Category: Chart of the Week

UK: Should I Stay or Should I Go?

This week’s chart looks at polling information for the UK Referendum scheduled on June 23rd. On that day voters will decide whether or not to remain in the European Union.

This week’s chart looks at polling information for the UK Referendum scheduled on June 23rd. On that day voters will decide whether or not to remain in the European Union. Taking inspiration from last year’s “Grexit”, the market has appropriately named this potential event as the “Brexit.” The chart shows a Bloomberg composite indicator which takes an average of polling data from several surveys. The most recent results report 41% in favor of remaining, 40% in favor of leaving, and 19% undecided, suggesting a very close vote. The odds-makers, however, place the chance of the “Brexit” around 35%. In terms of economic consequences, it is hard to predict exactly what would happen should the “Brexit” occur, but in general, investors can expect to see a weaker pound, reduced business investment, and weaker economic growth with some spillover effects to the Eurozone. This is an event worth watching as it will likely have some influence on short-term market performance leading into the summer.

A Continued Shift from Active to Passive in U.S. Equities

This week’s Chart of the Week examines the ongoing shift from actively managed to passively managed U.S. equity allocations. While active investing has historically been the predominant form of portfolio management, investors are increasingly recognizing that passive strategies are an efficient manner of capturing market beta.

This week’s chart examines the ongoing shift from actively managed to passively managed U.S. equity allocations. While active investing has historically been the predominant form of portfolio management, investors are increasingly recognizing that passive strategies are an efficient manner of capturing market beta. Within U.S. equities, the theme of fund flows migrating from active to passive has been dramatic over the past several years. Since 2007, passive strategies benefited from consistent fund inflows while active strategies continually dealt with fund outflows. With the exception of 2013, actively managed U.S. equity strategies saw net fund outflows over every calendar year since 2007. This trend continued during the first quarter of 2016 with outflows from actively managed U.S. equity strategies totaling $44.7 billion and flows of passively managed strategies gaining $27.1 billion.

Investors often view U.S. equities as an efficient asset class for which the case for passive management is the most compelling. Based on fund managers’ stated prospectus benchmarks, only 21% of large-cap U.S. equity funds who benchmark against the Russell 1000 index outperformed their index over a trailing 10-year period. Within small-cap where informational inefficiencies are greater, 52% of funds who benchmark against the Russell 2000 index outperformed their index over a trailing 10-year period. Given that the majority of actively managed funds often underperform their stated benchmarks and charge higher fees in the process, it should come as no surprise that investors are gravitating toward passively managed funds. While active managers who can generate excess returns over time are certainly desirable, identifying those consistent generators of alpha can be quite challenging, especially for efficient markets like U.S. large-cap equities.

Any Good Deals Out There in the U.S. Equity Market?

Given the current market environment right now, there are no real compelling “buy” opportunities, as measured by a variety of valuation metrics. On top of that, economic growth is slow, yields are low, and equity returns are weak. As such, one of the primary conversations we have with clients is around rebalancing, both at the broader asset class as well as between the underlying components of each asset class.

Given the current market environment, there are no real compelling “buy” opportunities as measured by a variety of valuation metrics. On top of that, economic growth is slow, yields are low, and equity returns are weak. As such, one of the primary conversations we have with clients is around rebalancing, both at the broader asset class as well as between the underlying components of each asset class. In particular, we have recently spent a lot of time discussing the relative valuations of large-cap and small-cap U.S. equities in an effort to identify the more attractive opportunity in today’s market.

In this week’s chart, we examine the P/E ratios of U.S. large-cap and small-cap stocks and compare today’s values to their 20-year averages, removing outliers for when earnings are near zero or negative. The intuition is that the farther today’s P/E ratio is from the long-term average, the more (or less) attractive it is from a valuation standpoint: a reading below the long-term average signals a discounted price, whereas a reading above the long-term average indicates the index is expensive. As seen in the chart, both are near their historical averages, suggesting there isn’t an overly compelling case for either.

How they have gotten to this point over the last 2–3 years, though, is very different. Large-cap companies have slowly returned to this average as a result of investor caution as well as the gradual — but consistent — rise in earnings from 2011 to 2015. Recently though, earnings have slightly fallen for larger companies, which has caused some concern for investors. Small-cap stocks, on the other hand, feature more volatile valuations, with swings in earnings the primary explanation of volatility. In theory, during times of “risk-off” sentiment, large-cap stocks should outperform smaller companies, and vice versa for “risk-on” periods. But with ambiguous market data and valuations so similar to historical averages, investor sentiment is unclear, thus making it extremely difficult to truly identify compelling value in either sleeve of the U.S. equity market.

Could Delinquent Student Loans Slow the Economy in the Coming Years?

This week’s chart of the week looks at delinquent balances by loan type from 2003 through 2015. In general, total loan delinquencies – auto, mortgage, student and credit card – remain subdued compared to their levels between 2007 and 2012.

This week’s chart of the week looks at delinquent balances by loan type from 2003 through 2015. In general, total loan delinquencies — auto, mortgage, student, and credit card — remain subdued compared to their levels between 2007 and 2012. However, one area of concern is the significant increase in delinquent student loans, which has increased 97% since 2008. Although they constitute a relatively small percentage of total delinquent loans, they could have negative ramifications for years, as current or former students attempt to pay down their debt and thus have less money to consume on other items, not to mention their damaged credit score could affect their abilities to obtain mortgages and other financing for large ticket items in the future. So while the current level of student debt may not be an immediate threat to the economy, it could create economic headwinds in future years.

Will the Emerging Market Equity Rally Continue?

For this week’s chart of the week we take a look at the year to date return stream of emerging market equities, as measured by the MSCI Emerging Markets (“EM”) Index, which has been on a wild ride as oil prices fluctuated over the first three months of the year.

For this week’s chart, we look at the year-to-date return stream of emerging market equities, as measured by the MSCI Emerging Markets (“EM”) Index, which has been on a wild ride as oil prices fluctuated over the first three months of the year.

After reaching their 2016 low in the middle of January, emerging markets embarked on a sharp rally in the second half of February that continued through March and early April. On February 10th, due to concerns about the impact of a further rate hike on both domestic and foreign economies, Federal Reserve Chair Janet Yellen signaled postponement on the March rate hikes. The postponed rate hike decision coupled with continued weakness of the dollar and stabilization of commodities led to the rally starting on February 12th.

Earlier this week, China released positive upbeat news, announcing its exports rose 11.5% compared to a year earlier and surpassing analyst expectations which led to a strong April start for emerging market equities. As volatile as this first quarter of 2016 was, we frequently remind clients of the importance of having a long-term approach to investing as we have seen the EM index swing from significantly negative in January to +6.7% year to date as of April 13th. Certainly, EM investments will demonstrate elevated volatility across market cycles, but it is critical to maintain a long-term focus on their performance as it relates to total portfolio returns.

Growth vs. Value: What Does Technical Analysis Tell Us?

Technical analysis enables speculators to make future market predictions based solely upon a charted historical past; the actions of the market are studied as opposed to the underlying fundamentals of a company. Analysts have studied these sorts of charts for years and in the process discovered trends that are believed to support specific future behavior. One of these trends is explored in this week’s chart as it applies to the market’s preference of style: value vs. growth.

Technical analysis enables speculators to make future market predictions based solely upon a charted historical past; the actions of the market are studied as opposed to the underlying fundamentals of a company. Analysts have studied these sorts of charts for years and in the process discovered trends that are believed to support specific future behavior. One of these trends is explored in this week’s chart as it applies to the market’s preference of style: value vs. growth.

Typically, these trends are applied to a single stock’s movement, but for the sake of assessing the future return prospects of value and growth, we will apply them to the Russell 3000 Value and Russell 3000 Growth indices. More specifically, we calculate the return differential between the two indices by subtracting the Russell 3000 Growth index from the Russell 3000 Value index. This differential is smoothed by using a 90-day moving average and indicates value’s outperformance versus growth when above 0. The 200-day moving average is used as an alarm to changing trends; if a stock price, or in our case a shorter period moving average, breaks upwards through the 200-day moving average, this is seen as a bullish sign, or in our case the outperformance of value over growth. The opposite can be said if our differential breaks through this line downwards. As pictured, value broke through its 200-day moving average line in November, suggesting its future outperformance over growth, which it has recently delivered.

Bollinger Bands, portrayed in green and blue, represent 2 standard deviations above and below the 200-day moving average. It is generally thought that breaking this upper band signifies the security is overbought, which in our case would suggest a trend reversal in growth’s favor and that perhaps, value’s brief period of outperformance is over. With sectors like Healthcare and Tech rallying lately — up 1.3% and 0.9% respectively in March — growth may truly be back in fashion. Given the oscillating nature of the differential, however, this may be a true case of ambiguity in which value and growth have yet to battle it out.

Reputational Risks and Takeaways for Investors

This week’s Chart of the Week examines the aftermath of three recent corporate scandals. 

This week’s Chart of the Week examines the aftermath of three recent corporate scandals.

On August 15, 2015, The New York Times released an expose of the work environment at internet retail giant Amazon, describing a cut-throat work environment where employees were pushed to their limits. The company’s stock price sharply dropped in the weeks following the article, but has since recovered and continued to rise. Amazon’s buoyancy can be attributed to its established presence among consumers, lack of direct competitors, and the absence of legal/financial ramifications following the article.

On September 18, 2015, the Environmental Protection Agency (EPA) issued a Notice of Violation of the Clean Air Act to Volkswagen (VW) alleging that the automaker used software to deliberately evade clean air standards in certain diesel cars. The Department of Justice (DOJ) is suing VW for up to $46 billion, and the automaker must provide a solution for the nearly 600,000 cars affected by April 21, 2016. VW stock fell 65% immediately following the EPA announcement and has seen a feeble recovery since.

On September 28, 2015, legislators called for a subpoena of Wall Street favorite Valeant Pharmaceuticals in response to concerns about inflated drug prices. Shares immediately fell 16%, a trend that continued as investigators uncovered that Valeant’s serial acquisition strategy was buoyed by questionable accounting practices and unfounded price hikes. In the six months following, Valeant stock fell nearly 90% – from a high of $262 on August 5, 2015, to a low of $27 by March 18, 2016.

Investor Takeaway: Some companies are more resilient against reputational damage than others. Investors often do not have access to all the information, and seemingly profitable companies may stand on shaky foundations. It is important to distribute assets across many stocks to ensure that the reputational risk of any one firm cannot cause dramatic effects. In other words, holding diversified portfolios of securities can help insulate investors from the effects of single stock volatility emanating from corporate scandals.

Activist Hedge Funds and Lackluster Returns

Activist hedge fund managers seek to outperform the equity markets over a market cycle by first purchasing a large amount of shares in publicly traded companies and then pushing these companies’ management teams to alter their approaches in an effort to unlock shareholder value. Some common practices include share buybacks, spinoffs, and strategic sales.

Activist hedge fund managers seek to outperform the equity markets over a market cycle by first purchasing a large number of shares in publicly traded companies and then pushing these companies’ management teams to alter their approaches in an effort to unlock shareholder value. Some common practices include share buybacks, spinoffs, and strategic sales.

Asset flows into activist hedge funds have more than doubled since 2011 and grown six-fold over the last 10 years making this a highly embraced strategy among hedge fund investors. Latest Hedge Fund Research, Inc (HFR) data estimates assets under management to be over $120bn among activist hedge funds.

Unfortunately, this week’s chart illustrates that returns produced by activist hedge funds have been quite underwhelming, trailing the S&P 500 index over the most recent 1-, 3-, 5-, and 7-year annualized periods through December 31, 2015 (data for the HFRI Activist Index does not go back far enough for us to run a 10-year return comparison between the two indices). Out of the approximately 120 activist hedge funds in business today, there are many who do not report performance to HFR so the comparison is not perfect. However, the index does serve as a reasonable proxy for the industry.

We show activist index returns relative to S&P 500 index returns because activist strategies are marketed as an equities substitute and most institutional investors view them as such. Therefore, the opportunity cost for investors tends to be returns which they would have otherwise obtained through an investment in a long only equity fund benchmarked to a broad market index like the S&P 500. Thus, while most activist funds’ strategies are well-intentioned, returns have struggled to maintain pace with the broad U.S. equity market.

Dividends and Buybacks are Flat… Just Like the Market

Following the recession, dividends and stock repurchases had a significant run, growing about 28% per year, reaching a new record of $241 billion in March 2014. While dividends continue to grow, buybacks have fallen in the last 18 months, leaving the combined total mostly flat. Not surprisingly, the market has also been relatively flat over the last year and a half.

Following the recession, dividends and stock repurchases had a significant run, growing about 28% per year, reaching a new record of $241 billion in March 2014. While dividends continue to grow, buybacks have fallen in the last 18 months, leaving the combined total mostly flat. Not surprisingly, the market has also been relatively flat over the last year and a half.

Stock buybacks reduce the amount of shares outstanding for a company which causes earnings per share (EPS) to increase since the same amount of earnings over fewer shares outstanding creates a higher EPS value. EPS is a metric used in the determination of stock price, so a higher EPS value provides support for the stock price to appreciate in the near term. 

A significant source of funding for stock buybacks in recent years came from the ability to borrow at short-term rates near zero. As interest rates continue to rise, companies will be less inclined to fund buybacks in this manner. While buybacks are estimated to be higher for the first quarter of 2016, going forward they could be scaled back significantly, which would be a further drag on equity returns.

Moving Currencies

Currencies are a popular topic in investment circles today, as their impact on total returns can be meaningful for investors. While many investment funds do not hedge currency exposure at the portfolio level due to the costs involved and the expectation of mean reversion over time, certain market participants are very active in the foreign exchange markets and seek to capitalize on price movements among currencies, which can be volatile in the short-term.

Currencies are a popular topic in investment circles today, as their impact on total returns can be meaningful for investors. While many investment funds do not hedge currency exposure at the portfolio level due to the costs involved and the expectation of mean reversion over time, certain market participants are very active in the foreign exchange markets and seek to capitalize on price movements among currencies, which can be volatile in the short-term. In this Chart of the Week, we look at carry trades, the fundamental strategy of market participants who speculate on currency movements. At its essence, a carry trade is borrowing money in a low-yielding currency and investing it in a high-yielding currency. At the close of the trade, the investor pockets the difference between the interest received on the higher yielding currency and the interest paid on the lower yielding currency (net of transaction costs).

This chart shows a collection of the top- and bottom-performing carry trades of 2015 and compares their returns with the year-to-date results of 2016. As the chart shows, speculating against the dollar generated severe losses for most currencies last year, as the dollar rallied throughout 2015. Many of the carry trades that lost against the U.S. dollar have seen positive gains through early March, but can the performance of these trades persist? On one hand, holding the U.S. dollar should remain beneficial as the currency is likely to show continued, albeit modest, strength vs. other major global currencies. Reasons for this include expectations of tightening by the Fed and diverging central bank policies. Even if the Fed does not raise rates for the rest of this year, it is unlikely that it would cut rates, so the supportive case for the U.S. dollar remains. The Euro, another major global currency, is contending with monetary easing from the European Central Bank. Furthermore, concerns over Euro-area growth and political tensions present a headwind for the currency.

On the other hand, emerging market currencies have shown strength thus far in 2016, as the turnaround in industrial metals prices elevated many commodity currencies, including the Brazilian real (BRL) and the Malaysian ringgit (MYR). Concerns over long-standing debt disputes in Argentina led to increased volatility for the Argentine peso (ARS) in recent years. The 2015 election of new President Mauricio Macri led to optimism over a deal with Argentina’s creditors, and the country reached an agreement with bondholders in early March. However, the country’s plan to raise new levels of debt in April caused a sharp downturn in its currency.

With the persistence of diverging central bank policies and the prospect of negative interest rates in many parts of the world, the outlook for many carry trades will continue to see meaningful impacts from macroeconomic volatility not only on a global level, but also on a country- and region-specific level.

Note: ARS=Argentine Peso; ISK=Iceland Krona; INR=Indian Rupee; BHD=Bahraini Dinar; JPY=Japanese Yen; EUR=Euro; DKK=Danish Krone; TRY=Turkish Lira; CLP=Chilean Peso; MXN=Mexican Peso; NOK=Norwegian Krone; CAD=Canadian Dollar; MYR=Malaysian Ringgit; ZAR=South African Rand; COP=Colombian Peso; BRL=Brazilian Real.