Tagged: Treasuries

Risk-Free Return

Everybody is talking about the weather. Why doesn’t somebody do something?

This witticism on human futility is often attributed to Mark Twain but traces to Twain’s friend and collaborator Charles Dudley Warner. A century later, it’s still funny.

There’s a lot of hand-wringing going on about interest rates, which from the IR chair may seem irrelevant until you consider that your equity cost of capital cannot be calculated without knowing the risk-free rate.

That and a piece in Institutional Investor Magazine some weeks back brought to my view by alert reader Pam Murphy got me thinking about how investors are behaving – which hits closer to investor-relations than anything.

When I say hands are wrung about rates, I mean will they go up? We’ve not had normalized costs of capital since…hm, good question. Go to treasurydirect.gov and check rates for I-Bonds, the federal-government savings coupon. I-Bonds pay a combination of a fixed rate plus an inflation adjustment. Guess what the fixed rate is? 0.00%. The inflation-adjusted return May-Oct 2013 is 1.18%.EE-Bonds with no inflation adjustment yield 0.20% annually. This is a 20-year maturity instrument. Prior to 1995, these bonds averaged ten-year maturities and never paid less than 4% annually, often over 7%. If the I-Bond pegs inflation at 1.18% every six months, translating to 2.36% annually, is the risk-free rate of return a -2.16%? (more…)

High Correlation in Stocks

While Irene splashed Wall Street, we Coloradans reveled in the ridden glory of the USA Pro Cycling Challenge. The 500-mile route hosted 130 of the world’s top cyclists including Tour de France winner Cadel Evans and both runners-up, Luxembourgers Andy and Frank Schleck.

We were there, clanging bells and hooting our hearts out. Here is winner Levi Leipheimer readying for the time trial that put him in yellow. The peloton left Avon here for Steamboat, and Levi is visible midway in yellow. At the finish, some 250,000 jammed downtown Denver for the epic, lapping conclusion. We are proud of American cycling and our state’s awesome organizational effort.

Speaking of peloton, Wall Street Journal reporter John Jannarone wrote Monday in the Heard column called “Traders Seek Salvation from Correlation” about how stocks race in formation. It’s among the best pieces we’ve seen on modern trading. Jannarone says that S&P 500 stocks show 80% correlation in the past month, meaning eight in ten move synchronously.

This is a source of distress for IR folks trying to distinguish a strong company story from the herd. We’d argue that rather than slamming the collective IR noggin into the burgeoning brick wall of macro-focus investing that you instead track program trading and establish what level is acceptable – and use it as an IR success measure. We wrote about this last week, so we won’t retrace the trodden path.

Why a mirror image across so much of the market? One driver Jannarone posits is Exchange-Traded Fund investing. According to Credit Suisse, these drive some 30% of daily stock volume. Jannarone also notes that trading in S&P 500 E-mini futures contracts is more than four times the combined daily volume of the two biggest S&P 500 ETFs, the SPDR, and iShares S&P 500 Index ETF. (more…)

Don’t Roller-skate in Buffalo Herds

Karen and I caught the PBR rodeo at Denver’s National Western Stock Show. I grew up on a ranch and Karen likes four-footed creatures. So we support cowboys and their furry fellow athletes. Those bull riders are tough guys, but what got me thinking was the team-penning competition.

It reminds me of the challenge IR folks face. We’re in the middle of earnings, with options expiring Wednesday through Friday and capital moving like a herd loping from one corner of the corral to the other while riders try to cut one here and there.

In team-penning, that’s what you do. You’ve got three folks on smart horses and a herd of calves with numbers on them, and a clock. Tom Bailey, founder of Denver’s Janus Capital, is in the sport. The announcer might say, “Four, four, four,” and the team of riders tries to cut three calves with the number four on them from the herd and pen them at the other end of the arena in about 45 seconds. If one of the herd that shouldn’t be cut gets by, you’re disqualified.

The hardest part is getting the few away from the many. Calves don’t want to leave the herd. It’s like stocks (aptly named). There’s a great herd of equities. If investors are cowboys and cowgirls on horses trying to cut the few from the many, it’s a tall task. The herd sways the behavior of the ones they want to single out.

When the herd is rattled and scattered, it’s nearly impossible to get the three you want without mixing in others you don’t want and getting disqualified. One thing that can scatter and rattle the entire equity herd is options expirations. This week, these include the VIX and RVX volatility measures Jan 19, stock and index options with morning expirations (often favored by European and Asian structured products) Thursday Jan 20; and the whole kit and caboodle Friday from stock and index puts and calls, to treasury, bond, currency and interest-rate derivatives. (more…)