The Public Pension Black Hole - Sucked in the vortex of an undiscovered universe

“It’s not what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so!” – Mark Twain

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The beauty of pension accounting is that slight tweaks can make a large unfunded liability seemingly disappear or at the very least shrink it to “she’ll be alright mate” levels. However if a pension fund plays the game of understating its risks for long enough then eventually it catches up, especially if performance is consistently poor. This is what we are starting to see in vivid colour among state and local (S&L) governments in America. Reality is biting. Let’s jump right in.

California Dreaming

To put this in perspective the California Public Employee Retirement System (CalPERS) lost around 2% of its funds in 2015/16. The fund assumes an aggressive 7.5% return. Dr. Joe Nation of Stanford Institute for Economic Policy Research thinks unfunded liabilities have surged to $150bn from $93bn in the last two years. Furthermore suggesting the use of a more realistic 4% rate of return. CalPERS has an unfunded liability of $412bn (or the equivalent of 3 years’ worth of state revenue).  California collects $138bn in taxes annually in a $2.3 trillion economy (around the size of Italy). With over-inflated asset markets and increasingly negative returns on highly rated paper, the growth in unfunded liabilities is even more concerning as any market correction (likely to be severe given such blatant manipulation to date). If the correction is huge it will push the unfunded portion to even more dizzying levels.

US Pension Tracker (USPT) defines its methodology to assess the true mark-to-market value of unfunded liabilities versus actuarial assumptions.

“[We] reflect market pension debt using a discount rate equal to 20-year Treasury yields rounded to the nearest one-quarter percentage point. The yield in 2014 was 3.00%. The use of this discount rate here is intended, as most financial economists agree, to more closely represent market realities and system liabilities.”

USPT assumes that public pension funds have a market based unfunded pension deficit of $4.833 trillion. The actuarial base (using a discount rate of 7.5%) of the pension deficit is approximately $1.041 trillion. This assumes an unfunded portion of $3.8 trillion. Using the 2016 20-year US Treasury bond yield of 1.71% the market based pension deficit explodes to over $8.8 trillion or a $7.5 trillion unfunded portion equating to around $74,000 per American household. For California alone this would push the pension debt per person above $135,000.

This study is a mere snapshot of the state of public pensions in the US. Once again we have a festering problem that is turning gangrenous yet not enough attention is being focused on solutions. The over reliance on authorities to get us out of this economic mess is concerning. Perhaps there is a wish that helicopter money (as B-52 might be more appropriate) will somehow kick off inflation and cut back into these unfunded liabilities. However, we should be careful what we wish for. The risk of duration on the negative yielding debt would wipe out large portions of pension assets making the journey highly challenging not to mention any hyper-inflation risks would reduce the purchasing power of any retirees who got paid their promised distributions. Quite simply there is no easy way out of this and whatever solution is found will involve pain. For all the kicking and screaming in the world, the problem has festered over the past decade and many administrators have chosen not to do anything serious about it. Brace yourselves.

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What Worked Asia - 12 Aug 2016 - Size domintated a little and Quality was hurt this week

What Worked – In China there was a pretty good move into Size this week. Credit China Holdings was up 21% and Semiconductor Manufacturing was up 19%. In Hong Kong it was all about Beta and to a lesser degree Value. Guotai Junan International was up 15% and Shanghai Industrial Holdings was up 13%. In South Korea there was a huge reversal in momentum names, particularly 1-month momentum.  Names that were down over the last month bounced back this week. Yungin Pharm was up 11% and CJ E & M was up 13% this week.

In Singapore there was also a slight move into Size this week. Sinarmas Land Limited was up 8% and Delfi Limited was up 2%. India saw a move into Quality names and away from high beta names. Bombay Burmah Trading was up 19% and Sundram Fasteners was up 22%. Taiwan also saw a slight move into large cap names and a move away from quality. Formosa Petrochemical was up 10% and PChome Online was up 7%. In the Philippines, names with positive EPS revisions did not do well this week. 

Who Moved

260 names moved on volume this week. At the sector level, Consumer Non-Durables and Health Technology picked up a good number of volume spikes. On the positive side, Oishi Group Public was up 29%, Merry Electronics was up 18% and Bombay Burmah Trading was up 19%. On the other side, Phison Electronics was down 15% and Grasim Industries was down 14% and Inox Wind was down 13%.

Summary

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What Worked Australia - 12 Aug 2016 - Reversion in long term momentum

What Worked – Pretty directionless week, with some reversion in the longer term momentum signals, and a pickup in trailing PER. This was, however, one of the first weeks in some time that all value signals managed to produce a positive, albeit weak, IC. Names looking cheap on a trailing PER basis that did well this week included Qantas Airways (QAN, +2.4%), Flexigroup Limited (FXL, +8.9%) and Bendigo and Adelaide Bank (BEN, +7.6%).

Reversion in 12-month momentum saw names that have fared the worst over the last 12 months coming back, including Slater & Grodon (SGH, +16.1%), Mesoblast (MSB, +38.9%) and Horizon Oil (HZN, +4.4%).

Who Moved – Volumes were not particularly good this week, with only 15 names managing to move on higher than normal volumes, and the market as a whole trading -0.2 standard deviations below the 3 month average. Fairfax Media (FXJ, -6.3%), IOOF Holdings (IFL, -5.2%) and Monadelphous Group (MND, -4.0%) faring the worst on strong volume, while Bradken Limited (BKN, +30.9%), Computershare (CPU, +13.7%) and Carsales (CAR, +9.8%) all up on significant volume.

Summary

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What Worked Japan - 12 Aug 2016 - Nothing really. Stuck between Earnings Ending and O-Bon starting

What Worked – Nothing stood out this week except Beta. This is one of those weeks we have come to expect during Earnings season and or during a Holiday. Although this one came at the end of Earnings season and right before O-Bon. High Beta names that did well this week were Brothers Industries (6448) up 28%, Toyo Tire & Rubber (5105) up 25% and DeNA Co (2432) up 21%. All the other factors were basically insignificant.

Who Moved – Despite the lack of conviction in factors, there were still 16 names that moved on volume this week. This is compared to 108 names that moved on volume last week. On the positive side, Brother Industries (6448) was up 28%, COSMOS Pharmaceutical (3349) was up 10% and Sumitomo Warehouse (9303) was up 7%. On the other side, ONO Pharma (4528) was down 15%, Sawai Pharma (4555) was down 8% and Daifuku Co (6383) was down 7%.

Summary

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What Worked Australia - 05 Aug 2016 - Growth off while Beta moving

What Worked – This week saw high growth names flat to market, while the low growth names beat out the index. OP Growth in particular returned its second lowest IC number in over a year, and the non-energy materials space saw a lot of the positive movement. Western Areas (WSA, +8.1%), Santos Limited (STO, +6.2%) and Genworth Mortgage (GMA, +8.3%) all forecasting negative OP growth for the coming fiscal year, and all posting good returns for the week.

In terms of Beta, the names with higher beta where naturally up with the market, while the lower beta names remained relatively flat. Beta itself has had a very good run over the last 6 months generating a spread of +2.0% above the market. High beta names like Whitehaven Coal (WHC, +10.7%), Origin Energy (ORG, +2.0%) and Seven Group Holdings (SVW, +11.5%) all up substantially for the week.

Who Moved – 18 names managed to move on higher than normal volumes this week, with 11 names down and 7 up. On the negative side, Seven West Media (SWM, -22.0%), Nine Entertainment (NEC, -9.6%) and REA Group (REA, -7.6%) all down on very high volume, while MMA Offshore (MRM, +18.6%), Virtus Health (VRT, +1.0%) and Qube Holdings (QUB, +4.1%) all up on significantly higher than normal volumes.

Summary

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What Worked Japan - 05 Aug 2016 - Crazy volume this week as factors move at the extremes

What Worked – Usually during Earning season factors stop working and it is pretty boring. However that is not the case this season and the movements are happening at the extremes and on volume. If you look at the Quintile spreads (top 20% - bottom 20%) you can really see the movements this week. There was a good selloff in names that were up over the last 12 months. The quintile spread is negative 4%. Miura (6005) was down 16%, Morinaga Milk (2264) was down 9% and MEGMILK SNOW BRAND (2270) was down 11%.

High Beta names did well this week with a quintile spread of 3%. Mitsubishi Corp (8058) was up 11%, Mitsubishi UFJ Lease (8593) was up 7% and Rohm (6963) was up 7% this week. Value, particularly high dividend yield and low PBR, also did well this week.  Chiba Bank (8331) was up 6%, Mitsubishi Gas Chemical (4182) was up 5% and Jafco (8595) was up 3%. However, high ROE names saw a pretty good sell off this week. TOTO (5332) was down 16% and Meiji Holdings (2269) was down 13%.

Who Moved – Crazy volume this week. 108 names moved on volume. That is good number of volume spikes for any week and an insane number for Earnings season. 20% of TOPIX 500 moved on volume this week and a third of those were in the Banks. On the positive side, Glory (6457) was up 16%, Familymart (8028) was up 15% and UNY Group0 (8270) was up 15% on strong volume. On the negative side, Nihon Kohden (6849) was down 18%, Ushio (6925) was down 16% and San-in Godo Bank (8381) was down 15%.

Summary

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What Worked Asia - 29 Jul 2016 - Selloff in Value in Korea but nothing really stood

What Worked – Nothing really stood out in China /  Hong Kong. However there was a slight move into size in Hong Kong. Goldin Properties Holdings was up 20% and Wang On Properties was up 13%. Dividend Yield continues to drive the market in Singapore. High dividend yield names have done well in Singapore since the beginning of June. This week Sheng Siong Group was up 5% and Mapletree Industrial Trust was up 5%.

Korea was all about Value this week. Low PBR names that did well were Hyundai Heavy Industries up 17% and Hyundai Mipo Dockyard up 11% this week. In Taiwan there was a good rotation away from low PBR names and into positive EPS revision names. Walsin Technology is up 17% and Realtek Semiconductor is up 7%. 

Who Moved – 204 names moved on volume this week. A good number of the volume spikes came in Taiwan and India. At the Sector level, the Finance and Process Industries Sectors had a number of volume spikes. On the positive side, Jindal Steel & Power was up 23%, Bank Pembangunan Daerah Jawa Barat dan Banten was up 23% and Bangkok Expressway and Metro Public was up 22%. On the other side, Dr. Reddy’s Laboratories was down 18%, Hansae Co was down 13% and Gudang Garam was down 11%.

Summary

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What Worked Japan - 29 Jul 2016 - Value and Beta bounced back this week

What Worked – After a super huge week two weeks ago and then a reversal last week, Value did well again, particularly PE. Low PE names that did well were Zeon Corp (4205) up 16%, Alps Electric (6770) up 15% and NTN Corp (6472) up 10%.  High Beta names acted the same. Two weeks ago high Beta names were super strong, there was a slight selloff last week and then they did well again this week. Tokai Rika (6995) is up 21%, Zeon Corp (4205) is up 16% and SUMCO (3436) is up 13%.

On the other side, there was a slight selloff in size this week. COLOPL (3668) was down 21%, KOMERI (8218) was down 12% and Capom (9697) was down 12%. There was also a selloff in names that were up over the last 12 months. M3 (2413) is down 12% and ONO Pharma is down 8%.

Who Moved – 27 names moved on volume this week. On the positive side, Shin-Etsu Chemical was up 13%, Nidec (6594) is up 10% and Advantest (6857) is up 11%. On the other side, Nintendo (7974) is down 25%, KOMERI (8218) is down 12% and Canon Marketing Japan (8060) is down 10%. All on strong volume. 

Summary

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What Worked Australia - 29 Jul 2016 - Complete reversal of last week

What Worked – This week was almost a complete mirror image of last week with Value once again in play, and longer term momentum signals also strong. PER along with 12 month momentum were both very strong, signals that are normally contradictory to each other. Names that are cheap on a trailing PER basis and have performed well over the last 12 months included Fortescue Metals (FMG, +9.9%), Metcash (MTS, +3.9%) and WPP AUNZ Limited (WPP, +11.6%) – all up this week, while the opposite end of the spectrum saw Cardno (CDD, -1.7%), Origin Energy (ORG, -8.5%) and Santos (STO, -9.3%) all furthering their 12 month losses.

ROIC, along with ROE to a certain extent, have made it 2 weeks in a row as a focus on profitability comes into play. JB Hi-Fi (JBH, +6.3%), Cochlear (COH, +2.7%) and Norther Star Resources (NST, +8.6%) all up this week and all near the top of the market in forecast ROIC.

Who Moved – Only 9 names managed to move this week on higher than normal volumes. On the positive side, Bradken Limited (BKN, +48.4%), Monadelphous Group (MND, +13.2%) and Qube Holdings (QUB, +6.3%) all up, while Asaleo Group (AHY, -9.3%) and Pact Group Holdings (PGH, -5.2%) the only names down on volume.

Summary

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What Worked Asia - 15 Jul 2016 - Size and Value domintated in Asia this week

What Worked – In China it was all about Size this week and to a lesser degree Value. ANTA Sports Products (2020 HK) was up 17% and China Pacific Insurance (2601 HK) was up 13%. Large-cap names also did well in Hong Kong this week and growth names were hurt. Haier Electronics Group (1169 HK) was up 18% and Johnson Electric Holdings (207 HK) was up 12%. Singapore was all about Size and Beta this week. Beta has been one of the strongest factors in the last 6 months in Singapore. Silverlake Axis (SILV SP) was up 7% and Yoma Strategic Holdings (YOMA SP) was up 6%.

South Korea was all about Value, particularly FY1 PE. Kolon (002020 KS) was up 14% and Young Poong (000670 KS) was up 16%. In Taiwan it was also all about Size and to a lesser degree Value. Growth and Beta dominated in the Philippines and in Indonesia high Beta and high Dividend Yield names did well this week.  Vale Indonesia (INCO LJ) was up 29% and Semen Baturaja (SMBR LJ) was up 21%.

Who Moved –  Lot of names moved on volume this week. 211 to be specific. Thailand, Taiwan and India made up a good portion of the volume spikes. At the sector level, Finance and Non-Energy Minerals made up a good number of the volume spikes. On the positive side, Bank Maybak Indonesia (BNII IJ) was up 35%, Godfrey Phillips India (INCO IJ) was up 29% and Dongkuk Steel (001230 KS) was up 21%. On the other side, Yeong Guan Energy Technology was down 14%,TV18 Broadcast was down 11% and Highwealth Construction was down 10%.

Summary

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