Autocorrelation for Rolling 36 Month Intervals Suggests Risk Underestimation

My analysis today suggests that it seems that we have a lot more autocorrelation between asset class returns than what meets the eye. The past period’s return should not determine the next period’s return for they need to be independent and identically distributed. Therefore, relying on conventional historical correlation and volatility assumptions for asset allocation is less than optimal now.

September 2020: Retail Sales Growth Slowing

“August retail sales rose by 0.6% relative to July, marking the slowest monthly increase since April. Sales in sectors such as groceries and online retailers were boosted by stay-at-home restrictions and are above pre-pandemic levels. By contrast, while sales in restaurants and bars rose a strong 4.7% last month, reflecting a gradual resumption of their activities, they remained below levels seen in February. This suggests that the services sector is still under pressure from social distancing behavior. On a year-over-year basis, retail sales are up by 2.6%, but momentum slowed in August, coinciding with the expiration of the $600 extra weekly unemployment payments. Services spending will likely remain depressed until we see the widespread distribution of a vaccine. This should contribute to a general slowing of the economic recovery.”

Deals Resume in Sale of Risky Loan Funds

1- clo investors hit brakes

“Deals Resume in Sale of Risky Loan Funds” The WSJ, Tuesday June 30, 2020, B9.

CLO sales cross $34 billion YTD, $5 billion in June alone as investors re-enter the risky loans market. The Fed’s corporate debt buying program is catalyzing U.S. investor appetite seeking higher spreads ( AAA at LIBOR+1.65) , even as Japanese institutional investors curtail risk taking and have been pulling back.

In 2020 CLO investors need to be especially hands-on to understand the origination processes, servicers, borrowers and quality of underlying collateral. Quality and performance of the underlying collateral is worsening materially more than expected, suggesting that the underwriting process did not consider severity of coronacrisis induced slowdown. In many cases originators had created loans primarily for sale and retained little, if any, interest in ongoing performance. Investors also need to get more deeply involved in the information cycle where excessive reliance on lagging ratings doesn’t help. In the 2008 global financial crisis default and delinquency data was artificially low because of extend and pretend and refinancing. Reliance on historical performance data and statistical models and stress test is insufficient. Investors need to manage the risk that their models are becoming irrelevant to changing conditions in the underlying loans space.

Debt From American Companies Lures Asian, European Investors

Wall Street Journal, June 29, B1 article “Debt From American Companies Lures Asian, European Investors”.

U.S. corporate debt  now much riskier as default rates rise, but Asian and European investor demand is very high. Fed backstop expectations prompts switch from holding low yielding treasuries to higher yielding corporate debt.

1-corporate debt

Comparing Share Buybacks to Dividends in 2020

Response to WSJ, Monday, June 8, 2020, ” Why Many People Misunderstand Dividends, And the Damage This Does”

We agree and opine that with earnings and therefore dividends  to remain low, companies should reduce outstanding shares to increase per share price through share buybacks. They ought to return value to shareholders through buybacks rather than dividends and provide investors the option to benefit from continued appreciation and defer taxes by selling shares at later date. We compare and highlight the benefits here.

1- Comparing Dividends to Share Buyback

Positive Reaction to Share Buybacks

3-positive reaction to share repurchase

Direct relationship between share repurchase size and excess returns at announcement. Multiple re-purchasers benefit more from large repurchase announcements. Smaller buyback announcements tend to be anticipated and partially priced in. Market reaction to buyback announcements is the uncertainty about whether the buyback will be executed. Larger repurchase correlated with greater abnormal return.

Major Financial Centers Widely Differ in Breadth of Activity

7-Breadth of Activity

The coronacrisis may well be a  watershed moment – both business mix and key players are likely to change. Development strategies will involve regional and global positioning for flow and advisory business; developing new products and market capabilities as well as going offshore. Meanwhile exchanges further consolidate faster than ever before as the world gets even more networked.