Tag Archives: management

Asset Class Weekly: From The High-Yield Bond Battlefront

Summary Capital markets are under fire. Just two weeks ago, Asset Class Weekly focused on the troubles that were brewing in the high-yield bond market. What a difference two weeks make. A growing number of creditors in the high-yield bond market are fighting for survival. Capital markets are under fire. Just two weeks ago, Asset Class Weekly focused on the troubles that were brewing in the high-yield bond market. What a difference two weeks make. For while many investors are getting ready to settle in for the holiday season, a growing number of creditors in the high-yield bond market are fighting for survival. Given the rapid pace of the descent in high-yield bonds over the past two weeks, it is worthwhile to check in with the latest from the high-yield bond market. It was almost exactly one year ago in December 2014 that I first began sounding the alarm about the stresses building in the high-yield bond market. At that time, the sharp decline in oil since the summer of 2014 and in particular since the OPEC meeting that came the day after Thanksgiving last year had the high-yield bond market starting to question the long-term viability of selected names in the universe. At the time, nearly all of the names under pressure in the high-yield bond space came from the oil patch. And the measure of stress at the time was the fact that 13 publicly-traded companies in the high-yield bond universe as measured by the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) had bonds were trading at a 25% to 50% discount to their par value while another 22 publicly-traded companies had bonds that were trading at a 10% to 25% discount to par. On December 12, 2014, when I published this first high-yield bond (NYSEARCA: JNK ) article, the stock market as measured by the S&P 500 Index closed at 2,002.33. As of the end of last week on December 18, 2015, the S&P 500 Index closed at 2,005.55. But while the headline stock market index might imply that not much has changed over the past year, oh so very much has changed underneath the market surface. And nowhere is this more true in a chronically bad way than in the high-yield bond market. Once again for emphasis, we had 13 creditors with bonds trading at a 25% to 50% discount to par and another 22 companies with bonds trading at a 10% to 25% discount to par almost exactly a year ago at this time. And this was a sign of building stress. So where exactly are we a year later? Today, we have 27 publicly-traded companies with bonds trading at a 25% to 50% discount to par. Sure, this is roughly double where we were at this time last year, but not so bad, right? Au contraire. W hile this 25% to 50% discount group was considered the front lines of high-yield bond market stress, this is the relatively better side of the story today. Triage Let’s begin. We have had a handful of companies in the high-yield bond space that have since either entered into bankruptcy or have creatively restructured in a grasp for survival. We also now have 11 publicly-traded companies that are trading at a more than 75% discount to par. In short, these are firms that have been badly wounded in operational battle and are now in financial market triage fighting for their lives. Arch Coal (NYSE: ACI ) BreitBurn Energy Partners (NASDAQ: BBEP ) Chesapeake Energy (NYSE: CHK ) Cliff Natural Resources (NYSE: CLF ) Energy XXI (NASDAQ: EXXI ) Linn Energy (NASDAQ: LINE ) Peabody Energy (NYSE: BTU ) Penn Virginia (NYSE: PVA ) Seventy Seven Energy (NYSE: SSE ) Ultra Petroleum (NYSE: UPL ) Verso ( OTCQB:VRSZ ) It should be noted that the list above is not at all from the fringes of capital markets as names like Chesapeake Energy and Ultra Petroleum are among the larger players in the energy space. The Front Line In the next group on the list, we have another 18 publicly-traded companies in the high-yield bond space whose bonds are also trading at a highly stressed 50% to 75% discount to their par value. These include the following: AK Steel (NYSE: AKS ) California Resources (NYSE: CRC ) CHC Group (NYSE: HELI ) Comstock Resources (NYSE: CRK ) Denbury Resources (NYSE: DNR ) EXCO Resources (NYSE: XCO ) Genworth Financial (NYSE: GNW ) Halcon Resources (NYSE: HK ) Intelsat (NYSE: I ) Memorial Production Partners (NASDAQ: MEMP ) Midstates Petroleum (NYSE: MPO ) Navios Maritime (NYSE: NM ) Pacific Drilling (NYSE: PACD ) Sanchez Energy (NYSE: SN ) SandRidge Energy (NYSE: SD ) Transocean (NYSE: RIG ) U.S. Steel (NYSE: X ) Vantage Drilling Company (NYSEMKT: VTG ) It is worth noting that seven companies descended into this group within the last two weeks. This includes California Resources, Denbury Resources, Intelsat, Memorial Production Partners, Midstates Petroleum, Sanchez Energy and Transocean. A number of the names on the above list are also meaningful players in the energy space. And the list is also not limited to just names in the energy space, as we also have communications, retail, industrial and consumer products companies now also showing up on this front line distressed list. Preparing For Battle: The Second Wave In the next group on the list, which was formerly the front line just one year ago, we have as mentioned above 25 publicly-traded companies in the high-yield bond space that are trading at a 25% to 50% discount to par. These companies currently under fire include the following: Advanced Micro Devices (NASDAQ: AMD ) Allegheny Technologies (NYSE: ATI ) Antero Resources (NYSE: AR ) ArcelorMittal (NYSE: MT ) Avon Products (NYSE: AVP ) Bombardier ( OTCQX:BDRBF ) Chemours (NYSE: CC ) CONSOL Energy (NYSE: CNX ) DCP Midstream Partners (NYSE: DPM ) Energy Transfer Equity (NYSE: ETE ) iHeartMedia ( OTCPK:IHRT ) Navistar International (NYSE: NAV ) Oasis Petroleum (NYSE: OAS ) ONEOK (NYSE: OKE ) Precision Drilling (NYSE: PDS ) Range Resources (NYSE: RRC ) QEP Resources (NYSE: QEP ) Scientific Games (NASDAQ: SGMS ) SM Energy (NYSE: SM ) Sprint (NYSE: S ) Talen Energy (NYSE: TLN ) Tronox (NYSE: TROX ) Whiting Petroleum (NYSE: WLL ) Windstream (NASDAQ: WIN ) WPX Energy (NYSE: WPX ) In addition to this list above that includes some eye-opening names, two notable retailers that are currently not publicly traded but are also now listed among this group. These are Neiman Marcus (Pending: NMG ) and Toys “R” Us. But perhaps more troubling than this list from the high-yield space is the suddenly expanding list from the investment-grade corporate bond universe as measured by the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD ). Just three weeks ago at the end of November, only one name (Freeport-McMoRan (NYSE: FCX )) made this 25% to 50% discount to par list. Today, once again just three weeks later, there are 13. These are listed below: Barrick Gold (NYSE: ABX ) Cenovus Energy (NYSE: CVE ) Continental Resources (NYSE: CLR ) Devon Energy (NYSE: DVN ) Ensco (NYSE: ESV ) Energy Transfer Partners (NYSE: ETP ) Enterprise Products Partners (NYSE: EPD ) Freeport-McMoRan Kinder Morgan (NYSE: KMI ) Newmont Mining (NYSE: NEM ) Southwestern Energy (NYSE: SWN ) Viacom (NASDAQ: VIA ) Williams Companies (NYSE: WMB ) It is one thing to see signs of credit stress in the high-yield bond space, but it is another thing altogether when these pressures begin to spread in the investment grade space. Overall, these lists combined bring us to 40 publicly traded or notable companies that are trading at a 25% to 50% discount to par. Bottom Line Perhaps this is all just a short-term phase in the bond market. It is possible that we are near or at a bottom and these increasingly stressed bond prices will soon start bouncing higher. Maybe, but probably not. The deterioration in the high-yield bond space has been brewing for some time. And it has picked up dramatically in the past couple of weeks with the magnitude of the price declines in many names across the high-yield bond spectrum well in excess of -20%. The fact that the problem has now started to spread to the investment-grade bond space is even more problematic, as it suggests that a broader cleansing process may now be at work. And the next time we regroup to explore this list, it seems highly probable that we will add a whole new cast of characters, as scores of names now reside in the 10% to 25% discount to par list that have not even bothered to explore here that are also experiencing accelerating price declines in their own right. Lastly, this decelerating pace of credit deterioration is taking place in an environment where the U.S. Federal Reserve just raised interest rates off of the zero bound for the first time since the outbreak of the financial crisis. While I applaud the Fed for finally showing the courage to act, it is unfortunately doing so far too late at this point. Thus, for those analysts and experts that are calling for another year of positive U.S. stock market gains in 2016 despite the fact that stock valuations are already hovering at historically high levels, unless we see the Federal Reserve do a complete about face and start pouring liquidity back into financial markets (do not rule this possibility out over the next 12 months), we may find ourselves with results that are decidedly different than positive for stocks this time next year. Special Notice : As many readers have likely seen by now, I also provide a premium service on Seeking Alpha called The Universal . The service targets winning investment portfolio strategies across the asset class universe in both bear and bull markets with a focus on attractive return opportunities, risk control and loss minimization. The Universal includes timely asset allocation models, weekly strategy updates, targeted stock watch lists, feature articles and specific buy/sell recommendations. It is also a forum for real-time updates and analysis during periods of heightened market stress. The Universal currently costs $29 per month or $239 per year to subscribe. But starting on January 1, 2016, the subscription cost for The Universal will increase to $39 per month or $299 per year. Existing subscribers as well as those who sign up by December 31, 2015, however, will continue to pay the lower $29 per month or $239 per year rate. As a result, if you are interested in trying my premium service and have not already joined, I encourage you to sign up before the end of the year to lock in the lower rate. And if you are concerned that the service may not be a good fit, you are protected by Seeking Alpha’s unconditional prorated money-back guarantee. Questions about The Universal? Send me an e-mail at anytime and I will respond with answers to your questions. Thanks, and I look forward to collaborating with you on The Universal. Disclosure : This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Why Does Dual Momentum Outperform?

Those who have read my momentum research papers, book, and this blog should know that simple dual momentum has handily and consistently outperformed buy-and-hold. The following chart shows the 10- year rolling excess return of our popular Global Equities Momentum (GEM) dual momentum model compared to a 70/30 S&P 500/U.S. bond benchmark [1] Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Performance and Disclaimer pages for more information. GEM has always outperformed this benchmark and continues to do so now, although the amount of outperformance has varied considerably over time. In 1984 and 1997-2000, those who might have guessed that dual momentum had lost its mojo saw its dominance come roaring right back. In Chapter 4 of my book, I give a number of the explanations why momentum in general has worked so well and has even been called the “premier anomaly” by Fama and French. Simply put, reasons for the outperformance of momentum fall into two general categories: rational and behavioral. In the rational camp are those who believe that momentum earns higher returns because its risks are greater. That argument is harder to accept now that absolute momentum has clearly shown the ability to simultaneously provide higher returns and reduced risk exposure. The behavioral explanation for momentum centers on initial investor underreaction of prices to new information followed later by overreaction. Underreaction likely comes from anchoring, conservatism, and the slow diffusion of information, whereas overreaction is due to herding (the bandwagon effect), representativeness (assuming continuation of the present), and overconfidence. Price gains attract additional buying, which leads to more price gains. The same is true with respect to losses and continued selling. The herding instinct is one of the strongest forces in nature. It is what allows animals in nature to better survive predator attacks. It is built in to our brain chemistry and DNA as a powerful primordial instinct and is unlikely to ever disappear. Representativeness and overconfidence are also evident and prevalent when there are strong momentum-based trends.Investors’ risk aversion may decrease as they see prices rise and they become overconfident. Their risk aversion may similarly increase as prices fall and investors become more fearful. These aggregate psychological responses are also unlikely to change in the future. One can easily make a logical argument for the investor overreaction explanation of the momentum effect with individual stocks. Stocks can have high idiosyncratic volatility and be greatly influenced by news related items, such as earnings surprises, management changes, plant shutdowns, employee strikes, product recalls, supply chain disruptions, regulatory constraints, and litigation. A recent study by Heidari (2015) called, ” Over or Under? Momentum, Idiosyncratic Volatility and Overreaction “, looked into the investor under or overreaction question with respect to stocks and found evidence that supported the overreaction explanation as the source of momentum profits, especially when idiosyncratic volatility was high. A number of economic trends, not just stock prices, get overextended and then have to mean revert. The business cycle itself trends and mean reverts. Since the late 1980s, researchers have known that stock prices are long-term mean reverting [2]. Mean reversion supports the premise that stocks overreact and become overextended, which is what leads to their mean reversion. We will show that overreaction, in both bull and bear market environments, provides a good explanation for why dual momentum has worked so well compared to buy-and-hold. Dual Momentum Performance Earlier we posted Dual, Relative, & Absolute Momentum , which highlighted the difference between dual, relative, and absolute momentum. Here is a chart of our GEM model and its relative and absolute momentum components that were referenced in that post. GEM uses relative momentum to switch between U.S. and non-U.S. stocks, and absolute momentum to switch between stocks and bonds. Instructions on how to implement GEM are in my book, ‘ Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk’ . Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Performance and Disclaimer pages, linked previously, for more information. Relative momentum provided almost 300 basis points more return than the underlying S&P 500 and MSCI ACWI ex-US indices. It did this by capturing profits from both indices rather than from just from a single one. We can tell from the above chart that some of these profits were due to price overreaction, since both indices pulled back sharply following strong run ups. Even though relative momentum can give us substantially increased profits, it does nothing to alleviate downside risk. Relative momentum volatility and maximum drawdown are comparable to the underlying indices themselves. However, we see in the above chart that absolute momentum applied to the S&P 500 created almost the same terminal wealth as relative momentum, and it did so with substantially less drawdown. Absolute momentum accomplished this by side stepping the severe downside bear market overreactions in stocks. As with relative momentum, there is ample evidence of price overreaction here, since there were sharp rebounds from oversold levels following most bear market lows. We see that overreaction comes into play twice with dual momentum. First, is when we exploit positive overreaction to earn higher profits from the strongest index selected by relative momentum. Trend following absolute momentum can help lock in these overreaction profits before the markets mean revert them away. Second is when we avoid negative overreaction by standing aside from stocks when absolute momentum identifies the trend of the market as being down. Based on this synergistic capturing of overreaction profits while avoiding overreaction losses, dual momentum produced twice the incremental return of relative momentum alone while maintaining the same stability as absolute momentum. We should keep in mind that stock market overreaction, as the driving force behind dual momentum, is not likely to disappear. Distribution of Returns Looking at things a little differently, the following histogram shows the distribution of rolling 12-month returns of GEM versus the S&P 500. We see that GEM has participated well in bull market upside gains while truncating left tail risk representing bear market losses. Dual momentum, in effect, converted market overreaction losses into profits. Market Environments We can also gain some insight by looking at the comparative performance of GEM and the S&P 500 during separate bull and bear market periods. BULL MKTS BEAR MKTS Date S&P 500 GEM Date S&P 500 GEM Jan 71-Dec 72 36.0 65.6 – – – Oct 74-Nov 80 198.3 103.3 Jan 73-Sep 74 -42.6 15.1 Aug 82-Aug 87 279.7 569.2 Dec 80-Jul 82 -16.5 16.0 Dec 87-Aug 00 816.6 730.5 Sep 87-Nov 87 -29.6 -15.1 Oct 02-Oct 07 108.3 181.6 Sep 00-Sep 02 -44.7 14.9 Mar 09-Nov15 225.7 89.4 Nov 07-Feb 09 -50.9 -13.1 Average Return 277.4 289.9 Average Return -36.9 3.6 Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Performance and Disclaimer pages, linked previously, for more information. During bull markets, GEM produced an average return somewhat higher than the S&P 500. This meant that relative momentum earned more than absolute momentum gave up on those occasions when absolute momentum exited stocks prematurely and had to reenter stocks a month or several months later [3]. Relative momentum also overcame lost profits when trend-following absolute momentum temporarily kept GEM out of stocks as new bull markets were just getting started. Absolute momentum on its own can lag during bull markets, but relative momentum can alleviate the aggregate bull market underperformance of absolute momentum. Relative and absolute momentum therefore complement each other well in bull market environments. What really stand out though are the average profits that GEM earned in bear market environments when stocks lost an average of 37%. Absolute momentum, by side stepping bear market losses, is what accounted for much of GEM’s overall outperformance. Large losses require much larger gains to recover from those losses. For example, a 50% loss requires a subsequent 100% gain to get back to breakeven. By avoiding large losses in the first place, GEM has avoided being saddled with this kind of loss recovery burden. Warren Buffett was right when he said that the first (and second) rule of investing is to avoid losses. Increased profits through relative strength and loss avoidance through absolute momentum are only half the story though. Avoiding losses also contributes greatly to investor peace of mind and helps prevent us from becoming irrationally exuberant or uncomfortably depressed, which can lead to poor timing decisions. Not only does dual momentum help capture overreaction bull market profits and reduce overreaction bear market losses, but it gives us a disciplined framework to keep us from overreacting to the wild vagaries of the market. [1] GEM has been in stocks 70% of the time and in aggregate or intermediate government/credit bonds around 30% of the time since January 1971. See the Performance page of our website for more information. [2] See Poterba and Summers (1988) or Fama and French (1988). [3] Since January 1971, there have been 9 instances of absolute momentum causing GEM to exit stocks and then reenter them within the next 3 months, foregoing an average 3.1% difference in return.

Book Review: Free Capital

Summary Guy Thomas profiles twelve private investors. The interviewees remain anonymous and speak frankly about their successes and failures. Free Capital is an inspirational and educational read. The Market Wizards of U.K. amateur investors. Actuary, private investor and honorary lecturer Guy Thomas put together a terrific read called Free Capital: How 12 Private Investors Made Millions in the Stock Market after a thorough process of selecting and interviewing over 20+ private investors. The book consists of interviews with twelve private investors. It could have been part of the Market Wizards series by Jack. D. Schwager and an appropriate subtitle would have been: Interviews with the U.K. best amateur investors . If you enjoyed the Market Wizard series you are almost certain to like this book. The final selection of interviewees is made up of investors employing a variety of styles. The author segments the styles as follows: Geographers: top-down investors. Start from a macro perspective and search companies that will benefit from that trend. Surveyors: bottom-up investors who look at individual company financials. Activists: Investors taking an active approach to their investments. Putting a large percentage of their portfolio in a name and developing a conversation with management. Eclectics: Go back and forth between styles or don’t fit the other styles. It even includes one day trader and varies from activists to buy and hold dividend investors. Every investor interviewed had been highly successful with many racking up the balance of their U.K. tax-free, limited contribution accounts, up to well over a million. A feat than can only be accomplished by highly skillful investors. Thomas was also careful to monitor results of the interviewees over a market cycle to ensure their strategies could withstand a bear market. What is the book about? First and foremost the book in an inspirational read. Although a few of the investors in the book are exceptionally intelligent, many appear to be just above average in intelligence and some had to deal with severe setbacks in life or very tough starting conditions. Most of the people profiled struggled to keep their pre-investment career on track. Yet, they were able to achieve tremendous success through investing. They accomplished this through a variety of strategies. An important takeaway is that when you study investing, stick to a strategy that suits you and keep at it ultimately you should be able to achieve financial freedom. For many in this book, becoming a private investor enabled them to get away from company politics. Why you shouldn’t read Free Capital First of all to enjoy this book it is required you are interested in the practice of active investing. If you a convinced passive investor you will not like this book very much. The interviewees are all U.K. based private investors. The author guards their real identity which allowed them to speak frankly. The book really stands out in its genre because the people profiled do not try to talk up their strategies, try to look smart or otherwise try to boost their own ego. However, if you are looking for sophisticated literature, you should read the papers authored by Thomas (highly recommended as well). Who should read Free Capital? Read Free Capital if you are looking for an inspirational read. Quite a bit of actionable advice is dished out by the various interviewees but there are no stock tips. Of course stock tips wouldn’t have a very long shelf life any way. The book is especially valuable if you are developing your style as a private investor. You may not yet realize that it is also possible to be an activist investor from your home office. Even though most people day trading end up broke, some prosper. Perhaps you are considering to become a full time investor because you hate your career but do not dare to take the plunge yet. These people did it but all took precautions. You may think you are handicapped because you don’t have a finance or business background but neither did these people and they destroyed their benchmarks. Free Capital is certainly one of the best investment books I read in 2015 and I highly recommended it.