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The True North Strong and Free! (But Not Free From Debt)

Rieger Report: Puerto Rico Watch

Where Are Spreads?

Watch Your Weight: How a Few Stocks Can Tilt the Scales

Rieger Report: Quietly higher- Municipal bonds continue to shine

The True North Strong and Free! (But Not Free From Debt)

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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Lyrics to the Canadian national anthem, “O Canada,” state “The true north strong and free!”  Like in the U.S and many other countries, government and corporate debt has become a big issue in Canada.

The Canadian overnight rate stands at 0.5% and will most likely remain unchanged or decrease even more.  Central Bank Governor Stephen Poloz’s decision on Jan. 20, 2016, to keep the benchmark rate at 0.5% halted a slide in the currency.

With rates so low, governments have been looking to more than just monetary policy to stimulate their economies.  The newly elected Canadian government has looked to infrastructure spending as a way to grease the economic skids.  Prime Minister Justin Trudeau said the federal government would fast-track infrastructure spending.

The newly elected liberal government said the deficit could swell to CAD 30 billion in the 2016-2017 fiscal year amid a starkly weaker outlook for the economy.  Such a large deficit would be 1.5% of GDP.  Compared to the amount of debt the U.S. carries, with obligations to other countries such as China, Canada’s AAA rating and debt amount look pretty good, but investors should be aware that the situation is and will be changing.  Larger amounts of longer-term debt may make the Canadian indices more sensitive to interest rate movements.

Exhibit 1 shows the percentage changes in the Canadian dollar amount of debt for each fixed income asset class for 2015.  The amount of debt outstanding for 2016 is expected to grow as the new government’s policies are put into place.

Exhibit 1: Index Increases of Market Value
Douglas Porter Quote

Canada Fixed Income Annual Issuance

Source: S&P Dow Jones Indices LLC.  Data as of Dec. 31, 2015.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes. *Globe and Mail, BoC holds rates; bets stimulus, global gains will ease economic pain, Barrie McKenna, January 20, 2016.

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

Rieger Report: Puerto Rico Watch

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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Another way to track the impact of the storm that is Puerto Rico is to look at the municipal bond market in two ways: with and without Puerto Rico.  The new S&P Municipal Bond High Yield ex Puerto Rico Index excludes any bond issued by Puerto Rico.  Puerto Rico bonds are included in the S&P Municipal Bond High Yield Index  and as a result add 129bps to the yield of the entire muni junk bond market (as of Feb. 24, 2016).

Chart 1: S&P Municipal Bond High Yield ex Puerto Rico vs. S&P Municipal Bond High Yield Index

Source: S&P Dow Jones Indices, LLC. www.spindices.com. Data as of February 24, 2016.
Source: S&P Dow Jones Indices, LLC. www.spindices.com. Data as of February 24, 2016.

 

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

Where Are Spreads?

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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In case you have had  your head down focusing on other things, and not taken a moment to look at what  spreads have been doing, the following chart will provide you with  a snapshot as of February 23, 2016.  Key takeaways include:

  • Looking at commodities, Oil, as measured by WTI futures contracts, has bounced from a low of $28 to a current price of $31; the Energy sector is a whopping 119 bps wider year-to-date and the Materials sector is 49 bps wider.
  • Telecommunications moved 41 bps wider due to the valuation of companies such as Verizon, AT&T and Qwest. Smaller rivals competing for sales have been a concern.
  • Consumer Discretionary has widened as spending has slowed possibly due to the winter season and consumers holding back until the economy shows more of a positive direction.


Chart 1: Year-To-Date Change in Option Adjusted Spreads of the S&P 500 Bond Index
Year-to-date Change in Option Adjusted Spread

Source: S&P Dow Jones Indices LLC., Data as of Feb. 23, 206. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

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

Watch Your Weight: How a Few Stocks Can Tilt the Scales

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Anthony Davidow

Vice President, Alternative Beta and Asset Allocation Strategist

Schwab Center for Financial Research

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Not all indexes are created equal. That’s because they weight the individual holdings differently. Market-cap indexes provide the largest weighting to the largest holdings regardless of fundamental characteristics, whereas fundamental indexes break the link between price and weight. With the proliferation of smart beta strategies, investors have more access and choice to select alternative weighting methodologies than ever before.

Why does weighting matter?
In 2015, the domestic equity markets were dominated by the FANG stocks – Facebook, Amazon, Netflix and Google (which later changed its name to Alphabet). They dominated the returns and the headlines. In fact, these four stocks became the darlings of Wall Street, rising in price without any apparent regard for valuation. Netflix and Amazon were the top two performing stocks in 2015. The chart below helps illustrate the differences in a market-cap index and a fundamental index.

2015 Year-end Index Comparison

S&P 500 Rank Fundamental  Rank 2015 Return P/E Dividend
Facebook 10 332 34.15% 105.67
Amazon 6 116 117.78% 975.20
Netflix 86 134.38% 305.57
Google (Alphabet) 11 70 46.60% 35.90

Source: Morningstar Direct, as of 12.31.2015

As the data shows, these four momentum stocks were some of the largest names in the S&P 500 index (the 10th, 6th, 86th & 11th largest holding), but had much smaller representation in the Russell Fundamental index (332nd, 116th, & 70th largest holding). Netflix was not a holding in the Russell Fundamental index. The differences are due to their weighting methodologies. Since all four companies have large market-capitalization, they have significant weighting in the S&P 500 where the only metric that matters is size. However, since the Russell Fundamental index weights securities based on adjusted sales, cash flow and dividends + buy-backs – these companies represent a much smaller weight.

The Price / Earnings ratio (P/E) is one of the most common measures of valuation. The FANG stocks had inflated P/E’s at year end (106, 975, 306 & 36 respectively). The overall market had a roughly 19 P/E which is at the higher end of the normal range. The P/E’s of these four stocks are extraordinarily high and pay no dividends. It harkens back to the “dot.com” bubble where companies traded at unrealistic P/E’s – and valuations didn’t seem to matter.

In today’s volatile market environment, do you want to overweight a high P/E stock that has already experienced a significant run-up, or would you rather overweight a stock with attractive fundamental characteristics? Fundamental index strategies systematically identify and weight securities based their financial health – not their popularity.

At Charles Schwab, we believe that market-cap and fundamental indexing can complement one another. Over the long-run, fundamental indexing has historically delivered alpha (excess returns), but lagged for much of 2015. We believe that the tide is turning, and fundamental indexing may outperform their market-cap equivalent in the coming year based on their more realistic valuations. In today’s market environment – we believe that fundamentals matter.

Important  Disclosures and Definitions  

S&P 500 Index – The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.  The S&P focuses on the large-cap sector of the market: however, since it includes a significant portion of the total value of the market, it also represents the market.  There is over USD 5.14 trillion benchmarked to the index, with index assets comprising approximately USD 1.6 trillion of this total.

The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data here is obtained from what are considered reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed.

Total Returns are from January 1, 2015 through December 31, 2015 and do not include fees or expenses.  Past Performance does not guarantee future results. 

“Fundamental Index” is a registered trademark of Research Affiliates, LLC. Russell Investments and Research Affiliates, LLC have entered into a strategic alliance with respect to the Russell Fundamental Index Series. Subject to Research Affiliates’ intellectual property rights in certain content, Russell Investments is the owner of all copyrights related to the Russell Fundamental Index Series. Russell Investments and Research Affiliates jointly own all trademark and service mark rights in and to the Russell Fundamental Indexes.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Charles Schwab & Co., Inc. is not affiliated with Russell Investments or Research Affiliates. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc  (0216-0714)

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

Rieger Report: Quietly higher- Municipal bonds continue to shine

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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A detailed Wall Street Journal article today Markets in 2016: The Year of the Pig clearly shows that many asset classes are continuing to show volatility and negative returns however municipal bonds have been resilient. Tax-exempt investment grade municipal bonds tracked in the S&P National AMT-Free Municipal Bond Index up 1.24% year-to-date and high yield municipal bonds tracked in the S&P Municipal Bond High Yield Index up 1.13%.

Taxable municipal bonds however have jumped ahead as the S&P Taxable Municipal Bond Index has returned 3.59% year-to-date.  Relative to corporate bonds this segment of the municipal bond market has longer durations and higher coupons which both contribute to positive price movement as rates move down.

Table 1: Select bond indices, their yields and returns

Source: S&P Dow Jones Indices, LLC. Data as of February 23, 2016.
Source: S&P Dow Jones Indices, LLC. Data as of February 23, 2016.

Table 2: Select bond indices and key characteristics

Source: S&P Dow Jones Indices, LLC. Data as of February 23, 2016.
Source: S&P Dow Jones Indices, LLC. Data as of February 23, 2016.

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