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  • A Simple Hedging System with Time Exit
    This post is a follow-up to the previous one on a simple system for hedging long exposure during a market downturn. It was inspired by H. Krishnan’s book The Second Leg Down, in which he referred to an interesting research paper [1] on the power-law behaviour of the equity indices.  The paper states,We find that the distributions for ∆t ≤4 days (1560 mins) are consistent with a power-law asymptotic behavior, characterized by an exponent α≈ 3, well outside the stable Levy regime 0 < α <2. .. For time scales longer than ∆t ≈4 days, our results are consistent with slow convergence to Gaussian behavior.Basically, the paper says that the equity indices exhibit fatter tails in shorter time frames, from 1 to 4 days. We apply this idea to our breakout system.  We’d like to see whether the 4-day rule manifests itself in this simple strategy. To do so, we use the same entry rule as before, but with a different exit rule.   The entry and exit rules are as follows,Short at the close when Close of today < lowest Close of the last 10 daysCover at the close T days after entry (T=1,2,... 10)The system was backtested on SPY from 1993 to the present. Graph below shows the average trade PnL as a function of number of days in the trade,[caption id="attachment_350" align="aligncenter" width="485"] Average trade PnL vs. days in trade[/caption]We observe that if we exit this trade within 4 days of entry, the average loss (i.e. the cost of hedging) is in the range of -0.2% to -0.4%, i.e. an average of -0.29% per trade. From day 5, the loss becomes much larger (more than double), in the range of -0.6% to -0.85%. The smaller average loss incurred during the first 4 days might be a result of the fat-tail behaviour.This test shows that there is some evidence that the scaling behaviour demonstrated in Ref [1] still holds true today, and it manifested itself in this system.  More rigorous research should be conducted to confirm this. References[1] Gopikrishnan P, Plerou V, Nunes Amaral  LA, Meyer M, Stanley HE, Scaling of the distribution of fluctuations of financial market indices, Phys Rev E, 60, 5305 (1999).Read Full Article Here: A Simple Hedging System with Time Exit
  • Historical Default Rates Do Not Predict Future Defaults
    Yesterday, Bloomberg published an article arguing that the current credit risk is low because the default rate is low,Insulated by cheap money from the QE era and bolstered by cash on their balance sheets, it remains rare for companies in Europe and the U.S. to miss debt payments. Among higher-risk speculative-grade firms the default rate fell to 2.9 percent last quarter, and may drop further to 2.1 percent by year-end, according to Moody’s Investors Service. And only one investment-grade firm has defaulted since 2012, data from Standard & Poor’s Global Ratings show.“Default rates are on the floor,” said Fraser Lundie, co-head of credit at Hermes Investment Management. “Fundamentals still broadly stack up.” Read moreHowever, note that the default rate they talked about is historical default rate. It does not predict future defaults. In fact, historical default rate to future probability of default is what historical volatility to implied volatility. Just because the recent historical volatility is low it does not mean that the volatility risk is low. This applies to the credit market too.  But default rates aren’t the only thing credit investors care about. Spreads have widened to levels not seen for more than a year as concerns grow of overheating in the U.S. market, trade disputes, rising rates, inflation and the end of the European Central Bank’s bond-buying program.… The credit market may also be downplaying the potential impact of tariffs, analysts at UBS Group AG wrote in a July 24 report. They say investors should be cautious about sectors including tech, industrials, metals and mining. Higher corporate leverage may also lead to an increase in stress among non-cyclical industries such as consumer staples and healthcare, the analysts including Bhanu Baweja wrote.…The end of loose monetary policies may also boost defaults in emerging markets next year, according to Abdul Kadir Hussain, the head of fixed income at Arqaam Capital, a Dubai-based investment bank.ByMarketNews
  • Are Collateralized Loan Obligations the New Debt Bombs?
    Last year, in a post entitled Credit Derivatives-Is This Time Different we wrote about credit derivatives and their potential impact on the markets. Since then, they have started attracting more and more attention. For example, Bloomberg recently reported that collateralized loan obligations (CLO), a type of complex credit derivatives, are becoming a favorite financing vehicle for corporate America....Investors haven’t been able to get enough of the repackaged corporate loans known as collateralized loan obligations. That intense demand, is allowing the managers that put these securities together to sell off pieces of CLOs that by law they previously had to hang on to. These sales are the crest of what could be a $7 billion wave of such deals. Read moreAs reported by the Washington Post, money raised from these CLOs is used to finance corporate stock buybacks and dividend payouts.The most significant and troubling aspect of this buyback boom, however, is that despite record corporate profits and cash flow, at least a third of the shares are being repurchased with borrowed money, bringing the corporate debt to an all-time high, not only in an absolute sense but also in relation to profits, assets and the overall size of the economy.In recent years, moreover, a greater part of corporate borrowing has come in the form of bank loans that are quickly packaged into securities known as CLOs, or collateralized loan obligations, which are sliced and diced and sold off to sophisticated investors just as home loans were during the mortgage bubble. Bloomberg News recently reported that pension funds and insurance companies, particularly those in Japan, can’t get enough of the CLOs because of the higher yields that they offer. Wells Fargo estimates that a record $150 billion will be issued this year, roughly double last year’s issuance. And as happened with the late-cycle home mortgages in 2007 and 2008, analysts are noticing a marked decline in the quality of loans in the CLO packages, with three-quarters of them now without the standard covenants designed to reduce the chance of default. Read moreBut how risky are these collateralized loan obligations?In the current market environment, it’s difficult to evaluate the riskiness of these CLOs. First of all, Value at Risk (VaR), a popular risk measure used by many financial institutions to quantify the risks and manage economic capital, has been developed and tested in a low-interest rate and low-volatility environment. This makes the VaR  vulnerable to future change in the market environment.Second, in the calculation of VaR for a credit derivative portfolio, we would have to determine the probabilities of default (PD) and loss given default (LGD) of the borrowers. Both of these quantities are difficult to estimate. Furthermore, the correlation between PD and LGD is not constant and will likely increase during a market stress.All of these factors make the VaR less accurate.  Consequently, managing the risks of a CLO portfolio is a non-trivial task. A slight change in the market environment can lead to damaging consequences.Post Source Here: Are Collateralized Loan Obligations the New Debt Bombs?
  • It’s Time for Contrarians to Get Bullish on Gold (GOAU)
    Gold can’t seem to catch a break. The yellow metal normally acts as a safe haven in times of political and economic strife, but in the face of Turkey’s lira meltdown, investors have taken cover instead in the U.S. dollar.… Read more ›
  • The Aerospace & Defense Sector Is Hotter Than Ever (ITA)
    From Zacks: President Trump has finally signed the $717-billion 2019 defense spending bill into law — the largest allotted to U.S. defense. Pentagon’s base budget holds $616.9 billion, overseas contingency operations have been authorized $69 billion and nuclear weapons programs… Read more ›
  • Try This Barbell Fixed-Income Strategy (AGGY)
    From WisdomTree: Although U.S. interest rates have risen from their record-setting depths, there is no doubt that, from a historical basis, they still remain rather low. Against this backdrop, I am asked on a regular basis: What’s a prudent strategy that fixed… Read more ›
  • Bearish Gold Sentiment Presents Long-Term Buying Opportunity (GLD)
    From Streetwise Reports: In his weekly precious metals market update, technical analyst Jack Chan charts the latest moves in the gold and silver markets. Our proprietary cycle indicator is down. The gold sector is on a long-term buy signal. Long-term… Read more ›
  • Emerging Markets Hurting Amid U.S. Dollar’s Rebound (EEM)
    From Adem Tumerkan: Since March – the dollar’s rallied over 7%. And it’s caused the Emerging Markets to implode. But the bigger problem is what lies ahead. And that’s a global dollar shortage – which the mainstream continues to ignore. . . I’ve… Read more ›
  • What Message Are Commodities Sending To The Markets? (DBC)
    From Chris Kimble: Commodities are becoming a hot topic… and an important investing theme. With the US Dollar coming back to life, commodities have pulled back. And that pullback now has the “equal weight” complex in trouble. Below is a chart… Read more ›
  • Examining The Treasury’s New 2-Month T-Bill
    From Invesco: A new 2-month Treasury bill (T-bill) will launch in October, according to details announced by the Treasury on Aug. 1. The new T-bill will share a schedule with the 1-month T-bill, which is currently auctioned on Tuesday and… Read more ›
  • Malaysian central bank liberalises FX policy
  • Global equity market shrinks as buybacks surge
    Repurchases outstrip new issuance by most in more than two decades
  • Gold on track for worst week in 15 months
  • Asia stocks rise on easing US-China trade tensions
  • Fast Asia Open: Malaysia GDP, Singapore exports
  • IEX-LTSE listings partnership in doubt
  • US-China trade hopes help risk appetite recover
    S&P 500 back in sight of record high; Turkish lira extends recovery
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