Archive for the 'Business' Category

Do ETFs Pump Up Emerging Markets?

Kurt Brouwer November 12th, 2009

Jason Zweig asks a very good question in a Wall Street Journal column:

ETFs Causing Bubble in Emerging Markets? (Wall Street Journal, November 10, 2020, Jason Zweig)

U.S. investors have pumped roughly $26 billion into emerging-markets funds so far this year. Of that, $15 billion came in through exchange-traded funds — portfolios that hold every stock in a market benchmark with utterly no regard to price.

…As money pours into the ETFs, they must mechanically match their holdings to those in the emerging-market indexes. That forced buying drives up stock prices, attracting still more new money into the ETFs, spiraling stock prices even higher.

…Consider Brazil. The iShares MSCI Brazil Index ETF has nearly tripled in size over the past 12 months. Now at $10.9 billion in assets, it has vacuumed up $2 billion in new money this year. Fully 38% of the fund is invested in only two firms: oil giant Petrobras and mining company Vale do Rio Doce.

Yikes.  U.S. regulations limit ETFs from huge concentrations in a given emerging market stock, but that limitation is still a matter of perspective because 38% in two stocks seems pretty concentrated. Unfortunately, the nature of many emerging market economies is that there are only a few large, publicly-traded companies in which to invest.  When a country specific ETF or mutual fund gets a flood of new cash, the only practical way to put that money to work quickly is to invest in large companies.

The Wall Street Journal continues:

…Thanks to obscure provisions of the U.S. Internal Revenue Code and the Investment Company Act of 1940, which governs how mutual funds are organized, ETFs can’t allow their assets to become over-concentrated in a handful of holdings. In general, they can’t keep more than 25% of their money in a single stock, and at least half of their assets must be in securities that each account for no more than 5% of total holdings.

Having 25% of an ETF’s entire portfolio in one stock can lead to problems at the fund level too.  Let’s say investors tire of Brazil and want to pull out 25% of the ETF’s assets.  The ETF (or mutual fund) has to sell shares in order to raise cash.  Ideally, the ETF would sell shares across its portfolio, but problems can ensue.

With only two very large holdings that together add up to 40% or 50% of the fund, it’s not practical to raise the 25% cash needed just by selling Vale and Petrobras.  The reason is that the fund’s selling of large amounts of stock would almost certainly put pressure on the share price of those companies, thus hurting the ETF’s net asset value and precipitating more sales of the ETF by rattled investors.

To avoid too much selling pressure on the two main holdings, the ETF might want to raise cash by selling smaller company shares.  Unfortunately, the same problem occurs.  Sales of even modest shares in thinly-traded small company stocks would probably lead to lower prices, leading to a lower NAV, which leads to more selling of ETF shares…You get the idea.

The Wall Street Journal continues:

…So what does all this mean for investors? ETFs probably haven’t caused a bubble, and they might even help a bit to prevent one from forming. But many will remain superconcentrated bets on very risky markets. If you invest in an ETF with most of its assets in a few stocks and think you have made a diversified bet, the real bubble is the one between your own ears.

The answer is that ETFs and mutual funds do not pump up emerging market stock markets all by themselves.  But, they do exacerbate the market mood swings, both on the way up and the way down.

My takeaway from this piece and from my experiences with emerging markets over the past 30 years is that the long-term returns from an investment in emerging markets should be higher than returns from investments in developed economies.  Therefore,  it may make sense for a diversified investor to have a stake in these rapidly-growing economies.

Like shark’s teeth…

However, the boom and bust cycles in emerging economies are far more pronounced too, so you have to patient. Like shark’s teeth, getting in is easy, but getting out unscathed can be more difficult…and more painful.

State Tax Revenues Plunge

Kurt Brouwer November 10th, 2009

The fact that state tax revenues are falling should not be a surprise given that we have been in a recession.  Nor, should it be surprising that income taxes have fallen far more than sales taxes or property taxes.  Historically, the bulk of income tax revenues come from higher income folks whose income is far more volatile.  This is all predictable, but I imagine this predictable outcome is still quite a shock to the powers that be in our state capitols:


Source: Nelson A. Rockefeller Institute

My prediction?  We will see a lot of interest on the part of politicians for additional sales taxes such as the value-added tax (VAT) as used in Europe.  This would not be so bad if it replaced an existing tax, but that will almost certainly not be the case.  The VAT will be increasingly touted as a way to ‘solve’ the state funding or Federal funding shortfall.

Hat tip: Barry Ritholtz

GDP Turns Positive (Sort of)

Kurt Brouwer October 29th, 2009

U.S. GDP rises 3.5% as stimulus kicks in (MarketWatch, October 29, 2020, Rex Nutting)

The U.S. economy expanded at a 3.5% annual pace in the third quarter, as massive government stimulus helped drag the economy out of the longest and deepest recession since the 1930s, the Commerce Department estimated Thursday.

This is an estimate and will almost certainly get revised.

Along with improvements in key monthly figures on output and sales, the rise in real gross domestic product means the Great Recession is likely over in a technical sense, even as further job losses occur. A formal call on the end of the recession isn’t expected for months

…It was the first increase in real gross domestic product in a year and it was the strongest growth in two years, the government said. Before growing in the June-to-September quarter, the U.S. economy had shrunk for four straight quarters for the first time since the Great Depression.

…In the past year, the economy has contracted 2.3%. The economy shrank 0.7% annualized in the second quarter and 6.4% in the first quarter. The figures are seasonally adjusted and adjusted for price changes.

…Third-quarter growth was due to higher consumer spending, a slowdown in the reduction of inventories, an increase in residential investments, and robust government spending…

How much of the growth was due to stimulus and other forms of robust government spending? The Bureau of Economic Analysis report referenced above can be found here.  It gives us a bit more detail on the elements of GDP growth:

…Motor vehicle output added 1.66 percentage points to the third-quarter change in real GDP after adding 0.19 percentage point to the second-quarter change…

Yikes.  That is, of the 3.5% growth, fully 1.66% came from motor vehicle output and that, of course, was goosed mightily by Cash for Clunkers.  If vehicle output had come in at the same level as the second quarter, then GDP growth would have been only been 2.03% (3.5 - 1.66 + .19 = 2.03).

This chart illustrates what I meant by vehicle sales were goosed by Cash for Clunkers:

Source: Clusterstock

The little sign in the chart indicating a car going off a cliff presumably is suggestive of a likely decline in vehicle sales now that Cash for Clunkers is over.  I would be shocked if we did not see a big dropoff in vehicle sales.

So, the good news is that the economy has sped up and we are seeing modest economic growth.  The bad news is that growth is still heavily dependent on various government spending programs which are unsustainable.

Surprising Corporate Earnings Buoy Stocks

Kurt Brouwer October 26th, 2009

One element in the stock market’s strong showing this year is simply a reaction to last year’s horrendous downdraft.  Another element that has more substance is improving corporate earnings.

This charts shows results the percentage of companies that are revising earnings upward (or downward).  The chart tracks the S&P 1500, which is a broader index than the S&P 500.  The S&P 1500 covers about 85% of the U.S. stock market.

In this chart, the blue line shows the price movement of the index on the left axis and the red line shows the percentage of companies (right axis) that were either raising or lowering earnings estimates at a given point in time.  Currently, the red line indicates that a number of companies are now revising estimates upward (above zero on the right axis).

Last year and even early this year, most companies were revising earnings estimates downward in line with the slumping economy.  Eventually, that trend began to reverse and the number of companies posting reduced estimates began to diminish.  The improved outlook for earnings coincided with the low point stocks hit back in March.

Source: Bespoke

Corporations are revising their earnings estimates upwards as we can see from the chart.  Yet, they are also beating those upwardly-revised estimates.  This is what needs to happen for a while if stocks are to go on a sustained upward path.  As the folks at Bespoke put it:

…Upside estimates have been outpacing downside estimates for a few months now, and companies have still been able to beat estimates at a high rate, which we believe is a major reason for the rise in the overall market…

This chart, also from Bespoke, shows the percentage of corporations beating their earnings estimate and puts this period in the context of the recent past:

Source: Bespoke 

Bespoke continues:

In conclusion, the data shows that companies have been beating raised estimates and not lowered ones during this bull market…

The key issue here is the long-term trend.  Are corporate earnings just bouncing back from last year or are they embarking on a new, sustained uptrend?  We will keep watching this and let you know.

Cash for Carts (golf carts that is)

Kurt Brouwer October 19th, 2009

In a post on the Cash for Clunkers program, I joked about a similar program for appliances.  But, I should not have joked because such a program was included in the economic stimulus program passed earlier this year.  CNBC reports [emphasis added]:

Dollars for Dishwashers? Appliance Rebates on the Way (CNBC, August 20, 2020, Christina Cheddar Berk)

…The government’s so-called “Cash for Clunkers” program has been grabbing headlines, but it’s not the only federal program putting money back into consumers’ pockets. A new government program is poised to help appliance manufacturers the same way “Clunkers” gave a jump start to auto manufacturers.

As part of the Obama Administration’s economic stimulus bill, nearly $300 million was set aside to fund a state-run rebate program for consumers purchases of Energy Star-qualified home appliances.

Like the “Clunkers” program, the plan takes aim at energy guzzlers. However, unlike in the popular auto program, consumers will not have to turn in their old appliances in order to buy a more efficient one and qualify for the rebate. However, the exact criteria remain unclear because states are still drafting their individual plans, with the hope of having the programs up and running by the end of this year…

Great line that says so much, ‘…the exact criteria remain unclear…’  It really is impossible to parody Congress anymore.  And, of course, the fact that Cash for Clunkers has been a fiasco will not stop implementation of Dollars for Dishwashers.

Now, we find that even Dollars for Dishwashers was not the end of the government’s effort to subsidize our purchases.  We also have Cash for Golf Carts.

Cash for Golf Carts 

As part of the American Recovery & Reinvestment Act of 2009 (ARRA), there is a stimulating program that is helping golfers buy electric golf carts.  I am not knocking golfers with this post, in fact, I play golf from time to time.  I even spent several years of my wayward youth caddying at a tony country club.

However, I really don’t see why we need to borrow money — that’s what economic stimulus really means at this point — to subsidize golfers who want to buy a cart, do you?

One problem with very large government programs is that there are always unintended consequences.  I suspect the legislators who worked on this program did not really intend to give electric golf cart sales a boost, but who knows what evil lurks in the heart of the vast golf cart lobby? This editorial from the Wall Street Journal describes  program [emphasis added]:

Cash for Clubbers (Wall Street Journal, October 17, 2020)

…Uncle Sam is now paying Americans to buy that great necessity of modern life, the golf cart.

The federal credit provides from $4,200 to $5,500 for the purchase of an electric vehicle, and when it is combined with similar incentive plans in many states the tax credits can pay for nearly the entire cost of a golf cart...which is typically in the range of $8,000 to $10,000. “The purchase of some models could be absolutely free,” Roger Gaddis of Ada Electric Cars in Oklahoma said…

Free.  When it comes to almost any consumer product, if you make it free, you can in fact stimulate demand. That’s not exactly news though.

The golf-cart boom has followed an IRS ruling that golf carts qualify for the electric-car credit as long as they are also road worthy. These qualifying golf carts are essentially the same as normal golf carts save for adding some safety features, such as side and rearview mirrors and three-point seat belts. They typically can go 15 to 25 miles per hour.

…The IRS has also ruled that there’s no limit to how many electric cars an individual can buy, so some enterprising profiteers are stocking up on multiple carts while the federal credit lasts, in order to resell them at a profit later…


This golf-cart fiasco perfectly illustrates tax policy…politicians dole out credits and loopholes for everything from plug-in cars to fuel efficient appliances, home insulation and vitamins…then insist that to pay for these absurdities they have no choice but to raise tax rates… 

This is kind of funny in a way.  We don’t generally think of golfers who tootle around in golf carts as needy, but they are just responding to incentives, so you can’t really blame them.

However, if you think of this as a wasted and misguided use of our money, then it’s not so funny.  And, if you multiply this sort of idiocy thousands of times in many different industries, then it starts to get infuriating.

Congress & the vast golf cart industrial complex

I doubt if anyone in Congress is in thrall to the vast golf cart industrial complex, but the American Recovery & Reinvestment Act is now funding well-to-do golfers who want a FREE personal golf cart.  I shudder to think of what’s next.

See also:

50 Ways the Feds Waste Our Money

CRASH for Clunkers

Clunking toward health reform

Convicts Cash In On Fed Stimulus

We’re in the best of hands


Collateral Damage From Cash for Clunkers

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