Stocktake: Preparing for interest rate lift-off

Farewell to the Brics, morality and the hedge fund manager and exploiting inattention

Janet Yellen, chairman of the US Federal Reserve: Recent strong jobs numbers mean a December rate hike now looks a safe bet. Photograph: Joshua Roberts/Reuters

Janet Yellen, chairman of the US Federal Reserve: Recent strong jobs numbers mean a December rate hike now looks a safe bet. Photograph: Joshua Roberts/Reuters

 

Investors have spent 2015 fretting as to whether the Federal Reserve would finally raise US interest rates and if so, when. Less attention has been paid to a much more important question: the pace of rate hikes.

Recent strong jobs numbers mean a December rate hike now looks a safe bet; futures data indicates a 70 per cent chance of a rate increase. Although stocks retreated last week, investors appear relatively sanguine regarding interest rates; a recent Barclays survey of institutional investors found just 7 per cent believed rate normalisation was the biggest risk over the next year, down from 40 per cent in 2013. Five times as many investors – 36 per cent – believe China poses the biggest risk.

Ironically, there is less need to be concerned if everyone is worried about the same problem – it indicates a China slowdown is already priced into stocks. In contrast, futures data indicates markets expect just two rate hikes in 2016 and another two in 2017, even though the Fed expects to hike rates roughly four times per year.

Markets may well be right – time will tell. However, if the Fed is right and quarterly rate hikes do ensue, there is potential for some market jitters as 2016 progresses.

Saying goodbye to the Brics

The recent closure of Goldman Sachs’s Brics fund (Brazil, Russia, India and China) marks the end of one of the great investment fads of the last decade.

With Russia and Brazil in recession and China suffering a major equity crash, Goldman’s decision was no surprise. The Brics underperformed every year between 2010 and 2015, losing a quarter of their value even as US indices almost doubled. Assets in the fund collapsed from their $842 million peak in 2010 to just $88 million.

There are two key takeaways here. One, emerging markets (EM) are increasingly diverse, and it’s not a good idea to lump them all together as if they are a single asset class. Some are very cheap, others extremely pricy; some are flying high (Indian equities have gained more than 40 per cent over the last three years), even as others have plunged (Brazilian stocks have halved).

Investors are belatedly realising as much; Bloomberg notes EM outflows have totalled $6 billion over the last three years, with some $7 billion making its way into single-country ETFs tracking EM countries.

Secondly, acronym investing tends not to be a wise move, whether it be in the Brics, the Mints (Mexico, Indonesia, Nigeria, Turkey), the Civets (Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa) or the various other gimmicky fund ideas.

Morality and the hedge fund manager

All of us have our unique moral codes, but billionaire hedge fund manager Bill Ackman’s is a little more unique than most.

Ackman is short shares in nutritional firm Herbalife, which he describes as a pyramid scheme targeting poor people. His $1 billion bet against Herbalife is a “moral obligation”; to benefit from the bet would be “blood money”, so he has promised to donate any personal profits to charity.

He also owns shares in controversial pharmaceutical firm Valeant, which has seen its shares collapse by 70 per cent since August amidst accusations of price-gouging and other questionable business practices. Valeant’s pricing strategy was recently described as “deeply immoral” by Warren Buffett’s Berkshire Hathaway investment partner Charlie Munger.

Replying, Ackman said he would never own Coca-Cola (one of Berkshire’s biggest holdings); its products “create obesity and diabetes” and have “caused enormous damage to society”.

Note that Ackman owns stakes in Burger King, Tim Horton’s and snack-food giant Mondelez International. A foolish consistency, it seems, is the hobgoblin of little minds.

Exploiting inattention

Don’t trade the news; trade when there’s no news. So say the authors of a new study exploring investor inattention, as measured by Google search volume data.

The study tested a strategy that took weekly positions in S&P 500 stocks recording an “abnormally low” number of Google searches the previous week. The strategy generated annualised returns of 19 per cent, trouncing the overall market by 14.3 percentage points.

Unfortunately, the authors suggest this strategy is best left to institutional players; retail trading costs would likely wipe out the outperformance.

Still, the results are intriguing, and the conclusion is backed up by other studies – “low attention results in underpricing”.

See http://goo.gl/YCyUti

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