Events that have recently been triggering the market have stimulated investor curiosity around the relationship between government bonds and the returns of equities. Looking back, the S&P 500 took a major downturn in January and February of 2018 due to poor market conditions. Not only that, but the 10-year government bonds also showed a positive trend from 2.6% - 2.8% in the beginning of the year. The reputation of bonds as a “safe-haven” asset during a time of crisis is being questioned by investors all around the world today.
With the recent rise in bond yields due to positive results in hourly earnings numbers and payroll, investors reassessed their outlook on inflation. This was backed by a slight increase in bond yields. Simply put, investors believe the shock started spreading from the equity market from the gecko. This is truly inaccurate and a major misconception as the shock emanated primarily from the bond market instead of the equity market. In theory, the relationship between bonds and stocks largely depend on whether a shock starts in the bond market or stock market. It is important to note that bond market shocks induce a positive stock-bond relationship, whereas equity market shocks prove a negative relationship due to the association with the flight-to-quality (FTQ). Government bonds have shown strong performance in nearly all types of economic recessions regardless of investors deciding to be proponents of this theory or not. These bonds have not only shown growth in the last six decades but have also served to act as a way to hedge against pro-cyclical equity exposure. We use equity prices to better understand the value of a set of discounted future cash flows. There is a major impact on the discount rates due to a shock in the real bond market. This lowers the stock price and increases equity yield thus capturing higher real rates. However, whenever FTQ occurs aka a negative shock in the equity market, bond yields fall as the bond market seems much more favorable to investors. Looking at equity risk premium, FTQ occurrences seem to be related to a slightly noticeable negative stock-bond relation, while real yield shocks result in a positive market correlation. When markets are expensive, equities become vulnerable to negative bond market shocks and rises in bond yields. Moving forward, this rise in bond yields will serve to be a risk that investors should be aware of and must consider when flocking to either side of the market in search for safe-haven assets.
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The Commerce Department released inflation numbers for the month of February on March 29th, revealing a 0.2% inflation figure for February, following a 0.2% figure in January. These figures are close to the 2% annual target the Federal Reserve set. Overall, the CPI increased by 2.2% YOY through February, compared with 2.1 percent in January. These figures exclude prices of what economists deem “volatile” categories, such as food and energy prices.
James Powell, the new Fed Chairman, was quoted as saying “In coming months, as those earlier declines drop out of the calculation, inflation should move up closer to 2% and stabilize around that level over the medium term.” If inflation figures are higher than expected, investors can expect more aggressive interest rates hikes from the federal reserve to avoid the economy from overheating. Should targets be met, the officials of the Federal Reserve have stated a three-quarter-point hike in interest rates this year, with the first one expectedly occurring during the first week of April. That idea has quelled the stock market, as early data on wages has created concerns about more aggressive rate hikes. Worries do remain about the implementation of tariffs proposed by the White House potentially increasing inflation figures in the short term. Keith Knutsson of Integrale Advisors commented, “While there remains some uncertainty for the rest of year, investors can expect a 25 basis points hike in interest rates in the coming month, rather than a more aggressive 50+ basis points. “ President Donald Trump has officially set out his plan to impose tariffs on steel and aluminum imports with China. Tariffs of 25% on steel imports and 10% on aluminum imports will result in a price increase for multiple consumers and slow down growth for many businesses globally. The rising tensions between China and the U.S. might seem like a time to move away from most growth-sensitive asset classes, but investors could be wrong.
The announcement resulted in a decline in the stock market as oil and metals started taking a big hit, but could this be a great opportunity to buy industrial metals? Copper has already fallen sharply by 4% in one month, while other oil and metal commodities follow the decline. Investors shouldn’t be too pessimistic and consider the chance of current tensions not escalating into a full-blown trade war. This is thanks to China’s massive stimulus during the financial crisis which is set to offer another boost to global metals prices. Commodity analysts predict, “The resulting acceleration in metals demand is expected to push the copper market, as well as other base metal markets such as nickel and zinc, into deficit, leading to inventory draws, a tightening of the future curve spreads, and higher prices.” We need to further investigate the backdrop to understand why a trade war might positively impact industrial metals. Looking back into December 2017, we have seen prices of aluminum and copper trend upwards even before rumors of a trade war started. Even though global trade remains strong, Chinese credit growth, a leading commodities indicator showed staggering trends in 2017. This means China’s President Xi Jinping will start another round of debt-fueled stimulus to repair the debt problem. Simply put, as long as China is tapering credit growth, the small increase in global trade won’t be an “unalloyed” positive for commodities. Alternatively, a high intensity trade war could initially hurt commodity prices but raise the probability of another round of stimulus in China in the next few years. Being wary of this stimulus will give investors an opportunity to buy during the dip and see industrial metal prices trend upwards. 3/15/2018 0 Comments The Aging WealthThe 10-year Treasury yield has risen from 2.0% last year to over 2.9% in 2018, causing many investors to announce the end of the 30-year bond bull market. With the U.S. economy gaining further stimulus from sweeping tax cuts and an expansionary budget, analysts fear this will finally promote inflationary pressures.
According to the U.S. Congressional Budget Office, the tax cuts are projected to increase the budget deficit from about 3.9% of GDP to about 6.1% in 2020. In addition, the Federal Reserve is cutting its balance sheet, allowing investors to assimilate approximately $1 trillion of Treasuries a year. Nevertheless, there are still major factors subduing inflation, interest rates, and bond yields. One of the main factors is demographics. While life expectancies rise, the world is getting older and richer. Due to the fact that pensioners are not big spenders, nor risk takers, this increases the demand for safer government bonds, thus affecting the economy and curbing inflationary pressures. Some analysts are worried that as pensioners grow even older, and start drawing down their savings, it will reverse the downward pressure on interest rates. This is surely to raise interest rates. However, most of these concerns are not an immediate issue for the following reasons:
As of right now, Germany is falling short of its European climate targets and will have to pay for access to produce and emit greenhouse gases due to the nations polluting farms, factories, and vehicles. This comes after Chancellor Angela Merkel, a longtime proponent of reducing emissions. delivered the news. As a result, Germany will now have to purchase greenhouse gas emissions allowances for the following two years from other European Union members.
“Germany has been on the forefront of industrial production in Europe for many years. However, every nation must choose a proper balance of economic growth that will not cause substantial, irreversible damage to the environment” said Keith Knutsson of Integrale Advisors. The extent of the shortfall will only be known after these next couple of years. The permits will then be purchased from another country in the European Union. This price can vary and has yet to be determined. One thing we do know, is it will come at the price at the expense of German taxpayers. As part of Germany’s agreement to prevent global warming under last year’s Paris Accord, the European Union has pledged to curb global warming by continuing to pursue reductions in carbon discharges not only for industrial production but also for agriculture and waste. A previous report from the European Commission displayed that emissions from the European Union would remain below the 2020 target, with 21 member States expected to keep or reduce their emissions below their national targets by 2020. 2/3/2018 0 Comments What Happens to Nafta?Trade officials from Canada and Mexico met in Montreal recently to begin laying out proposals aimed at convincing the United States not to pull out of the North American Free Trade Agreement (NAFTA).
Representatives from Canada and Mexico will discuss an array of factors and responses to the Trump administration’s demands for altering the trade pact. The initial focus will be on the U.S.’s demands for increased U.S.-made content for cars made in North America. Since the summer of 2017, the United States, Canada, and Mexico have been locked in negotiations to reconstruct the old trade pact. “The U.S.’s goal lies in improving the NAFTA agreement. The current administration has made it very clear that they are willing to go in a different direction if that can’t be done” said Keith Knutsson of Integrale Advisors. Tensions continued to arise this month after Canada filed a complaint with the World Trade Organization against the U.S. trade regime and how it unfairly applies tariffs. Nafta Dispute Resolution panels started on Sunday, with a focus on energy and agriculture. These discussions are scheduled to end Monday, Jan. 29, with a meeting of top U.S., Canadian, and Mexican trade officials. Even if there are adjustments to how the automobile industry trades, there will still be large differences between the three nations as to how trade disputes are handled. The United States administration is trying to come out on top in these negotiations. However, it would be in everyone’s best interest to have a commitment ensuring “mutually beneficial trade.” The city of Milan is stepping up its efforts to become a part of London’s asset management industry after Brexit is complete. A recent plan has been derived for a delegation from the Italian government to meet with UK companies in the next couple of weeks. Milan, the financial hub of Italy, hopes that up to 1,500 asset management and investment banking jobs will move from London to Italy. The initial attempts by the Italian Finance Ministry to entice fund managers in 2016 were unsuccessful after prime minister Matteo Renzi’s failure to finalize and pass through constitutional reforms. These reforms were to deregulate the financial industry, making it more appealing to foreign fund managers.
Last year, the Italian government changed its personal tax regime in an attempt to lure high-earning Italians to come back to the homeland. Mr. Pagani, the chief of staff of Italy’s Finance Ministry, said this was designed with the interests of portfolio managers and fund company executives in mind. Some of the new incentives include a 50% reduction of income tax for five years for middle managers and a flat €100,000 annual tax on foreign earnings for wealthy individuals, lasting around 15 years. According to recent figures from the European Fund and Asset Management Association, Italy’s fund industry is the sixth largest in Europe. This accounts for approximately 5% of the European Financial market share and €1.2tn in assets. “There is a consensus that London will remain an important player in the European financial sector in the future” said Keith Knutsson of Integrale Advisors. 1/22/2018 0 Comments GDP Growth Germany 2017Germany’s economy posted fastest growth in six years in 2017, as GDP grew 2.2%. The World Bank estimates that Europe economy grew 2.4% in 2017, comparable to the 2.3% projection of the US.
With a boost of low interest rates, low unemployment, a weak euro, positive economic growth trends and rising wages propelling the economy, economists believe for Germany’s positive growth to continue. Some additional numbers from the report revealed a 5.2% increase in imports and 4.7% increase in exports. The overall budget surplus has reached 1.2% of GDP, and Germany’s increased investment spending is reflected through figures such as the 3.5% increase on plant and machinery. For now, the political arrangement for a coalition in Germany has not stabilized. Analysts are evaluating the impact of these numbers on the final day of exploratory talks for formal negotiations with the SPD. Given that much of Merkel’s criticism is derived from accusations of economic apathy, with investors complaining about an over-restrictive tax system hindering much of Germany’s potential growth. The public sector as a whole posted a record surplus of 38.4 billion euros, indicating the ability for the government to trim the tax burden and increase spending. Meanwhile, the SPD continues to argue for increased taxing of high earners in Germany. Whether this data encourages Merkel to make additional concessions to an agreement with the SPD will remain to be seen. The SPD publicly remains skeptical to Merkel’s proposal for a coalition, but key leaders such as Martin Schulz are attempting to sway delegates of their own party towards agreement. Keith Knutsson of Integrale Advisors commented, “I have demonstrated my faith in Germany’s economic growth for years now – despite the current political limbo there is much potential left in the market. “ 1/18/2018 0 Comments German Economic GrowthIn 2017, Germany’s economy grew at the fastest annual pace in nearly a decade. As a result, this is a large contribution to the pickup in growth across the eurozone.
According to the German National Statistics Office, GDP (gross domestic product) grew 2.2% last year, after analysts expected growth of 2.3%. Nevertheless, it was the fastest pace of growth recorded since 2011. Germany’s strong performance feeds into the success of the eurozone. On Tuesday, the World Bank estimated the EU’s economy grew 2.4% in 2017, which would be its strongest performance since 2007. The expectation is that Germany’s positive growth and momentum will continue in the current year. Trade played a big role in the growth: imports grew 5.2%, exports were up 4.7%. “Looking to the future, the fundamental factors that supported growth in 2016 and 2017, such as rising industrial production and larger demand for real estate, should still be in place in 2018” said Keith Knutsson of Integrale Advisors. The recent pickup in growth across the eurozone has made policy makers at the European Central Bank more confident that they will reach their inflation target over the next couple of years. The central bank is decreasing monthly bond purchases under the quantitative easing program from €60 billion from €30 billion. The acceleration in growth has been fueled in part by a rise in business investment, with Germany seeing a 3.5% rise in spending on domestic plant and machinery in 2017. Eurozone industrial production was 1% higher than in October, and 3.2% higher than in November of 2016. As a result, Germany remains the Eurozone’s manufacturing powerhouse. 10/12/2017 0 Comments Retail space in the US: Too Much?Over the past 67 years, commercial retail space per capita has increased thirtyfold, according to CoStar Group. While some of this development is explained by the movement away from traditional mom and pop stores towards chains, the increased space has created additional vulnerabilities to retailers’ changing customers. Past retailer strategies consisted of expansion to increase sales growth. Yet, a report released by Barclays Inc. suggests that 38 of the top 50 grocery markets in the U.S. are already too saturated by food retail per capita or are on track to be so by next year. Without major strategical reorganizations, numerous retailers could very easily be facing enfeeblement.
Customers are becoming increasingly tolerant of online choices. Especially in cities online ordering has become increasingly prevalent with 23% of consumers living in a city with a population of 500,000 or more having made an online grocery purchase in the last 90 days, compared to 10% in smaller cities. Additionally, research has indicated that consumers are growing more unfavorable towards cooking. Cooking has gradually evolved from a daily activity to a niche, occasional, activity. Consumers now spend more money on food in restaurants than they do on groceries, and the biggest 25 food and average companies having lost $18 billion in market share since 2009. Even simple, non-taxing items like cereal are experiencing market losses as people shift their breakfast consumption towards the likes of Dunkin’ Donuts and Starbucks. Keith Knutsson of Integrale Advisors commented, “While it is difficult to forecast the developments of such a major US market, it would not be the first time that an entrenchment in traditional business methods and failure to adapt lead to the demise of an industry.” |
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October 2018
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