Category: Chart of the Week

Initial Results of the ECB’s Targeted Loan Operation Fall Below Expectations

This week’s chart examines the results from the first round of the European Central Bank’s (“ECB”) targeted long-term refinancing operation (“TLTRO”) which occurred on September 18th. The ECB announced this program in June 2014 with the goal of encouraging lending to small and mid-size companies in the region.

This week’s chart examines the results from the first round of the European Central Bank’s (“ECB”) targeted long-term refinancing operation (“TLTRO”) which occurred on September 18th. The ECB announced this program in June 2014 with the goal of encouraging lending to small and mid-size companies in the region. The TLTRO essentially provides a four-year loan to banks at a fixed low rate. This serves as one of several tools the ECB has utilized to address the low inflation and contracting credit conditions in the Eurozone.

With 400 billion euros available, only €82.6B were borrowed by banks, well below the €150B estimated by a Bloomberg survey. Considering the initial outcome, investors are starting to question the potential effectiveness of the program. However, it is important to note that in the month of October the ECB will announce the results of the Asset Quality Review (“AQR”), which is a comprehensive assessment of banks’ balance sheets. The Eurozone’s financial institutions may be more willing to participate in the TLTRO after the stress tests are complete. The second round of TLTRO is slated for December and will provide insight into loan demand in the region as well as essential feedback to the ECB about the effectiveness of its policies. Without stronger demand for loans from this program, strong growth in the Eurozone would seem dubious, and thus participation in later rounds of TLTRO bears watching.

Hedge Funds vs. the Equity Market

Recently, the California Public Employees’ Retirement System (CalPERS) announced its decision to completely shutter its hedge fund program. As a result of this news, investors have been asking whether hedge funds still deserve a spot in their portfolios.

Recently, the California Public Employees’ Retirement System (CalPERS) announced its decision to completely shutter its hedge fund program. As a result of this news, investors have been asking whether hedge funds still deserve a spot in their portfolios. In this week’s Chart of the Week, we examine the efficacy of hedge funds compared to equity markets over the last 25 years. To do this, we compare the rolling 3-year Sharpe ratios of hedge funds (using the HFRI Fund Weighted Composite as a proxy) and equity markets (using the S&P 500 as a proxy). As a reminder, Sharpe ratios are a measure of risk-adjusted return, so a higher score represents a more attractive risk profile.

A comparison of the two indices suggests that recent hedge fund performance has been disappointing as the S&P 500 has delivered higher risk-adjusted returns over the last few years. However, most investors who have added hedge funds to their portfolios have done so to add diversification and new sources of alpha to their portfolios, so a comparison based on returns may not be entirely fair when comparing the equity market to hedge funds. Moreover, it is critical to note that the last five years have featured an impressive bull market that will naturally outpace hedge funds, which endeavor to create more attractive risk-adjusted returns by utilizing various strategies designed to limit downside risk, but also limit upside potential in times of bull markets.

So while hedge funds may surrender some return in times of significant market rallies, they can be expected to offer protection from market corrections, which are a part of every market cycle. Over the long term, the graph shows that hedge funds have indeed delivered higher risk-adjusted returns, in spite of the recent dip. Given the long-term cyclical nature of the market, when equities exhibit a correction, hedge funds should see a shift in relative performance, and once again demonstrate their utility to investors.

S&P 500 Dividends and Stock Buybacks Hit Record Levels

This week’s Chart of the Week examines increases in dividends and stock buybacks for companies within the S&P 500 index during the prior six years. Following a recession low of $71.8 billion during the second quarter of 2009, combined dividend and buyback expenditures established a record high of $241.2 billion in the first quarter of 2014.

This week’s Chart of the Week examines increases in dividends and stock buybacks for companies within the S&P 500 index during the prior six years. Following a recession low of $71.8 billion during the second quarter of 2009, combined dividend and buyback expenditures established a record high of $241.2 billion in the first quarter of 2014. The previous record occurred during the third quarter of 2007 when companies spent a combined $233.2 billion on dividends and buybacks.

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 are set to eventually rise, companies will be less inclined to fund buybacks in this manner. Compared to dividends which typically don’t experience large changes from period to period, stock buybacks are more dynamic in nature and can be quickly reduced if needed. Going forward, a potential concern for future stock market returns is that if buybacks are scaled back significantly, returns will likely be adversely impacted by such a contraction in buybacks.

Weak Loan Demand in Euro Area

Due to stagnating growth and marginal inflation in the Euro area, Mario Draghi recently announced that the European Central Bank (“ECB”) would reduce the interest rate on main refinancing operations from 0.15% to 0.05%.

Due to stagnating growth and marginal inflation in the Euro area, Mario Draghi recently announced that the European Central Bank (“ECB”) would reduce the interest rate on main refinancing operations from 0.15% to 0.05%. Reductions would also occur for the rate on the marginal lending facility from 0.40% to 0.30% and the rate on the deposit facility from -0.10% to -0.20%. In addition, the ECB will start purchasing asset backed securities in an attempt to facilitate new credit flows into the economy.

This week’s chart examines the balance sheet of euro area monetary financial institutions (“MFIs”). In particular, the chart illustrates the year-over-year growth of loans in the region. Notably, the growth rate has been negative since the end of 2012. The low lending levels are likely due to poor demand as a result of the subpar economic situation in the euro area, particularly countries on the periphery.

While yields on European government debt have tightened dramatically since Mario Draghi pledged to do whatever it takes to preserve the European Union in mid-2012, the underlying economic environment has remained challenging. The unemployment rate is currently 11.5%, the inflation rate is a paltry 0.3% and projected euro zone growth for 2014 is just 0.9%. The lack of loan demand, slack in labor markets, and overall low growth point toward the likelihood of a protracted period of low inflation.

The potential for deflation has led the ECB to initiate its most recent rate cuts and asset purchases. Similar to the effects of the Fed’s quantitative easing, markets may react favorably to the ECB balance sheet expansion, albeit at the cost of the euro currency. It is important for investors to monitor the ECB monetary policy and structural reforms that have been implemented by many euro zone countries to gauge whether they are effective in stimulating growth, and by extension, promoting positive investment returns from the region.

Real Estate: The Income/Appreciation Story

Income and appreciation are the two main components of returns to any investment, including real estate. Core real estate returns, as measured by the NCREIF Property Index (NPI), have been driven by the appreciation component over the past several years…

Income and appreciation are the two main components of returns to any investment, including real estate. Core real estate returns, as measured by the NCREIF Property Index (NPI), have been driven by the appreciation component over the past several years, and this has naturally been accompanied by a compression in capitalization rates.

In this week’s Chart of the Week, we look at the income and appreciation components of core real estate returns and how they have contributed to total returns over the past twenty years. We can see that income has historically contributed approximately 60% to the total returns of core real estate.

The income component has been below this long-term average for most of the quarterly periods since real estate’s performance returned to positive territory in 2010, as appreciation and cap-rate compression have been the main stories since the rebound from the financial crisis. However, with the expectation for a rising-rate environment on the horizon and an end to cap rate compression looming near, we anticipate that income will start to represent a larger fraction of total returns over the medium term. This should provide comfort to investors with allocations to core real estate funds and even core-plus and value-add real estate funds that have meaningful exposure to healthy, stabilized, income-generating properties.

Emerging Markets Debt a Better Play than Developed Market Debt

Emerging markets debt (“EMD”) represents an outstanding asset class for investors to diversify away from U.S.-centric core bonds, which includes U.S. Treasury, U.S. investment grade corporate and U.S. mortgage-backed bonds, as well as U.S.-centric bank loans and high yield bonds.

Emerging markets debt (“EMD”) represents an outstanding asset class for investors to diversify away from U.S.-centric core bonds, which includes U.S. Treasury, U.S. investment grade corporate and U.S. mortgage-backed bonds, as well as U.S.-centric bank loans and high yield bonds. It gives investors a large and expanding investment opportunity set that has very low correlation with U.S. equities and U.S. bonds.

In addition to stronger yields, where EMD is currently between 6% to 10% versus developed market bond yields between 0% to 6%, emerging markets also exhibit much stronger fundamentals versus their developed markets counterparts. Case in point, GDP growth has been much stronger in the emerging world than the developed world, especially so in the last few years, and is expected to continue for some time. Moreover, demographics are much more favorable for the emerging world, where population growth, especially in the younger, working segment, is expected to outstrip the developed world for quite some time. Lastly, as shown above, emerging market countries have much stronger debt and deficit profiles than developed market countries.

The left axis shows the debt as a percentage of GDP. The greater a country’s debt, the further towards the bottom of the chart it will show. The top axis shows the country’s fiscal deficit as a percentage of its GDP. The greater a country’s fiscal deficit, the further to the right it will show.

Emerging market countries are clustered toward the top left, due to their lower debt-to-GDP ratios and lower fiscal deficits. Developed market countries are clustered towards the bottom right, due to their higher debt-to-GDP ratios and higher fiscal deficits. Greece and Japan are in especially dire straits, and are literally off the charts.

What this chart tells us is that, as a whole, EMD represents a relatively secure asset class as the countries in question have much less debt to service than their developed market counterparts. In addition, they have been more fiscally sound, with lower deficits than their developed market counterparts. All of this adds up to strong support for emerging market countries and corporations to pay both the interest and principal on their bonds. Couple this with their higher yields and low correlations to other asset classes, and it makes it a must-have for most institutional portfolios.

Investors can take advantage of this space through a dedicated emerging markets debt manager that provides a U.S. dollar-denominated “hard currency” sovereign EMD focus, a “local currency” sovereign EMD focus, a corporate EMD focus, or a blended strategy that invests in both hard and local currency EMD bonds as well as sovereign and corporate EMD bonds. Marquette recommends a blended EMD allocation for investors to take advantage of the broadest diversification.

Volatility Index Spikes in August

This week’s chart of the week takes a closer look at the CBOE volatility index (“VIX”) and the German implied volatility index (“VDAX”) in light of recent geopolitical events. Volatility indices are often describes as “fear indices” that tend to increase with market uncertainty.

This week’s chart of the week takes a closer look at the CBOE volatility index (“VIX”) and the German implied volatility index (“VDAX”) in light of recent geopolitical events. Volatility indices are often described as “fear indices” that tend to increase with market uncertainty.  As uncertainty increases, investors typically prefer the safety of U.S. Treasuries, driving up bond prices and pushing yields lower.

• On August, 1st, President Obama announced sanctions on Russia; VIX and VDAX reached their highest levels in more than five months over concern of Russian retaliation.
• On August, 7th, President Obama authorized a targeted strike against Iraq; triggering the VDAX to reach the highest level of the year as concern over global equity markets lead investors to push the 10-Year Treasury yield to 2.43%.
• Finally, August, 15th marked the fall of the 10 Year-U.S. Treasury yield to the lowest in 14 months at 2.34%, due in part to the global tension in Ukraine and conflict in the Middle East.

After spiking in early August on geopolitical worries, the VIX has returned to more normal levels seen throughout most of the year. However, with many of the geopolitical hotspots right on Germany’s doorstep, German market volatility has remained elevated. While U.S. investors may have put the latest crisis behind them, it is worth noting that markets closer to the epicenter of the conflict are not as sanguine.

Uneven Labor Market Recovery

This week’s Chart of the Week examines how total employment has changed by sector since the beginning of the recession. Recently, nonfarm employment recovered the total net jobs lost during the recession, but as the chart shows not all industries have fared equally during the recovery

This week’s Chart of the Week examines how total employment has changed by sector since the beginning of the recession. Recently, nonfarm employment recovered the total net jobs lost during the recession, but as the chart shows not all industries have fared equally during the recovery. It comes as little surprise that construction and manufacturing have been among the hardest hit, dropping about 20% and 12% respectively, for a combined loss of 3.1 million jobs. Additionally it should be noted that this does not account for population growth, making these losses more significant.

When the overall landscape of the economy changes so dramatically multiple issues can arise. First and most importantly, workers who lost jobs in sectors hit hardest have not seen their jobs return. As a result they must change careers and find work in a different industry, or risk being unemployed for the long-term. However, even if they are willing to make this career change they might not have the skills necessary to find a job in another industry. Similarly, expanding sectors may have difficulty finding qualified workers for their newly created positions. Both of these issues are inefficiencies that cause a drag on economic growth.

Service Sector of U.S. Economy Strengthens

This weeks’ Chart of the Week looks at the state of the service sector in the U.S., as measured by the Institute for Supply Management (ISM) Non-Manufacturing Index. On August 5th, the ISM released July data for the ISM Non-Manufacturing Index, which posted a reading of 58.7 (a reading greater than 50 indicates expansion in the service sector while a reading below 50 indicates contraction).

This weeks’ Chart of the Week looks at the state of the service sector in the U.S., as measured by the Institute for Supply Management (ISM) Non-Manufacturing Index. On August 5th, the ISM released July data for the ISM Non-Manufacturing Index, which posted a reading of 58.7 (a reading greater than 50 indicates expansion in the service sector while a reading below 50 indicates contraction). This was the highest reading since December 2005 and is one of the highest on record for the index (which dates back to July 1997). This index is important because it serves as a gauge of the overall strength of the service sector of the U.S. economy, and considering that the service sector is the single largest component of U.S. GDP (representing 45.7% of GDP as of 2Q 2014), it has fairly significant implications for the broad economy.

A deeper look into the underlying constituents of the ISM Non-Manufacturing Index points to continuing strength in the service sector. The new orders component, which reflects the level of new orders from customers, posted a reading of 64.9 in July. This was the highest reading of the new orders index since August 2005 and is also one of the highest on record. The employment component of the Non-Manufacturing Index also showed strength in July, posting a reading of 56.0. This was higher than the 54.4 reading in June but it is still lagging the broad Non-Manufacturing index. Given that the new orders index has increased significantly from 50.4 in December 2013 to 64.9 in July, we could see significant growth in service sector employment during the second half of the year if companies start to hire additional employees in order to keep pace with the increased demand.

An Alternative to U.S. Small-Cap Equity

This week we examine the valuation of developed non-U.S. small-cap equity (MSCI EAFE small-cap) compared to U.S. small-caps (Russell 2000). The chart displays the relative price-to-earnings (P/E) and price-to-book (P/B) ratios for the two asset classes. A lower number indicates the U.S. is more expensive compared to non-U.S small-cap stocks.

This week we examine the valuation of developed non-U.S. small-cap equity (MSCI EAFE small-cap) compared to U.S. small-caps (Russell 2000). The chart displays the relative price-to-earnings (P/E) and price-to-book (P/B) ratios for the two asset classes. A lower number indicates the U.S. is more expensive compared to non-U.S small-cap stocks. Based on the historical averages for both P/E and P/B, non-U.S. equity looks relatively attractive.

Small-cap companies in the U.S. have performed well in this historically low interest rate environment. Now five years into the economic recovery, market participants expect a rate hike from the Fed to occur sometime mid next year. With U.S. small-cap stocks lacking extraordinary earnings growth, many investors are questioning their valuations. In the Eurozone and Japan, two areas that account for over 40% of the MSCI EAFE small-cap index, the economies are earlier in their respective recoveries and experts anticipate lower interest rates to persist in these regions, which should be accretive for equities in those markets. Investors looking to reduce their U.S. small-cap exposure should consider developed non-U.S. small-cap, given the accommodative central bank policies and relative valuations.