Category: Chart of the Week

Divergent Central Bank Policy

This week’s Chart of the Week shows the divergence in Monetary Policy from the ECB, Bank of Japan and Federal Reserve. The Federal Reserve discontinued its quantitative easing (“QE”) strategy October 29th 2014; in contrast, after the end of 3Q14, the Bank of Japan and European Central Bank have increased asset holdings 30% and 26%, respectively.

This week’s Chart of the Week shows the divergence in Monetary Policy from the ECB, Bank of Japan, and Federal Reserve. The Federal Reserve discontinued its quantitative easing (“QE”) strategy on October 29th, 2014; in contrast, after the end of 3Q14, the Bank of Japan and European Central Bank have increased asset holdings by 30% and 26%, respectively.

During the same time period, the Euro and Yen have depreciated by over 10%, now trading at approximately 85% of their 10-year averages. The Bank of Japan and European Central Bank will continue large asset purchases for the foreseeable future in an effort to reduce borrowing costs and stimulate growth.

In the short term, foreign multinational corporations should utilize suppressed borrowing costs and weaker currencies as tailwinds for exports. This is best explained by third-party consumers’ attraction to the Eurozone and Japan’s relative prices of goods. QE’s goal to stimulate economic growth has had positive externalities on each bank’s respective currency; over the long run, the currency effect should be normalized as foreign direct investment is attracted to higher revenues and profits, yielding currency demand.

The Eurozone growth estimate of 0.3% advocates further action will be taken by the ECB through QE. Increased stimulus levels will force the Euro towards parity with the dollar for the first time in over a decade. Until there are better signs of growth from Eurozone nations, the ECB will be forced to use monetary stimulus and currency demand will continue to decline.

Babies Thrown Out With the Bathwater II: Emerging Markets Debt

Certain emerging markets countries have not been safe from being thrown out as “babies with the bathwater” during the past year’s global credit selloff trend.

Certain emerging markets countries have not been safe from being thrown out as “babies with the bathwater” during the past year’s global credit selloff trend.

This week’s Chart of the Week shows the spreads in basis points of the 10-year sovereign bonds from key Latin American, Asian, and EMEA (which stands for European, Middle Eastern and African) emerging countries.  The chart shows the widening of these spreads from December 2013 in the blue bars, through the energy dislocation of December 2014 and China’s devaluation of September 2015, to October 2015 in the red bars.  It is not surprising that Venezuela’s and Russia’s spreads are elevated as they are major oil exporters.

However, the countries that may at least in part have been subject to the “babies thrown out with the bathwater” effect have ranged from Latin America’s Mexico to Brazil, Asia’s Korea, and the EMEA region’s Bulgaria.  For example, Mexico’s spreads have widened from 112 basis points to 161 basis points from December 2013 to October 2015.  These emerging markets babies that have been thrown out with the bathwater represent possible value and interesting opportunities for emerging markets bond managers.

Are Retail Stocks on Sale?

Historically, the retail industry, a subset of the consumer discretionary sector, experiences an upswing during the winter months as holiday sales alone contribute 19% to yearly sales and Q4 earnings are generally released within the beginning of Q1. Highlighted in red is the November through February performance of the S&P Retail Select Industry Index; recession years aside, this upward trend usually holds.

Historically, the retail industry, a subset of the consumer discretionary sector, experiences an upswing during the winter months as holiday sales alone contribute 19% to yearly sales and Q4 earnings are generally released within the beginning of Q1. Highlighted in red is the November through February performance of the S&P Retail Select Industry Index; recession years aside, this upward trend usually holds.

In 2015, retail sales are expected to grow year over year by 3.7% and though this is a slight decrease from 2014’s 4.1% increase, it is still substantially above the 2.5% ten-year average. The U.S. employment rate is at a recent high of 94.8% however the participation rate has decreased to 62.4%, meaning that although the workforce appears to be buzzing along, some previous members of the workforce may be choosing to opt-out of their job searches and thus are less likely to take out their AMEX cards.

Though U.S. economic stats may be a mixed (gift) basket, currently the P/E ratio of the referenced retail index is at 22.37, down almost 30% year over year, making the retail industry seem attractive, especially for this time of year. Additionally, consumer confidence is currently at 97.6, modestly above the 93.8 level seen one year ago, leaving the U.S. consumer poised to shop ’til they drop.

High Yield: Don’t Throw the Babies Out With the Bathwater

This week’s Chart of the Week takes a look at the sell-off over the last month in risk credit as a direct result of global concern over China’s continued slowdown. Our chart shows the high yield bond spreads for each industry since the beginning of the year.

This week’s Chart of the Week takes a look at the sell-off over the last month in risk credit as a direct result of global concern over China’s continued slowdown.  Our chart shows the high yield bond spreads for each industry since the beginning of the year.

Not surprisingly, spreads for energy high yield issuers, shown in the purple, and spreads for metals/minerals high yield issuers, shown in the pink, have widened dramatically. In other words, their prices have depreciated significantly, as there is an inverse relationship between bond prices and their spreads.  This widening of energy and metals/minerals high yield bond spreads was due to the financial markets’ recognition of reduced Chinese demand for energy and metals/minerals.

However, all other sectors from chemicals, shown in the red, to utilities, shown in the orange, have seen their high yield spreads widen out as well. In our opinion, this is akin to throwing “the babies out with the bathwater.” In other words, the widening of spreads in all other industries except for energy and metals/minerals appears to be unjustifiably so.  The last two weeks have seen spread tightening across all industries as news of general stabilization has come out of China and Europe.  However, spreads for all other industries except for energy and metals/minerals remain elevated compared to where they were in the spring, suggesting some good value and opportunities in high yield within these industries.

How Have Capital Market Valuations Evolved Over the Last Year?

This week’s chart shows that current valuations across equity and fixed income markets are lower today compared to where they stood at the end of September last year. The big takeaway here is that equities broadly appear to still be cheaper than bonds.

This week’s chart shows that current valuations across equity and fixed income markets are lower today compared to where they stood at the end of September last year. The big takeaway here is that equities broadly appear to still be cheaper than bonds.

Japanese Government Bonds and German Bunds are some of the most expensive debt instruments currently available to investors. As it relates to the former, the Bank of Japan’s unprecedented stimulus has helped push Japanese Government Bond yields to record lows, and earlier this year, yields on securities with maturities up to five years turned negative for the first time. Looking ahead, the Fed’s willingness to delay an increase in U.S. interest rates should support demand for riskier assets and as a result, fixed income valuations may normalize over time. Compared to last year, the most precipitous drop in valuations has taken place in U.S. High Yield, U.S. Credit and U.S. dollar-denominated Emerging Markets Debt.

As it relates to equities, with the exception of the U.S., South Africa, and Mexico, valuations around other parts of the globe are on the lower end of their historical averages.  Finally, valuations in Canadian, Spanish, and Taiwanese equity markets have come down the most over the past year as these markets have sold off over the near term.

Note: Percentile ranks show valuations of assets versus their historical ranges. Example: If an asset is in the 75th percentile, this means it trades at a valuation equal to or greater than 75% of its history. Valuation percentiles are based on an aggregation of standard valuation measures versus their long-term history.

Has the Fed “Missed the Boat”?

The wait for the Federal Reserve to raise interest rates seems to be endless. Unemployment has fallen below the Fed’s desired level and inflation- when adjusted for the drop in oil prices – is just under target.  At the beginning of this year, many predicted September would be the right time for it to finally happen.

The wait for the Federal Reserve to raise interest rates seems to be endless. Unemployment has fallen below the Fed’s desired level and inflation — when adjusted for the drop in oil prices — is just under target. At the beginning of this year, many predicted September would be the right time for it to finally happen. Even with bad news coming out of China and other parts of the world hurting domestic financial markets, until the actual meeting, economists were still split on whether there would be a rate increase. But, clearly, there wasn’t.

Data suggests that a rate hike by the Fed in September would have been poor timing. Initial rate increases generally occur during periods of strong earnings growth. But for the past year, earnings have been relatively flat, and with global economies struggling this trend doesn’t seem likely to change. Additionally, after a rate increase valuations tend to fall. With the trailing 12-month P/E ratio for the S&P 500 dropping from 18.6x to just under 17x in the last two months stock prices have already undergone a sizeable correction. Any Fed action at this point in time would likely only lead to further losses.

CAPEX Cuts Continue in the Energy Industry

As oil prices oscillate around $40, market participants continue to wonder how long these low prices will persist. The decline in oil prices, due in part to strong supply growth and lower-than-expected demand growth, has caused headaches for many in the energy industry.

As oil prices oscillate around $40, market participants continue to wonder how long these low prices will persist. The decline in oil prices, due in part to strong supply growth and lower-than-expected demand growth, has caused headaches for many in the energy industry. Energy companies have made cuts to their CAPEX (capital expenditure) levels and canceled future expansions to reduce spending and maintain low costs. This week’s chart examines the Baker Hughes United States Crude Oil Rotary Rig Counts. Rotary rig counts are often included as an input when analyzing future oil prices — the logic is that a decline in rig counts foreshadows a reduction in supply, and a rise in rig counts precipitates an increase in supply.

Since peaking in October 2014, rig counts have fallen by 60% to the lowest level in over five years. Rig counts saw 29 consecutive weeks of decline between December 2014 and June 2015. The rig counts appeared to consolidate and even ticked up after that 29-week period, with 54 rigs joining the count over a period of 8 positive weeks. This led many investors and market participants to project a continuation of downward pressure on oil prices due to the expected additional supply as a result of the added rigs. However, CAPEX cuts continue in the energy industry, as 42 rigs have come offline since the end of June (with the majority coming offline in September), almost completely reversing the effects of the increase seen in July and August. For investors and market participants, the data suggests that a bottom is forming in the rig counts and energy companies may be nearing the end of their CAPEX cuts. Whether or not this translates into an increase in oil prices remains to be seen.

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.