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The Drop In How Many U.S. Stocks Equaled 1 Greek Economy?

The article shows that the capitalization change of a small number of large-cap U.S. stocks equaled the entire annual output of the Greek economy. This effort is in part to frame the impact Greek turmoil is having on U.S. assets. A qualitative discussion of whether this capitalization change is warranted is included. The title of this article asks readers to guess the number of U.S. stocks whose reduction in market capitalization on Monday was equivalent to the size of annual Greek economic output. The answer: 86 To come up with the figure, I compared the gross domestic product of the Greek economy from the World Bank to the capitalization change of the largest components of the S&P 500 (NYSEARCA: SPY ) by market capitalization until the change in value equated to the Greek GDP of $242B. I had some notable takeaways from this data that I wanted to share with readers. The question for market participants is whether these moves are justified. If the value of an asset is its future cash flows discounted back to the present, then the reduction in domestic equity prices on Monday was either a function of an expectation of lower future cash flows and/or a higher discount rate. The former, lower future cash flows, seems unlikely to have had a large impact given the limited trade between the U.S. and Greece and the fact that the Greek economy is roughly the size of the Minneapolis-area economy. The negative translation effect of broader global cash flows earned by these U.S. companies from a strengthening U.S. dollar would have had a proportionately larger impact. That means that the re-pricing of risky assets is more likely a function of a higher discount rate. The interest rate component of the discount rate fell on Monday as U.S. rates rallied on a flight-to-quality bid signaling that an “equity risk premium” applied to U.S. equities increased to move the discount rate higher. While the outcomes from a potential “Grexit” remain uncertain and difficult to analyze, the transmission mechanism for broader global contagion seems equally uncertain. The potential financial sector link, which roiled equity markets in 2012 given the amount of Greek debt held by European banks at the time, appears to have been muted by a rotation of Greek debt from bank balance sheets to official creditors, enhanced stability mechanisms, European quantitative easing, and much lower yields in the periphery. While the odds of a disorderly outcome in Europe are certainly rising, investors must handicap how much of a risk premium on global assets is justified. While we are likely to continue to see heightened volatility in the near term, if the Greek drama was responsible for the entirety of the move on these 86 companies, I believe that the impact has been overstated already. Disclaimer : My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon. Disclosure: I am/we are long SPY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

History Says Shorting Volatility Is The Right Move Here

VXX spiked almost 17% on Monday. That is the fourth largest move it has ever had. I believe this represents a unique opportunity to benefit from panicking investors. In the last couple of months of last year and into 2015, I spent a lot of time trading volatility (NYSEARCA: VXX ). I was fortunate enough to have pretty good success but when markets largely calmed down earlier this year, there wasn’t much going on. Well, for anyone that wasn’t under a rock on Monday, volatility returned all at once as the VIX spiked 34% on the day amid worries imported from Greece. I won’t go over the Greece drama because you can read about it many other places so in this article, I’ll focus directly on what I think is a very tradable move in the VIX via the ETF VXX. (click to enlarge) We can see the move in the VXX yesterday was absolutely massive. It gapped up on the open but that was just the start of the action as we can see from the chart. That sets up what I believe is a reasonably high risk, high reward setup in volatility that investors can consider if you believe the Greek crisis will be a ‘sell the news’ kind of event. The VXX moved up nearly 17% on Monday so that got me to thinking; that’s a huge move, how many times has this happened before? I pulled pricing data since VXX’ inception from Yahoo! and looked to see how many daily moves were in excess of Monday’s gain and the answer is just three. Three days in 2011 (two in August, one in November) posted up moves of more than Monday’s 16.8% move. First off, there have been more than 1,600 trading days for VXX so the fact that Monday’s move was larger than all but three days is quite extraordinary in itself. That alone would suggest a bit of value seeking may be in order simply due to the magnitude of the move. However, the three days in 2011 that saw moves this large were in the midst of a global meltdown in stocks. The S&P was getting crushed along with every other major index around the world so shorting the VXX after the first spike in early August would have been a rough trade. Here’s what happened starting with the day of the first 17%+ spike up in VXX back in 2011. VXX almost doubled after the first move up so in today’s terms, we’d be right there at the beginning of this chart if the pattern repeats. Shorting VXX would have produced sizable losses until the end of 2011 when VXX began to normalize. It looks like a blip on this chart but four months of gut-wrenching losses can get the best of anyone. That is why I always reiterate that trading volatility is not for everyone. There are days when you get crushed and you have to take the pain but if that’s not for you, there are plenty of other instruments to trade. The other point I wanted to make with this chart is that even though VXX nearly doubled after a similar spike to what happened on Monday, in time, it returned to its normal, wealth-destroying self. That is what I want to take advantage of and given that Greece is a small sliver of the Eurozone’s economic output, I’m betting that is exactly what is going to happen. I can’t tell you when it will happen but one thing I know with virtual certainty is that VXX will spike and fall as it always does. I don’t know how high it will go before it falls but fall it will and when it does, it will probably fall hard. That has been the pattern and I’m betting it will take place again. I bought some (NASDAQ: XIV ) on Monday as a way to short the VXX in a virtually costless way and to take advantage of when the VXX does roll over and begin to destroy wealth again. If the market is down again on Tuesday I will buy more because there is a very small chance this trade won’t work out in the favor of VXX shorts over the medium term. VXX is a trading vehicle that erodes value over time so holding the inverse creates value over time, on average. You can put the odds more in your favor when you short into intense strength like what we saw on Monday so that is what I have done. Best of luck out there, it should be entertaining. Disclosure: I am/we are long XIV. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Bill Gross: It Never Rains In California

Ted Cruz recently suggested praying for rain in Texas, and apparently someone did a few weeks ago, producing a deluge resembling a modern day Noah’s Ark of sorts. California’s Governor Brown on the other hand, has taken a more secular approach. He believes that Mammon, not God, bears responsibility for the Golden State’s record drought and that I, we, all of us simple folk should cut back water usage by a minimum of 25%. Well it’s hard to argue with Governor Moonbeam especially when it comes to the environment, although if you ask me, his other idea of hundreds of miles of high speed rail at a minimum cost of $25 billion is off the rails and on the governor’s private moon. But I will do my part. As a free citizen though, I have choices: replace the lawn with artificial grass, take fewer showers, jerry-rig the toilet bowl, or perhaps eat fewer almonds. I will choose a diet of fewer almonds. Growing almonds it seems, consumes 10% of all the annual residential water supplied to 40 million thirsty folks in California, and 60% of that production is exported, so I suggest we fight the drought “there” as opposed to “here”, if you get my drift. To that same point, an article in the impeccably objective Wall Street Journal claims that the water consumption for one pound of almonds is equivalent to 50 five minute showers, so I’m not giving up my shower for a bag of almonds. It’s here, though, where I have to do a little bragging. Some people will talk about having the world’s greatest dog or their newborn baby who slept through the night during the first week. But Sue and I have something very different. We have the world’s greatest shower. To be quite candid, it’s not the water, the temperature, the simple knobs, or even the shower head that makes it the best; nor is it the combination of all four. The key to our shower in fact, is not the actual experience of hot water on a 98.6° body at all. It’s the view; our shower has the world’s greatest view. The scenery from it is so gorgeous that when we sell our home, we may list the shower separately and see if it attracts an offer higher that the rest of the house. If not, we’ll just sell the house with a shower “easement” and continue to come in and out from the street every morning at 6:00 a.m. Back to the view. That it has one in the first place is, I suppose, outrageous in and of itself. But here Sue and I were in 1990, constructing our house on a Laguna Beach cliff overhanging more white water than you could shake a kayak at. The sailboats were drifting by, the surfers were hanging ten and it seemed like every minute of every waking day should be focused on that gorgeous piece of the Pacific that comes to rest 60 feet below our bathroom. So we built a shower with a window – not a picture window – but one big enough for a view. As is customary with a new home, I carried Sue over the threshold on the first day we moved in. But once the workers had cleared out, we headed straight for the shower. “Champagne?” she asked. “Nah”, I said romantically. “Just wanna look at the view.” When it comes to retirement, I don’t think we’ll need our 401Ks. We’ll just sell tickets to our shower, and use the proceeds to pay for some of Governor Moonbeam’s almonds. Speaking of liquidity, whether it be in surplus in a Laguna Beach shower, or an extreme deficit in the State of California, current concerns in the financial markets center around the absence of liquidity and the effect it might have on future market prices. In 2008/2009, markets experienced not only a Minsky moment but a liquidity implosion, as levered investors were forced to delever. Ultimately the purge threatened even the safest and most liquid of investments. Several money market funds appeared to “break the buck” which in turn threatened the $4 trillion overnight repo market – the center core of our current finance-based economy. Responding to this weakness, the Fed and other central banks imposed emergency liquidity provisions of their own – in effect they became the buyers of last resort. Recently however, Congressional legislation concerning “too big to fail” and Federal court rulings in favor of AIG regarding the expropriation of shareholders’ capital, have cast doubts as to whether central banks and their governments can exercise similar “puts” in the future to stabilize asset prices. As a result, regulators are proceeding with “better safe than sorry” mandates – tightening bank capital standards, curtailing the size of the potentially volatile repo market from $4 to $2 trillion, and pursuing inquiries as to which financial institutions are “strategically important” – code for “big enough to threaten asset market stability”. Not only major banks but several insurance companies and asset managers including PIMCO – just one block down the street – are being scrutinized. These individual companies which include Prudential, MET, BlackRock, and at least several others have responded as you might expect. “No problem” sums it up – markets are a little less liquid they claim, but recent experience would show that for PIMCO at least, there were no “fire sales” or “forced selling” after my recent departure, as stated by CEO Doug Hodge in a friendly WSJ article. Ah, now I’ve caught your interest. Well first of all let me state that the PIMCO example is not a good one to use to prove the current liquidity of mutual funds, ETFs, and even index funds. Hodge himself admitted to internal proprietary “liquidity” provisions, adding that it used derivatives for exposures “to support cash buffers and inflows” (sic). The fact is that derivatives on a systemic basis represent increased leverage and therefore increased risk – presenting possible exit and liquidity problems in future months and years. Mutual funds, hedge funds, and ETFs, are part of the “shadow banking system” where these modern “banks” are not required to maintain reserves or even emergency levels of cash. Since they in effect now are the market, a rush for liquidity on the part of the investing public, whether they be individuals in 401Ks or institutional pension funds and insurance companies, would find the “market” selling to itself with the Federal Reserve severely limited in its ability to provide assistance. While Dodd Frank legislation has made actual banks less risky, their risks have really just been transferred to somewhere else in the system. With trading turnover having declined by 35% in the investment grade bond market as shown in Exhibit 1, and 55% in the High Yield market since 2005, financial regulators have ample cause to wonder if the phrase “run on the bank” could apply to modern day investment structures that are lightly regulated and less liquid than traditional banks. Thus, current discussions involving “SIFI” designation – “Strategically Important Financial Institutions” are being hotly contested by those that may be just that. Not “too big to fail” but “too important to neglect” could be the market’s future mantra. Down the street from PIMCO, I must openly acknowledge that helping to turn Janus into one of these “too important” companies is one of my objectives, as it is for CEO Dick Weil. But that day lies ahead of us. For now, regulators and thus large institutional asset managers are at least contemplating an inability to respond to potential outflows. Just last week Goldman Sachs’ Gary Cohn cleverly suggested that liquidity is always available at “a price”. True enough in most cases, except perhaps for 1987 when stock markets declined 25% in one day as the vaunted portfolio insurance scheme met its maker due to sellers all rushing to the exit at the same time. Aside from the obvious drop in trading volumes shown above, the obvious risk – perhaps better labeled the “liquidity illusion” – is that all investors cannot fit through a narrow exit at the same time. But shadow banking structures – unlike cash securities – require counterparty relationships that require more and more margin if prices should decline. That is why PIMCO’s safe haven claim of their use of derivatives is so counterintuitive. While private equity and hedge funds have built-in “gates” to prevent an overnight exit, mutual funds and ETFs do not. That an ETF can satisfy redemption with underlying bonds or shares, only raises the nightmare possibility of a disillusioned and uninformed public throwing in the towel once again after they receive thousands of individual odd lot pieces under such circumstances. But even in milder “left tail scenarios” it is price that makes the difference to mutual fund and ETF holders alike, and when liquidity is scarce, prices usually go down not up, given a Minsky moment. Long used to the inevitability of capital gains, investors and markets have not been tested during a stretch of time when prices go down and policymakers’ hands are tied to perform their historical function of buyer of last resort. It’s then that liquidity will be tested. And what might precipitate such a “run on the shadow banks”? A central bank mistake leading to lower bond prices and a stronger dollar. Greece, and if so, the inevitable aftermath of default/restructuring leading to additional concerns for Eurozone peripherals. China – “a riddle wrapped in a mystery, inside an enigma”. It is the “mystery meat” of economic sandwiches – you never know what’s in there. Credit has expanded more rapidly in recent years than any major economy in history, a sure warning sign. Emerging market crisis – dollar denominated debt/overinvestment/commodity orientation – take your pick of potential culprits. Geopolitical risks – too numerous to mention and too sensitive to print. A butterfly’s wing – chaos theory suggests that a small change in “non-linear systems” could result in large changes elsewhere. Call this kooky, but in a levered financial system, small changes can upset the status quo. Keep that butterfly net handy. Should that moment occur, a cold rather than a hot shower may be an investor’s reward and the view will be something less that “gorgeous”. So what to do? Hold an appropriate amount of cash so that panic selling for you is off the table. A wise investor from nearly a century ago – Bernard Baruch – counseled to “sell to the sleeping point”. Mimic Mr. Baruch and have a good night.