Posted in Newsclips, Samples

Value ETFs Riding High on Small Cap Outperformance



 A quick look at large cap value equity performance so far this year suggests a challenging time for value stocks. But this is an incomplete picture and performance among smaller cap value stocks has been very strong. We note that year to date returns in value ETFs, particularly those with higher exposure to small caps, are outperforming the broad index and their large cap peers. 


A client inquiry regarding the performance of value versus growth equities in the U.S. led us to an interesting discovery. The chart below shows a clear divergence in returns this year for growth versus value equities in S&P 500. 



We typically see returns in ETFs track underlying indices fairly closely. But this appears to be a case where broad ETF definitions can give misleading impressions about performance characteristics. The next chart shows that although the faster price appreciation has driven total assets in U.S. growth ETfs higher, U.S. value ETFs have also seen year to date growth exceed 10%. 



Looking at net 20-day flows into value and growth ETFs shows surprisingly similar flows given the wide disparity in performance. We had expected to see year to date underperformance drive move value investors out of the strategy. 



Now there is enough variety in the ETF space for broad definitions like value and growth strategies to include a range of different return profiles. But there appears to be much greater variation among value ETFs than their growth focused competitors. 

The chart below shows YTD returns for all U.S. growth equity ETFs. These range from 19-28%, reasonably close to the S&P 500 Growth Index total return of 16%. 



The universe of U.S. value ETF returns has a much wider dispersion, and much less resemblance to the S&P 500 Value Index. Year to date returns range from 18-37%, well above the 4.9% return of the index. Most of the variation is explained by exposure to small caps. The best performing funds focus on small caps or value sector of the Russell 2000. 

Still, the fact that none of these ETFs are within 12% of the total return for a widely used, if large cap specific, benchmark value index illustrates how widely performance can vary within a defined space. The outperformance of small cap value ETFs is helping maintain investor interest in value ETFs even as larger cap value stocks are under-performing. 



The underperformance of large cap value stocks does not paint a complete picture of the value space in U.S. equities. Small cap value stocks are outperforming and helping drive superior performance in the value ETF space. Given the high concentration of stock market performance in a handful of large cap technology names, the strong performance of small cap value may offer some under-appreciated diversification opportunities. 


Posted in Newsclips, Samples

The Rise Of Emerging Markets

  • The Financial Times – Seven charts that show how the developed world is losing its edge

    What is happening to the world economy? Here are some answers, in seven charts. They reveal a world undergoing profound changes. The most important transformation of recent decades has been the declining weight of the high-income countries in global economic activity. The “great divergence” of the 19th and early 20th centuries, when today’s high-income economies leapt ahead of the rest of the world in terms of wealth and power, has gone into remarkably rapid reverse. Where once there was divergence, we now see a “great convergence”. Yet it is also a limited convergence. The change is all about the rise of Asia and, most importantly, of China.


The interactive charts below offer a look at the rise of emerging market economies on the world stage. The first chart shows that, while the U.S. still accounts for the largest portion of world GDP, China is quickly closing in.

The second chart shows that, on a regional basis, East Asia & the Pacific actually account for a larger share of world GDP than Europe and North America.

Finally, the last chart shows a breakdown of contribution to world GDP based on income groups. High income economies still account for over 60% of world GDP.



Posted in Charts of the Week, Samples

A decent year in stocks.  As the table below shows, the stock market is having a decent year.


Large cap stocks leading the way.  As the next chart shows, large cap stocks (blue) are leading the way as small cap stocks (red) lag badly.



Market Cap weighted beats equal weight.  Another way to show that large capitalized stocks are powering the overall market higher is the next chart.  It shows the S&P 500 stocks market cap weighted (blue) and equal-weighted (orange).  It is unusual for market cap to outperform equal weight by this degree.



Growth beats value.  The chart below shows the S&P 500 pure growth (orange) and pure value (blue).  “Pure” means the S&P 500 universe is out into one of these two groups.  Growth is dominated by large capitalization technology stocks (i.e., FAANMG) which explain why pure growth is handily outperforming.




The best and worst sectors.  The S&P 500 has 11 sectors.  The two best (info tech and healthcare) and the two worst (energy and telecom) are shown below.



The most positive and negative influences on the S&P 500.  The S&P also has 11 “x” sector indices.  These are indices that exclude a specific sector.  We show the two best and worst x-sectors below.

This is useful as it shows how much a sector influences the overall S&P 500 (by subtracting the “x sector from the overall S&P 500 in blue).  So x-energy is up 12.93% versus 11.05% for the overall S&P 500.  This means that the energy sector dragged down the overall S&P 500 1.88%.  Conversely, x-info tech is up 8.76% against 11.05% for the overall S&P 500.  This means the info tech sector has pushed up the overall S&P 500 2.29%. 



Interactive Chart 

The interactive chart below can be used to view the total returns for any or all of the 34 indexes provided under the “select an index” dropdown menu. The date range can be adjusted at the bottom of the chart.


Posted in Charts of the Week, Samples

The chart below shows the 35 categories that Hedge Fund Research (HFR) tracks on a daily basis (HFRX), None are beating the MSCI World (top green) and the S&P 500 (top blue).  

The best performing HFR category is Fundamental Growth Index (red).  Four are down for the year, Macro/CTA (dark green), Macro/CTA in Euros (brown), Macro Systemic Diversified CTA (light blue) and the MLP (energy) Index (light green) as the worst.

The best performing HFR category is Fundamental Growth Index (top red).  Four categories are down on the year; Macro/CTA (dark green), Macro/CTA in Euros (brown), Macro Systemic Diversified CTA (light blue) and the MLP (energy) Index (light green) is the worst.



Posted in Charts of the Week, Samples

Bitcoin continues to fascinate observers and frustrate some owners with its exceptionally high volatility in recent weeks. Now back above $2000, Bitcoin has fought off two sharp declines since the end of May. 

One contributor to higher volatility is the dramatic fall in volume after the regulatory intervention by the Peoples Bank of China. See the second tab in the story point below. Volume fell by more than 90% and has not recovered. 

If you click to the third tab you can see the share of volume by currency. The USD has been slowly gaining share since the intervention but the CNY still accounts for the 2nd largest share of volume followed by EUR and JPY. 


Click for static images of the price, volume by currency and volume share charts. 
Posted in Charts of the Week, Samples

The chart below shows various tenors of interest rates since the initial FOMC hike on December 17, 2015. 10-year yields are almost exactly where they were prior to this hike. 30-year yields are actually lower over this time period.

At the same time, yields on the short end of the curve have marched much higher. A look at 3-month T-bills shows yields have shot up 84 basis points.

The flattening of the yield curve was a topic of a recent Conference Call.


Posted in Charts of the Week, Samples

The Federal Funds market is showing no signs of reviving.  The Fed still targets the federal fund’s rate. They do this by using tools like fixed rate reverse repos and Interest on Excess Reserves (IOER).  This suggests they think it will return some day.  But as the chart below shows, this market’s volume is still down 90% from its peak and still bumping around a 40 year low.  It is showing no signs of reviving.  Should the Fed consider abandoning this target for another interest rate benchmark?

Posted in Charts of the Week, Samples


Measuring Political Risk.  The Economist Intelligent Unit compiles Political Risk measures for 132 countries at last count.  The next chart shows the 10 countries with the lowest political risk.  Pretty standard stuff (Denmark then Luxembourg are the lowest).


The next chart shows the 10 countries with the highest political risk.  Britain is on this list! Right above it is the Congo and Iraq.  Right below it is Cambodia and El Salvador.

The reason is understandable, Brexit.  But Britain with a higher risk that Cambodia?  Similar to the Congo?  We would argue this rating is more about the “intellectuals” at The Economist making a political statement about their disapproval of Brexit more than an honest assessment of Britain’s actual political risk.




Using the interactive chart below, you can view the political risk for any country over any period you choose.



How safe is Trump?  The bettors are giving him much better than a 50% probability of stay in office until the end of next year.





Click for static images of the President’s ratings comparison, President’s ratings over time and how Trump compares to past approval ratings


Posted in Charts of the Week, Samples

The blue line below shows a 50-day moving average of the total trading volume in actual high-yield bonds as measured by TRACE. In the 50 days ending July 19, $7.66B of high yield bonds traded on an average day.

The green line shows the 50-day average of the total dollar volume (price multiplied by shares) for the 25 largest high-yield ETFs. HYG accounts for roughly two-thirds of this total. In the 50 days ending July 19, $1.56B of high-yield ETFs traded on an average day.

The red line, which shows the ratio of the green line to the blue line, shows the ETF market is currently 20% the size of the underlying cash market.

This is how one-fifth of the high-yield market now trades.



By contrast. the chart below shows the same metric for investment grade.  Only 4% of investment grade market trading is driven by ETFs. Other than high yield, this is a large number when compared to other ETF sectors.  It shows how dominant high yield is relative to its underlying cash market.


Posted in Charts of the Week, Samples

 The black market rate of Venezuela’s currency continues to collapse resulting in hyperinflation and a worsening situation in the country.  Note that in the last year the black market rate went from 1,010 Bolivars to buy a dollar to 8,481 Bolivars today.  A drop of 88%.


At this rate of currency depreciation over the last year, prices in Venezuela would need to rise 833% in the last year to keep pace with inflation.  This is not happening with wages.  But, as the next chart shows, the Venezuelan stock market is keeping pace with this hyperinflation rate (for now).  It went up by 970% in the last year (blue) leading to a 27% currency adjusted rate (red now).  Venezuela’s stock market has 15 liquid stocks with Mercantil Servicios Financieros, C.A. and Banco Provincial, S.A. account for 85% of their stock market’s capitalization.  Mercantil Servicios is a junk rated credit and Banco Provincial is no longer rated.

Posted in Newsclips, Samples

U.S. Dollar Decline Looking Over-Extended

  • Financial Times – Dollar sinks on failure of healthcare reform
    US currency hits 10-month low as hopes fade for Trump economic stimulus
    The dollar has been a barometer of prospects for the Trump administration’s efforts to enact pro-growth policies of tax cuts and fiscal stimulus. As the administration has become bogged down in the past six months handling healthcare reform and dealing with the Russia scandal, the reserve currency has steadily retreated. Lacklustre economic data, notably a weaker tone for inflation and retail sales for June, have prompted the bond market to reduce the likelihood of further interest rate increases from the US Federal Reserve.

  • Wall Street Journal – Why a Weaker Dollar Is a Source of Market Strength
    The dollar is down. But that is good news for markets

    The WSJ Dollar Index has now unwound the boost it got from the election of Donald Trump in November, and is down about 6.5% this year. The greenback’s key counterpart, the euro, is up close to 10% in 2017. Early Tuesday, the euro rose above $1.15 for the first time since May 2016, reaching the top of the range it has been in since the start of 2015 under the influence of monetary-policy divergence between Europe and the U.S. The transformation in the dollar and euro’s relative fortunes in 2017 has been remarkable. The focus at the start of the year was on the U.S. Federal Reserve and its efforts to raise interest rates; now the European Central Bank has stolen the spotlight as it tacks gently away from ultraloose policy settings.

  • Wall Street Journal – Dollar Doldrums Mean Easier Money
    The Goldman Sachs Financial Conditions Index, a widely-watched gauge, was at its lowest since late 2014 this week. The lower the index, the looser the flow of money, based on factors like bond yields and the value of the dollar against its peers. Much of that is the result of a falling greenback. The WSJ Dollar Index, a measure of the U.S. currency against 16 others, is down 6.5% since the end of last year. The index was down another 0.6% Tuesday morning at its lowest level since October, before the presidential election spurred a big surge in the dollar.


Expectations for sustained weakening by the U.S. dollar seem to be fashionable lately. And there are many reasons why this could be the case. We discussed some of them yesterday as they related to potential tailwinds for emerging markets. But there are signs the dollar’s latest decline is over-extended, short-term outlook aside. The potential for sustained dollar weakness, which would mean persistently loose financial conditions, may complicate the Fed’s plans. 


Despite agreeing that medium-to-long-term influences point toward persistent U.S. dollar weakness, we see two signs that the short-term outlook is brightening. The first is a simple momentum indicator we use to highlight overbought and oversold conditions. The chart below shows oversold conditions (indicator below -0.5) beginning to appear. 



The second is that our 20-day forecast model is beginning to lean bullish for the dollar. The model estimates the probability that the Bloomberg U.S. Dollar Index will close higher in 20 days. The recent dollar selloff has seen this probability climb to 76.8%. You can read more about the model here

It’s important to note that the latest decline accelerated as the markets tried to gauge political consequences of a defeat to GOP-led health care reform. Deteriorating political risks would be well outside the scope of the model, which considers changes in changes in the yield curve, relative performance of global equities, global risk indices, economic data and gold. The volatile political environment in the U.S. is a risk fact for dollar weakness to continue or even worsen. 



Setting aside the short-term outlook for a moment, the potential for persistent U.S. dollar weakness will complicate discussions within the FOMC as they progress toward balance sheet normalization and consider further rate hikes in 2017. We have discussed how financial conditions do not necessarily tighten as the Fed is raising interest rates. And we’ve also discussed how uncertainty and financial stability concerns tend to accompany tighter financial conditions. But the second Wall Street Journal story above illustrates another point. 

The chart below from the Wall Street Journal story clearly shows just how influential the U.S. dollar weakness has been in driving financial conditions lower (looser). The potential for sustained dollar weakness means a potential medium-to-long-term bias for looser financial conditions. As we’ve mentioned before, New York Fed President William Dudley has promoted the Goldman Sachs Financial Conditions index within the Fed as a means to gauge policy effectiveness. We’ve noted that the influence of the stock market may be problematic if the Fed misses other signals like the yield curve. If the weaker dollar is clouding the signal in the index, the Fed risks tightening too quickly.



This is precisely the opposite challenge they faced as they marched toward the final tapering in late 2014 and the first rate hike in 2015. Both instances saw markets build a massive premium into the U.S. dollar as the Fed was the only central bank tightening policy. There is potential for this premium to be unwound as the Fed begins to slow its pace of tightening and other central banks converge on tighter policy stances. The Fed may be happy to see economic tailwinds from a weaker U.S dollar given recent weakness in economic data. But weighing these offsetting influences will make for complicated discussions and tricky communications in the months ahead. 


Despite valid reasons to expect persistent U.S. dollar weakness, we see some signs that this latest decline is getting over-extended. Firming expectations for more dollar declines are driving positioning across many assets, especially emerging markets. A near-term correction isn’t likely to derail medium-to-longer-term dollar weakening. An eventual return to dollar weakness, or continued dollar weakness despite oversold conditions, will complicate the Fed’s discussions about further tightening this year. 

Posted in Newsclips, Samples

The Market vs. The Fed Update

  • The Daily Reckoning – Jim Rickards: The Fed Has Hit the ‘Pause’ Button

    No rate hikes are coming at the July, September or November Fed FOMC meetings. The earliest rate hike might be at the December 13, 2017 FOMC meeting, but even that has a less than 50% probability as of today. I’ll update those probabilities using my proprietary models in the weeks and months ahead. The white flag of surrender came in two public comments by two of the only four FOMC members whose opinions really count. The four voting members of the FOMC worth listening to are Janet Yellen, Stan Fischer, Bill Dudley and Lael Brainard.


The market has 1.5 hikes priced in through the end of 2018 with no more hikes expected this year. The Fed’s June update to its Summary of Economic Projections predicted 1 more hike this year and three next year. The market and the Fed are once again on different pages. Go with the market as it has a better track record.


The Fed last updated their Summary of Economic Projections at the June FOMC meeting with an expectation for one more rate hike by the end of 2017 and an additional three by the end of 2018. This would leave the targeted funds rate at 1.375% as 2017 comes to a close and 2.125% by the end of 2018.



But, as the chart below shows, the market is not pricing in another hike this year. The odds of a hike at the September meeting are just 10% while the odds of a December hike are 42%.



Expressed another way, the market has 0.4 more hikes priced in for this year while the Fed expects one more hike. By the end of 2018, the market expects 1.5 more hikes while the Fed expects a total of four.

Posted in Newsclips, Samples

Market Not Convinced The Trump Trade Is Dead

  • Bloomberg View – Komal Sri Kumar: How Trump Could Puncture the Equity Bubble
    A delay in stimulus measures and the rise in global trade tensions could deflate valuations.

    Donald Trump’s appeal last November was linked to two factors. Both are now putting the valuation bubble in equities at risk. The first factor was his emphasis on stimulus — tax reform, infrastructure spending and fewer regulations — that has pushed markets to higher and higher levels. The new administration was targeting at least 3 percent annual growth in real gross domestic product, well in excess of levels that the U.S. economy has experienced since the financial crisis.  The second component of the Trump campaign presented the U.S. trade deficit as a sign that the country was being treated unfairly by its trading partners. The remedy was to impose higher tariffs on imports, with China and Mexico mentioned as specific targets. Fear that the trade restrictions the candidate threatened during the campaign would dominate the incipient administration was the reason U.S. equity futures plunged during the hours immediately after the election results were known. Retaliation by trading partners to new tariffs would have slowed global economic growth and demand, resulting in a headwind for equities.

  • The Wall Street Journal – The Last Market Still Betting on Trump

    Still, the market’s high valuation in the face of declining earnings growth and a tepid U.S. economy means some of the rally was likely driven by policy expectations. More than half of the respondents to a survey of nearly 1,100 clients conducted by Cornerstone Macro last month said they expected Congress to pass a significant tax bill before the 2018 midterm elections. The question to ask, says Cornerstone’s Andy Laperriere, is what would happen to stocks if all investors gave up on a tax cut? The answer: They would probably go down.


The Trump trade has three parts; healthcare reform, tax cuts and a business friendly environment. Healthcare reform is on life support, but not totally dead. Expectations are tax cuts, especially corporate tax cuts, can still happen. The massive reduction in regulatory activity is viewed as a big positive for markets. Sum it up and the Trump trade, or at least the hope of the Trump trade, will continue to be a tailwind for markets.


As we noted last month, the U.S. is experiencing an unprecedented drop in regulatory activity. This is in part due to Trump’s pro-business agenda.


In addition, the betting markets are not convinced that healthcare and tax reform are dead. As the next chart shows, the betting markets barely budged on yesterday’s news that Republicans were abandoning the current bill. Bettors have been giving less than a 50% chance of healthcare reform since May and have placed the odds near 20% in recent weeks. 



Regarding tax reform, bettors still place 51% odds on a cut to corporate tax rates. The odds the individual tax rate will be cut stand closer to 36%.



Posted in Newsclips, Samples

U.S. Banking Sector Lagging Despite Steeper Curve

  • Wall Street Journal – Bank Earnings Are Coming: Five Things to Watch
    Calm markets, the Fed and lighter lending are among the factors seen influencing second-quarter results
    The Federal Reserve’s decision to raise short-term interest rates in June, the fourth rate increase since December 2015, should boost banks’ lending income. The rates banks charge on credit cards, home equity lines of credit and other types of loans vary depending on the Fed’s target. Those higher yields will help push net-interest income at the median big U.S. bank up by 6.2% in the second quarter, according to analysts at RBC Capital Markets.


Recent steepening in the U.S. Treasury curve offers a brighter outlook for financials and especially regional banks, yet regional banks have lagged despite heavy inflows into the sector. Further steepening in the treasury curve could see regional banks outperform. 


As the chart in the health care block above shows, despite strong inflows in July, financials continue to underperform at only +5.2% for the year. We noted through the second quarter that U.S. bank equities looked vulnerable to further flattening in the Treasury curve. Interest rates were already well below forecasts and expectations for net interest margins were still tied to a steeper curve. Bank investors were granted some relief as the Treasury curve steepened over the past month. The chart above shows the U.S. 2y10y spread has steepened almost 20 bps since June 14. 

It appears that regional bank investors may now be too pessimistic about the outlook for net interest margins. The next chart shows 20 day change in the U.S. 2y10y spread (x axis) and U.S. regional bank total returns (y axis). The latest point is marked. Bank total returns are flat over the past 20 days even as the 2y10y steepened 17 bps. But past steepening moves greater than this have been heavily skewed toward stronger total returns for regional bank equities. 




ETF investors are flooding into financials despite continued under-performance. One potential headwind for the banking sector specifically has diminished as the Treasury curve steepened in the past month. Now regional bank investors appear wary of accepting the brighter outlook for profitability. We expect net interest margins to be in focus during earnings. Regional banks could be poised to outperform in the near term if the curve continues to steepen. 

Posted in Newsclips, Samples

The Fed’s Got a Fever and the Only Prescription is More Inflation

  • Bloomberg – The Study Europe’s Rate-Setters Should Read
    A new paper shows why the longer rates stay low, the fewer benefits they bring.
    A key argument for hurrying up with a monetary tightening is that negative rates have hurt bank profitability, restricting lenders’ ability to give credit to families and firms. But is it really the case? How low can interest rates go before they become a drag on the economy? A new way of thinking about this problem comes from a working paper by Markus Brunnermeier and Yann Koby at Princeton University. The two scholars believe there is a “reversal interest rate” below which a central bank prompts lenders to cut back on their lending, instead of increasing it. This boundary creeps up over time, setting a limit to how long central banks should keep interest rates low.
  • Bloomberg – The Fed Needs a Better Inflation Target
    A higher goal, with more public support, would benefit the central bank and the economy.
    Today, a group of economists published a letter urging the U.S. Federal Reserve to consider a monumental change in policy: raising its target for inflation above the current 2 percent.

    I signed the letter. Here’s why.

    The inflation target helps define how much stimulus the Fed can deliver when it lowers interest rates to zero (a boundary below which the central bank has been unwilling to go). In a higher-inflation environment, a nominal fed funds rate of zero results in a lower real, net-of-anticipated-inflation rate — the rate that economists typically see as most relevant for consumer and business decisions. If, for example, people expect inflation to be 3 percent, then a zero nominal rate translates into a negative 3 percent real rate — a full percentage point lower than the Fed could achieve if expected inflation were 2 percent.


We have two opposing perspectives in the articles above concerning further monetary stimulus. The ‘reversal rate’ suggests interest rate cuts can move from an accommodative to contractionary impact on lending. The research indicates balance sheet expansion increases this so called reversal rate, meaning interest rate cuts could more quickly become ineffective. In contrast, Kocherlakota continues his support for easier policy by signing a letter with fellow economists urging the Federal Reserve to increase its inflation target.

Who’s right? Unfortunately, the camp calling for continued accommodative policy has a difficult battle showing its ability to foster improved lending and ultimately economic/inflation growth. However, both perspectives appear to have value. We will explain.

The chart below shows two important components of financial conditions: 1) deposits and lending growth (orange line) and 2) leverage and volatility in the financial system (green line). Lower levels indicate expansion, while higher levels contraction. 

Financial leverage remains as elevated as ever and coupled with ultra-low volatility in market returns. Conversely, growth in deposits and lending has steadily retreated post-Great Recession to near average levels. We define values below the shaded green band as too expansionary and values above too contractionary. The Federal Reserve should likely aim for these financials conditions to remain near average (zero).



Prior to the Great Recession the changes in the fed funds rate led to better conditions (i.e. growth) for deposits and lending. The scatterplot below shows six-month changes in the funds rate versus changes in our composite of deposit and lending growth six months forward. More cuts (moving left in chart) were matched with accommodative conditions.


But this all changed post-Great Recession. Further easing actions were surprisingly often followed by diminishing growth in deposits and lending. Confusingly, recent hikes have had balanced-to-accommodative impact. We see some evidence of this ‘reversal rate’ suggesting cuts beyond a certain level can become contractionary. Is a rise in rates toward this ‘reversal rate’ actually good for the economy?



So the Federal Reserve’s steadfast committal to interest rate hikes may be the better path barring a significant shift in economic data. However the added pace of tightening created by balance sheet reduction may be better connected to a higher inflation threshold as suggested by Kocherlakota.

The chart below shows the impact of year-over-year balance sheet reduction on deposits and lending during varying rates of inflation. We are aiming to show the likelihood of the Fed going too far (i.e. mistake) when tightening. This model uses changes in major economic data releases to determine probabilities of balance sheet reduction forcing our composite of deposits and lending to exceed +1 standard deviation from the long-term average (above green band in the first chart above). For the probabilities below we have held constant current rates of economic growth and assumed a pace of hikes at 50 bps per year.

Current core inflation near 1.9% year-over-year (CPI ex-food and energy) shows the Fed has a higher probability of causing a contraction in deposits and lending at nearly any pace of balance sheet reduction. Inflation running above 2.2% indicates a better environment with lower probabilities of contraction.





The Fed will be taking a gamble with continued rate hikes in hopes economic growth remains stable and inflation rises. Losing this bet would likely force the U.S. Treasury yield curve flatter and flatter while demand remains high for longer-dated issues. We have recently shown the yield curve is on the precipice of flattening to quite unfavorable levels for banks and other financials. In this scenario, the Fed like Chistopher Walkin has a fever and the only prescription is ‘more inflation.’

Next Wednesday (June 14) we will see May’s CPI. We continue to believe inflation remains paramount to job growth as we reach full employment. 

Posted in Samples, Webcasts



In our latest webinar, Peter Forbes expands on the financial sector and yield curve

Similar to the block below about the financial sector and yield curve, ETF investors may still be optimistic enough about deregulation to look past the darkening outlook for net interest margins. But the combination of a hawkish Fed and a weakening economic outlook could be enough to shake the lingering confidence of bank ETF investors. The 2y10y spread has another 10 bps to the 2016 lows near 75 bps. A retest of those lows may be a moment of truth for the financial sector. 


  • Financial Times – Bank shares hit as Treasury yield curve flattens
    Net interest margins for financials been depressed for an extended period
    An important measure for US bank profitability plumbed an eight-month low on Tuesday, pressuring the shares of lenders and highlighting doubts in the bond market over the prospect of an acceleration in the economy and inflation this year. The difference in yield between two and 10-year Treasury notes narrowed 2.5 basis points to 84.99 bps, the lowest level since October 3, according to Bloomberg data. This closely watched relationship climbed to a post-election high of 135.5bp in late December, predicated on President Donald Trump’s pro-growth policies boosting inflation and sparking higher interest rates in the future.


Many ETF investors are clinging to elevated post-election expectations for the financial sector despite the worrisome flattening in the yield curve. In the wake of the November election, banking ETFs saw total assets surge by $4.5 billion. Through a mix of poor performance and more recently, steady but limited outflows, assets have fallen $2 billion from the March 1 peak. A substantial amount of the post-election flows have remained in financials despite souring conditions. 



ETF investors who were among the first to jump aboard the post-election rally are still in the money. The chart below shows the average cumulative return for banking ETFs since the election is +17.6%. Nearly anyone else who invested in banking ETFs since November is seeing performance suffer. 



And importantly, investor performance and bonuses are not measured using “Trump to-date” returns. The chart below shows year-to-date total returns for the broad S&P 500, S&P 500 Bank index and S&P 500 Regional Bank index. Regional banks which are more exposed to net interest margins are under-performing the broad market by almost 11%. 




Similar to the block above about the financial sector and yield curve, ETF investors may still be optimistic enough about deregulation to look past the darkening outlook for net interest margins. But the combination of a hawkish Fed and a weakening economic outlook could be enough to shake the lingering confidence of bank ETF investors. The 2y10y spread has another 10 bps to the 2016 lows near 75 bps. A retest of those lows may be a moment of truth for the financial sector. 

Posted in Newsclips, Samples

Discussing The Six Stocks Leading This Rally


Net Positions – Why Are Six Stocks Leading This Rally?
In this Net Positions, Jim Bianco takes a look at the six stocks leading the rally.


There is not a single clean metric to show if the stock market’s returns are concentrated in a few stocks. That is why we use several charts above to show the S&P 500’s gains this year are the most concentrated since the tech bubble of 1995 to 2000.  

To illustrate, a portfolio holding 86% cash and a market weighting of the six FAANMG stocks in the other 14% would be up 2.60% this year. Many fully invested, highly diversified funds have done worse.

2017 investment committee meetings can be condensed into two topics:

  • What to do with FAANMG stocks as a group
  • What to do with the other 494 stocks in the S&P 500 as a group

Simply put, managers will have a very tough time outperforming the market unless they are correctly positioned in the FAANMG stocks. While this simplifies investment meetings, managers are essentially living and dying by these six stocks.

  • Bloomberg View – A Few Big Stocks Don’t Tell the Whole Market Story
    Investor nervousness over concentrated gains in the markets is nothing new. The FANG stocks — Facebook, Amazon, Netflix and Google — accounted for a large part of the S&P 500 gains in 2015, as well. AQR’s Cliff Asness looked at the impact of individual stocks on the S&P 500 from 1994 to 2014 and compared those results to the 2015 FANG-driven market. Asness showed what the impact on overall market performance would have been if you removed the best performing stocks each year
Again, as noted above, there is no single statistic that measures the concentration of returns. This story uses a different set of statistics and comes to a different conclusion.


Posted in Newsclips, Samples

OPEC’s Compliance Test


  • Bloomberg Graphics – OPEC Reality: Saudis Delivered, Non-OPEC Didn’t.

    Just under a week from now, the Organization of Petroleum Exporting Countries will meet in Vienna to decide whether to extend the first oil production curbs in eight years in order to eliminate a glut. The group will evaluate data, described below, that highlights two key details: First, Saudi Arabia is shouldering much of the burden. Second, non-member producers – who pledged reductions of their own – haven’t delivered in full.

  • Bloomberg – OPEC Wants to Carry on Pumping Less and Earning More
    Production cuts produce higher petrodollar revenues, IEA says

    At first glance, OPEC’s cuts haven’t worked — global oil inventories remain well above normal levels. But the policy’s made a difference where it really counts: juicing the coffers of finance ministries from Baghdad to Caracas. The resurgent flow of petrodollars explains why Saudi Arabia and Russia have largely convinced everyone else in the deal to extend the production cuts another nine months to the end of March 2018.

  • Wall Street Journal – Why OPEC Plans Oil Cuts Into 2018: Aramco’s Coming IPO

    Saudi Arabia is pushing the OPEC oil cartel and other big producers gathered here this week to extend crude production cuts for another nine months. The reason: the timing of the blockbuster IPO of Saudi Arabian Oil Co., people familiar with the matter said. The Saudis want higher oil prices well into 2018 to support the initial public offering of their state-owned oil company, Aramco, people familiar with the matter said. The initial offering of 5% of the company is being timed for some time in 2018 and has been billed as the biggest ever, with valuations reaching over $2 trillion.

  • Bloomberg – OPEC Close to Agreement to Extend Oil-Supply Cuts for 9 Months
    Other proposals will be discussed including even longer curbs

    OPEC and its allies were close to an agreement to extend their oil-production cuts for another nine months as they seek to prop up prices and revive their economies. While ministers gathering in Vienna still planned to discuss other options — a shorter deal for six months or curbs lasting for the whole of next year — consensus was building around an agreement that runs through March 2018.


We have written quite a bit on the U.S. shale oil production side of the global oil market drama and did a Net Positions (webcast) on this subject last week reviewing our expectations for U.S. production. But with the OPEC meeting finally coming tomorrow, it is time to shift focus to the potential weaknesses in the planned extension. 

Expectations for this meeting have been set quite high as the Saudis and Russians publicly agreed to extend production cuts well in advance of the formal decision. Whispers of deeper cuts in production of a longer extension have been floated as well. As the largest producer and largest exporter of crude oil respectively, Russia and Saudi Arabia have made as much noise as possible in an attempt to regain control of the narrative. But U.S. shale oil producers are not the only risk in their hopes for a drawdown in global oil supplies. 

The Bloomberg Graphics story above includes the visualization below. The squares are sized to production cut targets with shaded squares indicating if they were met (orange) or not (yellow). The top row is OPEC producers led by Saudi Arabia. The bottom row is non-OPEC producers led by Russia. Compliance among non-OPEC producers has faltered. Russia has yet to be in compliance with its agreed cuts and smaller producers have followed suit. Malaysia, Kazakhstan and South Sudan have increased production since the cuts.

The Saudis have earned more excess revenue since the production cuts despite cutting production by more than they agreed. Non-OPEC producers have happily continued pumping oil to sell at higher prices. Despite any public agreements, real declines in global inventories will continue to face headwinds if non-OPEC compliance keeps eroding. 



The Wall Street Journal story above highlights the Saudis big incentive to keep oil prices high ahead of its planned IPO for Saudi Aramco. It strikes us that this is a major benefit of higher prices that is accruing only to the Saudis. Will they have to give ground to other key producers who sense this imbalance? Iran is another risk factor in achieving a balanced market and may see an opportunity in the vulnerable IPO. 


U.S. tight oil production is not the only threat OPEC faces in its push for meaningful cuts in global oil production. Non-OPEC compliance with production cuts could be a growing problem and the pending IPO will leave the Saudis potentially vulnerable as they try to defend higher oil prices for another nine months. 

Posted in Newsclips, Samples

U.S. Small Cap Outflows


  • Bloomberg – Investors Just Pulled the Most Cash From Small Caps in a Decade
    Pain in smaller stocks has some readying for selloff
    Investors pulled $3.5 billion from the biggest exchange-traded fund that tracks the Russell 2000 Index last week, spooked by the steepest selloff in the domestically focused stocks since before Donald Trump’s surprise election win. The biggest outflow in 10 years comes less than a month after small caps roared to an all-time high on speculation Trump administration policies would supercharge growth in the world’s largest economy.


The last time Bloomberg noted a similar mass exodus by U.S. small cap equity ETF investors was on April 4. Net 5-day flows bottomed on April 7 at -$3.18 billion. We published an update on small caps and the reflation trade on April 12 when it seemed the tide had turned. The Russell 2000 dipped by another 1% before rallying 5.5% through April 26. 

This time it appears as if net flows may have already bottomed. The top panel of the chart below shows total assets in U.S. small cap equity ETFs have fallen 2.5% since May 15 and 5% since the April 26 peak. The bottom panel shows 5-day net flows for small cap ETFs. 5-day net flows bottomed on Friday (May 19) with $3.46 billion leaving small cap ETFs in the prior week. Total net flows for the past 5 days were -$1.92 billion. 

Though slightly larger in magnitude than recent outflows, we think the Bloomberg story overstates the severity of the outflows. 



Performance for U.S. small cap ETFs has been strong. On average, small cap ETFs are +4.7%. They are up 6.6% since Trump’s election. Small cap ETF investors are likely to continue the dip buying behavior as long as the post-election investments are profitable.