Author: Marquette Test

Rising Gold Prices Fail to Benefit Gold Mining Companies

This week’s Chart of the Week compares gold prices to the MSCI ACWI Select Gold Miners Index. Typically, most investors would expect gold mining company returns to closely track those of gold prices.

This week’s Chart of the Week compares gold prices to the MSCI ACWI Select Gold Miners Index. Typically, most investors would expect gold mining company returns to closely track those of gold prices. Perhaps surprising is that our chart shows that since 2010, gold prices have increased 52% while the gold miners index is down 8% over the same time-period.

Theoretically, gold mining company and gold returns should be relatively similar. In reality, though, there are many factors that cause a divergence between the two prices. For example, many mining companies will hedge a portion of their underlying commodity exposures, thus causing their earnings to vary. In addition, there are large capital costs involved with mining gold which can prevent a company from realizing the full benefits of rising gold prices.

Despite the continued lag in performance, gold miners appear attractively priced with a forward P/E ratio of 9.591. However, this week’s chart illustrates that investing directly in the bullion is the only way to ensure investors receive pure exposure to gold’s returns.

1 MSCI

Interest Rates the Fertilizer for Farmland Prices?

This week’s chart of the week looks at the growth in mid-west farmland prices. Our chart shows the increase in farmland prices in Illinois, Indiana, Iowa and the Federal Reserve 7th District, which includes all three of these states.

This week’s chart of the week looks at the growth in mid-west farmland prices. Our chart shows the increase in farmland prices in Illinois, Indiana, Iowa and the Federal Reserve 7th District, which includes all three of these states. While this may surprise many investors, mid-west farmland has been one of the best performing investments over the last decade, up 12.3% annually. Higher crop prices and a shrinking supply of available high quality farmland drove this increase in farmland prices. Since both of these trends seem likely to persist into the future, institutional investors have begun to invest in farmland to take advantage of these trends. However, as our chart shows, the other driver of higher prices has been the persistent fall in interest rates which lowers the carrying costs (i.e. interest payments) of owning farmland for both farmers and investors. Given the recent rise in interest rates over the last few months it seems reasonable to question if farmland prices can continue their upward trajectory without the benefit of further reductions in interest rates.

Interest Rates Jump in 2013

This week’s chart is relatively straightforward but reflects some potentially powerful messages for institutional investors. As plainly seen from the chart, 2013 to date has seen a continued run-up in the equity markets (red line): as of February 7, the S&P 500 has returned 5.8% for the year.

This week’s chart is relatively straightforward but reflects some potentially powerful messages for institutional investors. As plainly seen from the chart, 2013 to date has seen a continued run-up in the equity markets (red line): as of February 7, the S&P 500 has returned 5.8% for the year. While this is good news for all investors, it is the jump in interest rates that holds more of a mixed message for investors.

Since the end of 2012, interest rates (as measured by the yield on the 10-year Treasury) have increased by about 22 basis points, a notable jump that led to losses for most core bond strategies. If the equity markets continue their upward trend, we expect further upward movements in interest rates, which will be dilutive for bond investors. Adding some exposure to floating rate bonds (such as bank loans) may help to offset these rate increases.

However, higher interest rates are not all bad news. Pension funds that report liabilities at market rates (primarily corporate plans) actually saw their funded ratios increase as a result of higher rates, given the relative mismatch between the durations of their assets and liabilities.

Is Risk Parity Right for Your Portfolio?

February 2013 Investment Perspectives

Driven by volatile equity markets, falling interest rates, and heightened aversion to portfolio losses, interest in risk parity has skyrocketed over the last three years. Unfortunately, the risk parity investment thesis is not always understood by investment committees and trustees, which can contribute to sub-optimal portfolio decisions. In the following newsletter, we address the salient points of risk parity to help educate investors so they can determine if it is an appropriate allocation for their portfolios.

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No Longer the Apple of Investor’s Eye

Apple (AAPL) shares dropped 12% last week after a disappointing earnings report and are down 37% from their September 2012 peak.

Apple (AAPL) shares dropped 12% last week after a disappointing earnings report and are down 37% from their September 2012 peak. As our Chart of the Week shows, after the recent fall in shares of Apple, Exxon Mobil (XOM) is once again the largest company in the S&P 500 index. Apple’s market capitalization first surpassed Exxon’s on August 10, 2011 and at one point Apple’s market capitalization was 57% larger than Exxon’s. Investors that own Apple through a passively managed index are likely to find that their exposure has shrunk considerably over the last few months.

Attractive Level for Bank Loan Discount Margin

This week we look at the historic three year discount margin for bank loans. Bank loans provide a source of financing for public and private corporations as well as private equity firms. They are a floating rate debt obligation generally linked to LIBOR and typically callable with few or no penalties.

This week we look at the historic three year discount margin for bank loans. Bank loans provide a source of financing for public and private corporations as well as private equity firms. They are a floating rate debt obligation generally linked to LIBOR and typically callable with few or no penalties. In comparison to investment grade bonds, bank loans have higher credit and liquidity risk, but lower interest rate risk. In a low rate environment, floating coupons can be attractive to investors.

In 2008 and 2009 liquidity issues caused bank loan prices to drop drastically. This can be seen in the chart, as the price drop drove the three year discount margin to all time highs. Since then, liquidity has improved and the discount margin has come down. In 2012 we saw the discount margin fall from 656 bp to 555 bp. Even with the pronounced decline from 2009, discount margins are still above the long term median of 387 bp. This spread appears to be an enticing option for investors looking to decrease interest rate risk. The discount margin also compares favorably with high yield bonds, and based on early data, institutional investors have begun to swap high yield investments for bank loans.

2013 Market Preview

January 2013 Investment Perspectives

In the following articles, we will take a closer look at critical issues for each asset class in 2013. Each article contains insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered. Articles are offered for the following asset classes: fixed income, U.S. equities, non-U.S. equities, hedge funds, real estate, private equity, and infrastructure.

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Is Forward P/E Ratio a Good Predictor for Market Returns?

Today’s Chart of the Week looks at the historic level of the S&P 500 Index relative to the forward estimated price-to-earnings (“P/E”) ratio of the S&P 500 from January 1, 2006 to January 15, 2013. The purpose of this chart is to see whether or not the forward looking P/E ratio can predict performance of the index.

Today’s Chart of the Week looks at the historic level of the S&P 500 Index relative to the forward estimated price-to-earnings (“P/E”) ratio of the S&P 500 from January 1, 2006 to January 15, 2013. The purpose of this chart is to see whether or not the forward looking P/E ratio can predict performance of the index. The P/E ratio compares the value of the share price to estimated earnings per share over the subsequent year. A higher P/E suggests that the market may be approaching a downturn, while a lower P/E may represent a buying opportunity and potential for market gains. Over the last seven years, the forward P/E ratio has averaged 12.5 (depicted in green).

The correlation between forward P/E ratio and the following one year return has been negative, which is to be expected: as suggested above, lower P/E ratios are typically followed by a rising market, while higher P/E ratios have predicted negative returns. Looking at the chart, we see that this basic intuition is supported: low P/E ratios are followed by rising markets. However, the correlation has not been especially strong, with a value of -.39 for the seven years studied in this analysis. More importantly, the correlation has not been stable over this time period, thus making the reliance on forward P/E ratios to predict market performance relatively useless. Certainly, outliers of this ratio – such as its extreme low value on March 9, 2009 (the date that the market bottomed following the financial crisis) – have been useful indicators of extreme market conditions, but they have not proven to be a consistent market predictor.

Therefore, inference of 2013 stock market performance based upon the most recent figure of 11.9 (below the long term average of 12.5) is not meaningful. As much as we would like to extract a precise prediction for the following year’s stock market performance, the relationship between the two variables is not strong enough to predict future performance.

Projected Trends in Employment

This week’s Chart of the Week shows projected trends for non-agriculture employment in the U.S. by major industry sectors over the 2010-2020 timeframe. Every two years, the Bureau of Labor Statistics (BLS) estimates labor force trends over a 10-year period.

This week’s Chart of the Week shows projected trends for non-agriculture employment in the U.S. by major industry sectors over the 2010-2020 timeframe. Every two years, the Bureau of Labor Statistics (BLS) estimates labor force trends over a 10-year period. BLS employment estimates are based on projected changes in both population growth and labor force participation rates within U.S. demographic groups.

Notable employment changes during this time include health care and social assistance (5.6 Mil), professional and business services (3.8 Mil), and construction (1.8 Mil). Nearly half of the projected job growth during 2010-2020 is expected to come from health care / social assistance and professional and business services. Despite strong projected growth in the construction industry, employment is not expected to reach pre-recession levels. Federal government employment is expected to lose approximately 370K jobs with nearly half of those reductions coming from the Postal Service.

The latest release, from February 2012, reflects key demographic changes taking place in the U.S. over the next 10 years. A slower rate of growth within the U.S. population, the continued aging of the baby-boom generation, and decreases in labor force participation rates are expected. These changes will have an effect on both the rate of growth within the U.S. economy as well as which industries will be the driving force of that growth.

Labor Force Participation Rate

Last week, The Federal Reserve agreed to continue purchasing mortgage backed securities, expanding its holdings of Treasury securities and keeping short-term interest rates near zero until the unemployment rate is below 6.5% and inflation remains under 2.5%.

Last week, the Federal Reserve agreed to continue purchasing mortgage backed securities, expanding its holdings of Treasury securities and keeping short-term interest rates near zero until the unemployment rate is below 6.5% and inflation remains under 2.5%.

The unemployment rate has declined from 8.5% at the end of 2011 to 7.7% as of November 2012. On average, the economy has added approximately 150,000 jobs per month in 2012. While 150,000 jobs is a positive figure, it has not been the only driver in reducing the unemployment rate. A drop in the labor participation rate has been the other factor in the declining unemployment rate.

The chart above illustrates the labor force participation rate from January 1948-November 2012. Note that the rate grew precipitously from the 1960’s through the late 1990’s based upon the secular trend of women entering the workforce. Cyclical changes such as recessions have traditionally led to declines as unemployed workers temporarily leave the workforce.

In December 2007, the participation rate was 66%; today it is 63.6%. Now that the Federal Reserve has tied its economic policies to specific unemployment figures, it is difficult to determine if the labor force participation rate declines are cyclical or secular changes. Are the declines due to the baby boomer generation retiring or the younger population staying in school longer? Conversely, are the declines due to a disproportionate amount of discouraged workers who have given up on the job search?

According to the Bureau of Labor Statistics, there are 12 million unemployed and 2.5 million marginally employed. Depending on if and when the marginally employed begin searching for jobs, there may be an uptick in unemployment if job growth cannot accommodate their reentrance and population growth. Given these facts, it may be difficult for the Federal Reserve to achieve its goal of 6.5% unemployment by 2015 without an uptick in the economy.