Friday, December 9th, 2016 TODAY The week is closing out on a positive note and markets are looking decent again for this Santa Trump rally heading into the close of the calendar year. With 14 trading days left, it is promising to be a great one, especially for Canada where materials and energy have powered the whole index to a 17.5% YTD return.
Commodities are the source there, obviously, but it is also driving headline inflation back to central bank target levels, while Core Inflation in the US remains about 2%. You can bet, as the entire market has, that this will result in a Fed Funds rate hike on Wednesday – throwing away all the narrative about the Fed’s actions with a new President-elect in waiting. Take note, the market has fully priced in a hike next week, and a 50/50 chance of another hike by mid-year. We have been watching the staggering run in High Yield bonds of late. The MarkIt HY index has declined to 365, meaning that the universe of junk bonds yields 3.65% more than a US Treasury. This is down from 430 at the beginning of November, outpacing the rise in the 5 year yield from 1.23% to 1.83%. This is also a 16 month low. As such, money is pouring into HY again. HYG and JNK, between the two have about $30bn, lead the pack in an HY ETF universe that has collected about $3.4bn of net inflows this year. Is 17x the new ceiling for valuations? That has seemed to be the norm for the S&P 500 dating back over 2 years (see chart of the day). Each time the S&P has reached the 17x level, it hangs around for a while then retreats. Now for the record, 17x isn’t cheap but it is also not expensive. The S&P 500 has averaged about 14.2x over the past 10 years, as there was clearly a period of depressed valuations. However, if you want a really long historical average, we have something for you. Our earnings model goes back to 1935 and the average PE has been just below 17x. While we would not expect to see multiple expansion at this point given rising bond yields (they tend to suppress multiples), the return of earnings growth in the past quarter and forecast for growth in quarters ahead certainly warrants a decent multiple….maybe even above average. We’re a little surprised with this Reuters exclusive article this morning that the big banks in Britain want to be subject to EU regulatory rules for five years post-Brexit. The pressure from the influential banking presence will be tough to stomach for those favouring a hard Brexit. From the banks perspective a departure in stages will be an easier transition and provide uninterrupted access to financial services, and hopefully for them full access to the European customer base. A good read for those who want to stay on top of the ongoing Brexit negotiations. Looks like we might have touched a nerve with our Launch Pad title yesterday. Over the course of the ECB’s press conference Draghi’s message was despite the bond buying programs reduction in monthly amounts, it shouldn’t be interpreted as a ‘taper’. From Bloomberg: Strenuously denying a “taper” is in place -- or was even discussed by policy makers -- the European Central Bank president cut the institution’s monthly bond buying to 60 billion euros ($64 billion) from 80 billion euros. He also added three more months of purchasing than economists expected, and followed up by saying quantitative easing is essentially open-ended and inflation will remain too feeble well past the supposed new end-date. Call it what you will, but by definition, to taper is to “diminish or reduce”. While no plans were announced to reduce amounts to zero, over time that has to be the end goal, this was just the first step. OPEC is back in the news after last week’s deal of a coordinated production cut, which included an agreement by Russia to scale back production. This weekend details of cuts have to be hashed out with at least four other non-OPEC producers. Some of the countries expected include Russia, Sudan, Malaysia and Mexico. In total the collected production of these non-OPEC members accounts for 18% of world supply. Not small potatoes. Co-ordination is key, as long as it is in the best interest of everyone at the table they should come to some form of agreement. Working closely with non-OPEC members is nothing new, but it doesn’t always work out. From the Wall Street Journal: Over its 56-year history, the cartel has often called on non-OPEC producers to join output cuts. In the late 1990s, Norway, Mexico and others cut back with OPEC after prices crashed during the Asian financial crisis. But in 2008, Russia said it would help OPEC trim global production and then reneged. Lesson Learned: Never trust the Russians. Chinese CPI numbers came in close to expectations, yet their PPI or factory-gate prices rose 3.3%, up from 1.2% last month. This is the fastest pace of gains since 2011, and comes after this measure turning positive for the first time in years just two months ago. Rising producer prices means that China will be exporting inflationary pressures to the rest of the world. Of course this also depends on currency movement. We should take notice of this trend, as it’s another reason to believe that the inflationary trade has legs. Diversion: Go ahead, try this at home. 17 home-made car jumps. (Seriously though… Don’t do this.) COMPANY NEWS Wells Fargo is trying aggressively to settle their fake-account scandal as quietly as possible as they try to salvage their reputation. However, in their home state of California they are facing legislative backlash which risks the public backlash flaring up again. Bombardier announced an order yesterday from Philippine Airlines for 12 Q400 planes, the order could be worth as much as $401mm. The first 5 are expected to be delivered next year. Lululemon’s share price rose the most in eight years yesterday after releasing earnings that showed increasing momentum in athleisure. Blackberry is rebranding all of their software products after a slew of acquisitions have left the brand in disarray. They are hoping the rebranding will make them the market leading platform for electronic device security. COMMODITIES Oil prices are higher this morning, up for a second day in the row. The rally was sparked after last week’s meeting in Vienna ended with an agreement from OPEC members to cut production. The other story making less of a splash was that nine non-OPEC member including Mexico, Oman, Malaysia, Russia and others which account for 1/5 of the world’s supply, were also at the meeting. Gold prices have headed steadily lower since the Brexit vote in early July and on pace for the fifth straight week of consecutive losses. There is a myriad of issues weighing on the price. Higher bond yields, rate hike expectations, a strengthening dollar, ETF outflows, weak physical demand, there is nothing moving in the right direction at the moment. FIXED INCOME AND ECONOMICS Some jitters coming out of Europe this morning as Banca Monte dei Paschi di Siena SpA, the oldest surviving bank in the world and Italy’s 3rd largest commercial/retail bank by assets, just had their request for more time to complete a €5 billion capital increase rejected by the ECB. The proposed extension to January 20 by Monte was needed to plan a share sale that’s part of a complex three part plan to improve their capital. Said plan would result in a debt-for-equity swap, a fresh stock offering, and the complete wipeout of €28 billion in soured loans by the issuer. We’re unsure of what will happen next but it appears that the Italian government is expected to intervene to recapitalize the Bank to avert the risk of it being wound down. The failure of Monte could threaten the savings of thousands of retail investors, ripple across the wider banking sector and provoke a financial crisis in the Eurozone's third-biggest economy still reeling from PM Renzi’s recent resignation. Monte’s equity was down -7.50% before being halted just now while the €500 billion in outstanding Monte 5% 4/21/2020 subordinated notes (rated CC by Fitch) are down €8.36 to €52.99 at time of writing. With the huge inflows seen in the high yield space (coupled with the recent seemingly unending rise in global risk taking), Deutsche Asset Management added to its line of fixed-income exchange traded fund strategies with a new high-yield junk bond option this past week. The ETF provider has launched the Deutsche X-trackers USD High Yield Corporate Bond ETF (ticker HYLB on NYSE) that with an MER of just 0.25%, is the cheapest amongst its asset class. The ETF tracks the Solactive USD High Yield Corporates Total Market Index which references the performance of corporate high yield bonds issued in USD with a remaining time to maturity between one and 15 years and a minimum amount outstanding of $400MM. Just over 85% of the fund is invested in bonds issued by U.S. domiciled firms with Canada (4.3%), the U.K. (4.1%) and France (4.1%) making up the balance amongst others. The index is market cap weighted and rebalanced monthly while a single issuer cap of 3% is used. There are currently 435 issuers within the index with an average duration of 3.5 years and a yield-to-worst is 5.90% (yes, below 6.00%!). The credit ratings to which the index is most exposed are BB (48.2%), B (33.8%) and CCC (9.9%). This new addition to the ETF junk space joins a crowd led by the iShares iBoxx “HYG” and SPDR Barclays High Yield Index “JNK”. CHART OF THE DAY QUOTE OF THE DAY | Certainly, travel is more than the seeing of sights; it is a change that goes on, deep and permanent, in the ideas of living.
- Miriam Beard | |
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