Commentary

Fisher Investments Editorial Staff
Media Hype/Myths

Did a Fed Waffle Cause Thursday’s Rebound?

By, 10/17/2014
Ratings274.574074

This investor is putting Thursday’s market action under a magnifying glass. Photo by Comstock.

We have to make sure that inflation and inflation expectations remain near our target. And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December.…

Commentary

Christopher Wong

Four Tips for Retirement Investing

By, 10/16/2014
Ratings984.163265

Retirement should mean more time to relax, not worry. Photo credit: Guillermo Murcia/Getty Images.

Retirement: the word strikes both joy and fear in the hearts of many long-term investors. Joy over the possibilities of post-working life: traveling, pursuing new hobbies and/or spending more time with family and friends. Fear due to all the unknowns: How much should I be saving?; Will I have enough to retire when I want?; What if I run out of money during retirement? The media exacerbates the fear with headlines screaming how unprepared Americans are for their golden years. But retirement investment needn’t intimidate. Now, ask most financial professionals how to prepare, and you’ll probably get a cliché answer—Save More! But here are four less-often-shared tips to get you started—tips equally applicable if you’re far from retirement or already in it.

Commentary

Fisher Investments Editorial Staff
Inflation, Media Hype/Myths

Why We Don’t Fear Deflationary Doom Is Here

By, 10/16/2014
Ratings424.392857

Stocks had a wild ride Wednesday, with the S&P 500 Price Index down as much as -3% before climbing back to finish the day down just -0.8%.  Perhaps the correction many have long awaited is here—at one point, the S&P 500 Price Index was about one percentage point removed from correction territory (10% lower than a prior high point)—but it’s only clear in hindsight. Such moves are sentiment-driven and tend to come and go fast. There is usually a host of negative headlines, surrounding a spooky story or stories. But corrections can be caused by virtually anything. Or nothing. Such headlines abound today.

Let’s consider one of the day’s big fears: global deflation. To many observers, the evidence prices are about to spiral downward is stacking up. Chinese consumer inflation slowed to just 1.6% y/y in September—the lowest since 2009—and Chinese producer prices slid faster, hitting -1.8% y/y. September US producer prices fell -0.1% m/m. UK CPI slowed to 1.2% y/y, also the slowest since 2009. 10-year US Treasury yields briefly dipped below 2%. Oil prices continued tanking.[i] Market-driven future inflation gauges, including five-year US TIPS spreads and the eurozone’s five-year/five-year inflation swap, are falling. German inflation is stuck at 0.8% y/y. The eurozone’s final September inflation estimate hits Thursday, and no one expects improvement from the 0.3% y/y first read. 

Two primary interpretations emerged from this data bonanza. One, the slow ebb in prices will be a self-fulfilling prophecy, and deflation will choke off the global expansion. Two, low inflation/deflation will make debt more burdensome—another growth headwind. These are big, popular, scary stories, but we don’t think either carries much weight—problematic deflation doesn’t appear to be in the cards.

Commentary

Fisher Investments Editorial Staff
Across the Atlantic, Media Hype/Myths

Return of the Euro Crisis’ Ghosts

By, 10/15/2014
Ratings153.566667

With volatility back, many seek to explain what has amounted to quite a back-and-forth October. And it seems many settled on recent developments in Europe as the culprit. While possible, a quick glance at Europe’s recent headlines might have you thinking it’s 2011 or 2012. In our view, fears around the eurozone likely lack the teeth to materially bite this bull. The questions may be slightly different now: It’s more, “How does the eurozone avoid a ’lost decade of growth?” than warnings of the imminent collapse of the common currency. But most of the fears—and many of the specifics—are the same. These recycled false fears likely lack the surprise power to knock a global bull off track.

Better Together, Spanish Edition

In Spain, Catalan leader Artur Mas canceled the November 9th independence referendum, two weeks after the Spanish Constitutional Court suspended the planned vote. In its place, Mas is planning a more informal means for Catalans to voice their opinion, without the risk of officials getting indicted. But with volunteers manning this “revised process” and Catalan officials unable to access voter registration records to see who can even legally vote, the original nonbinding referendum has become a glorified opinion poll—similar to the 2009 vote—with no way to tell whether it’s predictive or not. Even supporters suggest this version is virtually meaningless. The old fear Catalonia breaks away has become even more bunk now.  

Commentary

Fisher Investments Editorial Staff

The US Federal Deficit: Choose Your Own Fiscal Adventure

By, 10/13/2014

Last week, the Congressional Budget Office (CBO) released its final projection for fiscal year 2014’s US federal budget deficit. And it is down again! They estimate the feds ran a $486 billion deficit in 2014.[i] The direction, even the magnitude of the dip, isn’t all that surprising—the deficit has fallen for some time. However, it still managed to attract plenty of debate. Why? The deficit is a frequently kicked around political football, and this time there is something in it for everyone. But we’d suggest ignoring all the noise and taking the figure for what it is—a result of a growing economy!

This year’s reduction isn’t a new trend—aside from a teensy uptick in 2011, the deficit has been drifting since 2009’s peak—falling steeply in 2012 and 2013. Since 2009, the deficit is down 65.6%. Exhibit 1 shows the deficit’s progression over the past decade in dollars. Exhibit 2 shows it as a percent of GDP, down from 9.8% to 2.8%.[ii] (Exhibit 2)

Exhibit 1: US Federal Deficit, Fiscal Years 2004-2014 (Estimated)

Commentary

Fisher Investments Editorial Staff
Reality Check, Media Hype/Myths, Behavioral Finance

Putting Stocks’ Zigzags in Broader Perspective

By, 10/10/2014
Ratings1914.054974

After a big, volatile bounce back Wednesday, in which the S&P 500 surged 1.8%, negativity struck US markets on Thursday, with the S&P 500 down 2.1% on the day.[i] Since October began, the S&P has swung more than 1% up or down five times (two up, three down). The back-and-forth is rather predictably spurring some eye-catching headlines. Here is a small sample so you get the flavor:

However, all these headlines look at either one day or this month’s seven trading sessions under a microscope. A broader view can add some very valuable perspective.

Now, nearly all of these cite reasons: The stronger dollar threatening multinationals’ profits; eurozone economic data showing a less-than-robust recovery continues; Ebola; the Chinese hard landing; geopolitics. Many posit the question: Are we in a correction—or worse? Exhibit 1 shows the S&P 500’s recent swings that are garnering the attention.

Commentary

Fisher Investments Editorial Staff
Politics

Voting For Gridlock

By, 10/09/2014
Ratings354.228571

Editors’ Note: Our discussion of politics and elections is purely focused on potential market impact. Stocks favor neither party. Believing in the market/economic superiority of one group of politicians over another can invite bias—a source of significant investment errors.

Midterm elections are less than a month away, and you know what that means: Cable pundits are earning some massive overtime. This is the home stretch! A time for grandstanding, blathering, mudslinging and other good old-fashioned family fun! Now if you’re into this sort of thing, it can be entertaining political theater. If you aren’t, you are quite possibly sick to death of the rancor and just want to know whether stocks will be happy with the results. If you are in the latter camp, we have good news: You can tune out the noise, because nothing in these final weeks means very much for stocks—whether campaign hijinks tip Congress one way or preserve the status quo, it is overwhelmingly likely we get more gridlock, which stocks love.

Over the next four weeks, you’ll see no shortage of articles or TV reports claiming the contest is certain to go one way. These are a guesses, and useless ones. Campaigns’ last legs have too many unknowns, and these races are too close to call. Take the House. On the one hand, Republicans would seem to have an edge since incumbents are hard to beat (Eric Cantor notwithstanding). The majority of the 47 total open House seats belong to the Republicans in the present House. However, of these 47, only about 18 Republican seats and 7 Democratic seats were really in play at the beginning of the year. Cantor makes 19. To seize the House, Democrats need to win all these open seats (or the lion’s share and knock off a few incumbents) and about half are in traditional Republican strongholds—the sweep is unlikely. Possible! But not probable. The Senate is sort of the reverse of this. Democrats (including Senators Sanders and King, independents who typically poll with the Democrats) have a 55-45 majority. The Republicans need six to win and have the structural advantage, with fewer seats to defend in traditional Democratic territory. But they’d need a near-sweep of vulnerable Democratic seats—two in states where they’re trying to defend a governorship (South Dakota and Alaska). They also have more state houses to defend in blue states—including three where they’re also trying to nab Senate seats (Iowa, Michigan and New Mexico). Those governors’ races could divert GOP funding away from the Senate races, perhaps counterbalancing their structural advantage. In short: The Senate could change hands, but it’s anyone’s guess whether it actually does.

Commentary

Fisher Investments Editorial Staff

IMF Sees 99% Chance Growth Continues, Projects Acceleration

By, 10/08/2014
Ratings384.552631

Why the long face? The global economy is growing! Photo credit: Bloomberg/Contributor.

“Big Supranational Sees Global Growth Pickup, Recession Risk Less Than 1%: Go World!” That would be the headline we’d plop on a report of the IMF’s updated global economic outlook, which forecasts a repeat of 2013’s 3.3% global growth this year and acceleration to 3.8% next year. However, this forecast happens to be a bit lower than the IMF’s last missive. And it’s titled “World Economic Outlook: Legacies, Clouds, Uncertainties.” And it’s published by an outfit whose leader says the world economy is entering the “new mediocre.” So the common interpretation runs the gamut from pretty blah to dire. But the IMF’s downward-revised forecast shouldn’t dampen investors’ view of a growing global economy—dour spin doesn’t equal dour reality.

Commentary

Fisher Investments Editorial Staff
Currencies, Media Hype/Myths

Eight Charts to Show Why the Strong Dollar Won’t Knock Earnings

By, 10/07/2014
Ratings404.25


King Kong wreaks havoc. “King Dollar” doesn’t. Photo by Hulton Archive/Getty Images.

Well that didn’t take long. Just three weeks ago, headlines were all “Rah Rah Strong Dollar U-S-A! U-S-A!” Now they’re like this: Surging dollar may be triple whammy for US earnings. King dollar question mark for earnings and stocks. The strong dollar’s risk to 4Q earnings and beyond. Surging dollar may destroy US company earnings. Latest threat to corporate earnings: the almighty dollar. Their logic: A stronger dollar makes exports more expensive, making overseas business less profitable for globalized firms.[i] However, historically, there isn’t much (if any) evidence backing this case: A strong dollar isn’t inherently bad for US earnings, trade or stocks.

First, the theoretical evidence. Yes, a strong dollar, all else equal, makes exports pricier, and a weak dollar makes them cheaper. But the reverse is true for imports—strong dollar means cheaper imports, weak dollar means pricier imports. For most firms, these little factoids help cancel out most of the impact of a currency swing. Few US exporters make goods start to finish with American components. Even Coca-Cola—as American as apple pie—imports ingredients. When the dollar gets stronger, imported ingredients (or, for other firms, parts and resources) get cheaper. Production gets cheaper as a result, offsetting much of the drag from pricier exports. When the dollar gets weaker, imported components and production become more expensive, offsetting the benefits of having cheaper exports. This is why the weak yen hasn’t fixed Japan.

Commentary

Fisher Investments Editorial Staff

Taiwan Is Not Greece, and Other Reasons to View Emerging Markets Individually

By, 10/06/2014
Ratings164.25

China. India. Brazil. Insert Emerging Market country here. It didn’t matter which one! Everyone wanted a piece of these fast-growing darlings during the 2000s. But after the last few years of underperformance, sentiment has flipped and people have become quite dour toward Emerging Markets (EM) as a whole—save for some who are starting to consider EM countries individually—pointing out strengths and weaknesses of the 23 EM countries.[i] A rational mindset, in our view, and one that can help investors better understand where future opportunities exist.

In the 1990s and early 2000s, EM nations acted as more of a bloc. They were at similar stages of economic evolution, with many bearing the fruits of catch-up growth and emerging middle classes. Country-specific returns varied, but correlations were pretty high. That’s how we got snappy acronyms like BRIC—Brazil, Russia, India and China (and now with an S for South Africa). To many observers back in 2001 (when the term was coined) they appeared poised to take the world by storm. In the 2002-2007 bull market, most Emerging Markets went on a tear, beating developed markets widely. This reinforced the notion EM’s superior economic growth would generate big relative returns.

But the last three years have pretty much debunked this. EM overall underperformed, with the MSCI Emerging Markets index falling -18% in 2011 and -2.6% in 2013, and countries diverged quite a bit.[ii] (Exhibit 1) Fast growth didn’t necessarily mean high returns, and sentiment turned on the category overall. They were largely seen as one big lump of countries subject to the Fed’s whims, rather than 20 or so diverse countries with diverse economic drivers and political situations. Most still see them this way—despite 10 months of shifting Fed policy that hasn’t wrought havoc on EM economies.

Commentary

Fisher Investments Editorial Staff
Reality Check, Media Hype/Myths, Behavioral Finance

Putting Stocks’ Zigzags in Broader Perspective

By, 10/10/2014
Ratings1914.054974

After a big, volatile bounce back Wednesday, in which the S&P 500 surged 1.8%, negativity struck US markets on Thursday, with the S&P 500 down 2.1% on the day.[i] Since October began, the S&P has swung more than 1% up or down five times (two up, three down). The back-and-forth is rather predictably spurring some eye-catching headlines. Here is a small sample so you get the flavor:

However, all these headlines look at either one day or this month’s seven trading sessions under a microscope. A broader view can add some very valuable perspective.

Now, nearly all of these cite reasons: The stronger dollar threatening multinationals’ profits; eurozone economic data showing a less-than-robust recovery continues; Ebola; the Chinese hard landing; geopolitics. Many posit the question: Are we in a correction—or worse? Exhibit 1 shows the S&P 500’s recent swings that are garnering the attention.

Commentary

Fisher Investments Editorial Staff
Politics

Voting For Gridlock

By, 10/09/2014
Ratings354.228571

Editors’ Note: Our discussion of politics and elections is purely focused on potential market impact. Stocks favor neither party. Believing in the market/economic superiority of one group of politicians over another can invite bias—a source of significant investment errors.

Midterm elections are less than a month away, and you know what that means: Cable pundits are earning some massive overtime. This is the home stretch! A time for grandstanding, blathering, mudslinging and other good old-fashioned family fun! Now if you’re into this sort of thing, it can be entertaining political theater. If you aren’t, you are quite possibly sick to death of the rancor and just want to know whether stocks will be happy with the results. If you are in the latter camp, we have good news: You can tune out the noise, because nothing in these final weeks means very much for stocks—whether campaign hijinks tip Congress one way or preserve the status quo, it is overwhelmingly likely we get more gridlock, which stocks love.

Over the next four weeks, you’ll see no shortage of articles or TV reports claiming the contest is certain to go one way. These are a guesses, and useless ones. Campaigns’ last legs have too many unknowns, and these races are too close to call. Take the House. On the one hand, Republicans would seem to have an edge since incumbents are hard to beat (Eric Cantor notwithstanding). The majority of the 47 total open House seats belong to the Republicans in the present House. However, of these 47, only about 18 Republican seats and 7 Democratic seats were really in play at the beginning of the year. Cantor makes 19. To seize the House, Democrats need to win all these open seats (or the lion’s share and knock off a few incumbents) and about half are in traditional Republican strongholds—the sweep is unlikely. Possible! But not probable. The Senate is sort of the reverse of this. Democrats (including Senators Sanders and King, independents who typically poll with the Democrats) have a 55-45 majority. The Republicans need six to win and have the structural advantage, with fewer seats to defend in traditional Democratic territory. But they’d need a near-sweep of vulnerable Democratic seats—two in states where they’re trying to defend a governorship (South Dakota and Alaska). They also have more state houses to defend in blue states—including three where they’re also trying to nab Senate seats (Iowa, Michigan and New Mexico). Those governors’ races could divert GOP funding away from the Senate races, perhaps counterbalancing their structural advantage. In short: The Senate could change hands, but it’s anyone’s guess whether it actually does.

Commentary

Fisher Investments Editorial Staff

IMF Sees 99% Chance Growth Continues, Projects Acceleration

By, 10/08/2014
Ratings384.552631

Why the long face? The global economy is growing! Photo credit: Bloomberg/Contributor.

“Big Supranational Sees Global Growth Pickup, Recession Risk Less Than 1%: Go World!” That would be the headline we’d plop on a report of the IMF’s updated global economic outlook, which forecasts a repeat of 2013’s 3.3% global growth this year and acceleration to 3.8% next year. However, this forecast happens to be a bit lower than the IMF’s last missive. And it’s titled “World Economic Outlook: Legacies, Clouds, Uncertainties.” And it’s published by an outfit whose leader says the world economy is entering the “new mediocre.” So the common interpretation runs the gamut from pretty blah to dire. But the IMF’s downward-revised forecast shouldn’t dampen investors’ view of a growing global economy—dour spin doesn’t equal dour reality.

Commentary

Fisher Investments Editorial Staff
Currencies, Media Hype/Myths

Eight Charts to Show Why the Strong Dollar Won’t Knock Earnings

By, 10/07/2014
Ratings404.25


King Kong wreaks havoc. “King Dollar” doesn’t. Photo by Hulton Archive/Getty Images.

Well that didn’t take long. Just three weeks ago, headlines were all “Rah Rah Strong Dollar U-S-A! U-S-A!” Now they’re like this: Surging dollar may be triple whammy for US earnings. King dollar question mark for earnings and stocks. The strong dollar’s risk to 4Q earnings and beyond. Surging dollar may destroy US company earnings. Latest threat to corporate earnings: the almighty dollar. Their logic: A stronger dollar makes exports more expensive, making overseas business less profitable for globalized firms.[i] However, historically, there isn’t much (if any) evidence backing this case: A strong dollar isn’t inherently bad for US earnings, trade or stocks.

First, the theoretical evidence. Yes, a strong dollar, all else equal, makes exports pricier, and a weak dollar makes them cheaper. But the reverse is true for imports—strong dollar means cheaper imports, weak dollar means pricier imports. For most firms, these little factoids help cancel out most of the impact of a currency swing. Few US exporters make goods start to finish with American components. Even Coca-Cola—as American as apple pie—imports ingredients. When the dollar gets stronger, imported ingredients (or, for other firms, parts and resources) get cheaper. Production gets cheaper as a result, offsetting much of the drag from pricier exports. When the dollar gets weaker, imported components and production become more expensive, offsetting the benefits of having cheaper exports. This is why the weak yen hasn’t fixed Japan.

Commentary

Fisher Investments Editorial Staff

Taiwan Is Not Greece, and Other Reasons to View Emerging Markets Individually

By, 10/06/2014
Ratings164.25

China. India. Brazil. Insert Emerging Market country here. It didn’t matter which one! Everyone wanted a piece of these fast-growing darlings during the 2000s. But after the last few years of underperformance, sentiment has flipped and people have become quite dour toward Emerging Markets (EM) as a whole—save for some who are starting to consider EM countries individually—pointing out strengths and weaknesses of the 23 EM countries.[i] A rational mindset, in our view, and one that can help investors better understand where future opportunities exist.

In the 1990s and early 2000s, EM nations acted as more of a bloc. They were at similar stages of economic evolution, with many bearing the fruits of catch-up growth and emerging middle classes. Country-specific returns varied, but correlations were pretty high. That’s how we got snappy acronyms like BRIC—Brazil, Russia, India and China (and now with an S for South Africa). To many observers back in 2001 (when the term was coined) they appeared poised to take the world by storm. In the 2002-2007 bull market, most Emerging Markets went on a tear, beating developed markets widely. This reinforced the notion EM’s superior economic growth would generate big relative returns.

But the last three years have pretty much debunked this. EM overall underperformed, with the MSCI Emerging Markets index falling -18% in 2011 and -2.6% in 2013, and countries diverged quite a bit.[ii] (Exhibit 1) Fast growth didn’t necessarily mean high returns, and sentiment turned on the category overall. They were largely seen as one big lump of countries subject to the Fed’s whims, rather than 20 or so diverse countries with diverse economic drivers and political situations. Most still see them this way—despite 10 months of shifting Fed policy that hasn’t wrought havoc on EM economies.

Commentary

Elisabeth Dellinger
Monetary Policy, Into Perspective, Interest Rates

Fun With Mark and Janet

By, 10/03/2014
Ratings314.145161

These three front-row people are central bankers. They are apparently saying funny things. We wish we could hear. And hang out with Haruhiko Kuroda. Photo by Andrew Harrer/Bloomberg via Getty Images.

So unemployment is now under 6%, finally falling into the Fed’s “longer run” forecast range. But labor force participation, involuntary part-time workers and other less mainstream stats are still in the doldrums, which some say means there is a lot of slack in the labor market, which is jargon for “people aren’t working or earning as much as they could/should be.” Apparently this—and a similar situation in the UK—puts Fed head Janet Yellen and BoE chief Mark Carney in a pickle, because their rate hike decisions are apparently not cut and dry. And apparently this means we all need to parse every single one of their statements for clues into what they’ll do, because if they get it wrong the expansion could go poof and we will all need to brace for impact. I’m going to ignore that second part because my wonderful colleagues covered it earlier today here, and concentrate on the first part. Namely, the notion that we can divine future policy from central bankers’ words. If you have a magic decoder ring and fully functional crystal ball, perhaps you can, but for us nonmagical folk, it’s an impossible task, and we’re all best off not trying—and not putting much weight on analyses that claim they’ve cracked the code.

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 , The Wall Street Journal, 10/17/2014

MarketMinder's View: Yep. Asset allocation is fundamental to long-term portfolio return. But after the mix of stocks, bonds, cash and other securities you use, in our view, the next most impactful thing is the category of those securities you pick. Valuations, including the Cyclically Adjusted Price-to-Earnings ratio (CAPE), aren’t long-term return drivers. They aren’t predictive of cycles or long-run returns, as illustrated by the 1990s—CAPE was above 20 as early as 1992 then. It was at the present level as early as 1996. CAPE was also above-average for pretty much all of the 1960s. While most P/Es illustrate sentiment, the CAPE is too distorted to even accomplish that. Because it mixes in earnings a decade old, the figure wraps in data that may be a full cycle behind. Many CAPE apologists excuse this by claiming it adjusts corporate results for economic cycles. But this is a statement that doesn’t pass the logic test: Stocks and corporate earnings are inherently tied to economic cycles. The macroeconomic picture matters a whole lot for individual company results, and ignoring this factor is a big mistake.

By , The Wall Street Journal, 10/17/2014

MarketMinder's View: The next time someone tries telling you the myth that foreigners are going to shun our debt or dump our debt or whatever, take a look at the actual data. Despite volatility over time, foreign demand for US debt is running high. How else can you see this more broadly? Interest rates, which are historically low today. Oh, and when they inevitably bring up the risk that foreigners fire sell those assets, ask them to consider two points: 1) Who are they selling to? For every seller, there is a buyer. And 2) It is highly unlikely some foreign nation is going to blow out a huge chunk of their foreign reserves desperately, which would probably cause them to take a loss. That is what we call, “Shooting thyself in thine foot.” (Not sure why we went all olde English, but you get the drift.)

By , Bloomberg, 10/17/2014

MarketMinder's View: The SEC has its first high-frequency trading prosecution win, and it seems justifiable to us. But this entertaining article highlights a few really sensible points on its road to wisely concluding, “The lesson here is something like: There are manipulative strategies, and there are good strategies, and it is not easy to tell them apart. You can tell them apart, probably, but you need to understand their purposes first. And dumb e-mails and nicknames can be a big help.” Aside from interesting and humorous, the discussion of a market maker’s role is top notch.

By , The Wall Street Journal, 10/17/2014

MarketMinder's View: The ECB’s negative deposit rate was ostensibly put in place to spur lending—which the eurozone could truly use, given trillions worth of bank deleveraging the last few years.  But merely penalizing banks for holding excess reserves doesn’t incent lending. It might incent holding something else (like government bonds). And when those plunge to negative short-term rates (likely partly as a result), then those for-profit banks likely just whack consumers, passing on costs in a tried and true capitalist practice. Now, the depositors paying this charge are presently large depositors (above €10 million), hedge funds, large businesses and the like, but their response is worth watching, too. All this highlights the fact that when you tell banks they could be shut if they don’t have big capital in a rather arbitrary stress test—as the ECB has—they will find ways to hold that capital. What banks really need to start lending is for stress tests to conclude and the cloud of regulatory uncertainty to clear.

Global Market Update

Market Wrap-Up, Thurs Oct 16 2014

Below is a market summary (as of market close Thursday, 10/16/2014):

  • Global Equities: MSCI World (-0.2%)
  • US Equities: S&P 500 (0.0%)
  • UK Equities: MSCI UK (+0.2%)
  • Best Country: Canada (+1.7%)
  • Worst Country: Norway (-3.2%)
  • Best Sector: Energy (+1.3%)
  • Worst Sector: Telecommunication Services (-0.9%)
  • Bond Yields: 10-year US Treasurys rose by .02 to 2.16%

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.