QE Taper. For Real? Fed Interest Rate Policy. PDF Print E-mail
Written by Burnham Banks   
Thursday, 09 January 2014 06:55


QE Taper, for real?

  • The Fed is reducing UST purchases from 45 billion USD to 40 billion USD per month, a 11.1% reduction. It is reducing Agency MBS purchases from 40 billion USD to 35 billion USD, a -12.5% reduction.
  • US treasury issuance is shrinking at roughly 18% YOY due to an increase in tax receipts as the US economy recovers. Agency MBS issuance is also slowing, by about 30% YOY as banks underwriting standards have tightened and asset quality has improved to the extent that banks are willing to retain mortgages on balance sheet.
  • This implies that despite spending fewer dollars on buying bonds, the US Fed is buying up an increasing proportion of new issuance. This is hardly tapering.

Short term interest rates, low for how long? The market expects rates to be kept low till 2015. Its possible that rates may be kept low for even longer. Why?

  • Its possible that all that bond buying by the Fed was to maintain a respectable bid to cover ratio at auction, and not to reflate the economy. Why? Surely the Fed would understand that banks lend out of capital and not liquidity and all the LSAPs would do is liquefy the financial system, not provide it with capital.
  • Treasury relied on the Fed to keep yields low so that it could refinance itself cheaply.
  • The Fed balance sheet, at 4 trillion USD has reached critical limits making general prices potentially unstable. The Fed needed to find a less risky means of refinancing Treasury.
  • This month, Jan 2014, will see the inaugural issue of Treasury FRNs (floating rate notes). Treasury needs to fund itself longer than the T Bills market. It intends to issue 2 and 3 year paper. It understands that investors will only provide longer term financing if they do not have to take on duration risk. FRNs are ideal for both lender and borrower.
  • This provides the Fed with a cheaper and less risky way of suppressing Treasury’s interest expense. The Fed only needs to keep short rates floored at zero.
  • The risk to this strategy is that whereas fixed rate debt can be inflated away, floating rate debt becomes more expensive under inflation as rates react to inflation expectations.
  • Under the above thesis, interest rates will be kept low for another 3 years or more. Unless inflation perks up.

What about long rates?

  • Inflation expectations are one of the important determinants of UST yields. US inflation numbers are low. The headline number is 1.2%, down from 1.8% a year ago. Core inflation, which excludes volatile and transitory items such as food and energy are at 1.7%, down from 1.9% a year ago. Considering that shelter is a large item in the CPI, and US housing and mortgage rates are rising, we should expect to see much slower inflation in the larger cash flow items (that is ex owner equivalent rent, which is not a cash flow item.) CPI ex shelter has fallen from 1.4% a year ago, to 1.0% today. Again, a 4% 10 year UST yield is not a foregone conclusion.
  • However, given that the US Fed is a large buyer of treasuries, the eventual withdrawal of QE is likely to steepen the term structure.
  • Take note of the US trade balance which has been recovering quite steadily. US manufacturing is rebounding, an ageing population is consuming more services and less goods, more production is being re-shored and shale gas and fracking technology is reducing reliance on energy imports mean that the US will export less USD, less exported USD will mean less demand for US treasuries, implying a steepening of the term structure.

Food for thought…


Last Updated on Thursday, 09 January 2014 07:53
Wait Worry PDF Print E-mail
Written by Burnham Banks   
Monday, 30 December 2013 02:59


We began 2012 utterly dejected. Apart from the US, most regions from Europe to Asia to Latin America faced slowing growth. That said central bank pump priming managed to sustain global equity markets and 2012 turned out to be a good year for risk assets despite some mid year volatility. We began 2013 optimistic on the back of momentum in risk assets. As 2013 unfolded in became clear that the US real economy was actually improving and this helped to dampen volatility as the US equity market climbed steadily. In the latter half of 2013, the European economy began to signs of recovery driving their equity markets higher. Emerging markets fared less with slowing growth and rising inflation. Signs that the US Fed might slow down its large scale asset purchases added fuel to the fire and drove volatility there. Japan continued to confound the skeptics adding real economic progress to the improved sentiment. And even China appeared to recover from its apparent risk of a hard landing. Taken together, there is little to fear in the world of investing today. This is a thing to fear.

The risk of QE and its gradual withdrawal are significant. So far investors are pretty sanguine and some even interpret QE tapering as a sign of strength in the US economy and thus a positive development for equities, albeit less positive for fixed income. Depending on why US equities were bought up, there is a risk that the taper could be more damaging than expected. If for example, equities were bought as a claim on future production to hedge against future inflation, then higher discount rates further along the term structure could reprice equities making them more expensive than previously thought.

The other risk of QE is that we really don’t know what asset prices look like without it. Short rates are artificially low, but the arbitrary nature of the setting of short rates is something we have come to live with. That QE has been extended across the term structure means that the shape of the yield curve absent QE is also unknown, and the shape of the curve is a somewhat important factor in signaling economic growth and shaping asset pricing. Quite worryingly, we have come to rely on QE and embrace it as a reality in our investment strategy.

Like the consensus, we expect the world to be less globalized and that trade growth while positive will slow in the wake of the underground trade war that has been waged invisibly these last 5 years. However, there will be an impact on the leveraged shipping finance industry which is supported primarily by European banks. This could be another source of volatility in store for markets in the near future. A lot depends not only on the asset side of balance sheets but also on the liabilities. Some investments are simply not robust against rising interest rates.

The heavy issuance of debt in 2013 is also disturbing, almost like a last hurrah. As a rule of thumb, it is always good to be a reluctant lender, and thus to prefer securities companies are less willing to issue and to not prefer securities companies are more willing to issue. Overzealous lending is leading to a resurgence of covenant-lite issuance, now some 60% versus a mere 30% in 2007. Some companies have become, to an extent, passthru’s whereby their senior unsecured issuance is being used to fund dividends and payouts to other parts of the capital structure.

Pooling vehicles generally increase systemic risk. The rise of mutual funds and the return of CDOs and CLOs in the US add to instability in markets. The state of the art in risk management is backward looking. Any risk metric that aims to provide not only amplitude but timing of risk events must fail at one, or both. We believe that the estimation of timing of risk events is futile and advocate estimating the amplitude of risk events. We advocate a Gini Coefficient methodology for dealing with liability based risk.

A related risk is the large scale adoption of a small number of standardized risk models. Blackrock’s Alladin system stands out as an example. As more small, independent, boutique investment managers and traders outsource risk measurement to more standardized risk systems such as Alladin, investor behavior becomes more correlated and less independent. This violates the necessary conditions for convergence in many central limit theorems used in the same risk systems and could lead to highly leptokurtic markets.

Bank Regulation. Another Way PDF Print E-mail
Written by Burnham Banks   
Monday, 16 December 2013 01:18


The Volcker Rule, Basel 3. Dodd-Franck and all the rules and regulations will not help banking stability until banks are allowed to fail. As long as banks are not allowed to fail, managers will continue to be engage in willful or ignorant risky behavior.

Too much regulation also sacrifices efficiency.

The way to ensure a balance between stability and efficiency is to regulate in a different way.


  • No bailouts. Period. No lenders of last resort.
  • Regulate standards of disclosure in financial reporting to ensure transparency and clarity.
  • Encourage linear and not convex alignment of managers' rewards and losses to the institution's fortunes.


If a bank is too opaque, or too complex in its conduct of business and in its financial reporting, or if managers have too convex a call on its profits, investors and savers will direct funding away from them starving them of equity and debt capital, and deposits.

It is a remarkable state of the industry that savers and investors can no longer rely on bank management to act in good faith. The need for more regulation is simply a restatement of this hypothesis. If one believes that this new level of regulation is necessary, they must also accept the hypothesis.


Last Updated on Monday, 16 December 2013 01:20
US monetary and fiscal policy 2014 - 2017 PDF Print E-mail
Written by Burnham Banks   
Monday, 18 November 2013 06:23


US monetary and fiscal policy 2014 – 2017.

I believe it is inevitable that QE tapering will happen. This is driven by the need to control the growth, and one day shrink, the Fed’s balance sheet which is currently at 4 trillion USD and growing. The dangers of maintaining a balance sheet of this size are high. Any pick up in the velocity of money could cause nominal output to surge and capacity may not be able to expand as quickly. That said a reverse repo facility may mitigate much of this risk by being able to remove excess liquidity from the system very quickly. The other risk is that an unconventional policy tool has now been used quite some time with limited impact on the real economy and the Fed needs somehow to reset at least one of its policy tools in case another crisis should follow. Since QE had limited impact on the real economy, it has had significant impact on asset prices, the impact on the real economy of its gradual withdrawal should be orderly. Based on these considerations, I would say the risk of QE tapering is moderate and acceptable and the Fed will do it fairly soon.

The market has erroneously linked short term interest rates to QE tapering. QE is an attempt to monetize debt and to control the mid and back end of the curve, not the front where the Fed already has good control. A number of things suggest that the Fed will maintain its low interest rate policy for another 3 years at least (that is into 2017.)

Now there has been some talk of optimal control theory which is of limited use. Control theory is a methodology and tells us little about the actual path of interest rates or the intentions of policy makers. What the rhetoric and the introduction of control theory do is to widen the spectrum of potential determinants of monetary policy beyond inflation and growth. The definition of the Loss Function can include everything from traditional measures such as inflation and growth, but can also include multiple objectives such as unemployment, distribution of wealth, and even softer targets.

Forward guidance is another new policy tool which has been added to Large Scale Asset Purchases. Again there is little content in forward guidance. With interest rates at their lower bound, and the Fed’s balance sheet at acutely inflated levels, it seems that new and innovative ways of controlling the mid to back end of the term structure need to be found, and that forward guidance is a ‘cheap’ way of achieving this as the costs and risks are low. There are non-financial costs and risks, however, as it requires that the Fed is fairly accurate with its forecasts, and that the Fed’s credibility can be maintained. Choice and judgment are crucial in a complex and leveraged system as optimal control solutions are not unique, they yield a continuum of solutions, and the probability is high for boom and bust trajectories. The widespread adoption of forward guidance among the world’s central banks is somewhat troubling. On the one hand, if realized state variables deviate sufficiently from forecasts, central banks may lose credibility and the efficacy of forward guidance may be impaired, and on the other, such loss of credibility may lead to a more structural decline in central banks as influencers in the economy which is possibly a positive outcome.

For unclear and unspecified reasons, forward guidance and optimal control seem to imply to the market low interest rates for the next 3 years. I agree with this conclusion but present a simpler, cynical and causal explanation for my expectation. The clues to this expectation come not from the US Federal Reserve but from the US Treasury. The introduction of Floating Rate Note (FRN) issuance by the US Treasury supports the view of low interest rates for longer. As a borrower, the US Treasury has to provide investors or lenders with terms which are favorable to them in order to attract their capital. Investors are duration risk averse and seek low duration instruments. The US Treasury would like to finance itself over a longer term without steepening the term structure, and with the US Fed moderating its asset purchases, such funding terms may not be achievable. Funding itself with FRNs is useful in that it provides the US Treasury with longer term financing while providing investors with a low duration investment. The typical coupon for an FRN resets every quarter to some fixed level over the 3 month USD LIBOR or some other similar benchmark. For the US Treasury to maintain a manageable debt service profile, the US Federal reserve has to maintain short interest rates at close to zero. This is a cheaper funding strategy than longer maturity fixed coupon issuance that has to be monetized by the Fed via LSAPs.

What are some of the implications?

Short term interest rates will be kept low for some 3 years or so. The rest of the term structure will be determined less by LSAP but by market forces. Longer maturity volatility will rise, and yield levels are very likely to rise as well.

Conditions conducive to carry trades will arise. This will favor banks and deposit taking institutions. Hedge funds may also capitalize on this.

Implications for highly leveraged companies are complicated. Capital intensive industries will struggle with ongoing funding. In the current period, bond buybacks are accretive, however, over the longer run, this encourages consolidation over growth. Share buybacks will be more expensive as well, so expect a slowdown in volumes.

Increased yields and yield volatility will have real economy impact. Increased yields will discourage issuance and at least make it more expensive to finance with longer dated debt. Businesses may choose to issue more floating rate debt. On the demand side, increased yield volatility will cause investors to demand higher rates of compensation.

It is difficult to guess where the yield curve will settle without central bank large scale asset purchases. One of the more damaging consequences of QE has been to impair the allocative and productive signaling properties of the yield curve.


Last Updated on Tuesday, 19 November 2013 03:08
China In Transition. Outlook for the Chinese Economy. PDF Print E-mail
Written by Burnham Banks   
Saturday, 09 November 2013 01:42

Despite strong economic growth, Chinese equities have been derating over the past few years. There are technical reasons for the underperformance, mostly due to regulation and the nature of the investor base, which are mostly domestic retail investors.  Still, this does not explain the cheap valuations in offshore listings of Chinese companies.

The current structure of the Chinese economy is unbalanced with an over reliance on investment and exports. These features are not bad in and of themselves, however, when globalization is being slowed down or rolled back, when capital is scarce and when trade policy becomes more contentious, such over reliance becomes a weakness.

China is embarking on a rational if unpopular and short-term painful reorganization of its economy. Some of this reform is being forced upon it but it is in line with the long-term objectives of Chinese. Fortunately, China is in many respects still a centrally planned economy, the sovereign balance sheet is healthy, the workforce is diligent and productive, households are thrifty, and the urbanization cycle still has far to run. Standing against China is rampant corruption, domination of State Owned Enterprise in industry, and complexity of regulation and administration. These issues are currently being addressed by the government. Still, there is much left to do.

Last Updated on Saturday, 09 November 2013 02:08
Why the Fed is Issuing Floating Rate Notes. Floating Rate Strategy. PDF Print E-mail
Written by Burnham Banks   
Thursday, 07 November 2013 10:43

Treasury is reducing issuance of T bills. At the same time they are starting issuance of 2 - 3 year FRNs. Why?

There is a strong consensus among investors that rates will rise and therefore they should reduce duration. As a result they are buying shorter and shorter maturities.

This trend is hurting Treasury's ability to issue notes and bonds. The only way Treasury can issue outside of a year is to offer a short duration, long maturity instrument. Enter the FRN.

Now, in order for Treasury to control debt service the Fed Funds Rate will have to be kept at 0.25% for much longer since the FRN's coupons are benchmarked to short rates.

This only confirms what I've already expected, that regardless of QE tapering or not tapering, the FFR will be kept low for multiple years. 

A few questions PDF Print E-mail
Written by Burnham Banks   
Friday, 25 October 2013 01:33


Our system of politics and economics is very much a product of history, so much so that some basic questions about fairness and efficiency remain unresolved.


Why is income taxed more vigorously than capital gains? Why are the gains from gambling not taxed more aggressively?


In a meritocracy, what is to be done with under performers? More importantly, in a meritocracy, how should underperformance which is due to bad luck, or indeed outperformance which is due to good luck to be considered? Is the outcome more important than the route?


Does a sovereign country expect to repay its debts within a finite time period, by which is meant, achieve a net cash financial position?


A prudent way to run a business is to increase its equity over time. How should a business plan its capital structure? Should a business plan to achieve a net cash position within a finite time period?


A prudent householder should plan to accumulate equity over time while it is productive and to build an asset base to provide for retirement. Is it prudent to draw down equity during the retirement phase and if so how should it plan to do so? If a generation within a household is deceased with a positive equity, how much discretion should the deceased have (through their wills), over the distribution of the excess equity?


Last Updated on Friday, 25 October 2013 01:37
How the US Treasury Can Avoid Default Regardless of the Actions of Politicians PDF Print E-mail
Written by Burnham Banks   
Thursday, 03 October 2013 23:38

Treasury will want to ensure no default regardless of the actions of the politicians. There are a couple of ways out.

The Regulation of Banks, the Shadow Banking System and implications for Alpha Investment Strategies PDF Print E-mail
Written by Burnham Banks   
Friday, 27 September 2013 03:15


Since the financial crisis of 2008 it was patently clear that regulators would begin to regulate banks as utilities. Since then there has been a steady and gradual reanimation of the Glass-Steagall act, albeit not in a single legislation; this in a series of fragmented but correlated measures including Basel 3, Solvency 2, Dodd-Frank and the Volcker Rule. Henceforth, banks will be focused on their role as conduits and intermediaries of credit and funding and step away from principal activities and risk taking. Banks will be going back to basics, as it were. This wave of banking system reform is likely to be gradual and sustained, providing interesting investment opportunities. The complexity, multi jurisdictional, multi regional nature of current banking regulation will make a quick repeal such as was done to Glass Steagall, difficult and highly unlikely. The trend to greater regulation is therefore expected to be protracted and long lasting.

Last Updated on Friday, 27 September 2013 03:42
Bullish Europe Risk Assets PDF Print E-mail
Written by Burnham Banks   
Wednesday, 18 September 2013 01:04


We began to be bullish US equities 14 Oct 2011. On 13 Jan 2012, we called a buy on Europe across all risk assets on the back of the ECB’s unprecedented 3 year repo facility. This was a bit early and required the investor to sit through quite a lot of volatility. Some would have folded in May 2012 on the adverse price movements, but it turned out to be a profitable trade after all.

We continue to like the US and Europe. US equities, while still attractive on the back of a recovery are no longer as cheap as they were a couple of years ago, and are also more advanced in the profit cycle. While we continue to maintain exposure to the US, we now turn our attention to Europe, an under-represented exposure in many investors’ portfolios.

Last Updated on Wednesday, 18 September 2013 01:12
Confusing and Conflicting Signals. Contamination by QE. PDF Print E-mail
Written by Burnham Banks   
Tuesday, 10 September 2013 00:18

Its all rather confusing. But not any more so than usual. Things are always confusing in the present and clear in the past. What is confusing today, are the number and strength of the conflicting signals. We therefore consider, in broad summary, the bull and bear cases for general conditions. 

Current Thoughts About Hedge Fund Investing PDF Print E-mail
Written by Burnham Banks   
Wednesday, 04 September 2013 00:26

Concepts like volatility and correlation can be hard to visualize or grasp intuitively. I sometimes like to think simplistically about complicated matters. The insights gained are often far from simplistic. Hedge funds are unfortunately, a complicated subject, and try as one might, it is difficult to reduce the complexity of the issues.

One of the reasons that hedge funds are an attractive investment is that because they don't spend long spells in decline, they are a useful investment for someone who doesn't know when they might need liquidity and have to sell their investment. A steadily rising NAV provides a useful store of value which can be realized based on ones' needs and liabilities rather than based on the performance of the asset.

Ten Seconds. Are Developed Markets a Threat to Emerging Markets? PDF Print E-mail
Written by Burnham Banks   
Thursday, 22 August 2013 02:46

Economic growth in the developed markets appears to be in a general if tepid recovery. The US continues to exhibit steady recovery in economic growth supported by a robust housing recovery and manufacturing which has even now widened to a slightly healthier labor market. Tempering this is a falling participation rate, which is troubling since the unemployment is in the younger cohorts, and the increasing proportion of temporary work, which is more likely a consequence of Obamacare, which requires employers to provide health insurance to full time employees.

Last Updated on Thursday, 22 August 2013 02:48
Some Rudimentary Thoughts About Risk Measurement in a Simplistic Portfolio PDF Print E-mail
Written by Burnham Banks   
Tuesday, 06 August 2013 02:58

A couple of thoughts on risk…

In a portfolio consisting of assets of varying complexity, liquidity and aggregation structures (such as mutual funds, structured credit and structured products), the problem of risk measurement and management becomes a bit more complex.

Youth and New Graduate Unemployment PDF Print E-mail
Written by Burnham Banks   
Saturday, 27 July 2013 07:17

As the world recovers slowly from the Great Recession of 2008, employment has lagged, particularly youth and new graduate employment. Why is this? Employing new graduates and the young is a longer term investment involving money, time and resources towards future productivity. Employing older, experienced workers is an investment in current productivity. Any future productivity must be subject to discounting by variability depending on general business conditions. In times of uncertainty, it is rational to invest in fixed capital, for which there is ownership over a potentially transferable, marketable asset, and experienced workers. Only when there is less uncertainty, or sufficient comfort from current success will businesses invest in future productivity, which incidentally may be mobile with the benefits accruing to the employee, not the firm. Business investment is likely to be a leading indicator, therefore, for a recovery in youth and new graduate employment. Evidence supporting this conjecture can be found in the recovery in part time employment, while full time employment has lagged. The thesis that education derives more value as a signaling device is also supported here. Employers prefer a hard signal, that is, actual and relevant work experience over an indirect and soft signal carried by a college degree. This does not suggest that a college degree is unimportant; workers without a college degree with similar years of (in)experience fare even worse.

The US Consensus - Equities vs Bonds and QE Taper PDF Print E-mail
Written by Burnham Banks   
Tuesday, 07 January 2014 08:13


There has emerged a clear consensus about the outlook for US asset markets. While I am with the consensus for now, it is good practice to have an eye on the alternative view. With the tapering of QE, it has become established wisdom that equities will outperform bonds. Of course, there are many types of bonds; there are government bonds, municipal bonds, investment grade corporate bonds and high yield bonds. Bank debt, or loans are another debt instrument to consider in the analysis. The consensus view is the following:

  1. The US economy is sufficiently strong that QE can be moderated.
  2. The positive prognosis for the US economy implies the same for US corporate financial performance.
  3. The Fed has announced a moderation in its large scale asset purchases from 85 billion USD a month to 75 billion USD a month, the reduction to be split equally between its agency MBS and US treasury programs.
  4. The reduction in Fed purchases of US treasuries will lift yields at the mid and long end of the USD term structure.
  5. The impact on bonds with any significant duration follows from the above. The relative preference for equities over bonds also follows.

The above consensus relies on some assumptions and interpretations that deserve closer inspection.

  1. The US economy may be sufficiently strong that QE can be moderated. On the other hand, the Fed might be slowing LSAPs for other reasons. It could, for example, regard the size of its balance sheet as a risk to price stability. The Fed has never run a balance sheet of this size before and any pick up in demand or the velocity of money could spark of a rise in nominal output that real output might not be able to keep pace with – inflation. The Fed might have realized that interbank unsecured lending has shrunk and that lending has moved to the secured market – the repo market, and that its LSAPs are reducing the stock of available collateral for use in repo.
  2. The US economy is growing, but its long term trend rate is no longer the 4% it experienced pre 2008, and closer to 2%. The market expects growth to average 3% in 2014, but this would be above the new trend rate. Corporate earnings growth and profit margins at the same time are at a cyclical high. In the last quarter US corporate earnings saw more downward revisions and the current quarter is likely to see further moderation of earnings growth expectations. This will make current valuations, which are not cheap, harder to sustain.
  3. The Fed may have tapered its notional purchases but compared with a year ago, it is buying up an increasing proportion of new issue US treasuries. US treasury issuance is shrinking by about 18% YOY and Agency MBS issuance is shrinking by about 33% YOY. A 5 billion reduction in UST and MBS purchases amounts to a 12.5% reduction. It is not trivial nor a forgone conclusion that the 10 year UST yield is on a one way ride to 4%.
  4. One of the important determinants of UST yields is inflation expectations. US inflation numbers are low. The headline number is 1.2%, down from 1.8% a year ago. Core inflation, which excludes volatile and transitory items such as food and energy are at 1.7%, down from 1.9% a year ago. Considering that shelter is a large item in the CPI, and US housing and mortgage rates are rising, we should expect to see much slower inflation in the larger cash flow items (that is ex owner equivalent rent, which is not a cash flow item.) CPI ex shelter has fallen from 1.4% a year ago, to 1.0% today. Again, a 4% 10 year UST yield is not a foregone conclusion.

I am with the consensus on this one. However, whenever we have a strong consensus, we should be mindful of the alternative view and be particularly watchful for the signs that the consensus is wrong. One of the obvious indicators is price action itself. That’s why traders have a cut loss policy. At the same time we will be watching corporate profitability and economic numbers seeking signs of weakness, while remaining overweight in equities and underweight in duration.


Last Updated on Thursday, 09 January 2014 06:41
A slightly different style of investing: PDF Print E-mail
Written by Burnham Banks   
Monday, 30 December 2013 02:59


Traditional investing is all about asset allocation based on macro economic outlook and then drilling down to security selection. That’s a bit too fuzzy for my liking. Investing capital should be a more disciplined activity since it puts that capital at risk. The risk should always be well compensated by the prospect of returns. Thus, unless there is a very good reason to invest, capital should not be invested. There is a real cost to not being invested, but this is a relatively more certain cost, being the difference between short term cash rates and inflation. The short term cash rate will depend on the investor’s level of access and short term risk appetite. Deposit rates, LIBOR, or overnight repo rates are good proxies. This cost of not being invested can also be thought of as an option premium paid to not have exposure. It is the option to invest in the current period.

An investment would require a clear and present rationale, an event or a catalyst to justify it. Valuation itself is not sufficient. It is an important factor. Most successful value investors don’t just buy value; they buy value with a catalyst in mind. Sometimes, these investors not only have a catalyst in mind but they are active catalysts themselves. Distressed debt investors are a classic example, where the debt of a distressed business is bought with a view to reorganizing the business and the liabilities of the company in order to unlock value. Merger arbitrage is another example where the takeover code, anti trust regulation and other regulatory legislation drive investments to their fruition or deal-break.

The disciplines of event driven and distressed investing should be applied to traditional investments as well. Tighter definitions of investment rationale should be demanded by investors when they are asked to place capital in harms way.


Last Updated on Monday, 30 December 2013 03:01
Investment Strategy 2013 Recap and 2014 Outlook PDF Print E-mail
Written by Burnham Banks   
Friday, 13 December 2013 07:55

Time stamping...

Last Updated on Friday, 13 December 2013 08:20
Equity and High Yield Risk and QE. Why is QE Not Working for the Real Economy But Inflating Assets? PDF Print E-mail
Written by Burnham Banks   
Monday, 11 November 2013 00:19

Why is QE ineffective in reviving current demand and employment even as it drives up equity and high yield bond markets?

The massively expansionary monetary policies have yielded surprisingly low inflation while inflating asset prices across the globe. Bond yields have compressed and equity markets have surged in the past 5 years. Why is monetary policy ineffective at restoring normal levels of demand and employment? The answer is, because our specification of the set of prices over which monetary policy has domain is incomplete. Money can be spent on more things than just goods and services; it can be spent on claims on future goods and services. This is called saving, and saving is not consumption. A confluence of low interest rates, efforts to create inflation, expectations of high future inflation and efforts to flatten the term structure of interest rates have resulted in inflating the value of assets and not goods and services.

Ten Seconds Into The Future... A Quick Take on Market and Economic Outlook PDF Print E-mail
Written by Burnham Banks   
Friday, 08 November 2013 07:25

The world is witnessing renewed economic strength. Generally, fundamentals are strong(er), especially in the developed markets. Policy, however, remains nervous and uncertain and drives financial market volatility. Equities in the performing markets seem fully priced. Credit continues to perform in the face of potentially higher interest rates. What can we make of all this? Let’s do this back to front…

Last Updated on Friday, 08 November 2013 07:29
Its Time To Wean the Economy Off QE. PDF Print E-mail
Written by Burnham Banks   
Tuesday, 29 October 2013 07:44

With consistent central bank asset purchases, the term structure of interest rates cannot find its natural market clearing level. It is difficult to know if asset bubbles are being inflated or not, and it is hard to tell if the economy is yet on a self sustaining growth path. The only way to tell, to discover the price of things, is to wind down the asset purchase programs. 

Efficient Markets and Betting Against Market Distortions PDF Print E-mail
Written by Burnham Banks   
Wednesday, 16 October 2013 23:31

Markets are generally efficient in aggregate and over time. Markets can be inefficient in parts or for periods of time. Do I really believe this? Yes, provided they are proper markets by which I mean that there are sufficiently numerous independent participants, neither of which has sufficient individual influence over pricing.

Last Updated on Monday, 21 October 2013 03:42
US Debt Ceiling and Probability of Default. Almost Never. PDF Print E-mail
Written by Burnham Banks   
Wednesday, 02 October 2013 02:02


Oct 17 is D Day. If the debt ceiling is not raised, there is the possibility of a US default. The consequences are quite catastrophic, to such an extent that it is almost inconceivable that the US treasury will allow it to happen, despite the combined efforts of the Democrats and Republicans. Why is it so inconceivable?

Last Updated on Thursday, 03 October 2013 06:58
Tactical and Temporary Retreat. Tapering US equity exposure PDF Print E-mail
Written by Burnham Banks   
Tuesday, 24 September 2013 02:17


Good investment and trading practice is that you always have a thesis and the thesis implies certain milestones, and profit and loss levels. If the milestones are not met, and the thesis is unchanged, even if profit targets are met or exceeded, one should reassess the trade, preferably cutting it while the reassessment is taking place.

Last Updated on Tuesday, 24 September 2013 02:22
Fear Not QE Tapering PDF Print E-mail
Written by Burnham Banks   
Tuesday, 10 September 2013 00:25

Do not fear QE tapering. Its a good thing.

1. Its a sign of strength, that the economy is able to tolerate tighter monetary conditions.

2. US treasury issuance is falling as a result of improving economic growth and thus tax receipts. If the Fed maintains its purchases as a proportion of issuance, it would have to slow its rate of purchases.

3. By operating QE, the Fed is removing from the market the most ubiquitous, important, and highest quality collateral used in repo agreements. The Fed does not rehpothecate its assets on a large scale ongoing basis, although it has been contemplating a reverse repo facility in its last FOMC meeting. QE therefore reduces the liquidity in the collateralized lending market. Given that LIBOR markets have thinned, since 2008 and then the LIBOR scandal, the repo market is extremely important to global credit and liquidity. QE tapering is positive for repo liquidity. Because collateralized lending, particularly on such short tenures has a highly advantageous risk weighted treatment under Basel 3 capital rules, it is an important source of credit in the current environment.

Last Updated on Tuesday, 10 September 2013 02:07
An Alternative Investment Methodology PDF Print E-mail
Written by Burnham Banks   
Wednesday, 04 September 2013 09:32

Is Caterpillar a US company or a Latin American one, or a European one, or an Asian one? Is Santander Spanish, British, or Latin American? Is Alstom French, or Nestle Swiss, or HSBC British, or Chinese? Are any of the large listed Swiss companies Swiss?

When we say equities are cheap and bonds expensive, to which companies do we refer?  Should we compare the equity valuations of large caps with the bond yields of high yield issuers? Could the cheap equity issuers have even cheaper bonds?

The world fears peripheral European banks. How then should an investor regard the securities of the German operations of a Spanish bank? Or the securities of the Swiss operations of a US investment bank? How much did the holder of Lehman International UK bonds get in recovery, 9 cents or a dollar and change?


Last Updated on Wednesday, 04 September 2013 23:47
Emerging Market Currencies. Defend or Debase? PDF Print E-mail
Written by Burnham Banks   
Wednesday, 28 August 2013 05:47

In this time of emerging market capital flight, governments may be tempted to defend their currencies. This is a mistake. Such a defense rarely works. As governments buy local currency and sell hard currency, foreign reserves are further depleted signaling weakness to speculators who are encouraged to further short the currency. This establishes a death spiral. A better strategy, albeit a rather frightening one, is for governments to join in the carnage and sell local currency for hard currency. This drives the currency down improving the terms of trade and export competitiveness. In the short term it boosts reserves, and in the longer term, it boosts reserves.

There are of course, risks, to this strategy. The currency could depreciate too quickly. Governments have to stand ready to close the capital account in that eventuality. The alternative tends to lead to the same conclusion anyway.

Wall of Refinancing and EM assets PDF Print E-mail
Written by Burnham Banks   
Monday, 12 August 2013 08:12

The wall of refinancing in the developed markets presents a high risk to emerging market fixed income assets as they divert capital away from these markets.

Last Updated on Tuesday, 20 August 2013 08:15
Philanthropic Equity. PDF Print E-mail
Written by Burnham Banks   
Sunday, 04 August 2013 07:33

Let us consider a model for philanthropic, development finance. An interesting model for development philanthropy is one which provides equity capital to target low income groups to finance and encourage enterprise within this group.

Last Updated on Tuesday, 20 August 2013 08:16
Income and Wealth Inequality - Tipping Point? PDF Print E-mail
Written by Burnham Banks   
Saturday, 27 July 2013 07:17

Nothing happens without enterprise. Nothing happens without labor. There is at least the perception, that in the past few decades, and certainly accelerating into the past few years, enterprise has had the upper hand. 3 decades of falling interest rates have certainly helped enterprise through cheap funding while returns to savers have steadily diminished but funding costs are a side show. A paradigm shift is behind the steady rise of inequality. Under a purely capitalist, market economy, the strong thrive and the weak do not. Social security and welfare are socioeconomic band aids cobbled together to address the survival of the weak, or the unlucky. It takes an exceptionally enlightened capitalist elite not to over-exploit labor. Post the Great Depression, with the rise of labor unions and the rise of Communism, the capitalist elite were circumspect in dealing with labor. The fall of Communism has, among other things, removed the need for any pretense by removing Capitalism's nemesis and alternative. It has also contaminated the capitalist model but that is another story. On purely mathematical grounds and importantly ignoring important limitations and behavioral phenomena, a pure free market economy is efficient. However, it implies that the strong will thrive and the weak may not survive.

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