Posted in Charts of the Week, Client Conference Calls, Samples

The Growing Divide Between Survey-Based Data And Realized Data

Handout, mp3 replay and webcast replay for our conference call titled The Growing Divide Between Survey-Based Data And Realized Data on April 20, 2017.

The handout can be found here (starts with the second post).  Q&A from this conference call can be found here.

Mp3 replay can be heard below:

Webcast replay below:

Posted in Client Conference Calls, Samples

Implied Volatility on the Rebound, Calling Soft Data’s Bluff

  • The Financial Times – Diverging US economic data raise questions over ‘Trump bump’
    Gap between hard numbers and buoyant mood of companies and consumers is widening
    Since his inauguration, Donald Trump has enthusiastically trumpeted surging confidence readings, as well as stock market gains, as evidence that his presidency is yielding quick dividends for the US economy. Yet the gap between buoyant indicators of companies’ and consumers’ mood and hard data such as retail spending has been widening, leading to scepticism among economists about how real the Trump bounce will turn out to be.


The chart below shows hard (realized) in blue vs soft (surveys) in orange economic data changes. We prefer data changes over surprise indices as they show a stronger connection to market returns.
We have offered a ‘devil’s advocate’ approach to analyzing soft data post-Trump election. Divergences in consumer sentiment between younger vs older cohorts and Republicans vs Democrats are some of the largest on record. Trump’s approval ratings relative to consumer and business sentiment are only comparable to the likes of Johnson during the Vietnam War, Nixon during Watergate, and Bush during the Iraq War.
Markets have begun calling booming sentiment’s bluff. Equity markets have a history of following soft and not hard data, which explains their 10+% return post-election through early March 2017. Historically, U.S. Treasuries (and TIPS) have outperformed following excessive outperformance of soft over hard data.
The chart below shows indices for global implied (purple) and realized (blue) volatility across global equities, commodities, and sovereigns. Their spread is shown in the bottom panel.
Options traders are taking notice with implied volatility rebounding while realized volatility sinks to its lowest since October 2014. Similar divergences in the past have been followed by a rise in realized volatility. Again, this development favors safety over risk assets.
Posted in Client Conference Calls, Samples

Bonds and Equities Disagreeing on Pace of Economic Growth


The NFIB’s Uncertainty Index reported today for March remains well above its highest since prior to Trump’s election. However, the bond markets’ lack of volatility may be more a result of increased certainty over future growth. The arrival of Trump greatly raised the dispersion of growth expectations by economists, consumers, and business. But these expectations have steadily moderated throughout 2017.
We have built models designed to indicate expected growth in consumer and government spending components of GDP. We forecast four-quarter averages of QoQ growth to avoid seasonality noise. The chart below shows expectations for sub-industries of the S&P 500 (blue line) and U.S. fixed income (orange line). Bloomberg’s median and +/- 1 standard deviation are shown for comparison. Fixed income includes U.S. Treasury, investment grade, high yield, and mortgage bonds.
Both equity and fixed income markets are expecting rock solid consumer spending near 3.3 to 3.4%, above the highest economist’s estimate. However, bonds are not yet buying into improved government spending like equities. U.S. fixed income expects government spending to average 0.6%, well below equities at 1.9%.
The chart below shows an index for the ranges (maximum – minimum) of major economic data (blue line) along with 40-day changes in U.S. 10-year note term premium (orange line). The bond’s markets measure of uncertainty, term premium, leads economists’ forecasts ranges.
The ranges of economists’ forecasts for major economic data are narrowing, in contrast, to still elevated uncertainty found in consumer and business surveys. The bond market’s uncertainty over future growth is falling as reflected in dwindling term premiums. Unlike the equity market, the bond market is not exactly a believer in an ultra-rosy outlook including stimulative government spending.
In addition, the bond market has greatly tempered inflation expectations. The chart below shows U.S. 5y5y forward breakevens and U.S. 5-year inflation swap caps (2.5%). Options markets on CPI show inflation expectations peaking to start 2017 with TIPS breakevens finally playing catch-up.
However, one ray of light for bond bears, which we know there are a lot of them, is an FOMC allowing inflation to run above its 2% target. Our forecast for core PCE (YoY), the FOMC’s preferred inflation measure, expects inflation to run above 2% at an 81% probability within the next 12 months.
The chart below shows probabilities of core PCE YoY rising greater than 50 bps, rising 25-50 bps, rising 0-25 bps, and falling. Major economic data releases are used by a model for classification to each of these possible inflation growth rates. The NFIB’s small business surveys are a major component.
We believe falling market-based inflation expectations will soon run their course. How much they recover depends on the FOMC’s pace of tightening, consumer spending rebound, and Trump policies.
  • Equity and bond markets are not in agreement regarding GDP growth, specifically the government spending component. Bonds are not believers in an ultra-rosy growth outlook.
  • High uncertainty in consumer and business surveys are not being matched by the bond market. Term premiums are falling along with economists’ forecast ranges.
  • Inflation will remain on center stage as continued growth in core measures are likely. The decline in market-based inflation expectations will soon run its course.
Posted in Client Conference Calls, Samples

Extreme Divergence Between Confidence and Trump Approval Ratings

  • CNN/Money – Consumer confidence soars under Trump. Here’s what it means
    It’s also worth pointing out that the Conference Board’s consumer confidence index surged right after last November’s election as well — to the highest level since July 2007. The Great Recession began in December of that year and lasted until June 2009.  All of this is not to say that the economy is about to enter another downturn just because the notoriously late to the party consumer is suddenly feeling giddy.  It’s understandable why there is suddenly more hope on Main Street these days. While the Conference Board didn’t mention President Trump by name, it would appear that average Americans — much like small business owners and CEOs — are excited about the possibility of tax reform and stimulus.


Surveys of economic confidence ranging from consumers to small business to manufacturing are soaring to some of their best levels in a decade. We recently highlighted U.S. equities correlate moreso to these soft data measures than hard data like payrolls and industrial production (see here).
If Sesame Street were to review soft and hard data measures, they would sing a song of consumer and business sentiment “not looking like one of the others.” Hard data growth remains tepid and President approval ratings are sinking.
The interactive scatterplot below compares a composite of major consumer/business confidence surveys to Presidential approval ratings since 1953. Trump’s approval ratings (large red circles below) stand out as some of the worst given such positive consumer and business confidence.
The ratio between these two measures shown in the interactive chart below indicates just how ‘out of whack’ their relationship has become. Trump’s deviation from confidence is only rivaled by instances concerning the Vietnam War, Iraq War, and Watergate.  And all these instances were also consistent with equity bear markets and recessions.
The scatterplot below shows the ratio between confidence and Presidential approval ratings from above versus returns 12-months forward by the S&P 500. Excessively higher confidence relative to Presidential approval ratings have often been followed by higher volatility and drawdowns.
  • Consumer and business confidence rocketed higher post-Trump win, however, this does not square with ultra-low approval ratings.
  • The deviation between confidence and approval ratings is nearly its highest ever.
  • Similar divergences have historically been followed by higher equity volatility and draw-downs in the year ahead.
Posted in Client Conference Calls, Samples

Hard Data May Catch Up, But Does NOT Imply Risk Assets Perform

  • The Financial Times – Global surveys or hard data – which are the fake news?
    In conclusion, we believe that the hard data in the US are understating activity growth in that economy, and consequently in the official GDP series for the global aggregate. We expect to see this reflected in much stronger growth in US hard data and the official GDP series for 2017 Q2. Global activity growth is unlikely to be maintained quite at the elevated levels identified by our nowcasts in Q1 (because there is statistical mean reversion in the forecasts), but we expect consensus forecasts for global growth in the 2017 calendar year to be revised upwards, perhaps substantially.
  • Bloomberg – It’s a Big Week for One of the Most Important Debates in Markets
    The gap between soft data on confidence and other surveys that capture the optimism of the moment and expectations for policy, and hard data such as consumer spending that show actual performance, has been a hallmark of the economy this year. Figuring out which set is a better predictor of the economy in the coming months is critically important to the decisions companies and investors make this year.


History suggests hard data will follow soft data to higher growth rates. However improvements in realized economic growth does not necessarily imply risk assets will outperform. U.S. equities have a strong tendency to follow leading data like surveys over what has already come to pass.
Last week we wrote:
The chart below shows how major assets performed in the months following soft data greatly exceeding hard data. Surprisingly, the S&P 500 and U.S. dollar lag all other assets shown. Notably, TIPS and commodities are among the strongest performers. This further confirms analysis from last week showing TIPS expected to outperform given improvements in core inflation.
U.S. equity markets are still chasing these rosy expectations. 
We have built models training on returns of S&P 500 industry groups ranging from energy to utilities. These models essentially find those industry groups with a strong relationship to each GDP component and then uses these same industry groups to generate forecasts for the year ahead. We are attempting to answer just how much growth equities are expecting.
The chart below shows our forecasts for three components of GDP (orange) along with the Bloomberg’s survey average (blue), +1 standard deviation (green), and -1 standard deviation (red). We forecast four-quarter averages to avoid seasonality noise.
Surprisingly, equity markets have not tempered expectations for government spending given Trump’s failed healthcare bill and fears tax reform will also not happen. However consumer spending is expected to average 3.4% by 2018, higher than the most extreme economist’s estimate (green line).
Given such lofty expectations already priced into equities, we are concerned risk assets may encounter a bumpy road this summer.
Adding fuel to the fire for skeptics of a return to strong realized economic growth, we remain concerned about inconsistencies in soft, survey-based measures.
First, consumer and business confidence has been quite different by party. The chart below shows the average change in the NFIB’s survey of small businesses for their ‘outlook on general business conditions.’ Republican presidents are greeted by much better small business optimism than Democrats. Is an inherent Republican bias helping boost confidence?
Second, younger consumers inside 35 years of age (blue line) have shown lower sentiment since the election while older consumers over 55 years of age (orange line) are increasingly optimistic. Their spread is shown in gray in the bottom panel.
The spread between young and old sentiment is its tightest in the history available since 1980, making such divergent outlooks unprecedented.
Third, we highlighted a significant divergence between consumer/business confidence and Presidential approval ratings last week. The chart below shows the ratio between a composite of consumer and business confidence over Presidential approval ratings. Similar divergences have only occurred during raucous periods including the Vietnam War and Watergate scandal.
U.S. equities continue to price in a very rosy outlook for consumer spending, exceeding even the highest economist’s estimate.
Any hiccups in soft data or failure of hard data to catch up would lay a very bumpy road for risk assets.
Skeptics of growth have reason for concern as consumer and business surveys offer very divergent outlooks by party and age group.
Posted in Client Conference Calls, Samples

Investors All Too Giddy Over Emerging Markets

  • The Wall Street Journal – This Is a Dangerous Time to Own Emerging Markets
    Some worry a recent buying spree has resulted in lofty valuations as geopolitical tensions rise
    A crack is forming in the emerging-market resurgence. Almost $60 billion went into assets of developing economies during the first months of 2017, helping emerging-market stocks and currencies enjoy their best quarter in two years. Now, worries are setting in that the buying spree has resulted in lofty valuations as geopolitical tensions escalate. Yield-seeking portfolio managers, who made widespread purchases, could be just as indiscriminate when it comes to selling, market watchers say. And downturns could be long lasting: the MSCI Emerging Market Index fell three years straight before notching a gain in 2016.
  • The Wall Street Journal – ETFs Show Limits in World of Emerging-Market Bonds
    Debt issued by governments and companies in emerging economies can be harder to buy and sell, while higher transaction costs have resulted in tracking errors
    Exchange-traded funds have jolted stock picking with their low costs and strong performance. But in emerging-market debt, they are facing greater competition from active investors.  ETFs, baskets of assets that trade like stocks, have exploded in popularity as a low-cost way to access specific countries or markets. They have become impossible to ignore in the $3.6 trillion emerging-market bond market. Already in 2017, an iShares ETF has attracted more than $2 billion to become the world’s largest fund for developing-nation debt.  But in a year when emerging markets are in the spotlight as big winners, underperformance by the ETFs is also raising concerns over whether they are suitable instruments for betting on volatile developing nations.


Investors keep piling into emerging markets in search of higher returns. We have previously detailed the phenomenon of opting for higher risk assets during market slumbers (i.e. low volatility). The chart below shows 20-day rolling sums of flows into emerging market equity and debt ETFs.
The chart below shows GDP QoQ for emerging market economies (blue line) along with estimates by economists (red line) and emerging market equity returns (orange line).
Emerging market equities are discounting a four-quarter average of GDP growth of approximately 7.0% through early 2018. We feed yearly returns of major emerging market equity indices (e.g. Shanghai Composite, Ibovespa, and Korea Stock Exchange) relative to the MSCI World Index into a model (gradient boosted trees) to produce estimates.
Investors appear all too giddy and hopeful. Can this last?!
Posted in Client Conference Calls, Samples

U.S. Treasury Investors Stuck in Limbo

  • Macro Musings – James Bullard on Life as a Fed Bank President and Monetary Policy in 2017
    In this week’s episode, Jim Bullard, the president and CEO of the Federal Reserve Bank of St. Louis, joins the show to discuss his work as a Federal Reserve executive and as a researcher in monetary policy. Bullard shares his thoughts on why inflation has been so persistently low since 2008 and whether the Fed should pursue a more symmetric inflation target. He and David also discuss the Fed’s plans for monetary policy in 2017. In Bullard’s view, the Fed should focus on reducing its balance sheet before it turns to raising rates further.
  • Bloomberg – The Fed Could Take a Summer Vacation
    March data has shown a slowing of inflation, as well as growth, which takes pressure off the Fed in its push to fulfill half of its dual mandate — that of containing inflation. In data released April 14, the total and core consumer price index fell month over month, though they remain up year over year. Although the Fed uses the core PCE for policy purposes, the drop in core CPI to 2 percent is dovish for Fed policy and bearish for the dollar, since this is the lowest level of core inflation since October 2015.


Bullard openly discusses his views concerning a needed symmetrical approach to inflation targeting in the podcast above. Wages and inflation have yet to feel the impact of a tight labor market as foretold by the Phillips curve. However, allowing inflation to run hot in excess of 2% is not on Bullard’s agenda.
U.S. Treasuries have been very hesitant to discount inflation above the Fed’s target. The chart below shows the annual rate of inflation discounted for the next two years by the U.S. Treasury yield curve in orange. We use the Dallas Fed’s trimmed mean PCE inflation annual rate (blue line), which Bullard and others suggest is a better estimate of core inflation than the traditional ‘ex food and energy.’ Total returns and spreads across all maturities are fed into a model (gradient boosted trees) to produce inflation estimates.
U.S. Treasury yields are suggesting inflation will struggle to exceed the Fed’s target through at least early 2019.
A lack of fear over inflation as evidenced by now tumbling inflation expectations coupled with the Fed’s balance sheet have suppressed the long-end of the U.S. Treasury yield curve. The chart below shows U.S. 10-year TIPS breakevens (blue), inflation swap cap 2.5% (gray), and term premium (orange).
The demise of the Trump reflation trade has fewer and fewer expecting hard (realized growth) data will rise to meet lofty soft (survey) data. We are already seeing a rebound in implied volatility across risk markets even while realized remains eerily subdued.
One argument we have made is U.S. Treasuries have found more certainty in a slow pace of growth and inflation as evidenced by lower term premiums. The bond market is coming to terms with Trump’s shortcomings and a wish-washy Federal Reserve. This is in opposition to an equity market still all too hopeful for improving consumer and government spending.
The chart below shows the U.S. 2y10y and 5y30y spreads in the top panel and an index for Fed speak of ‘balance sheet normalization’ in the bottom panel. We cite a comprehensive record of Fed speak incorporating all official speeches, meeting minutes, and press conferences.
Federal Reserve officials have been discussing the balance sheet by their most since mid-2015. The U.S. yield curve has needed these discussions (i.e. hope of balance sheet reduction) to steepen in years past.
Will the Federal Reserve look to limit the twist of the yield curve and diminish potential of inversion by finally allowing balance sheet run-off? The U.S. yield curve is very hesitant to become a believer.
Unfortunately, U.S. Treasury investors are stuck in limbo until the direction of inflation becomes more concrete and the Federal Reserve better communicates their balance sheet intentions. 
Posted in Client Conference Calls, Samples

Maybe Friday’s Weak Payroll Number Was NOT Just Due To Weather

  • The Wall Street Journal – Economists React to the March Jobs Report: ‘Mostly Just Weather-Related Noise’
    What economists and analysts said about Friday’s jobs report from the Labor Department
    The disappointing 98,000 increase in nonfarm payrolls in March will be seized upon by the usual suspects as confirmation that the U.S. economy is poised for collapse, but the truth is this is mostly just weather-related noise. After the unseasonably warm January and February, which pushed monthly job gains back above 200,000, there was always going to be some payback in March, when the weather snapped back to seasonal norms, including some heavy snowstorms.


As the story above points out, economists are dismissing Friday’s payroll report as “weather-related noise.” However, some interesting new research suggests this might not have been the case.

Chicago Federal Reserve economists Justin Bloesch and François Gourio constructed some interesting weather indices that can help determine how much weather factored into the final payroll number. They took weather readings from the thousands of National Climate Data Center reporting stations, weighed each weather station by its local population and constructed a z-score for temperature and snow. These two measures most affect economic activity. A z-score of +1 standard deviations indicates a reading that is higher than 68% of all observations for the given month. A reading of -2 standard deviations indicates a reading that is lower than 95% of all observations.

State Weather

From their data, we constructed the interactive chart below.  You can mouse over for each state to see its measure and change the month to any month back to January 1950.

In the case of temperature for March, the top chart shows the upper midwest and northeast were colder than normal while the western half of the country was warmer than normal. The bottom map shows snow was much heavier than normal in the northeast and largely below normal in the rest of the country.

National Weather

From the state data above, they also constructed a national index. Every March back to 1950 is shown in the chart below. The blue bars in the top panel show snow z-scores and the orange bars in the middle panel show temperature z-scores. The brown bars in the bottom panel show the “economic effect” z-score. We constructed this measure which is the average of the snow index and half the temperature index since snow matter more than temperature.

Even though the majority of the land mass of the country enjoyed warmer-than-normal temperatures and less-than-normal snow, the heavily populated northeast saw “economically” worse-than-normal weather. Sum it up and the national z-score for snow was -0.018, or essentially a normal month while the temperature z-score was .628, a warmer-than-average month. Taken together, with temperature getting a one-half weighting, the “economic effect” z-score was a slight negative of 0.148.

The Bureau of Labor Statistics reports a measure of people “not working due to bad weather.” The green bars in the chart below show this metric for every March since 1976. An average of 143,000 people typically miss work in March due to weather. 164,000 people missed work for weather-related reasons in March 2017.  The red bars in the bottom panel show the deviation from average. March 2017 was only 21,000 above average.

The next chart shows the difference between measure those not working due to bad weather in orange and our projection based on the “economic effect” mentioned above in blue.

Our measure predicted 170,740 people would miss work because of bad weather. The actual number was 164,000, for a miss of 6,740 jobs. The average error rate for all March readings back to 1976 is 4,280 jobs.


The population-weighted weather measures developed by Chicago Federal Reserve economists Justin Bloesch and François Gourio suggest weather was not a big factor in March. Perhaps the payroll miss was more due to actual weak data than many want to believe.

Below is an interactive dashboard of the data in the static charts above.

Posted in Client Conference Calls, Samples

Earnings Update


  • The Financial Times – US earnings season sees play between hard and soft economic data
    Signs are promising despite divergence in consumer confidence versus unemployment
    A handful of big banks led by JPMorgan this week kicked off one of the more eagerly anticipated earning seasons in recent memory, with investors desperate for evidence that a revenue turnaround is gathering pace and the rotation back into technology is justified. Hopes are high. Headline earnings per share for the S&P 500 as a whole is expected to expand 9 percent year on year this quarter, the fastest growth since the third quarter of 2011. Assuming the usual number of results beat forecasts, the US blue-chip gauge will comfortably see a healthy double-digit earnings per share jump. But the closely watched metric will be flattered by the energy industry’s woeful start to 2016, which will make this quarter seem golden in comparison. Strip out that sector and EPS growth is expected to tick in at a respectable but more modest 5 per cent, which would actually be a slower pace of expansion than in the past two-quarters, David Kostin of Goldman Sachs notes.


Through Friday only 29 of the S&P 500 have reported Q1 2017 earnings. The chart below shows blended earnings estimates, meaning it uses the 29 actual reports and the median estimate of Wall Street analysts for the 471 that have not yet reported.

Analysts currently expect year-over-year operating growth to come in at 9.7% (blue). The S&P 500 has not seen double digit earnings growth since 2011. However, note that that ex-energy earnings is only expected to grow 6.0% year-over-year (red). Crude oil bottomed a year ago (February 11, 2016), so energy companies are contributing quite a bit to overall earnings.

Despite the fact that energy companies only account for 7.56% of S&P 500’s market capitalization, they alone are responsible for roughly 38% of the S&P 500’s Q1 2017 earnings.

The chart below shows quarterly earnings estimates back to Q1 2015. Many on Wall Street are noting the huge jump in earnings estimates this quarter.

However, the next chart shows ex-energy earnings estimates since Q1 2015. When looked at from this perspective, earnings estimates have not improved much this quarter. Ex-energy earnings actually peaked in Q3 2016 (green) at 6.6%, fell to 5.9% in Q4 2016 (pink) and are expected to be roughly the same at 6.0% for Q1 2017 (red).

Take out the volatile energy sector and earnings for the rest of the S&P 500 are looking like they are topping in the mid-single digit range.

The charts above offer a historical look at earnings. The market is often more concerned about forward-looking measures like guidance. The next chart shows the Company Offered Guidance Index. Its construction is noted on the chart. A 3-month average is used because the typical company will offer guidance once a quarter.

Note that the Guidance Index has turned negative.

The chart below shows the individual inputs used to create the chart above. Note the seasonal pattern. Companies typically offer more positive guidance in January (rising green line). However, by April, negative guidance is usually on the rise (rising red line).

Why is this? Does the optimism that comes with the beginning of the year give way to reality by spring? Are companies talking up their earnings prospects in January, right after year-end stock awards, so management can cash out with maximum profits?

Posted in Client Conference Calls, Samples

The Odds Of A June Hike Dip Below 50%

  • Bloomberg Business – Fed June Hike Odds Below 50% After Inflation Expectations Tumble
    Traders are pulling back from bets the Federal Reserve will raise interest rates in June as inflation expectations crumble. The odds of a hike have fallen back to about 44 percent from more than 60 percent earlier this month, based on a gauge compiled by Bloomberg. Yields on federal funds futures contracts for June and July are retreating as investors scale back forecasts for a move. Two-year Treasuries, among the most sensitive to Fed policy expectations, are poised for their first two-month rally in a year. Investors are questioning the strength of the U.S. economy and the Fed’s plan to raise rates three times in 2017 after a weaker-than-expected March jobs gain and a surprise monthly drop in consumer prices. They’re also voicing disappointment that President Donald Trump’s proposed tax cuts and infrastructure spending plans have yet to materialize.


Yesterday we highlighted Vice-Chairman Stan Fischer’s comment that the markets have accepted the idea of a reduced balance sheet. We disagreed and said:

Has it occurred to Fed officials that they have a credibility problem and the market does not believe them? Recall it was Fischer that said four hikes were “in the ballpark” for 2016. Obviously, this turned out to be off base.

The chart above shows the odds of a rate hike at the June FOMC meeting are now under 50% (the odds of a hike at the May 3rd FOMC meeting are just 13%). While several Fed officials have talked about the virtues of reducing the balance sheet, the market simply thinks the Fed will be forced to move at a much slower pace. The markets remain calm because they aren’t buying what the Fed is selling, not because they have accepted a reduced balance sheet.


  • Bloomberg Business – Markets Start to Ponder the $13 Trillion Gorilla in the Room
    Fed officials discuss when to start reducing asset holdings
    After heading into the uncharted territory of quantitative easing, the world’s central banks are starting to plan their course through the uncharted waters of quantitative tightening. How the Federal Reserve, European Central Bank and — eventually — the Bank of Japan handle the transition could make the difference between a global rerun of the 2013 “taper tantrum,” or the near undetectable market response to China’s run-down of U.S. Treasuries in recent years. Combined, the balance sheets of the three now total about $13 trillion, equating to greater than either China’s or the euro region’s economy. Former Fed Chair Ben S. Bernanke — who triggered the 2013 sell-off in risk assets with his quip on tapering asset purchases — has argued for a pre-set strategy to shrink the balance sheet. Current Vice Chairman Stanley Fischer says he doesn’t see a replay of the 2013 tantrum, but the best laid plans of central bankers would soon go awry if markets can’t digest the great unwinding.
Posted in Client Conference Calls, Samples

Central Bank Balance Sheets Dictating Magnitude of Returns


Last week we showed how the size of the Federal Reserve’s balance sheet could be converted into basis point hikes or cuts. We concluded that the Fed’s bloated balance sheet, combined with a nominal funds rate of 0.75%, pushes the “accomodative funds rate” to -1.73%. Below we take our analysis one step further by examining global central bank balance sheets’ impact on bond and equity markets.

The chart below shows the cumulative size of the five largest central banks. Currently they total over $18 trillion, up from $8 trillion right before Lehman’s failure and $2 trillion in 2000.

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We constructed a “Generalized Additive Model” (GAM) using 90-day log returns of the five separate balance sheets above. Additionally, we included measures of global economic and inflation growth. These measures are constructed using indices comprised of major releases relative to one-year averages. In the end, we have seven variables. Further detail on the model’s construction can be found here.

Actual (gray) and estimated 90-day returns from our GAM model (green) for the Barclays Global Aggregate Bond Index are shown in the top panel. The second panel shows the amount of returns explained by economic and inflation growth. The third panel shows the contribution of each central bank’s balance sheet to returns. On the whole, this model explains 68% of the variation in global bond returns since 2009. Interestingly, central banks are the dominant variables, explaining 60% of the variation by themselves.

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How much have central banks influenced markets over and beyond economic and inflation growth? To a certain degree central bank stimulus is seemingly fungible. Therefore, the recent discussion of reducing the Federal Reserve’s balance sheet should stoke fears, especially if stimulus slows elsewhere.

Throughout this era of heavy-handed monetary stimulus bond returns have still moved along with economic and inflation growth. However, central bank stimulus has very likely dictated the magnitude of returns.

The chart below shows the same analysis for the MSCI World Stock Market Index. This model explains 60% of the variation in global equity returns since 2009. Again, central banks are the dominant variables explaining 47% of the variation by themselves. Recent increases in balance sheets across the BOE, ECB, and BOJ are the likely instigators of rising equities since late 2016.

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The reaction functions of each variable relative to global equity returns are shown below. The plots show how the model believes equity returns move relative to changes in each variable.

Namely, reductions in balance sheets by the BOJ and PBOC have had severe negative impacts on equities (see red arrows under BOJ and PBOC). Additionally, rising inflation, a major theme of ours, is also assumed to negatively impact equity returns. The Federal Reserve has yet to see its balance sheet reduced, therefore its true reaction function to balance sheet reduction is mostly unknown. We believe it is very possible the Federal Reserves could follow the likes of the BOJ and PBOC.

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Central bank balance sheets are a hot topic for good reason. Yellen’s testimony before Congress on Tuesday (Feb 14) will be closely watched. Reductions in balance sheets have had a negative impact on both global sovereigns and equities, explaining a greater amount of their returns over and beyond economic and inflation growth.

Posted in Client Conference Calls, Samples

Bond Bears

  • Bloomberg Business – Bond Traders Stare Down Short Squeeze as Yields Test Key Levels
    Bond bears beware — the risk is building that Treasury yields go even lower. With yields across maturities reaching the lowest levels since November, and in some cases breaching key technical marks, traders are abandoning bets on higher interest rates. Hedge funds and other large speculators reduced net short positions in five-year note futures by about 86,000 contracts in the week through April 11, though more than double that amount of net shorts remain, the latest Commodity Futures Trading Commission data show.


As we have argued many times before, the constant bearishness in the bond market (higher yields) is actually helping keep yields low. Yields cannot rise in any meaningful way with this level of pessimism.

As the chart below shows, the 30-year Treasury’s year-to-date total return has essentially pulled even with the S&P 500.

Bonds continue to defy the consensus because the consensus is too bearish.

Posted in Client Conference Calls, Samples

Q&A From Our April 20, 2017 Conference Call


Mark asks:  “Updating our outlook for crude oil for the end of the year?”

Answer: I hinted at that a little bit before. The consensus opinion and I had this in Newsclips yesterday. As a matter of fact, one of the things I can do if I did this properly is I can go to Newsclips yesterday, if you’re on the webcast and I can show it to you. This is one of the reasons that I wanted to show this as well too is it gives me a little bit more of a freeform to go there as well too. We had a story yesterday in Newsclips, as I try and find it, that the price of crude oil is going to go to … Here it is, “Speculators’ big bet on crude oil. Citibank sees oil surging $10 as OPEC compacts, roaring U.S. sales. Undaunted by oil bus, financiers pour billions of dollars into U.S. sales.” That’s a Reuters’ story as well too.As I pointed out in looking at this chart that you’re looking at right here, which is the price of crude oil and the net position of the speculators, Citibank coming out and saying, “$10 surge in crude oil by the end of the year.” Congratulations. Everybody’s positioned for it. You’ve now told all of your customers, “Get ready for a $10 movement in crude oil.” I don’t have to do a trade, because I’m already there. That’s essentially what I’m trying to point out in a cynical way is that is the position in the market and that position has not been working for five months because we’re 50 bucks now in crude oil. We were 50 buck the day that OPEC announced its cut the day after Thanksgiving in November and that I don’t think we’re going to do it until we get rid of this short base.

So I’ve often argued that the first move in crude oil is going to be $40. Looked like we were on our way about a month ago and then we came back into this $50 range one more time. I still think we got to get rid of this long base in crude oil. We still got to get rid of it. I still think that the price of crude oil is going to head lower as we move forward from here and so I don’t think you’re going to see that surge and that feeds into, when I’m into the Q&A as well too, that feeds into the piece that we talked about yesterday as well as I scroll back up.

Excuse me for going really fast here. The climbing commodity prices become a slippery slope for world growth. This chart here basically shows you the correlations between commodity prices and your GDP growth and you’ll notice if you look at the chart that the deeper the blue, the more correlated your GDP is to world growth. So Russia is, Canada is, Venezuela is, Norway is, and the more negative it is. Well, China and India aren’t because they’re not big commodity producers, but in general, what we go through and talk about in this piece here is commodity prices have peaked and they’re starting back down. The positioning in commodities, and this is the total positioning in commodities, was very long and they’re getting out. The idea here is that they’re going to struggle and that’s going to be a problem for emerging markets as we move forward from here. So the crude oil call is the same way with it.

Todd asks: “Now with your target as two and a quarter on 10s, to get to three from here, does that mean the market needs further confidence in Trump’s agenda or an uptake in the data?” 

Answer: Yeah, I think that that’s fair. That if we go to two and a quarter on the 10-year by summer, what gets us to three next year is a belief, that’s the keyword, belief, that inflation is going to come back. Doesn’t mean we actually have to have it. We just have to have a belief it’s going to come back. What could get us a belief that inflation is coming back? An uptake in commodities, a rebelief in the Trump agenda. Let me define the Trump agenda. I know we live in a polarized world. I say Trump agenda and half the crowd repels in horror. The Trump agenda is narrowly defined here as cutting taxes, cutting regulations, and being business-friendly and the problem is that agenda is in doubt right now. So maybe it reemerges. This isn’t going to be next week, Trump’s going to hit 100 days of being president. That’s it, we’re not going to cut taxes. He might as well just quit. That’s it. It’s all over with. He’s got three and three quarter more years to reassert that agenda.

So yes, I do think that that agenda could be reasserted and that if he does reassert it, you will actually see a surge in the hard data, but we don’t have the hard data moving just yet as well too. Then you go on to say, the Trump agenda looks … Yeah, so let me read the second half of your question, “Trumps agenda or an uptake in data? If the political gridlock continues, Trump agenda looks less likely and hard data doesn’t converge with the survey data, would your ten-year ratings change at all? ”

Let me just be a little technical here. The political gridlock is within the Republican party. The Democrats don’t have the ability to stop them from raising taxes or cutting regulations or fostering a more pro-business-friendly environment. It’s all up to the Republicans to decide that they want to do this and it doesn’t really need to be a whole lot of wheeling and dealing with the Democrats. So keep in mind that the political gridlock is an unforced error on themselves. They can always at any moment decide they want to stop doing this and they want to move forward with this and that’s why I think that it can end real fast.

It can end real fast as well too as far as the political gridlock, but if it doesn’t you’re right. I would change my 10-year yield forecast and I think we’d go to two, two and a quarter and possible stay there, but for right now I think we’re going to go there. I think that in the second half of the year, late summer, early fall conference calls and stuff, I think we’ll be talking about a surge in interest rates and at that point I think it’ll be surging of interest rates without the giant short in the bond market, that that’s gone because everybody couldn’t take the pain anymore.

Geoffrey asks: “At one time, you thought relative rent levels would shift inflation up. How did this play out?” Rents and housing costs have gone up. Did rents have a lower impact on housing than thought? 

Answer: You’re right. We used to talk a lot about that within core inflation that the biggest component within core inflation is a thing called owners equivalent rent or OER. That is what the word says. It is taking house prices, converting it to if you rented your house, what would the rent be and how does it change over time and that that is inflation. In other words, the reason they use OER is they’re trying to separate from your house, your house is both a financial asset and a physical asset

So if your house goes up in price because of a wealth effect and that home prices are going up, that’s not inflation, but if your house goes up in price because of inflation, then your rent would go up if you owner equivalent rented your house. So that’s what they’re trying to do with that number. The thing that’s interesting about that is it’s 40. Four zero percent of core CPI and it’s more like 20ish, 25ish percent of core PCE. PCE and CPI, use exactly the same inputs, just weighed up differently. It is a single measure. It is single measure. It’s not a measure of lots of different things averaged together and it’s produced by the BLS through a computer algorithm.

It is not something that they go out and they knock on your door and say, “Okay, Jim, if you were to rent your house today, what do you think you would ask for in terms of the rental price for your house?” Well I don’t live in a neighborhood where we rent houses and I wouldn’t rent my house. So I couldn’t even hazard a guess as to what they would be. They’d do that and so that’s what they’re trying to do.

So what I’ve argued in the past was owner’s equivalent rent is a big driver of core inflation and over the last couple of years, OER has rebounded and has been one of the big drivers of core inflation higher. That’s what we’ve seen happen. So I think that as we move forward from here, if there’s a possibility that we’re finally going to see inflation move above that 2% target that the Fed has had, OER is going to be a big player of it. It has been and I think it will continue to be. This is actually a good topic for me to discuss tomorrow in Newsclips. So I’ll try to trot out all those charts and re-update everything and I’ll put it out in Newsclips as well too

Derrick asks:  “Do you feel actively managed U.S. equity strategies, with as a group if underperformed their benchmark for years, will ever stage a comeback? If so, what would you expect the catalyst to be?”

Answer: Yes. They will stage a comeback and the catalyst is fairly straightforward, a bear market. An index, keep in mind, is always fully invested and most indexes are price weighted or market cap weighted, which tend to be priced. What tends to happen with the indexes and here’s a good example of this. I’m going to type in the word Netflix on our search engine. What happens with the indexes is that the stocks that drive everything higher tend to be the big capped stocks. Big capped stocks by their nature tend to be overvalued and most people that have passed the CFA and manage money have learned that you don’t buy these kind of stocks.

So on April 3rd, I typed in the word Netflix, we talked about the FANG stocks and in this case, we talked about Facebook, Amazon, Apple, so we’ve got two A’s in there, Netflix and Google. I kept the G for Google even though it’s technically alphabet because the acronym works. We pointed out that in the first quarter, these stocks had tremendous gains and you can see on an annualized basis, well over 100% for most of them and even Google, which lags and still way up more than the overall market.

As the next chart shows, the FANG stocks are 11% of the S&P 500, 3.5% alone is Apple. Apple’s the largest stock in the S&P 500 and if you looked at the year-to-date returns, the stock market in the first quarter went up 1.1 trillion dollars. The FANG stocks increased their market capitalization by 332 billion, 136 billion for Apple alone. So that if you looked at the final chart here, what this shows you is Apple was 12% of the S&P 500’s return alone in the first quarter and if we were to look at all of the FANG stocks, which is this one, it was 29.65. Let’s call it 30%.
So let me sum this up for you. Five stocks of the S&P 500 with 30% of the return of the market. One of them, Apple, was 12% return of the market. So, if you wanted to beat the S&P 500 in the first quarter, there was basically three decisions, as we like to say. There was Apple, there was the other four FANG stocks, Facebook, Amazon, Netflix, and Google and then 495 stocks which we’ll refer to as cannon fodder. If the only way you could have beaten the index in the first quarter was you had to have been overweighted most if not all of these stocks.

The problem is if you look at most of their metrics on valuation and you passed CFA Level III, you wouldn’t touch these stocks because they’re all very highly overvalued and because they’re so big market caps, their influence grows and grows and grows as the market goes up. So there in lies the problem with active managers.

Now, I could write the same thing about the bond market. In the bond market, if you’re a global bond manager, the second largest weighting in your index is Japan. If you were to ask, what country has the worst fundamental sovereign debt, it’s Japan, but the only way to really outperform is you got to get that Japan bet right because it’s such a big part of a global bond index. I can keep going on and on with a lot of this as well too. So it becomes very narrowly focused.

So the first question is what would cause equity managers to outperform? The answer is, you got to get the FAANG stock call right. Now, the opposite works. If all these stocks have a terrible quarter like they did in the fourth quarter and you underweight them, then you outperform and there was a lot of stories in January. Hey, the equity guys had a pretty good fourth quarter. They really understand Trump. They’re going to turn the corner. No, the FANG stocks did bad because everybody thought after the election because Silicon Valley so hated Trump and was so anti-Trump that Trump was going to punish them, that their stocks slumped right after the election and since most managers are not overweighted these stocks, the stocks that they were underweighted took the indexes down and they outperformed, but then the reverse happened in the first quarter as well too.

So you go to get that call right. After that, if we have a bear market, the index is fully invested. Most managers are not. The index is highly weighted in these overvalued stocks. They get crushed worse than all of the other stocks, they outperform. Now what’s different about this cycle than any other cycle. Look, if this was 1974 and I was a friend of an overhead and had a meeting and we were talking about this, just trying to downgrade the technology to that period, exactly the same thing was true. The only difference is that technology has brought down the cost of creating an index to practically zero. So we could create thousands and thousands of ETS, sliced and diced every possible way you can imagine and probably 100 you never even thought of.

If you actually went and looked at the list of ETFs, you would not believe the number of ways that they’ve sliced and diced them up. Think She, S-H-E. All companies that have women CEOs. There’s actually an index of women CEOs and there’s actually an ETF. Now, I’m not trying to be sexist here, I’m just trying to say, wow, we’re really cutting this down and there’s all kind of things like that as well too. So that’s become cheap. So that the alternative is, the hell with the active manager. I can buy an index for practically nothing, has become into the frame of possibility and that’s what they have to compete with right now is those people as well.

So, yes, they will outperform in a bear market. Other than that, I read an interesting story. It was in the FT about two weeks ago, that basically said, maybe what active managers need to do is they need to rethink the role of an active manager and that currently, the role of an active manager is 80% of my portfolio looks like the index and then I tweak a little bit around the edges. I’ll overweight it a couple of sectors here, underweight it a couple of sectors there and then in this low cost index environment that’s just not going to work. Maybe what you need to be as a manager is a lot more out of index betting. Your beta maybe should be two or three times the index. You should just be making extreme bets on the market and people should understand that that’s what you do. That’s your value added.

When I win, I win big. When I lose, I lose big. You invest with me according to that schedule. That’s an idea that was thrown out there. There’s a place for bond managers as well too, but this 80% on the index and I overweight a couple things here and underweight a couple things there, when you’re done taking your fee versus practically taking no fee in an ETF, that’s going to be a problem. I think that that’s where the industry is right now, but a bear market will definitely bring it back.

That’s why I’ve often said that the interesting thing about it is that most active equity managers really bullish and they go on CNBC or Fox Business or Bloomberg and they’ve got that big smile on their face. Really bullish, start singing God Bless America, and the best thing to have in your business is a bear market because you will outperform the indexes. That will make a case for why an active manager is relevant and you’re out here telling me that stocks are never going to go down again, they’re going to keep going up. Well then I’ll take all my money away from you and I’ll put it in spiders and let them take the four basis points a year they take or whatever the low fee is and they’ll outperform you because they’ll all have a weighting in the FANG stocks that you’ll never approach and they’ll keep going and going.

So that’s the thing is that the industry has to evolve. That would be my guess. “On a global basis, do you have a view regarding the asset class segments, which are presently the most under or over valued right now?” I think that the most undervalued asset class, I’d have to get back to you on that one. I don’t want to start just pushing out just random names right now because I’ll forget some along the way, but I will say this, I think commodities are struggling and they’re going to probably go down. That’s probably going to hurt emerging. I think that sovereign yields will probably head lower from here, especially U.S. yields will head lower from here. I think that general develop market risk, markets like the S&P 500, the European stocks. I think will continue to pause as we decide what the next step will be from here as we go forward from here.

That’s it. I think I’ve got for this. Thank you. Hope you like the new format. Please shoot us any comments or criticisms about it. It is in flux. We are changing it. We are trying to make it simpler for everybody. The same analysis, just different way to deliver it. Feedback is always welcome.

Thanks and we’ll talk to you again at the next call.