Indexology^® Blog

After much economic activity this week, the Fed announced inflation moved “somewhat closer” to the objective and is showing signs of firming after running below its 2% target for the past two years.  In the last June report from the United States Department of Labor, food prices continued to increase although at a slower pace and unleaded gasoline prices had the biggest increase since March 2013. 

The Commerce Department reported earlier Wednesday the economy grew at a 4% annual rate in the second quarter, bouncing back after a 2.1% first quarter contraction driven by bad weather.  The combination of a growing economy and bad weather was great news for commodities in the first half of the year as evidenced by the 5.7% increase in the S&P GSCI through June. That all changed in July.

July 2014 was the worst month for commodities since May 2012. The S&P GSCI lost 5.3%, giving up almost its entire gain for the year, now positive only 11 basis points YTD. The DJCI also had a big loss of 4.9% that pushed it into negative territory for the year, down 39 basis points.

While this is not good news for commodity investors, this might be the relief consumers need to keep their wallets from shrinking. Energy and Agriculture were the two worst performing sectors in July, down 5.8% and 8.7%, respectively in the S&P GSCI. Energy was down even more, losing 6.7%, in the DJCI from its heavier weight in natural gas that lost 13.7%, the most since March 2012. However, agriculture fared slightly better in the DJCI than in the S&P GSCI losing 7.2% from its bigger weight in soybeans, which lost 6.5%, less than wheat and corn – plus coffee was up another 11.4%, bringing its YTD total up to 68.9%.

Although not the biggest loser in the index or the most heavily weighted, one of the most important commodities that we all care about is unleaded gasoline. Prices at the pump have been brutal, as I mentioned above that the government reported the biggest price increase since March 2013. If the S&P GSCI or DJCI Unleaded Gasoline is any indication of prices we may see, the -8.1% spot return was the 5th worst July on record since 1988 and may provide some indication of price relief at the pump. It is also the worst July since July 2008, when after the index drop, the CPI data showed a drop in price increase from 4.090 in July 2008 to 1.689 by Dec 2008.

Further we have been discussing the impact of climate change (and potentially el nino) on food prices, where food processors have been running out of choices (substitution and buying ahead) to keep food prices down for everyday consumers like you and me.  The result has been higher prices at the grocery store. This happened from the destruction of the agriculture and livestock chain from the freezing weather in Q1. Now after the decline in July from perfect weather that brought down the grains, the agriculture is priced the lowest since July of 2010.

This may open a window of opportunity for food processors to purchase cheap ingredients ahead of further price spikes that may happen from an el nino and climate change. Then, we may see lower prices again at the grocery store.

Stocks closed down today with the S&P 500 and the Dow Jones Industrials both down 1.8% despite yesterday’s stronger-than-expected GDP report, numerous earnings reports which beat Street expectations and no hints of early interest rate moves from the Fed.  Bearish or negative news stories weren’t much different from the day or week before – unrest in the Middle East, sanctions on Russia in response to fighting in the Ukraine and an on-going argument between Argentina and a hedge fund over debt.  There was no single event to send the market down for the worst loss in years.

Fear, greed, anxiety and the madness of crowds really do drive markets.  While it is often possible to cite shifts in the economy, corporate earnings or political events for market moves that extend over months or years; short term day-to-day shifts are driven as much or more by emotion than by reason and news. Robert Shiller, the author of Irrational Exuberance, describes surveys of investors down in the days following the 1987 market crash.  Clearly today’s dip is nothing like the 1987 event when the S&P 500 dropped over 20% in a day, but then investors couldn’t point to a news story or major event that sent the market plunging.  The most common news stories cited by investors were about falling stock prices, not some external change in fundamentals or the economy.

Was today’s drop driven by emotion or anxiety with little news or analysis of fundamentals?  The market has drifted in the last few days and closed flat on the best economic news in the last few years. The chart shows a rise in the frequency of searches for the phrase “stock market bubble” on Google Trends and the biggest news story seems to be a lack of action in the Congress.  It will take several weeks or months to see if today’s drop was caused by more worried people selling than confident people buying.  Unless news and the fundamentals turn much worse the best explanation may be simply worried investors.

Google Trends shows the relative frequency of searches for specific terms.  The letter A indicates the publication of an article in Forbes on Where to Invest When the Market Bubble Bursts.

Long-term bonds have posted solid gains thus far in 2014, with rates holding low longer than most expected. The composition of the municipal bond market is heavily weighted with short duration bonds. The looming sentiment of rising rates and inflation has investors focused on reinvestment risk; however, a supply imbalance systemic of voters’ hindrance for governments to take on additional debt has municipals as a whole outperforming their peers. This is demonstrated in the S&P Municipal Bond 20-Year High Grade Index which has a YTD return of 14.29% due to low rates & short supply.

In a year of record corporate bond issuance from low cost/easily available financing in an environment where investors are looking anywhere for high-yield returns, corporates are under performing. The S&P U.S. Issued High Yield Corporate Bond Index has a YTD return of 5.05% compared to the S&P Municipal Bond High Yield Index which is 9.23%. The raw yield statistics can be misleading when considering tax implications, where the S&P Municipal Bond High Yield Index has a tax equivalent yield of 9.86%, far superior to its corporate bond counterpart of 5.26%.

The heavily short-term weighted muni market is showcased in the broad market S&P Municipal Bond Index, which tracks over 75,000 bonds. The S&P Municipal Bond Index has a modified duration of 4.84 compared to 12.08 as seen in the S&P Municipal Bond 20-Year High Grade Index. Duration asserts not only the timeliness of cash flow repayment, but also the price volatility to interest rate changes. While the market prepares itself for rate inflation, those positioned for stagnant rates (long duration) have been benefiting.

Generally, all munis are surpassing analysts’ expectations in 2014, however, not all munis are created equal. High performing Tobacco bonds are up 11.26% YTD which can be seen in the S&P Municipal Bond Tobacco Index, whereas Puerto Rico bonds in the S&P Municipal Bond Puerto Rico Index continue to underperform at 4.37% YTD.

For a look into this week’s economic indicators, please refer to my colleague Kevin Horan’s recent post.

Following the success of the SPIVA publications in the U.S. and elsewhere, we have decided to launch a similar publication for Europe to shed some light on the ongoing active vs. passive debate.  Similar to the publications in other regions, SPIVA Europe will be published twice a year; mid-year and at the end of the year.

Let’s have a look at the results of the past year.

Euro-Denominated Equity Funds
The past year saw a strong rebound of the European equity markets, as measured by the S&P Europe 350®, which posted an impressive 21% gain.  Over 1-year, 3-years and 5-years, most actively managed funds invested in European and Eurozone equities underperformed. This was equally true for both global equities and emerging market equities, which would have been expected to outperform their respective benchmarks in conditions of heightened volatility and wide return dispersion.

GBP-Denominated Equity Funds
The significant majority of the U.K. and European actively managed equities funds have posted better returns than the benchmark.  This success was not repeated when it came to international funds, emerging market funds and U.S. funds, over the short-term and the long-term.

Today’s Pending Home Sales for June month-over-month came in lower than the expected 0.5% at a -1.1%.  The prior May number was a 6.1% later revised to a 6.0%.  Tomorrow the S&P/Case-Shiller 20-City Composite Home Price Index is due for release at 9am.

Heading into the release, the spread of the S&P/ISDA CDS U.S. Homebuilders Select 10 Index is at 155.7, steadily increasing the cost of insurance throughout the month after an initial step down the first week.  Year-to-date the cost of homebuilders insurance topped out at a spread of 178.05 on April 23^rd.  The spread touched a bottom point of 136.6 at the beginning of July, 11 basis points tighter than the December 31^st value of 147.58.  At 155.7 the cost of insurance would be $1,557,000 per million of coverage.

Spreads of the homebuilder issuers, of which the majority reside in the S&P U.S. Issued High Yield Corporate Bond Index due to the nature of the business and their credit worthiness, have widened on average over the course of July by 19 basis.  M/I Homes Inc. widened the most in option adjusted spread (OAS) by an average of 181 basis points, followed by Shea Homes LP.,at 105.

Kris Hudson of the Wall Street Journal recently wrote an article entitled: Some Home Builders Say First-Time Buyers Returning, Other Not Sure, which covers the indecisiveness of whether buyers, especially first time buyers, are returning to the housing market.

Source: S&P Dow Jones Indices, data as of 7/25/2014