David Fuller and Eoin Treacy's Free (Abbreviated) Comment of the Day.
Friday 12th August 2011
High-Frequency Firms Triple Trades in Rout - I mentioned high-frequency trading in my introduction yesterday and was interested to see this article from Bloomberg this morning. Here is a section:
The stock market's fastest electronic firms boosted trading threefold during the rout that erased $2.2 trillion from U.S. equity values, stepping up strategies that profit from volatility, according to one of their biggest brokers.
Surges and rapid declines in the S&P 500 are being driven by institutional investors turning over baskets of stocks and investment banks hedging positions in response to actions by central banks in Japan, Switzerland, Europe and the U.S., Quast said. Institutional investments generally focus on correlation between products and asset classes whereas speculative trading is driven by divergence from historical price relationships among stocks, indexes, currencies and other gauges, he said.
My view - In the question of which came first: the chicken or the egg - does high-frequency trading respond to volatility or is it a cause volatility? I think it is the latter.
Markets have always been much more volatile than changes in fundamental factors, because people are emotional, especially when leverage is used. Extreme volatility tends to be bearish because it frightens many investors and commentators who see it as a sign of instability. This can have economic consequences if it influences corporate decisions by making managers more cautious.
I do not think that the increase in volatility need be a problem for value investors, provided they are not influenced by it. In fact, it can help them by exaggerating moves, particularly to the downside. This increases buying opportunities.
However, increased volatility can certainly make trading more hazardous, especially for the majority of people who have little interest in sitting in front of screens, monitoring extremely short-term tick charts. In fact, that is physically impossible for anyone who wishes to monitor more than a few instruments, but the machines can do it for thousands of instruments, trading them in a frenzy of algorithmic signals.
We will never get rid of the machines, nor should we. Technology in its myriad forms marches on and is one of mankind's greatest achievements, especially when used for the common good.
However, investors and regulators may wish to consider whether or not high-frequency trading, often defended because it increases liquidity, actually reduces it when liquidity is needed most? Is it a good or bad idea for high-frequency trading to have prior access to price information? Is the industry sufficiently regulated to prevent front-running, scalping or other predatory practices?
So, where does this leave us? The ability of the US to stimulate the economy through further fiscal spending is surely limited now and any further boost to growth will have to be delivered via the Federal Reserve in the form of more quantitative easing. Indeed, Ben Bernanke, the Governor of the Federal Reserve, announced earlier in the week that interest rates would remain at zero until 2013. This announcement may result in higher inflation with US unable to raise the cost of borrowing for fear of crippling their economy. We do not subscribe to the double dip recession theory despite recent events and believe that very little has actually changed. Our core scenario remains that developed economies plod along on with anaemic growth for the foreseeable future, with drivers of the global growth to be found in the emerging economies, who seem to be getting on top of their inflationary issues. We believe the pitiful coupons and as such returns on US Treasury bonds will encourage more investors to look elsewhere for returns in excess of inflation. Good quality high yielding equities to us are the obvious choice. In stark contrast to the balance sheet of the UK or US government, corporation's finances are in great health and we believe they shall be able to continue to grow their already attractive dividends over time. The equity markets still offer the best long term returns and this week we have taken the opportunity to buy at discounted prices. Once the focus moves away from economies and back to the prospect of companies, we are confident that markets will begin to recover fairly swiftly.
My view - My impression is that more economists than investment managers expect a US double-dip recession. The economic data, including leading indicators, has mostly deteriorated ever since crude oil and many other commodities spiked higher earlier this year. Today's US data was mixed with retail sales improving but perhaps more importantly, consumer confidence slumped to its lowest level since 1980.
The double-dip - or not - question is too close to call in my opinion and the result may depend on a statistical slight of hand. Consequently, while the reported result may seem like a minor issue, many stock market historians would disagree.
They will point out that when US GDP is still growing, stock market corrections are mostly confined to a 10 to 15 percent range for the S&P 500 Index. Other stock markets, being smaller, will usually have somewhat larger corrections.
However, during recessions the S&P's corrections are usually larger, becoming statistical bear markets in the 25 to 35 percent range, and sometimes more as we last saw in 2008/9. To date, the S&P 500 has fallen just under 20 percent.
If the US does avoid a double-dip recession, it will do so with the help of demand from Asia's growth economies.
Stock market weakness is creating a buying opportunity and Eoin provides another interesting share review below. My preference is for high-yielding, successful multinational companies leveraged to Asian-led growth.
I prefer ITs, and further stock market weakness would increase my interest in ABD, AAIF, AAS and NII (listed elsewhere in the Library because it does not carry the Aberdeen name for some reason although it is managed by Hugh Young. His point about redemptions is interesting for the prospective buyer because it increases the discount to NAV at which these ITs trade in a downtrend.
I know what caused it, if you're interested. Despite the wisenheimers' head-scratching, garment- rending, finger-wagging and tooth-sucking, I actually do know the reason that out of the clear blue sky we were afflicted with a Biblical, mythological, medieval plague of rioting.
"There is no security on this earth; there is only opportunity."
How is Australia faring during the current period of heightened volatility? - The strength of the commodity sector which continues to represent some of the best performing Australian companies has helped push the Australian Dollar to 40-year highs against the US Dollar. This has put considerable pressure on the domestic economy. Let's look at some examples.
The S&P/ASX 200 Index broke downwards from its almost two-year range last week and found at least short-term support this week. However a sustained move back above 4670 will be required to check medium-term scope for additional lower to lateral ranging.
The S&P/ASX 200 Financial Index has more of a downward bias and also broke lower last week. Commonwealth Bank of Australia (9.41%), Westpac (10.47%), ANZ (9.9%), and National Australia Bank (10.08%) all share a similar pattern. We would welcome some feedback on whether payouts at these levels are sustainable?
Shares such as David Jones (16.84%), Myer (15.38%) and Billabong (8.16%) which either depend on the domestic economy or have to compete abroad in the highly competitive retail sector have been among the worst performers of late. David Jones has become deeply oversold and potential of a short covering rally has increased substantially. Myer is quite similar. Billabong has been deteriorating for a year and a sustained move above the 200-day MA, which would subsequently need to turn upwards, would be required to question downside potential. The dividends for these companies appear unlikely to be sustained.
As with other countries the strong cashflows of telecoms make them attractive in times of crisis. Telstra (13.11%), which has been a serial disappointment for many, surged this week to form a large upside weekly key reversal. A countermanding downward dynamic would now be required to question recovery potential.
In the commodity sector, closely held Coal & Allied (3.16%) surged this week. A sustained move below A$100 would be required to question medium-term scope for some additional higher to lateral ranging. BHP Billiton pulled back to test the A$35 area and a short covering rally appears to be getting underway. It will need to find support above this area to suggest a medium-term low has been reached. Rio Tinto has a similar pattern. Newcrest Mining is among the best performing gold shares, particularly when currency differentials are taken into account. It continues to range above A$35 and a sustained move below that level would be required to question medium-term scope for additional higher to lateral ranging.
The heightened sense of anxiety evident over the last week has exaggerated the differences between Australia's world-beating commodity sector and much of the rest of the economy. This is unlikely to change for as long as the Australian Dollar remains at such high levels. It found support in the region of $1 this week and a sustained move below that level would realistically be required to question the potential for additional upside over the medium term.
"Thanks for the timely update on dividend players.
"Canadian investors are unfortunately faced with a stiff tax on the dividends from foreign stocks, so we would appreciate it if you could do an update (when you have the time) on Canadian high yielders, where many of the income trusts have converted to stocks.
"Some of the charts also need fixing, either due to missing data or splits:
"LIF.UN, BTE, BA, BNP, CLC, VSN, DH, KEY, PVE, VET
My comment - Thank you for your kind words and suggestions for the Chart Library. I have added CFX and MMF and updated the others you mention.
Canada is a fertile market for yield hungry investors. The S&P/TSX Index currently has a P/E of 16.37 and 2.7%. Companies in the financial, energy, telecommunications and food sectors tend to yield considerably more. The S&P/TSX has had one of the more impressive bounces this week as a period of short covering begins. However, the Index has been deteriorating since March and a sustained break of the progression of lower rally highs, currently near 13,500, will be required to question the medium-term downtrend.
AGF Management Class B (6.74%), Bird Construction (6.03%) and Enbridge Income Fund Holdings (6.1%) are the higher yielding constituents. Of the three, the latter has the more attractive chart pattern. In common with other pipeline related Canadian shares such as TransCanada (4.1%) and Veresen (7.39%), They have rallied impressively this week to form large weekly upside key reversals. Pipelines are an economically essential sector with attractive yields. This week's lows could potentially represent medium-term lows for these particular shares.
Telus Corp (4.16%) has had a relatively shallow reaction to date. It also posted an upside weekly key reversal this week; having found support in the region of the 200-day MA.
Shaw Communications (4.35%) has been ranging with a mild upward bias for the last two years. It also rallied impressively this week and a sustained move below C$20 would be required to check potential for additional higher to lateral ranging. Bell Aliant (6.91%) has a similar pattern.
The Canadian banking sector has been lauded for its stability since 2008 but has not been immune from the selling pressure evidenced over the last couple of weeks. The S&P/TSX Financials Index found at least short-term support near the lower side of the 2-year range this week but a sustained move above 1750 will be required to question the current downward bias.
Royal Bank of Canada (4.18%) is currently testing the lower side of a potential two-year Type-3 top formation as taught at The Chart Seminar. This week's rally was impressive but a sustained move back above C$55 would be required to defray current scope for additional medium-term downside.
The S&P/TSX Income Trust Index (5.94%) has also posted the largest reaction in at least two years. While it bounced back impressively this week and there is room for an additional short covering rally, a sustained move above 170 would be required to indicate a return to medium-term demand dominance. The UK listed Middlefield Canadian Income Trust yields 5% and has a relatively similar pattern.
Most of the above chart patterns have experienced significant technical deterioration. Sectors essential to the functioning of the Canadian economy offering attractive yields are less likely to be subject to concerted selling pressure than those more focused on the banking sector for example. Canada is replete with high income investment opportunities and these are worth monitoring for signs that medium-term lows are being formed. At present it is too early to make that judgement call for the majority of shares.
"I refer to your interesting piece about over-extension beyond the 200 DMA, in respect of gold.
My comment - Thank you for this topical question sure to be of interest to other subscribers. I suspect that leveraged short-term traders are much more interested in absolute price moves. However, long-term unleveraged investors are often more concerned with percentage appreciation. As such I believe we need to look at both.
Gold is a much more expensive contract now than it was five years ago. Back then a $10 move could have been considered a dynamic, now it hardly registers on the chart. I find it useful to compare past overextensions relative to a mean such as the 200-day MA in percentage terms because it gives us a valid point of comparison.
"Please add Vallares PLC (VLRS-London) to the chart library. Thanks."
My comment - Thank you for this suggestion which has been added to the Chart Library.