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The Fed Puzzle Continues

High Quality Holding up Well

Islamic Index Market Update: August 2015

The bad kind of volatility?

What About the Debt of PEMEX?

The Fed Puzzle Continues

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Among analysts and Fed watchers, no matter what they expected from the Fed, they were all confident that this morning’s August Employment report would reveal the future.  No luck.

If anything, the report had something, but not enough, for everyone. The increase in payrolls was 173,000, far below the 220,000 expected; the previous two months were revised upward by 44,000; the unemployment rate dropped to 5.1%, the lowest since 2008; average hourly earnings rose 0.3% after a string of 0.2% reports and average weekly hours beat expectations at 34.6 vs. 34.5.  The treasury markets were as confusing as the report: at the release yields dropped – and then rose as people re-read the details.

With all the usual caveats of no guarantees and almost two weeks until the FOMC meeting, the odds slightly favor the Fed raising the Fed funds rate by a quarter-point. Set aside the top line payroll number for a moment and the rest of the employment report, and the economy, is solid. The unemployment rate dropped while labor force participation was steady, wages crept up and weekly hours were unchanged. Employment measured on the household survey rose by 196,000 jobs. Like all economic data, the devil is in the revisions. August payroll numbers tend to be low on the initial report but also tend to have large upward revisions. Altogether, the employment numbers favor a rate increase.

There are other factors favoring a September increase.  As Stanley Fischer noted in his speech at the recent Jackson Hole meetings, if the Fed waits until inflation is clearly rising, it will have waited too long. But will inflation begin to rise?  All oil prices have to do to remove downward pressure on inflation is to stop falling – and WTI has been in stuck between $40 and $60 per barrel so far this year.  The speculation about the timing of the rate increase will continue to grow until the Fed makes a move.  And attention is reaching extreme levels: Fed officials arriving for their conference in Jackson Hole last week were met by two groups of demonstrators – one for and one against raising interest rates.  Senators, congressman and presidential candidates are all offering the Fed advice. All the noise will only get louder and louder until there is a rate increase.  While lowering the noise level is not a reason to raise rates, giving the market clear signals of the long term direction is a good reason.

The turmoil in global stock markets is not an argument to wait before raising interest rates or an excuse to re-start quantitative easing.  The Chinese markets were reacting to a weakening Chinese economy, rapid changes in Chinese government policies and attempts by the government to manage stock prices. The US markets were over-valued and due for a long awaited correction.  While a rate increase is a negative for stocks, reducing uncertainty and getting passed the first move is a positive for the markets.

No guarantees, but a 60% change of a rate rise on September 17th.

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

High Quality Holding up Well

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Todd Rosenbluth

Director of ETF and Mutual Fund Research

S&P Capital IQ Equity Research

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Although the broader S&P 500® was down 7.2% between July 1, 2015, and Sep. 1, 2015, not all related indices performed as poorly.  Indeed, the S&P 500 High Quality Rankings Index was down just 5.3% during the same period.  The S&P 500 High Quality Rankings Index is a benchmark with constituents that must earn an S&P Capital IQ Quality Ranking of A- or above. These are companies that have consistently exhibited strong earnings and dividend growth records over the past 10 years.

These companies include packaged foods and meats producer Hormel (HRL), footwear maker Nike (NKE), and aerospace and defense issue Lockheed Martin (LMT).

According to Sam Stovall, U.S. equity strategist for S&P Capital IQ, S&P 500 constituents with above-average S&P Capital IQ Quality Rankings had a beta of 0.9, while those companies with below-average quality rankings (B or below) had a beta of 1.3—and 1.1 for those with average rankings (B+).

As of early September 2015, from a sector perspective, the S&P 500 High Quality Rankings Index had a relatively high exposure to industrials (27% of assets versus 10% for the S&P 500), consumer staples (19% versus 10%), and consumer discretionary (18% versus 13%).  In contrast, there were limited stakes in financials (6% versus 17%), information technology (6% versus 20%), and energy (1% versus 7%).

The S&P 500 High Quality Rankings Index is rebalanced and reconstituted quarterly, so no position garners a weighting greater than 1.5%, unlike the market-cap-weighted S&P 500.

S&P Capital IQ thinks in light of the likely continued volatility ahead of the upcoming Federal Reserve meeting, investors should consider securities that are above-average in quality.

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S&P Capital IQ operates independently from S&P Dow Jones Indices.
The views and opinions of any contributor not an employee of S&P Dow Jones Indices are his/her own and do not necessarily represent the views or opinions of S&P Dow Jones Indices or any of its affiliates.  Information from third party contributors is presented as provided and has not been edited.  S&P Dow Jones Indices LLC and its affiliates make no representations or warranties of any kind, express or implied, regarding the completeness, accuracy, reliability, suitability or availability of such information, including any products and services described herein, for any purpose.

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

Islamic Index Market Update: August 2015

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Michael Orzano

Senior Director, Global Equity Indices

S&P Dow Jones Indices

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August Highlights: 

  • Most Major Islamic Indices Closely Track Conventional Benchmarks in 2015
  • Emerging Markets Plunge Over China Growth Concerns, Weak Commodity Prices and Prospects for Fed Tightening
  • MENA Equities Drop Sharply as Oil Falls

Most Shariah-compliant benchmark have performed similarly to their conventional counterparts in 2015 as Financials have generated returns roughly in-line with the broader equity market.

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Through August 28, the S&P Global BMI Shariah and Dow Jones Islamic Market World Indices declined 3.2% and 3.6%, respectively, modestly outperforming their conventional counterparts.  Over the same period, the S&P 500 Shariah lost 3.6%, slightly underperforming the 3.4% decline of the conventional S&P 500.  Islamic indices covering Asia Pacific, Europe and Emerging Market equities each modestly outperformed their conventional counterparts, while the S&P Pan Arab Composite Shariah slightly underperformed.

After a strong start to the year, emerging markets have led global equity markets into negative territory in 2015. Concerns about the sustainability of China’s economic growth, plunging commodity prices and expectations for higher U.S. interest rates have combined to trigger major equity market and currency declines, particularly among emerging market commodity exporters and countries with larger fiscal and current account deficits. Capture

Volatility returned to U.S. markets as concerns over high valuations, the Fed possibly raising interest rates and the slowdown in China drove markets into the red for the year.  The steep decline in commodity prices has also led to equity market weakness in resource driven developed market countries such as Australia and Canada.    Despite relative strength in Japan, the DJIM Asia Pacific Index declined 3.5% year-to-date, driven by double-digit declines in Australian equities.  Europe has been the best performing region, as DJIM Europe declined by just 0.9%.

Largely driven by falling oil prices, MENA equities, likewise, experienced a sharp reversal after a strong start to 2015, After peaking up 11.5% on May 19, the S&P Pan Arab Composite Shariah lost nearly 20% through August 28, leaving the index down 10.6% year-to-date.

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

The bad kind of volatility?

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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Markets across the globe were rocked by volatility from sources new and old last month.

The old was a play-by-play repeat of the “taper tantrum” as capital fled from emerging markets in anticipation of a September date for the first rise in U.S. rates since 2006.

The new was triggered by evidence that the rollercoaster performance of equity markets in China (previously judged to be the result of high-octane day-traders learning the pain of a margin call) was also the first sign of a stall in the world’s economic growth engine.

August was a month of records – the VIX® recorded its biggest ever monthly gain, the average correlation between European equities rose to their highest ever.

VIX & 350 C

Why such high correlations in Europe, and such dramatic gains in VIX?  The answer is twofold.

  1. August is typically a quiet month. When something “happens”, it tends to dominate.  The only other major market to record a monthly stock-to-stock correlation in the 80’s was the U.S. S&P 500 during August 2011 (at that time, the failure to agree the budget threatened a technical default on U.S. Treasuries).
  1. There still remains very little dispersion. The world’s equity markets have been feeding on vast amounts of global, fiscal stimulus.  Our limited historical data suggests that such environments result in very little distinction between the performances of different stocks.  When every stock follows the same story, dispersion falls.  The impact of this is there is less diversification in stock indices; their correlations rise and index volatility rises with it.

This makes for a fragile environment.  As we saw in the “Flash Crash” of 2010, when correlations are high and dispersion is low, even a small and otherwise minor market disruption can have catastrophic consequences. This is the “bad” kind of market volatility, with few stocks providing refuge and little benefit to diversification. Be careful out there…

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

What About the Debt of PEMEX?

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Jaime Merino

Director, Asset Owners Channel

S&P Dow Jones Indices

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Since 1938, the state has been doing all the work. PEMEX was the only company managing the exploration, exploitation, and commercialization of oil but with the energy reform, things will change. PEMEX is the biggest company in Mexico, with sales over USD 123 billion and total assets over USD 156 billion as of 2013. Mexico recently opened the market for more participants through the tenders that started with “Ronda Uno” (Round One) in July 2015. In this first phase, only two blocks out of 14 were awarded, which was not what the Ministry of Energy was expecting (between 30%-50%). The next phase of Ronda Uno will be on Sept. 30, 2015, with five different contracts to be awarded in nine different blocks for drilling.

The global economy, especially China, has not helped with this. Year-over-year, Mexican crude fell 63.05%, from USD 91.22 to USD 33.71 (as of Aug. 24, 2015). Exhibit 1 shows the price of Mexican crude over the past five years.

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But, What About the Debt of PEMEX?

Nowadays, PEMEX issues debt in pesos, dollars, and euros. By the end of 2013, the debt in U.S. dollars represented 79% of the company’s total debt. Focusing on the local debt and using local information, we created four indices classified by: fixed-rate debt, inflation-linked debt, floating-rate debt, and a separate index comprising the other three. For the inflation-linked index, the cumulative returns were -2.50% YTD, and -1.04% for the one-year period. During the same time period, the fixed-rate debt returned only 1.52% YTD and 2.05% year-over-year, as shown in Exhibits 2 and 3.

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The total local debt was distributed into 14 issues (not including the PEMEX 09U series or ABS), with a total market value of USD 13.25 billion (as of July 31, 2015, using a spot price of MXN 16.1088), where 59% of the total is represented by fixed-rate bonds and 26.74% matures in 2024. Exhibit 4 shows the distribution of the different rates and Exhibit 5 the maturity in billions of U.S. dollars in market value.

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Finally, if we think about a peer for PEMEX —not from an oil perspective but from the perspective of a quasi-sovereign company in Mexico—the Federal Electrical Commission (CFE) is the first name that comes to mind. With six different types of bonds (excluding ABS) and USD 4.06 billion of market value, PEMEX represents 56% of the S&P/Valmer Quasi-Sovereign Bond Index, while CFE represents 28%. Comparing the fixed-rate bonds of these two, Exhibit 6 shows how PEMEX has underperformed CFE. Moreover, we can compare them with some of the indices of the S&P/Valmer Indices, and we can see also how PEMEX has underperformed year-to-date and over the one- and three-year periods.

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