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Inflationary Tales

The Rise of China’s Corporate Bond Market

Caught between a rock and hard place – Congress

Buying A Tail Wind For EPS

Is Small The New Big?

Inflationary Tales

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Tyler Cling

Senior Manager, Fixed Income Indices

S&P Dow Jones Indices

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The market waits in anticipation this week as key economic indicators will be released to shed light on the health and direction of the financial world. The Department of Labor released Consumer Price Index (CPI) data for May showing consumer inflation ticking up 2.1% over the past twelve months.  The Federal Reserve has stated an inflation objective of 2.0% prior to raising rates.  The S&P/BGCantor Current 10 Year U.S. Treasury yields have remained relatively flat, 2.66 YTM with a YTD return of 4.94%.  Bond prices and yields have an inverse relationship.

% Change in CPI vs. Monthly YTM Current 10 Year Treasury

Returns

(Source: S&P Dow Jones Indices)

European Banks Back in Vogue

Conversely, across the pond, inflation has dropped to 0.6% in May, a 0.2% decrease from the EU’s April 0.8% inflation stat (Source: Eurostat).  With the EU reaching some of its lowest inflation since 2009, the European Central Bank cut rates in early June in an attempt to fuel growth.

In a lower rate environment, credit default insurance for the European financial sector is becoming cheaper.  Observed by the S&P/ISDA CDS European Banks Select 15, the notional amount has fallen 116 bps since this time last year to 73 bps.  Essentially, where the market required $2,323 to insure an underlying credit of $100,000 in this sector in June 2013, now only requires $726 or 69% less.  The reduction in cost of CDS insurance could be due to the three-year rally of the S&P Europe 350 which has a 1-year return of 18.49%.  This trend could also be systemic of investors willing to take on more risk in search of yields in the low rate environment.

CDS Spreads vs Euro 350

By examining the difference in spreads relative to the CDS European Banks to Eurozone sovereign bonds and financials in the U.S., we see that insurance across these sectors has not been this comparable in price for years. Default spreads between the S&P/ISDA CDS U.S. Financials Select 10 and European banks have not been this close since October 2011.  Similarly, one would have to look back to June of 2012 to find European bank default insurance priced as comparably to S&P/ISDA Eurozone Developed Nation Sovereign CDS OTR Index.  The difference today, however, is the dramatically lower cost against the notional debt of European bank credit default swaps.

Difference in CDS Spreads from European Banks Select 15

While the U.S. is finally hitting inflation targets and the E.U. is missing their own by over half, little has changed.  U.S. 10-year treasuries are still below 3% and the pricing of the default risk between the two indicates a similar outlook.  With the Fed cutting QE, reducing growth projections, and holding off to significantly raising rates until 2015; the outlook is uncertain.  For now, we will just have to wait and see how the tale of raising rates and inflation will play out.

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

The Rise of China’s Corporate Bond Market

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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The size of the local-currency-denominated corporate bond market in China, as measured by the S&P China Corporate Bond Index, currently stands at CNY 7.58 trillion, representing an expansion by more than 14 times since December 2009. The strong issuance was driven by the country’s robust economic growth and tighter liquidity conditions. The corporate bond sector has also gained an increasing market share of the overall Chinese bond market; it rose from less than 10% to 33% over the period studied, see the exhibit below.

Exhibit: Corporate vs. Government Bond Markets in China

Source: S&P Dow Jones Indices.  Data as of June 11, 2014.  Charts are provided for illustrative purposes.   Past performance is no guarantee of future results.  This chart may reflect hypothetical historical performance.  Please see the Performance Disclosures at the end of this document for more information regarding the inherent limitations associated with back-tested performance.  The “Corporate (%)” represents the market cap of the S&P China Corporate Bond Index/S&P China Bond Index.  The “Government (%)” represents the market cap of the S&P China Government Bond Index/S&P China Bond Index.
Source: S&P Dow Jones Indices. Data as of June 11, 2014. Charts are provided for illustrative purposes. Past performance is no guarantee of future results. This chart may reflect hypothetical historical performance. Please see the Performance Disclosures at the end of this document for more information regarding the inherent limitations associated with back-tested performance. The “Corporate (%)” represents the market cap of the S&P China Corporate Bond Index/S&P China Bond Index. The “Government (%)” represents the market cap of the S&P China Government Bond Index/S&P China Bond Index.

As of June 18, 2014, the S&P China Corporate Bond Index has risen 5.81% YTD and 33.4% since the index’s first value date on Dec. 29, 2006. Besides the potential currency appreciation, the boom in Chinese debts comes amid an increasing appetite for fixed income assets in addition to the potential yield pick-up offered in the current low-rate environment.  Currently, the modified duration of the S&P China Corporate Bond Index is 3.45, with a weighted yield-to-maturity of 5.38%.

Within the corporate bond market, the S&P China Industrials Bond Index is the largest and the fastest growing sector, which represents over 48% of the market. It is followed by the S&P China Financials Bond Index with around 36% of the share.

In fact, over 90% of Chinese corporate bonds are issued by state-owned enterprises (SOE).[1] The SOEs are generally expected by the market to have a low default risk due to their implicit government guarantee and relatively easy access to other funding channels.  On the other hand, the non-SOEs that are in industries that face overcapacity issues are perceived to be at higher risk.

As China continues to implement new policies to strengthen the economy, the growth in the corporate bond market is anticipated to remain solid.

Please visit HERE to continue reading.

[1] Bank of America Merrill Lynch, More on China’s on-shore corporate bond market, Asia Credit Strategy, March 28, 2014

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

Caught between a rock and hard place – Congress

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Howard Silverblatt

Senior Index Analyst, Product Management

S&P Dow Jones Indices

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Caught between a rock and hard place – Congress, and in an election year no less (definitely a commentary, and not a company endorsed position)
Congress needs money – to spend (extending existing programs), and raising taxes only tends to be popular when the payer doesn’t pay taxes (or pays very little) or doesn’t contribute to a certain party. So one answer to ‘where do we get the money from’ is another tax repatriation holiday that permits companies to bring back cash from abroad, paying a reduced tax rate. In 2004 (the last tax repatriation holiday) the rate was 5.25% (15% of the 35% rate) and the intent was to create U.S. jobs and investments, but in retrospect few saw any job growth and what was seen was an increase in buybacks, dividends, along with another bad public relations issue for Congress (wonder if their approval rate can turn negative – you know, like bank deposit rates in the Europe). So why would Congress do it again? Well, similar to investor activists, they go to where the money is. If I use the current estimates of cash abroad, tax rates (corporate and qualified dividends) and the 2004 repatriation rate, we could feasibly be talking in the $50 billion plus area – enough to fund current projects and maybe have a little left over for a few new local pet projects (before November 4th). That money is very attractive to Congress, but also real is a potential public relations nightmare regarding giving money back to the corporations (via lower rates) and the 1%ers (let’s say the top 10% who would benefit directly from higher dividends – although a much higher portion would benefit from higher dividends via brokerage and 401k type accounts). It is not an easy choice, but neither is raising taxes or cutting programs. Good thing we have, as Will Rogers said, ‘the best Congress money can buy’ (or Ronald Reagan’s – ‘If the Congress wants to bring the Panamanian economy to its knees, why doesn’t it just go down there and run it?, or Mark Twain’s ‘Suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself’, or even Warren Buffett’s ‘I could end the deficit in five minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP all sitting members of congress are ineligible for reelection’).

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

Buying A Tail Wind For EPS

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Howard Silverblatt

Senior Index Analyst, Product Management

S&P Dow Jones Indices

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Commentary (ain’t no bodies opinion but my own):
Companies reached into their deep pockets this quarter and spent an extra $30 billion more than the prior quarter on buybacks, buying more than they issued and reducing their share count
Takeaway: companies bought a tail wind for EPS, in a quarter when they needed it most
But the question is – was the increase in buybacks just to help a weather poor Q1 or the start of a new trend
Regardless Q2,’14 already has a tail wind: Q1,’14 shares / Q2,’13 shares, even before any Q2,’14 action

Companies continue to increase their shareholders’ returns through buybacks and cash dividends, with the two expenditures combined setting a new index record at $241.2 billion in the first quarter – surpassing the prior record of $233.2 billion set in Q3,’07

While dividend payments are historical high, the payout rate remains low, with dividends being 37% of As Reported earnings for Q1,’14 (33.8% over the last 5-years and 33.6% for estimated Q2,’14), compared to a historical average of 52% (from 1936)

Buybacks need to be measured against issuance, and the current trend (and hype) is share count reduction, resulting in enhanced EPS

I expect this trend of greater shareholder return to continue throughout 2014, as activists remain strong, interest rates low, and companies awash in cash
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Q1 2014 S&P 500 Buybacks (just the facts)

Q1,’14 buybacks increased 59.2% to $159.3B from Q1,’13 $100.1B, as the quarter became the second highest period
Highest was Q3,’07 at $172.0B, with #3 now being Q2,’07 with $157.7B
The expenditure gain over Q4,13’s $129.4B was 23.1%, when the average daily stock price was up only 3.7% (so the higher expenditure was not due to chasing higher prices)
Translation -> the additional $30B was used for Share Count Reduction (SCR), reducing the average diluted shares used for EPS calculation and increasing the EPS
12 month buybacks increases 29.0% to $545.9B from $414.6B (12 month high was Dec,’07 at $589.1B, recession low was 12 month Dec,’09 at $137.6 billion

Share counts go down, as companies buy more shares than they issue (it’s not just what you buy, but what you issue)
S&P announced the quarterly rebalancing last Friday, 6/13 (effective after the close this Friday, 6/20), with the S&P 500 market value reduced 0.5% due to the adjustment

For Q1,’14, 290 issues reduced their diluted share count, up from 276 in Q4,’13 and the 212 in Q1,’13, while 181 increased them, down from 185 in Q4,’13 and the 246 in Q1,’13

Significant changes of at least 1% in the quarter increased, with 123 issues reducing their count (112 in Q4,’13) and 30 increasing them at least 1% (24 in Q4,’13)

Significant changes of at least 4% for the year-over-year period, where EPS are used in comparison, increased to 99 issues from the 83 reported in Q4,’13, with 34 issues increasing their share count at least 4% (potentially diluting EPS, depending if the issuance was used for M&A which was anti-dilutive), up from 22 in Q4,’13.

Of the 404 issues that reported buybacks in Q1,’14 (up from 401 in Q4,’13), 346 of them pay a dividend (up from 339 in Q4,’13), with 217 of them (196 in Q4,’13) spending more on dividends than buybacks

Cash (S&P 500 Industrials Old) declined after setting six quarters of consecutive record highs, as buybacks and M&A combined to reduce the holdings to $1.233 trillion from the Q4,’13 1.304 trillion record; the current level is equivalent to 90 weeks of net income siting on the books (here and abroad), earning very little, but getting a lot of attention from activists.

Information Technology maintained its dominance of buybacks, accounting for 30.88% of all buybacks in Q1,’14, up from 26.9% in Q4,’13

Apple set a record buyback expenditure of $18 billion in the first quarter, beating out the prior $16 billion record, which it held from Q2 2013. As a result of the large buybacks, Apple reduced its average diluted shares by 7.0% year-over-year, as it posted a 7.1% increase in net earnings, which due to a lower share count resulted in a 15.2% gain in EPS.

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

Is Small The New Big?

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Koel Ghosh

Head of South Asia

S&P Dow Jones Indices

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The recent launch of our S&P Dow Jones Indices India Index Dashboard brought to my notice the S&P BSE Small Cap Index. While the month’s report card was mostly green for the Indian indices due to the optimism in the Indian stock markets, the S&P BSE Small Cap Index did shine through.

  • The S&P BSE Small Cap Index returns as on May 30, 2014 was 54.36% (based on total return index) and 51.69% (based on price index). Further, the year to date return was 37.91% while it clocked in a one-month return of 20.41%.
  • During the one-year period ending May 30, 2014 the top 3 sectors attributing to this growth were Industrials, Materials and Consumer Discretionary.
  • The top contributors to the growth of the index in the one year ending May 30, 2014 were PMC Fincorp Limited and Sulabh Engineers & Services Ltd. Please see the list of top 10 below.
Security Name Stock Price Change (%) Stock Total Return (%) Contribution To Index Return
PMC Fincorp Limited 501.07% 501.66% 2.23%
Sulabh Engineers & Services Ltd. 212.82% 212.82% 1.41%
Risa International Ltd. 110.47% 110.47% 1.19%
Amtek Auto Limited 178.94% 179.95% 1.12%
Tilak Finance Limited 190.74% 190.74% 1.11%
CCL International Limited 275.42% 275.42% 1.05%
Kelvin Fincap Ltd. 254.49% 254.49% 1.02%
Sintex Industries Limited 329.37% 329.37% 0.95%
VA Tech Wabag Limited 155.53% 159.54% 0.95%
PTC India Limited 97.36% 97.36% 0.90%

Source: Asia Index Pvt. Ltd. Holdings Data as of S&P BSE Small Cap 31 May 2013 through 30 May 2014

If we compare the S&P BSE Small Cap Index with the benchmark S&P BSE SENSEX or even the broad market representative S&P BSE 500 for this one year period, the outperformance to both these broad market indices is clear.

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Source: Asia Index Private Limited, One year total return Performance for the period ending 30 May, 2014 

Indices One year Total Returns %
S&P BSE SMALL CAP (TR) 54.36%
S&P BSE SENSEX (TR) 24.04%
S&P BSE 500 (TR) 25.52%

Source: Asia Index Private Limited. One year returns for the one year period from 31 May 2013 to 30 May 2014 

S&P BSE Small Cap Index
Annualized Total Returns 54.37%
Annualized Standard Deviation 15.17%
Return per unit of risk 3.58

The S&P BSE Small Cap performance since inception has been 23.75% (Total return performance dated April 1, 2003 to May 30, 2014)

S&P BSE Small Cap Index is definitely displaying a new trend and one always needs to put this in perspective with the long term performance statistics to gain a better understanding of overall performance.

Capturing sector performance can be easily achieved through passive investing. Passive or index Investing allows investors to gain access to such index returns with very little effort and the ability to track the trends in the sector through its historical performance. In India, the trend of index investing is just about picking up with the existing offering of index funds and ETFs.

 

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