There’s more where that came from. Photo by yodiyim/Getty Images.
At long last, the Organization of the Petroleum Exporting Countries (OPEC) reached an agreement to cut production on Wednesday. While details are scarce, comments from oil ministers indicate the group will cut oil production to 32.5 million barrels per day (Mbpd), from recent levels of 33.5 Mbpd. Despite the hype, however, the change is basically window-dressing. It probably won’t much alter global supply or improve the outlook for Energy firms. Their earnings are tied to oil prices, which likely remain lackluster for the foreseeable future (albeit with short-term volatility).
This is OPEC’s first official action of this sort since oil began crashing in 2014. OPEC surprised markets that November by declining to cut production, as had been widely expected at the time. Oil supplies were growing briskly, primarily due to new output from US shale production, which got a boost from developments like horizontal drilling and hydraulic fracturing. The resulting oversupply led to the last two years of oil weakness. With Wednesday’s agreement to cut production, OPEC is arguably moving back to its traditional role of attempting to target a price range for oil.
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.
|By Fisher Investments Editorial Staff, 10/11/2016|
MarketMinder’s editorial staff sits down with Fisher Investments Capital Markets Analyst Austin Fraser.
Political uncertainty is stoking fear across much of the developed world. In the US, pundits pontificate about the potential negative market impact from either a Donald Trump or Hillary Clinton presidency. Similarly, recent and upcoming votes in the eurozone’s four biggest economies—Spain, Italy, France and Germany—have contributed to an environment of fear and loathing across the Continent, causing many to miss the region’s overall fine economic results. Time and again, forecasted political “disasters” have had a limited impact on the fundamental environment in Europe. The Brexit vote increasingly appears to have had little economic impact, with the most recent data pointing to the 14th consecutive quarter of expansion in Q3. Even long-beleaguered European Financials stocks are doing better, as issues like negative interest rates and regulatory changes have failed to live up to fears. While the upcoming votes might bring minor political shifts, all appear unlikely to result in big, sweeping change. Instead, they likely push governments deeper into gridlock—an underappreciated positive—which reduces uncertainty and legislative risk.
Spain is likely headed to its third general election in a year after its fragmented parliament failed to form a government following June’s election. Prime Minister Mariano Rajoy of the center-right Popular Party (PP) was unable to win a confidence vote to form a minority government with upstart, centrist Ciudadanos. If neither Rajoy nor the opposition Socialist Party is able to form a government by Halloween, Spanish voters will return to the voting booth—potentially on Christmas Day.
|By Christo Barker, 03/28/2016|
Financials stocks took it on the chin during 2016’s first six weeks, as investors freaked out over banks’ Energy exposure, eurozone banks’ capital ratios and bad loans, and negative interest rates. While these issues have impacted sentiment, in our view, they are overstated or misperceived. Energy loans lack the balance sheet exposure to ripple systemically. Negative interest rates are poor monetary policy but apply only to a tiny portion of global bank reserves. Bank lending is improving in most of the world, including the US and Europe, and bank balance sheets are the healthiest they’ve been in a generation. We believe the US and European financial systems are quite healthy and the risk of another near-term financial crisis is extremely low.
1. Potential Energy Loan Defaults Lack Scale
In the US, Energy loans account for just 3% of total loans—tiny. Overall, US banks were already conservatively positioned with 1.5% of loans set aside to cover all potential bad debts. Even with this conservative buffer, banks modestly stepped up these provisions as a precautionary measure, further limiting potential energy fallout. Just 6% of outstanding Energy debt globally is on bank balance sheets, while 86% is in the bond market. (Exhibits 1 and 2)
Some compare Energy loans today to subprime mortgages and 2008’s financial panic, but these fears lack credibility. Banks’ real estate exposure in 2007 amounted to 110 times their Energy exposure today. Plus, that 3% balance sheet exposure to Energy includes loans to huge integrated firms and state oil companies—neither have legitimate default risk. Even if half of the outstanding Energy loans were to default—extremely far-fetched—the conservative position of bank balance sheets is well-positioned to limit any major fallout from such an event.
Over the past year bond market liquidity—the ability to quickly redeem an asset for cash without moving the price much—has gone from an obscure, seldom-mentioned topic to one of the financial press’s favorite fears. Worries centered on high-yield exchange-traded funds (ETFs), with pundits and prominent investors frequently warning they operate on the illusion of liquidity. We’ve addressed this issue several times on MarketMinder (here, here and here). I won’t rehash those points in full, but for a quick refresher, regulatory changes made bond dealers less willing to hold large inventories and act as intermediaries. This, pundits theorize, makes bonds less liquid. Compounding the issue is the increased use of ETFs that promise equity-like liquidity but are backed by much less liquid bonds. This “mismatch” is the alleged liquidity illusion, and many claim a high-yield selloff and the accompanying high volumes will reveal a rough reality: that investors can’t redeem quickly without accepting dramatically lower prices. Yet despite a deep correction and record volumes in high-yield ETFs in 2015, we’ve seen no signs of liquidity issues. High-yield ETFs’ liquidity isn’t an illusion. These fears miss ETFs’ ability to create very real liquidity of their own.
To better understand why these liquidity concerns are false, let’s first consider bond ETFs’ size relative to their underlying benchmarks. High-yield ETFs are a fairly new investment tool—the first launched in 2007. Since then, they have gained popularity and, as of November, had over $42 billion in assets.[i] Yet despite the rise in high-yield ETF assets, they represent only a small portion of the US dollar-denominated high-yield market. In other words these ETFs are too small to dictate what happens to the overall index—it’s the other way around.
Exhibit 1: Total Value of High-Yield ETF Assets as a Percentage of High-Yield Index Market Value
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|By Ylan Q. Mui, Matea Gold and Max Ehrenfreund, The Washington Post, 12/02/2016|
MarketMinder's View: Look, we’re happy for the 1,000 people who get to keep their jobs because the President-elect jawboned one company into keeping a plant open and a state government forked over millions in sweetheart tax breaks. But markets are colder, and this is the sort of thing markets tend not to like if done repeatedly on a broad scale. Governments picking winners and losers while steering trade policy to favor national champions is nineteenth century mercantilism (and modern Japan), not modern capitalism. We know capitalism is a dirty word to many folks, but markets have overwhelmingly done best (and society has advanced the most, and poverty has fallen the most) where it flourishes freely. Intervention of this sort distorts competition, creates confusion, raises uncertainty and eventually discourages risk-taking. Married with trade policy aimed at punishing corporations for moving production abroad, it risks hollowing out the economy and starving the country of investment. Don’t take our word for it: Read Tyler Cowen’s most excellent Bloomberg column explaining how it (wouldn’t) work. For investors, this isn’t a reason to be bearish today. Numerous pundits are criticizing the move for the exact reasons we’ve outlined here, and the more chatter there is, the more the risk gets baked in to stocks, reducing surprise power. Plus, it is entirely possible the next administration moves on to other issues once in office, leaves Corporate America alone, and preserves free trade where it exists. But it is a thing to watch. Closely.
|By N. Gregory Mankiw, The New York Times, 12/02/2016|
MarketMinder's View: Here is a winner from the author of our Econ 2 textbook, explaining why policies aimed at reducing the trade deficit are solutions in search of a problem. For one, they will probably make it bigger by driving demand for US assets—and as a general rule, inbound foreign investments equal imports. Two, trade deficits aren’t problematic. We’ve run one for over 30 years, through good times and bad, and there is just no correlation with economic growth or stocks. “Rather than reflecting the failure of American economic policy, the trade deficit may be better viewed as a sign of success. The relative vibrancy and safety of the American economy is why so many investors around the world want to move their assets here. (And similarly, it is why so many workers want to immigrate here.)”
|By Ben Eisen, The Wall Street Journal, 12/02/2016|
MarketMinder's View: Here’s how: It could boost “S&P 500 earnings, which have been dragged down in recent quarters in part by oil. Profits can fluctuate based on a many factors, but the decline of crude has been a key piece of the puzzle. Much of that has been due to the impact of energy companies on the broader index. As the average price of oil dropped from $103.01 per barrel in the second quarter of 2014 to $33.69 in the first quarter of this year, S&P 500 energy sector earnings dropped from $29.5 billion to minus-$0.9 billion, according to FactSet. But its impact was felt on the index as a whole. S&P 500 profits dropped from $268.1 billion in the second quarter of 2014 to $242.8 billion in the January-through-March period of this year, per FactSet.” As Energy earnings stabilize, that drag wanes, making strength in the other nine sectors more visible. Higher oil prices aren’t necessary for this, as even stable earnings would look fine on a year-over-year basis once earlier high profits fall out of the calculation, but they sure help.
|By Barry Ritholtz, Bloomberg, 12/02/2016|
MarketMinder's View: Here is a wonderful thrashing of some fallacious comparisons of high-end real estate returns to stocks—including one arguing a single luxury home’s potential (based on asking price) 8.7% annualized inflation-adjusted return since 1976 outstripped stocks’ 4.1%. While we have some issues with adjusting long-term returns for inflation, this is a salient debunking all the same: “As an investor, I have spent the past few decades watching my costs go down. As a homeowner, I have spent the past few decades watching my costs go up. As for that Standard & Poor's 500 Index 4.1 percent annualized inflation-adjusted return. Yes, that may be accurate, but only if you omit dividends. Include them and the return jumps to 7.4 percent. That’s pretty close to the fictional 8.7 percent return cited above. Taxes, mortgage interest, insurance, maintenance, utilities? Although mortgage rates may be near historical lows, that probably is temporary. Meanwhile, the cost of almost everything else has gone up. Yale economist Robert Shiller pegs annual inflation-adjusted residential real estate returns, after costs, at 0.2 percent.”
Market Wrap-Up, Thursday, December 1, 2016
Below is a market summary as of market close Thursday, December 1, 2016:
- Global Equities: MSCI World (-0.2%)
- US Equities: S&P 500 (-0.3%)
- UK Equities: MSCI UK (+0.6%)
- Best Country: Norway (+1.6%)
- Worst Country: Belgium (-2.5%)
- Best Sector: Energy (+1.3%)
- Worst Sector: Information Technology (-2.1%)
Bond Yields: 10-year US Treasury yields rose 0.06 percentage point to 2.45%.
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.