Category: Chart of the Week

China: Manufacturing vs. Services

This week’s chart examines Markit’s Purchase Manager Index (PMI) for the manufacturing and services sectors in China.  PMI serves as an indicator of economic health.  A reading above 50 represents expansion while a reading below 50 indicates contraction.

This week’s chart examines Markit’s Purchase Manager Index (PMI) for the manufacturing and services sectors in China. PMI serves as an indicator of economic health. A reading above 50 represents expansion while a reading below 50 indicates contraction. The manufacturing sector (blue line) continues to weaken with the September flash coming in at 47. Meanwhile, the services sector (red line), an increasingly important part of the economy, remains in expansion territory.

Given the economy’s current size and transition from export-driven to domestic consumption-focused, a slowdown in overall growth should be expected, with more growth ultimately coming from consumption (represented by the service sector) than export-related activity (measured by manufacturing). Analysts have often cited 5–6% as a reasonable range for medium-term growth, a far cry from a crash landing. The IMF recently cited China’s progress in domestic rebalancing, with consumption contributing slightly more growth than gross fixed capital.1 Therefore, the traditional data points focused on manufacturing and infrastructure do not provide a complete picture of the current Chinese economy. Instead, the growth in services PMI reflects how the Chinese economy is becoming more dependent on domestic consumption than exports to other countries.

 

1 IMF Country Report No. 15/234, August 2015

Is the Canary in the Coal Mine of the Global Economy Sounding an Alarm?

This week’s chart of the week looks at the recent drop in South Korean exports, which fell by 14.7% in the 12 months ending August 31. South Korean exports have historically been a reliable and early indicator of the state of global trade, so much so that they have earned the nickname, the “canary in the coal mine” of the global economy.

This week’s chart of the week looks at the recent drop in South Korean exports, which fell by 14.7% in the 12 months ending August 31. South Korean exports have historically been a reliable and early indicator of the state of global trade, so much so that they have earned the nickname, the “canary in the coal mine” of the global economy. This is largely due to the fact that South Korean exports are a diversified mix of raw materials (such as oil, iron, and steel), intermediate goods (such as semiconductors and machine parts), and finished goods (such as cars, ships, and consumer electronics), as well as the fact that South Korea exports goods to both developed and emerging markets.

The fact that exports dropped by 14.7% in August (the largest drop since August 2009) is notable, especially considering that the consensus forecast was for a decrease of 5.9%. Even more concerning, this was the eighth consecutive month in which exports contracted. Since 1970, every prolonged drop in South Korean exports (defined as at least six consecutive monthly declines) has coincided with a material slowdown in the global economy. This was witnessed during the oil crisis of the mid-1970s, the Asian financial crisis of the late-1990s, the bursting of the tech bubble in the early-2000s, as well as the financial crisis of 2008.

While it is too soon to tell if the canary in the coal mine is accurately predicting trouble on the horizon, this prolonged drop in exports is clearly concerning.  However, there are a few factors that could be causing this signal to be a false alarm this time around. For one, exports to China (currently representing about 25% of all South Korean exports) are a greater share of exports than they have been historically, so the slowdown in China is having a larger impact on exports than in the past. In addition, the steep plunge in commodity prices over the past year has had a major impact on South Korea’s exports of oil products, petrochemicals, as well as iron and steel. These three export sectors, which represent 6.4%, 7.3%, and 6.1% of all South Korean exports respectively, have seen the largest declines of any major sector, declining 40.3%, 25.7%, and 17.4% respectively.

The Apple Effect?

On Wednesday, September 9th Apple announced the details on its latest iteration of its flagship product – the iPhone. The iPhone 6S and 6SPlus will be the ninth major iPhone announcement since the iPhone 1 was first unveiled to the world on June 29th 2007 (excluding new storage space and color variations of the same model).

On Wednesday, September 9th, Apple announced the details on the latest iteration of its flagship product – the iPhone. The iPhone 6S and 6SPlus were the ninth major iPhone announcements since the iPhone 1 was first unveiled to the world on June 29th, 2007 (excluding new storage space and color variations of the same model). The announcement events are widely covered by the media and fans of one of the most innovative companies of the 21st Century.

This week’s chart examines the change in Apple’s stock price from the announcement through the following six days and comparing that change to the return of the S&P 500 over the same time periods. On average, Apple has outperformed the index by 2.62% over the past eight announcement dates.

The importance of this announcement can be seen in the S&P 500 holdings, of which Apple is the largest contributor with a 3.71% weight. While it cannot be said with utmost certainty that Apple will outperform the market with its latest product announcement, it is safe to assume that these products will continue to be a major revenue source for the company, drive movements in the stock price, and therefore have a significant influence on the return of the index.

Is the U.S. Economy on the Brink of a Recession?

Historical analysis has shown that an inverted or flattening yield curve may be a warning sign of an upcoming recession. Since the 1950s, an inverted curve has preceded seven of the last eight recessions, with spreads near zero in 1960.

Historical analysis has shown that an inverted or flattening yield curve may be a warning sign of an upcoming recession. Since the 1950s, an inverted curve has preceded seven of the last eight recessions, with spreads near zero in 1960. An inverted yield curve occurs when short-term yields to maturity are higher than long-term yields to maturity (depicted where spreads fall below zero on the chart). This indicator has proven to be a reliable predictor of recessions and future economic activity.

Last week’s correction has led to investor concern that the market will continue to decline and evolve into a bear market, which is unlikely unless there is a recession and corresponding inversion of the yield curve. This week’s chart shows that the yield curve is currently positively sloped and has in fact steepened on a year-to-date basis, providing some confidence that recent market volatility is indicative of a correction rather than another recession.

It’s That Time of Year Again…

Between August 17th and 25th, the U.S. equity market – as represented by the S&P 500 Index – declined 11%. The pace and magnitude of the market drop came as a shock to many and left investors pondering how they should react to this swift downdraft. While some may be looking to underlying fundamentals or economic data for guidance, one could simply point to history as an indicator.

Between August 17th and 25th, the U.S. equity market — as represented by the S&P 500 Index — declined 11%. The pace and magnitude of the market drop came as a shock to many and left investors pondering how they should react to this swift downdraft. While some may be looking to underlying fundamentals or economic data for guidance, one could simply point to history as an indicator. This week’s chart looks at the maximum intra-year drawdown for the S&P 500 Index over the last 30 years.

While this recent decline is notable, it is not unusual for the market to experience a significant intra-year drawdown. Over the last 30 years, returns for the S&P 500 have only been negative five times. However, 15 of these 30 years have featured max intra-year drawdowns greater than 10%, with 10 of those years actually posting a gain for the year. In other words, the S&P 500 has shown resiliency over the long term, and the recent 12.4% drawdown for 2015 does not automatically translate to a negative year for U.S. equity investments. In fact, the last two days have seen an impressive rebound in the markets, and when markets closed on August 27th, the S&P 500 index was down only 2.1% for the year.

For more information on the recent market volatility as well as what to expect in the coming months, please read our U.S. equity market update which was released earlier this week.

Impact of Higher Interest Rates on High Yield Bonds

Under the Fed’s zero interest rate policy, high yield bonds have enjoyed a terrific run of performance. For the five year period ending June 30, 2014, the Barclays U.S. Corporate High Yield index produced an impressive annualized return of 14.0% per year. However, returns in this more speculative portion of the bond market have been disappointing since last summer, when the high yield spread over Treasuries reached a multi-decade low of 221 basis points.

Under the Fed’s zero interest rate policy, high yield bonds have enjoyed a terrific run of performance. For the five-year period ending June 30, 2014, the Barclays U.S. Corporate High Yield index produced an impressive annualized return of 14.0% per year. However, returns in this more speculative portion of the bond market have been disappointing since last summer, when the high yield spread over Treasuries reached a multi-decade low of 221 basis points. The index fell 0.4% in the twelve months ending June 30, 2015, and has continued to show weakness, falling another 1.9% through the middle of August.

This week’s chart examines the past relationship between high yield spreads and rate tightening cycles.1  Although there certainly isn’t a perfect correlation, tightening activity by the Fed has often caused high yield spreads to widen, significantly impacting total return potential. It is no secret that low and stable interest rates are good for speculative companies that are active in the debt markets. While a rake hike doesn’t spell impending doom for the entire high yield universe, some of the more speculative borrowers who have become accustomed to borrowing at ultra-low rates could be in trouble, particularly if the Fed embarks on a prolonged period of successive rate hikes. As we prepare for the first Fed rate hike — likely later this fall — it will be important to pay close attention to high yield exposure within investment portfolios as well as manager positioning within the high yield space.

1 Most recent rate tightening lines refer to the end of QE 1 and 2 and the start of the Fed’s tapering

Asset Class Review: What Has Worked So Far in 2015?

This week’s chart shows broad asset class returns through July 31st of this year. Perhaps the most surprising performer has been international equity, which has outperformed even U.S. equities. Much of the outperformance is due to the strong U.S. dollar, which has increased international developed countries’ exports and the number of tourists.

This week’s chart shows broad asset class returns through July 31st of this year. Perhaps the most surprising performer has been international equity, which has outperformed even U.S. equities. Much of the outperformance is due to the strong U.S. dollar, which has increased international developed countries’ exports. The same factor has in turn contributed to the lower performance of U.S. equities. With so many of the S&P 500 companies’ revenues dependent on international growth (about 46%), the strong dollar has weighed heavily on EPS growth. In addition, the same factors many of our readers have heard before — the slowdown in the energy sector and the cold winter — have also played major roles.

The other darling this year, as widely predicted, has been Real Estate. Throughout the first half of the year, growth has in large part been due to income, lease turnover, and appreciation (most notably in the Southwest U.S.). The remainder of the year is likely to see less contribution from income and more contribution from appreciation.

Now let us turn to the poor performers. Bonds, both Global and U.S., continue their same old story: the specter of the Fed rate hike continues to loom, in addition to the Greek debt crisis and China’s now not-so-secret efforts to prop up growth. Emerging Markets have been the worst performers this year, thanks in large part to their dependence on commodities and the domino effect of China’s slowing growth which has translated into weakening currencies.

Where will the rest of the year take us? As the issues we have discussed will continue to weigh on asset classes, it will not be surprising if meandering to disappointing returns across asset classes continue for the rest of 2015.

1 Real Estate Returns through 6/30/15; Private Equity Returns through 3/31/15

Time to Buy U.S. Small-Cap Value Stocks?

Through the first seven months of 2015, growth stocks have far outpaced their value brethren in the U.S. equity market. While the theme has played out across all size sectors of the market, this trend has been most obvious for small-cap stocks.

Through the first seven months of 2015, growth stocks have far outpaced their value brethren in the U.S. equity market. While the theme has played out across all size sectors of the market, this trend has been most obvious for small-cap stocks. The Russell 2000 Growth index has returned 9.18% while the Russell 2000 Value index has dropped 2%. Given this disparity, it is worth examining whether now is an appropriate time to re-allocate to small-cap value stocks, since their recent struggles have driven prices lower. To help answer this question, we turn to a comparison of the current index price versus its 200-day average, a common valuation metric used to measure the relative value of a particular stock or index versus a longer-term average. As shown in the chart, the index dipped below its 200-day trading average in July and is now trading at a discount relative to its historic values.

From the broader perspective of portfolio construction, small-cap value stocks have historically offered upside potential and outperformance versus other style and size sectors in the U.S. equity market. In addition, since smaller companies’ operations tend to be more domestically focused, they could potentially provide a sanctuary from the rough geopolitical turmoil that is occurring in Europe and Asia. On a related note, the potential drag from a stronger U.S. Dollar would also be muted due to small-cap companies’ limited international exposure. Given the long-term benefits of small-cap value stocks along with the current valuation of the index, now may be an attractive opportunity to either rebalance or create exposure to the asset class.

How Will the High Level of M&A Activity Impact Investors?

For this week’s chart of the week we take a look at quarterly M&A deals, measured by volume. Typically, summer is a quiet period for M&A activity; however, we have seen the volume of deals for the month of July already surpass $475 billion dollars which would put it on pace to surpass the previous quarter high that was last seen in 2007, just before the start of the great recession.

For this week’s chart, we take a look at quarterly M&A deals, measured by volume. Typically, summer is a quiet period for M&A activity; however, we have seen the volume of deals for the month of July already surpass $475 billion dollars which would put it on pace to surpass the previous quarter high that was last seen in 2007, just before the start of the great recession. There are a variety of explanations for the increased M&A activity: pressure from activist investors, hostile takeovers, and companies with large cash positions beginning to deploy their savings as they better position themselves for future growth. Whether it is a close competitor or a company that compliments current operations, we have seen a great increase in deals over the previous two quarters.

One of the concerns with the elevated M&A activity is that companies are stretching for valuations when acquiring other firms, and given the elevated prices they are paying, it will be difficult to realize a profitable return on the size of their investments. Comparing deal counts to their respective volumes, we have seen less deals over the past two years, but higher dollar volumes than during the 2006–2007 boom years for M&A. The next two months bear watching to see if the furious M&A activity continues, or if the pace begins to abate. Of course, the real result of this activity will not be known for years, but the success – or lack thereof – of these mergers and acquisitions will no doubt manifest itself in capital market returns.

Some Perspective on the Size of Chinese Equity Market Losses

Over the last month, the Chinese equity market has been a cause of concern for investors and it is impossible to ignore its impact on recent market volatility.

Over the last month, the Chinese equity market has been a cause of concern for investors and it is impossible to ignore its impact on recent market volatility. In an effort to provide some perspective on the size of recent market losses in relation to Chinese consumers, this week’s chart of the week compares the size of the market cap loss to household assets represented by household deposits, 2014 GDP, household financial balance sheets, and household total balance sheets. As shown above, the Chinese equity market cap loss only represented 12% of household financial balance sheet assets which include stocks, bonds, and cash. Additionally, the market cap loss only represented 5% of total household assets which notably include personal real estate. Although the recent loss in the Chinese equity market was not insignificant, at this point in time the overall effect on the Chinese economy is bearable and should not be considered catastrophic.