Indexology^® Blog

The yield-to-worst of the S&P/BGCantor Current 10 Year U.S. Treasury Index ended the week on Friday, June 19, 2015, 12 bps lower, at 2.26%.  Concerns over Greek debt financing with the European Union led investors to the safety of U.S. Treasuries.  Up to that Friday, the index had returned -1.11% MTD, recovering a bit after losing as much as 3.13% MTD as of June 10, 2015.   Year-to-date, the index has returned 0.48%.  The U.S. 10-year Treasury bond yield started this week higher (on June 22, 2015) at 2.3%, as a new proposal by Greek Prime Minister Alexis Tsipras has put the negotiations back on track and given optimism to an eventual settlement before the June 30, 2015, deadline.

The pickup in Treasuries last week also helped corporate bonds, as the yield-to-worst of the S&P U.S. Investment Grade Corporate Bond Index moved lower last week by 6 bps, half of the movement by Treasuries.  The pace of issuance has increased since May, as issuance continued throughout the week, with notable names such as Baxalta (USD 5 billion), Cardinal Health (USD 1.5 billion), Energy Transfer (USD 3 billion), IBRD (USD 3.5 billion), SoCal Gas (USD 600 million), and Union Pacific (USD 700 million) coming to market.  The index recouped its losses throughout the week and closed June 19, 2015, returning -1.2% MTD and -0.11% YTD.

Like the investment-grade index, the yield-to-worst of the S&P U.S. High Yield Corporate Bond Index moved lower by 5 bps to 6.41% for the week, as of June 19, 2015.  The slight improvement in performance did not curb the outflows from high-yield funds that continued, as the third week of June outpaced the prior two.  The past two weeks had seen a total of USD 5.5 billion of outflow.  The index was returning -0.92% MTD and 3.85% YTD this past Friday.

Following in the shadow of its credit cousin, the S&P/LSTA U.S. Leveraged Loan 100 Index had lost 0.63% MTD, while returning 2.0% YTD as of June 21, 2015.  Continued volatility and fund outflow in high-yield bonds and modest outflows from loan funds have contributed to the index’s current weakness.  The yield-to-maturity of the index was 4.96% on the same date, up 15 basis points from the beginning of the month’s 4.81%.

Two recent data points – existing home sales and mortgage debt outstanding – point to continued strength in the housing recovery.

May total existing home sales, including single family homes, town houses and condominiums, were 5.35 million, up 5.1% and the highest figure since November 2009. Sales of single family homes were 4.73 million, 5.6% higher than April and 9.7% above a year earlier. Inventories crept up slight and months supply was 5.1.  While existing homes continue recent gains, sales of new homes picked up in April. Together these figures point to further gains in the summer months. New Home sales for May will be reported on tomorrow, June 23^rd.  Pending home sales will be reported on June 29th, next Monday. The first chart shows sales of existing single family homes.

Prices have also been advancing. The S&P/Case-Shiller National Home Price index was up 4.1% in the 12 months to March, extending a pattern of gains 35 consecutive months. The next S&P/Case-Shiller report is due on Tuesday, June 30th. Median sales prices reported by the National Association of Realtors show gains as well.

Growth in mortgage debt outstanding has been on a long roller coaster ride, peaking in 2003 and then beginning a long slide into negative territory in 2006. In the last two quarters, growth has barley turned positive.  The peak level of outstanding mortgage debt was $10.69 trillion in the first quarter of 2008; the low point since then was $9.37 trillion in last year’s second quarter. Neither mortgage debt nor national home prices are about to surpass the bubble peaks, but they are headed in the right direction.  The second chart shows year-over-year growth in residential mortgages.

Uncertainty is a four letter word in bond markets and can lead to significant volatility.  The Greek debt dilemma is becoming more and more dire each day.  European government bond markets are reacting with some significant swings.  Germany and the IMF offered Greece a deal last week that would require strict adherence to austerity reforms, only to be harshly criticized by Greek PM Tsipras on Tuesday.  Last Wednesday, Standard & Poor’s Ratings Agency cut Greece’s credit rating one notch to CCC, and indicated a default could happen in the next year if they cannot come to an agreement with their creditors.

The European government bond markets are reacting to the possibility that an agreement may not be made and are choosing to play it safe.   The riskier countries like Spain, Italy and Portugal took a hit on Monday. While the impact of a Greek exit from the Eurozone may be less than it would have been back in 2012, the fear of contagion is still very real. The S&P Spain Sovereign Bond Index yield saw an 11 bps move upward from last week’s close, the S&P Portugal Sovereign Bond Index yield rose 13 bps, and the S&P Italy Sovereign Bond Index yield increased by 13bps.  In contrary, the S&P Germany Sovereign Bond Index tightened 3bps during this time period, along with the flight to safety.  (See table below.)

Greek sovereign debt took the biggest hit and the S&P Greek Sovereign Bond Index widened 148 bps as of Tuesday’s close.  While June 30th is a deadline for Greece’s ultimate fate, European finance ministers are meeting this Thursday to try to resolve the crisis.  For now, the only thing that remains constant in this crisis is that four letter word.

This is the fourth blog in a series on the evolution of Australia’s tax-aware investment management (TAIM) landscape.

The Super System Review of the superannuation industry was completed in mid-2010, a year after the industry crossed the AUD 1.1 trillion asset mark. The Review included an observation that although taxes are often the single biggest expense for most super funds, the Australian fund management industry, unlike its US counterpart, had no obligation to calculate or report after-tax returns for its funds. In addition, the Review noted that there was a near-universal use, by super trustees, of pre-tax market indices as benchmarks against which fund managers were assessed and remunerated. For example, the most commonly used benchmark in large-cap Australian equities is the S&P/ASX 300, a pre-tax benchmark incorporating the 300 largest companies listed on the ASX by float-adjusted market capitalization.  But what of taxes?  As a ‘cost’ of investing shouldn’t they too be incorporated into the evaluation of manager performance?  And if they were, would it change pre-tax performance outcomes when viewed through a post-tax lens?

In accordance with its views, the Review made a recommendation to include an obligation on each super trustee to explicitly consider the tax consequences of its investment strategy, a change adopted into super legislation with effect from 1 July 2013. Due consideration must now be given to the overall investment strategy not just in respect of risk/return, adequate diversification, liquidity and costs, but also the expected tax consequences of investments held by each fund.

One of the more intriguing insights into the effect of taxes on active management was provided by Tad Jeffery and Rob Arnott (co-founder of Research Affiliates) in 1993 in a paper entitled ‘Is Your Alpha Big Enough to Cover Its Taxes?’  To answer this strikingly simple question, Jeffery and Arnott reviewed the historical pre-tax returns of a range of U.S. equity mutual funds, calculating their post-tax equivalent returns.  Their conclusion was that on average, the answer was a resounding ‘no’.  The study, together with a number of subsequent papers, suggested that taxes have a significant negative impact on returns, in the range of 1% to 3% p.a., for the typical active equity manager.  For most managers this tax-related return drag often exceeded the value added by active stock selection and timing.

To learn more about how to weigh your after-tax benefits, visit www.spdji.com/tax-aware.

English speakers have grown to love the German word schadenfreude. But what’s the single word for indifference to the suffering of others? We need to figure this out to describe what’s happening in the US options markets.

For the past decade, European and US options investors have been sympathetic to each other’s pains. When we chart the EURO STOXX 50 Volatility Index (VSTOXX) against the CBOE Volatility Index (VIX), we can see that the VSTOXX has typically been a little higher than VIX, but that these two indices have moved largely in sync.

Something strange has happened, though, in the past year. VSTOXX and VIX have diverged. As VSTOXX has gone up, VIX has stayed near its floor in the low teens.

This is easier to see when we subtract the daily values of VIX from the daily values of VSTOXX and chart the difference. For only the third time in the past decade, the gap between these two measures has hit 15 volatility points.

The chart below shows the same measure, but just over the past 18 months. The trend is unmistakable.

Why this decoupling? One explanation I have heard is that investors see the troubles in Greece more as a political crisis than a financial one. Financial crises, such as the one that rocked the world in 2008, tend to more directly affect financial institutions that span multiple regions. Political crises, on the other hand, are less likely to spill over borders. Or so the theory says. Personally, I have difficulty seeing the difference between the two types of crises in this case.