Archive for Most Recent Stories – Page 2

Rail Traffic Just Keeps on Chugging

The latest trends in rail traffic showed more of the same that we’ve been seeing for the last few months.  Interestingly, despite the Ebola scare and the brief Europe shock, there was no substantive change in rail trends.

The latest weekly reading came in at 3% which is just below the 12 week moving average of 4.3%.  That’s down marginally over the last few months, but still a strong reading in the grand scheme of things.  Via AAR:

“WASHINGTON, D.C. – Oct. 23, 2014 – The Association of American Railroads (AAR) today reported increased U.S. rail traffic for the week ending Oct. 18, 2014 with 297,130 total carloads, up 2.7 percent compared with the same week last year. Total U.S. weekly intermodal volume was 272,554 units, up 3 percent compared with the same week last year. Total combined U.S. weekly rail traffic was 569,684 carloads and intermodal units, up 2.9 percent compared with the same week last year.”



Equity Shock Absorbers Pass October Test

By Kent Hargis and Chris Marx, AllianceBernstein

After nearly nine months of calm, equity market volatility has returned and is threatening investors with the prospect of losing money. We believe the recent episode in US and global stocks reinforces the case for having a strategic allocation to equities that can withstand shocks.

Until late September, equity markets seemed complacent. Even as global economic growth signals deteriorated and geopolitical risks escalated, volatility measures fell to their lowest levels since 2006. By October 17, implied US equity market volatility, as measured by the VIX Index, had jumped to about 10% above the long-term average. But for many investors, the jolt felt even more dramatic because markets were so tranquil earlier this year.

Diminishing the Damage

When markets are placid, it’s understandably hard for investors to think about turbulence. But in fact, theonly time to prepare for volatility is before it strikes. Those who did found that an allocation to stocks with less volatile characteristics absorbed much of the recent market shock, which led to better performance than being invested in the broader market over the year to date.

Return patterns are illuminating. From January through September, the S&P 500 Index returned 8.3%, outperforming the MSCI US Minimum Volatility Index—which focuses on stocks that have low absolute risk—by 0.9 percentage points (Display). The tables turned in October. This month, through October 17, less volatile stocks fell by just 1.8% while the broader market tumbled by 4.3%. As a result, in the year to date, lower-volatility stocks beat the broader market by a significant margin.


Similar performance patterns can be seen in global stocks. Here, the only difference is that the MSCI Global Minimum-Volatility Index also outperformed the broader market from January to September, because since the summer, non-US stocks had already been coping with concerns about growth—especially in Europe.

Focus on Quality Stocks

What’s been driving this performance? Looking beneath the surface, we find that stocks with less volatile characteristics (known as low beta) have done especially well this year. And stocks with higher quality characteristics (high dividends, strong cash flows and solid profitability) have also delivered strong returns (Display).


Both of these types of stocks are effective at capturing equity returns with less risk. But our analysis has shown that over a full market cycle, a strategy that combines both less volatile and quality stocks generated even stronger risk-adjusted returns than either approach alone. The reason is because they tend to work best at different times.

High quality stocks provide participation in bull markets, while low-volatility portfolios are much better at tempering losses in market slumps. So by combining both in a single portfolio, investors can maintain the higher return potential of a portfolio of stocks chosen simply for its high quality, while reducing risk more effectively than a simple, passive low-volatility screen.

Gaining More by Losing Less

This year could prove to be a case study in gaining more by losing less. Steadier stocks compound more of their gains than riskier stocks over full market cycles, in part because they don’t lose as much in sell-offs. Preserving capital in downturns can have a big impact on performance in the long run. By losing less in October, portfolios with lower volatility and quality stocks can recoup losses faster when market confidence returns.

Reacting to a downturn can be costly, especially given the natural tendency of people to sell low. Maintaining a proactive allocation to equities that are more stable in troubled markets allows investors to capture enough gains during market rallies while benefiting from protection in a downturn. This approach is designed to provide a smoother ride through market cycles. The best time to prepare for volatility is when it’s not there.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Kent Hargis and Chris Marx are the portfolio managers of the Low Volatility Equities services at AllianceBernstein  (NYSE:AB).

Negative Interest Rates – How’s That Working Out?

Back in June the ECB initiated a small negative interest rate on deposits held at the ECB.  Over the last 5 years we’ve repeatedly heard economists and other pundits say that Central Banks just need to reduce the demand for Excess Reserves by charging a negative interest rate and that this would surely cause inflation to increase as banks would lend out their reserves or “stop sitting” on their money (as Scott Sumner likes to say).

So, we’re almost 6 months into this policy change and what can we conclude thus far?  Well, as I stated back in June, this policy wasn’t likely to have much of an impact and in fact, the Eurozone has deteriorated since then.   Chart 1 shows the level of bank lending since the beginning of the year.  Clearly, the ECB’s negative rate policy isn’t forcing banks to “stop sitting on their money”:


Sumner also claimed that “If they did [charge a penalty] it would be easy to get inflation expectations up to 2%.”  But the rate of inflation has continued to decline since then:


Of course, the misguided thinking on this stems from the myth that banks lend their reserves in some money multiplier style fashion or that the Central Bank can control the rate of inflation directly by steering the banks to act in precise ways.  But bank lending is primarily a demand side function so supply side economics doesn’t apply to the degree that some economists seem to think.   This isn’t rocket science, but very smart people, even after all this time, continue to misunderstand the importance of bank lending and endogenous money….

Thus far, it’s pretty clear that this policy is having no discernible positive impact on either lending or the broader economy.


What This Nerd is Reading: X-CAPM – An Extrapolative Capital Asset Pricing Model

Just passing this paper along which I missed.  Noah Smith mentioned it yesterday on Twitter and it looks pretty interesting.  If any fellow nerds have thoughts feel free to use the comments…

X-CAPM: An Extrapolative Capital Asset Pricing Model

Nicholas Barberis, Robin Greenwood,
Lawrence Jin, and Andrei Shleifer

Yale University and Harvard University


Survey evidence suggests that many investors form beliefs about future stock market returns by extrapolating past returns: they expect the stock market to
perform well (poorly) in the near future if it performed well (poorly) in the recent past. Such beliefs are hard to reconcile with existing models of the aggregate stock market. We study a consumption-based asset pricing model in which some investors form beliefs about future price changes in the stock market by
extrapolating past price changes, while other investors hold fully rational beliefs. We find that the model captures many features of actual prices and returns, but is also consistent with the survey evidence on investor expectations. This suggests that the survey evidence does not need to be seen as an inconvenient obstacle to understanding the stock market; on the contrary, it is consistent with the facts about prices and returns, and may be the key to understanding them.

Read it here.

After the Beta Trade in Emerging Markets

By Sammy Suzuki and Morgan Harting, AllianceBernstein

It’s getting harder to generate equity returns in emerging markets (EMs). Simply chasing the index—the so-called beta trade—won’t do the job anymore. But with a more discriminating, active approach, we believe investors can still capture opportunities in the next phase of the EM growth evolution.

Over the past decade, turbocharged EM economic growth has coincided with turbocharged investment returns (Display). For the 10 years ended December 31, 2013, EM equities and bonds delivered respective annualized gains of 11.2% and 11.8%, far outperforming developed-market (DM) equity returns of 7.0%.


New Challenges in Changing Environment

But the era of easy index-driven equity returns is probably over. Economic growth has slowed. The credit, commodity and investment cycles have peaked. Reform efforts in many EM countries have stagnated or regressed. China’s difficult economic transition and waning appetite for commodities is taking its toll. And the gradual normalization of ultra-accommodative US monetary policies—and its resulting influence on capital flows—further clouds the outlook.

EM equity valuations have fallen with the sell-off of the past couple of years, and are currently at some of the biggest discounts to their DM peers over the past decade. But, though EM companies are more profitable today, the disparity between EM and developed-world corporate profitability is far less pronounced than it was in 2003.

Finding Great Companies

Against this backdrop, EM returns are likely to be more muted than during the previous 10 years. So should investors steer clear? We don’t think so.

Great companies exist across the developing world, even in not-so-great economies. That’s the story for South African discount-apparel retailer Mr Price Group, which has posted earnings growth of 24% a year for the past decade, despite a sluggish domestic economy.

And emerging markets are no strangers to technological innovation. Such advances are producing new leaders across a variety of industries in Taiwan, including textiles, semiconductors and key industrial components (for tech giant Apple and carmaker Tesla Motors, for example). The rise of the EM middle class is creating new sources of demand for companies as diverse as Brazilian credit-card-processing company Cielo and Chinese appliance-maker Haier. And over the past two decades, we’ve seen the rise of world-class EM companies (think Tata Consultancy Services and Hyundai Motor), with good management, strong brands and differentiated technologies.

Still the Land of Alpha Opportunity

But is there fertile ground to generate alpha, or market-beating returns, in EMs? In fact, our research shows that these markets are still far more inefficient and far richer with alpha potential than their developed-world peers. Certain equity factors, such as valuation, price momentum and balance-sheet quality, have been far more reliable drivers of excess stock returns in EMs than in advanced markets (Display).


Other tools are less effective. For example, simply investing in companies with high sales growth hasn’t been a good investing strategy in most regions around the world, and EMs are no exception to this rule. Our research also shows that focusing on a country’s economic growth potential has had little or no predictive value in helping investors pick countries or stocks within developing markets. For example, Mexico has been one of the slowest-growing EM economies for more than two decades, yet it is also home to one of the best-performing equity markets over the same period.

Game Plan for EM Investing

Beyond the metrics, to succeed in EMs, investors will need to identify companies that can most deftly navigate the new environment. Finding tomorrow’s EM winners will take rigorous research, entailing local knowledge and global industry insights—and a discriminating eye.

How best to capture the potential in EM depends on individual return requirements and risk tolerance. But, as a guiding principle, we think that shifting away from the benchmark, while focusing on companies with strong capital management, high odds of positive earnings surprises and attractive valuations, should be a rewarding formula for investing in emerging markets—even after the beta trade.

This blog was originially published in Institutional Investor

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Sammy Suzuki is Portfolio Manager for Emerging Markets Core Equities and the Director of Research for Emerging Markets Value Equities, and Morgan C. Harting is an Emerging Markets Portfolio Manager at AllianceBernstein (NYSE:AB).


Facts (and Minds) are Stubborn Things

By Robert Seawright, Above the Market

When making his defense of some British soldiers during the Boston Massacre trials in December of 1770, John Adams (later the second President of the United States) offered a famous insight. “Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.”  Legal Papers of John Adams, 3:269. In a similar vein, Sen. Daniel Patrick Moynihan once said that “[e]veryone is entitled to his own opinion, but not to his own facts.”

I have often warned about our proclivity to and preference for stories to the exclusion of data (for example, here, here and here). Because stories are so powerful, we want the facts to be neatly packaged into a compelling narrative. Take a look at John Boswell‘s delightful send-up of this technique in the TED context below.

We crave “wonder, insight [and] ideas.” Facts?  Not so much. As Evgeny Morozov puts it:

Today TED is an insatiable kingpin of international meme laundering—a place where ideas, regardless of their quality, go to seek celebrity, to live in the form of videos, tweets, and now e-books. In the world of TED—or, to use their argot, in the TED “ecosystem”—books become talks, talks become memes, memes become projects, projects become talks, talks become books—and so it goes ad infinitum in the sizzling Stakhanovite cycle of memetics, until any shade of depth or nuance disappears into the virtual void. Richard Dawkins, the father of memetics, should be very proud. Perhaps he can explain how “ideas worth spreading” become “ideas no footnotes can support.”

Felix Salmon’s excellent discussion of this argument in the context of Jonah Lehrer’s sad case (interestingly put into context here), which decries the use of “remixed facts in service of narrative,” establishes clearly (if unsurprisingly) that the facts are frequently too stubborn to fit neatly into a narrative-driven format — whether TED talk, blog post or bestseller. According to Seth Mnookin and reiterated by Salmon, “Lehrer had “the arrogance to believe that he has the right to rejigger reality to make things a little punchier, or a little neater.” Felix perhaps goes beyond Morozov to argue “that TED-think isn’t merely vapid, it’s downright dangerous in the way that it devalues intellectual rigor at the expense of tricksy emotional and narrative devices.”

To be clear, I am entirely in favor of using narrative to illustrate concepts. I am also in favor of making difficult concepts, and science in particular, more accessible. Moreover, there are many TED-talks I find inspiring, illuminating and useful. However, the issue and the danger is in forcing uncooperative (“stubborn”) facts, what Morozov calls “messy reality,” into a glib narrative in ways that simply don’t fit.

We are so susceptible to this problem (and our overarching bias blindness generally) that we fall prey to it often and don’t recognize it. Indeed, Snopes would not exist without our propensity for not letting facts get in the way of a good story. But even ascertaining the bare facts is far more difficult than we tend to think. As William James put it in The Will to Believe (1897): “Roundabout the accredited and orderly facts of every science there ever floats a sort of dust cloud of exceptional observations, of occurrences minute and irregular and seldom met with, which it always proves more easy to ignore than to attend to.”

We are utterly convinced that our senses are open windows through which we experience the real world as it truly is. But all of what we see, hear, touch, taste and smell is a re-creation by our brains – a useful model (guess) about what things “out there” are really like. To paraphrase neuroscientist Chris Frith, each of us is an invisible actor at the center of his or her world, which is designed to be a “map of signs about future possibilities.” Therefore, “[w]hat you’re experiencing is largely the product of what’s inside your head,” says psychologist Ron Rensink. “It’s informed by what comes in through your eyes, but it’s not directly reflecting it.”

In other words, the brain uses a variety of shortcuts to “sift through [the] superabundance of detail” around us (per V.S. Ramachandran and Susan Blakeslee). “At any given moment in our waking lives, our brains are flooded with a bewildering array of sensory inputs, all of which must be incorporated into a coherent perspective that’s based on what stored memories already tell us is true about ourselves and the world.” Accordingly, our default structure is to invent narratives to live by (initially) and then interpreting our experiences in light of these pre-existing narratives. These stories provide easy-to-remember frames of reference wherein we are typically exceptional, heroic, moral and right. Whenever necessary, we misinterpret “facts” or even invent facts out of whole cloth to fill-in the gaps in our knowledge or to explain what we don’t understand.

Sufferers of Korsakoff’s syndrome provide a marvelous (if unfortunate) example of this phenomenon. These people suffer from the inability to transfer short-term to long-term memory due to a thiamine deficiency, often related to excess alcohol intake. When asked a question, they simply invent wonderful and often entirely plausible answers which change each time the question is asked, because they don’t remember what story they told previously.

Cognitive psychologist Richard Warren from the University of Wisconsin recorded himself reading the sentence, “The bill was passed by both houses of the legislature,” cut a middle part of it out of the recording and replaced it with static. When played for subjects, nearly everyone reported hearing both static and the full sentence. Moreover, they couldn’t report when the static had occurred. The auditory system in the brain filled in the missing piece so that the sentence seemed uninterrupted. You don’t perceive blackness every time you blink, do you?

As reported in New Scientist, “We’ve known since the 1960s that memory isn’t like a video recording — it’s reconstructive,” according to psychologist David Gallo of the University of Chicago. The concept of “autobiographical memory” is not a true and accurate record of your past — it is more like a jumble of the remembrances of others, old yearbook and diary entries, photographs and newspaper clippings. “Your memory is often based on what you’ve seen in a photograph or stories from parents or siblings rather than what you can actually recall,” said Kimberley Wade, a memory researcher at the University of Warwick.

Within days of the atrocities of September 11, 2001, psychologists at the University of Illinois at Chicago asked a sampling of people where they were, what they were doing, how they heard the news and who they were with at that time. A year later they asked them again. More than half of the participants had changed their story on at least one count — while still expressing supreme confidence that their memories were accurate.Other studies confirm these results.

None of us starts our thinking or even our observing with a blank sheet of paper (so to speak). As Quine has shown philosophically (using his metaphor of the “web of belief”) and as vast quantities of research have shown practically, anyone sufficiently motivated to hold onto a conviction can always do so and usually will. All of our fact-finding and analysis is done in connection to our overarching beliefs and viewpoints — the stories we live by and the ways we see the world. Our attitude is often on the order of “Don’t bother me with the facts; I’ve already made up my mind.”

This problem is hardly a new one. More than half a century ago, Stanford psychologist Leon Festinger described the issue pretty clearly in the opening lines of his book, When Prophecy Fails. “A man with a conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point.”

To wax philosophical for a moment, there is a longstanding dispute on the nature of truth. Correspondence theory asserts that something is true to the extent that it corresponds to reality (from Aquinas). That’s pretty much the way we usually think about truth to the extent we actually think about it. Unfortunately, even straightforward facts require interpretation to have meaning (as my masthead proclaims, information is cheap; meaning is expensive). Worse, most things in life — including most of the really important things, like morality and justice — cannot be established to any degree of relative certainty. They must be argued for.

In that context, a coherence theory of truth makes sense.* Truth is ascertained by its level of coherence to a set of specified propositions. Thus one who values equality over freedom generally will tend to favor a policy that increases equality even if and when it inhibits freedom. However, the trouble here is that there is no way to come up with a set of foundational propositions without using correspondence and, more fundamentally for practical purposes, no way to adjudicate disputes about truth in this context, even in theory (why should one necessarily favor equality over freedom or vice versa?). In other words, our undergirding propositions (often narratives and beliefs) can be and often are wrong and usually disputed, throwing a monkey wrench into the whole works. Moreover, because reality is so “messy” we ought to be extremely skeptical about very high levels of coherence. I tend to doubt anyone who spins every item of fact into a neat little package supporting his or her point of view.

And therein lies the rub. Our brains are designed to operate using coherence theory without requiring that the underlying propositions be true (even to the extent possible). We start with narrative and belief and spend our time trying to cram the facts (as we see them) into our preconceived notions about the way the world works. Facts may well be stubborn things essentially, but our mental mindset ( a less redundant concept than you might think) means that they are not nearly stubborn enough. That’s because our minds are far more stubborn still.


* The pragmatic theory of truth (from James) holds that true statements are those that work for us and meet our needs better than their alternatives. For these purposes, this approach has the same difficulties as coherence theory.

A much earlier and shorter version of this piece appeared here.


We The Economy – 20 Short Films You Don’t Need to Watch

Morgan Spurlock has a new set of films out supposedly explaining how the economy works.  They’re 20 short films that explain various elements of the monetary system and economy.  The only problem is that the films are filled with basic errors.  For instance:

    • The film on “What is Money” uses a money multiplier model which, as I’ve explained a million times, is totally wrong.  The money multiplier is a myth.
    • They use a barter economy in an early video to try to explain how the market works.  Of course, a barter system is nothing like a monetary system and this obsession with barter is part of why so many people misunderstand how the modern monetary system actually works.
    • In the video on the Federal Reserve they state that the Fed “doesn’t even answer to Congress”.  The depiction is of a Central Bank that is some reckless and independent entity that does nothing but “print money” and hurt the economy by causing inflation and bailing out banks.  Actually, the Fed does answer to Congress, was created by an Act of Congress and does not really “print money” in any meaningful sense as I’ve explained multiple times in my explanations of Quantitative Easing.  Also see “Common Myths About the Federal Reserve”.
    • The same video says the Fed “controls the money supply”.  Actually, the Fed controls the overnight interest rate which only indirectly impacts the supply of money in the banking system at any given time.  The banking system controls the supply of money and the Fed only facilitates the use of this money.  See here for more details.
    • The film even states that the Fed has a triple mandate, one of which is to “help determine interest rates for people trying to buy homes”.  That’s a real quote.  Of course, the Fed has a dual mandate of full employment and price stability.

That only scratches the surface here.  I hate to be overly critical, but this is junk economics that perpetuates dangerous myths and does a great disservice to anyone who has a genuine interest in trying to understand how the economy really works. If you want to watch a useful film on the monetary system and the economy then try Ray Dalio’s 30 minute film. It will save you a ton of time and help you avoid having to unlearn some of the concepts you might think you’re learning from the Spurlock films.

Lies Investors Tell Themselves

By Ben Carlson, A Wealth of Common Sense

“The reason I talk to myself is because I’m the only one whose answers I accept.” – George Carlin

Hedge Fund manager Dan Loeb had this to say about a recent two month stretch of terrible performance (via Business Insider):

…there’s just an incredible amount of uncertainty in the country both in regards to the political situation and corporate governance. There’s also a great deal of uncertainty about big M&A deals getting done. Regulatory uncertainty “will be a wet blanket on top of investors until transparency and a level playing field are restored in the markets.”

It’s funny how regulatory uncertainty seems to be highly correlated with poor performance in the minds of portfolio managers.

I’m not trying to single out Loeb here. The guy is a very accomplished investor. But his statement just shows that even some of the most well-known investors lie to themselves instead of admitting they just had a period of poor performance or were simply unlucky.

It’s something all investors do. It’s a coping mechanism to deal with the inherent complexity of the markets. And with the benefit of perfect hindsight, we can craft a reasonable explanation for every past move.

Here are some other lies that investors tell themselves on a consistent basis, including many I’ve told myself over the years:

If only I would have taken my own advice…

I’m not wrong, the market is. You’ll see.

Investing is easy.

I can predict when the next correction is coming.

I’ll be greedy when others are fearful.

I have an accurate discounted cash flow model that tells me exactly what this company is worth.

I know everything there is to know about the markets.

I’ll invest when there’s more certainty in the economy.

If the politicians would just get their act together the markets would take off.

I can time the tops and bottoms in the markets.

I never make emotional decisions.

I’ll buy hand over fist the next time the market crashes.

I can predict where the markets are going next.

I know exactly what my investment returns are.

If I just try harder, my performance will improve.

I knew I should have sold that stock before the latest earnings release.

If only I would have bought Apple at $10 a share.

I know where interest rates are going.

I have a process in place to consistently pick the best up-and-coming fund managers.

High frequency traders are killing my trading system.

I have a fool-proof system.

Don’t worry, I can ignore the noise.

I know exactly what Tim Cook should do with Apple’s stockpile of cash.

I blame the Fed for my poor performance.

My returns are always in the top quartile.

I’m never wrong.

I have a good handle on my tolerance for risk.

My risk tolerance doesn’t change based on changes in the market.

My strategy works well in every market environment.

I’m intelligent, so I can just out-think the market.

I’ll start saving more money for retirement in the future.

In Two Paragraphs, Dan Loeb Perfectly Sums Up Why October Has Been A Nightmare For Hedge Funds (Business Insider)

Further Reading:
Excuses for underperforming the market

Q&A – Answers

Here are the responses to this week’s Q&A:

Q:  Your book says commodities aren’t good investments as a core piece of a portfolio because of their poor real, real returns. But what about MLPs?

CR:  There’s a difference between buying commodities outright and buying commodities for the purpose of investment.  A firm that buys oil in order to innovate is very different from a trader who just buys oil for the purpose of speculation or hedging.  I am not against owning firms who purchase commodities for the purpose of future production.  The thing you have to be aware of with MLPs is that they’re very sensitive to shocks.  We saw this in the recent downturn when MLPs fell over 10% in a matter of days….

Q:  How will you know if we are in a bear market?

CR:  The technical definition of a bear market is a -20% decline in the stock market.   So we’ll all know when that happens.  I don’t think it’s very useful to try to predict every micro move in the markets.  Instead, I focus on the macro picture and construct a framework for being able to ride the big trends while tilting the portfolio in a cyclical manner.  For instance, we know that tail risk events tend to occur inside of recessions.  This makes sense since this is the time when corporate profits falter.  Every 30%+ decline in the S&P in the last 75 years has occurred inside of a recession.  

So, if we can model the macroeconomy in a manner that helps us identify the 10-20% of the time when the economy is in recession (we don’t have to get it perfectly right, we just need to get moderately close) then we can tilt the portfolio in a manner that reduces exposure to big tail risk events. This is in keeping with my view of adaptive asset allocation and the understanding that relative risks of asset classes evolve over the course of the business cycle.  

In essence, the key isn’t identifying when the market will make small shifts.  Rather, it’s much more important to identify the larger trend, take advantage of Mister Market along the way when he makes mistakes (like the recent downturn) and make cyclical adjustments when it looks like the big trends are being disrupted.  The best part is, this can all be done in an extremely low cost and tax efficient manner if you’re mindful of it….

Q:  Where do you see the US dollar in one year – higher, lower or about the same?

CR:  The US dollar index has averaged a -0.5% return for the last 30 years.  The basket just isn’t that volatile in the grand scheme of things.  And since currencies are a zero sum game I don’t know how much sense it makes to try to forecast currencies.  Basically, I wouldn’t expect the USD to do anything spectacular in the next years.  It’s the world’s most stable currency in the world’s strongest economy.  I think the Fed would love to see it decline, but they’re not intervening directly so the better question might be whether China, Japan and Europe can devalue relative to the USD?   The answer to that is probably yes on all fronts….

Q: Asness mentions four market inefficiencies in his work (value, momentum, carry and risk parity). If it is fair for me to ask, what other strategies if any do you see mispriced by market (inefficiencies)?

CR:  I don’t know if I have a specific strategy style that I view as taking advantage of market inefficiencies. Markets are dynamic and inefficient at time.  So it makes no sense to be static and apply Efficient Market Hypothesis type thinking.  I believe an asset allocator should implement a macro adaptive approach not dissimilar to the way William Sharpe has discussed Adaptive Asset Allocation.  That means they should understand the big picture, ride big trends, and understand that the markets are dynamic.  This is somewhat similar to risk parity in that you’re basically allocating assets across broad classes while being mindful of the fact that relative asset class risks are dynamic during the course of the business cycle.  This means your portfolio should at least tilt at times to account for this dynamic landscape.  

The problem with risk parity is that you basically always conclude that fixed income is less risky than equity which I don’t think is necessarily true.  But I take an approach that is very similar to a risk parity approach in that I am using a broad asset allocation approach which is cyclically adjusted to account for changing relative risks in asset classes.  I don’t try to create risk parity as much as I try to tilt away from high risk asset classes during the periods of the business cycle when we know there’s a high probability that they will be risky in relative terms….

Q:  As I understand from the Kalecki equation, if the government cuts back on its spending then the private sector increases its level of debt to maintain growth levels. And since 2008, developed countries have slowed their accumulation of debt (and some have improved their trade deficit as well) whereas emerging have largely increased their debt levels. Does the world observe a global Kalecki equation of sorts influenced by the imports/exports or is each country a stand alone entity and in a closed system. That is, is this increase of emerging market debt the result of the slower debt accumulation in developed market?

CR:  There is no hard and fast law that is derived from Kalecki’s profits equation.  That is, if the government stops spending it doesn’t mean that debt necessarily needs to rise or that private sector profits will decline.  I think a lot of people expected this to happen in recent years as the deficit declined and I tried to explain on several occasions that this wasn’t necessarily going to be the case.  The reason why is because the deficit responds to changes in the private sector.  So, in the last 5 years we’ve seen steady govt spending and huge increases in tax receipts due to the improvement in the private sector.  The govt didn’t really do anything.  But the deficit responded by endogenously improving due to the organic improvement in the private sector.  So I think you have to be careful deriving changes directly from the deficit.  You have to look at what caused the deficit to decrease/increase in the first place.  

Now, one trend we’ve seen over the last 30 years is rising debt levels as inequality has increased.  I think what’s going on is that the middle class is borrowing to maintain a certain living standard.  As incomes have stagnated they’ve borrowed to make up the difference.  I would say that the deficit could be a lot larger in this environment, but I wouldn’t say it’s the cause of the borrowing.

Q: My question concerns the question of QE in the EU. I keep reading articles that suggest that the threat of deflation clearly implies the need for QE on a massive scale (or at least more larger than has been promised to date). Yet another strain of literature questions whether QE has been/can be effective in stimulating faster price inflation in the US and Japan where it has been tried on a large scale. The arguments that imply that QE has not/will not overly stimulate inflation (that it primarily adds to bank reserves that are not being lent out) seem to imply that it simply has not been very effective in doing anything except driving asset prices upwards. Why is it presented as a foregone conclusion that this is a wise strategy (resisted only by the selfishness of Germany) that is necessary to prevent deflation, if it has actually had little impact on inflation at all?

CR:  I don’t expect QE to do much in Europe.  First, we should be clear that banks don’t “lend out” reserves.  Banks lend first and find reserves later if necessary.  The money multiplier is a myth (see here).  So what Europe is basically doing is changing the composition of private sector balance sheets (see my QE primer here) from bonds to deposits/reserves.  I don’t see why this should do anything.  It might alleviate some funding needs at the sovereign needs, but that issue appears to have been solved with the OMT backstop.  So I don’t know why they expect QE to do much.  What Europe really needs is a massive peripheral fiscal program and a reformation of the system via the implementation of a central treasury like the USA has.    QE doesn’t fix the inherent problem in Europe’s monetary system.  

Q:  A question on inflation: What is it that is driving inflation in markets such as Indonesia or Kazakhstan – why is it so much higher than in say Singapore?

CR:  Sorry, but I’d have to learn a lot more about those specific economies before I could express a good opinion.  Sorry.  

Q:  You recently posted 3 macro charts that show a strong US economy. Do you analyse more forward looking indicators? If so, what are they telling you given recent movements in financial markets?

CR:  My general view is that the macro picture in the USA has not changed in recent weeks and that Mister Market was just having an Ebola and Europe scare….

Q:  In a previous Q&A ( you said that the current monetary system has not failed. If the developed world ends up like Japan, unable to escape deflation and implementing perpetual QE, would this constitute failure? If not, what outcome would?

CR:  We’ve been in a period of abnormally high growth for the last 75 years so it’s not surprising that the global economy has slowed some.  But the global economy is still growing at a rate of 4.5% so I don’t think it’s anything to get too worked up over.  And yes, developed economies will continue to lose market share to emerging markets.  That’s just competition at work.  When you’re #1 there’s only one direction to go and that’s lower.  The USA is in relative decline in this regard.   The failure of QE is, in my opinion, totally expected.  It’s not a failure of the monetary system.  It’s a failure of economists and policymakers to understand that fiscal policy is a much more powerful lever than monetary policy.  But we have an establishment of economist who are obsessed with monetary policy and what central banks can do.  So the world suffers.  

Q:  Related to the last question is what can the central bank do to cause real economic activity? Or is monetary policy now impotent?

CR:  Monetary policy isn’t impotent.  It’s just extremely blunt.  Some things they could do: 1)  buy long duration debt; 2) buy non-financial assets; 3) buy muni bonds; 4) buy sovereign bonds.  In the case of the states in the USA or Europe the Central Banks could directly fund govt spending.  In the USA the CB could buy non-financial assets which would be real “money printing”.  Of course, they can’t do this stuff or won’t do it, but it would have a big impact because it is, in essence, fiscal policy.  

Q:  Hypothetical question now: Why can’t an economy have competing private sector Fed-like clearing-houses (similar to the ones used to settle future contracts etc.) instead of one public central bank? Before you answer, just imagine the current global competing currencies but instead of spread out around the world, those currencies were all used within the US with competition eventually leading to the best currency system (essentially introducing FULL market forces to the monetary system). 

CR:  The USA already has a private clearinghouse called CHIPS.  The problem is that a clearinghouse is only as good as the liabilities issued by its members.  So with private clearinghouses you still have private sector solvency issues.  The power of the Central Bank is derived from its relationship with the Treasury whereby it can tax the output of the country.  So reserves are valuable and stable because US output is stable and valuable.  Private clearinghouses will never have this degree of stability or value because they’re inherently fragile entities.  So, in my opinion, Central Banks actually make a lot of sense because they stabilize the payment system that is essential to our economic well-being.  

Q:  How are you currently positioned?

CR:  Seated in an upright position.  Also, long stocks and bonds and Orcam Financial Group.  :-) 


The British Origins of the US Endowment Model

By David Chambers and Elroy Dimson (this article originally appeared on VOX)

Yale University has generated annual returns of 13.9% over the last 20 years on its endowment – well in excess of the 9.2% average return on US university endowments. Keynes’ writings were a considerable influence on the investment philosophy of David Swensen, Yale’s CIO. This column traces how Keynes’ experiences managing his Cambridge college endowment influenced his ideas, and sheds light on how some of the lessons he learnt are still relevant to endowments and foundations today.

In recent years much attention has been given to the so-called ‘Yale model’, an approach to investing practised by the Yale University Investments Office in managing its $24 billion endowment. The core of this model is an emphasis on diversification and on active management of equity-orientated, illiquid assets (Yale 2014). Yale has generated returns of 13.9% per annum over the last 20 years – well in excess of the 9.2% average return on US college and university endowments. Other leading US university endowments have followed this model (Lerner et al. 2008). Many other types of investors have thought to adopt this model, either in part or in whole.

David Swensen, Yale’s CIO, quotes John Maynard Keynes extensively in his excellent book Pioneering Portfolio Management. It is clear that Keynes’ writings were a considerable influence on Swensen’s investment philosophy. The key ideas that he takes from Keynes are:

  • The futility of market timing (Swensen 2009: 64);
  • The benefits of a value approach (Swensen 2009: 89);
  • The attractions of being a contrarian (Swensen 2009: 92);
  • Bottom-up security selection (Swensen 2009: 188); and
  • The great difficulties inherent in group decision-making, which push an investment organisation towards a situation where “it is better for reputation to fail conventionally than to succeed unconventionally” (Swensen 2009: 298).

A natural question which arises at this point is from where did Keynes gain these insights? Our study of Keynes’ experiences managing his Cambridge college endowment sheds light on how some of the lessons he learnt are still relevant to endowments and foundations today (Chambers et al. 2014).

Keynes managed the endowment of King’s College, Cambridge from 1921 until his death in 1946, and his appreciation of the attraction of equities to long-horizon investors proved to be his great investment innovation (Chambers and Dimson 2013). As Figure 1 illustrates, the King’s College endowment ignored equities in favour of real estate and fixed-income securities up to 1920. As soon as Keynes took over the management of the endowment he set about selling off a substantial portion of the real estate portfolio in order to reallocate these funds to equities. Upon Keynes’ death, the College had reached a one-third allocation to this new asset class. No other Oxford or Cambridge college endowment followed Keynes’ lead. Even the Ivy League endowments – far less restricted by statute as to the choice of investments – were slower to make a similar move (Goetzmann et al. 2010). King’s continued to allocate to equities for another quarter-century after Keynes’ death, and had 80% invested in public equities by the early 1970s.

Figure 1. King’s College, Cambridge endowment asset allocation, 1919–2013

chambers fig1

Note: The figure shows the proportion of the endowment held in real estate, fixed income, preferred stock, common stock, alternative investments, and cash (see Chambers et al. 2014).

Our analysis of the characteristics of his stocks, stock transactions, portfolio turnover, and performance substantiates Keynes’ own writings on the subject cited by Swensen above. Furthermore, his investment experiences during the Great Depression of the 1930s are relevant to modern-day investors having been through the recent Great Recession. He had to discover for himself the difficulty of making profits from market timing when the stock market crashed in 1929. His switch to a more careful buy-and-hold stock-picking approach in the early 1930s allowed him to maintain his commitment to equities when the market fell sharply once more in 1937–1938. His management of his college endowment provides an excellent example of the natural advantages that accrue to such long-horizon investors as university endowments in being able to behave in a contrarian manner during economic and financial-market downturns.

Keynes’ enthusiasm for equities is to be contrasted with his concerns about his endowment’s substantial allocation to real estate – the illiquid asset class of his day. A large allocation to illiquid assets, underpinned by the promise of superior returns to active management, has been one of the main characteristics of the Yale model. However, Keynes was more circumspect about such assets in his day and cautioned the need to understand the true nature of these assets. He warned that:

“Some Bursars will buy without a tremor unquoted and unmarketable investments in real estate which, if they had a selling quotation for immediate cash available at each Audit, would turn their hair grey. The fact that you do not [know] how much its ready money quotation fluctuates does not, as is commonly supposed, make an investment a safe one.” (Keynes 1938: 108)

Keynes was alerting his peers to the fact that the apparent low volatility of real estate returns was not a true reflection of underlying returns when a genuine attempt is made to mark these investments to market. His advice is as relevant to private equity today as it was to real estate in his day. Investors need to receive adequate compensation for the illiquidity risk they take on. Hence, even long-horizon investors should be wary of an over-allocation to such illiquid assets and avoid compromising any shorter-term liquidity requirements (Ang et al. forthcoming). This was advice which one of Yale’s closest competitors, Harvard, failed to heed during the 2008 financial crisis (Munk 2009).

Our research shows that Keynes was an extremely active investor who constructed equity portfolios that exhibited high double-digit tracking error compared to the UK market. Consequently, we are not surprised that he wrote as follows:

“[My] theory of risk is that it is better to take a substantial holding of what one believes in than scatter holdings in fields where he has not the same assurance. But perhaps that is based on the delusion of possessing a worthwhile opinion on the matter.”

At the same time, however, he acknowledged the likelihood that a fully diversified approach might be more suitable for investors not possessing the requisite skill in equity investing, saying that:

“The theory of scattering one’s investments over as many fields as possible might be the wisest plan on the assumption of comprehensive ignorance. Very likely that would be the safer assumption to make.” (Keynes 1945)

This is perhaps the most relevant piece of advice which Keynes had for those endowments and foundations with limited time and resources to devote to asset management. The alternative to an active investment approach is to focus on minimising management costs and to move towards a passive approach. Here again we find Swensen drawing inspiration from Keynes in that his second book on investment management, aimed at the general investor, extolled the virtues of a low-cost, passive approach (Swensen 2005).


Ang, A, D Papanikolaou, M M Westerfield (forthcoming), “Portfolio Choice with Illiquid Assets”,Management Science.

Chambers, D, and E Dimson (2013), “John Maynard Keynes, Investment Innovator”, Journal of Economic Perspectives 27(3): 213–228.

Chambers, D, E Dimson, and J Foo (2014), “Keynes, King’s and Endowment Asset Management”, NBER Working Paper 20421.

Goetzmann, W N, J Griswold, and A Tseng (2010), “Educational Endowments in Crises”, Journal of Portfolio Management 36(4): 112–123.

Keynes, J M (1938), “Post Mortem on Investment Policy”, King’s College Cambridge, 8 May, King’s Archive, PP/JMK/KC/5/7.

Keynes, J M (1945), “Letter to F.C. Scott”, February, King’s Archive, JMK/PC/1/9/366.

Lerner, J, A Schoar, and J Wang (2008), “Secrets of the Academy: The Drivers of University Endowment Success”, Journal of Economic Perspectives 22: 207–222.

Munk, N (2009), “Rich Harvard, Poor Harvard”, Vanity Fair, August.

Swensen, D (2009), Pioneering Portfolio Management (revised ed.), New York: Free Press.

Swensen, D (2005), Unconventional Success: A Fundamental Approach to Personal Investment, New York: Free Press.

Yale (2014), “Endowment Update”, Yale University Investments Office, 24 September.

The Core of the Modern Bond Strategy: Go Global

By Douglas Peebles, AllianceBernstein

“Keep Calm and Carry On” reads a popular World War II–era British motivational poster. We think the first half of the slogan is good advice for bond investors in today’s uncertain markets, but we’d substitute the second with “Go Global.”

As we’ve noted before bond investors around the world tend to harbor a strong “home bias”—a preference for domestic over foreign assets. This bias can be found in most core bond portfolios, which aim to provide investors with stability and income by focusing on investment-grade debt and holding a healthy share of government bonds.

Our research, however, suggests that global bonds have offered historical returns comparable to domestic ones—and with considerably lower volatility. What’s more, varied global exposure offers investors diversification of interest-rate and economic risk. That’s important today, as business cycles, national growth rates, monetary policies and yield curves around the world diverge.

Less Volatility, Better Risk-Adjusted Returns

But adding global isn’t just a tactical strategy for dealing with uncertain market conditions. A hedged global bond portfolio that strips out currency volatility can meet an investor’s core objectives of stability, income and diversification against equities. In other words, the ideal core portfolio should, by definition, be global.

When looking at the three-year rolling standard deviations of three different bond strategies—a hedged and an unhedged global approach and a US-only approach—over the past two decades, we found that the unhedged strategy was considerably more volatile than the US-only approach.

But here’s the part that may surprise some people: it was the hedged global strategy that had the lowest volatility of all—and investors did not have to sacrifice returns in the bargain. In fact, our analysis shows that returns over the period were about the same for all three strategies. But risk-adjusted returns were highest for the hedged global approach (Display).


Protecting Against Interest-Rate Risk

A global approach also offers protection when US bonds stumble. We reviewed quarterly returns between 1990 and 2013 and found that when the Barclays U.S. Aggregate Bond Index was positive, it returned 2.4% on average. The hedged global aggregate performed nearly as well, capturing 94% of those gains. We call this the “up capture.”

The “down capture” was a different story. To be sure, when the Barclays US Aggregate was negative, the hedged global aggregate was also negative. But its “down capture” was just 67%. In other words, we found that the hedged global approach captured nearly all the returns of the Barclays US Aggregate during positive quarters, but only about two-thirds of its average quarterly loss.

Over the years, those investors who shifted away from the US and toward other countries where rates were either rising more slowly or falling preserved more of their capital. That may be worth keeping in mind if, as expected, the US Federal Reserve is one of the first developed-market central banks to start raising policy rates in the year ahead.

Diversification When You Need It Most

Finally, we found something similar when looking at correlations. Since 1970, US Treasuries have shown a low correlation to UK, German, Japanese and Italian sovereign bonds. And the correlations were in many cases lowest during extremely negative months for Treasuries—in the case of German bunds, they fell by almost two-thirds during those months.

Of course, there are risks associated with global bonds, as there are with all investments and strategies. As we’ve seen, an unhedged global portfolio can be highly volatile and carries heightened risk because of its currency exposure. Investors also need to decide how global they want their core portfolio to be. I’ll take a closer look at these issues in my next couple of posts.

We understand that these are tense times for investors. Stretched valuations, increased volatility and the specter of rising interest rates have many on edge. But fear can be a great catalyst. And when it comes to bonds, this may be a perfect time for investors to go global.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Douglas J. Peebles is Chief Investment Officer and Head of Fixed Income at AllianceBernstein (NYSE:AB).

*A slightly altered version appeared in Institutional Investor on October 17.


Can We Identify Good & Bad Forecasters?

Forecasting is part of life.  And it’s certainly part of economics and finance.  Anyone who puts together a view of the economy or an investment portfolio has to make some forward looking assumptions.  They have to make forecasts about how the future might play out even if they’re just making vague implicit forecasts (for instance, you might be a buy and hold investor because, historically, stocks go up, therefore, you think they’ll continue to go up).  Some people do this in rather intelligent ways while others do this in biased and rather unintelligent ways.

I got to thinking about this as I read this nice post by Noah Smith on the difficulties of forecasting and the trouble with identifying good forecasters.   Noah says:

Obviously, these warnings would have zero informational content about actual inflation. But how would you go about differentiating between such a bot and a real human being? Is there some kind of Turing Test for macroeconomic forecasters?


In the meantime, our tools for identifying unreliable forecasters are rather primitive — a combination of reputation, bluster, excuses, insults and counter-insults. It’s all a bit silly, and it generates a lot of bad feelings all around. But what else can we do?

 So, how can we differentiate between the two?  How do we identify good forecasters and bad forecasters?  Well, there’s certainly no sure-fire way to eliminate the good from the bad, but I do think we can identify some red flags about forecasters by focusing on common behavioral biases:
  1. Does the forecaster work from a political perspective of the world?  If so, they are likely biased in their views and instead of viewing the world for what it is, they are making forecasts based on how they want the world to be.  We saw this consistently around QE forecasts when people who are politically against the Federal Reserve, made repeated predictions about impending doom.  Political bias is probably the most common and destructive bias that impacts forecasting.  Avoid politically biased forecasters at all costs.
  2. Beware of optimism/pessimism bias.  This often stems from political bias, but we tend to find that people in economics and finance are highly biased towards one view, either optimistic or pessimistic.  This will tend to cloud their thinking and lead them to conclude that any sort of policy or economic variable will naturally conform to their broader biased perspective.  People with a long track record of one consistent optimistic or pessimistic view should be ignored.  Classic examples include permabulls like Jeremy Siegel or permabears like Marc Faber.
  3. Beware the fallacy of composition.  People who can’t think in terms of the big picture are often biased in terms of their narrow views.  We are highly prone to thinking about finance and economics as it pertains to our lives at a personal level, but what’s good/bad for you at a personal level might not be true at the aggregate level.

We’ll never identify perfect forecasters (because they don’t exist).  But we can, with a high probability, eliminate the largely useless forecasters from the more valuable forecasters.  And identifying common behavioral biases is often one of the best ways to achieve that.  More importantly, when making your own forecasts, rather than relying on some talking head, ensure that you aren’t falling for these common biases yourself….

No, Higher Velocity Will Not Necessarily Mean Higher Inflation

In my book I go into some detail about the equation of exchange (MV = PQ) and why it can be terribly misleading. In essence, the equation is based on totally unrealistic assumptions such as the idea that “money” is some easily discernible item in an economy where financial assets have varying degrees of moneyness.  The most basic premise of the equation, the idea that more money necessarily = more inflation, has been thoroughly debunked over the last few decades, but unfortunately, I continue to field a constant barrage of questions about it and how high inflation or hyperinflation are lurking around the corner just waiting for the velocity of money to increase.  The problem is, velocity really has no statistically relevant relationship with the rate of inflation.

This whole conversation is a bit strange to begin with because Milton Friedman often assumed that V was relatively constant.  Which is bizarre because we know that V wasn’t constant even in the era before Friedman wrote his famous 1969 paper on the “Optimum Quantity of Money”.  He also made all sorts of other unrealistic assumptions in the paper such as a fixed money supply, no lending or borrowing and even assumed that people were immortal.  He called this a “hypothetical simple society”, but we really should have called it a “totally useless and fake society”.  How the paper even left a lasting impression on economists is worthy of debate….

Anyhow, I don’t want to get too deep in the weeds on this, but the idea that higher velocity necessarily leads to higher inflation can be easily debunked by looking at our “realistic complex society”.  Over the last 50 years there has been no, I repeat, no statistically significant relationship between the Consumer Price Index and the velocity of M2.  In fact, the relationship is virtually negative.  If you just eye ball the historical relationship you can see that there is none:


If you actually run the regression analysis you can confirm that there is zero relationship between the rate of inflation and the velocity of money:



So no, there is no reason to believe that higher or lower velocity of money will lead to deflation or inflation.  That’s not to say that the equation of exchange is not true.  Of course it’s true.  But you have to deep dive into the assumptions that its conclusions are based on to actually understand how useful it really is.  And when we deep dive into Uncle Milton’s “hypothetical simple society” you find that many of the conclusions are based on a world that resembles nothing like our actual monetary system.  And that is why so much of his economics has been proven void of value over the course of the last 30 years – it was based on a textbook world that made the math appear more relevant as opposed to the actual world we live in.

Yes, Boosting Gross Exports (and Imports) Would be Wonderful…

In a post today Scott Sumner says that the world would be better off if we could increase gross exports.   He refers to this Tyler Cowen post before going into more detail calling it “wonderful”.  I’ll probably never understand the Market Monetarism way of thought.  It just strikes me as reformed old school Monetarism (which has gone the way of the dodo) with a NGDP Targeting twist, but the same old laissez-faire foundation and most of the destructive nonsense that Milton Friedman injected into the field of economics.  Anyhow….

Now, Sumner doesn’t actually refer to gross exports, but I am going to assume that’s what he means.  And he’s right – boosting gross exports would be “wonderful”.  Or, said differently, if we all just produced more goods and services that other countries wanted then we could collectively increase our gross exports (as well as our gross imports).   But why is this news or some “wonderful” insight?  I mean, if I could produce a better car than Tesla then I could increase gross production for the global economy and that would be “wonderful”.  But isn’t this just an obvious fact?  But this is how neoliberal economists think. If we can just unleash unfettered capitalism then all of the untapped potential within us would just pour out into the economy, right?  As if there’s an Elon Musk inside of all of us just being held back by high taxes, regulation and the government….

Saying that we should all just boost gross exports is the mercantilists version of telling the poor guy with no job and no skills that he just needs to pick himself up by his bootstraps.  It’s obviously true, but it often makes no sense in reality because picking yourself up by the boot straps is not only extremely difficult, but takes a good deal of time.  From the perspective of economics it’s just obvious (yes, if we could all produce more then we’d likely all be better off).   But from a policy perspective it’s often just political rhetoric that sounds nice in theory and doesn’t translate into the real world in any realistic sense.  And then Sumner (predictably) goes into a bunch of laissez-faire policies that will supposedly unleash all this pent up production thereby allowing us to pick ourselves up by our boot straps.  Of course, none of the ideas are particularly new and many of them are things that many countries have been implementing for years already.  Nothing new here, certainly nothing “wonderful”….

This is the same thinking that has been poisoning economics, policy making and the global economy since the 1970s.  When will it end?

Will New Greek Drama Threaten European Periphery?

By Darren Williams and Dennis Shen, AllianceBernstein

Markets are reacting badly to Greek plans to exit its bailout program early. Uncertainties are being heightened by the prospect of early general elections. The end-result has been a sharp sell-off in Greek sovereign bonds, which has raised fresh concerns about the potential for spillover from Greek risks to other peripheral markets. 

Greece’s government is negotiating the country’s exit from its financial assistance program when it concludes at year-end. Under current agreements, Greece’s European Union (EU) loans stop at the end of 2014, but its IMF program continues through early 2016.

Prime Minister Antonis Samaras has proposed an early termination of Greece’s IMF program, in the hope that a clean exit from both lending facilities at the end of the year would boost support for his administration. Greece claims to be “fully comfortable” that it can meet its financing needs without assistance, but the EU and IMF are much less confident. And, based on the recent sell-off in Greek bonds, there are big doubts in financial markets about supporting Greece without external involvement and against a backdrop of heightened political risks. In our view, with market access now in question, Greece will most likely be forced to stay under at least a precautionary program from the EU.

A Presidential Obstacle

The negotiations on Greece’s bailout exit come at a difficult time for Samaras’ government, with a growing chance that the inability to elect a new Greek president could trigger an early parliamentary election next year.

Every five years, the Greek president is elected by members of parliament (MPs), rather than through a direct popular vote. If parliament can’t muster a three-fifths majority to support a presidential candidate, it must be dissolved and new elections called. Opposition parties can use this as an opportunity to block the presidential candidate, and force early parliamentary elections. That’s precisely what’s happening now.

Several opposition groups, led by the Coalition of the Radical Left (Syriza), are committed to blocking the government’s nominee in presidential elections due next spring—on the expectation that an early parliamentary election would strengthen their own positions. Opinion polls currently suggest that Syriza might win nearly half the seats in the event of an early election, potentially ushering in a government under its leadership.

Financial markets and European political leaders are very uneasy about this prospect. Syriza, with its traditional anti-establishment approach, is likely to escalate confrontation with Greece’s official lenders to new levels.

Greek Bond Yields Spike

Rising uncertainty around Greece’s financing and political outlook, alongside the recent spike in concerns about global growth, has led to a major sell-off in Greek government bonds. The yield on the 10-year bond has risen to 8.0%, from lows of 5.6% in early September.


In our base case, we now anticipate that an early parliamentary election will be held next year. If so, this will maintain selling pressure on Greek bonds in the near term. Against this backdrop, we are monitoring closely the potential for spillover to other peripheral markets. While in recent years there has been greater differentiation by investors between Greece and the rest of the periphery, the threat of an early election could reintroduce a degree of contagion.

Darren Williams is Senior European Economist and Dennis Shen is Economic Associate, both at AllianceBernstein.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.