Monthly Archives: June 2017

Covenant Weekly Market Synopsis as of June 23, 2017

June 26, 2017

EQUITY VOL IS DEAD!!! I, of course, don’t believe this to be the case and, like most of you, recognize that this period of equity market quiescence will end.  Yet, admittedly, it sure feels like volatility is dead, especially recently. Over the last 20 years, the VIX Volatility Index has ended the day below 10 on a total of 11 days (Source: JP Morgan). There is an average of 252 trading days in a year, so over this time horizon the VIX has closed below 10 only 0.2% of the time (11 out of 5,040 days). Here’s the kicker…. 7 of those 11 days were in the past month. No wonder it feels like volatility is dead.

Speaking of which, domestic equities moved higher again last week with the S&P 500 gaining 0.2%. The Nasdaq advanced by 1.9% and is now only 0.7% below its all-time high set earlier this month. Developed international stocks were mixed, with European equities sliding by 0.3% and Japanese equities gaining 0.3%. Likewise, Emerging Markets climbed 0.7%, but Frontier Market equities declined by 0.8%. In the realm of fixed income, the U.S. Treasury curve continued to flatten as the yield on 2-year notes rose to 1.34%, while the annual coupon on 10-year and 30-year notes edged lower to 2.14% and 2.72%, respectively. Precious metals eked out a small gain on the week. The price of crude jumped around quite a bit, falling nearly 5% in the first three trading days of the week. It recovered a little ground on Thurs/Fri, but ended the week down 3.9% and is now off by -19.9% year-to-date.

For a detailed view of weekly, month-to-date and year-to-date asset class performance please click here.


Poll Position – As has been widely reported, President Trump’s Approval Ratings amongst all voters is low. For example, the latest Gallup Poll (dated 6/22/17) shows he has an approval rating of only 42% (which is actually a marked improvement from his 36% approval rating in early June). Yet, viewed through a different lens, namely that of Republican voters, his approval numbers are respectable. At this point in his administration’s lifecycle, President Trump’s approval ratings are similar to that of previous Republican administrations as illustrated in the chart below.


*Includes Bush Jr., Bush Sr., Reagan, Nixon and Eisenhower. President Ford is excluded because he was not inaugurated.  Source: BCA Research

President Trump’s relatively strong approval ratings amongst his party imply that he remains a potential threat to House Republicans willing to challenge him and with midterm elections on the horizon, Trump retains more political influence than commonly believed. The administration may be able to play this “trump card” with Republicans up for re-election to push through a tax reform package that is not revenue neutral by threatening to support Republican challengers in the midterm elections next November (would a successful New York real estate tycoon take every advantage afforded him and play hardball to obtain his objective? – I think yes). Combined with the Republican Party’s longstanding goal (not to mention campaign promises) over the last 10 years to provide tax reform, President Trump is in a pretty good position to force Republican’s hand on approving a new tax package. It is for this reason that BCA Research forecasts stimulative tax reform will occur sometime before the late 2018. While the lack of revenue neutrality would further exacerbate the broader debt burden of the U.S. in the long run, it would have an immediately positive impact on risky assets in the short run.


Pick your Poison: Credit Risk vs. Interest Rate Risk – One byproduct of the coordinated effort by the world’s powerful Central Banks to reduce interest rates is the paltry return available on fixed income investments worldwide. This has forced yield-seeking investors into riskier fixed income investments (including debt issued by shaky sovereign nations) and to take on more credit risk, all of which has compressed yields in these sectors as well. For example, Greek 10-year bonds now have a lower yield (5.71%) than US High Yield debt (6%). Those seeking a “safer” investment have poured capital into domestic Investment Grade bonds, which now yield a paltry 3.67%. While this sector of the fixed income market may be safer from a credit-risk perspective, the skinny yields subject investors to increased interest rate risk. Indeed, the “breakeven yield change” (defined as the change in yield that makes the 1-year return on a bond equal to zero) is only 0.49% for Investment Grade debt. In other words, if the yield on Investment Grade bonds expanded by 0.49% over the course of one year, an investor’s total return would be zero (as the price decline in the value of the bond would offset the coupon payments). By contrast, U.S. High Yield Debt sports an average 1.72% breakeven yield change, offering a wider protective moat to rising interest rates for those willing to roll-up their sleeves and do the necessary credit analysis.


Source: Chatham Asset Management


Please note, this is not a recommendation to purchase high yield debt. If you are considering the space, it may be worthwhile to lean against the trend toward passive investing and select an active manager. Aside from the usual landmines in the high yield sector, the indexes tend to be heavily skewed towards names at the higher end of the credit quality spectrum and, as a consequence, pay a lower interest rate on their debt.  Thus a passive index allocation may not offer the interest rate risk protection you thought you were buying.


Be well,


Covenant Weekly Market Synopsis as of June 16, 2017

June 19, 2017

Continued weak economic data, including waning inflation and slower growth in housing, had little impact on the broader domestic equity indices last week. Although the Nasdaq (-0.9%) continued to nurse a hangover from the prior week’s “tech wreck”, the S&P 500 managed to move higher by 0.1% and the Dow Jones Industrial Average rose 0.5% to another record high. International stocks were largely on offer, with declines ranging from -0.8% in developed markets to -1.4% in emerging markets. Yields on fixed income instruments moved lower, likely in response to the disappointing economic data and the Fed’s plan to continue on their path towards monetary policy “normalization” (see below). The commodity complex, including precious metals, closed the week in the red and the US Dollar declined by 0.1%, though it us up 0.2% for the month.

For a detailed view of weekly, month-to-date and year-to-date asset class performance please click here.


Doubting Ms. Yellen – As widely anticipated, the Federal Open Market Committee (aka the “FOMC” or “Fed”) increased interest rates last week by 0.25% to 1.25%. They plan to increase rates again in the second half of the year, but Mr. Market is doubting their resolve. Three FOMC meetings remain on the 2017 schedule, yet Bloomberg data indicates the probability of a rate hike is approximately 16% for each of the next two meetings and only 35% for the final meeting of the year. Indeed, for all of 2018 the market is placing only a 40% chance of an additional rate hike. Supporting the probability-based data’s view on hikes, the two-year Treasury’s yield of less than 1.4% implies there will only be one additional hike for the next 24 months. The market-based view has become deeply separated from the Fed’s forecast to raise rates one more time in 2017 and an additional three hikes in 2018, which if it comes to pass will push the Fed’s Target rate up to 2.25%. Indeed, the market is assigning a 0% probability of that outcome and with the 10-year Treasury yielding 2.15%, bond holders don’t believe the forecast either. Absent a material increase in economic activity (of which we see little current supportive data), if the Fed continues on their target rate path the bull market will not die of old age, but will be murdered by the Fed (which is how these things usually go anyways).


Immigration and Unemployment:  A curious trend is emerging in the labor market. The unemployment rate amongst 20-24 year olds peaked at around 17% following the Financial Crisis, whereas unemployment “only” rose to 8.5% for workers who were 25 years and older. Although the unemployment rate for both age cohorts has declined steadily over the last seven years, there has been a marked increase in hiring younger workers. The expanded job gains amongst this younger cohort has pushed the unemployment rate down to approximately 7% – a level that is lower than before the Financial Crisis. Gainful employment of some of the youngest workers in our society is good for the economy, but why the sudden hiring binge?


FTN Financial suggests the increased hiring of younger workers is related to the Trump Administration’s border policies.  While there is no official data collected on illegal immigration, anecdotal evidence from arrests (down 65% since the election) and charities working with immigrants suggest undocumented immigration has plummeted since the election.  With the pool of undocumented workers drying up, employers are likely turning to younger workers to fill low-skill positions, driving down the unemployment rate.  For example, McDonald’s recently announced they would hire 250,000 employees via a Snapchat campaign, a hiring strategy clearly targeting younger workers.  Because the unemployment rate is a key input into the Fed’s monetary policy (they are devotees of the Phillips curve, an empirical model indicating that inflation is inversely related to the unemployment rate), Trump’s border policy could hasten additional tightening by the Fed. As detailed above, that may not be what the economy needs right now.

Be well,


Covenant’s Weekly Market Synopsis as of June 9, 2017

June 12, 2017

Another week of potential market moving events (more terrorism in the UK, the British election and former FBI director Comey’s congressional testimony) had little impact on equities, which treaded water for much of the week. Yet, a routine research piece released Friday by Goldman Sachs evidently found the sensitive spot in investors’ psyche catalyzing a volatile sell-off in highflying tech names. It’s not that research can’t move markets occasionally, but there are literally hundreds of reports issued on a weekly basis, and this research didn’t reveal much new information. Rather, it summarized a point that everyone already knows – FANG (Facebook, Amazon, Netflix and Google) stocks are expensive. The selloff in tech names was largely confined to the Nasdaq Index, which fell 1.8% on Friday, while the more concentrated and largely non-tech Dow Jones Industrial Average gained 0.4% to close at a new high. It’s also worth noting that Value stocks, while underperforming Growth stocks year-to-date, gained 0.7% on the week vs. a decline of -1.3% for Growth stocks. Friday’s action may mark the beginning of a rotation into less expensive/overpriced sectors of the market.

Developed international stocks declined on the week (-1.2%), while Emerging Markets gained 0.4%, largely on the back of a 3.2% gain in China’s main equity index. Interest rates on US Treasuries moved higher by about 0.05% across the yield curve, though yields on 10 and 30-year bonds remain lower than at the start of the year (signaling market expectations for low inflation and economic growth ahead). Precious metals declined (Gold -1%, Silver -2%) along with WTI Crude (-3.8% to $45.83 per barrel) as rig counts continue to rise in the U.S. shale plays.

The Fed meets this week and is widely expected to raise their target interest rate by 0.25% (to 1.25%). They may also hint at plans for beginning to reduce their balance sheet towards the end of the year.

For a detailed view of weekly, month-to-date and year-to-date asset class performance please click here.


Views from the Empire State – Spent last week in what CNBC has dubbed the “most powerful city in the world”, visiting with money managers large and small. Re-underwriting existing investments, exploring new opportunities….learning from the frontline generals who battle in the markets on a daily basis. Asked all of the managers a version of the following question: what keeps you up at night? Some were quick to respond with a laundry list of concerns, while others pondered the question before answering. Some managers cited statistical anomalies in the markets, while others provided subjective assessments honed through decades of trading experience. The result, a scatterplot/mosaic of opinions on prevalent market risks, including:

  • No one is pricing the left tail [bad market outcomes] and it is much fatter than the market thinks it is.
  • Investors are generally complacent, yet G7 countries (on average) have experienced dramatic equity drawdowns every 7 to 8 years through history
  • Difficult to see credit spreads getting tighter – asymmetric trade with little upside and lots of downside
  • Markets “feel” full
  • Volatility is extremely low and that is, itself, a risk
  • Typical credit cycles include 20 quarters of expansion – we are 17 quarters into the current cycle and default rates at about 0.45% are as low as they are likely to get. Expect defaults to begin rising in the next year and ultimately reach 5x their current level.
  • The connection between interest rates, debt and foreign policy. Would a massive tax cut force the U.S. government to issue more bonds that no one buys? Lack of bond demand would push interest rates higher impacting the delicate balance between high debt levels and the ability to service that debt.


The level of concern within this manager group varies, none of them are alarmists, and not all of them are bearish…but they all are vigilant. Yet, at the same time, few of the managers have had to significantly modify their investment approach in light of these risks. You see, they built their strategies, achieved successful track records and collectively amassed hundreds of billions of client-capital by following a disciplined approach to investing with a common thread of portfolio diversification and managing downside risk. This strategy has allowed them to sidestep periods of financial distress, deploying capital into ideas and markets when others are forced to sell and the upside potential is meaningful… the other side of the coin that is the market today. Most see opportunities to make money, a lot of them on the short side. Yet they know they must be patient. Even if the fundamentals dictate that a stock should roll over, a currency crash, or a commodity crater, asset flows matter. And right now, assets are flowing into risky assets creating a Teflon Market where terrorism, geopolitics and disappointing economic data have, to this point, created only a short-term impact, if any impact at all. These managers recognize, as do most of their clients, that there will be periods to be ultra-aggressive and periods, like now, to be more cautious. Likewise, and in a somewhat correlated manner, there will be periods of above average performance and periods of below average performance for their respective strategy. Yet, after a full market cycle, their returns will stand above those of the popular equity indices, even if the ride is not as “exciting”.

Most of the managers are as surprised as anyone that the market continues to levitate higher… seemingly following a late-cycle pattern in which investors are continually able to sell to someone willing to pay an ever-higher price. All the managers stated explicitly or implicitly that this would end at some point, but with humility they readily admit they do not know the approximate, let alone precise, timing. Echoing a comment you have seen peppered in our communications over the last two quarters, the business cycle is not dead and this time is not different.

One manager at a Top 3 global quant fund shared: “If you focus on building robust models, though they may not be the best performing at certain times they do well over longer timeframes. So we don’t overreact when a model is ‘underperforming’ relative to other models in the portfolio. We understand that we need to hold to our beliefs and convictions. We are statisticians at heart and are playing the numbers.” His insight can be applied to diversified portfolios. It’s not about the performance of any individual asset class, and certainly not when measured in a short timeframe (which should be measured on the order of years, not months or quarters), but rather how the various components of the asset allocation harmonize over a long timeframe to compound value with fewer downside surprises.

What many miss, especially when in the midst of a protracted period of rising markets and low volatility, is that you diversify for the capital destroying end of the cycle. Not the beginning, not the middle. Unfortunately, no one can predict when a cycle will end and, typically the longer the swing up, the more violent the swing down. So what can be gleaned from the decades of experience transcending multiple cycles of these managers we interviewed last week? In sum, be alert, be patient, diversify. And for whatever it’s worth, don’t lose sight of the fact that nothing goes up (and with few exceptions) down forever.

Be well,