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Contrarian Investing
Prof. Gerlach
Sacred Heart University
Deborah J. Weir, CFA
Author, TIMING THE MARKET (Wiley, 2005)
Fundamental Economics
As
Contrarian Investing
Because
Emotions Get In the Way
2
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
4
Economic Forecasting
Tools
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 Shapes
Positive 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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Asset Allocation Using Yield Curve
Shapes
• 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
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Economic Forecasting Theory
Normal
Curve,
Normal
Growth:
Inverted
Curve,
Recession:
Nov. 2004
March 2007
Equities
Fixedincome or
Cash
Steep Curve, Inflation:
July 2009
Gold, Foreign Currencies, Real Estate
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Forecasting Practice
The yield curve helps forecast the recent US
investment cycle.
Click on the “animate” option to see how these two markets
move:
http://stockcharts.com/charts/YieldCurve.html
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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
13
Normal Curve 2009
Forecast strong stock market.
http://stockcharts.com/charts/YieldCurve.html
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Steep Curve 2010
(3mo./10yr. Spread > 300 bp)
Forecast inflation expectations.
http://stockcharts.com/charts/YieldCurve.html
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Steep Curve 2009 - 2010
Inflation expectations weakened the US dollar.
http://stockcharts.com/h-sc/ui
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Steep Curve 2009 - 2012
Inflation expectations increased the
price of gold
http://finance.yahoo.com/q?s=GLD
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Steep Curve 2009 – 2011
Inflation 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 Bonds
Curve forecast stock market losses, bond market gains.
S&P 500 Index
30-yr
Bond
Price
http://stockcharts.com/charts/historical/
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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 Updates
October 26, 2012
Covering September 26, 2012–October 26, 2012
Highlights
October September August
3-month Treasury bill rate (percent) 0.10
0.11
0.10
10-year Treasury bond rate (percent) 1.79
1.81
1.76
Yield curve slope (basis points)
169
170
166
Expected real GDP growth (percent) 0.6
0.6
0.6
Old 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
8.5
http://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 BRICs
http://www.economist.com/news/economic-and-financial-indicators/21567095trade-exchange-rates-budget-balances-and-interest-rates%20%20
Country
Brazil
Russia
India
China
3-month
7.10%
7.66%
8.18%
3.80%
10-year
9.57%
7.36%
8.21%
3.19%
BP Spread
+274
- 30
+ 3
- 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
http://www.economist.com/news/economic-and-financial-indicators/21567095
-trade-exchange-rates-budget-balances-and-interest-rates%20%20
Country
*Portugal
Italy
*Ireland
Greece
Spain
3-month
0.19%
0.90%
0.19%
0.19%
0.19%
10-year
7.89%
4.84%
4.58%
16.08%
5.74%
BP Spread
+770
+394
+439
+1589
+555
•No information for Portugal or Ireland in 2011
Given these spreads, what’s your forecast:
GDP
Interest rates (up or down)
Inflation
Currency
Direction 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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Wall St. Journal Publishes High-yield Index
http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html
Nov. 2011
Nov. 2012 = 4.87%
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Other Sources
Federal 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 yield
http://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?
•Fiscal Cliff
•Greek Default
•Global Slowdown
S&P October 1 - Nov. 23, 2012
S&P
12
11
/1
9/
20
12
11
/1
2/
20
2
11
/5
/2
01
12
10
/2
9/
20
12
10
/2
2/
20
12
10
/1
5/
20
2
10
/8
/2
01
10
/1
/2
01
2
1480
1460
1440
1420
1400
1380
1360
1340
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Bull Market Confirmed
by Quality Spreads
Merrill-Lynch High Yield Less the Ten Year Note
12
11
/1
9/
20
12
11
/1
2/
20
2
11
/5
/2
01
12
10
/2
9/
20
12
10
/2
2/
20
12
10
/1
5/
20
2
10
/8
/2
01
2
5.4
5.2
5
4.8
4.6
4.4
4.2
4
3.8
10
/1
/2
01
%
Quality Spread Oct. 1 - Nov. 23, 2012
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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 billion
http://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
QE2
Market Turn
QE3
Turn
Turn?
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Global Economic Forecasting
Tools
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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Updates
Blog:http://timingthemarket.blogspot.com/
Twitter.com: @debweir
Voices of New York Institute of Finance
Faculty: http://www.nyif.com/blog.html
Email [email protected]
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Contrarian Investing
Prof. Gerlach
Sacred Heart University
Deborah J. Weir, CFA
Author, TIMING THE MARKET (Wiley, 2005)