Indexology^® Blog

Last week India witnessed a historic event at the declaration of its 16th Lok Sabha election results. After a span of over 30 years has there been such a majority mandate handed out by the Indian voters who confirmed their need for change.

Equity Markets
The Indian equity market investors greeted the news favourably with the S&P BSE SENSEX crossing the 25000 mark for the first time in the history of Indian stock markets and further recorded as the third-best performer in Asia in dollar terms. To put it more plainly, the S&P BSE SENSEX has had a return of 15% in just the past 5 ½ months, since the start of this year.

Expectations
Eminent leaders of their field, reputed professionals, and renowned market experts have expressed their recommendation on the areas of reforms. Some of the key expectations are lower Inflation, strengthening of the rupee, improving overall growth rates, lowering of the unemployment rate, revival of the investment scenario and a common wish list among many, a boost to infrastructure.

Government Direction
The Government of India, Planning Commission in its Twelfth Five Year Plan (2012–2017) estimated the total investment in infrastructure sectors to be approximately one trillion dollars. The plan outlines new projects and development in airports with three new airports namely Navi Mumbai, Goa and Kannur. Additionally two ports in West Bengal and Andhra Pradesh. Development in railways to build out the Western and Eastern Freight Corridor, the Mumbai Elevated Rail Corridor and the High Speed Corridor. Roads also form an integral part of the developmental plan along with expansion in power and telecommunication.

Given the gamut of plan, funding of these infrastructure projects is critical. There is an expectation of a contribution of nearly 48% by the private sector. A funding gap is already projected in the plan and this is where the scope for inviting investments in this space broadens to provide the necessary boost.

Value Unlocking
Infrastructure can be the catalyst to provide the necessary boost to many sectors that can cumulatively contribute to economic and overall growth for the country. For those who want to avoid timing the markets or lack stock specific insights, index investing enables exposure to the sector and related returns via a rules based approach provided by an independent index provider.

While the euphoria of the elections is now settling down, May 26, 2014 brings in the swearing in of a new Prime Minister and a new government to realize the hope of a change … a change for a better India…” Acche Din Ayenge”( Good days are here to come)

It’s not just because it took 10 years to negotiate with China or is worth $400 billion, but the new deal Gazprom signed to supply 38 billion cubic meters (bcm), which is about the amount NY state uses annually, of natural gas to China each year for the next 30 years may be a major game changer for 3 big reasons.

The first big reason is that this deal may reduce air pollution in China.  That may not only clean the air for breathing but may reduce the erratic weather causing global warming that is spiking agriculture prices  and now possibly food prices.  Since the deal implicitly prices the natural gas China is receiving from Russia at a 25% to 40% discount to the cost of importing liquefied natural gas from overseas, this may not only cause China to use this gas over the rest of the world’s but it may motivate China to more actively replace oil and coal with natural gas as main energy sources. Given natural gas is cleaner, this in turn may reduce pollution. 

The second reason this deal is a big deal is that it may be the catalyst to building natural gas from a local commodity to a global commodity.  If natural gas becomes more standardized and tradable as a global commodity, it may not only reduce pollution by motivating the switch from oil and coal, but it may include specifications within the contracts to set forth guidelines to control pollution. Currently natural gas is the only commodity in the S&P GSCI where the World Production Quantity is determined based on regional (North American) production.  The globalization largely depends on the logistics and technology in order to transport the gas. For example, in 2013 there was news of a U.K. company signing a deal to bring U.S. natural gas to U.K. homes, which may help the U.S. natural gas globalization, but the trick is having the infrastructure in place to execute the trade.  

Last, this deal may open investment opportunities across the energy spectrum. The construction of the pipeline may initially create some direct investment opportunities but as the pipelines start working, it may possibly further open futures markets, at least regionally if not globally, to encourage more production that may grow the entire market.

The U.S. Department of Commerce released data last Friday showing that housing starts in April were up 26.4% from April of last year and 13.2% since March. In a vacuum, you would expect that the market would look favorably on the homebuilder’s market when the amount of homes being built is increasing.

The home building market however continues to underperform as a sector in 2014. YTD the S&P Homebuilders Select Industry Index (TR) (which benchmarks homebuilding, buildings products, home furnishings, home improvement, retail home furnishings, and household appliances) is down -7.86%. Estranged from overall market benchmarks like the S&P 500(TR), which is up 2.14% on the year. Homebuilder returns are even more dismal when compared to leading sectors such as energy exploration and production, as indicated by the S&P Oil & Gas Exploration & Production Select Industry Index (TR) which is up 8.41% YTD.

 A more telling story is the market’s perception of elevated risk regarding the homebuilder’s market moving forward. Market wide credit default swap spreads for the largest investment grade and high yield issuers have continued to tighten in 2014. This is illustrated by the S&P/ISDA U.S 150 Credit Spread Index which has seen highs of over 91bps in January drop down to 51 bps in 2014. Lower spreads indicate market participants are willing to accept lower risk premiums to “insure” the underlying entities.

Credit default spreads in the housing sector have been widening however, up 21 bps in 2014 to 168 bps. Translated, default insurance on a credit with a notional amount of $100,000 would cost $1,689 or 14% more than it did in January. Energy CDS spreads while trading more closely in price to homebuilders have also fallen in 2014 (S&P/ISDA CDS U.S. Energy Select 10: -7 bps).

The homebuilders’ market sector that was once catalyst to driving the U.S. economy with the wide breathe of industries whom benefitted from its success, is underperforming and viewed as increasingly risky compared to its peers, even in lieu of positive growth.

NOTE: One should be mindful to differentiate the homebuilders market from the overall housing market (which can be tracked using S&P/Case-Shiller National Home Price Index).

 “A lot of people were hoping this year would turn out to be a stockpickers’ market, but that has turned out to be anything but the case so far” – Troy Gayeski, partner and senior portfolio manager at SkyBridge.

At the beginning of this year, we indicated that despite a chorus of voices to the contrary, 2014 would not prove to be a “stock-picker’s market”. We also speculated that 2014 might well be the first year in which ETF assets overtake those in hedge funds.

The first prediction was based on the observation that dispersion – a measure of the opportunity set for active management – was at record lows. Combined with dispersion’s historical tendency to change fairly slowly, we anticipated that dispersion would remain low for some time. So far in 2014, it has done:

Source: S&P Dow Jones Indices as of month-end April 2014. Charts provided for illustrative purposes. Past performance is no guarantee of future results.

There are two ways a fund (ETF or otherwise) can gain assets: it can attract new money, or gain new assets through positive returns. Even if hedge funds don’t perform, they may still attract assets; it certainly seems that they have been doing so. On the other hand, the record quarterly flows into hedge funds last quarter were outpaced by assets attracted to ETFs in April alone.

And what of the “stock-pickers” performance? According to today’s Financial Times, so far not so good.

The race is most certainly on…

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.