Ron Surz from PPCA Inc. claims he has created a superior set of indices for benchmarking and evaluating money managers. His approach draws on the insights of a Nobel Prize winner.
Professor William Sharpe, awarded the Nobel Prize in 1990 for developing the Capital Asset Pricing Model, established the groundwork for returns-based style analysis in a 1992 paper. This technique involves examining a fund’s returns by regressing it against various indexes to unveil the factors influencing performance. Essentially, it allows for a quick and fairly accurate examination of a portfolio to understand its underlying dynamics.
For instance, conducting a returns-based style analysis on an actively managed large-cap U.S. stock fund may reveal that the fund’s outperformance is largely attributed to significant investments in small-cap companies. While this is not inherently negative, it could lead to confusion—or even frustration—among investors if they believed they were investing in a large-cap strategy while the reality involved a focus on small-cap equities. In this case, a small-cap index might serve as a more fitting benchmark for the fund, altering the perceived effectiveness of the large-cap manager’s track record.
This scenario illustrates the complexities of evaluating managers. Striving for accurate comparisons poses challenges for analysts, who continuously seek to differentiate genuine alpha from mere beta. This task is often difficult, as talent is hard to define and can be obscured when relying solely on numerical performance metrics. Analyzing past results does not guarantee that manager A possesses superior skills compared to manager B. However, while past performance can provide insights, relying exclusively on historical data can only go so far when predicting future success.
Some experts argue that identifying genuine talent necessitates scrutinizing a portfolio’s holdings meticulously over time. However, a holdings-based analysis is often impractical due to the infrequency and potential outdated nature of managers’ reports. In some cases, particularly with hedge funds, it may be impossible to ascertain the portfolio’s contents, further complicating timely analysis.
Sometimes, a picture is indeed worth a thousand words. However, whether it can also serve as a predictor of future trends remains debatable. With this context in mind, we present a chart showcasing last week’s returns for various asset classes. It’s crucial to observe that the previously soaring returns associated with risk have recently reversed. Over the long term, risk can yield substantial rewards, but the question that looms is how steep the price for short-term gains may be.
Indices/Funds: MSCI EM ($), Russell 2000, MSCI EAFE ($), DJ REIT, S&P 500, DJ-AIG Commodity, ML HY Master II, Pimco EM Bond Fund ($), Lehman Bros. Aggregate, Pimco Foreign Bond ($)
Gold has reached record highs—it’s malleable and its value continues to surge.
An ounce of gold was recently valued above $725, marking a 40% increase this year and doubling its price from three years ago. The precious metal is experiencing its most robust bull market in twenty-five years.
The prevailing assumption about gold’s ascent points to inflation fears driving demand. Historically, gold has demonstrated its effectiveness as a hedge against inflation, and its thousands of years of pricing history are not easily overlooked. Yet, one dedicated gold proponent attributes the rising price to other factors. Bill Murphy, a former commodities trader and chairman of the Gold Anti-Trust Action Committee (GATA), asserts that the unwinding of the so-called gold cartel, which artificially suppressed gold prices for the last decade, significantly contributes to its current surge.
While some consider Murphy and GATA to be extremists—even among gold enthusiasts—GATA makes strong claims regarding a conspiracy involving the government and Wall Street, alleging that the Federal Reserve and major banks have manipulated gold prices for years. Despite the controversial nature of these assertions, the increasing attention GATA receives suggests that their theories are starting to gain credibility, as evidenced by a gold report published recently by the European bank Cheuvreux referencing GATA’s research.
The Capital Spectator spoke with Murphy by phone to delve deeper into his views. Given the current highs in gold prices, we deemed it timely to engage with one of the most ardent advocates of gold. Murphy even suggests that gold could rally to as much as $3,000 or more, a notion that isn’t entirely far-fetched given recent price movements.
Nevertheless, we cannot confirm Murphy’s claims, but considering current gold price dynamics, we remain open to various possibilities.
WHAT IS FUELING THE GOLD BULL MARKET TODAY?
There appears to be a massive short squeeze underway.
HOW SO?
The gold cartel—comprising the U.S. government, some other central banks, and bullion banks like Goldman Sachs and J.P. Morgan Chase—manipulated gold prices since the mid-1990s. This began under [former Treasury Secretary] Robert Rubin and the strong dollar policy. Several major banks secretly borrowed gold from central banks and sold it in the market, which contributed to keeping prices low. This allowed bullion banks to earn profits by trading within a controlled market, negatively impacting speculative investors who remained unaware of the ongoing manipulation.
The Federal Reserve’s announcement yesterday regarding interest rates seemed designed to leave the market in suspense, and the central bank certainly succeeded.
On that day, the bond market remained relatively unaffected, with sentiment swinging between bullish and bearish. In the end, the 10-year yield remained steady at 5.125% when markets closed on Wednesday.
Ultimately, it was reasonable to adopt a nonchalant attitude toward the Fed’s advisory. A key statement from the FOMC was: “The Committee recognizes that further policy tightening may still be necessary to address inflation risks, but emphasizes that the degree and timing of any such adjustments will heavily depend on the economic outlook as indicated by incoming information.”
This phrase represents a subtle shift from the March statement, which noted that “further policy adjustments could be necessary to maintain a balance between sustainable economic growth and price stability.”
Essentially, this suggests that a pause in rate hikes is highly likely during the next FOMC meeting in late June. This implies that the Fed funds rate is either at or near the challenging-to-define state of monetary neutrality. In this context, neutrality means that the Fed funds rate does not overly stimulate or hinder economic growth. The Fed appears to be indicating that this balance has been achieved, thus suggesting that any additional rate hikes may not be warranted or could even hinder the economy.
However, even in a neutral state, there are no free lunches. Increasing uncertainty surrounds the Fed’s next steps, as pointed out by Ken Kim, an economist at Stone & McCarthy Research Associates. Kim explains to CS that decision-making for the central bank has become more complex:
Now that the Fed is approaching what is considered a neutral rate, the uncertainty surrounding the stopping point for rate increases has heightened. Although they have models and forecasts, pinpointing an exact target within a quarter percent is challenging. I believe we are at neutrality. My opinion is that at the next FOMC meeting in late June, they will pause and keep the Fed funds rate at 5.0%.
The FOMC of the Federal Reserve will convene today, with widespread anticipation that interest rates will increase by 25 basis points, raising the Fed funds rate to 5.0%. This prediction has become routine, as the Fed has consistently implemented 25-basis-point increases since June 2004. Notably, the Fed funds futures contract for May is priced at 5.0%, meaning minimal surprises are expected.
What sets this meeting apart is Fed Chairman Bernanke’s recent suggestion that a pause in rate increases might be on the horizon. However, with the ensuing debate over Bernanke’s inflation-fighting capabilities, some are left questioning whether he might reconsider this approach.
Currently, there hangs an atmosphere of uncertainty over the Fed’s policy direction, a sentiment not commonly observed in recent times. This ambiguity may stem from the conflicting signals arising from the economy and capital markets regarding the extent of GDP slowdown. Regardless of its origin, the usual transparency associated with the Fed appears to have diminished. Previously predictable, Bernanke’s academic stance on transparency is now more challenged as he navigates his role overseeing monetary policy. This volatility in expectations may not align with what the Fed desires—but it could be a welcome development for market participants.
Interestingly, in a recent confession, Bernanke noted in March that the “implications for monetary policy of long-term yield movements are not at all straightforward.” Given the current puzzling context of Fed policy, this is a cautionary note no one can dismiss.
Saudi Arabia is exuding optimism. Their Minister of Petroleum and Mineral Resources, Ali al-Naimi, recently stated, “The world has at least 14 trillion barrels of reserves,” according to a transcript of a conference hosted by the Center for Strategic & International Studies in Washington. How significant is 14 trillion barrels? That figure is roughly three and a half times higher than previous peak estimates in a 2000 study published by the Energy Information Administration.
Meanwhile, a recent article from the Reason Foundation cites industry journal World Oil’s data on proven oil reserves—defined as recoverable oil available under current economic and business conditions—to be around 1.1 trillion barrels. BP’s estimate stands at 1.2 trillion, while the Oil and Gas Journal notes it at 1.3 trillion. Additionally, the Reason article mentions that IHS Energy consultancy estimated recoverable reserves, excluding unconventional sources like heavy oil or tar sands, to be between 1.3 trillion and 2.4 trillion barrels.
Although sharp differences exist in estimates, they typically fall below Minister Al-Naimi’s ambitious 14 trillion-barrel claim. Some discrepancies may arise from the definitions of “recoverable” reserves versus total remaining reserves considered uneconomical. Nonetheless, Al-Naimi’s optimism seems rooted in technological advancements, stating, “With advancements in technology, I believe we can recover more of the 14 trillion.”
The stakes surrounding these estimates are enormous, particularly given Saudi Arabia’s position as the leading oil producer globally and holder of the largest reserves. Matthew Simmons, Chairman and CEO of Simmons & Co., ignited intense discussion regarding Saudi reserves in his 2005 book, Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, questioning the country’s ability to increase future oil production.
However, the Kingdom remains confident. “We are undertaking an extensive investment program to elevate our production capacity to 12.5 million barrels per day by 2009, with potential for even greater output should market conditions dictate,” the minister assured during the CSIS conference. “This expansion will make a substantial contribution to meeting the increasing global energy demand.” If realized, this would represent a roughly 14% increase over Saudi Arabia’s production levels in March, according to EIA data.
While greed and fear often govern oil prices, when it comes to Saudi estimates of oil reserves, optimism is the underlying currency. The pressing question remains: is this optimism justified or merely overblown?
It was the best of times, it was the worst of times—much like the sentiment surrounding the economy and investment prospects.
Numerous concerns exist that could destabilize the status quo, yet there are also several counterbalancing forces that may delay pessimistic predictions. Monitoring this tug-of-war provides fertile ground for the discerning investor.
On the side of optimism, bullish sentiments are emerging from the stock market, which remains a key barometer of investor outlook. Equity traders seem buoyed by positive momentum, particularly following Friday’s session when the S&P 500 reached its highest level since early 2001. The 1% rise on May 5 reflects a notable increase. Although the stock market is not infallible, the consistent rise in equity prices over recent years raises questions regarding its sustainability and credibility during this cycle.
The train kept a-rollin’, all night long,
With a heave, and a ho,
Well I just couldn’t let her go.
–The Yardbirds
Risk is often heralded as a path to reward. While there are exceptions to this adage, the current environment offers ample evidence of its validity.
As illustrated in the chart below, risk has recently translated into substantial returns across various asset classes. This observation inspires celebration for investors who have maintained bullish positions. However, this situation also invites scrutiny regarding future allocation strategies. Does this chart depict a bull market that remains strong, or should it raise concerns?
Among the asset classes surveyed, emerging markets stocks stand out as the top performer this year and over the past three years. Equities, in general, alongside a diverse mix of commodities, continue to dominate the upper tier of performance rankings, while bonds—typically seen as less risky investments—have lagged behind. This trend holds true for both year-to-date and trailing 36-month returns as of May 2.
Indices/Funds: MSCI EM ($), Russell 2000, MSCI EAFE ($), MSCI REIT, S&P 500, DJ-AIG Commodity, ML HY Master II, 3-mo T-bill, Pimco EM Bond Fund ($), Lehman Bros. Aggregate, Pimco Foreign Bond ($), Vanguard Infl Prot Sec
Year-to-date, emerging markets stocks have surged, with the MSCI Emerging Markets equity benchmark achieving an annualized return of 42% when calculated in dollars. By any metric, American investors are enjoying an extraordinary level of returns over a brief time frame. Even the commodities sector, although performing strongly, has not kept pace with emerging markets stocks on a dollar-return basis.
There’s an increasing consensus that the economy is set to slow later in the year; however, recent economic reports have not aligned with this outlook. Could the forecasters be misjudging the situation, or are they simply jumping the gun?
Recent reports highlighting stronger-than-anticipated factory orders and service sector performance stack up against the prevailing narrative of economic slowdown.
Nonetheless, the Federal Reserve maintains its expectation of moderate economic cooling, prompting Chairman Ben Bernanke’s recent indication that a pause in interest rate hikes could be imminent.
This strategy aims to avert a recession, but the question arises: does halting monetary tightening risk solidifying inflation’s presence in the economy?
To delve deeper into this issue, we consulted Paul Kasriel, director of economic research at Northern Trust. In our conversation, Kasriel shared his belief that the economy is indeed on a moderating path.
WHAT IS YOUR PERSPECTIVE ON FED POLICY AT THIS TIME?
“The Fed is pursuing a restrictive monetary policy—not necessarily one that will induce recession. However, I believe a monetary constraint has already been established, which will lead us to a lower trend in economic growth. Although the first quarter grew year-over-year by 3.5%, I expect a gradual deceleration in growth throughout the year.”
WHAT EVIDENCE SUPPORTS YOUR VIEW?
“Leading indicators provide substantial support for this outlook.
FOR EXAMPLE?
“I am still among those who closely monitor the money supply, which indicates a significant deceleration in the price-adjusted M2 money supply. Though there has been some widening in the spread between the 10-year Treasury and the Fed funds rate, the long-term trend of that spread has declined noticeably.
Additionally, the housing market has historically been a leading sector of the economy. Year-over-year figures showcase a clear slowdown in housing activity, with both new and existing home sales declining, while housing prices are stabilizing.
Moreover, automobile sales have not shown growth, with three consecutive months of consistent sales around 16.5 million units, indicating a broader economic slowdown.
Pimco’s Bill Gross is frank in his assessment of the current investment landscape in his May commentary found here. Reflecting on previous predictions, he acknowledges that he has been mistaken before—specifically regarding the Fed’s trajectory of interest rates. Yet he continues to make bold predictions:
“Higher inflation, increasing personal and corporate taxes, and a weakened dollar are steering U.S. and global investors away from U.S. assets in favor of more competitive economies that are less encumbered by pension and health liabilities; those characterized by higher savings rates and investment as a percentage of GDP,” elaborated Gross, who manages the largest bond fund worldwide. He doesn’t hold back, advising, “Investors should consider selling U.S. assets and transitioning to Asian markets to be denominated in local currencies; or at the very least, engage a global asset manager capable of navigating this increasingly challenging investment landscape.”
Criticizing the U.S. investment outlook isn’t new, having been a popular sentiment in recent years—though it hasn’t proven overwhelmingly effective in terms of returns. Indeed, global investors have largely overlooked broader macroeconomic concerns and instead focused on tactical opportunities, a strategy that has paid off, particularly in the equity markets.
For example, those who embraced a bullish stance and invested in the S&P 500 Spider ETF in early 2003 have enjoyed impressive returns, boasting an annualized return of 14.11% over the past three years, according to Morningstar data. This far exceeds the long-term performance of the S&P 500 and likely surpasses conservative expectations for future growth.
Conversely, the same cannot be said for bonds. The Vanguard Total Bond Market Index fund, which tracks the Lehman Aggregate Bond Index, has struggled over the past three years, achieving an annualized return of only 2.43%—approximately half the yield of the 10-year Treasury.