Covenant Weekly Synopsis as of December 4, 2015

December 7, 2015

Equities wobbled on Wednesday afternoon when Fed Chairman Yellen gave the market further evidence the Fed will raise interest rates at their next meeting on December 15/16th The wobble turned into a stagger on Thursday when European Central Bank President Mario “Do-Whatever-It-Takes” Draghi failed to meet market expectations (and/or hopes) in the form of additional ECB stimulus.  On Friday, much of the market pain was reversed when Draghi and his team, obviously shocked at the market’s reaction to his latest stimulus plan, stated emphatically: “We have the power to act. We have the determination to act. We have the commitment to act.” Asset prices reacted powerfully, undoing much of the damage that had been inflicted the day before.


SPX Index


Market Recap. In spite of elevated daily volatility levels, weekly performance of stocks was muted. Large cap US stocks continued their run of outperformance (+0.1%), while small cap US (-1.6%) European (-3.3%) and emerging market (-1.7%) equity indices lagged. On a YTD basis, performance of regional equity indices ranks differently, led by Japan (+13.6%) Europe. (+10.6%) and China (+5.7%). Meanwhile, the S&P 500 was up +3.6% through last Friday, while Emerging Markets are down -13.0% YTD.

Volatility was also pronounced in global interest rates during the week, though again on a weekly basis yields rose only modestly. The UST 10-year bond yield rose +0.05% to 2.27% (the 10-year UST has been trading in a range of 2.0% – 2.4% over the last six months). High yield bond spreads compressed slightly.This is worth monitoring as the spreads have been on a widening trend since June of this year, implying lower credit quality (higher risk) corporations are having a more difficult time financing their businesses, which can serve as an early indicator of a recession (though that is not our baseline forecast).

Precious metals staged one of their best weekly rallies on the year, though gold, silver and copper prices are negative on a YTD basis. Crude oil had a tough week, with the price of WTI declining more than -4% to end the week at $39.97 per barrel. Surprisingly, in spite of the divergent monetary policy paths of the U.S. and most of the developed world, the USD declined -1.7% last week. The fall in the USD likely resulted from a short-squeeze, as the long USD trade is one of the most crowded trades on the planet right now. The USD may continue to rise against global currencies, but my guess is that a lot of that has already been priced into the marketplace.

Additional market detail can be found here.


Why didn’t Super Mario deliver? I think there are three potential reasons Draghi’s latest stimulus plan fell short of market expectations:

1. Growth in the Eurozone, though slow, is progressing and the ECB would like to see this play out further before taking more forceful monetary policy actions.

2. The ever-austere Germans are pressuring the ECB to take less, rather than more, monetary policy action. Germany has a long and strong history of financial conservatism. In fact, the country recently voted against making a bid for the 2024 Olympics citing concerns about the costs of hosting the world games. Keep in mind that Germany is the largest and strongest economy in the Eurozone, so they could certainly afford to host the Olympics.

3. In an interconnected global marketplace, it is logical to assume that Draghi and Yellen are in communication with one another choreographing, at least to some degree, their respective monetary policy actions. Draghi still has plenty of dry powder to apply to the market, but doing so directly in advance of a likely Fed rate hike may be less effective than waiting until after the event.

In reality, Draghi’s decision likely contained elements of all three reasons offered above. Leaving the reasoning for his recent policy decision aside, we are witnessing a changing of the guard in the ongoing narrative of central bank influence on the markets. In fact, Bloomberg recently called Draghi the “global economy’s chief protector” supplanting the Fed in that role. As such, we can expect global markets to pay increasing attention to Draghi with last week’s actions serving as an example of what is to come.


Economic Data Release Summary. The ISM manufacturing index declined to a six-year low of 48.6 in November (vs. 50.1 in October) as dollar strength continues to weigh on the manufacturing sector. The ISM non-manufacturing index declined from a near decade high of 59.1 to 55.9 in November. In spite of the decline, the reading above 50 indicates the service sector remains solidly in expansion territory (note that the services sector is a much larger component of the domestic economy than manufacturing). Non-farm Payrolls increased by a healthy 211,000 in November. The headline unemployment rate remained at 5% as more people entered he labor force. The Fed is on track to raise rates at their December 15/16th meeting.

Be well,