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Market Recap Friday, July 21, 2017

In Brief

  • Europe: Encouraging data now; ECB studying tapering
  • U.S.: Inflation down; housing permits back up
  • China: New data released; PBOC to coordinate work of new financial oversight body
  • U.K.: Unexpected softer inflation in June
  • LEIs: Global nominal reacceleration ending; real growth drivers needed
  • Given the magnitude and pace of change in the technology sector, it is vital to be early in identifying winning companies; key investment themes as followed

On Europe

Inflation is nascent in Europe. Euro Area (EA) CPI deaccelerated to 1.3% year over year in June, but that was mainly due to energy prices declining -0.9% month over month. Service prices, which is roughly 45% of the EA CPI, and core prices are in rebound mode, up to 1.6% year over year and 1.2%, respectively.

The ECB’s quarterly Bank Lending Survey (BLS) also showcased the economy’s progress. According to the ECB BLS, M&A activity and fixed investment made an important and increasingly positive contribution to demand for loans to enterprises in the second quarter of 2017. The general level of interest rates, inventories, and working capital also continued to have a positive impact on demand. Net demand for housing loans continued to be driven mainly by the low general level of interest rates and favorable housing market prospects. Spending on durable goods, the low general level of interest rates, and consumer confidence contributed positively to net demand for consumer credit.

The ECB opted for no decision and wants to be careful to avoid a “taper tantrum” in the bond market. On Thursday, the ECB left its stimulus measures unchanged but signaled it would discuss how to proceed with interest rates and bond buying, which is part of its bid to stimulate the regional economy in the fall.

On the U.S.

U.S. import prices fell for a second straight month in June amid further declines in the cost of petroleum products. The decline signaled less inflation in the pipeline. On a year-over-year basis, U.S. import prices slowed sharply to 1.5% since posting 4.7% in February. Import price pressures are, however, likely to pick up given the recent weakness in the dollar, which has declined 6.1 percent in value against the currencies of U.S.’ main trading partners this year.

U.S housing starts recovered and surged 8.3% year over year in June to a seasonally adjusted annual rate of 1.22 million units, despite it remains far below the pre-recession peak in level terms. Homebuilding has lost momentum after strong gains in both the fourth quarter of 2016 and first quarter of 2017.

On China

China’s real GDP grew 6.9% year over year again in the second quarter, both the service (7.7%) and manufacturing (6.4%) sectors contributed, while nominal GDP fell marginally to 11.1% year over year. Fixed asset investment rose 8.6%, property investment rose 8.5%, and retail sales rose 11.0% year over year. Property prices eased overall and by tier; the 70-city average growth rate cooled for the sixth month to 9.4% year over year.

Over the weekend, financial oversight changes were made to enhance the effectiveness of regulations. People’s Bank of China (PBOC) will be in charge of coordinating a new financial oversight body, namely, Financial Stability and Development Committee, mandated by President Xi Jinping to get China’s regulators to work together to contain rising credit risks. No indication has emerged on who could head the committee though. PBOC said on Tuesday that it would carry out the office duties of the new body, indicating the committee’s day-to-day operations might be conducted from PBOC. The new body’s responsibilities include formulating plans for the development of the financial sector, ensuring regulatory cohesion, formulating rules and regulations to fill in regulatory gaps, and holding regulators accountable when supervision is lacking.     

On the U.K.

The U.K. inflation fell unexpectedly in June for the first time in nine months; the CPI recorded 2.6%, as compared with an expected reading of 2.8% and a level of 2.9% in May. The fall was primarily driven by lower petrol and diesel prices, reflecting weaker global oil prices. Fuel prices fell by 1.1% between May and June, compared to a 2.2% rise over the same month a year earlier. Lower prices of games and toys also contributed to the fall. A softer inflation reading reconfirmed prices peaked earlier this year, after months of escalation.


The OECD’s Leading Economic Indicators (LEIs) are signaling activity will temper in most G7 countries in the second half of 2017. The reacceleration in the global economy this year bought time. Yet, the recent batch of LEIs plus inflation peaking year over year stress the urgency of real growth drivers, such as fiscal policy, to carry forward the momentum. Unlike the rest of the world, the LEIs for European countries continue to steam ahead. Further tapering of asset purchases by the ECB is looking more likely. The Italy election in 2018 is still a risk.

On Oil

Low oil prices are largely curbing both domestic and imported inflation pressures. Other factors such as declining prices for mobile phone services have also contributed to pushing inflation below the Federal Reserve’s 2% target. As oil prices have moved lower over the course of this year, some investors are beginning to wonder if they should brace for a repeat of 2015, when a sharp decline in oil prices led to an earnings recession, a blowout in high yield spreads and a slowdown across emerging markets. However, it is important to recognize that while the fall in energy prices may feel familiar, the results shouldn’t be the same.

First, the recent decline appears to have been driven by an increase in supply, rather than a softening in demand. Second, many of the most inefficient energy companies have defaulted, leaving the sector looking healthier than it was just a couple of years ago. These remaining companies have seen their earnings hit by write-downs of their oil-related assets in recent quarters, making it unlikely that this pullback in oil prices will have the same impact on earnings. Third, the lack of a fundamental threat has been reflected in markets – energy stocks have come under pressure as the price of oil has fallen, but as shown in this week’s chart, the relationship between oil prices and the S&P 500 appears to have broken down. Finally, high yield spreads outside of the energy sector look contained. As a result, it will be prudent to watch for signs of contagion going forward, but at the current juncture, energy sector weakness does not pose a threat to the economic expansion.

A big part of the Trump Administration’s economic agenda is to deregulate the energy sector in the U.S. Perhaps like the decision to remove price controls in the early 1980s this could be a development that is good for the economy as a whole but bad for energy stocks. Oil by shale is profitable below current spot prices while fiscal breakevens among OPEC members remain stubbornly high.

A Few Thoughts

In 2013, U.S. Treasury yields rose dramatically after then-Fed Chairman Ben Bernanke suggested the central bank might begin reducing its pace of monthly asset purchases. The so-called taper tantrum affected markets globally. Today, the Fed is openly discussing plans to begin shrinking its balance sheet in 2017 – yet Treasury yields remain stable. Two explanations for this striking disparity in the market’s response. First, unlike in 2013, both the Fed and market participants accept the New Neutral for U.S. monetary policy. Second, the Fed plans to continue buying duration and convexity risk for at least a year after balance sheet normalization begins.

Investors can seek out innovative companies that are taking advantage of megatrends in technology. These include cloud computing, the Internet, and the penetration of technology into areas such as factory automation and robotics, the automotive industry, health sciences, and aerospace. Given the magnitude and pace of change in technology, the early identification of companies with exceptional growth potential is vital.

In theory, investors should consider companies with strong intellectual property, high barriers to entry, a large addressable market, accelerating fundamentals, and strong cash flow and balance sheets. A company’s competitive advantage is key in assessing outcomes because success hinges on the ability to navigate challenging environments and market cycles. In addition, management is central to driving innovation and success, and investors should seek out leaders who can execute on their vision. Moreover, a company’s R&D pipeline and product pipeline are also important signals of a company’s innovation, but fundamental fitness is an important focus of the assessment. Beyond those, investors should seek far and wide for disruptive innovators in developed and emerging markets regions. Europe is a leader in some parts of industrial technology, including high precision manufacturing, science, and engineering. China has fostered the emergence of a strong domestic Internet industry. Japan has become a center of excellence in robotics.

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Market Recap Friday, July 7, 2017

In Brief

  • U.S. growth continues to hum along at a moderate pace
  • More hard evidence of European economic expansion
  • Capacity, labor, and price pressures accruing in Japan
  • In China government and private PMIs embody soft-landing
  • The Brexit/politics dulled 2Q17 economic activity in the U.K.
  • Equity markets performance was upbeat in 2Q17
  • U.S. government bonds rallied for most of the 2Q17 before retreating in the final week, reflecting a mix of softening inflation, falling commodity prices and firming monetary policy expectations.
  • Several ingredients create a generally supportive outlook for risk assets: Remain constructive on risk assets

Data flow over the course of 2Q17 confirmed that the global economy locked in a higher growth rate in 2017 after accelerating in 2H17. Measures of corporate sentiment moderated somewhat but remained healthy. Consumer sentiment was robust across developed markets (DM) and global export volumes accelerated modestly. International DM, led by the eurozone and Japan, were points of strength. Emerging markets (EM) were stable on balance. The U.S. economy rebounded after a soft 1Q17, bringing its first-half average growth rate to about 2%. The persistence of growth rates and positive sentiment were constructive fundamentals for equities. The supportive undertone was evident in decent upward momentum in global earnings revisions, and implied in the equity outperformance relative to other asset classes.

Slowing inflation was a lynchpin for the decline in government bond yields in 2Q17. Much of the reflationary impulse in 2H16 can be explained by evidence that global inflation was picking up, pushing nominal growth forecasts higher and garnering expectations that monetary tightening would follow. During 2Q17, the inflation outlook came under some pressure. For one, Brent crude prices fell 10%, bringing benchmark prices down nearly 15% year to date; OPEC officials believe, however, that inventory draws in July will double the levels in 2016 and will trend in the right direction. Indeed, weekly and monthly storage data are pointing to a tighter market by year end. With investors awaiting signs of a tightening oil market, July may be an important inflection point for sentiment. Inflation had been broadly softening even prior to the most recent oil price shocks.

In the U.S., the ADP nonfarm private payroll employment increased 158,000 month over month in June, and jobless claims remain low. The souring of U.S. relations will make it harder for President Trump to move forward on several matters with other nations; when it comes to North Korea, however, differences could be left at the door due to the urgency and severity of the matter. U.S. durable goods data for May indicated orders rose 0.2% month over month and shipments ticked up 0.1% versus contracting. U.S. growth continues to hum along at a moderate pace for now. Capex and employment are positively correlated to the U.S. economy as a whole.

In the EU, retail sales in volume terms continued to expand, which grew 2.7% in May compared to the previous year. This hard data is consistent with the elevated consumer and business sentiment in the region in recent months. Firms and consumers are reacting positively to the recent diminishing political uncertainty and anti-euro threats.

In the U.K., both the Services (53.4) and Mfg (54.3) PMIs were expansionary in June. Brexit- and general-election-related uncertainties have been holding back consumer and business spending for a few months. Panelists in the Services sector cited difficulties recruiting staff to fill vacancies as well as coincidently rising staff salaries, which may be the first sign of wage gains to come.

In Japan, the rises in services and manufacturing employment helped its rate of private sector job creation to reach the highest since September 2007. As has been the case in every month since November 2012, input prices faced by Japanese service providers rose in June. Moreover, Japan’s rate of inflation quickened to the sharpest in five months, amid reports of higher raw material and staff costs. According to The Guardian, Japan and EU expected to sign trade deal after a breakthrough in talks.

In China, new orders, output, hiring, and costs continue to ease. Yet, panelists remain optimistic as conditions are moderating. The Caixin Markit Mfg PMI bounced back to 50.4 in June, compared to contracting to 49.6 in May. The Services PMI declined fractionally to 51.6, but buoyed the 51.1 of the Composite index in June. In general, the milder China domestic growth becomes, the more incentive there is for policy makers to strengthen trade ties.


Several ingredients create a generally supportive outlook for risk assets: economic output at current levels, evidence that business cycles globally remain on a slow burn, and anticipated signs of firming inflation. The risk is best spread out more evenly across regions, with a tilt towards more cyclical markets like the euro zone, EM, and Japan. Investors should remain constructive on risk assets, with a broad-based regional exposure to equity markets.

Real yields are again leading the charge in 10-year yields. But inflation expectations, though lagging a bit, are drifting higher now too. Net, the relationship between these two now implies monetary policy is as tight as it’s been since last March, after easing for most of 2016 and 2017. The difference between the breakeven inflation expectation and the real yield may be interpreted as a measure of monetary tightness or even a first derivative on growth, with a higher number signaling looser financial and monetary conditions. Conditions in January of 2016 were at their tightest since the recession. Today, conditions are tighter than at the start of the year. Any further rise in real yields could start to weigh on risk sentiment.

The most powerful driver for yield curve flattening over the post-financial crisis period has been central banks’ active balance sheet policy, which has depressed longer-dated yields. Indeed, the rebound in bond yields towards the end of the 2Q17 has been mainly a function of heightened expectations of central bank balance sheet normalization this year. Federal Reserve statements suggest that its plan to let maturing securities roll off its balance sheet will shrink its holdings by $1.4 trillion over the next four years. As a result, an increased net supply of bonds, in tandem with a taper of asset purchases by the European Central Bank in 2018, will push up global yields. Spates of volatility over that period, as markets calibrate the pace and end points of this process, are to be expected.

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Market Recap Friday, June 30, 2017

  • In Brief

    • Momentum equity style factor is outperforming, backed by a sustained economic expansion.
    • Oil prices entered a bear market on concerns about higher-than-anticipated global supply.
    • Baa spreads hit fresh lows.
    • A notable Leadership shift since Comey’s Testimony in early June: Technology price looks corrective while financials are reaccelerating.
    • Stock volatility is near an all-time low.
    • U.S. and euro zone inflation data could shed light on the direction of central bank policies.
    • U.S. long-term yields fell in June mostly in response to another weak U.S. inflation print.

    The recent disconnect between the Fed normalization and the falling long-term rates is partly a result of markets overly focusing on softening inflation data, while the Fed focuses more on the outlook. This dynamic could persist in the near term. The sustained above-trend global growth and stabilizing inflation ahead, indicating the impact of the Fed’s pace of normalization may be greater than bond markets currently anticipate.

    The growth rate of France in the first quarter of the year has been revised up to 0.5%, which is the latest sign that the euro zone continues to recover. European companies have posted their fastest quarterly growth since the debt crisis started six years ago, but growth dipped in June, suggesting a slight slowdown. Worries over Brexit and deflation loomed over the City after a week of oil price falls. The European Central Bank has launched a bid to wrestle control of London’s euro-clearing market.

    While the S&P is roughly unchanged over the last several weeks, credit conditions remain supportive with Baa spreads hitting fresh lows last week, which marks an important difference from 2014 and 2015. Weakness in Oil and the Energy patch has not impacted corporate credit to any meaningful extent thus far. Similarly, the weakness in retail stocks and the rise in retail CDS have largely remained contained as well.

    Momentum equity style has historically outrun the broader market, but with periodic sharp drops. The biggest dips in its relative performance have coincided with recessions and financial crises. Momentum tends to perform best during steady economic expansions, which should have ample room to run.

    A Notable Leadership Shift since Comey’s Testimony on June 10

    On Technology Equity

    Recent technology price action, partially evidenced by the Nasdaq-100 Index (NDX), which includes 100 of the largest non-financial companies listed on The Nasdaq Stock Market capitalization, looks corrective. The NDX fell significantly. In the short term, this is likely a market that will continue to be difficult to hang onto, as the volatility continues to be a major issue. The alienation of technology equities from the rest of the market worsened Thursday as another violent industry rotation left the NDX with a loss that was twice as big as that of the S&P 500. With banks clinging to gains after unleashing a torrent of buybacks following Federal Reserve stress tests, money was draining from computer and internet companies. The contraction in internal momentum is also consistent with a consolidation pause in technology.

    On Financials Equity

    Financials are reaccelerating, following a four-month pause. Financials have exhibited renewed signs of momentum over the past several weeks. Internally, financials have been showing signs of reaccelerating for the better part of June. In the euro zone, banks are resuming higher and are now at a five-month relative high. The multi-month consolidation in global bank stocks is also resolving higher.

    China Urges Caution in U.S. Steel, Aluminum National Security Probes

    The Chinese Ministry of Commerce urged the Trump administration to employ caution in evaluating whether to restrict steel and aluminum imports that threaten U.S. national security. China called on countries to support the free and open international trade system and to resist trade protectionism, and exert caution with various forms of trade restrictions.

    It is expected that the Trump Administration will consider a broader definition of national security than just defense needs in the current investigation. Secretary Ross has noted that production of transformers for the electrical grid constitutes a national security concern. Steel producers have highlighted the need for steel in transportation and energy infrastructure, which could be the basis of the national security determination.

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Market Recap Friday, June 23

In Brief

  • Investing with a long-time horizon and through a diversified portfolio are the best ways to batten down the hatches against volatility and avoid emotional investing errors.
  • How should investors dampen portfolio volatility in the later stages of the business cycle?
  • In the bond market, an inverted yield curve has often predicted a recession in developed economies, but what does the recent inversion of the yield curve in China say about the country’s economic outlook?
  • China’s stimulus-led rebound has had widespread benefits but has made the risks from a tightening in credit in the country a global concern.

Is China’s Yield Curve Signaling a Further Economic Slowdown?

Since 2005, the yield on the 10-year Chinese government bond (CGB) has exceeded the one-year CGB yield by an average of 100 bps. An upward-sloping yield curve of this sort is normal in the $3.5 trillion CGB market and as in most countries, reflects expectations for future policy rates, a term premium and healthy market supply-demand dynamics. But on June 7, the 10-year CGB yield sank below the one-year yield. This yield curve inversion has occurred only once before, in June 2013, amid a severe liquidity crunch in the interbank market. What is causing the current yield-curve inversion?

  • The People’s Bank of China (PBOC) has tightened monetary policy since the fourth quarter of 2016 to curb an asset bubble, mitigating financial leverage and supporting the yuan. Since the end of the third quarter of 2016, the 10-year CGB yield has risen 85 bps to 3.59%, and the one-year yield has risen 145 bps to 3.62%.
  • The PBOC hiked the seven-day reverse repo rate twice – by a total of 20 bps, from 2.25% to 2.45% since the fourth quarter of last year. The PBOC’s liquidity-draining operation lowered the system’s excess reserve ratio from 2.4% at the end of 2016 to only 1.3% by the first quarter of this year, the second-lowest on record.
  • Wholesale funding, which accounts for a quarter of banks’ liabilities, has tightened sharply, and benchmark three-month negotiable certificate of deposit (NCD) rates have surged 220 bps to 5.1% since PBOC tightening began late last year. NCDs are the main interbank money market instruments and account for 3% of banks’ liabilities, thus setting most banks’ marginal funding costs.
  • There has been renewed regulatory pressure on banks to unwind their leveraged bond portfolios both on and off their balance sheets, which partly explains the severity of the sell-off.

The PBOC has clearly tightened monetary conditions, pressuring banks to curb corporate and mortgage lending while passing through higher lending rates to borrowers. Chinese growth, particularly nominal growth, clearly peaked. Historically, a flattening and inverted yield curve has indicated weakening industrial production with a lag of five months. China’s reflation momentum is also turning. The surge in producer prices from upstream commodities faded during the second quarter, and tight liquidity is expected to weaken construction demand and create some destocking pressure, particularly in commodities such as iron ore. On the margin, China’s monetary tightening and financial deleveraging will be a headwind to a rebound in global manufacturing and reflation in commodities.

Focus on the Destination: Investors with a Long Time Horizon Experience Less Volatile Returns

While volatility can cause major deviations in the near term for equity markets, investors should focus on their destination. Examining rolling returns for equities, while historic annual returns have varied from -38% to +47% in a single year, rolling annualized returns, over a 20-year period, have been positive for the past 60 years. Unfortunately, short-term investors are much more likely to realize the waves of volatility that occur over the one-year investment horizon. Investors with long-term goals, who are able to shift their focus to the long-term return potential of equity investments, have the luxury of realizing infrequent negative equity market returns.

We live in a headline-driven world, where media often impacts equity prices in the near term. But an investment portfolio should not be a dinghy tossed and turned by market churn; it is possible to gain portfolio stability through diversification. While equities tend to perform better with economic growth and moderate levels of inflation, rate-sensitive fixed income is important to portfolios when economic growth falters. Although most investors have a positive outlook on U.S. equities in the coming year, other developed market equities can give both exposures to risk factors outside the U.S. economy and to faster-growing emerging market economies that may help boost portfolio returns. Small cap stocks provide a pro-cyclical tilt to a portfolio compared to large cap stocks, though they can also be more sensitive to growth scares. While a combination of various asset classes should improve portfolio returns, diversification is most valuable for keeping a portfolio on an even keel.

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Market Recap Wednesday, June 14

In Brief

  • A rebound in U.S. economic data strengthened the Fed’s case for a rate hike in June; the Fed outlined a plan to reduce the balance sheet.
  • European growth surprised to the upside; data indicated that the eurozone’s recovery may be gaining momentum.
  • The UK election resulted in a hung parliament, creating uncertainty about the path ahead for Brexit negations.
  • Emerging market equities, bonds and currencies delivered strong performance in May, adding to their stellar start to the year.
  • China’s sovereign debt was downgraded by Moody’s Investors Service for the first time since 1989, due to the country’s rising liabilities and slowing growth.

A healthy U.S. employment report bolstered the Fed’s comments in May that the weakness seen in the first quarter was likely transitory. The economy added 211,000 jobs in April and the unemployment rate fell to 4.4%, alleviating some fears over the anemic 79,000 increase in jobs in March. Retail sales also rebounded, rising 0.4% and outpacing the prior 0.1% gain, as strength in the labor market and a 2.5% increase in hourly wages supported consumption. Against this backdrop, the Fed’s meeting minutes revealed that another rate hike could be appropriate soon, and outlined a plan to reduce the balance sheet by slowly and predictably ending reinvestments of maturing securities.

While the political turmoil contributed to a brief period of elevated market volatility, most risk assets recovered to end May higher. Investor unease over geopolitical events was apparent in May, particularly the controversies surrounding the administrations in the U.S. and Brazil. The seemingly inexorable trend higher in risk markets prevailed as equities globally gained and credit spreads tightened. The VIX also reflected the short-lived nature of the downturn in markets during May as it reached both its highest intraday level in 2017 and its lowest level since 1993.

The drivers of the recent equity market gains have changed from those that initially pushed equity markets higher following the U.S. election, while the “reflation trade” immediately following President Trump’s election focused on financial and energy companies, which have struggled more recently. The gains in May were driven by technology companies with strong earnings growth, as well as more rate-sensitive sectors like utilities as interest rates have fallen.

The expansions in Europe are robust, with all key segments of the economies participating in the upswing. The European economy grew at an annualized pace of 1.8% in the first quarter. The European Central Bank removed a reference in its statement to a potential rate cut but maintained its dovish policy stance. It lifted its growth forecasts but trimmed its inflation outlook.

Overall market reaction in the U.K. was muted. The British pound weakened and UK domestic stocks fell. Oil prices touched one-month lows on a surprise rise in U.S. crude stockpiles. Undeterred by weak oil, weekly flows into emerging market debt and equity funds logged their longest positive run since 2013.

The MSCI EM Equity Index returned 16.6% through the end of May, nearly double the return of the S&P 500 over the same period, while emerging markets local debt and currencies delivered returns in the high single-digits. With developed market rates trending lower and concerns over protectionism waning, investors have re-focused on improving emerging markets fundamentals, and investment flows have followed. Despite a fresh political scandal in Brazil, investors remain drawn to attractive yields in the sector as inflation abates and countries such as Russia and Brazil emerge from recession.

Moody’s Investors Service downgraded China’s sovereign debt for the first time since 1989, citing rising liabilities and slowing growth. China’s downgrade to A1 from Aa3 by Moody’s Investors Service on May 24 was not too surprising since both Moody’s and Standard & Poor’s had warned in March 2016 that they were reviewing China’s ratings. The market impact of the downgrade is also limited: China has not issued sovereign external debt for more than a decade, and local currency bonds are not included in the widely tracked global indexes yet, so there was no index-related selling. Chinese policymakers may now feel a sense of urgency to intensify regulation of the huge shadow banking system, maintain a hawkish monetary policy stance and somehow restore fiscal discipline. Although positive from a structural standpoint, such a policy shift could put more pressure on Chinese growth, financial markets and commodities prices in the coming year.

New Bond Issuance: The Active Management Advantage

When new bonds come to market, the alpha potential available to active managers is significant.

  1. New bond issues are a more frequent and much bigger share of the market. Over the past three years, newly issued bonds represented more than 20% of the capitalization of the U.S. corporate bond market. In contrast, equity IPOs were less than 1% of U.S. equity market capitalization during the period. This is logical because whereas common equity is typically a perpetual security, bonds have finite maturities.
  2. New bond issuance represents a consistent source of alpha potential. Active bond managers typically buy new issues when they come to market, often a week or more before the securities enter the index at the start of the month. This matters because new bonds tend to come to market at a slight discount to outstanding issues, hence the alpha potential active managers can access.
  3. While passive managers sometimes wait to buy: They risk tracking error if prices move before the bonds join the index; managers also may face limits in how much off-index exposure they can hold. After all, the goal of passive managers is not to beat the index but to replicate and match its performance.
  4. Active managers can pick and choose. Even though most new bonds come to market with a concession, active managers do not necessarily buy them. Passive managers, by contrast, have an incentive to buy all bonds that enter the index, regardless of price.

Further, size matters. Bigger managers often have an advantage in accessing new bonds, especially for larger deals. With billions of dollars of bonds to sell, investment banks create distribution syndicates. Individuals running syndicate desks may rely on a smaller pool of large investors to obtain lead orders and ensure there is ample interest to proceed quickly with the new issue, before borrowing rates rise. The 10 largest buyers received about 45% of the offering, with the top five buying about a third.

Other Thoughts

  • Broad-based, trend-like growth and favorable financial conditions combine to create a supportive backdrop for risky assets. With the U.S. economy progressing into late cycle, recent divergence between bond yields and equity markets raised some concerns, but that rates should resume their upward path in the second half of 2017.
  • U.S. credit is unlikely to outperform stocks, while it should still beat government bonds.
  • A diversified regional equity exposure is best suited to benefit from the pickup in global growth. At the margin, investors may favor Japanese, European and emerging market equities and keep a modest exposure to the U.S., with the UK the least preferred region.
  • Core European bonds look set to lead global yields higher over the latter part of the year, so investors should remain modestly underweight global duration, while the improving growth trends outside the U.S. markedly reduce the risk of a renewed, damaging surge in the U.S. dollar.
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Market Recap Friday, June 9

On U.S.

U.S. jobless claims declined 10,000 week over week to 245,000. With U.S. credit-scoring easing, and the credit damage from the U.S. downturn passing, U.S. consumption remains strong. Nowadays, trying to sell things in stores at full price is tough; consumers are buying more experiences over goods, more online vs in stores, and are using technology to comparison shop. The “death of retail” story is now quite well known.

In terms of U.S. stocks, the NYSE Airline Index broke out of a six-month consolidation with notable strength from UAL, AAL, and DAL. Energy stocks remain weak, with the weakness of oil continues to weigh on the sector which is again seeing new lows expand. Capital markets names are firming, with the Capital Markets Index hit a multi-month high on June 7 and among the Banks, Citigroup was a notable outperformer. The Chinese ADRs continue to act well; after a brief pause, the China ADRs are again resuming higher.

On U.K.

The Services PMI declined to 53.8 in May. Business-to-business sales have been filling the consumer void, but producers delayed their decisions in May ahead of the June 8th general election. Additionally, with a period of above-target inflation upon us and official interest rates already near the zero lower bound, the flatness of the U.K. yield curve does seem somewhat anomalous. With interest rates on intermediate U.S. bonds a full 1.15 percentage points higher, there appears to be a bigger inflation hedge in the U.S. bond market than in the UK. The direction of medium-term inflation risks remains an open question.


The ECB remained accommodative. Retail sales in the euro area continued to trend upwards in April. Retail sales signal consumer spending and thus, GDP are off to a good start in the second quarter. According to the expenditure breakdown, households and capital formation contributed the most.

On Japan

The Services PMI expanded further to 53.0. Panelists reported the largest increase in new business and the highest optimism level in four years, thanks to weaker yen and foreign demand. Encouraging sign for a better second-quarter GDP print. Core wages continue to be sluggish and weak relative to the 1990s, but are better than the past decade.

Japanese shares recently broke out to nearly two-year highs and in U.S. dollar terms performance is also notable at roughly 17-year highs. Importantly, internals are firm with the TOPIX making new highs and small-caps outperforming. The continued leadership from the Electric Appliances, such as Sony, Canon, etc., and the Chemicals groups are noteworthy, as they are among the most correlated to broader market returns. In U.S. dollar terms, Japan continues to make a trend change higher after a multi-decade bear market.

On China

FX reserves increased for the third month in a row to $3,053 billion. Capital outflow restrictions and Yuan strength are proving effective at lifting reserve levels.

Thought: Selecting the Optimal Investment Universe in Managed Futures

The depth and breadth of the investment universe are critical elements in building a robust managed futures strategy. An investor should add assets to the portfolio that exhibit low correlations to existing assets, and, if the trading costs are relatively higher, the bar for diversification must be higher as well.

In commodities, global benchmark contracts trade with significantly higher volumes than more specialized contracts. The two contracts have very different fundamental drivers and low historical correlations, and thus there is diversification when trading both markets.

In practice, if a large fund tried to trade hogs in the same volume that it traded oil, transaction costs would swamp the diversification benefits. To control for this, most managers will put a cap on the size of a position they can have in smaller markets.

This is a sensible way to manage the trade-off between diversification and transaction costs. Yet it means that looking only at the number of markets in which a manager trades is misleading without knowing how big a share of their portfolio these smaller markets can be. If the position of lean hogs can be only a fraction of the size of the oil position, then its portfolio impact will be small. In practice, the AUM of a manager’s trend-following strategy can be a more important driver of risk-adjusted returns than the number of markets.

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Market Recap Friday, May 19

On Oil: Prices Jump to Three-Week High on Talk of Extending Production Cuts

Oil prices jumped to a three-week high on May 15. U.S. crude futures rose to $48.85 a barrel on the New York Mercantile Exchange and Brent rose to $51.82 a barrel on ICE Futures Europe. The move capped a four-day streak of gains for oil prices, lifting both benchmarks to their highest levels since late April. In a joint statement, Saudi Energy Minister Khalid al-Falih and Russian Energy Minister Alexander Novak said a pact by the Organization of the Petroleum Exporting Countries and external producers, including Russia, to cut output by some 1.8 million barrels a day should be extended to the end of March 2018.

On U.S. Dollar: The U.S. Dollar remains soft with both EUR and GBP rallying

The USD has been a soft undertone as it struggled to rekindle the sort of form that saw it rally broadly, and strongly, in the immediate aftermath of the US presidential election in 2016. The Trump administration’s early policy setbacks, which investors fear will slow the broader drive for tax reform, deregulation and fiscal stimulus, account for some of the USD’s underwhelming performance in April. Geopolitical concerns, such as Asia, and political developments in Europe have also undercut the USD more recently. Finally, the U.S. economy appears to have stumbled out of the starting blocks this year again, which weakened the market’s confidence in the Federal Reserve’s ability to tighten monetary policy over the balance of the year.

On U.S. Markets: Stocks and Bond Appear to Be Telling Different Stories about the U.S. Economy

Stock and bond markets appear to be telling different stories about the U.S. economy, with stock prices climbing and bonds holding relatively steady. While strength from Technology remains notable, performance is not at a historical extreme. While the Nasdaq 100 has certainly been a standout performer, it has been significantly more stretched before.

Yields remain near 2.30%, the bond proxies and defensive groups continue to underperform. In addition to geopolitical risks in Syria and North Korea, several other factors continue to argue for a low-yield environment that is broadly range bound, including that inflation fears are contained, U.S. and Chinese economic data are showing signs of weakness, and the European Central Bank and Bank of Japan remain accommodative.

Bank of Canada on Hold, Assessing Uncertainties in Nation’s Economy

The April Bank of Canada (BOC) monetary policy statement was mildly hawkish: It acknowledged the recent stronger growth and better-than-expected economic data, yet revised down the forecast for the potential GDP growth rate. U.S. policy, especially trade, is by far the greatest source of uncertainty to Canada’s outlook. Any movement toward U.S. protectionism would have a major negative impact on the Canadian economy. Recognizing this risk, the BOC mentions U.S. trade policy often in the latest Monetary Policy Report.

The reliance on U.S. policy highlights one of the weak points in the Canadian economy: its persistently underwhelming exports, especially in non-commodity sectors. A key question for policymakers is whether this weakness is structural or cyclical. The BOC needs more time and data to make that assessment.

The housing market is clearly a concern for the BOC. Its 2017 forecast revised down housing’s contribution to GDP growth, demonstrating caution on the Toronto housing market as its boom continued in the first quarter of this year. The surge in home prices presents real risks to the macro economy, and residential investment and consumption as a percentage of GDP is very high by historical standards. As people “consume” a lot of housing and go deeper into debt doing so, they effectively borrow that consumption from the future. This means we can’t rely on Canadian consumers to be the main drivers of real GDP growth the way they have in the past – a vulnerability the BOC has consciously incorporated in its growth forecast.

A Couple Thoughts

With equities delivering strong returns since the post-crisis bottom in 2009, simple exposure to equity beta, or the market’s return, has been enough for many investors to achieve their return targets. While in the coming years, with equity returns likely to be significantly lower compared to recent levels.

A recent study by Morningstar revealed that only 14% of U.S. large cap managers outperformed their passive counterparts over 10 years, and only about 30% of managers outperformed in the perceived less efficient areas of small cap, international and emerging markets. Low returns, scarcity of alpha and the tendency to chase performance. With all of these challenges, how does an equity investor achieve higher returns going forward?

Part of the answer lies in portfolio structuring: that is, reallocating away from traditional passive and active strategies and toward structural or systematic approaches that may offer more reliable sources of returns. To be sure, investing in nontraditional equity strategies requires education and the ability to navigate an evolving landscape. But the potential rewards – achieving higher returns in an environment where beta alone may no longer be enough could be meaningful. Rethinking traditional approaches and moving toward strategies that benefit from systematic and structural sources of returns may help investors to achieve the excess returns they seek.