Commentary

Fisher Investments Editorial Staff
GDP

US Q3 GDP Solid, Media Take Largely Skeptical

By, 10/31/2014
Ratings204.375

The advance estimate of US Q3 2014 GDP hit Thursday, data showing the world’s largest economy grew at a 3.5% seasonally adjusted annual rate (SAAR) in the quarter. It’s a deceleration from Q2’s 4.6%, but still respectable—and above the US’s post-war average growth rate. It also topped analysts’ estimates of 3.0%. Now, this report will be revised and revised, then probably revised again much later, and revised yet again each and every time the US Bureau of Economic Analysis (BEA) decides to rejigger the tally, which it does every few years.[i] But still, the reading confirms US expansion continued in Q3. And the reaction to this data suggests skepticism remains—showing investors aren’t irrationally celebrating today.

Here is a collection of factoids from the report:

  • Consumer spending rose 1.8% in Q3, adding 1.2 percentage points to growth.
  • Gross private investment—the broad category including business investment in structures, equipment, R&D, residential real estate and inventory change—rose 1%, adding a measly 0.17 percentage point to growth.
    • But before you jump on the “businesses’ aren’t spending” bandwagon consider: business investment in structures, equipment and intellectual property rose 3.8%, 7.2% and 4.2%, respectively—adding a combined 0.68 percentage point to growth.
    • Residential real estate also positively contributed, with its 1.8% SAAR adding 0.06 percentage point to growth.
    • The category’s overall meager 0.17 percentage point contribution to growth was due to inventories falling, which detracted 0.57 percentage point from headline GDP.
  • Government spending was basically flat save for national defense, which rose by 16.0%, contributing two-thirds of a percentage point to growth.
  • Net exports added 1.32 percentage points to growth, though this wasn’t all rosy news.
    • Exports rose 7.8% SAAR in the quarter, but imports fell -1.7%. Falling imports add to GDP but can indicate weakening demand—eek—though we believe there are likely extenuating circumstances here.[ii]

Here is a picture.

Commentary

Fisher Investments Editorial Staff

RIP, QE

By, 10/30/2014
Ratings194.236842

It’s official—quantitative easing (QE) is no more. The Fed announced Wednesday the final round of bond buying will take place in November, sparking a series of grandiose epitaphs. Some suggest QE was a big bull market boost, some call it a lifeline for the economy, and many suggest it was a dud for Main Street but a boost for Wall Street. But in our view, Wall and Main are often one in the same, and QE boosted neither—instead weighing on growth by discouraging lending. Investors and everyday folks alike should cheer its end.

QE will end just shy of its sixth birthday. On November 25, 2008 then-Fed head Ben Bernanke unveiled plans to begin buying up to $500 billion in mortgage-backed securities in an effort to boost liquidity, free up bank balance sheets and drive demand for new loans. Bond buying began in January 2009 and ran through March 31, 2010. But one round wasn’t enough for our fearless Fed: QE 2, which added US Treasurys to the menu, ran from November 3, 2010 to June 30, 2011 and added $600 billion to the Fed’s balance sheet. A weird, wrongheaded interlude called Operation Twist ran from September 2011 to December 2012, as the Fed “twisted” its balance sheet longer term by swapping its shorter-term Treasurys for medium and longer-term. The most recent round, QE3, started September 13, 2012 and became QE-infinity in December 2012, when the Fed decided they would buy however many bonds for however long they wanted until they felt like they didn’t want to buy anymore (based on an ever-shifting set of data points, variables and, we’ll say it, whims).

QE sought to stimulate the economy, by incentivizing borrowing through ultra-low interest rates. So how’d they do? QE1 was alright. It boosted liquidity when credit was frozen and the US risked deflation. The yield curve steepened nicely through most of it, too. But the rest were a drag. They pulled down long-term rates. US 10-year Treasury yields spent much of 2012 and 2013 below 2%—far below historical norms. (Exhibit 1)

Commentary

Michael Hanson

Ignore Election “Momentum”; Gridlock Is Already the Big Winner

By, 10/30/2014
Ratings164.65625

It’s a truism that investors’ memories are short. We forget too easily. Myopia and shoddy memory are parts of what keep markets less than perfectly rational. But this also is perfectly human—generations come and go, experiences and perceptions vary, not everyone is a historian nor statistician.

I recall distinctly two years ago the general media feeling the GOP had “momentum” in the last few weeks leading up to the election, and Romney would ride this tide to victory. Here are some quotes from a Wall Street Journal editorial dated November 5, 2012:

Romney’s crowds are building—28,000 in Morrisville, Pa., last night; 30,000 in West Chester, Ohio, Friday. It isn’t only a triumph of advance planning: People came, they got through security and waited for hours in the cold. His rallies look like rallies now, not enactments. In some new way he’s caught his stride. He looks happy and grateful. His closing speech has been positive, future-looking, sweetly patriotic. His closing ads are sharp—the one about what’s going on at the rallies is moving.

Commentary

Fisher Investments Editorial Staff
Commodities, Into Perspective, Media Hype/Myths

Falling Oil Prices: Consumers’ Boon, Producers’ Bust?

By, 10/29/2014

Yay for consumers, boo for producers? Photo credit: Justin Sullivan/Getty Images.

Gas is under $3 a gallon! Woo-hoo! What a bonanza for the US consumer! But headlines also suggest the sharply falling oil prices responsible for consumers’ allegedly big gain bring producers pain. Particularly, the US shale drillers who have played a big part in driving up supply in recent years. While there is some truth to both the pluses and minuses of recently falling oil, we’d suggest not getting carried away with either. The reality, for both the benefits and threat of low oil prices, is more nuanced.

Commentary

Fisher Investments Editorial Staff
Across the Atlantic, Into Perspective

ECB Says 25 Banks Were Undercapitalized 10 Months Ago

By, 10/28/2014
Ratings64.083333

The ECB released the long-awaited results of its asset quality review (AQR) and stress tests Sunday, confirming what some documents leaked last week: 25 banks failed, collectively undercapitalized by €24.6 billion. But 12 have already made up their shortfalls, leaving 13 banks on the naughty list. They have two weeks to tell authorities how they’ll raise the remaining €9.5 billion and nine months to raise it, and all the healthy banks have one less axe hanging over their heads. The tests’ completion relieves some of the eurozone’s regulatory uncertainty—a positive—but it probably doesn’t trigger a rapid rise in loan growth.

The tests themselves contained few surprises. Of the 25 failing banks, 17 were from the eurozone periphery—nine from Italy, three from Greece, three from Cyprus, and one apiece from Spain and Portugal. No supersized banks failed—most were small regional lenders. Italy’s oldest (and third-largest) didn’t make the cut—though it has been much maligned for some time now; nor did Portugal’s largest (by market cap). Belgium’s Dexia, already under government administration for failing in real life, failed in the make-believe future, too. One French and one German bank failed, but both have already made up their tiny shortfalls. Here’s a chart:

Exhibit 1: The ECB’s Naughty List

Commentary

Fisher Investments Editorial Staff

A Nuanced Earnings Season

By, 10/27/2014

Editor's Note: MarketMinder does not recommend individual securities; the below is simply an example of a broader theme we wish to highlight. It is not a recommendation to buy, sell or take any other action regarding the specific securities mentioned.

Earnings season is well underway, with 208 S&P 500 firms reporting as of Friday. So what’s up with Corporate America? Earnings and revenues, that’s what! But while that in and of itself is noteworthy, there is perhaps a more nuanced takeaway we can glean from recent reports. They also put some alleged risks—Ebola, geopolitical turmoil and the many other things dominating headlines—into perspective. Many firms gave their takes on whether current headline-generating risks will impact their bottom lines in Q4 and beyond. The short answer: Most don’t think they will.

Thus far in the season, aggregate S&P 500 Q3 earnings per share are estimated to have grown 5.6% y/y—the 20th straight quarter of growth. Revenues are up 3.7% y/y, the sixth straight quarter sales have gone up. Growth has been broad-based, with all but two sectors in the black—Energy and Consumer Discretionary. As for revenues, Energy was the only sector in the red. (Exhibit 1) Now, a weaker Energy sector isn’t all that shocking—the sector is more price sensitive than volume and the oil supply glut has weighed on prices (a force that doesn’t seem all that likely to change soon). Consumer Discretionary’s dip thus far is largely driven by two firms—Ford and Pulte Homes. Those two are dragging down the headline figure, so this may just be a statistical snafu. Leaving these two categories aside, earnings and revenues are generally growing nicely.

Commentary

Fisher Investments Editorial Staff
Media Hype/Myths

The Great Global Disconnect: Headlines Versus Data

By, 10/24/2014
Ratings784.410256

While many headlines and sentiment have shown their skeptical streak lately, the data just don’t seem to want to cooperate and collapse. In fact, what we see in comparing sentiment and recent data seems much more like what we’ve seen during the five-plus year course of this big bull market.

First, let’s take a trip around the World Wide Web and assess the economic headlines grabbing eyeballs. All these headlines hit in the last two weeks:

Most of the theses underpinning these articles are very well known to investors: China faces a big slowdown—a hard landing—which will ripple globally; the eurozone is an economic quagmire; the US can’t grow alone; global growth is faltering; did we mention the eurozone is an economic quagmire? Economists have their standard prescriptions: Fiscal stimulus; don’t hike rates yet!; more (misguided) quantitative easing; weaker currencies; debt forgiveness.

Commentary

Fisher Investments Editorial Staff

Misinterpreting Volatility, Economic Edition

By, 10/23/2014
Ratings1023.97549

The recent volatility has not only given some investors pause, it caused economists and academics to speculate and ruminate on what it might foretell about the economy. Which the media has now picked up on, spinning the yarn that investors’ concerns about volatility would beget a weaker economy, in turn creating more volatility for markets. While stocks are a forward-looking economic indicator, they aren’t perfectly rational in the short-term. Volatility is often just markets being markets. It doesn’t necessarily reflect economic conditions, much less create them.

Many see the latest round of swinging stocks as evidence the weak global economy is entering a new and more uncertain stage, including monetary policy shifts that might conflict, slowing growth in pockets of the globe and even health fears. They point to recent sharp shifts in the Chicago Board Options Exchange’s Volatility Index (VIX)—which surged to a 28-month high last week, then plummeted at least 10% per day on October 16, 17 and 18—then rose the same amount the following trading day.[i] Many see the VIX as the uncertainty index—“The Fear Gauge.” (Nevermind that this is a fallacy, because the VIX merely attempts to measure the magnitude of future moves, not the direction.) The presumption is that with rising uncertainty/fear/VIX comes a near-inability for businesses to plan for the future.

The Kansas City Fed added some academic firepower to the issue, too. They published a paper September 4, suggesting spikes in uncertainty slow growth and hiring. The VIX is their uncertainty gauge, and they wag an accusatory finger at the sharply rising readings in 2011, 2012 and 2013. Hiring, they found, slowed during the volatility. They argue the effect didn’t go away as fast as the VIX fell, suggesting to them a lingering fear that weighed on the economy. In theory, uncertainty is bad for business and stocks. So you might presume there is some underlying truth to the notion today.

Commentary

Fisher Investments Editorial Staff

Moving Averages Don’t Move Stocks

By, 10/22/2014
Ratings424.119048

After a big surge to close Tuesday at 1941.28, the S&P 500 Price Index easily surpassed an average of its closing prices over the last 200 trading days, 1908.[i] To many, that’s trivia. But to bullish technical analysts, it’s confirmation—time to breathe a sigh of relief—the market’s bounce back is real! The 200-day moving average is a widely watched gauge for chart-lovers, and since the S&P fell through it recently, it has been a source of great consternation for some. But in our view, using stocks’ 200- (or any period, really) day moving average to predict future direction is pure folly. Past performance—whether smoothed, averaged or other—does not dictate the future, as the S&P’s recent ride (again) shows.   

For the unfamiliar, the 200-day moving average is a very common technical indicator. Broadly speaking, proponents argue if the S&P 500 is above its 200-day moving average, it should continue rising. If it falls through this average, look out below. Many cite instances when the 200-day moving average was broken during bear markets and, sometimes, corrections. But that is just kind of a function of longer-term average meeting shorter-term sharp move. It isn’t predictive, just a result.

Overall, the rule that breaking the 200-day moving average predicts bad times ahead doesn’t pass the logic test. If the S&P 500 staying above its 200-day moving average indicates future gains, stocks should never fall. Likewise, the S&P falling below its 200-day moving average would mean stocks would never rise. Both statements are quite obviously faulty, but when the S&P fell towards—and ultimately breached—its 200-day moving average last week, many technical analysts saw stocks entering a longer-term downtrend. However, unless you define “longer-term downtrend” as seven trading sessions, we’d say those concerns were a teensy bit off. (Exhibit 1)

Commentary

Fisher Investments Editorial Staff
Commodities, Media Hype/Myths

About Those Falling Commodity Prices

By, 10/21/2014
Ratings674.097015

Here is a scary story you may have heard this month: Commodity prices are tanking as Asia’s demand for crude oil and industrial metals dives, signaling a global economic slowdown. It has appeared, with varying degrees of detail and hyperbole, here, here, here, here, here, here and here. Some infer bad things from charts like Exhibit 1. Others use anecdotal evidence and rhetoric. We don’t think either approach—or the thesis—matches reality, however. Take a deep data dive, and you’ll see a far more boring, benign reason for falling prices: Supply is up way more than demand, which isn’t plummeting (contrary to widespread belief).

Exhibit 1: Select Commodity Prices Year-to-Date

Commentary

Fisher Investments Editorial Staff

A Nuanced Earnings Season

By, 10/27/2014

Editor's Note: MarketMinder does not recommend individual securities; the below is simply an example of a broader theme we wish to highlight. It is not a recommendation to buy, sell or take any other action regarding the specific securities mentioned.

Earnings season is well underway, with 208 S&P 500 firms reporting as of Friday. So what’s up with Corporate America? Earnings and revenues, that’s what! But while that in and of itself is noteworthy, there is perhaps a more nuanced takeaway we can glean from recent reports. They also put some alleged risks—Ebola, geopolitical turmoil and the many other things dominating headlines—into perspective. Many firms gave their takes on whether current headline-generating risks will impact their bottom lines in Q4 and beyond. The short answer: Most don’t think they will.

Thus far in the season, aggregate S&P 500 Q3 earnings per share are estimated to have grown 5.6% y/y—the 20th straight quarter of growth. Revenues are up 3.7% y/y, the sixth straight quarter sales have gone up. Growth has been broad-based, with all but two sectors in the black—Energy and Consumer Discretionary. As for revenues, Energy was the only sector in the red. (Exhibit 1) Now, a weaker Energy sector isn’t all that shocking—the sector is more price sensitive than volume and the oil supply glut has weighed on prices (a force that doesn’t seem all that likely to change soon). Consumer Discretionary’s dip thus far is largely driven by two firms—Ford and Pulte Homes. Those two are dragging down the headline figure, so this may just be a statistical snafu. Leaving these two categories aside, earnings and revenues are generally growing nicely.

Commentary

Fisher Investments Editorial Staff
Media Hype/Myths

The Great Global Disconnect: Headlines Versus Data

By, 10/24/2014
Ratings784.410256

While many headlines and sentiment have shown their skeptical streak lately, the data just don’t seem to want to cooperate and collapse. In fact, what we see in comparing sentiment and recent data seems much more like what we’ve seen during the five-plus year course of this big bull market.

First, let’s take a trip around the World Wide Web and assess the economic headlines grabbing eyeballs. All these headlines hit in the last two weeks:

Most of the theses underpinning these articles are very well known to investors: China faces a big slowdown—a hard landing—which will ripple globally; the eurozone is an economic quagmire; the US can’t grow alone; global growth is faltering; did we mention the eurozone is an economic quagmire? Economists have their standard prescriptions: Fiscal stimulus; don’t hike rates yet!; more (misguided) quantitative easing; weaker currencies; debt forgiveness.

Commentary

Fisher Investments Editorial Staff

Misinterpreting Volatility, Economic Edition

By, 10/23/2014
Ratings1023.97549

The recent volatility has not only given some investors pause, it caused economists and academics to speculate and ruminate on what it might foretell about the economy. Which the media has now picked up on, spinning the yarn that investors’ concerns about volatility would beget a weaker economy, in turn creating more volatility for markets. While stocks are a forward-looking economic indicator, they aren’t perfectly rational in the short-term. Volatility is often just markets being markets. It doesn’t necessarily reflect economic conditions, much less create them.

Many see the latest round of swinging stocks as evidence the weak global economy is entering a new and more uncertain stage, including monetary policy shifts that might conflict, slowing growth in pockets of the globe and even health fears. They point to recent sharp shifts in the Chicago Board Options Exchange’s Volatility Index (VIX)—which surged to a 28-month high last week, then plummeted at least 10% per day on October 16, 17 and 18—then rose the same amount the following trading day.[i] Many see the VIX as the uncertainty index—“The Fear Gauge.” (Nevermind that this is a fallacy, because the VIX merely attempts to measure the magnitude of future moves, not the direction.) The presumption is that with rising uncertainty/fear/VIX comes a near-inability for businesses to plan for the future.

The Kansas City Fed added some academic firepower to the issue, too. They published a paper September 4, suggesting spikes in uncertainty slow growth and hiring. The VIX is their uncertainty gauge, and they wag an accusatory finger at the sharply rising readings in 2011, 2012 and 2013. Hiring, they found, slowed during the volatility. They argue the effect didn’t go away as fast as the VIX fell, suggesting to them a lingering fear that weighed on the economy. In theory, uncertainty is bad for business and stocks. So you might presume there is some underlying truth to the notion today.

Commentary

Fisher Investments Editorial Staff

Moving Averages Don’t Move Stocks

By, 10/22/2014
Ratings424.119048

After a big surge to close Tuesday at 1941.28, the S&P 500 Price Index easily surpassed an average of its closing prices over the last 200 trading days, 1908.[i] To many, that’s trivia. But to bullish technical analysts, it’s confirmation—time to breathe a sigh of relief—the market’s bounce back is real! The 200-day moving average is a widely watched gauge for chart-lovers, and since the S&P fell through it recently, it has been a source of great consternation for some. But in our view, using stocks’ 200- (or any period, really) day moving average to predict future direction is pure folly. Past performance—whether smoothed, averaged or other—does not dictate the future, as the S&P’s recent ride (again) shows.   

For the unfamiliar, the 200-day moving average is a very common technical indicator. Broadly speaking, proponents argue if the S&P 500 is above its 200-day moving average, it should continue rising. If it falls through this average, look out below. Many cite instances when the 200-day moving average was broken during bear markets and, sometimes, corrections. But that is just kind of a function of longer-term average meeting shorter-term sharp move. It isn’t predictive, just a result.

Overall, the rule that breaking the 200-day moving average predicts bad times ahead doesn’t pass the logic test. If the S&P 500 staying above its 200-day moving average indicates future gains, stocks should never fall. Likewise, the S&P falling below its 200-day moving average would mean stocks would never rise. Both statements are quite obviously faulty, but when the S&P fell towards—and ultimately breached—its 200-day moving average last week, many technical analysts saw stocks entering a longer-term downtrend. However, unless you define “longer-term downtrend” as seven trading sessions, we’d say those concerns were a teensy bit off. (Exhibit 1)

Commentary

Fisher Investments Editorial Staff
Commodities, Media Hype/Myths

About Those Falling Commodity Prices

By, 10/21/2014
Ratings674.097015

Here is a scary story you may have heard this month: Commodity prices are tanking as Asia’s demand for crude oil and industrial metals dives, signaling a global economic slowdown. It has appeared, with varying degrees of detail and hyperbole, here, here, here, here, here, here and here. Some infer bad things from charts like Exhibit 1. Others use anecdotal evidence and rhetoric. We don’t think either approach—or the thesis—matches reality, however. Take a deep data dive, and you’ll see a far more boring, benign reason for falling prices: Supply is up way more than demand, which isn’t plummeting (contrary to widespread belief).

Exhibit 1: Select Commodity Prices Year-to-Date

Commentary

Fisher Investments Editorial Staff
Behavioral Finance

Amid Volatility, Beware Your Inner Investing Demons

By, 10/20/2014
Ratings504.56

Ebola, deflation, the Fed (!), bond market liquidity, technical indicators and more. The media seems obsessed with hunting down larger explanation for recent volatility. The more obsessive they get, the more likely investors get caught up in all the noise, increasing the risk their brains get the best of them. Take note: Now is a time to be conscious of your inner investing demons—the kind that can cause you to act counter to your long-term goals. Recognizing these pitfalls is a key step to keeping them in check.

Year to date, the MSCI World Total Return Index has closed more than 1% up or down 18 days.[i] Of those 18, five came in October’s 13 trading sessions, and two had intraday swings of greater than 1% (one was greater than 2%) this tally doesn’t capture.[ii] Friday continued October’s choppy start, with the MSCI World jumping +1.3% (yes, big up is still volatility). At one point, the global gauge had fallen -9.3% from its peak.[iii] After Friday’s big bounce, global stocks were -8.1% below the peak.[iv] Will they fall further? No one can know, in our view. There is no way to tell if Friday’s bounce marked the end of the short-term dip. We’ll know if markets avoided the first technical correction since 2012 only in hindsight.[v] But we do know when volatility runs higher, it often triggers humans’ innate fight-or-flight instinct. This is a useful evolutionary reaction when you are trying to avoid being a wild animal’s lunch, but it isn’t helpful in markets, which require rationality. Maybe you’re above making such errors. That’s possible. But at the same time, it doesn’t hurt to review some typical mental errors so you can learn from others’ mistakes and hopefully avoid making them.

Recency bias is one pitfall many investors succumb to when markets get rocky. Recency bias is the tendency to take very recent market behavior and extrapolate it forward, sometimes to degrees most people would think irrational when coolheaded. It’s easy to see how you might get engulfed by this today, as headlines proclaim, “October’s Wild Ride Isn’t Over Yet” and attempt to explain “Why All This Market Volatility Is Here to Stay.”

Research Analysis

Fisher Investments Research Staff

MLPs and Your Portfolio

By, 11/26/2013
Ratings823.890244

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).

Research Analysis

Elisabeth Dellinger
Reality Check

Inside Indian Taper Terror

By, 11/08/2013
Ratings174.294117

When the Fed kept quantitative easing (QE) in place last week, US investors weren’t the only ones (wrongly) breathing a sigh of relief. Taper terror is fully global! In Emerging Markets (EM), many believe QE tapering will cause foreign capital to retreat. Some EM currencies took it on the chin as taper talk swirled over the summer, and many believe this is evidence of their vulnerability—with India the prime example as its rupee fell over 20% against the dollar at one point. Yet while taper jitters perhaps contributed to the volatility, evidence suggests India’s troubles are tied more to long-running structural issues and seemingly erratic monetary policy—and suggests EM taper fears are as false as their US counterparts.

The claim QE is propping up asset prices implies there is some sort of overinflated disconnect between Emerging Markets assets and fundamentals—a mini-bubble. Yet this is far removed from reality—not what you’d expect if QE were a significant positive driver. Additionally, the thesis assumes money from rounds two, three and infinity of QE has flooded into the developing world—and flows more with each round of monthly Fed bond purchases. As Exhibit 1 shows, however, foreign EM equity inflows were strongest in 2009 as investors reversed their 2008 panic-driven retreat. Flows eased off during 2010 and have been rather weak—and often negative—since 2011.

Exhibit 1: Emerging Markets Foreign Equity Inflows

Research Analysis

Brad Pyles

Why This Bull Market Has Room to Run

By, 10/31/2013
Ratings884.102273

With investors expecting the Fed to end quantitative easing soon, the yield spread is widening—fuel for stocks! Photo by Alex Wong/Getty Images.

Since 1932, the average S&P 500 bull market has lasted roughly four and a half years. With the present bull market a hair older than the average—and with domestic and global indexes setting new highs—some fret this bull market is long in the tooth. However, while bull markets die of many things, age and gravity aren’t among them. History argues the fundamentals underpinning this bull market are powerful enough to lift stocks higher from here, with economic growth likely to continue—and potentially even accelerate moving forward as bank lending increases.

Research Analysis

Christo Barker
US Economy

Let’s Call It FARRP

By, 10/10/2013
Ratings93.777778

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.

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What We're Reading

By , Bloomberg, 10/31/2014

MarketMinder's View: So we have this sneaking suspicion that these moves—¥10 trillion more in “quantitative and qualitative easing” (QQE) and boosting the national pension fund’s equity allocation—are coordinated, as Shinzo Abe sought a buyer for all those bonds he’s about to sell. But aside from that! These moves clearly stimulated sentiment, but they likely won’t stimulate actual output or Japanese stocks. The pension thingy has been telegraphed nearly two years now, and it would be bizarre if markets hadn’t already (mostly) discounted it. As for QQE, it was a negative at ¥70 trillion annually and is still a negative at ¥80 trillion. It hasn’t done anything but boost bank balance sheets and flatten the yield curve.

By , The New York Times, 10/31/2014

MarketMinder's View: After deliberating for a couple years, the BoE finally set the leverage ratio for UK banks. For most banks, the minimum will be 3% (capital to total assets, not risk-weighted) by 2018. The biggest banks will have a higher threshold (unspecified, but estimated at just under 5%) and earlier deadline (2016). Most expected tougher, but this makes the BoE a touch more flexible than the Fed. The biggest banks are also pretty near compliant already and should be able to get there in time without unplanned capital raises. As ever, we don’t think this spells the end of bank failures—you can’t de-risk finance!—but it shouldn’t be a huge headache either. Considering this has been in the cards for years, banks (and markets) have had plenty of time to prepare.

By , The Telegraph, 10/31/2014

MarketMinder's View: Not just World War I bonds! (And actually they’ll still have about £2 billion in open-ended WWI debt outstanding after this.) This also closes the book on—wait for it—the  taxpayer bailout of the South Sea Company in 1720. And you thought TARP took too long! Her Majesty’s Treasury is also paying off debt used to fund Irish famine relief in 1847, the Napoleonic Wars and the Crimean War. All of which helped ratchet UK debt-to-GDP up to nosebleed levels. And they’re just now paying it off! (And not even paying it off, because they’re probably rolling it over to lower-yielding gilts—this is just smart financial management.) Ladies and gents, if you ever needed proof high debt doesn’t doom, this is it. (Also: They don’t make posters like they used to.)

By , Bloomberg, 10/31/2014

MarketMinder's View: The theory here, of course(!), is that that markets can’t get enough cowbell quantitative easing (QE). However, the market has known since May 2013 US tapering was approaching—and even a reality at the end of 2013. Yet stocks went up a lot. The correlation shown in the chart included is not convincing. There was a little matter called “The Global Financial Crisis” that hit in 2008 that made the chart look like that. It was not the end of Japan’s 2001 – 2006 QE, which occurred two years before the bear hit.

Global Market Update

Market Wrap-Up, Thurs Oct 30 2014

Below is a market summary (as of market close Thursday, 10/30/2014):

  • Global Equities: MSCI World (+0.2%)
  • US Equities: S&P 500 (+0.6%)
  • UK Equities: MSCI UK (-0.7%)
  • Best Country: Denmark (+2.0%)
  • Worst Country: Portugal (-3.1%)
  • Best Sector: Health Care (+1.3%)
  • Worst Sector: Materials (-0.9%)
  • Bond Yields: 10-year US Treasurys fell .01 to 2.31%

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. Sector returns are the MSCI World constituent sectors in USD including net dividends.