Monetary

Staying Behind The Curve, For Now

Highlights U.S. Treasuries: The surprisingly positive response from financial markets to last week's Fed rate hike should force the Fed to quickly shift back to a hawkish bias. Maintain an underweight exposure to U.S. Treasuries, and an overall below-benchmark portfolio duration stance. Bearish Fed Trade: As a new tactical trade, go short the January 2018 fed funds futures contract to benefit from the Fed ramping up the hawkish language again. Japan: Japanese inflation remains too low for the Bank of Japan to move away from its 0% target on JGB yields anytime soon, even with signs of better Japanese growth and rising pressure on global bond yields. Upgrade low-beta Japan to above-benchmark in global hedged bond portfolios, while downgrading core Europe (Germany, France, the Netherlands) to neutral. Feature Chart of the WeekAre Central Banks OK With This? The major central banks all had a chance to send a more hawkish message to the markets in the past couple of weeks, and every one took a pass. Even the Fed, who actually hiked rates, signaled that U.S. monetary policy would not be tightened more aggressively than previously planned, which financial markets took very bullishly. With the global economy finally enjoying a synchronized upturn after several years of sluggishness, policymakers are showing no interest in hitting the brakes too hard, too soon and risking a sudden downturn in growth The current backdrop of improving economic momentum, with central banks remaining accommodative, is sustaining the strong performance of growth-sensitive assets like equities and corporate debt over government bonds. This should continue over the next 6-12 months. Inflation rates, both realized and expected, continue to rise across the developed economies alongside faster economic growth, putting upward pressure on government bond yields (Chart of the Week). Central bank dovishness is looking increasingly non-credible as long as this dynamic persists, but policymakers will likely be slow to respond without a more rapid rise in inflation. Bond yields will continue to climb higher against this backdrop, first from continued increases in inflation expectations and, later, from a shift to less restrictive monetary settings. We continue to recommend a below-benchmark duration stance, while underweighting government bonds versus corporate debt, particularly in the U.S. This week, we are making a significant portfolio shift to get even more defensive within our government bond allocation, upgrading low-beta Japan to above-benchmark while downgrading core Europe (Germany, France & the Netherlands) to neutral. The Fed Declares Victory Over "Low-flation" The market response to last week's Fed tightening was consistent with the idea of a "dovish hike", with U.S. equity and bond markets rallying while the U.S. dollar sold off and overall U.S. financial conditions actually easing. There was heightened nervousness heading into the meeting that the Fed could signal a faster or steeper trajectory for interest rates. That turned out to be a false alarm, as not much was changed from the Fed's prior guidance to markets. The range for the funds rate was raised to 0.75-1.00%, as expected, but there was virtually no change to any of the median FOMC member projections for GDP growth, inflation or interest rates out to 2019. Another 50bps of increases are expected this year, with 75bps in both 2018 and 2019 (Chart 2). This would bring the funds rate to 3% in 2019, which is the median FOMC member's assessment of where the terminal rate lies. The pricing from the U.S. Overnight Index Swap (OIS) curve shows that market expectations for the funds rate are in line with the Fed's projections for this year, but lower for the next two years. Our proxy measure for the market's assessment of the terminal rate - the 5-year OIS rate, 5-years forward - sits at 2.25%, 75bps below the Fed's number. Our bias is closer to the market on this point, as we do not see a need for the funds rate, in real terms, to end this tightening cycle much above 0% against a backdrop of still very high U.S. debt levels and low U.S. productivity growth. A 0% real funds rate would be the result of the Fed successfully getting U.S. inflation expectations back to its 2% target level, with a nominal funds rate of 2%. That inflation goal has not yet been reached, however, as inflation expectations are still below levels consistent with the Fed's inflation target (Chart 3, bottom panel). Chart 2FOMC & Market Disagree Beyond This Year Chart 3Few Signs Of An Overheating U.S. Economy The FOMC has made it clear that they believe the U.S. economy is running very close to full employment. Yet the recent modest deceleration in the various measures of wage inflation (middle panel) suggests that there could still be some excess slack in the U.S. labor market - even with the recent Payrolls reports showing job growth of over 200k per month. If that pace is sustained for several months, however, the unemployment rate will likely fall further and wage pressures will intensify. In the near-term, the Fed will continue to focus on financial markets to get a sense of whether current policy settings are too restrictive or too accommodative. One recent development on this front is that the correlation between the U.S. dollar (USD) and risk assets has flipped, with a stronger USD now positively correlated to global equities and credit (Chart 4). This shift was already starting to happen before the election of Donald Trump and his pro-growth agenda last November, likely because the global economy was improving as evidenced by the accelerating trend in our global purchasing managers' index (PMI, bottom panel). We have written extensively about the Fed being stuck in a "policy loop" in the past couple of years, where a shift to a more hawkish bias would sharply drive up the USD and cause a risk-off move in global financial markets. This unwanted tightening of financial conditions would cause the Fed to back off from its hawkishness, causing the USD to soften and markets to rally. We have argued that the way to break out of this loop would likely be a rise in non-U.S. economic growth that would allow the Fed to continue slowly normalizing U.S. monetary policy without disrupting global markets. We seem to be in that period now. One implication of this is that the longer risk assets can withstand rising U.S. interest rates and a stronger USD, the more the fed funds rate and U.S. Treasury yields must rise in response to U.S. economic strength. For this reason, we continue to recommend a below-benchmark duration stance on U.S. Treasuries on a 6-12 month horizon. We also maintain our bias towards a bear-steepening of the Treasury curve through our butterfly trade, long the 5-year bullet versus a duration-matched 2-year/10-year barbell. The curve will remain positively correlated to inflation expectations until those reach the Fed's target level, after which any additional Fed rate hikes will likely flatten the yield curve in a more typical pattern during the latter stages of a tightening cycle. It is possible, though, that because markets shrugged off the latest rate increase, the Fed could return to sending hawkish signals in the near term. To play for this possibility, our colleagues at BCA U.S. Bond Strategy recommend that investors add a tactical trade: going short the January 2018 fed funds futures contract (Chart 5). We are today adding this trade to our list of Tactical Overlay Trades (see page 12). Chart 4The Strong USD Is Not A Problem Chart 5Go Short January 2018 Fed Funds Futures We calculate that this trade will return 11bps in a scenario where the Fed lifts rates twice more before the end of the year and 37bps in a scenario where the funds rate is raised a more aggressive-than-expected three times. However, we do not expect to hold this trade until the end of the year. Rather, we expect the Fed will nudge rate expectations higher in the next month or two in response to the latest easing of financial conditions, and that these gains will be realized over a much shorter horizon. We also add a caveat that, in the present environment, it is safer to implement any "hawkish Fed trades" in either fed funds futures or the OIS market. The Eurodollar market does not provide the same potential for gains because the LIBOR / OIS spread is currently elevated and could tighten to offset the profits from rising rate expectations. Bottom Line: The surprisingly positive response from financial markets to last week's Fed rate hike could force the Fed to quickly shift back to a hawkish bias. Maintain below-benchmark exposure to U.S. Treasuries. As a new tactical trade, go short the January 2018 fed funds futures contract to benefit from the Fed ramping up the hawkish language again. Japan: A Weaker Yen Is Still The Only Way Out The Bank of Japan (BoJ) stayed on hold last week, as expected. There had been some increased speculation of late that the BoJ could start to signal a potential increase in its 0% target for the 10-year Japanese Government Bond (JGB) yield, given the rising trend in global yields and signs of better growth in Japan. At the press conference following the BoJ meeting, however, Governor Kuroda shot down that notion, saying that the current accommodative policy stance must be maintained given how far Japanese inflation is below the central bank's 2% target. It remains far too soon for the central bank to signal any shift to a less accommodative stance, as both the pace of economic growth and inflation are not only modest but lagging the current global upturn. In Chart 6, we show some Japanese growth variables relative to an aggregate of the same data for the major developed economies.1 What is clear from the chart is that Japan is benefitting from faster global growth on the industrial side, with the manufacturing PMI above 50. However, the domestic demand story is not as positive, with consumer confidence and real retail sales growth languishing. The lack of real income growth remains the biggest drag on Japanese consumers, as we show in another set of international comparisons in Chart 7. Japan's unemployment rate, currently at 3%, is below the OECD's estimate of the full employment level (consistent with stable domestic inflation pressures). This is in contrast to the other major economies, which are either at, or close to, full employment. Yet Japanese wages continue to struggle, both in nominal terms (a year-over-over growth rate of 1%) and real terms (a year-over-year growth rate of 0.4%). The current annual spring round of Japanese wage negotiations is showing that downward pressure remains powerful, with many manufacturing companies offering pay raises only half as large as those of last year.2 Chart 6Japan Is Lagging The Global Upturn Chart 7Still No Wage Growth In Japan Japan is still struggling to generate positive rates of inflation, even as price growth is accelerating in the other major economies (Chart 8). This is keeping Japanese inflation expectations, which the BoJ believes are mostly a function of the recent performance of actual inflation, subdued. As always, the only reliable source of Japanese inflation seems to be yen weakness. We continue to see this as the only way out of the low-inflation trap for Japan - keeping Japanese interest rates depressed versus the rest of the world, thus weakening the yen through increasingly unattractive interest rate differentials. The BoJ's 0% yield curve targeting framework has been successful in keeping rate differentials wide enough to soften up the yen, especially against the USD (Chart 9). Given our expectations of additional Fed rate hikes, and higher U.S. Treasury yields, over the rest of the year, the yen will likely depreciate further as long as the BoJ sticks with its current interest rate targets. A similar argument holds for the yen versus the Euro, given the increasing likelihood that the European Central Bank (ECB) will be forced to signal a less accommodative monetary policy stance later this year. Against this backdrop, JGBs are likely to outperform the major global government bond markets over the rest of 2017. We upgraded our recommended stance on JGBs from underweight to neutral last October after the BoJ introduced its yield curve targeting framework. In Chart 10, we show the relative performance of JGBs versus some other bond benchmarks, on a duration-matched and common-currency (hedged into USD) basis. We broke up the returns into two periods, from our October 11, 2016 Japan upgrade to January 31 of this year when we upgraded our U.S. corporate bond exposure and cut our overall portfolio duration stance to below-benchmark. The chart shows that JGBs were a good defensive hedge during the latter part of 2016 when global yields were rising, led by U.S. Treasuries. The more recent period, however, shows a much more negligible relative performance, both against other government bonds and corporate debt, during a period where global bond yields have generally traded sideways. Chart 8Japan Inflation Still A No-Show Chart 9A Weaker Yen Is Still Necessary Chart 10Relative Performance Of JGBs Given our views that U.S. Treasury yields will continue to move higher in the next 6-9 months, and that the performance of core European government bonds will suffer over the same period as the ECB signals a slower pace of asset purchases for next year, a return to the late 2016 relative performance of JGBs is very likely. Thus, we are upgrading Japan to an above-benchmark stance in our model portfolio this week, while downgrading core Europe (Germany, France, the Netherlands) to neutral. This is purely a move to get even more defensive in our overall country exposures, by allocating into JGBs which are low-beta to both U.S. Treasuries (where we are already below-benchmark) and core European government debt. Bottom Line: Japanese inflation remains too low for the Bank of Japan to move away from its 0% target on JGB yields anytime soon, even with signs of better Japanese growth and rising pressure on global bond yields. Upgrade Japan to above-benchmark in global hedged bond portfolios, while downgrading core Europe (Germany, France, the Netherlands) to neutral. Robert Robis, Senior Vice President Global Fixed Income Strategy rrobis@bcaresearch.com 1 The U.S., Euro Area, U.K., Canada & Australia 2 https://www.ft.com/content/0895c4ee-eb3b-11e5-888e-2eadd5fbc4a4 The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Recommendations Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

9 年 9 年間 ago

The Yield Curve On A Cyclical Horizon

Highlights Duration & Fed Policy: The longer risk assets can withstand rising rates, the higher will be the ultimate resting place for Treasury yields. Maintain below-benchmark duration on a 6-12 month horizon and add a short fed funds futures trade to profit from increased Fed hawkishness in the near-term. Yield Curve: While the long-run trend will be for the yield curve to flatten as the Fed hiking cycle progresses, rising inflation expectations will cause the curve to steepen between now and the end of the year. Maintain a position long the 5-year bullet, short a duration-matched 2/10 barbell to profit from a steeper curve on a 6-9 month horizon. Feature Say Uncle Chart 1More Tightening To Come The Fed lifted rates last week but kept its median projected path for future rate hikes unchanged. Judging from the market's reaction, this was a more dovish outcome than was anticipated. Since last Wednesday's meeting the dollar is down 0.5%, junk spreads have tightened 10 basis points and the 2/10 yield curve has steepened 1 bp. In other words, financial conditions have continued to ease even as the Fed took another step toward more restrictive policy. All in all, money markets are now discounting only a slightly slower pace of rate hikes than the Fed's median forecast (Chart 1) and financial conditions suggest that further incremental tightening is in store. The financial conditions component of our Fed Monitor1 is above zero, meaning that financial conditions are more accommodative than the long-run average, and the Chicago Fed's Adjusted Financial Conditions Index also shows that conditions are easy relative to the strength of the economy (Chart 1, bottom panel). New York Fed President William Dudley has previously described how the Fed incorporates financial conditions into its decision making:2 Chart 2The Fed Policy Loop All else equal, if financial conditions tighten sharply, then we are likely to proceed more slowly. In contrast, if financial conditions were not to tighten at all or only very little, then - assuming the economic outlook hadn't changed significantly - we would likely have to move more quickly. In the end, we will adjust the policy stance to support financial market conditions that we deem are most consistent with our employment and inflation objectives. We have also described this process in the context of our Fed Policy Loop3 (Chart 2). In essence, the Fed will continue to nudge rate hike expectations higher until financial conditions tighten excessively. At that point - because with inflation below target the Fed still has an interest in supporting the recovery - it will quickly shift to a more dovish stance. Chart 3Short Jan 2018 Fed Funds Futures One implication of the Fed Policy Loop is that the longer risk assets can withstand rising rates, the higher will be the ultimate resting place for the fed funds rate and Treasury yields. As such, we continue to recommend a below-benchmark duration allocation on a 6-12 month horizon. Another implication is that because markets shrugged off the latest rate increase, Fed policy is likely to turn more hawkish in the very near term. We therefore recommend investors add a tactical trade: short the January 2018 fed funds futures contract (Chart 3). We calculate that this trade will return 11 bps in a scenario where the Fed lifts rates twice more before the end of the year and 37 bps in a scenario where the funds rate is raised three times. However, we do not expect to hold this trade until the end of the year. Rather, we expect the Fed will nudge rate expectations higher in the next month or two and that these gains will be realized over a much shorter horizon. We also add a caveat that, in the present environment, it is safer to implement any "hawkish Fed trades" in either fed funds futures or the overnight index swap market. The Eurodollar market does not provide the same potential for gains because the LIBOR / OIS spread is currently elevated and could tighten to offset the profits from rising fed funds rate expectations (Chart 3, bottom panel). Fed hawkishness also argues for a flatter yield curve in the very near term. While this could materialize, we continue to hold our position in the 5-year bullet over a duration-matched 2/10 barbell - a trade designed to profit from a steeper 2/10 slope. For reasons described in the next section we believe the yield curve will steepen between now and the end of the year, although the risks are tilted toward flattening in the very near term and in 2018 and beyond. What Drives The Yield Curve? In this week's report we present an overview of the main drivers of the slope of the Treasury yield curve. Specifically, we identify (i) the fed funds rate, (ii) inflation expectations, (iii) implied volatility and (iv) unit labor costs as factors that correlate strongly with the slope of the yield curve on a cyclical horizon. We review the outlook for each of these factors and conclude that the Treasury yield curve has room to steepen between now and the end of the year. Beyond that, the curve will likely resume flattening as inflationary pressures start to bite and the Fed's rate hike cycle picks up steam. Chart 4Fed Rate Hikes Flatten The Curve 1. The Fed Funds Rate Not surprisingly, the slope of the Treasury curve correlates very strongly with the level of short rates (Chart 4). Typically, short-maturity yields are much more influenced by the expected path of Fed rate hikes than long-maturity yields. As such, when the Fed is lifting rates the yield curve tends to bear-flatten - both the 2-year and 10-year Treasury yields rise, but the 2-year rises more quickly. In contrast, when the Fed is cutting rates the yield curve tends to bull-steepen - both the 2-year and 10-year Treasury yields fall, but the 2-year falls more quickly. In a typical cycle the yield curve will start to flatten as the Fed lifts rates and will eventually become completely flat when the end of the rate hike cycle is reached and the fed funds rate is at its "equilibrium" or "terminal" level. Usually, at that point in the cycle, the Fed will keep policy too tight in an effort to rein in inflation. This causes the economy to slow and the yield curve to invert, signaling the start of the next recession. A recent BCA Special Report4 speculates that if the federal government succeeds in delivering sizeable fiscal stimulus, inflationary pressures could start to build next year, leading to a more rapid pace of Fed rate hikes and a flat or inverted yield curve by the end of 2018. This would be consistent with a recession in 2019. In terms of the behavior of the yield curve, this is not far off from the Fed's own projections. At present, the median FOMC projection calls for the fed funds rate to reach its equilibrium level of 3% by the end of 2019. If this forecast plays out, it means that the 2/10 Treasury slope must flatten by roughly 117 bps between now and then. Turning back to Chart 4, we see that the Treasury curve has already flattened considerably even though the Fed has only raised rates three times. This means that either the equilibrium fed funds rate is much lower than the Fed's 3% projection and the 2/10 slope will reach zero with a much lower fed funds rate, or that the curve flattening is overdone and the curve has room to steepen before it resumes its cyclical flattening trend. As is explained below, we favor the latter interpretation. 2. Inflation Expectations The 5-year/5-year forward TIPS breakeven inflation rate is also highly correlated with the slope of the yield curve (Chart 5). As long-dated inflation expectations increase the yield curve tends to steepen, and vice-versa. Interestingly, the positive correlation between long-dated inflation expectations and the slope of the Treasury curve persists even when the Fed is hiking rates. Notice that in the 1999 rate hike cycle, the yield curve did not start to flatten until the 5-year/5-year breakeven fell. Also, in the 2004-06 hike cycle, curve flattening ebbed just as the breakeven started to widen. Chart 5Rising TIPS Breakevens Steepen The Curve Charts 6 and 7 show the relationship between the 2/10 Treasury slope and the 5-year/5-year breakeven in more detail. Chart 6 shows the correlation between monthly changes in the 2/10 Treasury slope and the 5-year/5-year breakeven using all available data back to January 1999. We see that a positive correlation between the slope and the breakeven prevailed in 64% of monthly observations, while only 36% of months displayed a negative correlation. Chart 62/10 Nominal Treasury Slope Vs. TIPS Breakeven ##br##Inflation Rate 5-Year/5-Year Forward (February 1999 - Present) Chart 72/10 Nominal Treasury Slope Vs. TIPS Breakeven Inflation Rate 5-Year/5-Year ##br##Forward During Fed Tightening Cycles (June 1999 To May 2000 & June 2004 To June 2006) In Chart 7, we focus exclusively on the past two Fed tightening cycles (1999-2000 & 2004-2006). Not only does a linear regression show an even stronger correlation than was achieved with the full sample, but we also see that a positive correlation between the slope and the breakeven existed in 73% of monthly observations, while only 27% of months displayed a negative correlation. At present, core PCE inflation is still below the Fed's 2% target and different measures of inflation expectations are all well below levels that prevailed during prior rate hike cycles (Chart 8). In other words, the Fed must proceed slowly enough with rate hikes to ensure that long-dated inflation expectations continue to trend higher, which argues for a steeper yield curve until inflation and inflation expectations are more firmly anchored around the Fed's target. For the 5-year/5-year forward TIPS breakeven inflation rate we think a range of 2.4% to 2.5% would signal that inflation expectations are well anchored around the Fed's target. 3. Volatility Implied interest rate volatility - as measured by the MOVE volatility index - is another factor that correlates with the yield curve on a cyclical horizon (Chart 9). In theory, higher rate volatility should coincide with a steeper yield curve, all else equal, and this is exactly the correlation we observe. Chart 8Fed Wants Inflation Expectations To Rise Chart 9Higher Vol Steepens The Curve Let's consider that there is a risk premium applied to taking a unit of duration risk (usually called the term premium) and that said risk premium is larger for longer-maturity bonds that carry more duration risk. All else equal, the risk premium applied to one unit of duration risk should be larger when rate volatility is higher. This should also coincide with a steeper yield curve, since there is more duration risk at the long-end of the curve. In a recent report,5 we concluded that the level of disagreement among forecasters about future GDP growth and T-bill rates were the two most important drivers of cyclical swings in implied rate volatility, the Global Economic Policy Uncertainty Index has at times also played a role (Chart 9, bottom 3 panels). Chart 10Higher Unit Labor Costs Flatten The Curve At the moment, the amount of forecaster disagreement about future GDP growth is near its lows since 1990 and T-bill forecast disagreement has, until recently, been suppressed by the zero lower bound on interest rates. All this implies that the balance of risks favors higher implied interest rate volatility in the months ahead, which will apply steepening pressure to the yield curve. 4. Unit Labor Costs Unit labor costs are the final yield curve indicator we discuss in this report. Since faster wage growth tends to coincide with Fed tightening and slowing wage growth tends to correlate with Fed easing, it makes sense for wage indicators to be inversely correlated with the slope of the yield curve. While it is broadly true that all wage indicators show a reasonable inverse correlation with the slope of the curve, unit labor costs are the best. The reason is that unit labor costs (compensation per unit produced) actually measure both wage growth (compensation per hour) and labor productivity (output per hour) (Chart 10). It turns out that the yield curve can flatten in the traditional way - a bear-flattening driven by rising wages and Fed tightening - but occasionally it can also bull-flatten if the market starts to discount a lower equilibrium (or terminal) fed funds rate. We might expect this sort of curve behavior in an environment of extremely low productivity growth, and this is exactly what has occurred during the past few years. Notice in Chart 10 that compensation per hour does not explain the curve flattening that started in 2014, but unit labor costs do because they also factor in incredibly low productivity growth. In the longer-run, we would strongly expect unit labor costs to remain in an uptrend. Wage growth is accelerating and there are structural headwinds that will prevent productivity growth from returning to the levels seen at the height of the IT revolution in the late 1990s and early 2000s. As was discussed last year in a Special Report from our Global Investment Strategy service,6 the rate of human capital accumulation is in a secular downtrend as is the share of workers in their 40s - the age cohort when people are most productive. However, there has also been a cyclical component to the productivity slowdown and it is possible that productivity growth could accelerate somewhat in the near-term as the cycle matures. The capital stock per worker correlates strongly with productivity growth (Chart 11), and while capital investment has been depressed for most of the recovery there are finally some signs that it may return (Chart 12). Chart 11Productivity Held Back By Lack Of Investment Chart 12Getting Optimistic About Capex In fact, it is even conceivable that more rapid wage growth itself might encourage firms to replace labor with capital, causing traditional measures of wage growth to accelerate relative to unit labor costs. Also, the prospect of tax reform and regulatory relief could give capital spending a boost - it has already led to a jump higher in small business optimism (Chart 12, bottom panel). Unit labor costs will likely continue to accelerate on a cyclical investment horizon, applying flattening pressure to the yield curve. But this flattening pressure would be mitigated to the extent that there is any cyclical rebound in productivity growth. Yield Curve Strategy Upon consideration of the four factors described above, we conclude that while the slope of the yield curve will likely be close to zero sometime in late 2018, curve flattening won't start in earnest until late this year or early next year when inflation expectations are higher (2.4% to 2.5% on long-dated TIPS breakevens) and core PCE inflation is firmly anchored around the Fed's 2% target. This conclusion is based on our observations that: TIPS breakevens and the slope of the curve tend to be positively correlated, even during rate hike cycles. Interest rate volatility is more likely to rise than fall. Unit labor costs are likely to remain in an uptrend on a cyclical horizon, but there is scope for them to level-off if we see a modest late-cycle rebound in productivity growth. To position for a steeper yield curve between now and the end of this year we continue to recommend that investors favor the 5-year Treasury note relative to a duration-matched position in a 2-year/10-year barbell. Long bullet/short barbell trades tend to outperform when the yield curve steepens, and our model suggests that the 5-year yield is currently very cheap relative to the 2/10 slope (Chart 13). We have been recommending this trade since December 20, 2016 and it has so far returned +2 bps even though the 2/10 slope has flattened 13 bps during that time. The strong positive carry means that not much curve steepening is required for the trade to realize strong positive gains. Chart 13The 5-Year Bullet Is Cheap On The Curve Ryan Swift, Vice President U.S. Bond Strategy rswift@bcaresearch.com 1 For further details on our Fed Monitor please see U.S. Bond Strategy Weekly Report, "Buy The Back-Up In Junk Spreads", dated March 14, 2017, available at usbs.bcaresearch.com 2 https://www.newyorkfed.org/newsevents/speeches/2015/dud150605 3 Please see U.S. Bond Strategy Weekly Report, "Caught In A Loop", dated September 29, 2015, available at usbs.bcaresearch.com 4 Please see BCA Special Report, "Beware The 2019 Trump Recession", dated March 7, 2017, available at usbs.bcaresearch.com 5 Please see U.S. Bond Strategy Weekly Report, "The Road To Higher Vol Is Paved With Uncertainty", dated February 14, 2017, available at usbs.bcaresearch.com 6 Please see Global Investment Strategy Special Report, "Weak Productivity Growth: Don't Blame The Statisticians", dated March 25, 2016, available at gis.bcaresearch.com Fixed Income Sector Performance Recommended Portfolio Specification

9 年 9 年間 ago

A Simple Message

Dear Client, In addition to an abridged Weekly Report, we are also including a Special Report written by our Global ETF Strategy team. BCA's Global ETF Strategy, launched in September joins comprehensive ETF analysis with BCA's global macroeconomic thematic research: its aim is to help clients connect the dots from BCA themes to individual ETF ticker symbols with real-time market expressions of our views. The team is currently producing a series of reports on smart-beta ETF selection, whereby they examine the key factors recognized by academia and investment practitioners as persistent drivers of market performance. In this second installment, the team focuses on dividend-focused funds. Although the team finds that dividends do not qualify as a true standalone factor consistently explaining equity returns, dividend policy can add to multi-factor models' explanatory power at the margin. Given the popularity of dividend investing, we think dividend policy could be a fruitful subject for further research. Best regards, Lenka Martinek Feature U.S. financial markets breathed a collective sigh of relief last week when the FOMC followed through on a fully discounted 25 bps rate hike, but did not increase the number of expected rate hikes for the year. In other words, the Fed successfully delivered a "dovish hike", thus reassuring investors that the policy sweet spot - the period when interest rates are rising but have not become restrictive - will last a while longer (Chart 1). Chart 1A "Dovish Hike" Chart 2Low Structural Unemployment Rate The Fed's assessment of the economy is not very different from our own, though there were a few details in the economic projections worth highlighting. First, the estimate for the structural rate of unemployment was scaled down further by a tenth of a percentage point to 4.7%. This may seem minor, but it suggests that policymakers believe the labor market has more running room before wage inflation moves higher. Granted, any forecast for structural unemployment should be taken with a dose of salt, but our bias throughout this cycle - and as outlined in our November Special Report - has been to expect wage inflation to lag relative to past cycles due to structural factors (Chart 2). And as can be seen in Chart 3, Japan provides a roadmap: in that country, demographic factors helped push the unemployment rate to below 3% without creating inflationary pressures. Of course, the U.S. economy is very different from Japan and we do not expect unemployment to drop as low. However, as occurred in Japan, we would not be surprised to see the FOMC trim its forecast for the structural unemployment rate further in the coming quarters. A related point is that the Fed also adjusted the wording of the FOMC statement regarding its inflation targets. The statement said that the Fed was looking for a "sustained" return to 2% inflation, while also referring to its inflation target as a "symmetric" one. Our interpretation is that the Fed is trying to clarify that it will not react too aggressively if core inflation were to drift somewhat above 2%. Clearly, the Fed is beginning to see the balance of risks toward higher inflation. That makes sense, given that the economy is operating close to full employment. However, we maintain that a sustained rise in inflation above the Fed's 2% core PCE target is not imminent. Indeed, the message from last week' CPI report reinforces our view that with the exception of a few components, inflation is very well contained (Chart 4). Our diffusion index of the major inflation components is in negative territory. Importantly, price surveys continue to show that businesses are not able to easily raise prices. For example, despite the continued optimism in the headline components of the NFIB small businesses survey, small businesses have not been able to - and do not yet anticipate being able to - raise prices. This reinforces our long-held view that after a long period of disinflation - and outright deflation in the retail sector - inflation expectations are extremely well-anchored and savvy consumers know how to extract a better deal. Core PCE inflation may converge on the Fed's target of 2% in the second half of 2017, but an inflation overshoot should not be a major driver of investment decision-making over the next 6-12 months. Chart 3Japan: A Low Unemployment Rate ##br##And Little Wage Inflation Chart 4Inflation ##br##Still Low In the end, it is Fed Chair Yellen's least sophisticated remarks that provide the best summation. During the FOMC press conference, she stated that "the simple message is the economy is doing well". Indeed, the moderate pace of growth that has prevailed since the beginning of the recovery means that the typical imbalances and pressure points that accumulate in the advanced stages of a business cycle are so far still absent. The backdrop overwhelmingly favors stocks relative to government bonds on a cyclical horizon. To be sure, equities are expensive, but as we wrote last week, relative to competing assets, valuations are not extreme. The greater near-term risk continues to be a phase of economic and earnings disappointments that could develop later this year, since there remains a tremendous amount of optimism in the business community regarding regime change in Washington. Note that the policy uncertainty index remains very elevated (Chart 5) and Trump's "skinny budget", which aims to slash spending across all discretionary items save military and veterans affairs, will be contested. Our geopolitical team notes that Democrats could threaten a government shutdown later this year to try to force Republicans' hand at removing the most controversial elements of the budget. Democrats can filibuster parts of the appropriations process which makes the concrete budget allocations. Chart 5Political Uncertainty Still Elevated On this basis, we remain skeptical that fiscal policy will be clean fuel for the equity bull market. However, we adhere to Yellen's "simple message" that the economy is on a stable footing. That implies that Washington disappointments will most likely lead to equity setbacks rather than a painful breakdown. Lenka Martinek, Vice President U.S. Investment Strategy lenka@bcaresearch.com Appendix Monthly Asset Allocation Model Update Our Asset Allocation (AA) model provides an objective assessment of the outlook for relative returns across equities, Treasuries and cash. It combines valuation, cyclical, monetary and technical indicators. The model was constructed as a capital preservation tool, and has historically outperformed the benchmark in large part by avoiding major equity bear markets. Please note that our official cyclical asset allocation recommendations deviate at times from the model's recommendation. The model is just one input to our decision process. The model's recommendation weightings for the major asset classes are unchanged: neutral equity exposure at 60% (benchmark 60%), neutral Treasury allocation at 30% (benchmark 30%) and cash at 10% (benchmark 10%). The diffusion index of the three components for The Equity Model remained neutral. The technical component "buy" signal strengthened, with sturdy advances for both the breadth & trend and momentum indicators. The monetary component, which measures overall liquidity conditions within the financial and economic system and designed to lead equity prices, is slightly more bullish and still favorable for equities. The earnings-driven component continues to give a cautious signal. Real operating earnings remain at a significant distance from positive economic expectations which have moved higher yet again. Moreover, earnings momentum is still sluggish, based on our earnings diffusion index, which compares nominal earnings growth relative to four key macro proxies for business costs. The model's recommendation for bonds remains at benchmark which still fits with our neutral qualitative stance for Treasuries in balanced portfolios since November 7, 2016. Although the cyclical component of the bond model is more constructive than the valuation component, the further deterioration in the technical component maintains the "sell" signal for Treasuries firmly in place. Chart 6Portfolio Total Returns Chart 7Current Model Recommendations Note: The asset allocation model is not necessarily consistent with the weighting recommendations of the Cyclical Investment Stance. For further information, please see our Special Report "Presenting Our U.S. Asset Allocation Model", February 6, 2009. Highlights Factor attribution began a half-century ago with the Capital Asset Pricing Model ("CAPM"). Although the CAPM itself has been superseded, selected factors have exerted a consistent influence on equity performance. The empirical evidence does not support including dividends among the proven factors, yet dividend-focused funds are the most numerous in the smart-beta universe. The ambiguity surrounding dividends' effect on equity performance leaves plenty of room for smart-beta purveyors to build a better mousetrap, but our own research suggests that they will have to do so with something other than purely dividend-related metrics. Reflecting the fact that many of the dividend funds already incorporate multi-factor inputs, we evaluate them based on their exposure to all of the metrics within our Equity Trading Strategy service's multi-factor model. Feature Welcome to the second installment of our series on smart-beta ETF selection. Over the course of the series, we intend to examine the factors widely recognized by academia and investment practitioners as persistent drivers of equity performance. Each Special Report will weigh the evidence for the factor's efficacy, consider the metrics that best reveal its presence and compare our ideal metrics with the metrics utilized by our proprietary Equity Trading Strategy ("ETS") multi-factor model. It will then evaluate the menu of smart-beta ETFs using either our ETS model's metrics or an augmented version of them. The series began last month with a review of the Value factor, enshrined by Fama and French's research, and the current subset of Value smart-beta ETFs.1 This month we examine Dividend smart-beta ETFs. Subsequent installments will examine Quality, Momentum and Volatility,2 and we will likely wrap up the series with a review of Multi-Factor smart-beta ETFs. This installment provides some background on factor investing and the smart-beta process before subjecting Yield (Dividends) to scrutiny to determine whether or not it really constitutes a standalone equity factor. Back To The Beginning The ubiquity of beta in discussions of investing performance originates from the Capital Asset Pricing Model ("CAPM"), as advanced by William Sharpe and other researchers in the early 1960's. The CAPM posits that the expected return of stock XYZ is solely a function of XYZ's riskiness relative to the overall equity market. XYZ's riskiness is a function of its covariance with the market, and is represented in the CAPM's simple linear model as the coefficient "beta.3" The elegantly simple CAPM holds that any stock's expected return (E(rs)) is the sum of the risk-free rate (rf) and the product of its beta (ßs) and the difference between the expected market return (E(rm)) and the risk-free rate (rf): E(rs) = rf + ßs x (E(rm) - rf) As noted by several researchers, including Eugene Fama and Kenneth French,4 CAPM's return predictions are woefully errant when applied to stocks. As Chart 1 indicates, the returns projected by the CAPM bear little relationship to empirical results. It turns out that low-beta stocks have systematically outperformed high-beta stocks on a risk-adjusted basis (Chart 2), just as low-book-multiple stocks have crushed high-book-multiple stocks without regard for beta (Chart 3). This is powerful evidence for value, and for the low-volatility factor that we will examine in a subsequent report, but it is damning for the simple application of the CAPM to stocks. Chart 1CAPM Sounded Great In Theory ... Chart 2... But It Flopped In Practice Chart 3Low-Book-Multiple Stocks Systematically ##br##Flout CAPM Predictions A New Vocabulary Despite its empirical shortcomings, the CAPM provides an intuitive way of conceptualizing the risk-return tradeoff, and it paved the way for the asset-pricing research that followed it. The notion that individual securities' risks come in two flavors, market and idiosyncratic, is a critical element of portfolio theory and its thou-shalt-diversify commandment. It is also the basis, as we shall see, for beta, alpha and the factor-investing approach enabled by smart-beta ETFs. For that application, let us add an alpha term to the CAPM to account for the component of realized returns that cannot be explained by market exposures: rs = rf + ßs x (E(rm) - rf) + a Rearranging terms to solve for alpha shows it to be the difference between the realized return and the return expected by CAPM: a = rs - (rf + ßs x (E(rm) - rf)) From CAPM To Factors To Smart Beta In today's accepted usage, alpha is the ex-post difference between portfolio and benchmark return, adjusted for risk. It is the component of return attributed to portfolio manager skill, whereas beta is the return accruing to simple market exposure. As return-attribution research has uncovered the systematic factors underpinning performance, beta has claimed an increasing share of the pie from alpha. The salubrious effect for investors, especially those who employ third-party managers, has been to demystify the sources of portfolio returns. Beta's expanding share has also opened the door to a middle course between purely active and purely passive portfolio management strategies. Factor research has made it possible to join the main advantages of passive strategies - transparency, predictability and low cost - with active strategies' aim of delivering a risk-adjusted return profile distinct from those offered by cap-weighted benchmarks. Investors have embraced the factor approach and traditional asset managers have obliged them with a torrent of smart-beta ETF choices. Both should put investors on alert: according to the late Barton Biggs, there is no investment idea so good that it can't be destroyed by too much money, and fund company enthusiasm may correlate more closely with its own profits than its clients'. Biggs' admonition is always on our mind, but we don't think the established factors are in imminent danger of losing their zest. Factor excess returns are not new news. 25 years after Fama and French's paper, low-book-multiple stocks continue to outperform high-book-multiple stocks and smaller stocks continue to outperform larger stocks. We do not see the comparatively modest aggregate smart-beta ETF AUM as a catalyst for bidding away the returns that have durably accrued to factors. Are Dividends Really An Equity Factor? For the purposes of this report, our first objective is to determine whether or not Dividends can properly be considered a factor alongside the big five (Value, Quality, Momentum, Volatility and Size). Unable to find compelling evidence for their inclusion, we do not think they should. Yield may be a promising factor in fixed income, but extending the concept to equities is problematic. Across all capitalization buckets for the last 20 years, it cannot even be said that dividend payers outperform non-dividend payers (Chart 4). The empirical record for more sophisticated slicing and dicing is mixed, depending on the level of granularity. Breaking the universe of U.S. equities into non-dividend payers and dividend payers, and then segmenting the latter by yield into the lowest three deciles, the median four deciles and the highest three deciles, Fama and French's 90-year dataset supports the idea that higher-yielding stocks generate higher total returns (Chart 5). The breakout is neatly consistent, with dividend payers outperforming non-dividend payers, and each yield cohort of the dividend payers outperforming the lower-yielding cohorts beneath it (Chart 6, top panel). Zoom into the dividend payers at the quintile and decile levels, however, and the consistency disappears as the tidy staircase pattern begins instead to resemble a jagged picket fence (Chart 6, lower panels). Chart 4Dividends Have Been Hazardous To Investors' ##br##Wealth Over The Last 20 Years ... Chart 5... Though They've Rewarded Investors ##br##Over Nine Decades Chart 6Not Ready For A Close-Up Adjusting for risk makes the picture even murkier. While the non-payers and the lowest-yielding cohorts always post the smallest risk-adjusted returns, they are the only cohorts the highest-yielders manage to beat. The median 40 is the winner among our 30-40-30 cohorts, while the fourth and the second quintiles bracketing the median 40 easily outpace the top quintile, and the eighth, fourth and seventh deciles break away from the rest of the decile pack (Chart 7). It should come as no surprise that our long top 30%/short bottom 30% litmus test failed to reveal any viable excess return strategies based on dividend yields. Our attempts to develop simple portfolio construction rules based on markers of dividend quality and sustainability failed to conclusively advance the dividend cause. Long/short strategies founded on dividend growth added no value to a simple portfolio built from dividend yield and change in share count (Chart 8). Payout ratio metrics, which might shed some light on both quality and sustainability, provided pretty solid results, but they weren't enormous winners (Chart 9). Our analysis left us unable to conclude that Yield merits inclusion among the established equity factors. Chart 7No Theme To Risk-Adjusted Return Profiles Chart 8No Viable Long/Short Dividend-Growth Strategy ... Chart 9... But Payout Ratios Work Pretty Well An Ideal Dividend Index The fact that the way forward for dividend strategies is not obvious is good news for smart-beta sponsors. The ambiguity leaves plenty of room for developing better index-construction methods. Some sources of improvement might include: A means of identifying and sidestepping "yield traps," high and/or growing yields that are actually a distress signal. A way to review historical metrics to gain a sense of ongoing dividend growth. An evaluation of a dividend's source, valuing dividends supported by operating cash flows more highly than those supported by financing activities or asset dispositions. A process for limiting sector exposures, and an awareness of the most auspicious backdrops for taking on exposure to specialized yield plays like mortgage REITs, MLPs and BDCs. Ticking off every item on this wish list, however, would necessarily involve infringing on other factors' turf. Quality, Value, Size and Volatility could all spill into the process of assessing dividend quality and sustainability. Given that our attempts at creating our own tests to measure up to the wish list came up empty, it seems that a cross-disciplinary approach might be the only option. Even if the indexes are not based completely on dividend-derived metrics, it may be possible for a few dividend accents to add some incremental value to the overall stew. Smart-Beta Fund Evaluation These issues were on our mind when we set out to define the metrics that we would use to evaluate the indexes created by our Dividend smart-beta ETF subset. The two payout metrics in the ETS model, dividend yield and change in shares outstanding, are pretty thin gruel for evaluating the dividend ETFs. The ETS payout metrics were selected based on their interaction with the Value, Safety, Quality, Momentum and Sentiment metrics, 23 in all, that comprise the rest of the stock-level inputs into our model. They were not intended to be stand-alone measures. Many of the ETFs in our subset explicitly screen for Quality, Value and/or Low Volatility. They could just as accurately be described as multi-factor funds in a dividend-first wrapper, and we have therefore deployed the entire ETS model to evaluate them. To assess whether or not their constituent selection process consistently improves upon a simple dividend strategy, we compare their ETS scores to those of VIG, the Vanguard Dividend Appreciation ETF, which tracks the NASDAQ US Dividend Achievers Select Index of stocks (ex-REITs and LPs) with at least 10 consecutive years of dividend increases. First Trust Rising Dividend Achievers ETF (RDVY) RDVY's ETS scores have stood out from its smart-beta peers' since the fund's inception at the beginning of 2014. Its concentrated 50-stock portfolio allows it to focus on exposure to its preferred growth and sustainability metrics. Only stocks that have grown their dividends over 3- and 5-year periods, and their non-zero earnings per share over a 3-year period, make it through the growth filters. The sustainability filters admit only stocks with cash-to-debt ratios of at least 50% and dividend payout ratios of 65% or less. Chart 10Good Things Come To Those Who Wait Although the fund has outperformed VIG since inception, its relative performance has not been nearly as consistent as its relative ETS scores (Chart 10). It has taken a 40% surge over the 12 months ended February 28th to put RDVY over the top. We recognize that performance can be capricious, however, and place more weight on RDVY's consistently stellar relative ETS scores, which are 20% more, on average, than its smart-beta peers'.5 RDVY's 50-basis-point ("bps") expense ratio exceeds the 36-bps group average, but we think its screens and concentration are worth the incremental 14 bps. The fund is on the smaller side with $127 million of AUM, and daily turnover of just over $2 million, but larger investors can make use of the creation/redemption unit process to transact in larger volumes without concern. We recommend RDVY for investors seeking large- and mid-cap dividend exposure. FlexShares Quality Dividend Index Fund (QDF) QDF stands second to RDVY on an ETS score basis. Its relative scores have been remarkably stable, rarely falling below 110% en route to averaging 113% of the aggregate Dividend smart-beta score. QDF's selection process is proprietary, and it incorporates measures of cash flow, profitability, and management's skill at deploying capital and financing its activities. The mix has enabled QDF to outperform VIG from the get-go, and steadily pad its lead ever since (Chart 11). Its 37-bps expense ratio is right in line with the group's and its $1.7 billion AUM and $5 million average daily turnover provide a nice sense of ballast. We recommend QDF, along with RDVY, as the best Dividend smart-beta options. Chart 11Wire-To-Wire Outperformance WisdomTree MidCap Dividend Fund (DON) O'Shares FTSE US Quality Dividend ETF (OUSA) WisdomTree has been a pioneer in creating dividend-weighted indexes, but the formula it's applied to selecting constituents for DON, its mid-cap dividend ETF, has not found favor with the ETS model. The fund's constituents have repeatedly earned an aggregate ETS score below 40, holding its relative score below 80% for extended periods. OUSA is a newer fund, with less than a year of history, but its ETS scores have been noticeably weak. We would avoid OUSA until it compiles enough of a track record to permit more conclusions about its process and we would advise investors seeking targeted mid-cap exposure to gain it via funds other than DON. Dividends' Curious Attraction Our work in researching this Special Report has brought dividends' many contradictions to light. In countries like the U.S., where ordinary income is taxed at a higher rate than capital gains, dividends represent an especially tax-inefficient way of redeeming a portion of one's investment. Either share buybacks or sales to third parties would yield more after-tax cash. Humans feel a strong pull to book gains, and steadily redeeming portions of a successful investment has an intuitive emotional appeal: "Let's quit while we're ahead, let's go while the getting is good." It's exactly the wrong thing to do with investments, however. If the quarterly dividend flow assuages the remorse over a mistaken investment, encouraging an investor to stick with a losing position, it's even worse. It is possible that dividends, even though they're small, help reinforce our innate resistance to selling losers and letting winners run. From management's perspective, legacy dividend payments can act as handcuffs. Fearful of issuing a signal that is sure to be interpreted negatively by the market, firms take pains to refrain from cutting dividends. Dividend declarations, then, are a part of the capital budgeting process that is not rooted in economics. A rigorously utility-maximizing visitor from outer space may have found the oil majors' borrowing to fund their dividends in the midst of the severe downturn in crude prices to be very odd indeed. All of these shortcomings may help explain why we were unable to find clear evidence that dividends exert a clear and consistent influence on stock prices. And yet, dividends are enormously popular, with dividend funds by far outnumbering every other flavor of smart-beta ETF. We, too, like to think of positions in balanced portfolios on a total-return basis, as does our U.S. Investment Strategy service, which has successfully recommended the Dividend Aristocrats much longer than we have. Total return is important, but we are increasingly leaning toward the view that specialty dividend plays, purchased at the right point of the cycle, are the best way for an investor to capture income from equity holdings. Such an all-or-nothing approach may well be superior to the one-foot-in, one-foot-out stance that is embodied by the average 2% large-cap dividend yield. Our U.S. Investment Strategy service has successfully surfed the cyclical wave in mortgage REITs, and we are attempting to do so now with the inclusion of BIZD, the business development company ETF, in our U.S. portfolios. Adding cycle analysis would make our smart-beta studies too long, but we are conducting research into the interaction between factor performance and cycle phases, and we will share our findings with our clients in standalone Special Reports if they are insightful enough to merit their attention. Doug Peta, Vice President Global ETF Strategy dougp@bcaresearch.com Jennifer Lacombe, Research Analyst Global ETF Strategy Jenniferl@bcaresearch.com Philippe Morissette, Associate Vice President Equity Trading Strategy philippem@bcaresearch.com 1 Please see Global ETF Strategy/Equity Trading Strategy Special Report, "Smart-Beta ETF Selection, Part I - Value Funds," published February 15, 2017, at etf.bcaresearch.com. 2 Size may be too straightforward to allow for an index-construction edge. 3 Stock XYZ's beta is equal to the covariance of its returns with the market's returns, divided by the variance of the market's returns, where its covariance with the market equals its returns' correlation with the market's times the product of XYZ's volatility and the market's volatility. 4 Fama, Eugene F. and French, Kenneth R., "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, Volume 18, Number 3 (Summer 2004), pp. 25-46. 5Befitting its benchmark status, VIG’s ETS scores have averaged 99.8% of the entire subset’s since inception.

9 年 9 年間 ago

The Fed's Unhike

Dear Client, In addition to this brief note concerning Wednesday's FOMC meeting, we will be sending you a Special Report written by my colleague Brian Piccioni, head of BCA's Technology Strategy service. Brian discusses the investment implications of what could be one of the most profound technological developments of the 21st century: CRISPR, a radical new technique for genetic engineering. Best regards, Peter Berezin, Senior Vice President Global Investment Strategy The dollar and U.S. Treasury yields fell sharply in the aftermath of Wednesday's FOMC meeting, while equities rallied. Indeed, so pronounced was the asset market reaction that financial conditions eased markedly for the day, making the Fed's actions an "unhike" of sorts. The FOMC meeting produced several dovish surprises. First, the number of participants who expected four rate hikes or more did not increase, as some observers had anticipated. Second, the estimate for the structural rate of unemployment was scaled down further by a tenth of a percentage point to 4.7%. Third, the FOMC statement said that the Fed was looking for a "sustained" return to 2% inflation, while also referring to its inflation target as a "symmetric" one. Fourth, Minneapolis Fed President Kashkari dissented in favor of keeping rates unchanged, which few people had expected. Having said all this, the market's reaction still seems rather excessive. The key message from the March meeting was that the Fed now sees inflation as having finally reached its 2% target. This was reflected in the decision to strip the reference to the "current shortfall of inflation" from the statement. Consistent with this, the FOMC raised its growth forecast for 2018 from 2.0% to 2.1%. In addition, it lifted its inflation forecast for this year from 1.8% to 1.9%. The median projection for the funds rate also edged up from 2.9% to 3% for 2019. The mean dot rose 9 bps in both 2018 and 2019, while the modal dot increased by 25 bps in both years. None of this is particularly dovish. As far as the reference to the Fed's "symmetric" target is concerned, this is something that Chair Yellen and other FOMC officials have stressed many times before. All it means is that the Fed will not react too aggressively if core inflation were to drift somewhat above 2%. It does not mean that the Fed will purposely try to engineer an inflation overshoot. If the Fed had wanted to do that, it would have lifted its 2019 inflation forecast. It didn't do that and the inflation forecast remains stuck at 2.0%. Why, then, did the FOMC bother massaging the language? The answer is that the Fed simply wanted to reassure the public and the investment community that it would maintain its "go slow" approach to raising rates. After all, investors were pricing in only a small probability of a March hike just a few weeks ago. A "hawkish hike" could have led to an excessive tightening in financial conditions, similar to what happened during the taper tantrum. However, given that financial conditions actually eased significantly in response to the FOMC's decision, it is likely that Fed speeches will lean in a less dovish direction over the coming weeks. The implication for investors is that the dollar is likely to rebound. Indeed, the longer-term risk to the dollar is not that the Fed turns out be too dovish, but that it turns out to be too hawkish - that it raises rates so much that the economy begins to roll over. However, with interest rates still low in absolute terms, this is more of a risk for late 2018 or 2019 than it is for the next 12 months. As such, investors should continue to cyclically overweight global equities, favouring stock markets such as those in Europe and Japan that have a "higher beta" to global growth than the U.S. A modest bearish tilt towards long-term government bonds is also warranted. Peter Berezin, Senior Vice President Global Investment Strategy peterb@bcaresearch.com

9 年 9 年間 ago

Global

March Madness

Highlights Fed: The Fed will deliver another rate hike tomorrow, but we do not expect a signal that a higher trajectory for the funds rate is necessary. The Fed wants to see higher inflation expectations and will remain as accommodative as possible until that happens. Maintain a below-benchmark allocation to U.S. Treasuries within global fixed income portfolios. ECB: The ECB opened the door slightly to a less-accommodative policy stance last week, although the talk of a rate hike is premature. A 2018 taper is the more probable scenario, likely to be introduced at the September 2017 policy meeting. This will raise longer-dated European bond yields and widen spreads for both Peripheral European government debt and Euro Area corporate bonds. Reduce Euro Area IG to below-benchmark. U.S. High-Yield: U.S. junk bond spreads have widened even though default rate indicators continue to show improvement. With valuations now looking more attractive, we upgrade U.S. High-Yield from neutral to overweight. Feature Chart of the WeekStill A Positive Backdrop ##br##For U.S. Corporates After a run of smooth sailing for the markets so far in 2017, investors will have a lot of event risk to chew over this week. A slew of central bank meetings - the Fed on Wednesday followed by the Bank of England, Bank of Japan and Swiss National Bank all on Thursday - provide opportunities for policymakers to respond to the rising trends in global growth and inflation. Only the Fed is expected to make a change, though, delivering a now fully priced rate hike. Throw in the Dutch elections on Wednesday and the G20 finance ministers meeting in Germany at the end of the week and there are plenty of potentially market-moving headlines that can hit the tape. While there has been selling pressure on all global bonds during the bear phase since last July, U.S. Treasuries still remain most exposed to additional losses in the near term given the combination of improving growth, booming asset markets, a whiff of Trumpian "animal spirits" and a Fed that still appears to be playing catch-up to the overall positive U.S. macro backdrop. A bigger potential move in yields could occur if and when the European Central Bank (ECB) shifts to a less accommodative monetary stance - a taper of asset purchases first, not a rate hike, in our view - although that will likely require more evidence that medium-term Euro Area inflation expectations are sustainably moving back to the ECB's 2% target (Chart of the Week). For now, we continue to see a more negative near-term environment for U.S. Treasuries over core European debt, and a more positive environment for U.S. corporate bonds than European equivalents. As we have discussed in recent Weekly Reports, the time is coming for a shift out of core European government debt into U.S. Treasuries, although we prefer to wait for that switch until after the French elections. After the recent back-up in U.S. High-Yield spreads that has restored some value to junk bonds, however, we are upgrading our allocation to U.S. High-Yield this week to above-benchmark, while downgrading Euro Area Investment Grade corporate bonds to neutral from above-benchmark. Simply put, we prefer to take our growth-sensitive spread risk in U.S. corporates over European equivalents. Fed Vs. ECB: Dawn Of Hawkish? Some investors and financial media pundits have been asking if the Fed has fallen "behind the curve" with regards to U.S. monetary policy, especially after another solid Payrolls report and with U.S. inflation expectations holding firm despite a pullback in oil prices. In our view, being a little bit behind the curve is exactly where the Fed wants to be, allowing the economic upturn to blossom and inflation expectations to continue drifting towards the Fed's 2% target. We do not anticipate that the Fed will shift to a more aggressively hawkish stance this week, with no signal that rates will rise in 2017 more than is currently projected (three times by year-end). However, we do expect some acknowledgement of the positive macro backdrop both in the U.S. and abroad, justifying the need to move sooner by hiking now. This is especially true with the U.S. dollar still well off the 2017 peak and not providing much of a tightening in monetary conditions that could postpone a Fed rate hike. Any surprise shift higher in the Fed's interest rate projections (the "dots") would not be taken well by the Treasury market, particularly after last week's European Central Bank (ECB) meeting where a message that was merely less dovish than expected sent European bond yields sharply higher. A more hawkish shift by either central bank would be premature right now, as bond markets are not yet signaling that significantly higher real interest rates are necessary. It is important to note that most of the rise in Treasury yields since last July, and virtually all of the rise in German Bund yields, has come from rising inflation expectations rather than higher real yields (Chart 2 & Chart 3). Also, the market expectation for the real terminal policy rate - where interest rates should end up at the end of the tightening cycle - remains around 0% in the U.S. and -1% in Europe, using our proxy measure of the 5-year Overnight Index Swap (OIS) rate, 5-years forward minus the equivalent forward inflation rate from the TIPS and CPI swap markets (bottom panel of both charts). In other words, markets are only expecting a cyclical rise in interest rates in response to faster inflation, not a structural rise in interest rates because of faster potential economic growth. Chart 2Rising Inflation Explains ##br##Most Of The Rise In U.S. Yields... Chart 3...And All Of The Rise##br## In European Yields On that front, the winds are shifting in a fashion that is more bearish for Treasuries, at least in the near term. In Chart 4, we show the relationship between inflation expectations and oil prices for the U.S. and Euro Area. As can be seen in the bottom panel, the correlation between oil and expectations remains high in the Euro Area, but has fallen to zero in the U.S., where inflation expectations are increasingly influenced by domestic price pressures (i.e. rising wage growth and faster core inflation). Chart 4U.S. Inflation Now Not Just About Oil, ##br##Unlike Europe This remains a key element underpinning of our current below-benchmark call on U.S. Treasuries, particularly versus core European bonds. U.S. yields are likely to have more upside from higher inflation expectations with the Fed likely to stay as accommodative as possible by hiking rates at a slower pace than inflation is rising. At some point, monetary policy will become restrictive, particularly if the U.S. dollar bull market resumes with gusto as the Fed is delivering additional rate hikes and expectations for U.S. growth and inflation moderate, capping the current cyclical rise in Treasury yields. We are still some time away from that point, however. Bottom Line: The Fed will deliver another rate hike tomorrow, but we do not expect a signal that a higher trajectory for the funds rate is necessary. The Fed wants to see higher inflation expectations, and will remain as accommodative as possible until that happens. Maintain a below-benchmark allocation to U.S. Treasuries within global fixed income portfolios. ECB Begins The Path To Tapering The ECB last week put a relatively positive spin on the Euro Area economy, while declaring that the worst of the deflationary pressures have passed. President Draghi sounded less downbeat on the Euro Area economy than he has for some time, citing the broadening Euro Area economic upturn that was pushing down unemployment and absorbing economic slack. The ECB only slightly raised its growth forecast for 2017 and 2018, though, raising both figures by 0.1 percentage points to 1.8% and 1.7%, respectively. This would still be sufficient to remove additional slack from the economy, with the ECB currently estimating trend growth of around 1% in the Euro Area. A look at the details of those projections showed that real consumer spending is only expected to grow by 1.4% this year and next, even as the Euro Area unemployment rate is projected to fall below 9% in 2018 on the back of steady job gains. Capital spending is also expected to pick up in the next couple of years, but the projections were downgraded slightly from previous forecasts. These numbers seem a bit too cautious compared to the recent improvements seen in consumer and business confidence in the Euro Area (Chart 5), and to the more positive tone on the economy expressed in the ECB policy statement and in Draghi's press conference following the meeting. Perhaps this is simply central bank prudence at work, particularly in an environment where there is still considerable uncertainty about politics within the Euro Area and global trade in the Trumpian era. Whatever the reason, it now seems likely that growth will at least match, if not exceed, the relatively low bar set by the ECB. This is important, as the central bank is already projecting that the Euro Area will reach full employment by 2019, when the unemployment rate is projected to fall to 8.4%. The ECB expects wage pressures to rise as a result, helping boost core inflation up to 1.8% within two years (Chart 6). This would be consistent with the rising path of interest rates currently discounted in the Euro Overnight Index Swap (OIS) curve where rates are now expected to start going up in the middle of next year, with the negative rate era ending in 2019 (bottom panel). Chart 5ECB Too Pessimistic On ##br##Euro Area Growth? Chart 6ECB Will Not Hike Rates Before ##br##Full Employment Is Reached The ECB knows that interest rates will have to rise if its core inflation forecast pans out, as this would almost certainly mean that headline inflation and inflation expectations would be at the ECB target of "at or just below" 2%. Yet it is still too soon to discuss that scenario, with core inflation struggling to surpass 1% and the 5-year CPI swap rate, 5-years forward at similar levels. The ECB did slightly alter its forward guidance in its policy statement to suggest that it was now much less likely that additional monetary easing would be needed to boost growth, and that it would no longer be necessary to use "all instruments" to fight deflation in Europe. This was taken as a hawkish surprise by the markets, particularly after media reports indicated that some members of the ECB discussed raising interest rates before the tapering of the ECB's asset purchases. As we discussed in our previous Weekly Report, the current backdrop in Europe looks similar in many respects to the U.S. prior to the "Taper Tantrum" episode in 2013.1 We see the ECB following a similar path to what the Fed did during the Tantrum, by signaling a tapering of asset purchases several months in advance, then raising interest rates after the taper is complete. Many clients have asked us if it is possible for the ECB to raise short-term interest rates before starting a tapering of asset purchases. This question also came up at last week's ECB meeting, and President Draghi reiterated the view that rates would be expected to "remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases." This fits with the ECB's unemployment and inflation scenarios, which do not project a return to full employment - which would justify a rate hike - until 2019. A rate hike too soon would result in an unwanted tightening in financial conditions in Europe that could threaten the current economic upturn. We do not believe that investors could neatly separate the impact of a rate hike from that of a taper. A tightening is a tightening, as can be seen in the strong correlation of our Euro Area months-to-hike measure and the term premium on 10yr German Bund yields in recent years (Chart 7).2 If the ECB were to deliver a rate hike, even a modest one of less than the typical 25bp increment, while maintaining the current pace of bond buying, it would send a contradictory message given the ECB's benign inflation outlook for the next couple of years. Clearly, the market is already a bit confused, as the months-to-hike has been rapidly declining, even as shorter-dated bond yields in core Europe stay low and the term premium on longer-dated government debt has stopped rising. We still see a taper next year as a more likely scenario, to be announced at the September 2017 ECB meeting, with a rate hike to occur within 6-12 months of the completion of the taper. This would allow the ECB to reduce the pace of monetary expansion in line with a less deflationary backdrop in Europe, while leaving the rate hike for a more traditional move when full employment is reached in 2019. In Chart 8, we present some potential tapering scenarios and what it would mean for the growth rate of the ECB's monetary base. We show the base case for this year of €60bn/month in asset purchases that ends in December (a "full-stop" with no tapering), along with alternative scenarios of a pace of tapering that reduces the bond buying to zero within six months (i.e. a €10bn/month reduction until June 2018) and with a full taper over 12 months (i.e. a €5bn/month reduction until December 2018). We also show an additional scenario where the ECB decides to extend the asset purchases into 2018 at the same current pace of €60bn/month. Chart 7A Rate Hike Before Tapering ##br##Is A Confusing Message Chart 8Taper Or Not, ECB Effect ##br##On Bund Yields Fading... The bottom panels of Chart 8 show the annual growth rate of the monetary base under the different scenarios, and how that maps into longer-term German bond yields through a widening term premium. Importantly, the growth rate of the ECB's monetary base would decelerate even if there was no taper next year, which would put upward pressure on European bond yields. Unless the ECB is willing to raise the pace of bond buying next year, which would only occur if there was an unexpected downturn in the Euro Area economy before full employment is reached, then the writing is on the wall for Euro Area government bond yields. They are moving higher. The same goes for Peripheral European debt and even Euro Area Investment Grade corporate debt, which the ECB has also been buying. A slowing pace of ECB buying will put upward pressure on both yields and spreads next year (Chart 9), although a better Euro Area economy that improves corporate profits and tax revenues will help mitigate the rise in yields. It is possible that the ECB could alter the composition of its purchases while tapering, choosing to continue to buy more shorter-dated bonds to limit the potential of an unwanted rise in the Euro. As can be seen in Chart 10, the typical indicators that correlate to the EUR/USD currency pair - the relative balance sheets of the Fed and ECB, and the 2-year interest rate differential between European and U.S. interest rates - are still pointing to an extended period of Euro weakness. It would take a combination of rate hikes in Europe and rate cuts in the U.S. to turn EUR/USD around on a sustainable basis. While the tapering announcement will likely push the Euro immediately higher, such a move will not last without a more fundamental change in relative interest rates. Chart 9...And For European ##br##Spread Product, Too Chart 10Tapering Will Not Sustainably ##br##Boost The Euro Bottom Line: The ECB opened to door slightly to a less-accommodative policy stance last week, although the talk of a rate hike is premature. A 2018 taper is the more probable scenario, likely to be introduced at the September 2017 policy meeting. This will raise longer-dated European bond yields and widen spreads for both Peripheral European government debt and Euro Area corporate bonds. Reduce Euro Area Investment Grade to below-benchmark. The Value Is Back In U.S. High-Yield One of our key themes for 2017 is that the uptrend in the U.S. High-Yield default rate is due for a pause.3 With the first quarter of the year nearly complete, all the indicators that make up our U.S. Default Rate Model are showing noticeable improvement (Chart 11). Interest coverage remains elevated A strong U.S. Manufacturing PMI points to a rebound in after-tax cash flow Lending standards have rolled over and are now just barely in "net tightening" territory An improving sales/inventory ratio portends a return to positive industrial production growth Job cut announcements have fallen back to 2011 levels on a trailing 12-month basis Chart 11Default Rate Indicators Are Showing Improvement Meantime, even though the default outlook continues to improve, junk spreads have actually widened during the past couple of weeks. The average option-adjusted spread on the Bloomberg Barclays U.S. High-Yield index has widened from a low of 344bps up to 378bps (Chart 12). Some of that spread increase is likely attributable to declining oil prices, as energy sector credits have indeed underperformed the overall index. However, the underperformance of the energy sector did start before the sharp drop in oil prices (Chart 12, bottom panel). In any event, our commodity strategists are not expecting the current decline in oil prices to persist and their estimates show that the oil market has recently shifted from an environment of excess supply to one of excess demand. U.S. crude oil inventories are poised to decline later this month and the OPEC / non-OPEC production deal negotiated by the Kingdom of Saudi Arabia and Russia at the end of last year should be met with high compliance.4 If this view is correct, then the energy sector will not drag overall junk spreads wider in the months ahead. The combination of wider junk spreads and an improving default outlook has led to an increase in our preferred gauge of value for high-yield bonds - the default-adjusted spread (Chart 13). The default-adjusted spread is calculated by subtracting an ex-ante estimate of default losses from the average spread on the Bloomberg Barclays U.S. High-Yield index. Chart 12Energy Contributed To Junk Sell-Off Chart 13Some Value Returns To High-Yield To arrive at an estimate of default losses we use the Moody's baseline forecast for the default rate and our own forecast for the recovery rate based on the historical relationship between recoveries and defaults. With the release of February's default report, the Moody's baseline default rate forecast fell to 3.14% for the next 12 months. Based on this forecast, we estimate that the recovery rate will be 44%. Combining the default and recovery rate forecasts gives an estimate for default losses of 3.14% x (1- 0.44) = 176bps for the next 12 months. Since the average option-adjusted spread of the Bloomberg Barclays U.S. High-Yield index is currently 378bps, we calculate the default-adjusted spread to be: 378 bps - 176bps = 202bps. A default-adjusted spread of 202bps is 60bps higher than the reading of 142bps that prevailed just last week. This 60bps spread advantage makes a considerable difference in terms of projected excess returns. Chart 14 shows the relationship between 12-month excess returns and the starting default-adjusted spread. We observe a reasonably strong correlation and note that, using a linear regression, an extra 60bps of spread translates to an extra +251bps of excess return on average over a 12-month period. Chart 1412-Month Excess High-Yield Returns Vs. Ex-Ante Default-Adjusted Spread (2002 - Present) Table 1 provides more detail in terms of what excess returns have historically been associated with different levels of the default-adjusted spread. We see that when the default-adjusted is between 100 bps and 150bps, high-yield bonds earn positive excess returns 64% of the time over the following 12 months. When the default-adjusted spread is between 200bps and 250bps, high-yield earns a positive 12-month excess return 71% of the time. Table 112-Month High-Yield Excess Returns & Ex-Ante Default-Adjusted Spread Given our upbeat assessment of the trend in defaults and a wider junk spread than we have seen in a while, we think it is a good time to upgrade high-yield from neutral to overweight. The key near-term risk to this view is that the Fed will be more hawkish than we anticipate at this week's meeting. If the Fed's median forecast is revised up to four hikes in 2017, then it is possible that the recent bout of junk spread widening will have a bit further to run. However, given still-low inflation readings, the Fed would eventually be forced to back away from its hawkish rhetoric and support renewed spread tightening. In our view, the main risk to upgrading junk this week is that we are a bit too early. Bottom Line: U.S. junk bond spreads have widened even though default rate indicators continue to show improvement. With valuations now looking more attractive, we upgrade U.S. High-Yield from neutral to overweight. Robert Robis, Senior Vice President Global Fixed Income Strategy rrobis@bcaresearch.com Ryan Swift, Vice President U.S. Bond Strategy rswift@bcaresearch.com 1 Please see BCA Global Fixed Income Strategy Weekly Report, "Will The Hawks Walk The Talk?", dated March 7, 2017, available at gfis.bcaresearch.com 2 Last week, we presented the Euro Area months-to-hike measure. We discovered that our measure was not calibrated for the current era of negative interest rates in Europe, and the months-to-hike indicated was actually signaling the "months until interest rates turned positive." We have since corrected our methodology to show the months until one full 25bp rate hike was priced in from the current negative levels, which is what is shown in Chart 7 of this report. This does not change the direction of the months-to-hike indicator, but it does bring forward to date of the first rate hike versus what was presented last week. 3 Please see U.S. Bond Strategy Special Report, "Seven Fixed Income Themes For 2017", dated December 20, 2016, available at usbs.bcaresearch.com 4 Please see Commodity & Energy Strategy Weekly Report, "Fed's Pre-Emptive Hike Will Hit Gold, Not Oil", dated March 9, 2017, available at ces.bcaresearch.com The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Recommendations Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

9 年 9 年間 ago

Buy The Back-Up In Junk Spreads

Highlights Monetary Policy: The Fed will lift rates this week, but will likely leave its median forecast for three hikes this year unchanged. With inflation still below target the Fed has an incentive to take it easy. Curve steepeners, TIPS breakeven wideners and overweight spread product positions will benefit. Duration: The growth outlook is improving and the 10-year Treasury yield could soon move higher, breaking out of its recent trading range. An already elevated economic surprise index should not be a deterrent. High-Yield: Junk spreads have widened even though default rate indicators continue to show improvement. With valuations now looking more attractive, we upgrade high-yield from neutral to overweight. Feature Chart 1How Much Hawkishness ##br##Can Markets Take? In early November, just prior to the U.S. election, money markets were still only discounting one rate hike before the end of 2017. The Fed has already raised rates once since then and the market is now almost priced for another three hikes before year-end (Chart 1). Encouragingly, financial markets digested the shift up to two 2017 rate hikes without much of a hiccup - the yield curve steepened, TIPS breakevens widened and junk spreads tightened - but the journey from two to three hikes has not gone down quite as easily (Chart 1, bottom panel). The yield curve has now started to flatten, breakevens have leveled off and junk spreads have edged wider. The worry is that a further shift in expectations - from three to four hikes in 2017 - might cause markets to choke. Fed Will Take It Slow Markets are already priced for a rate hike at this week's FOMC meeting along with no change to the Fed's median forecast for three hikes in 2017. As such, we would not expect much of a market reaction if that outcome is delivered. If the Fed were to increase its median forecast from three to four hikes in 2017, then we would anticipate at least some tightening of financial conditions. In other words, we would expect the yield curve to flatten, TIPS breakevens to narrow, the dollar to strengthen and credit spreads to widen. As we have written several times,1 with core inflation and TIPS breakevens still below target, the Fed must ensure that the economic recovery continues. It will therefore be quick to back away from any nascent hawkishness if financial conditions start to tighten. With markets already showing some signs of stress, we expect the Fed to err on the side of caution this week. This means the Fed will lift rates, but also leave the median forecast of three 2017 rate hikes unchanged. This notion that the Fed should be lifting rates, but only very slowly, is confirmed by our Fed Monitor (Chart 2). The Fed Monitor is a composite of 32 indicators that track the evolution of U.S. economic growth, inflation pressures and financial market conditions. Historically, a positive reading from the monitor has coincided with rate hikes, and vice versa. Chart 2BCA Fed Monitor Suggests A Slow Pace Of Rate Hikes The Fed Monitor just recently moved above zero, suggesting that only modestly tighter monetary policy is required. As an aside, we view the strongly positive readings from the Fed Monitor in 2011 and 2012 as anomalous and an artifact of the zero-lower-bound on interest rates. Since interest rates could not be lowered as much as would have been necessary (according to the Fed Monitor) in 2009, they also could not be raised as quickly as the monitor suggested in 2011. With the base effects from the financial crisis now out of the data, the Fed Monitor should go back to providing a useful signal about the future course of monetary policy. Chart 3BCA Fed Monitor Components We gain further insight from splitting the Fed Monitor into its three key components: growth, inflation and financial conditions (Chart 3). The growth component has accelerated strongly into positive territory but the inflation component still suggests that an easy policy stance is required. Financial conditions are also consistent with modest Fed tightening but have ticked down in recent weeks as the market has discounted a more rapid pace of hikes. Judging from the prior two cycles, an acceleration of the inflation component will be necessary for the Fed to deliver on its current expected path of rate hikes. While the Fed has sometimes started to lift rates with the inflation component below zero, that component has always surged into positive territory soon after hikes began (Chart 3, panel 2). While economic growth is accelerating, below-target inflation means that the Fed must continue to nurture the economic recovery. Investors should position for a steeper curve, wider TIPS breakevens and tighter credit spreads until inflationary pressures are more pronounced. This means at least until long-maturity TIPS breakevens reach the 2.4% to 2.5% range and core PCE inflation is firmly anchored around 2%. Bottom Line: The Fed will lift rates this week, but will likely leave its median forecast for three hikes this year unchanged. With inflation still below target the Fed has an incentive to take it easy. Curve steepeners, TIPS breakeven wideners and overweight spread product positions will benefit. Consolidation Complete? The 10-year Treasury yield has been stuck in a tight range below 2.6% since mid-December (Chart 4), but recent trends in the economic data suggest that it could be on the verge of breaking through this key resistance level. Economic surprises are positively correlated with changes in the 10-year Treasury yield and currently appear extended (Chart 4, bottom panel). While not a mean-reverting series by construction, economic surprises tend to follow a mean reverting pattern because investors revise their expectations higher as the economic data outperform. Eventually, expectations are bound to become excessive and the series will mean revert. However, we have found that economic surprises are usually first reflected in Treasury yields. In fact, changes in the 10-year Treasury yield tend to lead the economic surprise index by several weeks. This means that stagnant yields during the past few months have already foreshadowed a reversal in the surprise index. In other words, some mean reversion in economic surprises is already in the price and should not prevent yields from rising in the coming weeks. More important is that economic growth should be sustainably above trend on a 6-12 month horizon. This will continue to put upward pressure on inflation and ensure that the Fed remains in a rate hike cycle. Judging from recent data, not only is growth sustainably above trend, but it is probably even accelerating. Last week's February employment report showed that nonfarm payrolls rose by 235k, the second consecutive month of gains above 200k. The rate of change of employment growth is now threatening to reverse the downtrend that started in early 2015, and aggregate hours worked have accelerated suggesting that GDP growth will be strong in Q1 (Chart 5). Chart 410-Year Yield Facing Resistance Chart 5Labor Market Points To Stronger Growth... Financial conditions are also supportive of a further acceleration in growth. We found that the financial conditions component of our Fed Monitor provides a strong indication of near-term trends in GDP growth (Chart 6). This highlights that growth should be strong during the next few months but also that the Fed must respond to any tightening in financial conditions if it wants growth to remain robust. Chart 6...So Do Financial Conditions Bottom Line: The growth outlook is improving and the 10-year Treasury yield could soon move higher, breaking out of its recent trading range. An already elevated economic surprise index should not be a deterrent. The Value Is Back In High-Yield One of our key themes for 2017 is that the uptrend in the high-yield default rate is due for a pause.2 With the first quarter of the year nearly complete, all the indicators that make up our Default Rate Model are showing noticeable improvement (Chart 7). Chart 7Default Rate Indicators Are Showing Improvement Interest coverage remains elevated A strong Manufacturing PMI points to a rebound in after-tax cash flow Lending standards have rolled over and are now just barely in "net tightening" territory An improving sales/inventory ratio portends a return to positive industrial production growth Job cut announcements have fallen back to 2011 levels on a trailing 12-month basis Meantime, even though the default outlook continues to improve, junk spreads have actually widened during the past couple of weeks. The average option-adjusted spread on the Bloomberg Barclays High-Yield index has widened from a low of 344 basis points up to 378 bps (Chart 8). Some of that spread increase is likely attributable to declining oil prices, as energy sector credits have indeed underperformed the overall index. However, the underperformance of the energy sector also started before the sharp drop in oil prices (Chart 8, bottom panel). In any event, our commodity strategists are not expecting the current decline in oil prices to persist and their estimates show that the oil market has recently shifted from an environment of excess supply to one of excess demand. U.S. crude oil inventories are poised to decline later this month and the OPEC / non-OPEC production deal negotiated by the Kingdom of Saudi Arabia and Russia at the end of last year should be met with high compliance.3 If this view is correct, then the energy sector will not drag overall junk spreads wider in the months ahead. The combination of wider junk spreads and an improving default outlook has led to an increase in our preferred gauge of value for high-yield bonds - the default-adjusted spread (Chart 9). The default-adjusted spread is calculated by subtracting an ex-ante estimate of default losses from the average spread on the Bloomberg Barclays High-Yield index. Chart 8Energy Contributed To Junk Sell-Off Chart 9Some Value Returns To High-Yield To arrive at an estimate of default losses we use the Moody's baseline forecast for the default rate and our own forecast for the recovery rate based on the historical relationship between recoveries and defaults. With the release of February's default report, the Moody's baseline default rate forecast fell to 3.14% for the next 12 months. Based on this forecast we estimate that the recovery rate will be 44%. Combining the default and recovery rate forecasts gives an estimate for default losses of 3.14% x (1- 0.44) = 176 bps for the next 12 months. Since the average option-adjusted spread of the Bloomberg Barclays High-Yield index is currently 378 bps, we calculate the default-adjusted spread to be: 378 bps - 176 bps = 202 bps. A default-adjusted spread of 202 bps is 60 bps higher than the reading of 142 bps that prevailed just last week. This 60 bps spread advantage makes a considerable difference in terms of projected excess returns. Chart 10 shows the relationship between 12-month excess returns and the starting default-adjusted spread. We observe a reasonably strong correlation and note that, using a linear regression, an extra 60 bps of spread translates to an extra +251 bps of excess return on average over a 12-month period. Chart 1012-Month Excess High-Yield Returns Vs. ##br##Ex-Ante Default-Adjusted Spread (2002 - Present) Table 1 provides more detail in terms of what excess returns have historically been associated with different levels of the default-adjusted spread. We see that when the default-adjusted is between 100 bps and 150 bps, high-yield bonds earn positive excess returns 64% of the time over the following 12 months. When the default-adjusted spread is between 200 bps and 250 bps, high-yield earns a positive 12-month excess return 71% of the time. Table 112-Month High-Yield Excess Returns & Ex-Ante Default-Adjusted Spread Given our upbeat assessment of the trend in defaults and a wider junk spread than we have seen in a while, we think it is a good time to upgrade high-yield from neutral to overweight. The key near-term risk to this view is that the Fed will be more hawkish than we anticipate at this week's meeting. If the Fed's median forecast is revised up to four hikes in 2017, then it is possible that the recent bout of junk spread widening will have a bit further to run. However, given still-low inflation readings, the Fed would eventually be forced to back away from its hawkish rhetoric and support renewed spread tightening. In our view, the main risk to upgrading junk this week is that we are a bit too early. Bottom Line: Junk spreads have widened even though default rate indicators continue to show improvement. With valuations now looking more attractive, we upgrade high-yield from neutral to overweight. Ryan Swift, Vice President U.S. Bond Strategy rswift@bcaresearch.com 1 Please see U.S. Bond Strategy Weekly Report, "Inflation: More Fire Than Ice, But Don't Sound The Alarm", dated January 24, 2017, available at usbs.bcaresearch.com 2 Please see U.S. Bond Strategy Special Report, "Seven Fixed Income Themes For 2017", dated December 20, 2016, available at usbs.bcaresearch.com 3 Please see Commodity & Energy Strategy Weekly Report, "Fed's Pre-Emptive Hike Will Hit Gold, Not Oil", dated March 9, 2017, available at ces.bcaresearch.com Fixed Income Sector Performance Recommended Portfolio Specification

9 年 9 年間 ago

How Expensive Are U.S. Stocks?

Highlights U.S. equity valuations are historically high, based on a variety of metrics. However, relative to competing assets and global equity peers, U.S. stock valuations are not an extreme. For U.S.-based investors, our upbeat view on the U.S. dollar implies that efforts to diversify globally may come up short. The Fed will allow its Agency bond and MBS portfolios to run off starting in 2018, but it is much more uncertain whether it will ever cease the reinvestment of its Treasury holdings. Feature The S&P 500 remains near record highs, despite a modest setback last week. And the only period when stocks were more expensive was during the halcyon days of the dot-com bubble. Have stock prices outpaced fundamentals, and if so, how much of a risk does this present over the cyclical horizon? And should U.S. investors look further afield than domestic markets for a relative deal? On a historical basis, it is hard to argue that U.S. equities are anything other than expensive. A preferred valuation metric is the cyclically adjusted P/E ratio (CAPE), see Chart 1. Based on this metric, stocks are expensive, trading at their highest valuation outside of the dot-com bubble. However, valuing equities is a complicated issue, and the CAPE is not without its weaknesses. Examining a broad array of valuation indicators provides a slightly different message; U.S. stocks are expensive in absolute terms based on historic relationships, but are less stretched relative to both other asset classes and other equity indexes. Expensive, But... Our BCA valuation index captures the message from a broad range of metrics in one gauge (Chart 2). The valuation index was constructed using 11 different measures in an attempt to approach valuation from multiple angles. Decomposing the index into its three major components - earnings, balance sheet metrics and yield - show that stocks prices are well into expensive territory in absolute terms based on traditional fundamentals: Chart 1(Part I) U.S. Stocks Are Expensive ##br##Relative To History Chart 2(Part II) U.S. Stocks Are Expensive Relative ##br##To History Earnings Group: There are five inputs to the earnings component of our valuation indicator, including trailing price/earnings ratio, price/sales, market cap as a share of GDP. The second panel of Chart 2 shows that the aggregate of the Earnings Group indicators sits at historical highs, excluding the tech bubble. Balance Sheet Metrics: This component includes measure of the market value of equities relative to corporate net worth, both using market value (replacement cost) and historical cost. This measure of valuation has the same profile as the Earnings Group. Yield Group: The yield group compares the price of stocks to interest rates, nominal and real, government and corporate. Of the three groups, it is this Yield Group that gives a less expensive reading on equities (bottom panel of Chart 2). Overall, the Valuation Indicator is already well into "overvalued territory". There is only one episode since 1970 when the indicator has reached a significantly more extreme reading (the dot-com bubble). ...Not So On A Relative Basis Stocks are expensive on an absolute basis, but are far more appealing in relative terms. The current earnings yield on stocks is well above the real corporate bond yield and corporate bond spreads are historically very tight, despite the erosion in balance sheet health (our corporate health monitor has been deteriorating for several months). And compared to housing returns, stocks look downright cheap (Chart 3). Within the U.S., we expect stocks to be the biggest beneficiary of investment flows in the next year or two, in part because equity market value is the most appealing. Meanwhile, relative to global peers, U.S. equities valuations have been climbing since 2009 (Charts 4 and Chart 5). This eight-year rise in valuations now leaves U.S. P/Es at the higher end of the historical range relative to G10 ex-U.S. equities. U.S. stocks are especially expensive relative to Japanese equities. In any case, standard valuation measures have always been lower in Japan, with the exception of price-forward earnings. As our Bank Credit Analyst monthly publication points out, Japanese companies generally have a much higher interest coverage ratio compared to Corporate America. Nonetheless, they tend to come up short in terms of profitability. Operating margins in the U.S. have typically been double that of Japan. Japan's return-on-equity (RoE) has been dismal because of low levels of corporate leverage and loads of low-yielding cash sitting on balance sheets. Nonetheless, the valuation gap is at an extreme, with Japanese equities appearing to be a screaming value relative to U.S. stocks. Chart 3Stocks Look Less Expensive Relative To Competing Assets Chart 4(Part I) U.S. Outperformance Phase Can Continue Chart 5(Part II) U.S. Outperformance Phase Can Continue A similar, albeit less extreme, valuation case can be made for European stocks relative to the U.S. Eurozone stocks have also almost always traded at a discount to U.S. equities and this continues to be the case. Stocks have gotten even more expensive, more quickly, in the U.S. over the past year. But relative valuations are not near historic extremes. Tack on the fact that BCA's view is that the dollar will continue to appreciate over the next six-twelve months. For U.S.-based investors, the coming rise in the domestic currency implies that efforts to diversify globally may come up short, despite better value in major foreign markets. It is important to note that BCA does not view valuation measures as market timing tools. They are only useful at extremes. The bottom line is that U.S. equities are certainly far from cheap, but are not so expensive in relative terms to warrant an allocation change on this basis. We believe that equity returns should outperform Treasuries, cash and high-quality corporate bonds over the next 1-2 years as the bond bear market plays out. The Fed's Balance Sheet: What's Next? Recently we have received a number of client questions about the Fed's balance sheet and how it will evolve during the next few years. In response, we reprint below work from our U.S. Bond Strategy team, who recently addressed the topic in detail. The Fed's Stated Plan The most up-to-date guidance we have received about the Fed's balance sheet plans comes from Janet Yellen's recent Congressional testimony: "The FOMC has annunciated that its longer run goal is to shrink our balance sheet to levels consistent with the efficient and effective implementation of monetary policy. And while our system evolves and I can't put a number on that, I would anticipate a balance sheet that's substantially smaller than at the current time. In addition, we would like our balance sheet to again be primarily Treasury securities, whereas as you pointed out, we have substantial holdings of mortgage-backed securities." From this, and similar statements from other Fed officials, we conclude that the Fed will allow its balance sheet to shrink once the fed funds rate is somewhere in the range of 1% to 1.5%. Surveys also show that the median primary dealer expects the Fed will change its balance sheet policy when the target fed funds rate is 1.38%. As such, and under reasonable assumptions for the pace of rate hikes, we think it is very likely that the Fed will start to let its balance sheet shrink sometime in 2018. MBS First, Treasuries Maybe Later Yellen's statement to Congress also makes clear that the Fed would be more comfortable with a balance sheet that consists entirely of Treasury securities. For this reason, the central bank will start by simply ceasing the reinvestment of its Agency bond and MBS portfolios. At least initially, the Fed will continue to reinvest the proceeds from its maturing Treasury portfolio. Yellen also left open the possibility that reinvestment could be "tapered" rather than just halted altogether. While this is possible, and in fact 70% of primary dealers think that reinvestments will be phased out over time while only 14% think they will be ceased all at once, it seems to us like a needless complication. We expect that reinvestments of Agency bonds and MBS will end all at once sometime in 2018. As for the Fed's holdings of Treasury securities, it is much less clear whether the Fed will allow these balances to run down. In a Report in 2014,1 we describe in detail the differences between the Fed's pre-crisis mode of operation, when bank reserves were scarce, and the Fed's current mode of operation with large bank reserve balances. As of now, the Fed has stated that it intends to eventually drain bank reserves from the system and return to its pre-crisis mode of operation, but there are several possible advantages to running a system with an outsized Fed balance sheet and large bank reserve balances. None other than Ben Bernanke pointed out a few of those reasons in a blog post last fall.2 In our view, the most compelling is that regulatory changes have increased private sector demand for safe, short-maturity, liquid assets in recent years. If the Treasury department is unwilling to supply T-bills in sufficient numbers, then the Fed can supply safe, short-maturity, liquid assets to the market by purchasing long-maturity Treasury securities and replacing them with bank reserves. Chart 6Reserves Can Be Drained Fairly Quickly Of course, we take the Fed at its word when it says that it would like to eventually drain excess bank reserves from the system. But even in that case, the steady growth of currency in circulation means that bank reserves will decline over time even if the Fed keeps the asset side of its balance sheet flat. For example, Chart 6 shows what would happen to bank reserves if the amount of currency in circulation grows at a conservative 5% per year pace, and if the Fed decides to allow its Agency bond and MBS portfolios to run off at the beginning of next year while keeping its Treasury portfolio flat. We assume that MBS runs off the Fed's balance sheet at a pace of $15 billion per month, slightly below the recent pace of MBS reinvestment. During the past three years, the Fed has reinvested between $20bn and $40bn MBS each month with an average monthly reinvestment of $32bn. In this scenario, outstanding bank reserves would decline to zero by the end of 2025. At that point the Fed would have to start adding to its Treasury holdings just to keep pace with the amount of currency in circulation. Bottom Line: While it is very likely that the Fed will allow its Agency bond and MBS portfolios to run off starting in 2018, it is much more uncertain whether it will ever cease the reinvestment of its Treasury holdings. If the Fed does allow its Treasury holdings to run down as well, it will have to start buying Treasuries again before 2025. Lenka Martinek, Vice President U.S. Investment Strategy lenka@bcaresearch.com 1 Please see U.S. Bond Strategy Special Report "Cleaning Up After The 100-Year Flood", dated June 10, 2014, available at usbs.bcaresearch.com. 2 https://www.brookings.edu/blog/ben-bernanke/2016/09/02/should-the-fed-keep-its-balance-sheet-large/

9 年 9 年間 ago

Three Battles That Will Determine The Euro Area's Destiny

Highlights We discuss three "battles" that will shape the investment landscape in the euro area over the remainder of the decade. Battle #1: Reflation Versus Deleveraging - Reflation will triumph over the next 12 months. For the time being, this justifies an overweight position in euro area equities. Beyond then, the outlook is likely to darken. Battle #2: Hawks Versus Doves - The doves will win. Germany will reluctantly accept an overheated economy and higher inflation. Stay short the euro. Battle #3: Globalists Versus Populists - Marine Le Pen will lose this year's election, but Europe's populist parties will finally gain the upper hand by the end of the decade. Buy gold as a long-term hedge. Feature Market Update Global equities are technically overbought in the short term, but the longer-term cyclical (12-month) trend remains to the upside. Chart 1 illustrates the "reflation trade" in a nutshell. The Citigroup global economic and inflation surprise indices have surged and now stand at their highest combined level in the 14-year history of the series. While tracking estimates for Q1 U.S. GDP growth have fallen, this is mainly because of negative contributions from government spending, net exports, and inventories. Taken together, these three factors have shaved about 1.4 percentage points off of Q1 growth according to the Atlanta Fed's GDPNow model (Chart 2). Private final domestic demand is still growing at a reasonably robust 2.6% pace, and forward-looking indicators such as the ISM indices suggest that this number could rise over the next few quarters. Chart 1The Reflation Trade In One Chart Chart 2Underlying U.S. Growth Is Still Healthy As such, it is not too surprising that U.S. equities have had little trouble digesting the prospect of a March Fed rate hike. The market is still pricing in less than three rate increases this calendar year. Four hikes would not be out of the question. Investors should remain positioned for a stronger dollar and higher Treasury yields. We continue to favor higher beta developed markets such as the euro area and Japan over the U.S. on a currency-hedged basis. The Battle For Europe History is often shaped by great battles. Sometimes these are of the military variety. But often they transcend physical conflict, pitting competing ideas, interests, and trends against one another. In the remainder of this week's report, we discuss three economic and political battles that will determine Europe's fortunes over the next 12 months and beyond. Battle #1: Reflation Versus Deleveraging The euro area grew faster than the U.S. in 2016, the first time this has happened since 2008. While the U.S. is likely to resume pole position in 2017, we still expect the euro area economy to expand at an above-trend pace. That should be enough to keep unemployment on a downward trajectory. The euro area economic surprise index remains in positive territory. The composite PMI rose to 56 in February - the highest level since April 2011 - with the forward-looking "new orders" component hitting new cyclical highs. Capital goods orders continue to trend higher, which bodes well for investment spending over the coming months (Chart 3). In addition, private-sector credit growth has sped up to the fastest pace since the 2008-09 financial crisis (Chart 4). All this is good news for the region. Investors should overweight euro area equities on a currency-hedged basis over the next 12 months. Chart 3Euro Area Growth Holding Up Well Chart 4Euro Area: Accelerating Private-Sector ##br##Credit Growth Beyond then, things look murkier. The ECB's Bank Lending Standards survey showed a modest tightening in lending standards for business loans in Q4 of 2016 (Chart 5). Private-sector debt levels also remain elevated across the region, which is likely to dampen credit demand (Chart 6). Both of these factors suggest that loan growth could begin to moderate later this year. Chart 5Slight Tightening In Lending Standards ##br##For Business Loans And Mortgages In Q4 Of 2016 Chart 6Still A Lot Of Debt If the positive impulse from rising credit growth does begin to fade, GDP growth will fall off. Whether that proves to be just another run-of-the-mill "mid-cycle slowdown" or something more nefarious will depend on the policy response. On the fiscal side, the period of extended austerity has ended. The fiscal thrust in the euro area turned positive last year, the first time this has happened since 2010. The European Commission is advising member states to loosen fiscal policy further this year, but the governments themselves are targeting a modest tightening (Chart 7). With a slew of elections slated for this year, budget overruns will be hard to avoid. Nevertheless, barring a significant economic slowdown, no major European economy is likely to launch a large fiscal stimulus program anytime soon. Thus, while fiscal policy will not be a drag on growth, it will not provide much of a tailwind either. Chart 7European Commission Recommending Greater Fiscal Expansion This puts the ball back in the ECB's court. As we discuss next, monetary policy is likely to stay highly accommodative. That should help extend the cyclical recovery into 2018. Battle #2: Hawks Versus Doves Jean Claude Trichet's decision to raise rates in 2011 would have gone down as the most disastrous blunder the ECB ever made, were it not for his even more disastrous decision to raise rates in 2008. Mario Draghi has gone out of his way to avoid repeating the mistakes of his predecessor. Nevertheless, the risk is that the improving growth backdrop instills a false sense of complacency. There is no doubt that Draghi has become more confident about the economic outlook. The ECB revised up its growth and inflation projections for 2017-18 at this week's meeting and signaled that it was unlikely to extend its targeted longer-term refinancing operations, or TLTROs. The ECB is also likely to further reduce the value of its monthly asset purchases in 2018 with a view towards phasing them out completely by the end of that year. It is possible that these steps could trigger a "taper tantrum" in European government debt markets of the sort the U.S. experienced in 2013. If that were to happen, we would see it as a buying opportunity. As Draghi stressed during his press conference, wage growth is anemic. Without faster wage growth, inflationary pressures will remain muted. Granted, euro area headline inflation reached 2.0% in February. However, this was mainly the result of base effects stemming from higher food and energy prices. Our expectation is that headline inflation will fall back close to 1% by the end of the year. This is where core inflation currently stands. One should also keep in mind that the trade-weighted euro has depreciated by 8% since mid-2014 (Chart 8). To the extent that a weaker euro has put upward pressure on import prices, this has caused core inflation to be higher than it would otherwise have been. In contrast, the trade-weighted U.S. dollar has appreciated by 24% over this period. Yet, despite the diverging path between the two currencies, core inflation in the euro area remains noticeably lower than in the U.S. This is true even if one excludes housing costs from the U.S. CPI in order to make it more comparable to the European estimate of inflation. Excluding shelter, U.S. core inflation is currently 43 basis points higher than in the euro area (Chart 9). The point is that the Fed is much further along the path to monetary policy normalization than the ECB. Chart 8A Stronger Dollar Has Restrained U.S. Inflation... Chart 9...Yet Core Inflation In The U.S. ##br##Is Still Higher, Even Excluding Housing If that were all to the story, it would be enough to justify the ECB's wait-and-see approach. But there is so much more. Start with the fact that the euro area's poor demographics, high debt levels, and dysfunctional institutions all imply that the neutral rate - the interest rate consistent with full employment - is lower there than in the U.S. How does one ensure that real rates can fall to a low enough level in the event of an economic slowdown? One solution is to target a higher inflation rate. If inflation is running at 1% going into a recession, it might be impossible to bring real rates down much below -1%. But if inflation is running at 3%, real rates can fall to as low as -3%. This implies that the ECB should actually target a higher inflation rate than the Fed. Then there are the internal constraints imposed by the common currency. Countries with flexible exchange rates can adjust to adverse economic shocks by letting their currencies depreciate. That is not possible within the euro area. If one or a few countries in the region are suffering while others are not, the unlucky ones have to engineer an "internal devaluation." This requires that wages and prices in the ill-fated countries decline in relation to those in the better-performing ones. However, if inflation is already low in the latter, outright deflation may be necessary in the former, something that only a deep recession can achieve. The travails experienced by the peripheral countries over the past eight years brought home this lesson in stark and painful terms. Will Germany accept higher inflation? There is little in its recent history to suggest that it won't. Mario Draghi was not the odds-on favorite to become ECB president. That job was supposed to go to Axel Weber, the former president of the Bundesbank. Weber met with Angela Merkel on February 10, 2011. During this meeting with the chancellor, he made it clear that he did not support the ECB's emergency bond buying. Merkel balked and so the next day Weber tendered his resignation. Six months after that, ECB board member and uber-hawk Jürgen Stark quit, leaving the ECB more firmly in the control of the doves.1 Chart 10Germans Turning Radically Europhile Merkel's preference for a less hawkish ECB leadership wasn't solely based on altruistic feelings towards her European compatriots. Politically, Merkel knew full well that Germany would be blamed for the breakup of the euro area. Economically, German taxpayers also stood to lose a lot from a breakup. It is easy to forget now, but Germany spent 8% of GDP during the global financial crisis on bailing out its own banks. All that effort would have been for naught if German banks had been forced to write off billions of euros in loans that they had extended to peripheral Europe. Critically, the demise of the euro would have also saddled German exporters with a much more expensive Deutsche Mark, thus blowing a hole through the country's gargantuan current account surplus. The calculus has not changed much over the last six years. Germany may not welcome higher inflation, but the alternative is much worse. If anything, the polls suggest that German voters have become even more Europhile since the euro crisis ended (Chart 10). This gives Draghi even more free rein. For investors, this implies that the ECB is unlikely to raise rates for the next two years, and perhaps not until the end of the decade. As inflation expectations across the euro area drift higher, real rates will fall. This will push down the value of the euro. We expect EUR/USD to approach parity over the course of this year. Battle #3: Globalists Versus Populists First Brexit, then Trump, and now Le Pen? The spread between French and German 10-year government bond yields briefly touched 68 basis points in February, the highest level since the euro crisis (Chart 11). While the spread has edged down since then, investors remain on edge. Betting markets are currently assigning a one-in-three chance that Le Pen will become president, close to the odds that they were giving Donald Trump before his surprise victory (Chart 12). Chart 11Investors Worried About The Coming ##br##French Election Chart 12Will Le Pen Rule? Wanna Bet? There is little doubt that populism is in a secular "bull market." However, that doesn't mean that every populist politician is going to win every single election. For all their faults, U.S. nationwide presidential election polls were not that far off the mark. The RealClearPolitics average had Clinton up by 3.2% going into the election. She won by 2.1 points. Where the polls fell flat was at the state level. They completely underestimated Trump support in the Rust Belt states of Pennsylvania, Ohio, Michigan, and Wisconsin. That's not an issue in France, where the presidential vote is tallied at the national level. Le Pen currently trails Macron by 26 percentage points in a head-to-head contest (Chart 13). It is highly unlikely that she will be able to close this gap between now and May 7th, the date of the second round of the Presidential contest. The only way that Le Pen could win is if one of the two leftist candidates drops out.2 However, given the animosity between Benoit Hamon and Jean-Luc Mélenchon, that is almost inconceivable. And even if that did occur, the odds would still favor Macron slipping into the final round. As such, investors should downplay risks of a populist uprising this year. Beyond then, things are likely to get messier. At some point, Europe will face another downturn, either of its own doing or the result of an external shock. Many voters have been reluctant to vote for populist leaders out of fear that the ensuing economic turmoil could leave them out of a job. But if they have already lost their jobs, that reason goes away. Chart 14 shows the strong correlation between unemployment in various French départements, and support for Marine Le Pen's National Front. If French unemployment rises, her support is likely to increase as well. The same goes for other European countries. Chart 13Macron Leads Le Pen By A Mile Chart 14Higher Unemployment Would Benefit Le Pen In addition, worries about large-scale immigration from outside Europe will continue to work to the advantage of populist leaders. Recent immigrants and their children have sometimes struggled to integrate into European society. This has manifested itself in the form of low labor participation rates, poor educational achievement, elevated involvement in criminal activity, and high welfare usage. The problem has been especially acute in European countries with very generous welfare states (Chart 15). Chart 15Many Immigrants To Europe Are Lagging Behind The reaction of establishment parties to mounting concerns about immigration has been completely counterproductive. Rather than acknowledging the problems, they have sought to censor uncomfortable "hatefacts" and stage show trials of populist leaders - such as the one Marine Le Pen will likely be subjected to for her alleged crime of tweeting graphic photos of terrorist atrocities. This strategy will backfire and the result will be a wave of populist victories towards the end of the decade. With that in mind, investors should consider buying some gold as a long-term hedge. Peter Berezin, Senior Vice President Global Investment Strategy peterb@bcaresearch.com 1 Please see BCA Geopolitical Strategy, “Europe: Game Was Changed A Long Time Ago,” in a Monthly Report, “Fortuna And Policymakers,” dated October 2012, available at gps.bcaresearch.com. 2 Please see BCA Geopolitical Strategy, “Europe – Election Update, France,” in a Weekly Report, “Donald Trump Is Who We Thought He Was,” dated March 8, 2017, available at gps.bcaresearch.com. Strategy & Market Trends Tactical Trades Strategic Recommendations Closed Trades

9 年 9 年間 ago

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