Charter Trust - Global Market Update

Is there a whale in your future? Recently  JP Morgan released its internal investigation of what went wrong with its “London Whale” trade—the ill-conceived credit “hedge” that cost the bank  between 5 and 10 billion dollars. Buried on page 127 of the 132 page document is this nugget:  "Risk was monitored “through a series of Excel spreadsheets, which had to be completed manually, by a process of copying and pasting data from one spreadsheet to another.” A couple of simple errors in this process led the bank understate its risk. Then the market turned against the bank and—poof--$7 billion gone. Excel is perhaps the most important business software application of all time. It allows analysts to do sophisticated statistical analyses, create pro-forma financial statements, and format sweet-looking reports, all while letting you see what happens to the data as you manipulate it. But its very power is its danger. Amateur hacks create quantitative monsters, with no sense of versioning, testing, or regression. There are millions of spreadsheet mavens out there who don’t know the first thing about programming in a methodical, well-documented way. They just start with a little model that grows and grows and grows. Excel is everywhere. And who knows what it will blow up next? Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd

Where do we go from here?Is Cyprus another Greece, threatening the Euro? Or is it a special case, with an outsized banking system that needs propping-up from outside the system.Like most things, it’s a little bit of both. Ironically, an answer can be found in the title to this commentary. The Bitter Lemons of Cyprus is a personal memoir of the author’s time on the island in the mid-‘50s during the run-up to violence between the Greeks, Turks, and British.In the book normally friendly neighbors become hostile and violent, as outside pressures force trust to break down. Transactions that were a source of profit and pleasure become impossible, and the author’s colonialist attitudes—emblematic of the British Empire—undermine any good he tries to do.In the end, the author sneaks out of the country, lamenting what was lost. As civil wars go, Cyprus was mild—nothing like the Greco-Turkish war on the mainland, with its hundreds of thousands of casualties. It was an outgrowth of a larger problem, but didn’t precipitate further problems in its own right.Europe can only hope that Cyprus’s current financial problems will be similarly contained. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

So what’s the big deal?The leadership of the EU has proposed that Cyprus dun its bank depositors by $5.8 billion in order to qualify for a bailout that will recapitalize their banks. And banking is a big deal in Cyprus. Because of lax money-laundering rules, it’s become the Cayman Islands of the Mediterranean.But 6.75% was too much of a hit on small deposits for lawmakers to accept. Never mind that bank deposits in Cyprus pay almost 5% and inflation has averaged about 2 1/2 % over the past 5 years. Bank depositors were seeing a positive real return from their holdings, unlike Germany or the UK or the US. As we all know, bank deposits rate here in the US have been paying less than the inflation for the past 4 years.So savers in the US have been dunned by almost 10% in real terms since the beginning of the Financial Crisis. But there’s no sense of panic, no lines in front of ATMs, no protests at the Fed--just a steady drip, drip, drip of negative real interest rates.So what’s the big deal, Cypriots? If you think a one-time charge punishes the thrifty, try investing in US Dollars. Because over here, what’s safe doesn’t pay, and what pays isn’t safe. Economists call it “financial repression.” I call it a “stealthy Cyprus.”Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

The Euro-crisis has reached a new level.The country of Cyprus is tiny. Its $25 billion economy is smaller than Vermont’s, but it has bank deposits of $56 billion. In this it resembles Switzerland, whose $660 billion economy supports a banking sector with $1.2 trillion in deposits. The banking sector has grown because Cyprus has liberal money-laundering rules and extensive ties with Russia. It has been estimated that over a quarter of all bank deposits originated there. Limassol, the financial center, has three daily Russian-language papers.But unlike Switzerland, Cyprus is part of the Euro. Due to losses on Greek government bonds, their banking sector needs to be recapitalized. Credit has dried up, but they can’t just print Cypriot Pounds. Cyprus needs to borrow Euros. Seventeen European finance ministers met over the weekend and decided that in exchange for a € 10 billion bailout package, Cyprus would need to dun all depositors for € 6 billion.But apparently the leaders didn’t think breaching deposit insurance would cause a run on the banks. Now every ATM on the island is out of cash, and the banks are closed until Thursday. The implications of a deposit-tax are reverberating across southern Europe, wherever the Euro-crisis has been a prominent issue.Europe has been searching for a solution to its currency crisis for years. Punishing savers seems unlikely  to help.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

Have we reached the silly season? The news is filled with movie starlets discovering the stock market and 16 year-old actresses day-trading from their iPhones. Are these signs of a bubble?An old market saying goes, “When even shoeshine boys are giving stock tips, it’s time to sell.” The market is a discounting mechanism that incorporates not only the latest news, but our sentiments about the news. So big, emotional events like Pearl Harbor, 9/11, Neil Armstrong’s walk on the moon, or the Lehman Bankruptcy tend to magnify what we’re already feeling.But market buzz can permeate the culture, and encourage otherwise sensible people to buy and sell on a whim. Until Friday the market had risen for 11 straight days, something that hadn’t happened since 1996. And market volatility has fallen to the lowest level in six years. Complacency and momentum are a powerful cocktail.I have nothing against bubbles. They can be profitable if you have the good sense to leave the party before authorities show up. But what the wise do at the beginning, fools do in the end. When the music stops, be sure there’s a chair nearby.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd 

In Rome, the Catholic Church has a new Pope. When I read the news, I couldn’t help but be impressed by how efficiently they acted. For an office that’s a lifetime appointment, that holds tremendous moral, spiritual, and worldly power, that has millennia of history behind it, the conclave of Cardinals took only 2 ½ days and 5 ballots to make their decision.Maybe it was the inspiring frescoes by Michelangelo in the Sistine Chapel where they met; maybe it was the delightful Italian weather; but whatever it was, the conclave acted with efficiency and dispatch.Well, all I can say is: put these guys in charge of the Federal Budget! Clearly, they know how to reach a compromise without causing a crisis. Their choice of pontiff isn’t without controversy, and pundits around the world are weighing in with their opinions. But there doesn’t seem to be a lot of grumbling from various factions within the Church. And as far as I can tell, not a single Bishop staged a filibuster. Before they all hop on their planes and head back home, why not ask the Cardinals to go back into the Chapel and take a stab at balancing the budget? Heaven knows it couldn’t hurt. And even if they take twice as long as they did choosing a pope, we’ll still be way ahead of where we are now. But when the smoke comes out of the chimney, we just have to pray that they haven’t given up and burned the thing up.Douglas R. Tengdin, CFA Chief Investment OfficerHit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

Does insider buying or selling mean anything?Unlike most of us, corporate insiders need to tell the SEC when they buy or sell their company’s stock. There are armies of analysts who examine these filings for clues as to whether this is a good time to buy or sell the market. In theory, insiders should have better information than the rest of us. In practice? Not so much.Consider the following:In 1991 insider selling spiked as the stock market roared out of the 1990 recession. Insiders had held their sales back for several years. We know what the market did after these sales;In 1999 insider buying hit an 8-year high, as corporate executives became enamored of their own shares;Again, in August 2007 insider buying set a new record; Now the wires are filled with stories of insider selling, just as they were in 2009, 2010, 2011, and 2012. At some point, they’re bound to be right. But a stopped clock isn’t useful, even if it’s accurate twice-a-day.While CEOs and CFOs may have a good handle on their company’s fundamentals, they often don’t have a clue what constitutes a fair valuation. And they may need to sell shares for all kinds of other reasons—tuition, home-buying, taxes—that have nothing to do with the business.Trading in inside information is illegal. And trading on insider’s actions can be downright foolish. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

InTrade has stopped doing business. What does this mean?InTrade is either an online betting site, or futures site, or predictive market site—depending on your priors—that allowed participants to take small positions on political futures, weather futures, and other obscure items. They abruptly shut down their site on Sunday. In November, the US Commodities Futures Trading Commission compelled the Irish company to close its site to Americans, because they were offering betting contracts on gold and oil.The results were predictable: trading volume fell off a cliff.  The CFTC later reversed itself, but the damage was done. On their website the company cites financial irregularities, and a lot of people are speculating that InTrade’s segregated accounts got co-mingled with company funds. After all, revenues were falling, all that money was just sitting there. Who would be looking? This is partially what happened at MF Global.Which raises a good question: whenever a new financial instrument requires you to write a check and send it off, it’s a good idea to ask, who’s checking them out? If you don’t like the answer, don’t send the money.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

East Coast, West Coast … The conventional wisdom used to be to buy East Coast companies during bear markets, West Coast companies during bull markets. With the East Coast concentration in consumer products and pharmaceuticals, and the West Coast focus on technology and cyclical companies.While that approach seems hopelessly simplistic, it does contain a nugget of truth: there are sectorial distinctions in the market that work better at different points in the business cycle. During downturns, defensive companies like Proctor and Gamble or Johnson and Johnson do well; during expansions it’s cyclical companies such as Intel or Boeing that tend to lead. (In my mind, Boeing is still a West Coast company.)How do you know when to switch? That’s actually pretty simple. Six to nine months after the start of a recession it’s usually profitable to be more aggressive. A famous investor once said, “The time to buy is when the blood is running in the streets.” And when to get cautious? After you’ve doubled your money is often a good time to even-up—not to get out of the market, just less aggressive. No one rings a bell at the market’s top; the only sure thing is that six months after a downturn, everyone will claim to have predicted it. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

Is the Fed helping or hurting?In an era where the loudest, most passionate voices often seem to gain credibility simply by cranking up the volume, it’s useful to back up and look at some of the fundamentals.Monetary policy is complicated. It acts with long and variable lags. It’s easy to misunderstand, and even easier to distort. A lot of folks have garnered a lot of (underserved) attention for themselves and made a lot of money by attacking an institution that has multiple, conflicting mandates: low inflation, full employment, and a safe and sound financial sector.To go back to the beginning—that is, to go back to 2008—money market funds were hemorrhaging cash. The Fed put guarantees in place and actually purchased on its own authority the corporate money-market obligations that keep our economy working. When those obligations began to run off, they replaced them with Treasury Notes. But when deflation started to hit, they initiated QE2, then QE3. And inflation is still moderate.There are those who think the Fed’s monetary puts the economy on steroids. But speaking from experience, sometimes steroids are necessary to keep you alive.Hit reply if you have any questions—I read them all!Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

The original computer bug was a moth short-circuiting a Mark II relay switch. Since then, it refers to any glitch that can disrupt a system. Financial markets are notoriously “buggy.” Sometimes their pricing becomes absurd. In 1982 stocks traded at an 8 price/earnings ratio. In 2000 this had expanded to 32. In 2007, AAA-rated sub-prime MBS only yielded 1.5% more than Treasuries; in 2003 junk bonds traded 10% above risk-free bonds. Unexpected news can create manias and panics. Careful, self-aware investors can take advantage of these massive miscalculations and profit by being greedy when others are fearful—and fearful when others are greedy. News organizations have a different set of motives, however. For them, the model is to create content, attract an audience, and sell ads based on that audience. The sensational is what sells—“If it bleeds, it leads.” For markets, irrational behavior is a bug, based on human self-protectiveness and self-delusion. For media, irrational hype is a feature, emphasizing the outrageous and creating buzz. I’ve thought about this dichotomy when it comes to gridlock in Washington, the budget-sequester, and the recent, breathless news stories. For all the hype, the markets have responded with a collective yawn. For the month of February, 10-year bond yields are down 0.1%; stocks are up about 1%; Oh. My. Goodness. If you wonder which approach is right, all you have to do is ask who you trust: the process designed to match buyers and sellers; or the one trying to create an audience and sell it? Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

Is it smart to be stupid? Are the incentives in trading and financial markets so skewed that it’s profitable to be foolish and reckless? It sure seems so. One of the frequent targets of financial reformers is proprietary trading—the infamous “prop desk.” At this work-station, young men and women stare at multi-screen monitors all day, divining relationships between volatility, forward rates, overseas markets, and other traders. The goal is to get 15 seconds to 15 days ahead of the next trend, and ride it to a profit.The pay-structure at the big banks and hedge funds creates a moral quagmire. Traders earn a base salary, enough to live comfortably in a big city. But they also receive an annual bonus, typically 10-15% of their trading profits. Have a good year, and that bonus can total tens of millions of dollars. Have a bad year, and you may not get a bonus. You may even get fired. But you never have to pay back your prior earnings.The problem is the asymmetry: win big and you can get fabulously wealthy; lose big and go home and look for a new job. And it’s a pretty simple system to “game”: start small, build credibility, and get your trading limits expanded. Then bet big--really, really big. If you win, you may just have earned enough to fund a lavish retirement, your children’s and grandchildren’s college education, and a new hospital wing in your name. Lose, and—perversely—you may have gained enough credibility to start your own hedge fund.Wall Street is littered with traders who have blown up their employers, their clients, and much of the financial landscape. As long as traders can just walk away from huge losses, they’ll just keep blowing things up.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

In the 1969 British caper film The Italian Job, Michael Caine assembles a team of criminals to steal a load of gold bullion from Fiat headquarters in Torino. In a series of mad-dash chase scenes and high-wire stunts, the crooks pull off the heist and head off to Switzerland, leaving the city in chaos. In a remarkable parallel, Bunga-Bunga master Silvio Berlusconi has engineered his own high-wire electoral comeback, pushing Italian politics into gridlock and threatening the stability of the European common currency.Italy’s economy is the third-largest in Europe and the third-most indebted in the world. But much of their debt was incurred over 20 years ago. For most of the past decade, they have run a primary budget surplus, only in deficit by interest payments. And most of their debt is long-term. They do not face an immediate funding crisis.Nevertheless, the austerity measures of technocratic leader Mario Monti have not set well with the electorate. The economy is in recession and his party finished fourth, behind that of a former communist, a former television clown, and Berlusconi. With Italy’s lower house and upper chamber in flux, it’s hard to tell who’s in charge.Given their weak economy, Italy needs financial support. The European creditor nations have been willing to help, but they want someone responsible to negotiate with—and that’s just what they don’t have. Like the movie, the outcome is a cliffhanger.In the movie’s ending, the escape vehicle teeters on the brink of a precipice, the stolen gold pulling it over the edge. In the same way, Italy’s hard-money could be pulling its economy over the edge. And just like the movie, we don’t know how this will end. Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Home maintenance isn’t on most people’s list of favorite things to do, but without scheduled upkeep, bad things happen. Hot water tanks rust, roofs leak, painted walls start peeling, and your shiny new home begins to look tired and frayed around the edges. In the same way, an investment portfolio needs to be maintained if it is to continue to meet your needs.There are two major forms of adjustment to an investment portfolio: strategic and tactical. Strategic adjustment has to do with you--you do a strategic reevaluation when your circumstances change. Tactical adjustment has to do with the securities in the portfolio—usually when an asset class does a lot better or worse than the overall market.Rebalancing at these times encourages investors to buy assets that have done poorly, and to trim holdings that have done well. While this is psychologically hard, it’s a good way to add value over time. It helps people to sell stocks when they’re hot, and to buy them when they’re not. But be careful. A stock that sold at 50 isn’t necessarily cheap at 25, if their business model is broken. At such times it pays to be cautious.When the whole market becomes irrationally exuberant or gloomy, though, it makes sense to rebalance. If you had a balanced portfolio in 1985 and rebalanced it whenever it got to 60/40, you would have added 25% to your portfolio over the next two decades, purchasing equities in 1993 and buying bonds in 2000.Portfolio maintenance isn’t terribly exciting, but it’s necessary. Sometimes the most mundane tasks that turn out to be the most valuable.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Finishing out your home is a big part of the building process. Setting up electrical outlets, plumbing, heating, flooring and other details will, in many ways, determine how enjoyable it is to live there. Your structure may be sound; your plans perfect; your layout exactly suited to your needs; but if there aren’t enough outlets in the kitchen, or the cable connections are in the wrong place, you’re not going to be happy.In the same way, investment reporting establishes the way that you interact with your portfolio. Some people want as much detail as possible—individual asset data, updated monthly. Others just want to see a broad overview, perhaps annually or quarterly. Most people want something in between. But everyone wants some type of presentation of where they are and what has happened.There are essentially three types of reports: position reports, activity reports, and performance reports. Position reports tell you where you are. There is usually some kind of asset-allocation overview, along with a listing of individual assets. The way assets are listed is important—how items are presented frequently will determine what we see. The best layout is by economic sector, with some consideration of you position’s size. That way you can quickly see how diversified or concentrated your portfolio is.Next is activity—buys and sells, and payments or stock splits. It’s important to know what’s happening with your investments. Unfortunately, this is where many systems get bogged down. There’s too much detail and users get overwhelmed. A simple overview usually suffices. Finally, there is performance reporting. Again, there are many choices, but a simple time-weighted presentation of portfolio performance—with perhaps a breakout for stocks, bonds, and cash—is usually enough. It’s often the case that less is more—simple well-designed reports are better than lengthy tomes filled with mind-numbing detail.Reporting may seem like a minor detail, until you have to deal with a poorly designed and executed system. But details matter. Getting them right can make all the difference.