Author: Marquette Test

Fragile Five Now Fragile Four?

In 2013, Brazil, India, Indonesia, South Africa, and Turkey were dubbed the “Fragile Five” due largely to high current account deficits and dependence on foreign capital flows. During the “Taper Tantrum”, these currencies were hardest hit recording double digit losses. This week’s chart provides an update on current account balances for each respective country.

In 2013, Brazil, India, Indonesia, South Africa, and Turkey were dubbed the “Fragile Five” due largely to high current account deficits and dependence on foreign capital flows. During the “Taper Tantrum,” these currencies were hardest hit recording double-digit losses. This week’s chart provides an update on current account balances for each respective country.

While the “Fragile Five” have been famously linked together, India has taken steps to distance itself from the group, improving its current account deficit from -5.1% in March 2013 to -1.3% in September of 2014. In addition, markets have praised the election of Narendra Modi as Prime Minister, given his focus on business confidence, economic growth, and structural reform. In sharp contrast, Brazil’s current account balance has declined and its political turmoil has heightened.

With the U.S. preparing to raise rates, emerging market participants are concerned about the possibility of a “Taper Tantrum” repeat. Relative to 2013, India is in a better position to handle such an environment. India’s contrasts with Brazil exemplify a growing trend of divergence within emerging markets, one that investors should expect to continue. Another tantrum will negatively impact the entire asset class, but some countries are better positioned to navigate the turbulence.

Nasdaq: Then and Now

The NASDAQ Composite recently reached 5,000 for this first time since the days of the “tech bubble” back in March 2000. Given that IPO activity has picked up substantially over the last few years, and Silicon Valley is booming again, investors have begun to wonder whether we are witnessing a “tech bubble 2.0”.

The NASDAQ Composite recently reached 5,000 for the first time since the days of the “Tech Bubble” back in March 2000. Given that IPO activity has picked up substantially over the last few years and Silicon Valley is booming again, investors have begun to wonder whether we are witnessing a “Tech Bubble 2.0”. This week’s chart attempts to answer that question by looking at how the NASDAQ in 2000 compares to the NASDAQ today.

Back in 2000, the NASDAQ Composite included over 4,500 listed companies compared to roughly 2,500 companies today. At the beginning of the millennium, companies were commonly going public with no real business plan and often with no revenue and little cash on the balance sheet. As a result, back in 2000, the NASDAQ index as a whole actually had negative earnings.1  Contrast that market environment with today, when the NASDAQ trades around 30x earnings and most new public companies have both revenue and profits. All in all, we aren’t saying there is no bubble, but this time around the fundamentals look much more sustainable.

1The gap in the P/E ratio line on the chart is due to the negative earnings during this time frame.

Has Oil Been Oversold?

Between June 2014 and the end of January 2015, oil experienced a precipitous fall from $107 per barrel to $45 as reduced demand and excessive supply combined to drive its price significantly lower. During that time, the Credit Suisse High Yield benchmark experienced a -3% total return, as 15% of the index is comprised of energy issuers. In February, oil recovered to $52 and the high yield benchmark rebounded by 3%. Given the wide dispersion of projected oil prices, we attempt to gauge how fairly priced both oil and high yield energy bonds currently are, based on the Baker Hughes North America Rotary Rig Count.

Between June 2014 and the end of January 2015, oil experienced a precipitous fall from $1071 per barrel to $45 as reduced demand and excessive supply combined to drive its price significantly lower. During that time, the Credit Suisse High Yield benchmark experienced a -3% total return, as 15% of the index is comprised of energy issuers. In February, oil recovered to $52 and the high yield benchmark rebounded by 3%. Given the wide dispersion of projected oil prices, we attempt to gauge how fairly priced both oil and high yield energy bonds currently are, based on the Baker Hughes North America Rotary Rig Count.

The Baker Hughes North America Rotary Rig Count is an important business barometer for the oil and gas industry because it tracks active oil drilling rigs and serves as a leading indicator for the demand for oil and gas products and services. The rig count nosedived from 1,931 at the end of September 2014 to 1,267 at the end of February 2015, a period of just five months.

This week’s chart divides the price of oil by the rig count. By doing this, we can see how overpriced or underpriced oil is in the context of active rigs. The blue line shows that oil was generally overpriced over the last six years and is now somewhat cheaply priced as it falls below its average shown by the dotted blue line; the significant reduction in rig count has helped to improve this ratio. The green line shows the spread of energy bonds in the Credit Suisse High Yield benchmark divided by the same rig count. It currently sits above its average, suggesting that perhaps energy high yield bonds have been oversold, and may offer a buying opportunity for value-driven investors.

1As measured by West Texas Intermediate crude, the benchmark for oil prices in the United States.

3Q15 Rate Hike and Yield Curve Flattening Expected – Marquette Associates Survey

February 2015 Investment Perspectives

Consensus among market prognosticators is that the Federal Reserve (“Fed”) will raise interest rates this year. However, there is less agreement about when rates will start to rise, as well as how the shape of the yield curve will shift as rates start to ascend. To gain a better sense of when the rate hike can be expected to begin as well as how the shape of the yield curve is expected to change, we surveyed 41 fixed income investment management firms, large and small, for their best estimates based on the current market environment. In addition, we collected responses on when to expect a major credit spread widening, i.e., when we should expect major defaults from corporate bond issuers given the re-leveraging that has taken place over the last eight quarters. We also obtained from the respondents their expectation as to which region of the world might provide the best fixed income returns in 2015.

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Emerging Trend in the Labor Force?

As of January 2015, the headline unemployment rate (U-3) stood at 5.7%. Since hitting a recession high of 10% in October 2009, this headline rate has steadily fallen to pre-financial crisis levels. However, headline unemployment is but one of many measures used by the Bureau of Labor Statistics to gauge the health of the labor market since one single measure can’t possibly tell the whole story.

As of January 2015, the headline unemployment rate (U-3) stood at 5.7%. Since hitting a recession high of 10% in October 2009, this headline rate has steadily fallen to pre-financial crisis levels. However, headline unemployment is but one of many measures used by the Bureau of Labor Statistics to gauge the health of the labor market since one single measure can’t possibly tell the whole story.

While the percentage of those officially counted as unemployed has fallen, that decrease also accounts for changes in the amount of those classified as marginally attached to the labor force (those who have stopped looking for work but still want a job) as well as workers employed part-time for economic reasons (those working part-time and unable to find full-time employment). The broadest measure of unemployment (U-6), which includes these two categories, was 11.3% in January.

Part-time workers as a percentage of the labor force have improved slightly over this time period, but not nearly as much as the headline rate has. There is a multitude of possible reasons for the increase and slower decline in part-time workers for economic reasons. Possible reasons include job-seekers lacking the skill sets that employers require, employers being more selective and/or hesitant to add new staff following the Financial Crisis, and the effect of the Affordable Care Act’s 30-hour threshold rule to be considered a full-time employee and receive health coverage. The trend of higher part-time workers as a percentage of the labor force bears watching as this may be part of a secular trend in the labor market.

Do Liquid Alternatives Deserve the Hype?

Liquid alternative assets, as defined by Morningstar, have continued to grow since 2009 and by the end of 2014, reached nearly $158 billion, up 11% from the previous year. The top 2014 fund flows within Morningstar’s liquid alternative category were concentrated across multi-alternatives (+$9.8B), long/short equity (+$6.5B), and managed futures strategies (+$2.3B).

Liquid alternative1 assets, as defined by Morningstar, have continued to grow since 2009 and by the end of 2014, reached nearly $158 billion, up 11% from the previous year. The top 2014 fund flows within Morningstar’s liquid alternative category were concentrated across multi-alternatives (+$9.8B), long/short equity (+$6.5B), and managed futures strategies (+$2.3B). Additionally, multi-alternative flows have already totaled $1 billion in the first month of 2015, continuing to lead all other categories.

Before jumping on the bandwagon, it is important to take a step back and analyze how some of the liquid alternative strategies have performed compared to their private counterparts. Although not an exact apples-to-apples comparison, this week’s chart of the week compares the growth of $1 since January 2000 of the HFR equity hedge index (private) vs. the Morningstar long/short category (liquid). Interestingly, while the liquid long/short equity strategies outperformed private HFR equity hedge from early 2001 through mid-2003, private funds have beaten their liquid counterparts by a significant margin over the long run. Although liquid alternatives offer an attractive liquidity profile, they come with all the restrictions of a 40 Act mutual fund which limit illiquid holdings and leverage. When it comes to investing in alternative strategies, this is one reason we believe that private vehicles are most appropriate for institutional investors.

1Liquid alternatives encompass non-traditional investment strategies or asset classes (beyond equities and bonds) such as REITs, MLPs, commodities, currencies, distressed debt, or hedge fund strategies in a mutual fund format.

Is the Bull Market in U.S. Equities Running Out of Steam?

Since the current bull market began in March 2009, the S&P 500 has posted an annualized return of 19.5%. During that time period, the trailing 12 month price to earnings ratio (P/E ratio) of the S&P 500 has increased from 14.2 to 18.1 (an increase of 27%). Over that same period, the trailing 12 month price to sales ratio (P/S ratio) has increased from 0.8 to 1.8 (an increase of 118%).

Since the current bull market began in March 2009, the S&P 500 has posted an annualized return of 19.5%. During that time period, the trailing 12-month price to earnings ratio (P/E ratio) of the S&P 500 has increased from 14.2 to 18.1 (an increase of 27%). Over that same period, the trailing 12-month price to sales ratio (P/S ratio) has increased from 0.8 to 1.8 (an increase of 118%). The current P/E ratio of 18.1 is below the 20-year average P/E ratio of 19.2 but above the longer-term average P/E ratio of 16.7. The current P/S ratio of 1.8 is greater than the 20-year average P/S ratio of 1.5 and is higher than it has been at any point since 2000.

As seen in the chart, the P/S ratio has grown at a much steeper rate than the P/E ratio during the past few years. Over this period, the growth in earnings per share of the S&P 500 has significantly outpaced the growth in sales per share. This tells us that cuts to bottom line expenses — not growth in top line revenues — have been the primary driver of earnings growth. It is fairly typical for this scenario to occur, especially in the early stages of a bull market, as companies tend to cut expenses in order to remain profitable following downturns in the economy. However, in order for earnings growth to be sustained over longer periods of time, there needs to be a pickup in sales growth, as there are limits to expenditure cuts. This is especially concerning because current forecasts indicate that the market expects negative sales growth for both the first and second quarters of 2015. To be sure, this may just be a statistical quirk caused by the significant drop in oil prices in recent months, but it bears monitoring nonetheless.

The End for Non-U.S. Equities?

Since 2009, the S&P 500 has been on a historic run with six straight calendar years of positive performance, producing an annualized return of 17.2%. Meanwhile, the MSCI EAFE index has failed to keep pace during the same time period, thus leaving many investors to question their non-U.S. equity allocations.

Since 2009, the S&P 500 has been on a historic run with six straight calendar years of positive performance, producing an annualized return of 17.2%. Meanwhile, the MSCI EAFE index has failed to keep pace during the same time period, thus leaving many investors to question their non-U.S. equity allocations. This week’s chart examines the historical performance of these two indices over the last thirty plus years.

Since October 1982 the S&P 500 and MSCI EAFE have taken turns as the leader, each going on significant bullish runs. Between 2000 and 2007, international equities (7.7%) outperformed domestic stocks (1.4%). Since then, the S&P 500 has returned the favor, beating by nearly 7% on an annualized basis. The data shows that long periods of outperformance have been a common occurrence for both indices. However, this does not assure the imminent resurgence of international equities since past performance does not guarantee future results. Similarly, investors should note that the recent run by U.S. stocks does not mark the end for non-U.S. equities.

Is Student Debt Stifling Growth?

The total amount of student loans outstanding has grown from approximately $500 billion in 2006 to $1.3 trillion at the end of 2014. Of the $1.3 trillion in student loans outstanding, approximately $1.1 trillion are either direct loans from the U.S. Department of Education or outstanding loans from the now terminated Federal Family Education Loans Program (FFEL). The remaining $190 billion can be attributed to private loans.

The total amount of student loans outstanding has grown from approximately $500 billion in 2006 to $1.3 trillion at the end of 2014. Of the $1.3 trillion in student loans outstanding, approximately $1.1 trillion are either direct loans from the U.S. Department of Education or outstanding loans from the now terminated Federal Family Education Loans Program (FFEL). The remaining $190 billion can be attributed to private loans.

There are several reasons that have contributed to the rise in the amount of student loans outstanding: overall college/advanced degree enrollment has increased over the past decade, cost of higher education has increased, graduates pre-recession have had a difficult time repaying their obligations, and as a result of the recession, students are relying on financial aid more heavily.

This week’s chart illustrates the portfolio of direct and FFEL loans by their loan status at the end of 2014. We focus on the categories described as Deferment, Forbearance, Default, and Other (see glossary below). These categories represent over 30% of the loan portfolio and are considered the highest risk categories because payments have been postponed, suspended, or ceased completely.

The pace of the economic recovery has been muted for a multitude of reasons; however, the overwhelming student debt load that has accumulated over the past decade has only exacerbated the problem. Studies have shown that people with student loans are less likely to start businesses of their own, which leads to less job creation and investment. Young Americans are delaying marriage and household formation which leads to a decrease in consumption. Additionally, holders of student debt are delaying the purchase of their first home.

It’s difficult to say if the recession and increase in student loans is a cause and effect relationship or vice versa, but most Americans can agree that some reform is necessary with regard to the cost of tuition or the cost of debt. If neither is addressed, we may continue to see the high risk categories discussed earlier increase as a percentage of debt outstanding, thus further depressing economic growth.

 

Glossary:
In-School – Includes loans that have never entered repayment as a result of the borrower’s enrollment in school.
Grace – Includes loans that have entered a six-month grace period after the borrower is no longer enrolled in school at least half-time. Borrowers are not expected to make payments during grace.
Repayment – Includes loans that are in an active repayment status.
Deferment – Includes loans in which payments have been postponed as a result of certain circumstances such as returning to school, military service, or economic hardship.
Forbearance – Includes loans in which payments have been temporarily suspended or reduced as a result of certain types of financial hardships.
Default – Includes loans that are more than 360 days delinquent.
Other – Includes loans that are in non-defaulted bankruptcy and in a disability status.

Europe’s QE: Better Late than Never?

The European Central Bank (ECB) announced Thursday it will begin a quantitative easing (QE) program in which it will buy €60 billion worth of assets a month. The program, which will commence in March and continue through September 2016, will purchase both government and private sector bonds as well as other institutional debt securities. This move comes after the U.S. and U.K. have ended their own QE programs following declining unemployment and modest GDP growth.

The European Central Bank (ECB) announced Thursday it will begin a quantitative easing (QE) program in which it will buy €60 billion worth of assets a month. The program, which will commence in March and continue through September 2016, will purchase both government and private sector bonds as well as other institutional debt securities. This move comes after the U.S. and U.K. have ended their own QE programs following declining unemployment and modest GDP growth.

Though there are a wide variety of opinions on the effectiveness — and consequences — of QE, the ECB hopes it will be the economic jump start that many of the countries in the Eurozone desperately need. The most recent GDP growth for the region was 0.8%, while unemployment was 11.5%. Additionally, the latest IMF forecast gave the Euro Area a 38% chance of falling into another recession. But the most troubling issue for the Eurozone is its inflation rate, which fell to -0.2% in December. Deflation can make it more difficult to pay back debt, which is especially worrisome for countries such as Greece, Italy, and Spain that have debt exceeding 100% of GDP. If the ECB is successful in achieving its 2% target inflation, this, in theory, would lead to further devaluation of the Euro, which has already fallen over 17% against the U.S. dollar since the start of last year.

How QE will affect the different parts of the Eurozone is difficult to predict. Unlike other QE programs, this one spans multiple countries and banking systems, some of which are opposed to this monetary policy. Stronger economies, such as Germany, warn that this shouldn’t be used as a method to avoid structural reforms while others feel the move was long overdue. Either way, with the threat of a third recession since 2008 looming, Europe appears to be left with little choice.