In Portfolioticker today
- Today at the stock market
- The portfolio today
- Japan Update
- China Update
Today at the stock market
“The S&P 500 ended slightly higher on Monday as financial stocks rose ahead of a Federal Reserve meeting, but the Nasdaq pared gains sharply as technology stocks lost ground late in the session.
Five of the 11 major S&P sectors ended lower. Rising U.S. Treasury yields boosted financial stocks, as higher interest rates tend to lift bank profits, but rate-sensitive sectors such as utilities were the weakest.
- The S&P 500 .SPX gained 3.64 points, or 0.15 percent, to 2,503.87
- The Dow Jones Industrial Average .DJI rose 63.01 points, or 0.28 percent, to 22,331.35
- The Nasdaq Composite .IXIC added 6.17 points, or 0.1 percent, to 6,454.64.
- Advancing issues outnumbered declining ones on the NYSE by a 1.36-to-1 ratio; on Nasdaq, a 1.55-to-1 ratio favored advancers.
- About 5.97 billion shares changed hands on U.S. exchanges on Monday, compared with the 5.91 billion average for the last 20 sessions.
The Fed meeting, which starts Tuesday, is expected to yield details on how the central bank will unwind its $4.2 trillion portfolio of Treasuries and mortgage-backed securities, nearly a decade after the global financial crisis.
After pushing the S&P above its 2,500-point milestone last week, investors were holding their fire as they awaited more clues on the timing of the next rate hike from Fed Chair Janet Yellen.
“You just had that little momentum spurt after it went through 2,500 but it is kind of running out of steam and is going to bide its time until Wednesday, when they listen to Janet” said Ken Polcari, director of the NYSE floor division at O’Neil Securities in New York.
However, the Dow still clocked a closing record for the fifth day in a row while the S&P had a closing record for the second consecutive session.
“There’s momentum in the market. There’s lots of cash. Even though the Fed’s about to reduce their balance sheet, you continue to have incredibly aggressive monetary policy. That continues to lead to money flowing into the market almost in an indiscriminate fashion,” said Stephen Massocca, senior vice president at Wedbush Securities in San Francisco.
Big technology stocks such as Microsoft and Google parent Alphabet came under pressure late in the session after Amazon said it would move to charging businesses in one-second increments for use of its servers. “That competes with Google and Microsoft, and it’s going to weigh on the entire tech space” because of price competition, said Michael O‘Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut. Microsoft shares ended down 0.2% while Alphabet was off 0.6%, with both stocks seeing a pickup in volume late in the day.” Reuters
^ Market indices today (mouseover for 12 month view) Chart: Google Finance
The S&P 500 index closed on a record high of 2,503.87, up 0.15% on Friday’s record of $2,500.23
The Dow Jones Industrial Average closed on a record high of 22,331.35, up 0.28% on Friday’s record of $22,268.34
|Index||Ticker||Today||Change||31 Dec 16||YTD|
|S&P 500||SPX (INX)||2,503.87||+0.14%||2,238.83||+11.83%|
^ USD and AUD indices over the past 52 weeks (mouseover for longer term view) Chart: Bunting
|Index||Currency||Today||Change||31 Dec 16||YTD|
Portfolio stock prices
PayPal closed on record high of $62.92, beating its 11 Sep 2017 record of $62.64.
|Stock||Ticker||Today||Change||31 Dec 16||YTD|
^ Bloomberg Dollar Spot Index (DXY) movements today (mouseover for 12 month view) Chart: Bloomberg
“The Bloomberg Dollar Spot Index (DXY) rose 0.3%.
The EUR fell 0.1% to USD 1.1931.
britain’s GBP fell 0.8% to USD 1.3483. Bank of England Governor Mark Carney reiterated that inflationary pressure may be mounting.” Bloomberg
^ AUD movements against the USD today (mouseover for 12 month view) Chart: xe.com
Oil and Gas Futures
“West Texas Intermediate crude hit a wall at $50/barrel and settled at $49.91.” Bloomberg
Prices are as at 15:49 EDT
- NYMEX West Texas Intermediate (WTI): $49.90/barrel +0.02% Chart
- ICE (London) Brent North Sea Crude: $55.44/barrel -0.32% Chart
- NYMEX Natural gas futures: $3.15/MMBTU +4.23% Chart
EU: Inflation (CPI/HICP). Aug 2017
Press Release Extract [ser_eu_cpi]
“Euro area annual inflation was 1.5% in August 2017, up from 1.3% in July 2017. In August 2016 the rate was 0.2%. European Union annual inflation was 1.7% in August 2017, up from 1.5% in July 2017. A year earlier the rate was 0.3%. These figures come from Eurostat, the statistical office of the European Union.
The lowest annual rates were registered in Ireland (0.4%), Cyprus (0.5%), Greece and Romania (both 0.6%). The highest annual rates were recorded in Lithuania (4.6%), Estonia (4.2%), and Latvia (3.2%). Compared with July 2017, annual inflation rose in twenty Member States, remained stable in five and fell in three.
The largest upward impacts to the euro area annual inflation came from fuels for transport (+0.16 percentage points), accommodation services (+0.10 pp) and air transport (+0.06 pp), while telecommunication (-0.12 pp), vegetables (-0.05 pp) and social protection (-0.04 pp) had the biggest downward impacts.“
Eurostat, “August 2017: Annual inflation up to 1.5% in the euro area, Up to 1.7% in the EU“, 18 Sep 2017 More
BIS: Quarterly Report
Press Release Extract [ser_bis]
“Strong outlook with low inflation spurs risk-taking
Monetary policy came sharply back into focus in global financial markets. In late June, market participants interpreted a speech by the European Central Bank (ECB) President and (comments by) the Bank of England (BOE) Governor as possible signs of the beginning of a broader-based tightening in major advanced economies other than the United States. Long-run government bond yields jumped. However, they soon softened in response to weak inflation data and central bank statements that investors perceived as having a more dovish tone. Moreover, low realised inflation led markets to also anticipate an even more gradual path for US monetary policy tightening than at the beginning of June.
[ECB Forum on Central Banking: Sintra, 27 Jun 2017]
European Central Bank: Introductory Speech, Mario Draghi Speech (Sintra)
Bank of England: Comments, Mark Carney
Propelled by reduced expectations of monetary tightening in the United States and positive macroeconomic news, global markets surged. US equity markets reached new historical highs in August, and emerging market economy (EME) equities steamed ahead. Corporate credit spreads were at, or close to, their narrowest levels since the beginning of 2008. Both realised and implied volatility in all major asset classes, and for bonds in particular, were subdued. The MOVE – a measure of implied volatility in the US Treasury market – reached new historical lows. In mid-August, volatilities spiked somewhat due to rising political risks in the United States and increased geopolitical tensions relating to North Korea. But even as political tensions remained high, they returned to low levels by the beginning of September.
The shifting outlook for the future paths of monetary policy and increased US policy uncertainty put strong downward pressure on the US dollar (USD). As macro news was also better than expected globally while disappointing in the United States, the USD depreciated vis-à-vis all major advanced economy and EME currencies. The USD lost most ground against the euro (EUR), given the strengthening economic outlook in the euro area and monetary policy signals.
Low measures of volatility and a depreciating USD supported a “risk-on” phase. It whetted investors’ appetite for EME assets as carry trades delivered large returns. Equity market investors used record amounts of margin debt to lever up their investments, even though price/earnings ratios indicated that equity valuations might be stretched by historical standards. And there were some signs of search for yield in debt markets: issuance volumes in leveraged loan and high-yield bond markets rose while covenant standards eased.
A brighter outlook and subdued inflation drive markets up
Monetary policy took centre stage at the end of June. Market participants interpreted a speech by the President of the ECB on 27 June as providing a signal of a forthcoming tapering of quantitative easing in the euro area.
Long-term yields rose globally in anticipation of an end to the exceptionally easy monetary policy in major advanced economies other than the United States. The prospects of a simultaneous tightening jolted markets.
The rise of global yields came to a halt as investors took cues from further central bank announcements and higher inflation did not materialise. Subdued wage pressures, despite tightening labour markets, contributed to low headline inflation in the United States and the euro area of 1.7% and 1.3%, respectively, in July. Low inflation fed into low inflation expectations, which were further depressed in the United States by fading prospects for a large fiscal stimulus. In Japan, inflation remained close to zero, and inflation expectations changed little after 20 July when the Bank of Japan (BOJ) delayed the timeline for reaching its inflation target.
[CNBC: "BOJ delays 2017/2018 inflation target for sixth time", 20 Jul 2017] Article
Against this backdrop, market participants expected a more gradual tightening, in particular in the United States. Despite a small uptick after the ECB President’s speech, rate hike expectations in the euro area and Japan remained minimal. In June, market prices had already been implying a much more gradual pace of tightening than in previous episodes in the United States and the United Kingdom. While events in late June pushed up rate hike expectations somewhat, the “missing inflation” flattened yield curves again. Accordingly, the market-implied probability of at least one rate rise within one year fell from 60% in early July to around 30% in early September in the United States. Long-term bond yields fell steadily, with the US yield reaching levels last seen in November 2016.
Despite subdued inflation in advanced economies, the global macro outlook was upbeat. Market commentators label such an environment the Goldilocks scenario – where the economy is “not too hot, not too cold, but just right”.
The purchasing managers’ index (PMI), a leading indicator of economic activity, signalled continued economic expansion in advanced economies. In Japan, profit margins rose rapidly. The economy grew in the second quarter at an annualised rate of 4% – the fastest pace in more than two years, beating expectations by a wide margin.
The economic outlook for the euro area was particularly positive. As the area recorded its lowest unemployment rate in nine years, the manufacturing PMI rose to its highest level since 2011. Euro zone economic confidence breached even pre-crisis levels. The profit margins of European companies also grew strongly, even though their overall profitability remained below that of their US or EME counterparts. The positive outlook was further underpinned by progress in cleaning up bank balance sheets and by reduced policy uncertainty following the presidential and parliamentary elections in France.
US macroeconomic data were strong, but the US economy underperformed relative to market expectations. In July, the US unemployment rate fell to levels last seen in 2001. At the same time, the Citi Economic Surprise Index reached its lowest point since 2011, indicating that economic data poorly matched market expectations. That said, rising and better than expected profit margins supported equity markets.
[CNBC: "Trading the tumble in the Citi economic surprise index", 22 Jun 2017: Chad Morganlander of Washington Crossing Advisors and Bill Baruch of iiTrader discuss with CNBC's Brian Sullivan.] Article
Investors were also positively surprised by the macro news coming from EMEs. Corporate profit margins rose. And while the outlook was not as optimistic as for advanced economies, PMIs indicated a macroeconomic expansion for major EMEs. Growth in China held up unexpectedly well, at around 7% in the second quarter, giving a major boost to market confidence.
Market participants’ concerns about financial stability risks in China also retreated. At the beginning of the year, strong capital outflows and rapidly shrinking FX reserves had prompted market jitters against the backdrop of persistent aggregate credit growth and high credit-to-GDP ratios. Since then, credit growth has slowed even though house prices continue to rise, partly driven by property developers. China’s net capital inflows have turned positive, and its foreign exchange reserves have stabilised.
The strong global macro backdrop and reduced expectations of interest rate increases in the US boosted stock markets. US equity indices reached new peaks in early August, and EME equities steamed ahead. While European and Japanese stocks softened somewhat in recent months, they have still returned around 11% and 14%, respectively, since early September 2016.
Credit markets remained buoyant. Sovereign bond spreads continued to tighten slowly in the euro area. They remained broadly flat for EMEs, but below the previous five-year average. In June, Argentina took advantage of the favourable market conditions to issue a 100-year USD-denominated bond with a yield around 8%. And Greece returned to capital markets in July, selling a five- year bond denominated in EUR with a 4.6% yield. Other infrequent or new issuers, such as Iraq and Belarus, also tapped bond markets, while Tajikistan prepared its benchmark offering of a 10-year USD-denominated bond.
Corporate credit spreads were tight and falling. In mid-August, they stood at, or just a few basis points off, their lowest levels since the beginning of 2008. But they remained well above the levels prevailing before the Great Financial Crisis.
The overall positive market mood was disrupted by political events from mid- August onwards. However, while dominating headlines, politics did not weigh strongly on markets. Stock markets fell initially from their historical highs amid rising political risks in the United States and increased geopolitical tensions relating to North Korea. Yet the effects were short-lived. Even South Korean credit default swaps hardly budged and the Korean won (KRW) scarcely moved against the USD after North Korea fired a long-range missile over Japan and conducted its biggest ever nuclear test a few days later.
Shifting global outlook reverberates in FX markets
Shifting expectations about the future paths of monetary policy and the change in the relative macro outlook across major economic regions, along with political risks, put strong downward pressure on the USD. As the expected path of future Federal Reserve rate hikes shifted downwards and the US economy underperformed relative to market expectations, the USD depreciated against all major advanced economy currencies. Movements against the yen were muted given the minimal change in the Bank of Japan’s policy outlook. Moreover, speculative positions, as reported by the Commodity Futures Trading Commission (CFTC), in USD vis-à-vis other currencies swung to net short at the beginning of Q3. This indicated expectations of a continued depreciation of the USD.
USD depreciation was most pronounced against the EUR – around 7% since mid-June. The USD lost most ground after the ECB President’s remarks in June about reflationary forces being back in the euro area. The depreciation came to a halt in early August, partly due to concerns over the potential of a strong currency adversely affecting the euro area economy. But the USD resumed its decline against the EUR at the end of August.
The USD also fell against most EME currencies. With the exception of central and eastern European currencies, which tend to follow the EUR, exchange rate adjustments of the USD vis-à-vis EME currencies were not particularly strong and volatility was low.
Is volatility exceptionally low?
Buoyant markets and a falling USD went hand in hand with subdued volatility in all major asset classes. Bond market volatility across the globe was extremely low. The MOVE index, a measure of implied US bond market volatility [MOVE:IND] Article, fell to new historical troughs in August. At the same time, the VIX [VIX:IND] Chart, which measures the implied volatility of US equity markets, reached levels close to the very low ones last seen in 2005. While volatilities remained low compared with historical benchmarks, they edged up somewhat and experienced a few spikes following political events in August.
Low expected volatility and a low volatility premium both seem to have contributed to the overall decline in the VIX. This is suggested by a decomposition of the VIX into the conditional variance of stock returns (the volatility that would be expected from actual stock return volatility in the recent past) and the equity variance premium (the extra amount investors are willing to pay to protect themselves from volatility). Both of these factors, along with the VIX itself, fell to their lowest points in several years, although they remained above their historically compressed pre-crisis levels.
Low stock market volatility has been typical of monetary tightening cycles since the early 1990s. During such episodes, both the VIX and 30-day realised stock market volatility have tended to stand between half and one standard deviation below their long-run averages. This may have been due in part to the fact that volatility tends to be lower when equity markets rise, and tightening episodes tend to happen when such markets are rising. When set against this benchmark, the average VIX in the last 90 days prior to 5 September was not so unusual.
Recent bond market volatility, however, has been extremely low by historical standards, in line with extraordinarily low bond yields and gradual rate hike expectations. The MOVE index, for instance, has been unusually depressed in recent months, despite the increase in the federal funds target rate in June. This contrasts with previous tightening episodes, during which bond market-implied volatility was close to its long-term average.
Large net short speculative positions on VIX futures signalled expectations that volatility would remain low. US CFTC net short positions on VIX futures – ie bets against rising volatility – reached record levels at the end of July. In line with the somewhat higher VIX, they decreased in August but remained three times higher than the average for the last 10 years.
At the same time, markets priced in the risk of large asset price declines. The CBOE Skew Index Index – a measure of tail risk in the S&P 500 index – was high compared with its historical values. This suggests that investors were pricing in a significant likelihood of large asset price drops.
A “risk-on” phase
As is typical for periods of low volatility and a falling USD, a “risk-on” phase prevailed.
Against the backdrop of persistent interest rate differentials and a depreciating USD, returns from carry trades rose sharply and EME equity and bond funds saw large inflows during the period under review. Speculative positions also pointed to patterns of broader carry trade activity: large net short positions in funding currencies, such as the yen (JPY) and Swiss franc (CHF), and large net long positions in EME currencies and the Australian dollar (AUD).
Equity market investors also employed record amounts of margin debt to lever up their investments. In fact, margin debt outstanding was substantially higher than during the dotcom boom and around 10% higher than its previous peak in 2015.
While margin debt levels breached new records, traditional valuation benchmarks, such as long-run average price/earnings (P/E) ratios, indicated that equity valuations might be stretched. Recent market moves pushed cyclically adjusted P/E ratios for the US market further above long-run averages. Cyclically adjusted P/E ratios also exceeded this benchmark for Europe and for EMEs, though by a smaller amount. That said, given the unusually low bond yields, valuations may not be out of line when viewed through the lens of dividend discount models. Indeed, estimates of bond yield term premia remained unusually compressed, well below historical averages in the United States and drifting further into negative territory in the euro area. This suggests that equity markets continue to be vulnerable to the risk of a snapback in bond markets, should term premia return to more normal levels.
There were also some signs of search for yield in debt markets, as issuance volumes of leveraged loans and high-yield bonds rose while covenant standards eased. The global volume of outstanding leveraged loans, as recorded by S&P Global Market Intelligence, reached new highs (above $1 trillion) Index. At the same time, the share of issues with covenant-lite features increased to nearly 75% from 65% a year earlier. Covenant-lite loans place few to no restrictions on the borrowers’ actions and as such might signal a less discriminating attitude on the part of lenders while potentially fostering excessive risk-taking on the part of borrowers. According to Moody’s, the covenant-lite share in the high-yield bond market also increased while covenant quality declined to the lowest levels since Moody’s started to record these numbers in 2011.
While corporate credit spreads were tightening, the health of corporate balance sheets deteriorated. Leverage of non-financial corporates in the United States, the United Kingdom and, to a lesser extent, Europe has increased continuously in the last few years. Even accounting for the large cash balances outstanding, leverage conditions in the United States are the highest since the beginning of the millennium and similar to those of the early 1990s, when corporate debt ratios reflected the legacy of the leveraged buyout boom of the late 1980s. And despite ultra-low interest rates, the interest coverage ratio has declined significantly. While the aggregate interest coverage ratio remained well above three, a growing share of firms face interest expenses exceeding earnings before interest and taxes – so-called “zombie” firms. The share of such firms has risen especially sharply in the euro area and the United Kingdom. At the same time, the distribution of ratings has worsened. The share of investment grade companies has decreased by 10 percentage points in the United States, 20 in the euro area and 30 in the United Kingdom from 2000 to 2017. The relative number of companies rated A or better has fallen especially sharply, while the share of worst- rated (C or lower) companies has increased. Taken together, this suggests that, in the event of a slowdown or an upward adjustment in interest rates, high debt service payments and default risk could pose challenges to corporates, and thereby create headwinds for GDP growth.”
Bank for International Settlements, “BIS Quarterly Review: International banking and financial market developments , September 2017“, 25 Sep 2017 More
^ JPY movements against the USD over the past month (mouseover for inverse) Chart: xe.com
Stockmarket: Nikkei 225
^ Nikkei N225 movements over the past week Chart: Google Finance
^ CNY movements against the USD over the past month (mouseover for inverse) Chart: xe.com
^ Shanghai CSI300 movements over the past week Chart: Google Finance