Bond Prices Relatively Unchanged

Bond prices were in both positive and negative territory today, with the yield of two-year Treasuries settling up 8 basis points, the highest level in four and a half years. Bond traders are uncertain of the direction of interest rates leading into the Federal Reserve meetings this week. So will the Fed raise interest rates this week? Yes, No, No, Yes.  

Correlation With Apple

A recent article discusses the correlation that various stocks have with Apple and some of the stocks are surprising. For example, industrial products manufacturer Illinois Tool Works (ITW) has the highest correlation at .61. Payment technology firm Fiserv and Honeywell have the next highest correlations with Apple. Facebook and Texas Instruments also have high correlations with Apple, which is expected since Facebook is a tech stock and Texas Instruments is a major supplier to Apple. By now, we hope you understand how important correlation is to diversification, but, as with most numbers, we need to apply economic rationale to the numbers. There is no reason that ITW and Fiserv should have such high correlations with Apple, and in the future, these correlations will likely fall. Remember, what we really want is the correlations going forward, not correlations in the past. As Eric Chemi, the author of the article, states in the accompanying video: "That's where the data can get you and I think people need to be careful to not get trapped in these types of numbers."

Macy's Options

When a company makes an announcement, most people do not consider that many of these announcements are in fact real options. For example, yesterday Macy's made two separate announcements that are both real options. First, the company announced that it would close 35-40 underperforming stores, the option to abandon. Next, the company announced that it would open Best Buy outlets in 10 of its stores. While this is a small capital budgeting decision, it is an option to expand as Macy's and Best Buy both hope the combination is successful, in which case more Macy's will feature a Best Buy outlet.

VIX Volatility

The VIX, which measures the volatility of the S&P 500, has recently had an increased volatility, reaching levels not seen since the financial crisis of 2008. The level of the VIX is still in the area that generally occurs when the economy is in a recession. A JPMorgan analyst argued that the increased volatility was the result of price-insensitive traders who had "trend following strategies (CTAs), risk parity portfolios, and volatility managed strategies", all of which served to increase market volatility.

Market Efficiency Wins Again

Skeptics of stock market efficiency are always ready to argue "evidence" that the stock market is grossly inefficient. One piece of evidence that has been used in recent years is the performance of hedge funds. An oft reported statistic is that the average hedge fund return since 1996 was 12.6 percent per year. A recent article highlights research that indicates this claim is incorrect. Overstated hedge funds returns are due to the fact that hedge funds self-report returns. So, if a fund has poor returns, it stops reporting returns. Additionally, when a hedge fund is started, it will often not report returns until it has "something to brag about."  After removing these biases, the researchers found that the average annual hedge fund return since 1996 was only 6.3 percent, half of the reported average!

Annuity Sales

The stock market crash in 2008 made many investors nervous. As a result, many of these investors have searched for more certain investments, including annuities. We describe annuities as an equal payment at some specified interval for a fixed period. In an investing prospective, annuities are an investment vehicle that can have a fixed rate. Although there is more involved in an annuity, the basics of an annuity are that an investor deposits money into the account and either immediately or at some point in the future receives payments. The payments are calculated like the annuity payments in the textbook. So, the payments are based off the amount deposited, the interest rate, and the number of payments. Since annuities are currently paying below 3 percent, it is surprising that sales of annuities have increased because this lower interest rate results in lower payments than when the interest rate is higher.

Stock And Gold Correlation

Historically, the correlation between the stock market and gold prices is low, or even negative during some periods. Because of this, gold is often seen as a good asset for a diversified portfolio since a low or negative correlation can increase diversification. However, just because it happened in the past does not mean that it will happen in the future. For example, while the market dropped on Monday, gold prices also took a hit. While one day does not a trend make, both the stock market as a whole and gold are down year-to-date. All of this should be taken as a warning. Just because two assets have had a low or negative correlation in the past does not mean that the correlation will hold going forward. In other words, when using correlation, we want the correlation going forward but are often forced to use historical correlation.