Weekly Z Turn Letter 31/05/2009
1. Quote of the week
The people want to be deceived, let them be deceived. -- Nephew of Pope Paul IV
2. Quantitizing S&P500 from ZH (Charts courtesy of CapitalIQ)
Using Enterprise Value (EV) to Projected EBITDA to catorgorize S&P 500 into 4 groups: EV/EBITDA 0-5.0x (44 companies); 5.0x-7.5x (186 companies); 7.5x-10.0x (121 companies); 10.0x and higher (101 companies), with the negative multiples ignored.
Chart 1_1 month and 6 month Vs Benchmark.jpg
The first chart is a 1-6 month performance matrix relative to both the set's average and the S&P. The companies are segregated by market capitalization and scatterplotted by sector. Not surprisingly, the cheapest companies (lowest EV/Fwd EBITDA) are the ones that have performed the weakest on both an absolute and relative performance basis.
The average of all 4 buckets is still below the 6 month average return for the entire S&P500, meaning that the highest returns within the index, were driven by companies that have an EV/EBITDA less than 0x, or in other words, companies projected to have negative cash flow outperformed every other company bucket. That might be why Jim Simons's RIEF is largely underperforming the market, well...
Chart 2_1 month by sector
Relative performance of specific sectors in the 4 EV/Fwd EBITDA buckets. Obviously, the biggest pain was focused in the Consumer and Telecom sectors, especially for constituent companies that were already richly priced (over 10.0x EV/Fwd EBITDA). Two sectors that beat across the board were Energy and Materials, most likely due to the reincarnation of the inflation trade over the past month, and the rapid rise in commodity costs. Investors were much less sensitive to relative value in energy as a result and were buying stocks of both cheap and expensive companies.
Chart 3_Beta vs performance
While one would expect merely a diagonal line by definition, as higher betas provide better returns in a rising market, the relative flat lining of the S&P over the past month may have provided a glimpse into some more relevant inner workings of the market. Whereas beta stacking was not surprising in the cheap bucket (<5.0x), the richest bucket demonstrated that the lowest beta companies generated nearly as high a return as those with the highest beta. And the lack of beta correlation in the other 2 buckets was just as evident. In other words, this demonstrates that over the past month, neither quant value and momentum factors worked, nor did signals based on any traditional reliance on beta. In yet other words, the confusion in the market is reaching dangerous levels...
Chart 4_Hedge Fund ownership
Performance of companies by valuation buckets scaterplotted by % hedge fund ownership. A curious observation here is that while hedge funds that had bought en masse cheap, sub 5.0x companies generated solid, 20%+ returns in the last month, overpriced companies, especially in the 10x+ projected valuation range, caused a lot of pain for their hedge fund masters, with the groupthink which accounted for anywhere between 40-60% of given companies' stock share count generated an ugly -10% return over the last 30 days.
3. Plunge of FDIC's Reserve Ratio, check out Chart 5_FDIC Ratio
The FDIC's Deposit Insurance Fund, as of 31st Mar, has plunged to an all time low of just $13 billion, or 0.27% of $4.8 trillion in insured deposits. It is worth nothing that since March 31, 15 new banks have failed which includes the biggest one so far this year, BankUnited(which Marla has a special fondness for in her heart and will be providing some ongoing entertainment on). It is thus safe to say that the $13 billion has been spent in the past 2 months, especially since banks no longer issue debt under the TLGP (of which, nonetheless, there was $336 billion outstanding at March 31 - somehow when banks are talking about repaying TARP, their FDIC-guaranteed debt, by far the biggest crutch to the banking system, is conveniently never mentioned) and therefore no longer pay FDIC guaranteed debt issuance associated fees.
4. Charts on 10 yrs UST, Mortgage rate, Fed Open Market Operation, Gold...
While there has been way too many talks over this, let me just show you few charts here.
(a) Chart 6_30 year FNMA rate, and usually your mortgage rate is a 50bpts+ on that;
(b) Chart 7_Fed Treasury Purchase, while many people had been hoping that Fed will be out there defending a level they obviously are now disappoited, because either Fed does not intend to do that or they actually had a higher goal in mind?
(c) Joining John Paulson and David Einhorn, Eton Park actually increased their Gold Holding, too on a net basis cos they are owning puts on SPDR GLD as well.
Top 5 Holdings(by % of portfolio)
- SPDR Gold Trust (GLD) Calls: 15.9% of portfolio
- SPDR Gold Trust (GLD) Puts: 7.2% of portfolio
- Potash (POT) Puts: 6.48% of portfolio
- Brazil ETF (EWZ) Puts: 6.05% of portfolio
- SPDR Gold Trust (GLD): 5.3% of portfolio
5. USD + Stock chart on different periods, check out Chart 8_USD and Stock.
6. Fun of the week - A funny song
http://www.youtube.com/watch?v=2fq2ga4HkGY
INFLATION OR DEFLATION?
By Merle Hazard
As we go through this recession
As farther down we slip
Will our central bank get traction soon, or
Will it lose its grip?
It's a mini-Great Depression
Our markets went berserk
The Fed is printing trillions now, but
Will their efforts work?
Inflation or deflation?
Tell me, if you can
Will we be Zimbabwe
Or will we be Japan?
Credit markets came undone
And still are in distress
Will the dollars in my mattress
Buy much more next year or less?
It's a desperate situation
When you're at the zero bound
If a tree falls in a forest,
Is it making any sound?
New money makes inflation
If folks who have it spend
But if it only sits there,
Then the misery will not end
Inflation or deflation?
The choice is looking grim
I wonder what John Maynard Keynes would say
If we asked him
Have a good weekend and a great week ahead.
Best
Oliver Zeng
