Category: Chart of the Week

How Will the Stock Market React to June’s Decline?

After 7 months of consecutive gains, the S&P 500 Index (“SPX”) dropped by 1.3% in June. While a down month in the market was inevitable, one of the primary worries for investors as we enter the second half of the year is how the stock market will react to June’s losses. In an effort to answer this question, this week’s chart examines market reactions after previous “winning streaks” were broken.

After 7 months of consecutive gains, the S&P 500 Index (“SPX”) dropped by 1.3% in June. While a down month in the market was inevitable, one of the primary worries for investors as we enter the second half of the year is how the stock market will react to June’s losses. In an effort to answer this question, this week’s chart examines market reactions after previous “winning streaks” were broken. For purposes of the analysis, we define “winning streaks” as positive streaks of six months or more for the SPX. From 1954 to 2012 there have been 18 such winning streaks that were broken. Because we are focused on the second half of 2013, we chart the subsequent 6 month returns of the SPX.

Of the 18 data points in the analysis, there were 16 winners (89%) with a median percentage change of 8.87%. In other words, almost 9 out of 10 times, the end of a winning streak has been followed by positive returns in the U.S. stock market. Although historical data may not be indicative of future performance, investors might take comfort from the S&P 500’s past responses to snapped win streaks.

Health Care Borrowing Costs

This week’s chart compares non-profit health care organizations’ (“HCOs”) cost of debt versus their size. The table illustrates the financial characteristics of 630 HCOs divided into quartiles based on borrowing costs measured by option-adjusted spread (“OAS”). The HCOs examined show a wide dispersion of borrowing costs.

This week’s chart compares non-profit health care organizations’ (“HCOs”) cost of debt versus their size. The chart illustrates the financial characteristics of 630 HCOs divided into quartiles based on borrowing costs measured by option-adjusted spread1 (“OAS”). The HCOs examined show a wide dispersion of borrowing costs. Top quartile HCOs have an average OAS of 0.76%, while bottom quartile HCOs have an average OAS of 3.69%.

Looking at the data, there is a clear positive correlation between an HCO’s size, as defined by revenue and assets, and its OAS. Higher revenue and more assets appear to equate to lower borrowing costs. In addition to revenue and assets, average days cash-on-hand is a financial metric commonly used to assess HCOs financial health. The table illustrates that a higher days cash-on-hand metric typically, but not always, translates into lower borrowing costs.

It appears that while days cash-on-hand is an important determinant of an HCO’s financial health, an HCO’s size, as defined by revenue and assets, is the primary determinant of borrowing costs. If size continues to be the main determinant of HCOs borrowing costs, we would expect to see smaller HCOs continue to merge with larger peers.

1The option adjusted spread is the spread over U.S. Treasuries that would discount a bond’s future cash flows back to its current price.

Planning the End of Fed Stimulus: Can the Housing Recovery Continue Amid Tapering Talk?

Since the end of 2008, the Federal Reserve has held the Federal Funds Rate at approximately 0% in an attempt to stimulate bank lending and revive the collapsing U.S. housing market. The aggressively accommodative monetary policy has caused borrowing rates on traditional 30-year mortgages to steadily decrease from 5.94% in September of 2008 to 3.40% at the beginning of 2013.

Since the end of 2008, the Federal Reserve has held the Federal Funds Rate at approximately 0% in an attempt to stimulate bank lending and revive the collapsing U.S. housing market. The aggressively accommodative monetary policy has caused borrowing rates on traditional 30-year mortgages to steadily decrease from 5.94% in September of 2008 to 3.40% at the beginning of 2013. Following the commencement of this loose monetary policy and a period of bank deleveraging, the deterioration in the housing market began to subside by the close of 2009. Accordingly, the percentage of mortgages considered seriously delinquent (i.e. 90+ days past due or in foreclosure) has steadily declined since then. Additionally, the level of “Shadow Inventory” in the housing market which includes not only homes for sale but also estimates of those that may come to market has decreased by over one third during the same period.

Collectively, these forces have driven a significant recovery in the housing market. However, the recovery may soon face some considerable headwinds as mortgage rates have recently reversed their downward trend. This reversal was partly a result of the release of the Federal Open Market Committee minutes on June 19th in which the Fed indicated the mere possibility of scaling back its stimulus program later this year. While the Fed’s policy remains unchanged and the Federal Funds Rate is expected to remain low through 2015, the perception that federal stimulus cannot continue has had a tangible impact. One week after the release of Fed minutes, the average borrowing rate on a 30-year fixed mortgage has increased from below 4.0% to around 4.6%, one of the more rapid rises in U.S. history. According to the Mortgage Bankers Association Weekly Mortgage Applications Survey, applications fell 3.0% on a seasonally-adjusted basis in the week ending June 21st and 3.3% in the week prior.

It remains to be seen if the housing market, which has been aided by decreasing borrowing rates to this point, can continue along its current trajectory of recovery with rising borrowing costs for homebuyers. A stalling housing recovery would have negative implications across the broad economy and slow nascent growth.

Tough Times for TIPS

This week’s Chart of the Week illustrates the significant increase in yields on the 10 Year Treasury Inflation Protected Security (TIPS) over the past several weeks. From May 1, 2013 to June 19, 2013, the yield on 10 Year TIPS increased from -0.67% to +0.26% (an increase of 0.93%).

This week’s Chart of the Week illustrates the significant increase in yields on the 10 Year Treasury Inflation Protected Security (TIPS) over the past several weeks. From May 1, 2013 to June 19, 2013, the yield on 10 Year TIPS increased from -0.67% to +0.26% (an increase of 0.93%). Over that time frame, investors holding 10 Year TIPS contracts suffered losses of approximately 8.0% (there is an inverse relationship between prices and yields, so as yields increase, prices fall). This huge selloff in TIPS has largely been driven by the increase in yields on the 10 Year Nominal Treasury, which saw yields jump by 0.72% over the same time period (representing a loss of 4.9%). Much of the increase in the 10 Year Nominal Treasury yield has been attributed to expectations that the Federal Reserve Bank, which is currently purchasing $85 billion worth of Treasuries and Mortgage Backed Securities every month as part of its various quantitative easing programs, is going to start winding down its asset purchases in the near future. This was confirmed on June 19, when Federal Reserve Chairman Ben Bernanke announced that if economic data continues to come in line with the Fed’s current expectations, the Fed will begin to scale back the level of asset purchases later this year, and could end the asset purchases entirely by mid-year 2014.

However, the jump in nominal Treasury yields does not fully explain the recent increase in TIPS yields. The yields on TIPS are driven by two primary forces, nominal Treasury yields, and inflationary expectations. Thus, the increase in TIPS yields that is not explained by the increase in nominal Treasury yields is primarily attributable to falling inflationary expectations. This should not be surprising given that one of the primary goals of the Fed’s quantitative easing programs was to prevent deflation from occurring in the U.S. economy (i.e. increasing inflation). The simultaneous combination of higher nominal Treasury yields and falling inflationary expectations are the perfect storm that led to the significant losses in TIPS over the past several weeks.

Fiscal Health Improvements for the U.S.

This week’s chart looks at the CBO’s updated fiscal projections for the U.S. federal government published on May 14th (the red line on this chart is the updated deficit/GDP estimate). These projections are an update from the last set of projections made in February (gray line) and include the full effect of the tax increases implemented on January 1, 2013 and the budget cuts mandated by sequestration, which began on March 1st.

This week’s chart looks at the CBO’s updated fiscal projections for the U.S. federal government published on May 14th (the red line on this chart is the updated deficit/GDP estimate). These projections are an update from the last set of projections made in February (gray line) and include the full effect of the tax increases implemented on January 1, 2013 and the budget cuts mandated by sequestration, which began on March 1st. These updated projections show a $642 billion drop in the expected federal budget deficit in 2013, and over a $6 trillion reduction in the expected deficit over the next decade. The bars on this chart show the projected improvement in the deficit (higher revenue or lower expenditures) compared to the previous projections. Interestingly, a large part of the improvement in 2013 is driven by payments to the U.S. Treasury from Fannie Mae and Freddie Mac, which have recently returned to profitability after being taken over by the federal government during the credit crisis. While the deficit-to-GDP ratio is now expected to shrink substantially over the next few years, the CBO projections still show the U.S. federal government running a structural deficit of 3%-4% of GDP indefinitely. This is because the recent improvement in the deficit has been driven by a cyclical recovery in the U.S. economy and fiscal austerity, but the long term problem of entitlements remains unsolved. These updated projections are clearly good news for the economy and the market in the near term, but until the long term structural deficits are addressed, investors are unlikely to view the U.S. as back to full fiscal health.

What To Do With All That Cash?

This week’s chart of the week examines the cash holdings of companies in the S&P 500 following the recession. Since 2007, the cash per share for the S&P 500 index has risen to $329.01 for a compounded annual growth rate of 11.5%.

This week’s chart of the week examines the cash holdings of companies in the S&P 500 following the recession. Since 2007, the cash per share for the S&P 500 index has risen to $329.01 for a compounded annual growth rate of 11.5%. This was the result of companies protecting themselves against another economic downturn, but as the S&P 500 has hit record highs, cash and other short-term investments have continued to grow.

Investors often view high levels of cash as a sign of inefficiency. If companies have no favorable projects to invest their cash in, it should be returned to the shareholders. The most apparent instance of this was when shareholder activists began demanding Apple (AAPL) pay out some of its cash to investors. While Apple has announced it will return $100 billion to shareholders, it partially financed this buyback with debt to avoid taxes on its overseas cash. Although these high levels of cash are often viewed negatively, it could provide investors with opportunity if and when businesses decide to use these holdings. In addition to being paid out to shareholders, this cash could be reinvested in the firm or used to make new acquisitions, both theoretically leading to increased growth for the company. However, issues such as Apple’s international taxation may continue to discourage businesses from dispersing these positions. Furthermore, holding high amounts of cash may be the new norm as companies look to avoid liquidity problems during any decline the economy might face.

Comparing Consumer Debt to Federal Debt

This week’s Chart of the Week focuses on debt levels of the U.S. consumer and federal government. The Federal debt has increased significantly since the 3rd quarter of 2008 (onset of the Global Financial Crisis), and appears to be maintaining this trajectory. On the other hand, while consumers’ household debt has increased in absolute terms, there have not been dramatic spikes in the debt level.

This week’s Chart of the Week focuses on debt levels of the U.S. consumer and federal government. For consumer debt, all forms of debt other than mortgages are included in the analysis. As of the fourth quarter of 2012, U.S. consumers collectively held debt of $2.8T. Over the 32 year time frame since 1981 (when data was first collected), consumer debt has increased from $378B to $2.8T, a whopping increase of 635%. However, this still constitutes a relatively small percentage of U.S. debt, and has hovered between 5 and 10% over the years.

On the other hand, federal debt has not only been a much higher dollar amount (not surprising), but has also been a much more volatile component of overall U.S. debt. As of the fourth quarter of 2012, the Federal Government’s debt was $11.6T. In the 32 year time frame, Federal debt has increased from $821B to $11.6T, an even larger jump of 1313%. Federal debt has averaged 22% of total U.S. debt ranging from a low of 16% to a high of 29%.

The chart above depicts these four debt data points: households’ consumer credit dollar amount, Federal government’s dollar amount, consumer debt percentage of total U.S. debt, and Federal debt percentage of total U.S. debt. The takeaways are quite evident. The Federal debt has increased significantly since the 3rd quarter of 2008 (onset of the Global Financial Crisis), and appears to be maintaining this trajectory. On the other hand, while consumers’ household debt has increased in absolute terms, there have not been dramatic spikes in the debt level. Additionally, it has maintained its weight in the overall debt picture. Given the disparity in both dollar amount and share of overall debt, the level (and trend) of federal debt will continue to have a much more notable impact on the economy and financial markets than consumer debt.

Further Support for Emerging Market Equities

This week’s Chart of the Week examines historical and projected contributions to total world Gross Domestic Product (GDP) based on Purchasing Power Parity (PPP) at exchange rates prevalent in the United States.

This week’s Chart of the Week examines historical and projected contributions to total world Gross Domestic Product (GDP) based on Purchasing Power Parity (PPP) at exchange rates prevalent in the United States. The International Monetary Fund (IMF) in its April 2013 release of the World Economic Outlook report shows the share of total world GDP between advanced economies and emerging and developing economies from 1980 through 2018. As seen in the above graph, advanced economies’ share of world GDP has steadily declined since the early 1990’s with emerging and developing economies comprising an increasingly larger percentage of world GDP over this time.

2013 is the first year that emerging and developing economies are expected to contribute a larger share of total world GDP than advanced economies. In addition, emerging market countries typically have lower levels of government debt and more favorable demographics than their advanced economy counterparts. While emerging market stocks have underperformed in recent years compared to other equity markets, their growing contribution to world GDP offers a compelling case for continued allocations to this asset class.

 

Has The Volcker Rule Affected Loan Syndication Activity?

This week’s chart looks at current U.S. Syndicated Loan Underwriting Volume in comparison with the new business environment created by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd Frank was enacted by President Obama in 2009 – 2010 with stated objectives of increasing financial accountability and transparency, ending “too big to fail” institutions requiring corporate bailouts, and protecting consumers.

This week’s chart looks at current U.S. Syndicated Loan Underwriting Volume in comparison with the new business environment created by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd Frank was enacted by President Obama in 2009 – 2010 with stated objectives of increasing financial accountability and transparency, ending “too big to fail” institutions requiring corporate bailouts, and protecting consumers. However, the ability of the Act’s provisions to accomplish these goals has been the subject of fierce debate. Amidst many new regulations imposed on the Financial Services Industry, Dodd-Frank restricts the types of proprietary trading activities that financial institutions are allowed to practice. This restriction comprises part of what is known as “The Volcker Rule”, which was implemented on July 21, 2012.

One of the major criticisms of the Volcker Rule has been one voiced by Canadian, British, and Japanese government finance ministers and bankers. These countries say the Volcker Rule is a disincentive for their banks to transact with their American counterparts because the Volcker Rule exempts U.S. government securities from its restrictions on proprietary trading but leaves similarly-rated foreign institutions out of the exclusion. Volcker Rule proprietary trading prohibitions would thus apply even if a transaction were between foreign parties wherein an American bank is involved only in an ancillary (ex. clearinghouse) capacity. Under this theory, in order to avoid this interference, foreign banks may avoid syndicating with U.S. banks.

Given that as of 1Q2013, North American deals constitute 82.1% of all Global Syndicated Loans1, the number of domestically-originated syndicated loans which receive financing should be significantly affected if these doomsayers’ warnings ring true. However, per this week’s chart, over three quarters have passed since the Volcker Rule has become effective, and U.S. Syndicated Loan Underwriting Volume has recovered to pre-subprime crisis levels. Thus, while Dodd Frank and Volcker will continue to be scrutinized along other lines, it would seem that the hypothesized downward pressure on syndicated deals has been much to do about nothing.

1Bloomberg

Household Wealth Rises, Will Job Growth Follow?

This week’s chart illustrates recent shifts in the personal savings rate and household net worth. As seen in the graph, household wealth is approaching its pre-recession level as the recovery in the stock and housing markets has helped repair household finances.

This week’s chart illustrates recent shifts in the personal savings rate and household net worth. As seen in the graph, household wealth is approaching its pre-recession level as the recovery in the stock and housing markets has helped repair household finances. The Federal Reserve’s tactics of holding interest rates low and offering stimulus in the form of Treasury and mortgage purchases seem to be creating its intended wealth effect, albeit slower than anticipated.

As household finances improve, consumers will be less inclined to save and more likely to purchase goods and services. Currently, the personal savings rate is hovering around 2.5% which is substantially less than its recession high of 6%. If the current rallies in the stock and housing markets continue, we should see a trickledown effect to many sectors of the economy, most notably jobs. In theory, an increase in consumer demand should lead to an increase in labor demand as companies ramp up production in response to more consumer spending. Additionally, labor demand will increase wages, further perpetuating the wealth effect.