Trader’s Narrative

Executive compensation is one of the glaring issues at the heart of the financial crisis. We haven’t even come close to dealing with it in a meaningful way as the powerful Wall St. lobby moved quickly to throw obstacles in the path of any regulation or even discussion of the matter.

The most common argument that is trotted out to defend the obscenely disproportionate compensation packages on Wall St. is that the bonuses, salaries and stock options are needed to keep ‘talent’. But no one is able to ask how ‘talent’ that nukes the global financial system and brings down once mighty investment banks is worth even a shiny dime.

A look at the global bank CEO compensation also throws cold water on this non-sequitur:

Source: Reuters

The only non-US bank that approaches lofty compensation levels is Santander. Since the graph above shows the compensation and the market capitalization of each bank, I thought it would be interesting to show the relative compensation, so here is a graph of that:

There is incredible variation in executive compensation around the world with many very large banks being run by CEOs who are paid next to nothing (compared to US counterparts). So are they stupid to stick around? or is the North American mindset wrong?

I’m not really in favor of a government cap on compensation. But regulation is needed to bring salaries and bonuses in line with performance. And they clearly are not right now. The industry itself nor the market is going to deal with the agency issue at the heart of the matter. Shareholders theoretically are in control but in reality, there is so many layers of bureaucracy insulating them and the compensation committees appointed by the CEOs that no one really believes in this free market fairy tale anymore. A third objective party needs to step in and rescue Wall St. from themselves for the good of all.

For a while now, we’ve been concerned that volume hasn’t been powering the market higher. In fact, if you think of volume as fuel for any sustainable market rally, then we’ve been running on fumes for a few months. Since I wrote that in early June the market wobbled a bit and traced a shallow correction but before long it was on to new highs for the year. This has been a teflon coated rally.

But there is no mistaking that what we are seeing is a true outlier in terms of historical market performance. Here is a chart from Hussman’s most recent commentary which shows the six-month percent change in the S&P 500 from the bottom of each bear market (going back to the early 1940’s) compared to the percent change in volume over that same period:

Source: Hussman Commentary

As you can see, this rally is the largest one powered by the least volume. If we imagine a “best fit” line for the data, it would be going from the lower left to the upper right, implying that usually, the more volume, the bigger the recovery from a bear market low.

The state of volume (or lack thereof) is even more alarming when you consider that for the past year a baker’s dozen of stocks have grown to account for eyepopping proportions of total volume on the exchanges. Just to give you an example, on August 6th 2009 Citigroup (C) and Bank of America (BAC) accounted for 25% of total NYSE volume. Dr. Brett have brought attention to this last month: The Recent Concentration of Volume.

There are many theories about what exactly is behind this crazy volume: daytraders, HFT, short covering, secret government recapitalization, etc. Whichever reason is the real one, a market structure where total volume is distorted by such gigantic proportions from a handful of issues is, simply put, deceptive.

According to a June 1st press release from Dow Jones: “The Travelers Companies, Inc. (TRV) is taking the place of Citigroup, Inc. (C) and Cisco Systems, Inc. (CSCO) is going in for General Motors Corp. (GM).”

The changes will go into effect on the opening of trading next Monday - June 8, 2009. The last time the Dow Industrial Average was changed was about a year ago when Bank of America and Chevron (CVX) replaced Altria (MO) and Honeywell (HON) (Dow Jones Technical & Fundamental Analysis)

There is an ongoing debate between ‘passive’ vs. ‘active’ portfolio management. Very few money managers are able to beat wide indexes over time. But when you think about it, we don’t really have passive portfolios. If the Dow was truly passive it would still be comprised of companies like Standard Rope & Twine (a component from 1898). But obviously, such an index would have long ago ceased to exist; just like its component companies. To continue to exist and be relevant, an index must evolve along with the stock market. And that makes it an actively managed portfolio.

The only real difference is that a ‘passive’ investment portfolio like the Dow Jones has a much lower turnover rate than more actively traded portfolios managed by you or a hedge fund trader or a mutual fund portfolio manager. So the debate is really about turnover. When you start to buy/sell at a furious pace, not only do you have to deal with transaction costs but shrinkage due to spreads, errors and taxes. Unless you have an edge that can beat those costs, you’re trying to get out of a hole by digging faster.

The funny thing is that although these index changes are necessary, most of them result in lower performance. There have been a lot of studies done on indexes like the Dow and the S&P 500 which show that in the short term, companies that are removed provide higher returns than those which they were replaced by. Which means that GM (GMGMQ) and Citigroup (C) are probably going to outperform Cisco (CSCO) and Travelers (TRV) going forward. So the price that you pay for having an index like the Dow or the S&P 500 continue indefinitely is that their performance is actually lower than it would be, had there been less interference with their composition.

Book Giveaway
If you haven’t already, throw your name into the hat for a giveaway of:
Hedge Fund Operational Due Diligence (follow link and submit comment)

Tuesday’s rocket ride was attributed to a news trifecta:

Rep. Barney Frank, made public that the SEC is considering the reinstatement of the uptick rule. Bernanke’s mused on more flexible accounting for banks to allow them to replenish their capital base and to prevent them from limiting their lending in a downturn (as they are now). Finally, Pandit made wildly optimistic statements about the profitability of Citigroup (C), based on the first two months of the year.

Whatever the actual rationale, Tuesday, March 10th, was yet another Lowry 90%-90% days. Of course, if you’ve been paying attention, this is nothing new. In fact, if we just count the times that we’ve fallen to a 52 week high, only to zoom higher on a Lowry 90-90 up day, it would be the fourth time:

The last time was just a few weeks ago (February 25th) when I asked cynically, Does Yesterday’s 90-90 Lowry Up Day Change Anthing? If you’re unfamiliar with what a 90%-90% Lowry up day is, follow the previous link for an explanation.

Of course, this bear market has been remarkable for its lack of significant counter rallies. So it isn’t surprising that although there is a lot of chatter about a bear market rally, not a lot of people actually think it will materialize.

Believe it or not, we’d gone 288 days without a rally (that lasted 80 days or more). That is among the longest stretches ever. It is only topped 3 times in market history since the 1920’s:
Continue reading ‘A Close Look At Yet Another Lowry 90-90 Up Day’

Sentiment Surveys
For the past few sentiment overviews, I’ve been bemoaning the lack of bearishness from retail investors. According to the AAII weekly survey, we did see a huge spike up to 60% bearishness, but then a very quick nonchallant attitude took over Mom and Pop investors across the land. For some strange reason, as the bear continued to maul markets with blood curdling ferocity, they didn’t care. Or maybe they were numb from shock already.

It was not surprising then that the market broke through the October and November lows. This week’s AAII numbers show an increase in fear (finally!). It is important to note that they came in on Wednesday - before the elevator drop through previous support levels - so it is curious to guesstimate where sentiment would be if the survey was administered afterwards.

AAII bulls came in at 24.37% and the bears at 57.14%. While this is a good development, as I’ve said for the Nth time, what we really need to see is the market recover and a commensurate increase (or plateau) in bearish sentiment. That would give me confidence in any ensuing rally. But if once again people start clinging to every uptick as a hopeful recovery, it will be short lived.

ChartCraft’s Investor’s Intelligence sentiment measure was mostly unchanged with 31% bulls (a tiny decrease) and 43.6% bears (slight bump up from last week). This survey came out on November 18th and it continues the slow trending decrease in bearishness from October.

Of course, the completely useless Citigroup Panic Euphoria model continued to impersonate a dead parrot’s heartbeat monitor. If Vikram wants to cut costs at Citigroup (C), he could start at worse places.

Market Vane’s bullish consensus sentiment dropped slightly to 40%. During this downturn this measure of sentiment has also stubbornly remained above previous panic levels. The lowest it reached was 32%, a far cry from the 20% range we saw in the darkest hour of the previous bear market.

Options Market
The options market continues to confound. While the CBOE equity only put call ratio increased to 1.16 as a result of Wednesday’s 6.12% plunge in the S&P 500, the next day’s carnage which took the index down 6.7% actually saw the put call ratio fall to 1.05.

The same pattern was noticeable in the ISE Sentiment index. The ISE call put ratio fell to 78 on November 19th - low but not extreme - but then it rebounded the next day even as the market took a more intense drubbing.

The options market continues to act crazy. Although put call ratios don’t walk hand in hand with the market every day, this is just bonkers. It is almost as if we’ve entered an alternative universe where previous market indicators and measures mean nothing.

Volatility
Volatility hasn’t imploded (yet). In fact, the VIX is back at previous highs last seen in late October. The thin layer of good news may be that while the market has broken to new lows, volatility hasn’t.

It wasn’t long ago when 45 was considered “extreme”. Since mid October the VIX has stayed above “extreme” and redefined it. Beforehand, we had broken above 45 on only four occasions. So yes, this is an absolutely unprecedented market.

Value Investors Peek Out
The ever cautious head of Fairfax Holdings (FFH), Prem Watsa, has peeked from under the covers and decided to remove the protective hedges for the firm’s equity portfolio. While Fairfax still holds the bulk of their assets in fixed income, it is another sign of valuations coming to attractive levels. Watsa is compared by some to Buffett because of his cautious nature and his strict adherence to a value oriented investment philosophy.

Watsa wrote to Fairfax shareholders: “While we believe the recession may be long and deep, we also believe that stock prices may have already discounted the worst of the economic decline. As value investors, we are finding an incredible number of investment opportunities across the world. That said, in the short term we recognize that stock markets can continue to fall significantly.”

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