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Equity Markets May Be “Sassy”, But Bond Markets Are The “Cool” Kids On The Block…

China’s Currency Devaluation and Its Impact on the Indian Stock Markets

Investment-Grade Corporate Bonds, Smooth Sailing

Perseverance and Low Vol

Contango Costs Oil Investors 10 Extra Years

Equity Markets May Be “Sassy”, But Bond Markets Are The “Cool” Kids On The Block…

Contributor Image
Heather Mcardle

Director, Fixed Income Indices

S&P Dow Jones Indices

Bond markets may not be the most “sassy” of all the asset classes, but they certainly are a lot “cooler” in light of the global equity sell-off of the last two days.   Bond markets are traditionally known to be less volatile than all of the financial asset classes.  Global stock markets are taking serious hits over concerns that China’s growth is significantly slowing, and the impact this has for the world economy.   Bonds on the other hand, have been relatively stable, and despite a Chinese Yuan devaluation earlier in the month, Chinese sovereign bonds haven’t moved much.

The China S&P China Sovereign Bond Index, an index to track the performance of local-currency denominated sovereign bonds from China, is currently yielding 3.19%, has had 1 year annual returns of 8.49%, and as of today, is trading at the exact same yield as of June 1, 2015.  (Chinese equity volatility began in early June).  Between June 1 and today, this index has yielded between 3.07% – 3.23%, a considerably tight range considering the uncertainty and volatility in the region.  In particular, on the two biggest equity sell-off days globally, this index reacted in a rather “cool” manner:  on Thursday, August 20th, the index yielded 3.21%, was unchanged on Friday, and then tightened to 3.19% as of Monday’s close.  That’s a 3bps change.  Even on the day of the Yuan devaluation, the index widened only 2bps in reaction.

What does this say about Chinese sovereign bond markets?  They have low correlation to the Chinese equity market.  They behave like most other AA rated bonds in terms of lower volatility and “flight to safety” behavior.  Chinese sovereign bonds also have relatively higher yields compared to other AA rated countries.

The S&P Germany Sovereign Bond Index, has reacted similarly over the last few days. The S&P Germany Sovereign Bond Index yielded .20% on Thursday August 20th, tightened only 1bp to .19% on Friday the 21st, and closed Monday at .21%.  Even the S&P Spain Sovereign Bond Index, an index with a higher risk profile than Germany, tightened 1bp from Thursday to Friday, to 1.20% and closed at 1.24% on Monday.  Despite risk profiles, the stability of these indices show the appeal of bond markets in times of global market turmoil.

Capture

The posts on this blog are opinions, not advice. Please read our Disclaimers.

China’s Currency Devaluation and Its Impact on the Indian Stock Markets

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Alka Banerjee

Former Managing Director, Product Management

S&P Dow Jones Indices

Monday’s stock market crash coming on the heels of the US market fall on Friday, August 22nd is creating jitters for investors around the world. However the signals have been around for some time, with many predicting for some time an end to the bull run that US market has enjoyed for the last 6 years leaving valuations at an all-time high and China’s own stock market run up of more than 150% in the last one year.

The devaluation of the Yuan was highly unexpected by market participants, and as a result, the market reaction was very strong and erratic.  Many are once again calling China a “currency manipulator” and fears are rampant that this is a sign of major weakness in the Chinese economy as the authorities are desperate to prop up exports. In the end the devaluation appears to have sent a signal that the Chinese economy is weaker than understood and if the idea was to prop up exports or stocks markets, it has done the opposite. Due to its linkage to the dollar, the Yuan has strengthened substantially over the past year – in relation to most global currencies including many of China’s most important Asian export markets such as Korea, Taiwan and Thailand.  This, along with domestic economic weakening, has created downward pressure on the Yuan relative to the dollar and the Chinese authorities have, in recent months, been actively propping up the currency to maintain stability versus the dollar. In this context, a 4% depreciation of the Yuan versus the dollar seems like a rather modest decline and the intervention may be better described as a minimal effort to stabilize exports as the Yuan remains relatively strong compared to other global currencies.

Chinese currency devaluation is also viewed by some as a desperate effort to shore up its declining stock market. China has the delicate task of managing a slowing economy, an exchange rate made vulnerable by this slowing growth, a depressed stock market and the temptation to keep exchange rates low. Whatever may be rationale for the currency devaluation, the world is extremely worried about a slowdown of the world’s second largest economy and the response has been seen in the global stock market meltdown starting in the US on August 22nd and continuing globally the following Monday.

Examining the direct impact of Chinese currency movements on the Indian economy and stock markets there are several strains immediately visible. A cheaper Yuan makes it even more difficult for Indian exports to compete with Chinese exports as in textiles and apparels. Slowing Chinese economy also means lower commodity prices globally which hurts Indian commodity producers though helps the overall inflation levels to come down. Though the S&P BSE SENSEX has remained relatively flat in the last three months, it succumbed to global fears over the weekend with the SENSEX down 8.5% accompanied by an accompanying sharp fall in the INR. The real impact can be witnessed in the USD version of the SENSEX. The S&P BSE Dollex 30 has fallen 11.9% in the wake of the RS.3 depreciation brought on by the stronger dollar. A weaker rupee reduces the amount FIIs reap on stock market returns giving them less reason to bring in inflows to the Indian market.

Global stock market volatility is expected to remain given the weak Chinese economy and the expectation of an interest rate rise in the US. India’s Reserve bank Governor has assured that they are well prepared to defend the rupee against a further fall with USD 354 billion chest and it is to be noted that the Rupee has not yet slid to its previous low of Rs. 68.80. Consumer price inflation is also under control at least in the immediate term though it remains to be seen if it can be sustained. No doubt falling commodity prices will help contain inflation.

Comparing Indian stock markets to other major emerging markets, the picture is a lot rosier. Looking at chart 3, we see that the Indian Rupee has been holding up better against the US dollar and its stock market performance has also been more stable. The Indian authorities have rushed in to calm fears. While the short term may remain volatile given global fears, in the long term the stronger fundamentals should help the Indian market.

  • India/China – 

performance

  • Select Asian countries ex-China – 

performance 2

Source: Currency quote sourced from Bloomberg; total returns indices in local currency sourced from S&P Dow Jones Indices, from Dec 31, 2014 up to Aug 24, 2015.

Currency code INR CNY USD KRW MYR TWD BRL
Currency description India Rupees Chinese Yuan United States Dollar Korean Won Malaysian Ringgit Taiwan Dollar Brazilian Real

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Investment-Grade Corporate Bonds, Smooth Sailing

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Kevin Horan

Former Director, Fixed Income Indices

S&P Dow Jones Indices

There is an old weather-predicting proverb that goes “red skies at night sailors delight; red skies in the morning sailors take warning.”  Well, there has been a lot of red over the last two mornings, and it has not been in the hot August skies but more so in the global financial markets.  Oil prices, which had recovered from a bad 2014, moved up from the January 2015 support price of USD 50 to a recent high of USD 63 in May.  Since June 30, 2015, the price of oil has dropped from USD 60 to its current level of USD 39.  The drop in the price of oil, in addition to other commodities, has boosted fears of a slowing global economy.

On the back of these fears, safe-haven investments, like government securities, have increased in demand.  The yield-to-worst of the S&P/BGCantor Current 10 Year U.S. Treasury Index dropped 15 bps between Aug. 14-21, 2015, to 2.05% and is now even lower, at 2.03% as of Aug. 24, 2015.  The yield had been as high as 2.49% as recently as June 10, 2015.  The index had a total return of 1.53% for the month of August and 2.94% YTD as of Aug. 24, 2015.

Recent events have highlighted the importance of the credit quality of investment holdings.  The S&P 500® Bond Index is designed to be a corporate-bond counterpart to the S&P 500, which is widely regarded as the best single gauge of large-cap U.S. equities.  The bond index is a broad index that is designed to measure 430 of the 500 equity issuers who have issued debt, and it includes both investment- and high-rated securities.  The majority of the index is investment-grade bonds, with only 7.6% of the issuers rated high yield.  As of Aug. 24, 2015, the worst-performing sector for the month is energy.  Energy makes up 7% of the S&P 500 Investment Grade Corporate Bond Index and 10% of the S&P 500 High Yield Corporate Bond Index

As of Aug. 24, 2015, the overall bond index (S&P 500 Bond Index) has returned 0.39% for the month and 0.30% YTD, while the S&P 500 Investment Grade Corporate Bond Index has returned 0.58% month-to-date and 0.36% YTD, and the S&P 500 High Yield Corporate Bond Index has returned -1.88% for the month and -0.64% YTD.
S&P 500 Bond Index Total Returns

Source: S&P Dow Jones Indices LLC.  Data as of Aug. 24, 2015.  Table is provided for illustrative purposes.  Past performance is no guarantee of future results.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Perseverance and Low Vol

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Fei Mei Chan

Former Director, Core Product Management

S&P Dow Jones Indices

“He conquers who endures.” ~Persius

Weak markets tend to make low volatility indices shine. As a strategy that attenuates the performance of the broader market, the S&P 500 Low Volatility Index had lagged the benchmark S&P 500 by 1.22% from the beginning of 2015 thru July 31. As of last Friday, the tide has shifted in favor of low vol. In the U.S., our low volatility indices for large, mid-, and small-cap stocks all outperformed their benchmarks for 2015 through August 21. Abroad, the S&P BMI International Developed Low Volatility Index has done the same.

Below are the summary performance for a few low volatility indices and their benchmarks.

perserverance and low vol

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Contango Costs Oil Investors 10 Extra Years

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Jodie Gunzberg

Former Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

Headline news on Friday was that oil dropped below $40 per barrel, the lowest since March 3, 2009. It’s bad news for an oil investor to learn 6 1/2 years are wiped out – that is no gain since the bottom of the financial crisis.

Unfortunately, the reality is so much worse than that. The price per barrel of oil is an unrealistic measure for most investors since the oil needs to be stored and that can be costly. Futures contracts are priced to include the storage costs, so according to the theory of storage equation, one is indifferent between buying an oil futures contract or buying physical oil and storing it until the time of expiration of the contract. Needless to say, storing at least 1000 barrels of oil is inconvenient, so most investors prefer futures. Sometimes, returns of futures contracts are more profitable than the spot returns and at other times futures lose more than the spot market. Inventories drive the difference where excess inventory that is expensive to store is losing to a futures investor from a curve condition called contango. The opposite condition, called backwardation, is profitable and happens when there is a shortage so there is no value to storage, and a premium, called convenience yield, is put on owning the commodity immediately.

Obviously right now there is excess oil inventory, but how much is being lost from the term structure of futures as described by the theory of storage equation? It might be more than you think. The answer is shown graphically below where the S&P GSCI Crude Oil Total Return includes the term structure costs from rolling but the S&P GSCI Crude Oil does not. With a quick glance, it is clear that 10 additional years of returns are wiped out from these costs.

Source: S&P Dow Jones Indices. Daily data from 1/6/1990 - 8/21/2015.
Source: S&P Dow Jones Indices. Daily data from 1/6/1990 – 8/21/2015.

At Friday’s close, the S&P GSCI Crude Oil index was at 221.69, the lowest since 3/2/2009 when the level was at 220.05, and it fell 62.1% since its high on June 20, 2014. However, the S&P GSCI Crude Oil Total Return fell 66.3% from its June high to a level of 516.55, its lowest since Oct. 11, 1999 when the index was 508.38. Four percent may not seem like much, and although the difference is small from the backwardation that was present through Nov, 2014 (as shown in the chart below,) again, it is enough to erase an additional 10 years of returns.

Two things are interesting. One is that the current rolling costs are currently only about half of what was observed in the drawdown from July 14, 2008 to Feb. 18, 2009. The other interesting observation is that the huge negative rolling costs don’t exactly correlate with the timing of the drawdowns. It was really in Jan and Feb of 2009, that the roll cost spiked with a 33.5% loss in the total return versus a 10.0% loss in the spot return. It took the inventories over 4 years to deplete with no significant shortage for roughly 6 years as shown in the chart below:

Source: S&P Dow Jones Indices.
Source: S&P Dow Jones Indices.

It is difficult to predict how long this glut will last. However, It may be longer than expected if China decides to use some oil from its (unkown) strategic petroleum reserve as prices rise, and its devalued yuan makes it more expensive to import the oil.

To add to the turmoil, on average when oil is down, it drops 6.9% in a negative month. Historically, gas falls about the same amount, losing 7.0% in a negative oil month. This time unleaded gasoline has held its value relatively well, only dropping about 1/4 of the drop in oil, reducing the benefit to consumers.

From processing issues to labor costs, despite commodity drops, prices seem to be rising for consumers. Check out announcements from: Starbucks about raising prices despite a near 25% drop in coffee this year; the USDA announced rising beef and pork prices despite S&P GSCI Feeder Cattle,  Live Cattle and Lean Hogs losing 8.2%, 12.1% and 22.6%, respectively; some are even reporting bread price increases despite a drop of 14.5% and 21.4% in Chicago and Kansas Wheat. At least chocolate prices are increasing with a the rise in the cocoa commodity price – that is up 5.6% year-to-date. Maybe a little extra serotonin is helping the demand in this otherwise stressful market.

To end this on a sweeter note, many index innovations have been developed to better manage rolling costs from contango. The chart below shows an annualized 10-year comparison of an enhanced rolling strategy that is relatively simple but reduced the loss by half. It also compares a more sophisticated dynamic roll that has lost less than 3%. If diversification and inflation protection are goals, a smarter rolling strategy may be useful for a potentially prolonged term structure in contango.

Rolling

 

 

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.