Given the attempted coup in Turkey last Friday (7/15) evening, risk assets were looking vulnerable going into the weekend. However, the coup was quickly quelled and by Monday risk assets were back in rally mode. Equities did not move up in a straight line, as there was some intraweek volatility, but ultimately global equities ratcheted higher by about 0.4%. Domestic equities fared a bit better, partially due to currency effects of the US dollar rising 0.8% (against a basket of trading partner currencies) on the week. In spite of the rally in stocks, bond yields didn’t budge as the “smart money” (as bond investors are often referred to) see little to worry about with regards to inflation (we agree and will offer more details when we distribute our “Q2 Economic Review and Outlook” next Thursday). Precious metals declined for the second week, but remain one of the top performing sectors year-to-date.
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Scary words: President Ronald Reagan once joked that the nine most terrifying words in the English language are “I’m from the government and I’m here to help”. Like any good joke, President Reagan’s statement contains an element of truth. Take government mandated programs like the Affordable Care Act (ACA or “Obamacare”) and state-mandated minimum wage hikes, for example. Each of these programs has raised the cost of labor for businesses. Business owners and hiring managers have responded by hiring more part-time workers (to avoid providing healthcare) and reducing the overall number of hires. In other words, higher input costs with regards to labor have resulted in a reduction of total labor hours (both through fewer hours worked and fewer full-time hires). In turn, this has translated into a stubbornly high number of employees working part time that desire full-time work and an overall reduction in the growth rate of national income levels. While the ACA and minimum wage increases are well-intended government programs, they have had a negative impact on many of the people they were anticipated to help.
The New Economy: In 2015, Facebook reported $5.7 billion in property, plant, and equipment on its balance sheet. Meanwhile General Motors has about 10x that amount. Facebook’s market capitalization is about $327 billion, while GM’s is $44 billion. As a result, for every dollar in market capitalization, GM has roughly 67 times as much physical capital as Facebook. If the Facebook model is the future, in what BCA Research refers to as a “capital-lite” economy, companies will have significant excess cash on their balance sheets from reduced capital expenditures that can be used for acquisitions, R&D, stock buybacks and, potentially, human capital.
Economic Data Wrap-Up: Slow week data wise… Housing Starts and Permits data for June were slightly ahead of expectations, with starts at 1.189mm annualized (vs. expectations of 1.165mm). Existing Home Sales increased 1.1% month-over-month to 5.57mm annualized (also modestly above expectations). Both data points indicate the housing market is a relatively rare source of strength in an economy bumping along at a 2.5% annualized growth rate.
Be well and Godspeed,
In yet another week marred by terrorist atrocities, equity markets recorded strong gains with the S&P 500 hitting a new high. While domestic stocks set records, it was international stocks that shined brightest with Japan leading the way gaining 5% on hopetations (hope + expectations) that the BOJ will inject more stimulus into the flagging economy (the Nikkei is still down 12.5% year-to-date). As investors embraced risk, safe haven fixed income instruments in the U.S. sold off causing yields to rise by about 0.2% on the 10 and 30-year bonds. An increase of 0.2% may not seem like much, but relative to the pricing of the instruments it represents an 8% move over 5 days and that is a pretty large move for stodgy bonds. In commodity-land: precious metals declined on the week and the energy complex clawed back some of its month-to-date losses, but generally remains underwater this month (e.g. WTI Crude is down 4.9% at $45.95 per barrel). The VIX Index (a measure of expected volatility in the S&P 500) declined 4% on the week and, given the geopolitical events, it is fairly shocking that the VIX now has a 12-handle, closing the week at 12.67 (vs. a long-run average of 20).
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Gravitational Pull: The black hole of negative interest rates claimed another victim last week, this time drawing in the 10-year German Bund (Europe’s benchmark bond issuance). While other Eurozone nations had previously sold shorter maturity bonds at negative interest rates, Germany became the first kid in the bloc to issue new 10-year debt at a negative yield. On that same day, Portugal and the U.K. were also able to raise inexpensive financing, even though the strength of their economies is questionable, highlighting the deflationary pressures that monetary policies have failed to quell. In other news from Wednesday’s debt financing smorgasbord, Switzerland (the first country to issue 10-year bonds with negative rates back in April 2015) sold bonds that mature in 2058 at a yield of minus 0.023%, meaning the buyers of those bonds will “enjoy” negative interest rates for more than 40 years. What happens, in a practical sense, when you buy a negative yield bond? You receive no interest payments and, if you hold to maturity, you will be paid back a smaller principal amount than you originally lent. Incredibly, the total amount of negative yielding debt globally has risen from $11 trillion to $13 trillion just in the three weeks since the Brexit vote. Note, there was virtually no negative interest rate debt as recently as mid-2014 (source: BAML). It would seem that negative yields beget more negative yields, creating a positive feedback system that will require fiscal stimulus (not monetary stimulus alone) to break.
Speaking of which: Fiscal stimulus may be on the way, at least according to a number of well-regarded economists and political observers. Their theory is as follows: since the Financial Crisis central banks have relied on monetary policy in an effort to kindle economic growth. While the success of that strategy is debatable, central bank actions have unequivocally driven up asset prices. Rising asset prices are benefitting the wealthiest classes of citizens (since they are the ones predominantly holding investments), leading to greater income inequality. This, in turn, is fueling populist fervor globally as evidenced recently by Brexit, Trump, and the Liberals winning the election in Canada on a pledge to spend more on infrastructure. In response to their citizens’ demands, politicians will need to (gasp) work together to increase deficit spending, or risk failing in their respective reelection bids. If this comes to pass, inflation will rise (something central banks are desperate for) and traditional fixed income investments will no longer provide the tailwind to portfolios that they have for the last 30 years.
Economic Data Wrap-Up: The JOLTS (Job Opening and Labor Turnover Survey) for May missed expectations, as did much of the other May labor data. Total Job Openings fell from 5,845 in April to 5,500, while Quits (2.0%) and Layoffs (1.0%) rates remained unchanged from the previous month. This data is largely consistent with our house view that the best labor numbers are behind us – that is not to say that we expect significant declines, rather that the labor market momentum is slowing. June’s monthly Producer Price Index rose 0.5% in June (exceeding expectations of 0.3%), while core prices (which exclude food and energy) rose 0.4% (vs. expectations of 0.1%). This data suggests that Producer Prices have stabilized, and if energy prices remain relatively steady there will be modest upward pressure on wholesale prices in the second half of the year. Retail Sales rose 0.6% in June, exceeding expectations of a 0.1% increase and the retail sales control group (used to calculate GDP) increased by a better than expected 0.5%. The increase in Retail Sales should boost the real annualized Q2 GDP growth rate to around 2.5%. The Consumer Price Index (CPI), aka “headline inflation”, came in as expected at 1.0% year-on-year. Core CPI (which excludes food and energy costs), rose to 2.3% year-on-year. Although consumer inflationary pressures have risen recently, it has largely been due to rising medical care and housing costs, and rents have been showing a moderating trend of late. Bottom-line, some inflation is good and there is nothing in the data currently to suggest a period of rampant inflation is imminent.
Be well and Godspeed,
Domestic equities recorded gains last week approaching new highs, even as the yields on US Treasuries (USTs) plumbed new lows. Outside of the U.S. however, the picture was less rosy as the effects of Brexit rippled through equity markets: Europe (-1.5%), Japan (-4.2%), Emerging Markets (-1.2%), and Frontier Markets (-0.4%). Precious metals continued to receive investor attention, while industrial metals such as copper declined (generally a negative indicator for industrial activity). The energy complex also took a hit last week with the price of WTI Crude falling 6% to $45.41 per barrel and Natural Gas falling by a similar amount.
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“Lola” – “It’s a mixed up, muddled up, shook up world” sang Ray Davies of the English rock band The Kinks in the group’s iconic 1970 hit song “Lola”. Of course the song’s subject matter was not financial markets (much darker, in fact), but the lyrics admirably capture the current environment. In today’s reality the surreal has become the norm as central bankers and investors are increasingly recognizing that monetary policy has limits and ultra-low, or negative interest rates, do not stimulate economic activity nor inflation. They may actually impede both: there is an estimated $11.7 trillion of global debt securities with negative yields, yet the global economy is sputtering and sustained modest inflation remains elusive, especially in those countries with the most negative interest rates (i.e. Japan). Central bank forecasting, which has about as good a track record as your local weatherman’s seven-day outlook in the best of times, has deteriorated further as their favored financial models simply do not work in today’s shook up world (see St. Louis Fed President James Bullard’s recent adoption of a new forecasting method). Meanwhile, investors are piling into anything that offers a yield, chasing numbers and pushing up valuations of “stodgy” stocks, such as utilities. The result: on Friday the S&P 500 closed just 0.04% below its all-time high, even as the 10-year UST touched an all-time low of 1.366%. Indeed, it’s a mixed up, muddled up world and though prices keep rising, it’s not a time to be complacent.
Disruptors – Spent last week in California, meeting with a variety of investment managers. By far the most intriguing meetings were with emerging managers operating in the private lending sector. These managers epitomize entrepreneurialism, from their visionary goals to disrupt traditional lenders to their offices where they are transforming theoretical business models into practical applications (and revenue). In summary, these firms are seeking to capitalize on the confluence of two trends:
· Consumers increasing use of, and comfort with, technology as a platform for conducting transactions; and
· A lack of credit supply from traditional financial sources, namely banks.
The offices consist of industrial austerity, creative energy, and shared workspaces where computer programmers are designing sophisticated algorithms to underwrite loans, while simultaneously creating simple, intuitive interfaces for consumers to request those loans. You are more likely to see a pinball machine in these offices than the mahogany desks favored by traditional bankers. Demand for credit remains robust, while at the same time the sources of credit are waning. The opportunity is to provide that credit, be paid for the risks you are taking, and generate good returns for investors and clients. These entrepreneurial disruptors sense opportunity, as do we.
Economic Data Wrap-Up: The ISM Non-Manufacturing index rose to 56.5 in June (vs. consensus estimate of 53.3), the highest in seven months. Much of the gains came from business activity and new orders sub-indices, which is a good sign for current and future business conditions. One thing to note however, is that this survey was conducted prior to the UK referendum. June’s Nonfarm payrolls jumped a hefty 287k, well above expectations and likely a contributing factor to Friday’s equity market rally. However, following May’s wildly disappointing job’s number (11k based on revisions), job growth is averaging only 151k in the second quarter which is consistent with the slowing trend in jobs creation witnessed over the last several months. Much of the job growth has come in the healthcare and leisure sectors, but sustained employment growth in manufacturing and construction sectors is necessary to propel the economy forward at an improved pace.
Be well and Godspeed,