Indexology^® Blog

For the first time since June 2014, the Dollar Spot Index yoy% was negative in March. That was one of the main reasons commodities had such a strong month with the S&P GSCI gaining 4.9% and Dow Jones Commodity Index (DJCI) up 4.0%. Since commodities are priced in US dollars, when the dollar rises, it hurts commodities.

However, not all of the commodity market demise can be blamed on the the strength of the US dollar. Historically in the past 10 years, there is a -0.60 correlation between the rising dollar and commodities, meaning the relationship is negative but not very strongly. More importantly, when the dollar rose year-over year, it increased on average 8.1% driving commodities down 7.0% on average. While some economically sensitive commodities are moved more by the rising dollar, especially in energy, many are less sensitive and some even rise with a rising dollar.

When the dollar rises, it is possible some opportunistic buying happens to take advantage of cheaper commodities, helping the prices from falling even further. On average the up $ market capture ratio for the commodities is -87.2, meaning for every 1% the dollar rose, commodities on average fell 0.872%.

Now that the dollar has started to fall, it is interesting to note how much more power a falling dollar has in boosting commodities than a rising one hurts. On average when the dollar fell it fell 6.5% year-over-year, pushing commodities up on average 25.5%. The average down $ market capture ratio for commodities is -393.2, meaning for every 1% the dollar fell, commodities on average rose 3.932%. The falling dollar is 4.5 times more powerful than the rising one on commodities. Plus every single commodity benefits from the falling dollar, with the metals gaining most.

Not only does every single commodity benefit from a falling dollar, but only natural gas gets hurt more by a rising dollar than it gets helped by a falling one. It may be since it is so difficult to store.

If the Fed continues its more dovish sentiment, the dollar may fall more, which could be highly beneficial for commodities.

As with the weather for the northern hemisphere, the U.S. high-yield market seems to be making a comeback.  The 0.54% return in February for the S&P U.S. Issued High Yield Corporate Bond Index appears to be the green shoot of return for high-yield bonds.  March 2016 followed the prior month’s gain with a blossom of its own.  The index returned 4.5% for the month, which was the largest monthly return since October 2011’s return of 5.07%.  Year-to-date, the index returned 3.36%, which is refreshing to high-yield investors, who, before this month, had not seen a positive year-to-date return since November 2015.

The S&P 500 High Yield Corporate Bond Index performance behaved similarly returning 3.43% for March, which was the index’s largest return since a 3.86% return in October, 2011.

High yield option-adjusted spreads (OAS) for the year have double peaked, reaching highs of 907 and 883 bps on Jan. 20, 2016, and Feb. 11, 2016, respectively.  Since then, the OAS spread has tightened by 180 bps, giving bankers a window of opportunity to work with issuers in providing more debt to the market before any possible additional rate increase by Fed.  According to IFRMarkets, 57% of Q1 2016 high-yield issuance was sold in March, and at USD 6.3 billion, with the last week of March being the busiest for 2016.  Next week, an additional USD 3-5 billion more is expected.  Notable new issues for the week were included the following.

• T Mobile USA, Inc., with USD 1 billion of an eight-year maturity and a coupon of 6%.
• Western Digital Corp., with USD3.35 billion of an eight-year maturity and a coupon of 10.5%.
• HD Supply Inc., with USD 1 billion of an eight-year maturity and a coupon of 5.75%.
• BPCE S.A., with USD 750 million of a six-year maturity and a coupon of 8.25%.Exhibit 2: OAS History for the S&P U.S. Issued High Yield Corporate Bond Index
  

  

   

In part 2 of this blog series, we will look at the effect the 25%+ increase in new membership related to the Affordable Health Care Act (ACA) has had on costs.  From the time of the initial drafting of the ACA rules, there was concern that the new enrollees in the individual insurance market would increase overall costs.  Since many of these enrollees were expected to have pre-existing health conditions, overall costs could go up as utilization increases.  However, the key question that needs to be studied is whether the average cost per person has increased, and if so by how much?

Looking at Exhibit 1, we can clearly see that the average cost on a Per Member Per Month (PMPM) basis has increased significantly.  When the ACA was under development in 2009-2010, the average PMPM cost was just above USD 160 per person for an individual policy.  However at the same time, the average member covered by an employer-based plan, either large group or self insured, cost just above USD 260, or USD 100 more a month.  Since the introduction of the ACA, and in particular since 2013, we have seen a drastic increase in the PMPM costs for an individual to over USD 360 a month, while employer-based plans are still just below USD 360 a month.

Why the difference?  The key component in the legislation is the requirement that plans are no longer allowed to decline coverage for pre-existing conditions nor charge more for patients with pre-existing conditions.  This means that the once healthy population of members in the individual pool will now have to help cover the costs for more enrollees that are not as healthy.  However, employer coverage pools have always had a predictable sampling of unhealthy individuals.  Further, employer group medical insurance has not discriminated between the healthy and non-healthy, since they provide coverage to everybody.  Now that individual medical policies are required to provide coverage regardless of a person’s health status, it would be expected that PMPM costs should rise to a similar level as the employer coverage, as shown in Exhibit 1.  The key question is, are the ACA rules strong enough to entice the majority of the healthy population to maintain or add coverage in the individual market?  If not, then will average costs continue to rise above, and could individual policies face a “death spiral” rendering them unaffordable?  Keep watching this space as we continue to monitor healthcare costs moving forward.

In the first half of March, the S&P GSCI Total Return had added 9.6% and staged its biggest comeback ever, gaining 18.8% from its bottom on Jan. 20, 2016. Unfortunately, the index gave up 4.3% since March 17, 2016, losing about half its March gain. Despite the loss, the index posted its first positive monthly gain of 4.9% (data ending Mar. 30, 2016) since Oct. 2015. March’s commodity return is historically big and is the biggest March since March 2006, when the index gained 5.1%.

All 14 commodities in the Agriculture (8) and Energy (6) sectors in the S&P GSCI TR gained in March. This has not happened since July 2012. In fact, all commodities inside the agriculture sector have never been positive together in any historical March.

March 2016 has also been a historically big month for the energy sector and some of the constituents inside it, in addition to coffee and sugar. For example, coffee gained 10.4% in March, it was the best March since March 2002 and the second best March since 1981, and the best month since July 2014.

The central bank of England has said that the European Union referendum in June 2016 is the most significant near-term domestic risk to the country’s financial stability.  Because of its separate currency, Britain is one of the countries that could disassociate itself most easily from the EU.  It is a long time until June, and the question lingers: is this another Scotland situation with a heavy amount of press, but in which case, like Scotland, the U.K. will stay just where it is?

The “Brexit,” as it is being called, could have varying consequences, depending on the terms of a departure agreement.  Such terms would be negotiated after the vote.  To try and predict the outcome is sheer madness, as they say.  The decision will rely upon prevailing economics, future outlook, crowd sentimentality, and many other factors.

What can be observed from S&P Dow Jones Indices is the following.

• K. corporate bonds reached their widest spread for the year on Feb. 17, 2016, as the S&P U.K. Investment Grade Corporate Bond Index reached an option-adjusted spread of 218 bps (see Exhibit 1).
• K. corporate bonds had been tightening in spread ahead of the March 10, 2016, European rate cut.
• Since the EU rate cut, all U.K. corporate spreads have been tighter, with the S&P U.K. A Investment Grade Corporate Bond Index performing the best, at 32 bps lower.
• The S&P U.K. Investment Grade Corporate Bond Index has returned 50 bps more in total return than the S&P Eurozone Investment Grade Corporate Bond Index (2.6% versus 2.1%, respectively).
• AAA U.K. investment-grade corporate bonds have returned 5.31% YTD. However, as discussions continue on the possible outcome of the “Brexit,” investors have moved back into risk, and the BBB corporates have returned 2.63% for the month, as of March 28, 2016 (see Exhibit 2).

Exhibit 1: Option-Adjusted Spread History–U.K. Investment-Grade Corporate Bond Indices