Rules for Investors with UNG and GLD

[Joshua Brown]

361 Capital portfolio manager, Blaine Rollins, CFA, previously manager of the Janus Fund, writes a weekly update looking back on major moves, macro-trends and economic data points. The 361 Capital Weekly Research Briefing summarizes the latest market news along with some interesting facts and a touch of humor. 361 Capital is a provider of alternative investment mutual funds, separate accounts, and limited partnerships to institutions, financial intermediaries, and high-net-worth investors.

361 Capital Weekly Research Briefing
December 16, 2013
Timely perspectives from the 361 Capital research & portfolio management team
Written by Blaine Rollins, CFA

[Joshua Brown]

Tuesday links: die-hard discipline

?Tis the season. From Science Friday some science book picks from 2013 including Clive Thompson?s Smarter Than You Think: How Technology is Changing Our Minds for the Better.

Quote of the day

Rick Ferri, ?Multi-factor investing isn?t for tourist investors. The strategy requires die-hard discipline, which means a complete understanding of all risks.? (Rick Ferri)

Chart of the day

[Joshua Brown]

In the aftermath of the Fed?s first hint at tapering this past spring, mortgage rates shot up a bit along with the entire complex and the narrative was that the Fed just opened its stupid mouth too soon and staked the housing recovery right through the heart. ?That?s the end of the cycle,? we were told. The new home sales data softened concurrent with the rise in mortgage rates and the pundits drew a line between A and B to explain it.

But just-released data from the month of October tells us we may have been premature ? it could be that the housing market is digesting these (minimally) heightened rates and plowing on ahead. If this is the case, there are positive implications for the rest of the economy as QE begins to unwind ? an affirmation that we can, in fact, tolerate rising rates without stumbling.

Here?s Bank of America Merrill Lynch?s US Economics team this morning:

New home sales: Sales of new single-family homes climbed 25% in October, reversing the weakness in summer and early fall. This mini-downturn in sales was seemingly in response to the spike in mortgage rates this spring and the gain in October suggests it was transitory.

[Joshua Brown]

There is a dangerous malady sweeping the United States.

According to the Centers for Disease Control and Prevention, over a third of American adults -- more than 72 million people -- suffer from this ailment. It is a well-known cause of killers like heart disease, stroke, certain cancers and Type 2 diabetes.

Unfortunately, here in the U.S., many aspects of advertising and the general culture actually seem to promote this condition, even though it costs Americans an estimated $147 billion in annual medical costs -- nearly 10% of all U.S. medical spending. The American Heart Association has gone so far as to call this issue an epidemic and has projected that 44% of the U.S. population may be afflicted with this condition by 2030.

If you haven't guessed, I'm referring to obesity. While the causes of this malady are many, society does little to curtail the constant promotion of factors that eventually result in an obese population. High-fat and high-sugar foods are not only usually among the least expensive, they are the most readily and easily available, not to mention the most heavily advertised.

Fortunately, many companies are focused on solving the obesity epidemic. The leading names in this space are Nutrisystem (Nasdaq: NTRI), Medifast (NYSE: MED) and Weight Watchers International (NYSE: WTW). Out of these three, I think Weight Watchers will make the best investment for 2014.

I can hear some of you now: "Are you kidding me? Shares have plunged nearly 50% this year, and the chart looks absolutely terrible." Well, you are 100% correct -- but that's the reason I like the stock right now. Let me explain.

Founded in 1961, Weight Watchers is an international health-oriented company that provides nutritional, exercise and behavioral modification tools to facilitate weight loss. The company boasts more than 1 million members who attend weekly meetings, and consumers spent over $5 billion on Weight Watchers branded products and services in 2012.

Given the current obesity epidemic, one would assume that Weight Watchers would be a thriving business. However, the company's stock price has been in a downward spiral. In the third quarter, revenue dropped 8% from a year ago, to just below $394 million, but still beat consensus estimates of just under $387 million. In addition, earnings per share came in at $1.07 for the quarter, beating consensus estimates of $0.83.

Weight Watchers has been hurt by a decline in the number of subscribers, a result of the availability of free smartphone applications that provide similar weight loss guidance. However, it's important to note that despite offering online community encouragement, those free apps don't provide the critical one-on-one counseling that Weight Watchers does.

Weight Watchers recently took the bold step of suspending its dividend in an effort to increase liquidity. In addition, the company recently appointed a new technology officer and president to bring fresh ideas, and a new CEO took the helm in August.

In my view, Weight Watchers needs to overhaul its marketing and integrate technology into personalized programs. Combining the constant reminder of a smartphone app with weekly personal meetings would create a powerful weight loss system. Remember, the personalized network of meetings and advisors is what sets Weight Watchers apart. Competition will have a difficult time replicating this network.

The new management remains decidedly downbeat into 2014. CEO James Chambers said, "While we are working aggressively on both near-term commercial activities and longer-term strategic initiatives, 2014 will be a very challenging year."

I think due to its strong branding and unique value proposition of the support network, Weight Watchers' share price will soon turn around. In addition, the technical picture is indicating an approaching oversold condition and support in the $31 range.

[Joshua Brown]

While December 2013 may seem like a pretty quiet end to a strong year for U.S. stocks, the VIX is actually on a tear thus far through the month. It closed out November at 13.70, and is up some 17% since then to close at 16.03 today. Against the average decline of 3.1% we noted, that?s a visible bump. And considering that the typical move from now through year end is another 1.1% increase, it looks like the rally in expected volatility may be around to ring in the New Year.

Is volatility on the rise? You?d never know it unless you were looking at the Vix itself ? the market commentary of late is quite complacent with only tomorrow?s Fed meeting standing in our way of closing out the year quietly.

And yet vol is having a big month, unbeknownst to most.

Here?s Nicholas Colas, chief market strategist at ConvergEx Group with his take on what we could be seeing:

The historically anomalous move for the VIX in December 2013 forces one question to the fore: is this the beginning of a return to more ?Normal? volatility, or just some year-end insurance buying by active managers looking to lock in their gains? There are good arguments for both camps:

We?ve experienced a remarkably quiet year for volatility in U.S. stock markets, and even at its current reading of 16 the CBOE VIX Index is still well below its long run average of 20. We chalk that up to the Federal Reserve?s interest rate and Quantitative Easing policies. Aside from a few weeks of doubt in June, these have been the market?s best friend and constant companion throughout 2013.

How long will the Federal Reserve and equity markets be able to hold onto their friendship? That?s the question for 2014, and it makes sense that options investors would want to hedge their portfolios ahead of Wednesday?s FOMC meeting as well as those in Q1 2014. It has been a great run from the lows in March 2009, equity valuations are fair (if not a little full), economic fundamentals are only slowly improving (and about time, too) and corporations are not yet fully out of their foxholes and hiring.

Of course you?d start to hedge with options ? makes all the sense in the world.
At the same time, there is a strong correlation between the year-to-date performance for the sectors and asset classes in our study and the recent moves in their Implied Vols. Options players aren?t bidding up the VIX for gold or silver because, well, who cares about precious metals these days? Same for corporate bonds for that matter.

Given this relationship between performance and Implied Vol, it is equally easy to write off this year-end rally in the ?VIX of? winning equity sectors and market caps to risk aversion in the final days of the year.

You?ve had a great year ? of course you?d hedge out your risk. Makes all the sense in the world.

The truth is BOTH these explanations resonate. Volatility got way too cheap ? and complacency too high ? in 2013. There?s a great temptation in market commentary to call everything either a ?Bubble? or a ?Generational low?. Life rarely hit such extremes, so I am reluctant to hitch my wagon to either train too often. Still, reversion to the mean ? in this case ?20? on the VIX ? is a powerful force in life and markets. As old time TV detective Baretta used to say, ?You can take that to the bank.?

[Joshua Brown]

I don?t know that the retail investor matters anymore. They didn?t come back to the market after the 2000 crash. The idea that the individual investor believes in the stock market now is challenged. We have a market that is increasingly institutional investors trading back and forth with each other?, said Dan Greenhouse, chief global strategist at BTIG.

[Joshua Brown]

I rely on hundreds of ?moles? around the world whose job it is to watch a single, but important indicator for the world economy. One of them checks for me the want ads in the manufacturing mega city of Shenzhen, China, and what he told me last week was alarming.

Wage demands by Chinese workers have been skyrocketing this year. The biggest increases have been at the low end of the spectrum, where migrant workers from the provinces are earning up to 40% more than a year ago. Wage settlements of 20% or more for trained workers are common. One factory that gave staff only a 10% increase saw many of them fail to return after the recent Chinese lunar New Year.

Of course China?s blistering 8% GDP growth is the cause, which has pushed inflation well beyond the government?s 4% target. So the cost of living in the Middle Kingdom is rising dramatically. The problem has been particularly severe with imported commodities, such as in food. Hence, the increased demands.

This is important for the rest of us because low wages have been the cornerstone of the Chinese economic miracle. In just the last decade, average monthly Chinese wages have climbed from the bottom rung to the middle tier. That seriously erodes the country?s cost advantage, which has gained it such enormous shares in foreign markets, like the US. Take away the country?s price advantages, and demand will wither, slowing growth globally.

What will they be demanding next? Collective bargaining rights? In the meantime, keep checking those Craig?s List entries for Shanghai.

Average Monthly Salary
$3,099 Yokohama, Japan
$1,220 Seoul, South Korea
$888 Taipei, Taiwan
$235 Shenzhen, China
$148 Jakarta, Indonesia
$100 Ho Chi Minh City, Vietnam
$47 Dhaka, Bangladesh