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Wednesday, October 26, 2011

Is Pure Expectations Hypothesis useful?

Does Pure Expectations Hypothesis provide good estimates of future rates?

Does PEH matter?

Most finance students at one point or another have the Pure Expectations Hypothesis. The professor will show term structure data, and then say something like…

“If PEH holds (big if) we can use today’s data to calculate what the market expectations are for next year’s rates. “

How good are these predictions?

Based on 2010’s daily term structure data, I calculated the PEH expectations for 2011. Take a look for yourself. The chart below shows the prediction and the real outcome.

Will they come closer?

Friday, October 21, 2011

Soccer and Efficient Market Hypothesis

I always enjoy showing my students live examples of how EMH works in reality. I usually use an online earnings call while looking at the stock prices, tick by tick. This week for instance, I shared the afterhours drop in the price of Apple after their earnings miss. Students are generally impressed by this market wisdom and by how quickly prices incorporate information.

But every now and there are some situations that leave me speechless.

Coincidentally this week I witness one such moment. Please bear with me.

My favorite Chilean soccer club: Universidad de Chile (not related to any university), like many others in Chile is a publicly traded company trading under the mnemonic AZUL AZUL. Yes, imagine the Patriots, Cowboys, Sox and Yankees trading in the NYSE.

My team’s share price went up this Friday. A lot! It went up so much that the bourse had to stop trading when it had literally doubled in value.  After trading was re-started it settled for a67% gain. This on top of a 28% gain on Thursday.

The reason? On Wednesday the team had a superlative performance (4-0) against Flamengo a Brazilian team in a South-American tournament.

You can watch the beautiful 4th goal here.

I am buying some AZUL AZUL!!!

Is the Nikkei that bad?

Japanese stocks have performed badly since, ... well since what seems forever. Looking from a long term buy-and-hope strategy, had you invested in the NIKKEI in 1984 your returns would be around nada. No matter how much we complain about our financial markets and their crises, had you invested in the S&P500 you would be sitting in a 600-700% return.

 From a shorter term perspective, say after the dotcom bubble, results are similar. Japanese stocks underperform US equities. Does this mean that investors should avoid Japanese stocks? Not really. Look in the same chart how the JPY/USD is doing.

Oversimplifying calculations, and assuming that an American investor put 10,000 USD (around 1,333,333 JPY) in the Nikkei in 2002, he/she would be sitting on a20%equity loss. Today he/she would only have 1,066,666 JPY, which at the current exchange rate (75 JPY/USD) would be 14,222USD…

I don’t know about you… but I would take it.

Is the Nikkei that bad? Not if you are an American.

Wednesday, October 12, 2011

Slovakia and the Kentucky Derby

Slovakia and the Kentucky Derby.

An old mentor of mine once told me... "Son... you don't put a mule in the Kentucky Derby"

At first, I thought the old man was funny but crazy. In time, I have learnt to appreciate those words of wisdom.

In fact it is exactly what Slovakia is arguing in their resistance to approve a bailout package for Greece.

Why help a country that is broke? Why throw good money after bad?
I totally agree with them

That is not the whole story, there are two moral issues that needs to be explored.

1) Should one of the poorest countries in the EU have to pay for the rescue of a richer one? Should Slovakia, a model of good governance and responsibility have to pay for the irresponsibility and corruption of Greece?

2)  According to the EU budget, between 2007 and 2013, Slovakia will receive 11 billion Euros in net transfers, or 2,039 Euros per capita. Greece... they will receive 25 billion (2,238 per capita). Should Slovakia have the right to renege on this?

Sunday, October 9, 2011

What is ahead?

According to intrade here is what to expect for 2012

Romney to be the Republican Candidate (62% chance), and the DOW below 12,000 (60% chance).
Republicans will control the senate (67% chance) with a 50% chance of going into recession


... and the winner is...

Just a few more hours to find out who will be the next Nobel Prize in Economics. The WSJ has an article showing various candidates...

I have mine:
Richard Thaler.
One of the founding fathers of behavioural economics. Yes, that "science" that questions the omnipresence of the EMH.

His work is vital, well understood by the lay person, mostly ignored by others. The best part is that he has not written a book or article about the crisis.

Betting against France

James Mackinstosh from the Financial Times has a great article on a strategy many hedge funds seem to be taking.

Long Italy - short France... and not because Italy is better shape... No way... The point is simply the spreads

According to the spreads (against the Deutsche Bund) here is how closely they stack (in basis points)

Italy 350

France 70

Is Italy really 5 times riskier than France?
So something is got to give. F
a) Things get bad, ECB intervenes to stop a run on Italy, France gets infected increasing its spread to level it to that of Italy, or
b) Things get better, Italy's spread goes down to match France's
There is always c) ECB dumps the PIIGS (Italy included) and let everybody fend for him/herself...

Just for the fun here is where the PIGS stand

Portugal 995

Ireland 575

Greece 2,227

Spain 298

And Belgium, courtesy of Dexia 195

To me, it seems like these spreads are priced as if there was no correlation between debtors, just as the CDOs were before 2008. The problem is that given that one country goes belly up, the probability of the next one going under is much higher.

Friday, October 7, 2011

Reshoring and the CNY

In a great piece at the HBR blog, Hal Sirkin from the BCG argues that increasing productivity in the US and increasing labor costs in China are making some US companies reshore their operations back the US.

Further, an article by Peter Marsh from the FT explains how US consumers and companies are beginning to value the "Made in the USA" noting that the cost advantage is not that great.

Brazil's Embraer chose Florida, while Germany's Volkswagen chose Tennessee. American workers are up to 3 times more productive than their Chinese counterparts...

According to Mr. Sirkin, up to 3 million re-shoring jobs could be created by 2020

Can you imagine how many more would be created with a 20% revaluation of the CNY?