Topic Tags: U.S Economy

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.

How to Position Fixed Income Portfolios for the Rate Hike

October 2015 Investment Perspectives

Much has been written and discussed in the media about when the rate hike will begin and the pace at which it will occur. Ultimately, the timing and pace are difficult to predict because they depend on many moving parts, including unemployment, inflation, and a host of unpredictable economic and political factors. The right question to ask is: How should an institutional investor position a fixed income portfolio for the rate hike, regardless of the associated timing and speed?

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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.

Is the U.S. Economy on the Brink of a Recession?

Historical analysis has shown that an inverted or flattening yield curve may be a warning sign of an upcoming recession. Since the 1950s, an inverted curve has preceded seven of the last eight recessions, with spreads near zero in 1960.

Historical analysis has shown that an inverted or flattening yield curve may be a warning sign of an upcoming recession. Since the 1950s, an inverted curve has preceded seven of the last eight recessions, with spreads near zero in 1960. An inverted yield curve occurs when short-term yields to maturity are higher than long-term yields to maturity (depicted where spreads fall below zero on the chart). This indicator has proven to be a reliable predictor of recessions and future economic activity.

Last week’s correction has led to investor concern that the market will continue to decline and evolve into a bear market, which is unlikely unless there is a recession and corresponding inversion of the yield curve. This week’s chart shows that the yield curve is currently positively sloped and has in fact steepened on a year-to-date basis, providing some confidence that recent market volatility is indicative of a correction rather than another recession.

It’s That Time of Year Again…

Between August 17th and 25th, the U.S. equity market – as represented by the S&P 500 Index – declined 11%. The pace and magnitude of the market drop came as a shock to many and left investors pondering how they should react to this swift downdraft. While some may be looking to underlying fundamentals or economic data for guidance, one could simply point to history as an indicator.

Between August 17th and 25th, the U.S. equity market — as represented by the S&P 500 Index — declined 11%. The pace and magnitude of the market drop came as a shock to many and left investors pondering how they should react to this swift downdraft. While some may be looking to underlying fundamentals or economic data for guidance, one could simply point to history as an indicator. This week’s chart looks at the maximum intra-year drawdown for the S&P 500 Index over the last 30 years.

While this recent decline is notable, it is not unusual for the market to experience a significant intra-year drawdown. Over the last 30 years, returns for the S&P 500 have only been negative five times. However, 15 of these 30 years have featured max intra-year drawdowns greater than 10%, with 10 of those years actually posting a gain for the year. In other words, the S&P 500 has shown resiliency over the long term, and the recent 12.4% drawdown for 2015 does not automatically translate to a negative year for U.S. equity investments. In fact, the last two days have seen an impressive rebound in the markets, and when markets closed on August 27th, the S&P 500 index was down only 2.1% for the year.

For more information on the recent market volatility as well as what to expect in the coming months, please read our U.S. equity market update which was released earlier this week.

Impact of Higher Interest Rates on High Yield Bonds

Under the Fed’s zero interest rate policy, high yield bonds have enjoyed a terrific run of performance. For the five year period ending June 30, 2014, the Barclays U.S. Corporate High Yield index produced an impressive annualized return of 14.0% per year. However, returns in this more speculative portion of the bond market have been disappointing since last summer, when the high yield spread over Treasuries reached a multi-decade low of 221 basis points.

Under the Fed’s zero interest rate policy, high yield bonds have enjoyed a terrific run of performance. For the five-year period ending June 30, 2014, the Barclays U.S. Corporate High Yield index produced an impressive annualized return of 14.0% per year. However, returns in this more speculative portion of the bond market have been disappointing since last summer, when the high yield spread over Treasuries reached a multi-decade low of 221 basis points. The index fell 0.4% in the twelve months ending June 30, 2015, and has continued to show weakness, falling another 1.9% through the middle of August.

This week’s chart examines the past relationship between high yield spreads and rate tightening cycles.1  Although there certainly isn’t a perfect correlation, tightening activity by the Fed has often caused high yield spreads to widen, significantly impacting total return potential. It is no secret that low and stable interest rates are good for speculative companies that are active in the debt markets. While a rake hike doesn’t spell impending doom for the entire high yield universe, some of the more speculative borrowers who have become accustomed to borrowing at ultra-low rates could be in trouble, particularly if the Fed embarks on a prolonged period of successive rate hikes. As we prepare for the first Fed rate hike — likely later this fall — it will be important to pay close attention to high yield exposure within investment portfolios as well as manager positioning within the high yield space.

1 Most recent rate tightening lines refer to the end of QE 1 and 2 and the start of the Fed’s tapering

Asset Class Review: What Has Worked So Far in 2015?

This week’s chart shows broad asset class returns through July 31st of this year. Perhaps the most surprising performer has been international equity, which has outperformed even U.S. equities. Much of the outperformance is due to the strong U.S. dollar, which has increased international developed countries’ exports and the number of tourists.

This week’s chart shows broad asset class returns through July 31st of this year. Perhaps the most surprising performer has been international equity, which has outperformed even U.S. equities. Much of the outperformance is due to the strong U.S. dollar, which has increased international developed countries’ exports. The same factor has in turn contributed to the lower performance of U.S. equities. With so many of the S&P 500 companies’ revenues dependent on international growth (about 46%), the strong dollar has weighed heavily on EPS growth. In addition, the same factors many of our readers have heard before — the slowdown in the energy sector and the cold winter — have also played major roles.

The other darling this year, as widely predicted, has been Real Estate. Throughout the first half of the year, growth has in large part been due to income, lease turnover, and appreciation (most notably in the Southwest U.S.). The remainder of the year is likely to see less contribution from income and more contribution from appreciation.

Now let us turn to the poor performers. Bonds, both Global and U.S., continue their same old story: the specter of the Fed rate hike continues to loom, in addition to the Greek debt crisis and China’s now not-so-secret efforts to prop up growth. Emerging Markets have been the worst performers this year, thanks in large part to their dependence on commodities and the domino effect of China’s slowing growth which has translated into weakening currencies.

Where will the rest of the year take us? As the issues we have discussed will continue to weigh on asset classes, it will not be surprising if meandering to disappointing returns across asset classes continue for the rest of 2015.

1 Real Estate Returns through 6/30/15; Private Equity Returns through 3/31/15

Is Home Ownership a Thing of the Past?

Home ownership has historically been part of the American dream; however, recent data trends show that more consumers are postponing or bypassing this life event in favor of renting. The sting of the Great Recession still resides within consumers’ minds, many of whom are still struggling from a period in which millions of homes went into foreclosure and trillions of dollars of home equity was wiped out.

Homeownership has historically been part of the American dream; however, recent data trends show that more consumers are postponing or bypassing this life event in favor of renting. The sting of the Great Recession still resides within consumers’ minds, many of whom are still struggling from a period in which millions of homes went into foreclosure and trillions of dollars of home equity was wiped out. While the devastating housing crash is certainly one culprit, a shift in millennials’ attitudes could also be contributing to this change in sentiment.

In this week’s chart, we examine the declining rate of homeownership versus the increasing costs of renting. Despite the attractive level of home affordability, homeownership is at its lowest level in 29 years and monthly rents are at an all-time high. In ten short years, the percentage of non-vacant housing units occupied by the unit’s owner has declined from its 2005 peak of 69.1% to just 63.7% this year. Meanwhile, the median monthly asking rent has risen 31.4% during the same period. The U.S. Census Bureau reported that the most recent median asking sales price was $149,500, the same nominal levels we were seeing in the latter part of 2005 but significantly lower than the 2Q 2007 peak of $201,500.

While the U.S. economy has made great strides in its economic recovery, the housing market has yet to come out of its shell. The impact of increased home purchase activity and its resulting consumption effect would be a boon to the domestic economy. Thirty-year mortgage notes can still be obtained for less than four percent interest, but the availability of cheap credit has not been enough to drive more millennials into homeownership. As we debate the impacts of tightened monetary policy by the Federal Reserve, the consequences of rising interest rates and its direct effect on the housing market cannot be ignored.