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Are TIPS Insurance on a Sunny Day?

Energy Related Municipal Bonds Help Push the S&P Municipal Bond Default Rate to a 3-Year High in 2014: 0.17%

2015 Resolution: Diversification

Rebalance 2015: Handle-Side Or Blade-Side Down?

Don’t Worry About the Fed

Are TIPS Insurance on a Sunny Day?

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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The current quote of NYMEX crude is lower by $2 today as the price action of crude oil has been on a downhill slide since the end of June 2014.  The news is loaded with stories of oil and its effects on consumers and the economy.  Min Zeng of the Wall Street Journal published “Closely Watched Inflation Gauge Falls to Lowest Level in 14 Years,” while his colleague Jason Zweig approached the issue from a differing angle.  In his article, “Here’s a Tip: Buy More TIPS,” Mr. Zweig makes a case for investors to keep an eye on the performance of TIPS (Treasury Inflation-Protected Securities) and to be opportunistic with investing.  The article states, “in recent months, as oil has fallen, TIPS ‘have taken a huge adjustment,’ says Gemma Wright-Casparius, portfolio manager of the Vanguard Inflation-Protected Securities Fund, with $24.8 billion in assets. ‘They look fairly priced to me now.’”  This asset class may be down, but don’t count it out, if I was to paraphrase the message.

The return of the S&P U.S. TIPS Index for 2014 was 3.10%, though the index did have a tough December, returning -1.1%, and an even tougher September, losing 2.38%.  As of Jan. 9, 2015, the index was returning 0.80% MTD.

The U.S. Fed seems determined to get inflation up to its target level of 2%, though the current, all-items CPI of 1.3% YOY is nowhere near the target.  Extreme as it may seem, the Fed does have the tools to print money in order to push the inflation level upward.  Current expectations are that inflation will stay low, but as we know, the idea of insurance is to protect against the unexpected.  As the saying goes, “the best time to buy insurance is when the sun is shining.”
S&P U.S. TIPS Indices-Total Rate of Return Performance

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

Energy Related Municipal Bonds Help Push the S&P Municipal Bond Default Rate to a 3-Year High in 2014: 0.17%

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Tyler Cling

Senior Manager, Fixed Income Indices

S&P Dow Jones Indices

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In 2014, the default rate of the S&P Municipal Bond Index rose for the first time since 2011, finishing the year at 0.17%. In 2013, the overall default rate fell to 0.107% from 0.144% in 2012. The corporate bond sector of the municipal bond market has historically been one of the sectors where bonds have a higher propensity to default. That was the case in 2014. The Energy Future Holdings Corporation default (previously TXU) accounted for over 17% of the deals entering default in 2014.

Based on the index data, the high-yield municipal bond default rate also jumped from 0.807% to 1.264% in 2014.  In comparison, according to Standard & Poor’s Ratings Services Global Fixed Income Research estimates, the 2014 U.S. speculative-grade corporate bond default rate was 1.52%.  Combining this data reveals a definitive trend: Historically, municipal bonds have had a lower propensity to default.  Default data from 2014 suggest that this trend may be correcting itself in the high yield space.

The number of deals tracked in the index has declined in 2014 as the pace of new issues qualifying for the index did not outpace bonds maturing.

The S&P Municipal Bond Index has been a live benchmark since Dec. 31, 2000.  The index tracks over 79,000 bonds from over 22,000 different issuers, and it represents a market value of more than USD 1.5 trillion.  Some unique features of the index are that it is designed to measure bonds throughout their “lifetime,” meaning from issuance to maturity (as of the index rebalancing date, the bond must have a minimum term to maturity or complete call date greater than or equal to one calendar month), and it includes bonds that range in quality from “AAA” to “Default.”  By keeping bonds in the benchmark even when a default occurs, the index has become a living timeline, allowing us to track the municipal bond default rate.  The vast swath of the municipal bond market tracked by the S&P Municipal Bond Index makes this analysis possible.

Capture

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

2015 Resolution: Diversification

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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Most bond markets ended on a positive note in 2014. Some of the outperformers are the S&P Eurozone Developed Sovereign Bond Index (up 11.98%), the S&P U.S. Issued Investment Grade Corporate Bond Index (up 7.71%) and the S&P China Government Bond Index (up 10.35%). Yet the global yields remained low, i.e. the yield-to-worst of the S&P Eurozone Developed Sovereign Bond Index tightened by 92bps to 0.98%. Please see Exhibit 1 for the selective total return and yield comparisons.

Exhibit 1: Total Return and Yield-To-Worst Comparisons

Source: S&P Dow Jones Indices. Data as of December 31, 2014.  Charts are provided for illustrative purposes.  The S&P China Government Bond Index is calculated in CNY and the S&P Eurozone Developed Sovereign Bond Index is calculated in EUR, while the other two indices are calculated in USD.
Source: S&P Dow Jones Indices. Data as of December 31, 2014. Charts are provided for illustrative purposes. The S&P China Government Bond Index is calculated in CNY and the S&P Eurozone Developed Sovereign Bond Index is calculated in EUR, while the other two indices are calculated in USD.

With the global uncertainties in economic growth, inflation and monetary policy remain; portfolio diversification seems to be the key in 2015, which allows upside participation while minimizes the downside risk of over-concentration.

Looking into 8-year historical data, despite the differences in their economies and monetary policies, the S&P/BGCantor U.S. Treasury Bond Index has a correlation of 0.47 with the S&P Eurozone Developed Sovereign Bond Index.

On the other hand, the U.S. and European bond markets exhibited low correlations with the Pan Asia and Chinese local currency bond markets over the same period.

S&P/BGCantor U.S. Treasury Bond Index S&P Eurozone Developed Sovereign Bond Index
S&P Pan Asia Government Bond Index 0.179 0.173
S&P China Government Bond Index 0.169 0.140

Specifically, the S&P China Corporate Bond Index had a negative correlation with the U.S. issued high yield and investment grade bonds.

S&P U.S. Issued High Yield Corporate Bond Index S&P U.S. Issued Investment Grade Corporate Bond Index
S&P China Corporate Bond Index -0.224 -0.104

Hence, Pan Asian bonds offer portfolio diversification through the exposure to local rates, credits and currencies. For more information on the performance of the S&P Pan Asia Bond Index family, please visit here.

*Correlation data are as of December 31, 2014, computed from the monthly returns since December 29, 2006.

 

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

Rebalance 2015: Handle-Side Or Blade-Side Down?

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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The 2015 rebalance for commodity indices may be remembered as the one trying to catch a falling knife.  Today, two significant events are happening in commodity indices: 1. The world production weighted S&P GSCI is entering its first year with Brent crude oil as the biggest commodity in the index, overtaking WTI. 2. The passive index may be the absolute smartest or dumbest strategy of the year by reallocating to oil now.

In 2014, the target weights of Brent and WTI in the S&P GSCI were 23.1% and 23.7% but with returns of -47.3% from Brent and -45.9% from WTI, the weights by the year’s end fell to 18.1% in Brent and 19.7% in WTI. Source: S&P Dow Jones Indices. Data from Jan 30, 1987 to Jan 8, 2015. Past performance is not an indication of future results. Source: S&P Dow Jones Indices. Data from Jan 30, 1987 to Jan 8, 2015. Past performance is not an indication of future results.

Now amid of one of the worst oil drops in history, the index is adding significant weights to both Brent and WTI bringing them up to their 2015 target weights of 24.7% in Brent and 24.5% in WTI. Not only is the total weight of 11.3% that is being added to crude big, the increase in Brent, the poorer performing oil of the pair, is much bigger with a 6.6% increase versus only a 4.7% for WTI.  Please see the charts below:

Source: S&P Dow Jones Indices. Past performance is not an indication of future results.
Source: S&P Dow Jones Indices. Past performance is not an indication of future results.

Sound risky? Rebalancing is one of the main sources of return in commodity indexing:

5 Commodity Return Sources

According to PIMCO, the rebalancing return can naturally accrue from periodically resetting a portfolio of assets back to its strategic weights, causing the investor to sell assets that have gone up in value and buy assets that have declined.  Lower cross correlation increases the return benefits from rebalancing.

Cross Correl

As of yesterday, Brent lost 53.4% and WTI lost 53.6% off theirs highs in June last year (based on monthly data) and in 2008-9 the drawdowns were 66.4% for Brent and 68.0% for WTI.  As I’ve mentioned before, it wouldn’t be unprecedented to see oil fall more but based on history it looks as if much of the damage has been done.  We’ll see if the 2015 rebalance ends handle-side or blade-side down.

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

Don’t Worry About the Fed

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Money is often described has having four functions: store of value, unit of account, medium of exchange and a source of anxiety.  Investors reading about the FOMC minutes published earlier this week are focused exclusively on the last function worrying about what will happen when the Fed raises interest rates.  A glance at the last two times the Fed shifted from easing to raising rates suggests that these fears are misplaced.  As Boston Fed President Eric Rosengren explained in a speech this week, even with some unusual market conditions, the Fed’s shift shouldn’t send markets into turmoil.

The last two Fed tightening moves began in February, 1994 and in June 2004.  Both were taken in stride in the economy, the stock market and the foreign exchange markets.  The move in February, 1994 was a bit more of a surprise than the 2004 shift. Moreover, in 1994 most Fed Watchers expected the Fed to move slowly and raise the Fed funds rate gradually over several quarters. However the central bank moved more quickly and the faster pace created some disturbance in the mortgage backed securities market.  At the same time technology stocks began a five year bull run of mythical proportions.

The charts show what happened when the Fed began tightening in 1994 and again in 2004.  On each chart the two vertical lines mark the timing of the Fed’s move.  The market where a reaction was expected and did occur is the treasury market. Short rates rose, long rates rose but by less and the spread narrowed.  When the Fed moves next time it is possible that long rates will move quite a bit. The 10 year T-note yield at about 2% is unusually low and any effort to move the markets back to a more normal condition could more than double the yield on the ten year note.

In both 1994 and 2004 the stock market took the move in stride and continued to advance. The 1994 move did see VIX bounce a bit, but neither move led to a bear market. If the next move is being driven by further declines in unemployment and inflation finally touches 2%, the immediate risk to the stock market is likely to be small.

There is some concern at the Fed about how a tightening move may affect foreign economies, especially since they are currently suffering from weaker conditions than in the US. The last chart shows the dollar versus the euro, British pound and the yen.  The Fed’s move isn’t likely to change the dollar’s current strength much. However, higher US interest rates could put upward pressure on some foreign interest rates and raise borrowing costs for foreign economies with dollar-denominated debts.

Lest we banish all anxiety about the Fed, think again.  The initial Fed move isn’t likely to cause massive damage. However, the Fed’s first step will probably be followed by further tightening and the cumulative effect will grow.  For investors the message of the data is not to panic at the Fed’s first tightening move, but not to ignore it either.

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