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Recession Chatter

REITs: A Rare Bright Spot in an Otherwise Difficult Year for Canadian Equities

The Importance of China Onshore Bonds in a Portfolio Context

Signing Off 2018: India Equity Market Performance

Large Caps Lag In Rebounds

Recession Chatter

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Inspired, or worried, by the stock market there is more and more talk of a recession in 2019.

To look past the usual comment that the stock market predicted nine of the last five recessions, a short list of positive and negative signals:

Why There Won’t be an Early Recession

  • Economy has momentum, growing faster than its potential now
  • Employment, wages rising; unemployment rate low
  • Consumer debt levels and defaults not a problem
  • Consumer spending increasing
  • Interest rates and inflation are low

Why There Will be an Early Recession

  • China, European economic growth slowing
  • Sales of New and existing homes falling
  • Turmoil in Washington
  • Fed is tightening
  • Business facing tighter credit

Economic expansions don’t die of old age. Changing economic conditions lead investors, consumers and business to cut spending, hunker down and hoard cash. What conditions? Sharply higher interest rates, bankruptcies and defaults, collapsing economies in other countries or large natural disasters. The second list isn’t that grim.

What can one conclude? The economy in 2019 is likely to grow more slowly and not feel as good as in 2017 or 2018. Secondly, if the negative factors don’t vanish or shrink a lot, there will be a recession, though it is not clear when.

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

REITs: A Rare Bright Spot in an Otherwise Difficult Year for Canadian Equities

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John Welling

Director, Equity Indices

S&P Dow Jones Indices

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Despite weak Canadian equity market returns this year, REITs have continued their long-term outperformance. The benchmark S&P/TSX Composite has fallen 8.5% on a total return basis through Dec. 18, 2018, while the S&P/TSX Capped REIT continues to be a bright spot, gaining 8.8% over the same period—a difference of over 17%.

Market analysts tend to point to rising interest rates as a potential threat to equity REIT valuations. Though prior research[1] has shown this to be a misconception, a common assertion is that REITs are destined to underperform when interest rates rise. The Bank of Canada has raised rates three times in 2018—in January, July, and October, while Canada 10-Year Benchmark bond yields have been unpredictable throughout the year. Canada REIT performance appears to have little to do with the current rate environment; in fact, Canadian REITs have been on a steady rise, particularly in comparison with the largest S&P/TSX Composite sectors as depicted in Exhibit 2.

The outperformance phenomenon further extends across the most recent 3-, 5-, 7-, 10-, and 15-year periods, demonstrating consistently higher returns and lower risk over longer periods when compared to broad Canadian equities.

As of Dec. 18, 2018, the S&P/TSX Capped REIT included 16 constituents. Exhibit 4 shows the five largest components along with estimated contribution figures to the 8.8% YTD total return of the index.

Conclusion

REITs have enjoyed strong returns amid a bumpy Canadian equity market in 2018. While the recent contrast in performance is particularly pronounced, consistently higher returns and lower volatility of the S&P/TSX Capped REIT over longer periods demonstrates strong underlying fundamentals of Canadian REITs.

[1] Orzano, Michael and Welling, John, “The Impact of Rising Interest Rates on REITs,” S&P Dow Jones Indices.

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

The Importance of China Onshore Bonds in a Portfolio Context

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Hong Xie

Senior Director, Global Research & Design

S&P Dow Jones Indices

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China’s onshore bond market, the third-largest debt market in the world and trailing only behind the U.S. and Japan, is an important market for international investors, given that China is the second-largest economy in the world. However, historically foreign ownership of Chinese bonds in the domestic market has been negligible, largely due to a lack of market access for foreign investors. As of November 2018, foreign ownership in China’s onshore inter-bank bond market was at 2.5%.[1]

With China opening up its onshore bond market for foreign investors, key progress on the issue of market access was achieved in the second half of 2018. This progress included the implementation of delivery-versus-payment, block trading, and the clarification of tax treatment. Progress on these issues cleared some significant roadblocks for foreign investors to access Chinese onshore bonds, which could promote foreign inflows into China’s bond market in the years to come. In fact, foreign ownership of Chinese bonds in the inter-bank market has increased by 46% and 450 billion RMB (65 billion USD)[2] since the end of 2017 as of November 2018, even though other emerging markets are facing outflows in 2018.

In 2014, S&P Dow Jones Indices launched the S&P China Composite Select Bond Index as a benchmark that is designed to represent high-quality bonds with reasonable liquidity traded onshore in China. The index includes bonds issued by the Chinese central government, three Chinese policy banks, and Central State-Owned Enterprises (CSOEs[3]), and it effectively covers bonds of sovereign and quasi-sovereign credit quality.

Our goal in this blog is to use the S&P China Composite Select Bond Index to examine the performance profile and diversification effect of high-quality Chinese onshore bonds from the perspective of a US investor.

Exhibit 1 displays trade-offs between return and volatility for the S&P China Composite Select Bond Index and other major U.S. asset classes. From August 2013 to November 2018, Chinese onshore bonds had an annualized return of 2.2% and volatility of 4.0%, as compared to an annualized return of 0.9% and volatility of 4.4% for the Bloomberg Barclays Global Aggregate Bond Index.

Exhibit 2 shows the correlation of the S&P China Composite Select Bond Index in both RMB and USD terms with major U.S. asset classes since August 2013.[4] We noted the following findings.

  1. The correlation between the S&P China Composite Select Bond Index returns in USD and RMB is 0.4, which indicates that bond returns in RMB explained 13% of variation for total returns in USD terms for the index. Currency risk contributed to the majority of return variation for RMB-denominated bonds when currency risk was unhedged.
  2. The correlation between the S&P China Composite Select Bond Index returns in either USD or RMB with U.S. equities and U.S. bonds were both relative low, ranging from close to 0 to 0.2. This exemplifies the potential diversification benefit of having Chinese sovereign and quasi-sovereign bonds in a U.S.-focused bond or equity portfolio.
  3. Chinese onshore bonds and stocks are good potential diversification options for each other, as returns from both markets when expressed in RMB shows near zero correlation.
  4. The S&P China Composite Select Bond Index returns in USD correlated with the Bloomberg Barclays Global Aggregate Bond Index at 0.4, which could argue for the potential diversification benefit of having China’s government and quasi-sovereign bonds in a global bond portfolio.

[1]   Source: http://www.chinabond.com.cn/

[2]   Source: http://www.chinabond.com.cn/

[3]   CSOEs are defined as Chinese corporations directly governed by the State-Owned Assets Supervision and Administration Commission of the State Council.

[4]   The first value date of the S&P China Composite Select Bond is Aug. 30, 2013.

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

Signing Off 2018: India Equity Market Performance

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Mahavir Kaswa

Associate Director, Product Management

S&P BSE Indices

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The 2017 calendar year noted significant returns after a couple years with nearly flat returns. Continuing with the excitement from 2017, the 2018 calendar year started with exuberance, as the S&P BSE SENSEX reached more frequent lifetime highs through the end of January 2018. However, it failed to sustain these highs, as immediately after the budget was passed, the S&P BSE SENSEX and all other leading indices experienced a sharp fall. As of Dec. 13, 2018, the S&P BSE SENSEX gained approximately 1,872 points YTD, up 6.8% in terms of total returns.

Source: Asia Index Private Limited. Data from Dec. 29, 2017, to Dec. 13, 2018. Index performance based on total return in INR. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

After witnessing the least volatile year during 2017 (with an annualized volatility of 8.9%), the Indian market has seen an uptick in volatility during 2018, with an annualized volatility of 12.5%. On the global front, higher oil prices, the U.S.-China trade war, and global monetary tightening were the top three drivers of volatility. On the domestic side, factors such as the introduction of the long-term capital gains tax on equity, perceived overall higher valuations of Indian equities, increasing interest rates, concern over falling GDP, and lately, the non-banking financial company (NBFC) liquidity crisis kept the market volatile throughout the year.

The S&P BSE AllCap, which covers more than 95% of India’s listed equity universe in terms of total market capitalization, declined by 4.2%. The declines in the S&P BSE MidCap (-14.1%) and S&P BSE SmallCap (-24.0%), with the simultaneous positive returns for the S&P BSE SENSEX (6.8%) and S&P BSE LargeCap (2.7%), could be attributed to a shift in focus of investors from mid-cap and small-cap stocks to relatively safer bets in large- or mega-cap stocks.

On the sectoral front, the S&P BSE Information Technology and S&P BSE Fast Moving Consumer Goods noted gains of 31.9% and 11.4%, respectively. The revival in demand and sharp depreciation of the Indian rupee helped the Information Technology sector, whereas Fast Moving Consumer Goods stocks noted positive total returns, reflecting India’s consumption story.

Meanwhile, the S&P BSE Finance and S&P BSE Energy ended flat. The S&P BSE Telecom was the worst-performing sector index, with a total return of -41.2%—not surprising, given that most telecommunication services companies tend to be highly leveraged and are facing a potentially intense price war.

Source: Asia Index Private Limited. Data from Dec. 29, 2017, to Dec. 13, 2018. Index performance based on total return in INR. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

Outlook: With the U.S.-China trade war not cooling off, the IMF’s recent revision of the global GDP growth estimate to 3.7% in 2018 from 3.9%, and the downward bias in India’s GDP growth, the Indian equity market is expected to remain volatile in the near future. Market participants may also be interested in seeing how the government of India will respond to the recent losses in state elections, and how this may affect voter confidence in the upcoming general elections in 2019.

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

Large Caps Lag In Rebounds

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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The entire U.S, equity market lost on Monday, Dec. 17, 2018, meaning every one of the 42 segments by size, sector and style finished negative for the day.  This was the second day in a row with losses across the board.  From Oct. 10-11, 2018 was the last time two consecutive days with all losses occurred.  Now every segment of the U.S. equity market is negative in December (month-to-date through Dec. 17, 2018.)  Only 9 times in history has every segment of the U.S. equity market lost in a month (with all sector data starting in 1995 and style data in 1997.)   Those months were Aug. 2015, Sep. 2011, May and Jun. 2010, Jan. and Feb. 2009, Oct. 2008, and Jul. and Sep, 2002.

The only sectors that are still positive in 2018 (year-to-date ending Dec. 17, 2018) are health care and utilities, though health care has experienced some of the worst returns in the month dropping 13.1%, 11.3% and 8.4% for small-, mid- and large-caps, respectively.  Volatility remains high across the sizes, though mid-cap 30-day annualized volatility has fallen below 20%, which hasn’t happened for small-caps since Oct. 24, 2018 and large-caps since Nov. 2, 2018.  Many uncertainties have been driving the volatility in U.S. equities including the interest rate decision, trading tensions, Brexit, and other soft economic data like slower housing, and weaker-than-expected economic data out of China and the eurozone.

On average, S&P 500 bear markets lose 36.0%, ranging between the least severe bear market loss of 19.9% before the 1990 bull market, and the biggest decline of 60.0% before the 1942 bull market.  The last two bear markets lost 56.8% in the global financial crisis and 49.1% in the tech bubble burst.  While this drop since Sep. 20, 2018 may feel painful, the S&P 500 has further to fall before it reaches bear market status of a 20% drop.  As of now, only the S&P SmallCap 600 has entered a bear market defined by its 20% loss.

Source: S&P Dow Jones Indices. Data ending Dec. 17, 2018.

While it is possible, stocks may decline further, it is important to remember that timing the market is difficult.  However, the returns in the first days of a bull market are historically big on average, so it is important to try not to miss them.  After just 3 days, the S&P 500 average return was 6.6%, and after 5, 10 and 20 days, the respective returns on average were 7.5%, 10.3% and 11.3%.  Also, in 5 of 13 years (1932, 1970, 1974, 2002 and 2009,) returns of 10% or more were measured after just 5 days.

Source: S&P Dow Jones Indices

Within the U.S. equity complex, the positioning matters to capture the upside in those first few days of a rebound.  Notice in just the first four days, both the mid- and small-caps returned  double digits on average.  Historically, in the first nine days of an S&P 500 bull market, the S&P MidCap 400 has returned the most on average, though the S&P SmallCap 600 pulled ahead after the 10th day.  More importantly, the large caps, represented by the S&P 500 distinctly lag.  After 20 days, the S&P 500 has returned on average just 11.3% versus 22.9% and 23.9% for mid- and large- caps, respectively.  Possible reasons can be how sensitive mid- and small-caps are to growth, the dollar, inflation or interest rates.  Moreover, mid-caps may do well in these first bull-market days since they are generally not as risky as smaller companies, yet have solid infrastructure but are nimble enough to take advantage of opportunities, especially overseas if the dollar drops.

Source: S&P Dow Jones Indices

Further, regardless of size, the financial and real estate sectors have done best on average in the first days of a new bull.  Every size of these sectors develop into a bull market in the first 20 days on average after S&P 500 bottoms with large- and mid-cap financials returning nearly 28%.  Even in just the first 3 days, the average returns of these segments were between 11.3% and 15.4%.

Source: S&P Dow Jones Indices

Lastly, if large caps are the size of choice, the value style helped, but style really only mattered for large caps with the S&P 500 Value posting a 25.0% average return versus 18.1% for the S&P 500 Growth.

Source: S&P Dow Jones Indices

Again, with the high levels of volatility in the market today as a result of several unknown events, there is a possibility of a further decline but the bottom will likely be difficult to time.  Given the risk, the only way to be certain of earning the potentially big returns in the rebound is to be invested.  Throughout the U.S. equity market, the returns in early bull market days have been significant, but historically, the mid- and small-caps have done better.

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