Indexology^® Blog

Investor’s search for yield continued at the very start of last week’s heavy economic calendar.  The Retail Sales numbers continued the trend of lower yields as the number released (0.1%) was weaker than the 0.4% surveyed.  The news started a process of investor reassessment of economic growth expectations not only domestically but globally.

Year-to-date the yield of the 10-year as measured by the S&P/BGCantor Current 10 Year U.S. Treasury Bond Index is 51 basis points lower closing on Friday at a 2.52%.  To date the rise in interest rates has not materialized as has been expected.  As a result, performance in longer maturity indices has been strong as seen by the year-to-date total return of the S&P/BGCantor 20+ Year U.S. Treasury Bond Index which is 13.2%.

This week the calendar is light as the U.S. heads into a holiday weekend.  Wednesday will be the first release of the week as MBA Mortgage Applications for May 16^th will be released along with the minutes from the FOMC meeting of April 29^th and 30^th.  Initial Jobless Claims (310K, expected), Existing Homes Sales for April (4.69M, exp.) and the conference Board U.S. Leading Index (0.4%, exp.) will follow on Thursday.  Friday morning’s New Home Sales (425K) release will close out the week as the April surveyed number is expected to be stronger than March’s 384K.

The recent mediocre economy and current earnings expectations is reflected in the performance of the S&P 500’s whose total return year-to-date is presently 2.4%.    Continued equity underperformance could keep bond yields lower in the near term continuing the demand for the steady income streams of fixed income products.  Comparing equity returns to the hybrid product of preferreds, which contain components of both equity and debt, the hybrids are returning 9.74% year-to-date as measured by the S&P U.S. Preferred Stock Index.

The continued demand for higher yields can also be seen in the high yield and senior loan markets.  The yield-to-worst of the S&P U.S. Issued High Yield Corporate Bond Index on the year is 42 basis points lower and currently at a 4.97%. Recent demand has been so popular that there is much discussion as to whether these markets are trading “rich” or overvalued.  The total rates of return performance for both the S&P U.S. Issued High Yield Corporate Bond Index and the S&P/LSTA U.S. Leveraged Loan 100 Index on the month are in step at a 0.57% and 0.60% respectively.   Year-to-date these indices do differ, 4.25% for high yield versus 1.75% for senior loans.  Senior Loans have had small but steady increases to date while high yield’s strong February performance (1.92%) has carried the other months.

Activity in the new issue investment grade market has increased along with the lower interest rates.   Multiple maturity deals issued in the primary market by names such as Pfizer, General Electric, Prudential Financial, Toyota Motor Credit, Volkswagen and more have added to investment grade issuance totals.  A number of the fixed rate deals should find their way into the S&P U.S. Issued Investment Grade Corporate Bond Index.  The index has returned 0.97% month-to-date and 5.08% on the year.

Source: S&P Dow Jones Indices, Data as of 5/16/2014, Leveraged Loan data as of 5/18/2014.

The U.S. preferred stock market is exhibiting the qualities of the hybrid equity / bond like structure they are.  Through May 15th, 2014, the S&P U.S. Preferred Stock Index has recorded a year to date total return of 9.61% mirroring more the bond market than the stock market in this low rate environment.  The index is heavily weighted in the financials sector, a sector that has seen a resurgence.  The May 16, 2014 Wall Street Journal article entitled Higher-Yielding Bank Debt Draws Interest highlights the appetite for higher yields including subordinated debt and preferred stock.  The bond like characteristics of preferred stocks seems to be rewarding investors so far in 2014.

As of mid May 2014, the S&P Municipal Bond Index has returned 5.91% as the supply demand imbalance continues.  New issue supply remains comparatively low to relative to past years and munis have been enjoying a flight to quality halo despite the weaknesses shown by Detroit and Puerto Rico.   The S&P 20 Year High Grade Index has erased its 2013 losses and has returned over 13.9% year to date.

Puerto Rico General Obligations tracked in the S&P Municipal Bond Puerto Rico General Obligation Index have rebounded positively in 2014 but may have peaked in recent days as the market has shown little indication of continued forward progress.   The weighted average yield of the index has been hovering around 7.67% and 7.73% for the month to date without a major move in either direction. The Puerto Rico bond market has a long way to go to offset it’s 2013 losses of over 20%.

Source: S&P Dow Jones Indices, LLC. Data as of May 15, 2014.

The recently published research paper on S&P GIVI®: Factor Investing: A Review of the S&P Global Intrinsic Value Index analyzes in detail the source of GIVI returns globally and regionally. S&P GIVI is a multi-factor global index which provides exposure to low volatility and the value factors by removing 30% of the highest beta stocks in each country and weighting the rest of the stocks by their intrinsic value. The case for factor investing has gathered momentum post the 2008 crisis when it became clear that diversification by sector, geography and size was not sufficient and factor diversification was equally essential. S&P GIVI launched in March 2012 and we now have almost two years of live performance data and back tested data for 13 years prior to 2012. Analyzing the live data we see immediately the benefit of low volatility in emerging markets which have seen severe volatility recently (Figure 1). In the US where markets have seen a sharp rise, the drag effect of a low volatility approach is negated by the value tilt which is experiencing a strong uptick (Figure 2).

The full period (2000-2013) Sharpe ratio of the S&P GIVI Global is 0.46 which compares favorably with a Sharpe ratio of 0.17 for the corresponding market capitalization- weighted S&P Global BMI (Figure 3). While the performance gap shrinks when we examine shorter and more recent time periods, the S&P GIVI Global either matches or outperforms the S&P Global BMI during the corresponding time periods. The S&P GIVI Developed clearly outperforms the S&P Global BMI in every time period examined (Figure 4).

The research paper shows the impact of using portfolios in a sequential fashion starting with a portfolio which is 100% intrinsically value weighted and progressively allocating in increments of 10% a portfolio of low beta stocks with the final portfolio being 100% low beta and no allocation to intrinsic value weighting. The most interesting observation was that the S&P GIVI Global matched or outperformed each of these combinations over each time period measured (Figure 5).

S&P GIVI allows investors to invest in two factors simultaneously without worrying about the right allocation mix in a cost efficient manner. Exposure to low volatility and value provides a diversification from regular market capitalization weighted indices, with downside protection in time of downturn and potential for growth in up markets.

Watch the S&P GIVI video now and find out more about GIVI returns globally and regionally. bit.ly/1v9fYHD

The coming week will provide Europeans with a chance to vote in the 2014 EU parliament elections. Nationally and internationally, the contest is viewed as somewhat moot; the majority across the EU will most likely not even vote.

But whilst voters in the EU elections are not voting for members of the ECB or its president Mario Draghi, the European central bank IS directly governed by the laws of the EU parliament. With laws defining a financial transaction tax, bank regulation and a potential banking union all on the immediate agenda for the EU, the outcome may be more important than the minimal degree a low turnout and sparse media coverage implies.

At the time of the last elections (held between 4 and 7 June 2009), the EU exhorted citizens to vote with campaigns with titles such as “How much should we tame financial markets?”. Since then, in price terms, the S&P Europe 350 index of large-cap stocks is up by over two thirds. And, whilst the markets were not “tamed” entirely, volatility has certainly come down:

S&P Europe 350 price return and volatility, May 2009 – May 2014

Source: S&P Dow Jones Indices, May 2014. Charts are provided for illustrative purposes only. Past performance is no guarantee of future results.

Most equity investors would not be disappointed with such returns – including the effects of dividends before tax, the gross total return of the S&P Europe 350 was 100% – but investing is a relative game. If you had decamped to the U.S. markets and the S&P 500 in particular, as many did during the Eurozone crisis, you would have done better.

Source: S&P Dow Jones Indices, May 2014. Tables are provided for illustrative purposes only. Past performance is no guarantee of future results.

More recently, Europe-focused ETFs listed in the U.S. saw large inflows and flows from U.S. investors to European stocks have been tilted in favour of the latter since the new year. Why are those outside Europe now buying in? 

Value is part of the answer: after five years of stellar performance, valuations in the U.S. have risen too; and by a greater extent than their underperforming European equivalents. So by now on most measures of “value” Europe certainly looks “cheaper” than the U.S.

But it is not just U.S. value investors who are attracted. The considerable fillip to the U.S. markets provided by tens of billions of monthly bond purchases by the Fed’s stimulus program looks likely to be wound down by the coming October; interest rates are predicted to rise shortly thereafter. The ECB has so far only provided oral guarantees supporting the Euro (“whatever it takes”). And while the ECB does not look set to make a surprise announcement of anything like the U.S. program; the prospect of deflation has brought on more bullish talk. The ECB has also relied less on signalling their intentions than the Fed, a consequence of which is greater uncertainty.

Judging by the experience of Japan and the U.S., expanded fiscal stimulus in Europe will likely boost the equity markets in its wake.  Those investors who won’t “fight the Fed” – and those flocked to Japan early last year – will be watching Europe closely. It is impossible for us to predict who will do better out of Europe or the U.S. over the next five years. But we can certainly understand why U.S. investors are looking to Europe at present. 

Ultimately, the role and composition of pan-EU institutions impacts the demand from international investors for equity markets in the region.The winners of the 2009 elections, still reeling from a financial crisis, were shortly served a potent cocktail of challenges to the integrity, currency, credit and economic future of the region via the Eurozone crisis. The challenges ahead will hopefully not prove equally testing, but for their impacts on the financial markets alone, these elections may well prove important.