2016 Investment Symposium Opening Keynote
2016 Investment Symposium opening keynote by James A. Bianco
This presentation covers the 2016 election, negative interest rates, and post-crisis challenges for investment managers with James A. Bianco, president, Bianco Research.
November 2016
To the surprise of pollsters, analysts, and much of the American public, Republican presidential candidate Donald Trump trampled predictions by winning the presidential election in stunning fashion.
The long-term impact of Trump’s presidency on financial markets is impossible to predict at this point, given the amount of uncertainty around his expected policies. However, the short-term dynamics surrounding his election win are starting to emerge, and we share with you what we are seeing and hearing in the market in this newsletter.
This week’s chart of the week looks at the recent spike in the London Inter Bank Offered Rate (LIBOR), which is the rate at which banks charge one another for short term loans. As the chart illustrates, over the past year the 3-month LIBOR rate has increased from 0.32% to 0.88% (an increase of 0.56%), which is the highest rate for 3-month LIBOR since the spring of 2009. While other measures of short term interest rates – such as the Fed Funds Rate (increasing from 0.25% to 0.50%) and 3-month T-Bills (increasing from 0.01% to 0.33%) – have also risen over the past year, the magnitude of the LIBOR increase is significantly larger and warrants further examination.
This week’s chart of the week looks at the recent spike in the London Inter Bank Offered Rate (LIBOR), which is the rate at which banks charge one another for short-term loans. As the chart illustrates, over the past year the 3-month LIBOR rate has increased from 0.32% to 0.88% (an increase of 0.56%), which is the highest rate for 3-month LIBOR since the spring of 2009. While other measures of short term interest rates — such as the Fed Funds Rate (increasing from 0.25% to 0.50%) and 3-month T-Bills (increasing from 0.01% to 0.33%) — have also risen over the past year, the magnitude of the LIBOR increase is significantly larger and warrants further examination.
Over the past few months, both the Fed Funds Rate and T-Bills have remained flat, while LIBOR has continued to increase steadily (increasing from 0.65% on June 30th to 0.88% on September 18th). During this time period, the spread between LIBOR and T-Bills (known as the TED spread) has increased from 0.39% to 0.55%. In fact, the current spread of 0.55% is higher than the 0.42% average TED spread since the year 2000. This is concerning because historically, an increase in the TED spread has indicated stress in the financial markets. The TED spread spiked in mid-2007 when signs of the financial crisis first started to appear, and spiked again in 2008 as the crisis unfolded. Now that the TED spread is increasing again, there is some concern that this may be an early sign of another financial crisis starting to unfold.
In order to put the recent rise in LIBOR (and the corresponding rise in the TED spread) in context, it is important to look at what has driven these rates higher. Unlike the 2007/2008 financial crisis, the recent increase in LIBOR is not a result of distress in the credit markets. In fact, between June 30th and September 18th, high yield credit spreads (a reliable measure of the health of the credit markets) decreased by 1.4%. And unlike the 2007/2008 financial crisis, the recent increase in the TED spread has been relatively small. While the current 0.55% TED spread is slightly greater than the long-term average, it is well below the 4.63% peak we saw during the fourth quarter of 2008. The recent increase in LIBOR appears to be driven primarily by the money market reforms that went into effect on October 14th that require most money market funds to invest exclusively in U.S. government securities. As a result of this new regulation, more than $1 trillion has moved out of “prime” money market funds, which were allowed to invest in short-term corporate bonds and certificates of deposit tied to LIBOR rates, and into “government only” money market funds. It is unclear whether the increase in LIBOR rates and TED spreads are a temporary phenomenon driven by a supply/demand imbalance or if this is a permanent structural change. Either way, this is something that should be monitored closely in the coming months.
While this year’s political election has featured much discussion about jobs going overseas, a larger impact on manufacturing employment has come from technology advances. Over the years, manufacturing companies have replaced jobs with computerized equipment to reduce production costs. However, the considerably more complex equipment demands workers with new skill sets to operate these machines. So while such technological advances helped the manufacturing industry reduce the number of required workers yet increase production, many factories are finding it difficult to find employees with the necessary skills to operate and maintain the advanced machinery. This week’s chart takes a look at the number of manufacturing jobs that are going unfilled even with improving employment rates and the steady addition of jobs.
While this year’s political election has featured much discussion about jobs going overseas, a larger impact on manufacturing employment has come from technology advances. Over the years, manufacturing companies have replaced jobs with computerized equipment to reduce production costs. However, the considerably more complex equipment demands workers with new skill sets to operate these machines. So while such technological advances helped the manufacturing industry reduce the number of required workers yet increase production, many factories are finding it difficult to find employees with the necessary skills to operate and maintain the advanced machinery. This week’s chart takes a look at the number of manufacturing jobs that are going unfilled even with improving employment rates and the steady addition of jobs.
The chart above compares the number of people hired for manufacturing jobs versus the number of job openings. Any ratio above 1 indicates that more people are hired in a month than the number of jobs available in the market; this is explained by elevated hiring levels as well as turnover in the industry. Critically, a ratio above 1 also suggests minimal mismatch between worker qualifications and desired skill sets for the open manufacturing jobs. This ratio peaked in late 2009, as companies were aggressively hiring as they emerged from the trough of the recession. Since then, the ratio has steadily decreased and now sits below 1, therefore suggesting a growth in the divide between qualified workers and the required skill sets to fill these new open manufacturing jobs. Broadly speaking, this mismatch poses problems for the economy as these unfilled positions slow production and weigh on growth. While there are no easy solutions, further training and education for potential workers will help fill these roles vital for production output and stronger economic growth.
Productivity is the change in output per hour worked and serves as a key indicator of real economic growth. Not surprisingly, it is one of the critical macroeconomic variables analyzed by the Fed when deciding whether or not to raise interest rates. Lower levels of productivity can result from economic policy and shocks, changing demographics, and slower gains from technological innovations.
Productivity is the change in output per hour worked and serves as a key indicator of real economic growth. Not surprisingly, it is one of the critical macroeconomic variables analyzed by the Fed when deciding whether or not to raise interest rates. Lower levels of productivity can result from economic policy and shocks, changing demographics, and slower gains from technological innovations.
This week’s chart shows the productivity changes of the three largest developed market currency blocks: the United States, Japan, and the Eurozone. The graph illustrates that all three are currently struggling to produce meaningful productivity gains. In the U.S., output per hour worked has now contracted for three consecutive quarters. Most of the U.S. contraction can be accounted for by lower energy prices, but the more important theme is the lower levels of productivity across the developed world and their likely contribution to stagnating global growth. If this trend continues, it will be serve as yet another headwind for stronger growth across the globe.
As the Federal Reserve maintains interest rates at all time lows, corporate balance sheets continue to benefit from this accommodative environment, as the low rate environment combined with a bull market has allowed corporations to add leverage to their balance sheets at an alarming rate. With borrowing costs so low, corporations have used this debt to finance stock buybacks, dividend growth, and M&A deals.
As the Federal Reserve maintains interest rates at all time lows, corporate balance sheets continue to benefit from this accommodative environment, as the low rate environment combined with a bull market has allowed corporations to add leverage to their balance sheets at an alarming rate. With borrowing costs so low, corporations have used this debt to finance stock buybacks, dividend growth, and M&A deals.
The growth of net debt among the S&P 500 constituents has hit levels not seen in the past 10 years, rising significantly against EBITDA levels. Thus, corporations’ operational cash flows are not expanding quickly enough to keep pace with their growing debt loads. This type of imbalance in past cycles has led companies to cut back on spending and hiring.
While consumers have deleveraged since the 2008 housing crisis, corporations have taken advantage of the low rates and subsequent cheap financing. If the Federal Reserve begins to raise rates or economic growth continues to slow, corporations could struggle to cover interest payments on their outstanding debt, which would likely translate to subpar returns for both equity and debt investors.
The United Kingdom’s (UK) vote to leave the European Union on June 23 was an unprecedented event that impacted markets across around the world. While this exit won’t actually take place for another two years, equities sold off in a knee-jerk fashion as investors feared the ramifications on the global economy. Due to the heavy exposure to Europe, non-U.S. developed markets suffered the most, losing nearly 10% before rebounding.
The United Kingdom’s vote to leave the European Union on June 23rd was an unprecedented event that impacted markets around the world. While this exit won’t actually take place for another two years, equities sold off in a knee-jerk fashion as investors feared the ramifications on the global economy. Due to the heavy exposure to Europe, non-U.S. developed markets suffered the most, losing nearly 10% before rebounding.
With the U.S. viewed as a safe haven, domestic equities have fared relatively well in the Brexit aftermath. The U.S. dollar appreciated following the decision while the British pound slumped to a 30 year low against the greenback. Emerging market (EM) currencies have also depreciated against the dollar however EM equities have been one of the stronger performers. This asset class has benefitted from the U.S. Federal Reserve indicating it will not make any significant interest rate movements due to the risk the Brexit poses to the economy. Only a few days after the UK vote, EM equities rallied for its biggest weekly gain since March. While the Brexit will undoubtedly have long-term ramifications, many of which are currently unclear, equity markets have rebounded from the initial sell-off.
June 2016
On June 23rd, the United Kingdom (UK) shocked markets with its vote to leave the European Union (EU). The Remain vote lost to the Leave vote, 48.1% to 51.9%, with a strong turnout throughout the UK. Younger voters sided with the Remain camp by a wide margin, while older voters supported the Leave camp (Exhibit 2). In the weeks leading up to the referendum, global equity/credit markets and the British pound experienced positive price movement in anticipation of a Remain verdict. Using polling information and odds makers as indicators, investors were caught off guard at the Brexit result, leading to dramatic losses for risk assets on June 24th.
Given the current market environment right now, there are no real compelling “buy” opportunities, as measured by a variety of valuation metrics. On top of that, economic growth is slow, yields are low, and equity returns are weak. As such, one of the primary conversations we have with clients is around rebalancing, both at the broader asset class as well as between the underlying components of each asset class.
Given the current market environment, there are no real compelling “buy” opportunities as measured by a variety of valuation metrics. On top of that, economic growth is slow, yields are low, and equity returns are weak. As such, one of the primary conversations we have with clients is around rebalancing, both at the broader asset class as well as between the underlying components of each asset class. In particular, we have recently spent a lot of time discussing the relative valuations of large-cap and small-cap U.S. equities in an effort to identify the more attractive opportunity in today’s market.
In this week’s chart, we examine the P/E ratios of U.S. large-cap and small-cap stocks and compare today’s values to their 20-year averages, removing outliers for when earnings are near zero or negative. The intuition is that the farther today’s P/E ratio is from the long-term average, the more (or less) attractive it is from a valuation standpoint: a reading below the long-term average signals a discounted price, whereas a reading above the long-term average indicates the index is expensive. As seen in the chart, both are near their historical averages, suggesting there isn’t an overly compelling case for either.
How they have gotten to this point over the last 2–3 years, though, is very different. Large-cap companies have slowly returned to this average as a result of investor caution as well as the gradual — but consistent — rise in earnings from 2011 to 2015. Recently though, earnings have slightly fallen for larger companies, which has caused some concern for investors. Small-cap stocks, on the other hand, feature more volatile valuations, with swings in earnings the primary explanation of volatility. In theory, during times of “risk-off” sentiment, large-cap stocks should outperform smaller companies, and vice versa for “risk-on” periods. But with ambiguous market data and valuations so similar to historical averages, investor sentiment is unclear, thus making it extremely difficult to truly identify compelling value in either sleeve of the U.S. equity market.
This week’s chart of the week looks at delinquent balances by loan type from 2003 through 2015. In general, total loan delinquencies – auto, mortgage, student and credit card – remain subdued compared to their levels between 2007 and 2012.
This week’s chart of the week looks at delinquent balances by loan type from 2003 through 2015. In general, total loan delinquencies — auto, mortgage, student, and credit card — remain subdued compared to their levels between 2007 and 2012. However, one area of concern is the significant increase in delinquent student loans, which has increased 97% since 2008. Although they constitute a relatively small percentage of total delinquent loans, they could have negative ramifications for years, as current or former students attempt to pay down their debt and thus have less money to consume on other items, not to mention their damaged credit score could affect their abilities to obtain mortgages and other financing for large ticket items in the future. So while the current level of student debt may not be an immediate threat to the economy, it could create economic headwinds in future years.
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