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Investing in Solutions: Leaders in Finance and Climate

National Credit Default Rates Decreased in December 2013 According to the S&P/Experian Consumer Credit Default Indices

The Yellen Fed

US Economy Finished 2013 Healthier than Ever

Index Investing Did NOT Spike Price; BRENT FELL

Investing in Solutions: Leaders in Finance and Climate

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Alka Banerjee

Managing Director, Product Management

S&P Dow Jones Indices

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This week, I participated in an event at the White House on Women Leaders in Climate Finance and Investment that highlighted the pioneering role women leaders in the finance sector are playing to mainstream climate change into finance and investment decisions.  Women around the world are often the first to feel the effects of climate and at the same time can offer unique perspectives and solutions.

I was privileged to be part of a conversation on “making climate finance work for growth,” where we discussed that a consistent global policy framework on climate change could make implementation of scalable solutions practical and possible. At S&P Dow Jones Indices, we are working to advance these solutions by creating equity indices — tools for investment products like exchange traded funds — which respond to consumer demand for products that help address climate change. We have created specialized indices, such as the global clean energy index, and variations of mainstream indices, such as the S&P U.S. Carbon Efficient index and the S&P/IFCI Emerging Markets Carbon Efficient index that weight companies by their carbon emissions, with higher weights going to lower emitting companies. These indices help investors choose whether to invest in companies with high carbon pollution. Over time, we have seen investor perceptions change from excluding large polluting companies from their portfolios for environmental reasons, to doing so to manage risk, to understanding that companies with progressive environmental standards are poised for more sustainable, long-term growth. We are also seeing some investors seek to completely avoid fossil fuel investment in their portfolios.

The event also included Administration officials such as Presidential advisor John Podesta, Chair of the Council on Environmental Quality Nancy Sutley, Domestic Policy Council Director for Energy and Climate Change  Dan Utech, Ambassador-at-Large for Global Women’s Issues Cathy Russell, and President and CEO of the Overseas Private Investment Corporation Elizabeth Littlefield,  who described  efforts under the President’s Climate Action Plan to make U.S. cities and states more resilient, support good clean energy and clean technology jobs, and help developing countries adapt to climate change and access renewable energy. U.S. Senator Jeanne Shaheen (NH) discussed her energy efficiency legislation, which supports investment in clean energy technologies that help to reduce carbon pollution.

The discussions revealed some key challenges and unique initiatives associated with mainstreaming climate change into finance. For example, Lindene Patton, Chief Climate Product Officer of Zurich Insurance Group, discussed the insurance industry’s role in managing climate risks and a commitment by Zurich to provide climate-smart insurance products and invest up to $1 billion in “green bonds,” which would help address climate change. Nancy Pfund, Founder and Managing Partner of DBL Investors, stated that while many private investments in green energy make good business sense and several have delivered good returns to their investors, the challenge is to attract positive attention from all sectors to the benefits of these options.

The event brought to focus the real desire to make a positive social and environmental impact through investment decisions and showed that women are playing an increasingly crucial role to make this happen.

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

National Credit Default Rates Decreased in December 2013 According to the S&P/Experian Consumer Credit Default Indices

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Dave Guarino

Director, Global Index Communications

S&P Dow Jones Indices

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S&P Dow Jones Indices released the latest results for the S&P/Experian Consumer Credit Default Indices. Data is through December 2013

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

The Yellen Fed

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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The FOMC, the Fed’s monetary policy unit, meets next week on January 28th and 29th. It will be Ben Bernanke’s last meeting and the beginning of Janet Yellen’s leadership of the central bank.  No immediate change in Fed policy is likely – winding down QE3 over the next few months as announced in December will continue, the Fed funds rate target won’t shift from its current zero to 25 basis points and the yield on the ten year Treasury note won’t rise by much.

While there won’t be an immediate shift, the membership of the FOMC will change and a review of the economic outlook and monetary policy is likely at this meeting.  The changes to the FOMC include the usual rotation of the four representatives from among 11 of the 12 regional banks as well as two recently nominated members of the Fed Board of Governors.

What will the new year and new members bring?

Tapering and the end of QE3 are expected in 2014.  The quantitative easing programs were successful in lowering intermediate and long term interest rates and boosting the stock and housing markets. However, with the economy better off than it was a few years ago and questions heard about the additional benefits of further bond buying, this effort is likely to fade away.  Despite fears voiced by some, the program did not create inflation.  In fact, inflation at about 1.5% is below the Fed’s target and deflation is seen by some analysts as a larger worry for 2014.

With the end of QE1-2-3, the Fed’s policy making tools will focus on interest rates, forward guidance or announcements of future policy and possibly some of the Fed’s banking regulations.  The target for the Fed funds rate is likely to stay at zero to 25 basis points well into 2015 if not longer.  This will keep a lid on the yield on the ten year Treasury note, even if economic growth exceeds expectations. The ten year yield can be thought as the average of the ten successive one year returns.  With assurances that the one year returns won’t rise much in the next two or three years, the longer 10 year number is likely to be somewhat contained.

Jawboning – as forward guidance used to be called – is both powerful and hazardous.  For investors and traders, ignoring the Fed is always a risky policy. So, forward guidance of lower interest rates will encourage a rapid market response to bring rates down towards the Fed’s desired levels.  But the Fed is not clairvoyant when it comes to predicting the economy or future policy needs. Sooner or later there will be a moment when the central bank will need to change its forward guidance, change from lower interest rates to higher interest rates.  In the days when watching the Fed was “watch what they do, not what they say,” a policy reversal was accepted, maybe even expected. But if forward guidance is cancelled and reversed, investors are likely to doubt or even ignore future forward guidance.  For now announcing intentions works, but for how long no one knows.

Currently the Fed pays interest on the reserves banks hold at the Fed.  Excess reserves – funds greater than the required level of banks’ reserves – rose sharply during the financial crisis when the Fed began to pay interest on reserves. Whether or to what extent the Fed can influence banks’ reserve positions through the interest rate it pays remains to be seen. However, this is one area that the Fed may look to if the needs of monetary policy shift.

What Next?

Expect a new economic forecast from the upcoming FOMC meeting.  If it is as optimistic as the last one or more so, say goodbye to QE123, expect more focus on the Fed funds rate and a little less interest in forward guidance. The transparency that Ben Bernanke brought won’t change.

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

US Economy Finished 2013 Healthier than Ever

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Bluford Putnam

Managing Director and Chief Economist

CME Group

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The US economy finished 2013 healthier than it has been since the depths of the financial recession in 2008 and 2009.  There were a number of milestones in 2013; many have not been fully appreciated.

First, the US energy production boom has probably adding some 0.5% annually to US real GDP.  US crude oil production and natural gas production are already some 40% higher than 2005-2006 levels.  But what really has given the economy a big assist is the less expensive energy prices compared to global competitors leading to an industrial renaissance as well as the huge build-out of infrastructure to move the new gas and oil to market.  In economics, it is often the case that indirect effects swamp the direct observations, and that is certainly happening with the energy boom.

Second, the hugely positive monetary policy event that occurred at the end 2013 was the change in the Fed’s signaling about the economy.  Even though the US economy has been growing at a steady, if not exciting, pace of +2% real GDP since Q3/2009, the Fed has been telling the world that the economy was so fragile it needed life support and emergency measures.  Our perspective is that this negative message caused much more damage to confidence than any jobs that might have been created by quantitative easing.  The Fed’s negative messaging encouraged corporations to sit on their cash and to be much hesitant to invest and expand than otherwise, while quantitative easing did nothing to help the state and local governments get their finances in order – the sector where the job losses have been concentrated since 2009, which leads us to our next point about the milestones passed in 2013.

Third, fiscal drag diminished markedly in 2013.  Most market analysts do not even realize that about 850,000 government jobs were lost between mid-2009 and mid-2013, mostly from states and local authorities.  This was a huge drag on the economy and was the main reason job growth was not stronger and the unemployment rate lower.   This sector finally stabilized in mid-2013.  And then there is the US federal budget deficit, which was vastly expanded to combat the financial crisis.  The federal budget deficit peaked in FY2009 at $1.4 trillion (approaching 10% of GDP).  For FY2013, the deficit had been cut in half, on the back 8% growth in tax revenues and virtually no growth in expenses.  Progress on reducing the federal budget deficit has been coming much faster than many had thought possible.

Fourth, the biggest hurdle of the past few post-crisis years has been resolved.  Recoveries from financial disasters generally are longer and more difficult than a recovery from a cyclical economic correction, because financial disasters expose fundamental weaknesses in the over-extended balance sheets of nearly every sector of an economy.  The process of deleveraging and rebalancing has taken nearly four years, and now that the process is largely complete, the US economy finished 2013 in the best health it has been since 2003-2006, before the financial crisis.

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only.  The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions.  This report and the information herein should not be considered investment advice or the results of actual market experience.

S&P Dow Jones Indices is an independent third party provider of investable indices.  We do not sponsor, endorse, sell or promote any investment fund or other vehicle that is offered by third parties. The views and opinions of any third party contributor are his/her own and may not necessarily represent the views or opinions of S&P Dow Jones Indices or any of its affiliates.

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

Index Investing Did NOT Spike Price; BRENT FELL

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Maybe the verdict is still undecided for some, but it is hard to look at the evidence and still be questioning the idea that index investing drives underlying commodity prices.   Now that the commodity index rebalance is over and the shift between WTI and Brent is behind, we can examine the impact.  As I mentioned in a prior blog post, Not ALL Weights are EQUAL: Why Brent isn’t Heavier than WTI, there has been a dramatic move out of WTI and into Brent since 2011.  Below is the table:

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

If one follows the logic that prices increase based on index investing, then one would have witnessed falling WTI prices and rising Brent prices.  However, that is not what happened. 

Source: S&P Dow Jones Indices. Data from Jan 2011 to Jan 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.
Source: S&P Dow Jones Indices. Data from Jan 2011 to Jan 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.

Notice 3 out of 4 years when the index weights were increasing in Brent, the return over the rebalance period was negative.  Also notice that in 2 of 4 years when the index weights were decreasing in WTI, the return over the rebalance period was positive.

Supply and demand should be unaffected by commodity futures investing since there is no physical delivery from commodity futures investing.  Along with the simple example over the rebalance, there are fundamental stories that demonstrate a disconnect between money flow and price. For example, Brent recently fell pressured by incremental increases in Libyan oil supply and expectations that Iranian crude will return to market.

Another simple argument is as follows: trading, production and open interest stats are similar for crude oil and natural gas where futures trading volume is several times larger than production or consumption.  Sometimes oil prices are up while natural gas is down, so how can futures trading be driving price of oil up while gas, with same trading stats, is down? (Nat gas may be down from fracking technology increasing supply.  A supporting comment is at http://www.econbrowser.com/archives/2012/04/a_ban_on_oil_sp.html with a follow up at http://www.econbrowser.com/)

There is a helpful summary of research studies on the topic of futures trading versus spot prices, which states that currently, there is no clear evidence of futures trading driving spot prices. An article on Vox by Lutz Kilian was based on his paper, “The Role of Speculation in Oil Markets: What Have We Learned So Far?” He co-authored the paper with Bassam Fattouh and Lavan Mahadeva. The article neatly summarized the results of a number of studies on the topic and concluded that the literature has shown that the presence of index funds has, if anything, been associated with reduced price volatility. (This is since long-only investors provide insurance to producers, hence reducing price volatility from the supply side) They found that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003. Instead, there is strong evidence that the co-movement between spot and futures prices reflects common economic fundamentals, rather than the financialization of the oil futures markets.

Another research piece on the link between commodity futures investing and spot price can be found at http://docs.edhec-risk.com/ERI-Days-Asia-2012/documents/Long-Short_Commodity_Investing.pdf.  The 2009 Staff Report by the U.S. Senate Permanent Subcommittee on Investigation argues that commodity index traders were disruptive forces, driving prices away from fundamentals. If established, this would support calls for an increase in transparency, position limits and margins to curb excessive speculation, and it is hoped – volatility. Since then, the claim that the financialization of commodity markets is responsible for the observed volatility in commodity prices has been the subject of an intense academic debate – the overwhelming conclusion of which has been that it is not possible to empirically link investments in commodity futures and commodity futures prices. (See for Irwin and Sanders (2011) for a recent review of the evidence at Irwin, S., and D., Sanders, 2011, Index funds, financialization, and commodity futures markets, Applied Economic Perspectives and Policy, 1-31.)

The Edhec paper also studies whether the observed financialization of commodity futures markets (as evidenced by the increase in the long, as well as short, positions of speculators over time) has led to change in the conditional volatility of commodity markets or to changes in their conditional correlations with traditional assets. Their results find no support for the hypothesis that speculators have destabilised commodity prices by increasing volatility or co-movements between commodity prices and those of traditional assets. Interestingly, this conclusion holds irrespective of whether speculators are labelled as “non-commercial” in the CFTC Commitment of Traders report or “professional money managers” (i.e., CTAs, CPOs and hedge funds) in the CFTC Disaggregated Commitment of Traders report. Thus their analysis does not call for a change in the regulation relating to the participation of professional money managers in commodity futures markets.

One last simple example, beyond oil, that commodity futures investing is not driving prices is from the summer of 2012.  According to Barclays Capital, commodity index flows were negative approximately $5-6 billion in 2012, but S&P GSCI Grains was up between 30-50%. Why? There was a major drought that destroyed the crop yield. The yield was worst for soybeans from the crop rotation out of the soil, which had the highest return not only from the low supply but from the relatively inelastic demand due to lack of substitutes for soy products.

 

 

 

 

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