Five years ago, on Black Friday 2008, quantitative easing (QE) was born. In its quest to battle the deflationary effects of the financial panic, the Fed launched the “extraordinary” policy of buying long-term assets from banks. In exchange, the Fed credited banks’ reserve accounts, believing the banks would lend off these reserves many times over—a big money supply increase to boost growth.
To date, through multiple rounds of (now infinite) QE, the monetary base (M0) has swelled by nearly $3 trillion. Yet this economic expansion has been the slowest in post-war history.
Exhibit 1: Cumulative GDP Growth
Is the UK housing market overheating, or is it merely the latest example of froth fears that are detached from reality?
Recent home price data and the UK’s Help to Buy scheme’s early expansion already have some UK politicians and business leaders wondering—some going as far as calling for the Bank of England to cap rising home prices. Taking a deeper look, however, I see a different story: Rapid housing price gains have been concentrated in London. Restricting overall UK housing with more legislation likely won’t fix that, and it probably won’t help spread London’s gains to UK housing elsewhere. More importantly, the fact UK housing gains aren’t widespread tells me a nationwide bubble neither exists nor is particularly probable—even with an expanded Help to Buy program.
While UK housing started slowly improving after Help to Buy began in April, the program has only been lightly used in the early going—suggesting the housing recovery is coming from strengthening underlying fundamentals and isn’t purely scheme-driven. In Help to Buy’s first phase, the government promised to lend up to 20% of a home’s value at rock bottom rates (interest free for five years, 1.75% interest after) to buyers with a 5% down payment—providing up to £3.5 billion in total loans. Only first-home buyers (of any income strata) seeking newly built houses valued at £600k or less could participate. The Treasury began a second (earlier-than-expected) iteration in October, in which it guarantees 20% of the total loan to lenders, instead of lending directly to the buyer. The program was also expanded another £12 billion for buyers purchasing any home (new or not).
|By Fisher Investments Research Staff, 11/26/2013|
With interest rates on everything from savings accounts to junk bonds at or near generational lows, many income-seeking investors are looking for creative or, to some, exotic means of generating cash flow. Some are turning to a relatively little-known type of security—master limited partnerships (MLPs). MLPs may attract investors for a number of reasons: their high dividend yields and tax incentives, to name a couple. But, like all investments, MLPs have pros and cons, which are crucial to understand if you’re considering investing in them.
MLPs were created in the 1980s by a Congress hoping to generate more interest in energy infrastructure investment. The aim was to create a security with limited partnership-like tax benefits, but publicly traded—bringing more liquidity and fewer restrictions and thus, ideally, more investors. Currently, only select types of companies are allowed to form MLPs—primarily in energy transportation (e.g., oil pipelines and similar energy infrastructure).
To mitigate their tax liability, MLPs distribute 90% of their profits to their investors—or unit holders—through periodic income distributions, much like dividend payments. And, because there is no initial loss of capital to taxes, MLPs can offer relatively high yields, usually around 6-7%. Unit holders receive a tax benefit, too: Much of the dividend payment is treated as a return of capital—how much is determined by the distributable cash flow (DCF) from the MLP’s underlying venture (e.g., the oil pipeline).
|By Christo Barker, 10/10/2013|
While the rest of the country fretted over taper terror, government shutdown and debt ceiling limits, the Federal Reserve tested its Fixed Rate Full-Allotment Reverse-Repo Facility (a mouthful—let’s call it FARRP) for the first time September 24. FARRP allows banks and non-banks, like money market funds and asset managers, to access Fed-held assets—i.e., the long-term securities bought under the Fed’s quantitative easing—via securities dealers’ tri-party repo (and reverse-repo) market for short-term funding. (More on repos to follow.) FARRP aims to address what many feel is a collateral shortage in the non-bank financial system caused by too much QE bond buying concentrating eligible collateral on the Fed’s balance sheet, where it doesn’t circulate freely. As a result, many private sector repo rates turned negative. But, should FARRP be fully implemented, the facility could actually hinder some assets (in this case, high-quality, long-term collateral like bonds) from circulating through the financial system—much like quantitative easing (QE) locked up excess bank reserves. A more effective means of freeing collateral in the repo market is tapering the Fed’s QE.
Repurchase agreements, or repos, are used to generate short-term liquidity to fund other banking or investment activity—a means to move liquidity (cash) from one institution to another. In a repo, one party sells an asset—usually long-term debt—agreeing to repurchase it at a different price later on. A reverse repo is, well, the opposite: One party buys an asset from another, agreeing to sell it back at a different price later. In both cases, the asset acts as collateral for what is effectively the buyer’s loan to the seller, and the repo rate is the difference between the initial and future sales prices, usually expressed as a per annum interest rate. The exchange only lasts a short while—FARRP’s reverse repos are overnight affairs to ensure markets are sufficiently funded. In the test last Tuesday, the private sector tapped the facility for $11.81 billion of collateral—a small, but not insignificant, amount.
FARRP’s first round is scheduled to end January 29, and during that time, non-bank institutions can invest between $500 million and $1 billion each at FARRP’s fixed overnight reverse-repo rates ranging from one to five basis points. A first for repo markets: Normally, repo and reverse-repo rates are free-floating, determined by market forces. Another of FARRP’s differentiating factors is private-sector need will facilitate reverse-repo bids instead of the Fed. Ideally, FARRP’s structure will encourage unproductive collateral to be released back into the system when it’s most needed—and new sources of collateral demand may help ensure this. Swaps, for example, are shifting to collateral-backed exchanges due to Dodd-Frank regulation—meaning more collateral will be needed to back the same amount of trading activity. Collateral requirements for loans will likely also rise.
China’s August economic results are in, and overall, the data showed continued improvement. The economy appears stable and growing at a healthy rate, and the long-dreaded hard-landing appears increasingly unlikely—an underappreciated positive for global markets.
Nearly across the board, China accelerated and beat expectations—illustrating broad-based stabilization in the wider economy. Of particular note, industrial production had its best reading since March 2012, and together with China’s most recent PMIs, the results suggest Chinese manufacturing data are rebounding nicely. Retail sales were also robust and exports accelerated, with shipments to the US and EU up for the second consecutive month. On the whole, August economic data signal a fundamentally fine China—growth may be slowing from recent years, but that’s likely more a function of China’s gradual economic development than weakness.
War drums are banging a terrible rhythm—and the growing crescendo now is about Syria. The world over, citizens are concerned. If that’s you, please know you aren’t alone. My heart aches for the Syrian people—for them this is a very real and terrible situation. From an investment point of view, however, should the (seemingly imminent) strike on Syria come to pass, it is unlikely to move markets in a material fashion.
I’ll not rehash any of Elisabeth Dellinger’s excellent analysis of Syria’s limited economic and market impacts. My reasoning is more about how markets function. Markets don’t wait for events to happen before deciding to move—volatility occurs in both directions as investors weigh the probable future outcomes. This efficient mechanism of assigning probabilities is why a strike on Syrian military targets by a “coalition of the willing” is unlikely to be materially negative for equities. Quite simply, a Syrian strike lacks surprise power.
It seems most folks know that last week Syria’s two and half year civil war reached a new point of darkness, as reports of a chemical weapons attack in Damascus surfaced—seemingly, the deadliest chemical strike in over two decades. The United Nations is presently attempting to verify the facts on the ground, but multiple sovereign nations and intelligence agencies already assert without equivocation the attack was conducted by the Syrian government on its own people. The evidence seems to be a phone call US intelligence intercepted in which Syria’s defense ministry demanded an explanation for the strike from a chemical weapons unit official.
For the past several quarters, US import growth has been pretty lackluster. Ordinarily, this might be concerning—weak imports typically mean weak demand—but in this case, it isn’t. Falling petroleum imports are the primary driver of headline weakness—a happy byproduct of the shale boom and another tailwind for US stocks.
Exhibit 1 shows US import volumes (units, not dollars, in order to remove the skew of fluctuating oil prices) since 1967—total, petroleum and total ex-petroleum. Petroleum peaked in Q2 2007. Today, petroleum imports are back near 1997 levels. Yet headline imports are back at all-time highs, and non-petroleum imports are well into record territory. Demand is robust.
Demand for petroleum products is robust, too! It’s true US petroleum consumption is down from 2007’s peak, but since 2009 it has largely held steady—even as imports have continued falling. Thanks to shale, domestic production is up! In 2009, domestic oil production averaged 162.8 million barrels per month. Year to date, the monthly average is 217.4 million barrels.i
|By Staff, Reuters, 12/03/2013|
MarketMinder's View: When small firms can borrow more, they can invest more in growth-oriented endeavors. We’d expect business borrowing to continue increasing as quantitative easing (QE) ends and long-term interest rates normalize—a wider spread between short- and long-term interest rates makes lending more profitable, encouraging banks to lend more.
|By Aaron Smith, CNN Money, 12/03/2013|
MarketMinder's View: While this is nice to see, it’s just one day—just as a lackluster Black Friday was just one day. Seasonal totals matter more, and yearly matters more than seasonal. Over the season and year, the highs and lows should average out, and with disposable incomes rising, overall consumer spending should keep growing. For more, see our 12/2/13 cover story, “Doorbusters! Discounts! Ka-ching!”
|By Jude Webber, Financial Times, 12/03/2013|
MarketMinder's View: Mexico’s energy reform plans are moving closer to reality, and with the leftist Party of the Democratic Revolution abandoning the multiparty Pact for Mexico, the two main parties have more bandwidth to pursue more sweeping change than President Enrique Peña Nieto first outlined, including allowing private firms to enter production-sharing or outright concession agreements. For more, see Elisabeth Dellinger’s column, “What to Do About Mexico’s Energy Reforms.”
|By Alison Sider and Kristin Jones, The Wall Street Journal, 12/03/2013|
MarketMinder's View: The benefits of shale fracking aren’t limited to energy markets—the boom creates opportunities throughout the economy. In this case, it has driven demand for sand, one of the key ingredients in hydraulic fracturing, and firms are lining up to mine, process and transport it.
Market Wrap-Up, Tues 03 Dec 2013
Below is a market summary (as of market close Tuesday, 12/3/2013):
Global Equities: MSCI World (-0.5%)
US Equities: S&P 500 (-0.3%)
UK Equities: FTSE 100 (GBP) (-0.7%)
Best Country: Japan (+0.9%)
Worst Country: Finland (-2.4%)
Best Sector: Information Technology (+0.2%)
Worst Sector: Materials (-1.1%)
Bond Yields: 10-year US Treasurys was at 2.79%.
Editors' Note: Tracking Stock and Bond Indexes