|By Fisher Investments Editorial Staff, 01/19/2017|
In this podcast, we talk to Content Group Manager Todd Bliman on how investors can navigate the modern financial news media.
In a year where populism has swept the ballot box, is Italy next? On December 4, the country will hold a referendum on whether to reform the size, powers and appointment process for Parliament’s upper house, the Senate. If the referendum is approved, the Senate’s powers would be greatly curtailed and size reduced. It would shrink from 315 members to 100, the government would no longer have to win a Senate confidence vote, fewer measures would require Senate approval and senators would be appointed by Italy’s Regional Councils instead of directly elected. If passed, it would foster government stability and make it easier to pass badly needed reforms. But if it fails, many fear it will destabilize Italy’s pro-euro government, potentially propelling anti-euro populists to power and raising the risk of a domino effect across the eurozone. In our view, however, fears of broader market impact are likely overstated.
Prime Minister Matteo Renzi proposed the referendum to mitigate the Senate’s ability to block legislation and increase the Italian government’s stability, through elimination of one confidence vote. However, he also indicated his government will step down if the referendum is defeated. Opposition parties, such as the Five Star Movement (M5S), are against the referendum, as they believe it gives too much control to the Prime Minister. Many believe a Renzi resignation could give M5S an opening to enter the national government.
Italy doesn’t allow the publication of polls 15 days prior to an election or referendum, but the last polls indicated the “No” vote was ahead by about three points. PredictIt, a betting website similar to the late, great InTrade, puts the odds of the “No” vote prevailing at ~80%. But as US elections and the Brexit vote showed, polling and prediction have been unreliable lately. The considerable number of undecided voters (~20%) also suggests any poll isn’t conclusive.
A few months ago, 10-year Treasury yields hit an all-time low of 1.36%, as investors piled into Treasury bonds in the wake of the Brexit vote.[i] Since then, Donald Trump’s win and expectations for higher inflation have sent yields up 70 basis points (0.70%).[ii] As rates have risen, so have fears about the end of the alleged 35-year bond bull market—and the possibility of a bond bear market, should rates climb higher. Since bond prices and interest rates move inversely, many seemingly fret higher rates mean bonds are doomed to poor long-term returns—arguing bondholders should ditch them post-haste. In our view, this overlooks important nuances suggesting the case for investors who need fixed income exposure hasn’t changed.
First, let’s look at the last 35-ish years of yields—that long-term bond bull. Fast-rising inflation and aggressive Fed rate hikes pushed 10-year yields to 15.84% in 1981. But after the Volcker Fed put inflation in check, rates began a secular move downward to recent lows. However, this wasn’t a straight line down.
As Exhibit 1 shows, bond yields went through several cycles where yields increased. Since 10-year US Treasury yields peaked in September 1981, rolling 12-month yields rose 35% of the time.[iii] Even if yields do experience a long-term climb, odds are investors will see plenty of periods where yields fall. Having an actively managed fixed income strategy can help take advantage of these opportunities.
With oil up from its most recent low, many see a prime opportunity in Energy stocks. However, despite oil’s nascent rebound, the bigger picture hasn’t changed. The primary headwind facing Energy is an oil oversupply, which puts downward pressure on prices. Even if prices don’t plunge anew, this force still impacts the sector’s future profits. For investors, the question isn’t, “how much have prices risen recently?” Rather, it’s, “are there any meaningful supply constraints that will alleviate pressured profits?” All evidence today suggests there aren’t, making it premature to load up on Energy stocks.
Demand growth likely remains steady, as it has since 2012, but supply probably won’t abate any time soon. Domestic producers are quick to bring supply back online at the first signs of price strength. As seen in Exhibit 1, US producers have responded to stronger oil prices by putting rigs back to work, with a narrow lag time of only three months. In many shale regions, new wells are profitable with oil at $40 a barrel, according to estimates by ConocoPhillips. Indeed, the abundance of US supplies—accessible at ever-lower costs—led ExxonMobil CEO Rex Tillerson to refer to domestic shale as a source of “enormous spare capacity,” which has visibly changed the industry. That quick producer response and abundant supply dampens the likelihood oil prices significantly rise over the next 12-18 months.
Exhibit 1: Rig Count Response to Oil Prices
|By Fisher Investments Editorial Staff, 10/11/2016|
MarketMinder’s editorial staff sits down with Fisher Investments Capital Markets Analyst Scott Botterman.
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|By Shobhana Chandra, Bloomberg, 01/18/2017|
MarketMinder's View: By the numbers: “Prices were up 2.1 percent from a year earlier, the most since June 2014. ... The core CPI measure increased 2.2 percent from December 2015, after rising 2.1 percent in the prior 12-month period.” Don’t get caught up in the breathless takes on inflation being over 2%; December’s levels are still benign. After the large Energy price drop in 2015, headline inflation dipped well below “core” inflation (excluding food and Energy). With oil’s recovery in 2016, headline inflation has simply moved back to the core rate but is still below where it’s been for most of the last 50 years. Core CPI, meanwhile, spent all of 2016 bouncing between 2.1% y/y and 2.4%. There is no sharp acceleration here.
|By Landon Thomas, Jr., The New York Times, 01/18/2017|
MarketMinder's View: This spills an awful lot of pixels for what amounts to a -0.4% pullback in the S&P 500 since January 6. It seems based on the weird premise that returns from November 8 through then were a product of irrational euphoria, as investors were overlooking myriad political risks, and since then investors have started properly assessing the situation. That is an odd claim to make, considering markets discount widely known information, and every financial publication we read has been trumpeting these alleged risks since November 9. Markets don’t move in straight lines, and pauses (and pullbacks) are normal. Given fundamentals haven’t noticeably shifted in recent weeks, we’re inclined to chalk this up as markets being markets. Consider the risks, as this article lists: 1) a rising dollar; 2) trade wars; 3) Trump not delivering on his promises of infrastructure spending and tax cuts. First, the dollar has no correlation with stocks—stocks and the economy have done fine alongside a stronger and weaker dollar. Trade wars could be a concern, if protectionist campaign rhetoric translated to protectionist policies, but presidents have a long history of being reborn as free traders once in office. Watch what politicians do, not what they say. And as for Trump delivering stimulus or tax cuts, we don’t see evidence the economy or consumers need that help. Stimulus accomplishes little when used during economic expansions (it’s best used at the depths of recession), and history shows tax cuts/hikes have little to no bearing on global markets. As for pundits also being upset by “global shocks that could unnerve the markets ... driven by the growth of populist political movements, across Europe in particular [where] higher volatility would kick in as central banks cease intervening so aggressively in markets,” populists are far from, um, popular in Europe and not close to winning elections. And if the ECB or any central bank stops intervening, well, thank goodness as that would allow the yield curve to steepen. That’s good, not bad.
|By Clifford Krauss, The New York Times, 01/18/2017|
MarketMinder's View: Have cake and drink your milkshake! Texas is not only big, it is deep: “The Permian, in production for almost a century, is so bounteous that it fueled the Allied forces battling Germany and Japan during World War II. [After a period of decline,] companies found multiple layers of shale — six to eight oil-rich zones, one on top of the other, like a layer cake — that offer companies the opportunity to drill through multiple reservoirs on the same real estate.” OPEC nations say it’ll be a while before American oil production recovers, but with break-even prices in the basin as low as $40 a barrel and market prices above $50, they can probably pump a lot more than most presume.
|By Staff, Reuters, 01/18/2017|
MarketMinder's View: So a lot of the “surge” was weather-related as a warm November that sapped electricity and gas usage gave way to a chilly December, bringing the Utilities subcomponent up 6.6% for the month. More interesting in our view is looking away from Utilities, toward manufacturing and mining production and broadening out the timeframe to Q4: “Overall manufacturing output rose at an annual rate of 0.7 percent in the fourth quarter while the index for mining surged 11.9 percent in the quarter.” This corroborates evidence that US manufacturing remains a modest economic tailwind, while the Energy industry might have ceased being a drag.
Market Wrap-Up, Wednesday, January 18, 2017
Below is a market summary as of market close Wednesday, January 18, 2017:
- Global Equities: MSCI World (+0.2%)
- US Equities: S&P 500 (+0.2%)
- UK Equities: MSCI UK (+0.0%)
- Best Country: Hong Kong (+1.0%)
- Worst Country: Singapore (-0.6%)
- Best Sector: Materials (+0.5%)
- Worst Sector: Telecommunication Services (-0.4%)
Bond Yields: 10-year US Treasury yields rose 0.11 percentage point to 2.43%.
Editors' Note: Tracking Stock and Bond Indexes
Source: FactSet. Unless otherwise specified, all country returns are based on the MSCI index in US dollars for the country or region and include net dividends. S&P 500 returns are presented including gross dividends. Sector returns are the MSCI World constituent sectors in USD including net dividends.