U.S Economy Archives — Page 49 of 62

This Market is One Cool Cat

Hurricanes Harvey and Irma substantially impacted the lives and infrastructure of all that was in their paths. They also directly impacted certain investments, namely catastrophe bonds, (“cat bonds”). Catastrophe bonds can help diversify a bond portfolio’s rate, credit and currency risk with non-correlating nature risk. Cat bonds are issued by insurance companies that pool property and casualty policies. They pay coupons to the bondholder using the policy premiums received. However, when a natural disaster occurs, the principal of a cat bond can be used to pay insurance claims on the pool of policies. Historically, annual cat bond returns average 5% to 10%.

This week’s chart shows the Swiss Re Cat Bond Index on the top compared to the Credit Suisse High Yield Bond Index on the bottom. Hurricane Harvey caused only a negligible 0.3% decline in the cat bond index followed by a 0.5% rebound, since the most severe damage came from flooding. Flooding is generally not covered by cat bonds, as cat bonds primarily cover hurricane damages associated with wind. However, Hurricane Irma caused a 16% initial decline, as the index has roughly 20% exposure to Florida hurricanes. Moreover, the state of Florida requires that all homeowners hold hurricane insurance.

Hurricane Irma qualifies as one of the top 10 costliest natural disasters ever recorded, with damage estimates ranging from $50 billion to $100 billion. It is akin to the 2008 housing crisis for the corporate credit and equity markets. The bottom chart shows the high yield bond index declining during the 2008 housing crisis by 33% peak-to-trough, which was over twice the initial decline of the cat bond index due to Hurricane Irma. With recent damage estimates adjusted downwards from an initial overshoot, the Swiss Re Cat Bond Index has already rebounded by 10% only a few days after Irma struck. This makes its net decline 6% to-date as the index continues to recover, showing inherent resilience in the cat bond market. Our thoughts are with those affected by these recent disasters.

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Does the Impact of Natural Disasters Discriminate by Stock Sector?

To date, hurricane Harvey has caused more than 100 deaths in the United States and at least $70 billion in estimated losses. Without much time for recovery, hurricane Irma, recorded as the most powerful Atlantic hurricane in history, has already destroyed Caribbean islands and is now approaching Florida. As market participants’ sentiment is one of the most important drivers of asset prices, this week’s chart investigates how traders react to such natural disasters, and the impact on S&P 500 sector performance.

In this analysis, trader sentiment is measured by the number of messages about a specific company posted to the StockTwits website and then the PsychSignal algorithm computes their intensity (scaled from 0 to 4, 4 being the most intense), and groups the scores by sector. The mood score is calculated by bullish score minus bearish score. The more positive the score is, the more bullish the traders are toward that specific sector. The mood scores for each stock are averaged over 10 trading days since the outbreak and averaged again across stocks in the sector.

Considering that the maximum score is 4, the chart shows traders are slightly bullish but close to neutral across the board, and it is difficult to discern a profitable pattern based on these readings. If anything, traders tend to be more bearish on basic material and utility companies whose ability to process minerals and supply power can be tapered. On the other hand, traders are more bullish on consumer staples, energy and health care companies, which may see more demand amidst recovery efforts. During hurricane Harvey, traders have been bullish on energy companies and the sector returned 3.6%.

However, the series of natural disasters shown in the graph above reveals that there really is not a predictable correlation between sentiment and sector performance. For example, traders were bearish on basic material companies in 2009 and 2010. However, the sector returned 1.7% and 1.1%, respectively, during the earthquake (2009) and flood (2010) disasters. Traders were bullish on energy companies in 2011 but the sector returned -4.6%. This unclear relationship could be because the members of S&P 500 sector indices are large cap companies that are less influenced by short-term shocks than small cap companies. Also, StockTwits only represents a small portion of market participants and covers topics beyond natural disasters.

According to this analysis, how traders feel about the natural disasters cannot solely predict how the sectors will perform. Traders tend to keep quiet as natural disasters are an unknown factor and considered too risky upon which to make a buy/sell decision. It is interesting to observe how traders feel about natural disasters in terms of asset prices but not indicative of future returns.

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The Market’s Bad Breadth

While many are familiar with technical analysis and its claimed prophetic approach to the markets using historical performance, this week we look at a derivative of the 50-day moving average through the lens of breadth.

Crossing below the 50-day moving average is considered a point of weakness whereas crossing above this trendline is viewed as a sign of future strength and bullish activity for the market or index in question. While the broad market, as proxied by the Russell 3000, had a strong May and June and remained above this moving average, it found weakness in August and has been below this trendline for the past few weeks. Instead of just analyzing the index as whole, we examine the behavior at a component level through market breadth which is a ratio of stocks with increasing prices to those with falling prices. A derivative of this metric is charted below as a ratio of stocks above their 50-day moving averages over those below; a ratio above 1 is a positive indicator for the market as this means more stocks are above their short-term average than below and indicates substantial market breadth. This is a good sign for the market as it means the majority of index constituents are exhibiting strength as opposed to only a few mega-caps lifting up the market.

Recently, however, this ratio fell below 1 which means stocks falling in price outnumber those increasing in price. Less than 42% of stocks in the Russell 3000 universe are trading above their short-term moving average whereas back in July more than 70% were trading above their short-term averages. That the market is trading flat during this new trend means that the upward movement of only a few stocks relative to the universe is keeping the market flat; this does not make for a stable market. While these are only technical indicators and are not cause for extreme alarm, the general indication of these data points is that market stress in the near future would not be completely surprising.

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Central Bank Balancing Act

The Federal Reserve continues to signal its intention to reduce its $4.5 trillion balance sheet, with the markets anticipating the first move to occur in September. Much of the liquidity, and consequently, asset returns, in the global markets today could be attributed to the substantial bond and other securities purchases made by the major central banks, thereby ballooning their balance sheets.

Our chart this week shows the Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BOJ) balance sheets over time, totaling $14 trillion today. While the Fed has effectively stopped growing its balance sheet since 2014, the ECB and BOJ continue to expand their balance sheets. With the U.S. enjoying the strongest economy relative to Europe and Asia, the Fed will be the first to taper its balance sheet. This move would effectively slow down stimulus in the U.S., with the ECB and BOJ’s balance sheet tapering to follow at some point in the future when their economies have resuscitated. The Fed has been broadly communicating the mechanics of its tapering, and we expect the markets to respond relatively moderately to the first reduction event.

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Is it Time for a Raise?

Wage growth continues to be one of the most disappointing parts of the recovery as increases in pay are relatively low despite record levels of employment. However, the growth individuals see can vary significantly. This week’s chart shows how $1000 five years ago would have grown under the different quartiles of wage growth, as well as how costs have increased under inflation. Given the low levels of inflation in recent years, it is of little surprise that costs have not changed much, rising just over 6.5% during this time frame. Workers whose raises were consistent with median wage growth gained an extra $150 for every $1000 earned in 2012, which was enough to beat inflation and increase their purchasing power.

What is most notable though, is that those who received the 75th percentile for wage growth nearly doubled their pay, while individuals at the 25th percentile lost more than 10% before inflation. It is important to consider that many workers will not consistently be at one end or another of the spectrum; a promotion one year could put an individual in the top quartile, while the loss of an important customer could move them to the bottom the next. Still, this shines some light on the different scenarios workers are facing as a quarter of the population lost about 2% or more of their income this past year, while another gained over 14%.

Although it seems like this gives some credence to the complaints about rising inequality, it should be noted that the biggest determinant of wage growth is age. Younger workers just starting out their careers saw the largest raises with those age 16–24 gaining almost 8% this year on average, compared to just 2% for those 55 and older. Not surprisingly, those with higher skills and better education also fared better on average. The industry in which a person works is less important than one might expect, with most sectors having a growth rate between 3–4%. Ultimately, given the wide range of wage growth rates this could affect increases in consumer spending with those on the lower end of the spectrum not able to increase their spending habits. Spending growth is more dependent on those who experience larger gains and if they choose to start saving more, economic growth could suffer.

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Fueling the Future: The Evolving Economics of Oil

Oil prices may have made headlines on Monday – closing above $50 a barrel for the first time since late May – but the economic outlook for fossil fuels remains uncertain. The International Energy Agency (IEA) reports that global energy investment fell by 12% in 2016, a second year of decline experts attribute to reduced spending on upstream oil and gas investments. Meanwhile, clean energy spending reached 43% of total global energy supply investment in 2016, a record high. While the IEA and large oil companies predict a greater than 10% rise in oil demand by 2040, a recent report by Bloomberg suggests that shifts in the energy economy could dampen such estimates.

This week’s Chart of the Week illustrates the hypothetical effects of technological advances, electric cars, and alternative energy sources on the IEA and oil industry’s demand predictions. Transportation – which alone accounts for about 60% of oil use – has enjoyed technological advances which have led to increasingly efficient engines, less fuel waste, and shorter trips due to better navigation systems. Concurrently, Bloomberg predicts more than 20 million sales of electric cars by 2030 due to shifting consumer preferences and aggressive policies in China, India, and Europe. Lastly, alternative energy sources such as biofuels and natural gas could supplant oil demand as clean energy investments continue to gain traction and popularity. These variables combined could drastically impact the economics of oil over the next several decades.

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Will the Yield Curve Invert?

The Chinese yield curve inverted recently. Does this mean that the U.S. yield curve might invert soon? What does inversion mean for investors? Inverted yield curves have been precursors of bad news for the equity market. In the past 20 years, the U.S. yield curve inverted twice, once in 2000 and once in 2006 and the S&P 500 subsequently dropped 48% and 53% following each inversion, respectively. When the yield curve inverts, it usually means that the market is pessimistic about the economy and drives up long bond prices as safe havens, thereby reducing their yields relative to short bond yields, which typically have been driven up by rate hikes.

This week’s chart observes several signals that appear just before the yield curve inverts. First, there are several years of a downward trend in the spread between 10-Year and 2-Year Treasury yields (also known as steepness) and an upward trend in the equity market, as the orange and red arrows show in the chart. Since the last inversion in 2006, we have seen this signal for a while. Second, GDP growth reaches its peak. For the last five years, GDP growth has been stable and at a moderate level, and it is unclear if it has reached a peak or could grow further. Lastly, it takes time for the spread to become negative and the change is not abrupt. Before the inversion, the spread was around 30bps in 2000 and 15bps in 2006. The spread as of May 2017 was around 50bps and still has room to contract.

Overall, there are several signals that suggest that yield curve inversion is coming. However, inversion is unlikely to happen in the near future. The current yield curve is reasonably steep, the market has a positive sentiment about the economy and other economic boosts from the Trump administration may come into play, such as job creation initiatives and tax cuts for businesses and consumers. Yield curve inversion is not yet impending.

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What’s Realistic for GDP?

Though GDP growth varies greatly throughout an economic cycle, the last several decades have seen it slowly decline. One of the many promises made by Trump and other presidential candidates during the election was to restore GDP to its higher levels once again. But even with beneficial policy changes, is it possible to achieve 3%-4% year-over-year growth?

GDP growth essentially comes from two areas: an increase in the number of workers or an improvement in output per worker. Output per worker, or productivity, generally comes from businesses investing in technology and equipment to improve efficiency. In this week’s chart, we’ve estimated this by taking the difference between growth in GDP and total workers. As the chart shows, productivity gained very little the last several years as most of GDP’s growth came from an improvement in the employment situation. The exception to this came during the financial crisis when employers tried to cut costs and become leaner. It seems after this there has been little room for businesses to become more efficient.

What makes this concerning is that the growth seen in employment is not sustainable. With the unemployment rate at about 4.5%, we are either at or nearing full employment, meaning that any growth in workers has to come from people joining the worker force. However, the opposite is expected over the next 10 years as baby bombers continue to retire. This suggests that productivity will have to improve just to maintain the current growth rate of the economy. While things like tax reform and infrastructure spending should boost growth, it seems unlikely that GDP will return to more historic levels any time soon.

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Who’s Buying?

Over the last 15 years, the U.S. Treasury market has grown from $3.3 trillion in 2000 to $14.3 trillion at the end of 2016; certainly the Financial Crisis and subsequent stimulus programs have contributed to this massive growth. Throughout this period, foreign demand has constituted a consistent 40–50% of the market for U.S. Treasuries. However, the demand has shifted over the years, and our chart of the week chronicles the evolution of foreign buyers and sellers of U.S. Treasuries from 2000 through 2016. Perhaps most notable is that in 2015, foreign demand began to wane as China and other emerging market nations began to defend their currencies against appreciation and consequently reallocated away from U.S. debt.

On Monday, former Federal Reserve Chairs Bernanke and Greenspan spoke about the Federal Reserve’s balance sheet and the United States debt market. Bernanke believes the Federal Reserve should aim to reduce its balance sheet from $4.4 trillion to somewhere in the range of $2.3–2.8 trillion. Of the Federal Reserve’s $4.4 trillion in assets, approximately $2.5 trillion are U.S. Treasury Securities. From 2019-2026, $250 billion in Treasury securities will reach maturity each year. These securities will have to be rolled over in addition to any further deficit spending. To avoid this constant debt overhang, the administration is considering “ultra-long-term bonds”, which would push the repayment of this debt to beyond 2049. Ultimately, the declining foreign demand for U.S. Treasuries combined with the Trump Administration’s plans to cut taxes and increase spending could make it difficult for the Federal Reserve to reduce its balance sheet without facing higher yield demands at Treasury auctions.

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