to bring one about.

SOURCES

Recent News

08/08/2013
08/09/2103
08/16/2013

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Thursday, August 15, 2013

Investor Options

               The current status of the stock market has some investors worried about the 54 month bull market nearing its end.  Are there reasons for this fear?  Looking at bond yields, inconsistency in the housing development market, and the looming decrease in quantitative easing will shed some light.  10 year Treasury bond yields have traditionally opposed the market.  During their rise, the market was generally stagnant.  Upon their decline beginning in the mid 1980’s, the market began to rise.  In 1987, there was a disconnect between the bond yield rising and the market.  The market continued to rise until a staggering decline in the market restored the balance.  What we see now is a similar trend regarding the bonds relative to the market; i.e. both have been increasing over the past few months.  The homebuilding index ETF, XHB, peaked in May as the S&P 500 peaked.  However, while the S&P 500 continued to climb, the homebuilding index has fallen off.  Like the bond yields, this is out of step with the general trend. 
                A tremendous amount of influence on the market is held by the Federal Reserve.  An announcement that hinted towards a decrease in quantitative easing (QE) on June 19 caused the S&P 500 to decrease by 2.5%.  This drop happened without an actual change in the policy, simply a suggestion that it may begin to taper.  Enter the Chicago Board Options Exchange’s Volatility Index (VIX).  This tracks volatility in the S&P 500.  As shown in the figure below, spikes occurred during the 2008 financial crisis, and again in June of 2010 and June of 2011, corresponding to the termination of QE1 and QE2.  A 23% increase occurred in the VIX when the aforementioned 2.5% drop in the S&P 50 occurred.  Some investors who believe that the market will take a downturn are using the VIX to hedge their investments.  They are doing this though purchasing call orders on VIX.  This is to ensure that if the market falls and VIX spikes, they can profit from the right to purchase the volatility index at a low price.  Call orders were at an all-time high of 1.12 million on Tuesday.  One strategy being employed is to purchase calls at a lower price and sell calls at a higher price to offset the cost of the purchased calls.  This limits the profitability of the call option placed on the lower price.  Of course, this is not an issue if the price of VIX never exceeds the strike price of the calls sold.  One particular fund manager has purchased calls at 10, 11, and 12 dollars, while selling calls at 19, 20, and 21 dollars.  Today’s (August 15) performance already has this strategy in the money as VIX closed at $14.56, a 12% daily gain.

Figure 1: VIX 5 year chart

                Taking the bond yields, homebuilding index, and uncertainty surrounding the Federal Reserve into account relative to how they affect the market, it does appear that there is reason for investors to believe the bull market will turn bearish.  Options can serve investors looking to hedge against such a downturn.  Several options can result in profits assuming this bearish assumption is correct.  One can purchase put options on a market index, sell call options on the market index, sell put options on the volatility index, or do what was described above and buy call options on the volatility index.  One could short sell market indexes as well.  With options, one thing is certain: investors are not without choices.

Sources
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Wednesday, August 14, 2013

Tesla




Tesla has been on the news a lot recently in the past week for being one of the fastest growing stocks of the week.  YTD change for Tesla is 335.13%. Tesla went public on June 28, 2010 and is the first American automaker to go public since Ford in 1956. Tesla Motors, Inc designs, develops, manufactures and sells electric vehicles and advanced electric vehicle components.
Tesla is currently only producing Model S vehicles. The Model S sells on average for $70,000 and has received the top rating from Consumer Reports'.  Sales for the Model S jumped to a record 5,150 in Q2, surpassing the 4,500 sales the company expected to sell. Production also increased by 25 percent to nearly 500 vehicles leaving the line a week. Tesla now makes a gross margin of 22 percent on each car, in fact, compared to 17 percent in Q1 2013. Revenues grew to $405.1 million compared with $26.6 million in the same quarter of the previous year and exceeded the analysts' consensus estimates of $386.9 million.


YTD
 


Last 5 days

Despite all the good news for Tesla, they were downgraded by stock analysts at Lazard Capital Markets from a “buy” rating to a “neutral” rating. Lazard analysts  believe shares could fall as low as $100. Tesla shares fell 3.67% on Monday and closed at $147.38 compared to a high of $158.88 on Thursday.  On Wednesday Tesla closed at $139.36.  In the future, Tesla hopes to speed up the development of its next model, which is the Model X crossover expected to be on the market next year.  


Sources




http://seekingalpha.com/article/1630002-no-significant-upside-in-tesla-motors?source=yahoo
http://www.wired.com/autopia/2010/06/tesla-ipo-raises-226-1-million/

http://money. http://money.msn.com/technology-investment/post--analyst-downgrade-weighs-on-tesla-sharescnn.com/quote/quote.html?symb=TSLA

http://www.bloomberg.com/news/2013-08-07/tesla-posts-surprise-adjusted-profit-on-model-s-output.html

http://www.marketwatch.com/story/tesla-motors-ipo-opens-12-above-offer-price-2010-06-29

http://www.slashgear.com/tesla-q2-2013-5150-model-s-sold-income-up-70-and-expansion-ahead-07293080/




Luis Nieto 
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