Dragenomics

Now that we are in a post Alibaba IPO world, with 3 consecutive quarters of Equity performance, and a falling Euro relative to the dollar, it is time for every investor to take a step back and evaluate their positions. As we enter October, the historic month mutual funds sell their positions to cash out; it is clear the correction that has been predicted for the past year and a half has not occurred. The past two years have been a bad time to avoid equities. The buying on the dip mentality has worked, and although we have seen dips there has not been a correction. A strong defensive portfolio, with significant equity exposure, is the only way to continue to generate above average returns. Interest rates cannot fall much lower, and when the rise comes, bond managers will continue to be hit with redemptions. The bond king himself, Bill Gross, shocked investors on Friday by leaving PIMCO, the company he started. His work in bond futures was flat out inspiring. See “Gross Used $45 Billion in Derivatives ” for more. But, Gross’s departure is not a fundamental threat to the financial markets.

As expected, BABA surged on its first day and raised over $25 Billion. Kudos to the bankers for leaving the valuation in line with those of other Chinese internet companies. The bankers were able to issue additional shares and raise an extra $2 Billion than expected, courtesy to the Green Shoe option. Although the growth rates at BABA are ripe, the corporate governance structure leaves a lot to be desired in my eyes. The most interesting aspect of the BABA IPO was actually indirectly related to BABA. Investors had been worried that institutional investors would have to liquidate tech positions in order to buy BABA. Investors were correct that the markets did experience a sharp downturn. However, the losses did not spiral out of control and have recovered from Thursday’s Lows. The NASDAQ, S&P, and Yahoo (Major BABA Shareholder) inched down 1.48%, 1.37%, and .66%, since the September 19^th adjusted close, when BABA went public. BABA is due to posts earnings in November, it will be very interesting to see how the market reacts. I would argue that poor BABA earnings could increase sentiment as we begin to close out the year. Even with a poor fourth quarter, Investors have a lot to be happy about.

Year to date as of Market Close 9/26/2014 the S&P, NASDAQ Composite, and DJIA are up 7.3%, 8.00%, and 3.02%[1]. These numbers are welcomed given an ambivalent federal reserve and relatively stable, yet potentially stretched valuations. The S&P, NASDAQ, and DJIA have P/E’s (TTM) of 19, 24, and 16.[2] While these valuations are nothing to salivate over, equities are still the only game in town. So, in some respects valuations are justified. Additionally, as the 10YR T-Bill is 2.54%, investors need to get yield somewhere. Going into next week, the number to look for is undoubtedly job numbers on Friday October 3^rd. These numbers could dictate how the market will react in October, as Mutual Funds begin to sell positions and analysts begin to size up the holiday season. So, the question everyone is think: Where is the hedge right now?

In my opinion, the best way to trade in this market is sticking to Index ETFs. Buying puts on these positions are and extremely cheap way to insure your portfolio. To lower the cost of the puts, sell some stretched calls. Yes, you will be limiting your upside but I do not see many macroeconomic events that could radically push returns further. Looking towards 2015, it is time to evaluate the Euro – Dollar relationship. After Draghi’s announcements on interest rates[3] the Euro has been falling quickly against the dollar. The Euro is at its lowest price relative to the Dollar since March of 2013. This movement gives investors a few potential ways to profit. Obviously the pure currency trade is an option. But, for long term value investors, I believe there are better way to profit over the course of the next year. As the ECB begins to pump billions into the Euro Zone, there is potential that this quasi “quantitative easing” will give European financial markets the boost they have been craving. But, just like in the US, the ECB has had trouble hitting their inflation targets. This could mean a prolonged easy money period for Europe. Draghi actually announced that target interest rates on deposits will fall from -.1% to -.2%. This means that the velocity of money could be faster in Europe than the US as banks will prefer to lend their excess reserves rather than pay to house them with the ECB.

Still, there is a large question mark regarding when the European economy will take place. So, the dividend paying, European stocks look attractive. The IDV (Disclosure, this author has a position in the IDV) with a yield of 4.88% (9/27/2014) seems to be a way to find yield with international exposure.  The MSCI EAFE could also be a strong option. European stock with high yield could be tempting for European Managers to buy as they will eventually need to find yield and growth. If this does happen, large cap dividend paying stocks will most likely benefit. Lastly, US companies still have operations in Europe. Those companies with the largest sales volume in Europe might rally the most. It is important to remember we are in a globalized world. US companies with large European operations could offer the exposure needed to profit from easy money in Europe without as much of the risk. 

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[1] http://online.wsj.com/mdc/public/page/2_3022-usclosingstk.html?mod=topnav_2_3021

[2] http://online.wsj.com/mdc/public/page/2_3021-peyield.html

[3] http://www.bloomberg.com/news/2014-09-04/ecb-unexpectedly-cuts-interest-rates-as-outlook-darkens.html