Contrarian Investing Prof. Gerlach Sacred Heart University Deborah J. Weir, CFA Author, TIMING THE MARKET (Wiley, 2005)
Jan 12, 2016
Contrarian Investing
Prof. Gerlach
Sacred Heart University
Deborah J. Weir, CFAAuthor, TIMING THE MARKET (Wiley, 2005)
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Fundamental Economics
As
Contrarian Investing
Because
Emotions Get In the Way
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Background
• SEC Registered to sell hedge funds
• MBA in finance: NYU Stern School of Business
• Stamford CFA Society, Past President
• Deutsche Bank/Scudder: United Technologies, Rockwell, Mayo Clinic
• Instructor: NY Institute of Finance
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We Will Forecast
GDP
Interest rates (up or down)
Direction of stock & bond markets
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Economic ForecastingTools
1) Yield curve shape
2) Quality spreads
3) Central bank actions
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Contrarian Tools?
• These tools are fundamental economic analysis
• People get caught up in emotion and overlook them
• It is always “different this time”
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Ground your thinking in solid economic analysis to rise above hysteria.
Old adage, “Keep your head while all about you are losing theirs.”
New adage:
Make money when all about you are losing theirs.
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1) Yield Curve ShapesPositive Slope (normal) Negative Slope (inverted)
http://stockcharts.com/freecharts/yieldcurve.html
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Curve Reflects Investor Expectations for Future Rates
• Investors stay short if they expect rates to increase
• Investors go long if they expect rates to decrease
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• Positive slope – increase risk: buy stocks, real estate, gold
• Negative slope – decrease risk: buy bonds or cash
• US Federal Reserve uses the shape of the yield curve to help forecast the economy
Asset Allocation Using Yield Curve Shapes
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Normal Curve, Normal Growth: Nov. 2004
Equities
Inverted Curve, Recession:March 2007
Fixed-income or Cash
Steep Curve, Inflation:
July 2009
Gold, Foreign Currencies, Real Estate
Economic Forecasting Theory
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Forecasting Practice
http://stockcharts.com/charts/YieldCurve.html
Click on the “animate” option to see how these two markets move:
The yield curve helps forecast the recent US investment cycle.
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Inverted Curve 2006 Forecast the financial crisis of 2007 – 2009 and the decline of the S&P 500
Index.
http://stockcharts.com/charts/YieldCurve.html
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Normal Curve 2009
http://stockcharts.com/charts/YieldCurve.html
Forecast strong stock market.
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Steep Curve 2010(3mo./10yr. Spread > 300 bp)
http://stockcharts.com/charts/YieldCurve.html
Forecast inflation expectations.
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Steep Curve 2009 - 2010
http://stockcharts.com/h-sc/ui
Inflation expectations weakened the US dollar.
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Steep Curve 2009 - 2012Inflation expectations increased the price of gold
http://finance.yahoo.com/q?s=GLD
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Steep Curve 2009 – 2011Inflation fears may end the decline in real estate.
http://www.dallasfed.org/microsites/research/econdata/housing-charts.pdf
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Inverted Curve
Forecasts recessions
• Lower stock market
• Higher bond prices (& lower yields)
• Lower inflation
• Stronger currency
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Ten-yr./Three-mo. Spread 1953–2012
http://www.clevelandfed.org/research/trends.cfm
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Stocks Inverse of BondsCurve forecast stock market losses, bond market gains.
http://stockcharts.com/charts/historical/
S&P 500 Index
30-yr
Bond
Price
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Federal Reserve Bank Uses the Yield Curve
http://www.clevelandfed.org/Research/Data/Yield_Curve/
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This Site Has Monthly UpdatesOctober 26, 2012Covering September 26, 2012–October 26, 2012
Highlights October September
August3-month Treasury bill rate (percent) 0.10 0.11 0.10 10-year Treasury bond rate (percent) 1.79 1.81 1.76Yield curve slope (basis points) 169 170 166
Expected real GDP growth (percent) 0.6 0.6 0.6Old Formula: GDP = 1.87 + (.97 X spread)New Formula: GDP is weighted by the previous growth rates
Probability of recession in 1 year 8.2 8.1 8.5http://www.clevelandfed.org/Research/Data/Yield_Curve/
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Applications to Global Economies
• BRIC
• PIIGS
• Managed economies limit the use but still can indicate the direction of growth
• 2011 indicators were negative
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Outlook for the BRICshttp://www.economist.com/news/economic-and-financial-indicators/21567095-
trade-exchange-rates-budget-balances-and-interest-rates%20%20
Country 3-month 10-year BP SpreadBrazil 7.10% 9.57% +274Russia 7.66% 7.36% - 30India 8.18% 8.21% + 3China 3.80% 3.19% - 61
Given these spreads, what’s your forecast:
GDP
Interest rates (up or down)
Inflation
Currency
Direction of stock & bond markets
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Outlook for PIIGS
Country 3-month 10-year BP Spread
*Portugal0.19% 7.89% +770
Italy 0.90% 4.84% +394
*Ireland 0.19% 4.58% +439
Greece 0.19% 16.08% +1589
Spain 0.19% 5.74% +555
http://www.economist.com/news/economic-and-financial-indicators/21567095-trade-exchange-rates-budget-balances-and-interest-rates%20%20
•No information for Portugal or Ireland in 2011
Given these spreads, what’s your forecast:GDPInterest rates (up or down)InflationCurrencyDirection of stock & bond markets
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2) Quality spreads
• Forecasts trouble in emerging markets (1998 Russian bond default)
• Forecasts trouble in developed markets (1987 S&L crisis, 2008 crisis)
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Merrill-Lynch High-yield
Index Constrained Less the Ten-year US Treasury Note:
(sometimes not available & no history)
http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html
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http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html
Wall St. Journal Publishes High-yield Index
Nov. 2011
Nov. 2012 = 4.87%
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Other SourcesFederal Reserve Bank of St. Louis (two-day lag)
Gives previous five days for easy comparison
http://research.stlouisfed.org/fred2/series/BAMLH0A0HYM2
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You Can Get the Spread in Real Time
Good for trading options during the day…
High-yield ETF (JNK) – Ten-year yieldhttp://finance.yahoo.com/q?s=JNK&ql=0 http://finance.yahoo.com/q?s=%5ETNX
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Is This Stock Market Recovery Sustainable?
S&P October 1 - Nov. 23, 2012
1340
13601380
14001420
14401460
1480
10/1
/201
2
10/8
/201
2
10/1
5/20
12
10/2
2/20
12
10/2
9/20
12
11/5
/201
2
11/1
2/20
12
11/1
9/20
12
S&P
•Fiscal Cliff
•Greek Default
•Global Slowdown
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Bull Market Confirmed by Quality Spreads
Merrill-Lynch High Yield Less the Ten Year Note
Quality Spread Oct. 1 - Nov. 23, 2012
3.84
4.24.44.64.8
55.25.4
10/1
/201
2
10/8
/201
2
10/1
5/20
12
10/2
2/20
12
10/2
9/20
12
11/5
/201
2
11/1
2/20
12
11/1
9/20
12
%
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3) Central Bank Actions
• Open Market Operations
• Money Supply
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Federal Reserve Open Market Operations
• Normal repurchase agreements = $3.25 billion daily prior to 9/11
• September 11, 2001 = $35 billionhttp://www.ny.frb.org/markets/omo/dmm/temp.cfm
What is the Fed doing today? Tightening? Easing?
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Federal Reserve Controls Money Supply and the Shape of the Yield Curve
http://www.dallasfed.org/assets/documents/research/econdata/us-charts.pdf
Financial Crisis
Market Turn
QE2
QE3Turn
Turn?
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Global Economic ForecastingTools
1) Yield curve shape
2) Quality spreads
3) Central bank actions
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Fixed-income Is a Good Data Set for Forecasting Economies and Markets
Large Data Set (Eight Times the Volume of Equities)
Depicts Investors’ Actions Rather Than Opinions
Forward-looking; No Reliance on Historical Financial Statements
Low Turnover and Transactions Costs
Government influence on the shape of the yield curve works for you; not fighting City Hall
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UpdatesBlog:http://timingthemarket.blogspot.com/
Twitter.com: @debweir
Voices of New York Institute of Finance Faculty: http://www.nyif.com/blog.html
Email [email protected]
Contrarian Investing
Prof. Gerlach
Sacred Heart University
Deborah J. Weir, CFAAuthor, TIMING THE MARKET (Wiley, 2005)