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Janet Yellen’s Message: Last Friday’s Employment Report Didn’t Change Much

Master Class Prep: The Transparency of Canadian Indices

A Possible Brexit, a Weak Pound, and an Outperforming U.K. Gilt Bond Market

Divining Brexit

Rieger Report: Bond Market Malformation, Trouble Ahead?

Janet Yellen’s Message: Last Friday’s Employment Report Didn’t Change Much

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Last Friday the markets were expecting to see May payrolls rise by something between 160,000 and 190,000 new jobs. Instead the report was an upsetting shocker with only 38,000 new jobs and a downward revision to the previous two months.  Stocks sold off at the opening, gold rose, talk of a fading expansion resumed and everyone agreed that there wouldn’t be a Fed rate hike this month.  Until Friday morning Fed watchers were expecting a last minute confirmation of a June rate hike from Janet Yellen in today’s speech.  After the bad news employment report analysts feared the weakness would limit the Fed’s ability to move rates higher until later in the year.

Speaking in Philadelphia today, Fed Chair Janet Yellen was clear that one nasty employment report doesn’t change the world or the economic outlook: “So the overall labor market situation has been quite positive. In that context this past Friday’s labor market report was disappointing.”  The Fed is making progress in meeting its mandate of 2% inflation and full employment:

  • Inflation is expected to move to 2% over the next couple of years. The sharp drop in oil prices and the strengthening of the dollar which were holding inflation down are reversing and these downward forces on prices are dissipating.
  • Friday’s report notwithstanding, the job market has improved throughout seven years of expansion. The unemployment rate has fallen, the job openings rate was a record high in March and the quit rate moved up. Weekly initial unemployment claims continue at very low levels.

Yellen’s economic outlook remains cautiously optimistic, even though there are a few clouds on the horizon but further progress is expected.

  • Further improvements in the labor markets and moderate GDP growth are foreseen. Rising equity and home prices have helped restore households’ wealth and the housing sector should see further gains. Housing is supported by low mortgage rates and consumer spending is helped by low gasoline prices.
  • “On the other hand” there are some less positive issues: China’s slowing growth, falling commodity prices and weak business fixed investment in the U.S.

There are four important uncertainties that could affect the economy and monetary policy:

  • The US expansion has been largely supported by domestic demand. The question is whether US moderate growth can continue without support from other economies, especially with the weak domestic investment performance.
  • Risks outside the US require attention as well. China’s growth is a concern although their currency has moved in a more predictable fashion recently. In the current environment of low interest rates and weak growth investors’ perception of risks can change quickly.  One unknown risk factor is the possibility that Britain will vote to leave the European Union.
  • US productivity has performed poorly in recent quarters and has not shown any signs of returning to stronger growth so far. This contributes to sluggish GDP growth and poor wage increases.
  • The inflation outlook is uncertain and dependent on expectations of future inflation. While oil prices are likely to recover and the labor market is improving, there are signs that expectations of future inflation are falling somewhat.

In the face of these uncertainties, Janet Yellen remains cautiously optimistic, describes monetary policy as stimulative with the Fed funds rate below its neutral level. Given all this, Yellen expects “further gradual increases in the federal funds rate will probably be appropriate to best promote the FOMC’s goals of maximum employment and price stability.”

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

Master Class Prep: The Transparency of Canadian Indices

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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In anticipation of S&P Dow Jones Indices’ ETF Masterclass for Canadian Advisors on June 23, 2016: A Bright Future for Financial Advisory, it helps to revisit some of the company’s involvement in the country.  Our firm has always been committed to Canada, with an office on King Street West, and the company has always shown an eagerness to serve the country’s investment community.  Through the partnership with the Toronto Stock Exchange, the S&P/TSX Composite Index has been the headline index for the Canadian equity market since 1977.  In addition to equity performance measurement and design of strategic investing approaches, S&P DJI has provided Canadian market participants with products for other areas of investment.  The S&P/TSX Preferred Share Index launched on June 12, 2007 and is designed to measure the performance of Canadian preferred stock.

Recently, a Canadian fixed income family of indices was introduced, expanding S&P DJI’s product offerings.  The index series seeks track the entirety of Canada’s fixed income market by providing performance measurement tools that range from Treasury bills, benchmark sovereigns (through core fixed income products) to Canadian high-yield and real-return bonds.

The S&P Canada All Bond Index is a broad, market value weighted index that is designed to measure both high-yield and investment-grade bonds.  The index has been broken down into respective subindices (the S&P Canada Aggregate Bond Index and S&P Canada High Yield Corporate Bond Index) that match the different money management styles between the high-yield and investment-grade categories.  Within each of these indices, the segments of fixed income have been broken down further into subindices that measure the characteristics and performance of each respective fixed income product group.

Notably, the March 30, 2016 launch of an ETF product by Toronto Dominion Asset Management has added to the ability of investors to track the performance of the S&P Canada Aggregate Bond Index.

In upcoming blog posts, we’ll analyze more of the sovereign, provincial and municipal (quasi-government), corporate, and collateralized subindices in regard to total return performance, index characteristics, and issuer composition.

Exhibit 1: S&P Dow Jones Canadian Indices

Source: S&P Dow Jones Indices LLC. Data as of May 31, 2016. Table is provided for illustrative purposes.
Source: S&P Dow Jones Indices LLC. Data as of May 31, 2016. Table is provided for illustrative purposes.

If you would like to hear more on our Canadian fixed income indices, attend our upcoming event in Toronto on June 23, 2016.

 

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

A Possible Brexit, a Weak Pound, and an Outperforming U.K. Gilt Bond Market

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Heather Mcardle

Director, Fixed Income Indices

S&P Dow Jones Indices

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Year-to-date, the U.K. gilt market has performed the best out of all of Europe’s safe-haven government bond markets.  The S&P U.K. Gilt Bond Index has returned 6.15% YTD, one of the highest in Europe.  Yields in U.K. gilts have tightened by 41 bps since the beginning of this year, with the S&P U.K. Gilt Bond Index yielding 1.36% as of June 1, 2016.  U.K. gilts are still seen as a safe haven despite concerns that the U.K. might elect to exit the European Union.  Concerns over a possible exit have put the pound near its seven-year lows versus the USD.  At the end of Q1 2016, GDP growth in the U.K. slowed to 0.4% from the 0.5% growth seen in the previous quarter, while annual growth was revised down to 2%.

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U.K. polls offer no clear sign as to which direction the June 23, 2016 referendum will take.  Uncertainty often leads to a flight to safety, and the U.K. gilt market continues to be seen as a safe haven.  If a Brexit is voted for and uncertainty in the U.K. economy loom, U.K. gilts could benefit further (prices continue to rise and yields fall), as the Bank of England could keep rates low for longer.  Alternatively, if the British pound weakens significantly as a result of a Brexit, there could be a foreign capital flight out of the U.K.  This could cause a spike in inflation as import costs increase, thus encouraging bond yields to rise.

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

Divining Brexit

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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The markets’ view of the pending British referendum on EU membership displays the hallmarks of a low probability, high impact event.  Correlations, and volatility expectations, are the key indicators.

When macroeconomic risk is dominant, as a select few narratives come to preoccupy investors, correlations increase.  For example, in August and September 2015, markets worldwide were roiled in concert: on the changing winds of a collapsing oil price, and a loud “pop” in Chinese equity prices, correlations achieved multi-year highs.

The chart below shows the average monthly correlation among the constituents of the S&P United Kingdom index:

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Compared to recent levels, and to longer-term averages, UK equity correlations remain reassuringly low.  This tells us that Brexit risk is not currently a major driver of equity pricing. 

But British equities include a number of global standard-bearers with disperse operations such as BP, Unilever and HSBC.  Conversely, the pound sterling has far more direct sensitivity to specifically British trade opportunities, economic growth and sovereign credit.  We can also assess Brexit risk with the CBOE/CME FX Pound Sterling Volatility Index, a measure of the expected movement implied by options on the pound / U.S. dollar exchange rate.

The pound’s volatility gauge is warning of considerable trouble ahead.  The index currently stands at 21.7, having more than doubled in the last few weeks – to its highest level since February 2009.

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Note that the current spike in the chart began just as the June 23rd referendum date moved within the 30-day range measured by the volatility index.  Currency volatility shows investors’ Brexit fears.

How can we reconcile these two indicators?  Is the market unconcerned with Brexit, as equity correlations indicate?  Or should we infer, as currency markets seem to be doing, an impending disruption on a level not experienced since the financial crisis?

Correlations tell us when events have come to dominate, implied volatility indicates the magnitude of misfortunes which may never happen.  The key is to appreciate that Brexit is a low probability, high impact event.  The low probability means that minor swings in polling have had little impact on the day-to-day fluctuations in the British equity markets.  Meanwhile, the high impact is shown by the greatly increased cost of insuring against the possible disruption that a vote for “leave” might entail.

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

Rieger Report: Bond Market Malformation, Trouble Ahead?

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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There is no doubt about it the bond markets are malformed due to quantitative easing (QE). The possibility of a Fed change of short term rates in June or July is on the minds of many. Are the investment grade municipal and corporate bond markets primed for a near term correction as a result? Only time will tell.

However, there are factors that would argue against such a proposition:

  • A rise in rates is most likely ‘baked in’ to each of these markets.
  • The technical imbalance that overhangs both of these markets is supply vs. demand:
    • While investment grade corporate bonds were issued in record numbers, that issuance has slowed, demand however has not. That demand is driven by the need for low risk but incremental yield over risk free yields. Please see yield spread chart below of the bonds of the companies in the S&P 500 (the S&P 500 Bond Index is approximately 92% investment grade) vs. the 10 year U.S. Treasury Bond Index.
    • Municipal bond issuance has seen periods of increased issuance as well as relative ‘dry spells’. The net effect is new issue supply remains below historical norms. Demand for quality tax-exempt bonds remains firm yet still historically cheap relative to U.S. Treasury bond yields.
  • While setting record highs, the equity markets have also seen periods of high volatility. The lower volatility seen in the investment grade corporate and municipal bond markets may continue to be seen as a value proposition for risk averse or ‘risk off’ investor mind sets. The volatility and risk adjusted returns for the S&P 500, S&P 500 Bond Index and the S&P Municipal Bond Index for 3, 5 and 10 year periods ending May 2016 can be seen in the table below.

For a discussion on the U.S. Treasury bond market there is a good read in the recent article “I wouldn’t buy a bond with your money” by Jared Dillian at Mauldin Economics which is focused on the U.S. Treasury bond market, particularly the 10 year bond.

Chart 1: Select indices and their yields (Yield to worst):

Source: S&P Dow Jones Indices, LLC. Data as of June 2, 2016. Chart is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results.
Source: S&P Dow Jones Indices, LLC. Data as of June 2, 2016. Chart is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

Table 1: Risk and Risk Adjusted Returns of Select Indices as of May 31, 2016:

Source: S&P Dow Jones Indices, LLC. Data as of May 31, 2016. Table is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results. Risk is defined as standard deviation calculated based on total returns using monthly values.
Source: S&P Dow Jones Indices, LLC. Data as of May 31, 2016. Table is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results. Risk is defined as standard deviation calculated based on total returns using monthly values.

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