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 Garfield Clinton Reynolds and Adam Haigh, Bloomberg, 12/05/2016|
MarketMinder's View: 20 years ago today, then Fed head Alan Greenspan uttered the following words: “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?” (Boldface ours.) This piece conjures up that anniversary and imagery to argue markets are looking frothy today, based on the post-US election rally and valuations, which it argues are at their highest levels since 2000’s bubble. The trouble with this logic: Markets have been largely flat for two years, which is kind of un-bubble-like and that Trump rally amounts to a 3% up move at this juncture. Valuations may be higher than at points since 2000, but they are only about half of what they were then and just barely above their long-term average. That’s not frothy, it’s pretty typical. As it pertains to bonds, is anybody anywhere euphoric about the outlook for fixed income? We find mostly fear, as expressed in this piece. Sorry, but signs that “irrational exuberance” has returned are few and far between. Oh, and might we add: Greenspan uttered those words more than three years before the 1990s bull market peaked. Exiting stocks because of his “warning” could have been quite costly. And we’re not singling him out—no policymaker we are aware of, including the present Fed, has a track record of successfully forecasting markets.
|By Peter S. Goodman, Neil Gough, Sui-Lee Wee and Jack Ewing, The New York Times, 12/05/2016|
MarketMinder's View: This piece does a smashing job demonstrating the global supply chain at work. Consider the recliner described herein, made in the US using many American products. Designers in Michigan create the chair plan—American intellectual property. Local workers affix wood from Wisconsin timber to an American-steel frame—and it’s all assembled in a factory in the States. However! The fabric for the chair, and the electronics that make the recliner actually recline, are imported from Germany and China. The reason: Because those countries currently have the infrastructure and workforce to produce those goods as quickly and cheaply as possible. If one country were to disrupt the supply chain (e.g., through tariffs or import restrictions), that would cause some displacement and unintended consequences. While some economists argue that punitive tariffs from the US would bring jobs back here, that seems unlikely. Automation is already claiming many manufacturing roles, and plus, companies may just shift operations to countries without those barriers. As one business owner quoted here says, “Money and goods will always find their way, regardless of what barriers you put up. You just make it more difficult and more expensive.” This is why we say following trade policy developments—separating talk from action—is key.
|By Gideon Rachman, Financial Times, 12/05/2016|
MarketMinder's View: Yesterday, Italian voters overwhelmingly rejected Prime Minister Matteo Renzi’s referendum on constitutional reform (59% to 41%). As promised, Renzi announced he would resign, and talking heads are already speculating about the fallout. The result is an avalanche of articles like this one, pondering questions that seem quite a stretch from where things stand today. Questions like: Will the populist Five Star Movement now sweep into power, putting Italy’s future in Europe at risk? Will the uncertainty roil Italy’s banking system, causing a financial crisis? Is the European Project doomed? But realistically, this vote doesn’t mean any of those things. For Italy’s near-term political future, President Sergio Mattarella will likely tap a caretaker government rather than call snap elections, and that means gridlock—more of the same for Italy. More importantly, the referendum’s result also resolves some broader political uncertainty, which is a common theme for this year—that falling uncertainty will help investors see a better-than-appreciated reality. Finally, consider: Markets discount all widely known information, and the referendum’s result wasn’t a huge surprise, as polls showed “No” winning. That’s probably why markets barely batted an eyelash. For more, see today’s commentary, “Italian Referendum Fails, Stocks Smile.”
|By Anton Troianovski, The Wall Street Journal, 12/05/2016|
MarketMinder's View: For evidence populists aren’t running roughshod over in Europe, see Austria’s presidential election—a re-run from May’s contested election. Granted, a couple caveats: The victor, center-left candidate Alexander Van der Bellen, was the former head of Austria’s Green Party and ran as an independent, so this isn’t an “establishment” triumph. (But he is very pro-EU, so in that sense, it’s not in keeping with the narrative of populists upsetting the international status quo.) Also, the presidency is largely ceremonial, with the more important parliamentary elections to come in 2018. Those conditions aside, Van der Bellen’s victory over far-right candidate Norbert Hofer of the Freedom Party is another counterpoint to the narrative of a populist wave sweeping across Europe. Despite all the headlines they command, populists aren’t uniformly grabbing power. Some examples: After 10 months of no government in Spain, the establishment parties formed a minority government, sans far-left Podemos’ support. While France’s far-right Front National will contend for the presidency next year, it has yet to score a major national victory. Elections in France and Germany next year will be telling about populists’ staying power and influence, but for now, concerns about a populist uprising seem overwrought.
Market Wrap-Up, Friday, December 2, 2016
Below is a market summary as of market close Friday, December 2, 2016:
- Global Equities: MSCI World (+0.0%)
- US Equities: S&P 500 (+0.0%)
- UK Equities: MSCI UK (+0.0%)
- Best Country: Belgium (+0.6%)
- Worst Country: Hong Kong (-1.5%)
- Best Sector: Utilities (+0.7%)
- Worst Sector: Consumer Discretionary (-0.4%)
Bond Yields: 10-year US Treasury yields fell 0.06 percentage point to 2.39%.
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.