|By Fisher Investments Research Staff, 12/10/2013|
In its second release, Q3 US GDP was revised up to a seasonally adjusted annual rate of 3.6%—the fastest growth in more than a year and among the quickest rates in the current expansion to date. However, most economists and pundits greeted the acceleration with a resounding thud. Under the hood, they claim, the data were not so hot. Reason being, the most notable contributor to growth was increasing inventories, adding 1.7 percentage points to the headline number. Some posit this means growth is hollow—after all, inventory change is open to interpretation. It could be due to slowing sales, a potential negative for profits and growth ahead. Or due to inventory build ahead of an expected pick-up in sales this holiday season. If the pessimists are right, one would expect wholesale inventory growth to sharply slow as we enter Q4. Yet Tuesday, the first inventory report of the quarter suggested no such thing: US wholesale inventories grew at their fastest clip in two years.
In October, wholesale inventories grew 1.4% m/m (3.3% y/y) vs. estimates of 0.3%. Both durables and non-durables stockpiles grew (0.4% m/m and 3.0% m/m, respectively.) So what gives?
While inventory growth undoubtedly contributed strongly to GDP in Q3, that never meant inventories were at historically high levels. As Exhibit 1 shows, the inventory-to-sales ratio isn’t overall elevated. Total goods and non-durable goods are at relatively low levels compared to history, and while durable goods inventories are somewhat higher relative to sales, they are not alarmingly high. In short, there is nothing suggesting inventory growth is unsustainable overall relative to the pace of sales. Of course, maybe inventory growth does slow in the period ahead, but it wouldn’t seem to be related to overall overstocked shelves. This is yet another factor illustrating the fact reality may be considerably better than skeptics presume.
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).
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
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.
|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
Germany holds Federal elections on September 22 and, unlike recent European elections (read: Greece and Italy), most expect the results to maintain the eurozone policy status quo. However, foreign policy is only one piece of the puzzle—the main parties and potential coalition partners have differing domestic agendas. Investors’ expectations on this front could impact markets, too.
Five parties seem to have a shot at winning representation in the ruling coalition—the Christian Democratic Union/Christian Social Union (CDU/CSU), Social Democratic Party (SPD), Free Democratic Party (FDP), Green Party and Die Linke. Center-right CDU/CSU, the current majority coalition partner, is the front runner, polling at 40%. CSU is CDU’s Bavarian sister party, but tends to be more socially conservative and more euro-skeptical—most pin Chancellor Angela Merkel’s limited flexibility in eurozone political matters on this. The pro-business FDP, CDU/CSU’s current junior coalition partner, currently polls at 5%—the cutoff for earning seats in parliament. The center-left SPD and Green parties, coalition partners in the early 2000s, are running second at a combined 38%. Die Linke is Germany’s radical left party, composed of some remaining members of the Socialist Unity Party—the former ruling party in East Germany. Die Linke polls at 8% and has an outside chance at becoming a junior coalition partner.
The ruling coalition likely takes one of four forms. The most probable, in my view, is a so-called grand coalition of CDU/CSU and SPD. These parties last co-governed from 2005-2009, during Merkel’s first term. This coalition would almost certainly remain committed to the eurozone, and the SPD’s presence might result in more flexible bailout terms, should the need arise. Probable domestic policies include shifting energy costs and subsidies for alternative energy from consumers to businesses, no tax increases and rent control and wage floors in areas with no collective agreement.
The People’s Bank of China announced it will remove the floor on bank lending rates, moving Chinese rates one step closer to a market-oriented system. China has long kept a firm grip on lending and deposit interest rates in order to maintain some degree of control over the money supply and broader economy. Most recently, the lending rate was set at 0.7x the one-year benchmark lending rate—after being reduced a year ago from 0.8x and 0.9x before June 2012. This is a noteworthy indication of the government’s dedication to reforms despite the slowing economy—a positive—but its near-term financial impact is likely limited.
For one, the move likely won’t have an immediate impact on banks as most loans were already priced about 90% above the benchmark rate, as you can see in Exhibit 1.
Exhibit 1: Chinese Loans Below and Above Benchmark Rate
Evidence suggests Emerging Markets’ party won’t stop when the Fed pulls the punchbowl. Photo by Feng Li/Getty Images.
Since Ben Bernanke suggested the Fed might soon wind down quantitative easing (QE), folks have fretted the potential impact on Emerging Markets (EM). Many believe massive amounts of “hot money” have flowed from the US and UK into EM assets since QE began (November 2008 for the US, March 2009 for the UK), and they fear QE’s end will prompt massive capital flight, hurting EM economies and cutting into revenue streams globally as a result—potentially triggering a bear market. Yet evidence suggests this fear is overwrought, and Emerging Markets should hold up ok once QE ends.
|By Fisher Investments Research Staff, 07/16/2013|
Advance retail sales rose +0.4% m/m (+5.7% y/y) in June—behind expectations, but still growth. In our view, the report likely reflects normal monthly volatility, not a trend of weakening consumer spending. Headline and core retail sales are actually at all-time highs and rising (Exhibit 1).
On a monthly basis, underlying results were overall mixed, with big-ticket items particularly strong: Sales at auto dealers (2.4%) and furniture stores (2.4%) grew nicely, but this was partly offset by weakness at building materials (-2.2%), department stores (-1.0%), miscellaneous retailers (-2.5%) and food services & drinking places (-1.2%). Overall, the mixed results seem fairly typical of mid-year retail sales, which tend to be weak even with seasonal adjustments. Yearly numbers are more telling, and y/y growth in headline and core sales accelerated (Exhibit 2), suggesting spending is still growing at a decent clip.
Exhibit 1: US Retail Sales Volume (Nominal)
|By Fisher Investments Research Staff, 12/10/2013|
A quick look at October inventory data may add valuable perspective to the debate over US GDP growth’s sustainability.
What has five years of quantitative easing accomplished?
UK housing has seen rapid price increases recently. But before calling a bubble, consider: Could one area be skewing the average?
|By Fisher Investments Research Staff, 11/26/2013|
As MLPs come further into the spotlight, many investors wonder what exactly they are and what they can do for portfolio returns.
Did Fed rumors roil India’s currency markets?
Market Wrap-Up, Fri Mar 07 2014
Below is a market summary (as of market close Friday, 03/07/2014):
Global Equities: MSCI World (-0.3%)
US Equities: S&P 500 (+0.1%)
UK Equities: FTSE 100 (GBP) (-1.2%)
Best Country: Japan (+0.5%)
Worst Country: Ireland (-2.3%)
Best Sector: Energy (0.0%)
Worst Sector: Materials (-1.1%)
Bond Yields: 10-year US Treasurys rose .05 to 2.79%.
Editors' Note: Tracking Stock and Bond Indexes