Category: US & Canada

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Bond spreads: Financial risk is easing

Bond spreads are an important indicator of risk in financial markets. When corporate bond yields are at a substantial premium to Treasury yields, that indicates higher default risk among large corporations. The graph below, from the RBA chart pack, shows the premium charged for AA-rated corporations compared to US Treasuries. Anything over 150 basis points (bps) indicates elevated risk. For lower-rated BBB corporations, a spread greater than 300 bps is cause for concern. At present, both credit spreads are trending lower, suggesting that financial risk is easing.

US Credit Spreads

Australia displays a similar picture, with AA-rated spreads trending lower. BBB spreads are also falling but remain high at 200 bps relative to 150 bps in the US, reflecting Australia’s vulnerability to commodities and real estate (both here and in China).

Australian Credit Spreads

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Gold: “Trump rally” unlikely to last

Gold reacted with urgency to the news that Donald Trump was closing on Hillary Clinton in the polls. After a lackluster start the rally gained new energy in the last week, with the yellow metal climbing to test resistance at $1300/ounce.

Spot Gold

Experienced pollsters seem to think that Trump’s gains are too little and too late. According to GOP pollster Whit Ayres, in this PBS Newshour interview, Trump has about the same chance of winning as drawing an inside straight in poker. “He has spent his entire campaign preaching to the converted rather than reaching out to undecided voters….”

Unless there is an upset in next week’s election, I expect gold to respect resistance at $1300/ounce, followed by a test of primary support at $1200.

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Gold: Further weakness likely

US Treasury yields are rising, with the 10-year yield breaking through 1.80 percent to signal a test of 2.0 percent. Further rises are likely on the back of stronger GDP figures for the last quarter.

10-year Treasury Yields

The Chinese Yuan continues to depreciate against the Dollar in anticipation of another rate rise from the Fed.

USDCNY

Spot gold displays a weak retracement off support at $1250/ounce, with short candles indicating a lack of conviction. Another primary decline is likely and would test primary support at $1200.

Spot Gold

The ASX All Ordinaries Gold Index respected the descending trendline, suggesting another decline. Reversal below 4300 would confirm, offering a target of 4000.

All Ordinaries Gold Index

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Bob Doll’s bullet points

From Bob Doll’s weekly commentary for Nuveen Investments:

  • Third-quarter earnings started strong. Should this persist, it may mark the end of the earnings recession.
  • It looks likely that Hillary Clinton will win the presidency while the House remains in GOP hands.
  • Equity markets face near-term pressures, but the economic and earnings environment should provide tailwinds….

Bob is right that earnings excluding the Energy sector are improving. The graph below compares As Reported earnings per share (EPS) for the S&P 500 to those excluding the Energy sector.

S&P 500 Index

But while EPS may be increasing, profit margins are shrinking. Which makes me wonder how long EPS will continue to rise.

Profit margins (after tax) per unit of gross value added

Source: Weekly Investment Commentary from Bob Doll | Nuveen

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Weekly Investment Commentary from Bob Doll | Nuveen

From Bob Doll:

Equities may struggle until corporate earnings improve.
For the past 18 months, equities have been able to make modest gains despite declining corporate profits. This has largely been due to highly accommodative monetary policy and central banks’ willingness to engage in new easing measures. Additionally, investors have been willing to look past the earnings recession since we have not seen a corresponding economic recession. Looking ahead, we believe earnings must advance for equity markets to make meaningful gains. It is early in the third quarter reporting season, but so far the news hasn’t been favorable.

It may take another quarter before corporate earnings accelerate.
At present, consensus expectations are that earnings will decline 3% in the third quarter while revenues rise 3%. Excluding energy, earnings would be up 1% with revenues advancing 4%. Conditions should improve in the fourth quarter, with consensus expectations pointing to a 6% earnings increase…..

Source: Weekly Investment Commentary from Bob Doll | Nuveen

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Obama’s Wrong: The New Cold War’s Only Just Begun | The Daily Beast

Michael Weiss writes: “From propaganda to missile deployments, Russian leader Vladimir Putin is testing Obama’s resolve—while claiming to be America’s victim”…..

Putin has demanded, as the price for restoring at least the first frozen accord, that Washington end all sanctions against Russian officials; pay reparations for any losses sustained from those sanctions as well as retaliatory ones imposed by Russia against U.S. entities; cancel the Magnitsky Act, a landmark human rights law passed in 2012 aimed at penalizing corrupt and murderous Russian officials; reduce NATO personnel forces to levels they were as of 2000; and essentially rewrite the original radioactive disposal deal so America bears the brunt of the responsibility for it.

In response to what was, even by Putin’s standards, a risible attempt at extortion, the Russian opposition’s Leonid Volkov wrote on Facebook: “He should have asked for Alaska back, eternal youth, Elon Musk and a ticket to Disneyland.”

….what a turn for Obama, who has spent the last eight years insisting that the “Cold War is over” only to spend the eve of his departure witnessing its renascence.

The response should be to talk softly and continue polishing that big stick.

Source: Barack Obama’s Wrong: The New Cold War’s Only Just Begun – The Daily Beast

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Australia & Canada’s experience with equal weighted indices

Correction to my earlier post. Equal-weighted indices don’t always outperform cap-weighted indices, as with the S&P 500. Australia’s ASX 100 Equal Weighted Index underperformed the cap-weighted ASX 100, recording annual growth of 3.79% (EWI) compared to 5.28% for the ASX 100 on a total return basis over the last 10 years.

ASX 100 Equal Weighted Index compared to cap-weighted ASX 100

Canada’s TSX 60 Equal Weighted Index, on the other hand, mimics the S&P 500. Equal Weight achieved an returns of 6.17% over the last 10 years compared to 5.33% for the cap-weighted index.

TSX 60 Equal Weighted Index compared to cap-weighted TSX 60

I will investigate further why Australia bucks the trend but I suspect the banks play a major role. The ASX 300 Banks Index substantially outperforms the broad ASX 300 Index.

ASX 300 Banks Index compared to ASX 300

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US private investment dwindles

Private investment is declining as a percentage of GDP. Not a good sign when you consider that a similar decline preceded previous recessions.

Private Investment and Private Credit to GDP

Click graph to view full-size image.

Also a concern, when private credit is rising as a percentage of GDP while investment is falling. Crossover of the two lines would indicate that the private sector is borrowing more than it is investing. That is not likely to end well.

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Why Putin will fail | UPI.com

From Harlan Ullman:

Frozen conflicts are not in Russia’s long-term interest. Of course, while the short-term aim of preventing Georgia and Ukraine from joining NATO because of contested borders is working, the long-term economic damage done to Russia will prove politically destructive. Putin certainly is riding a political tiger. However, he has no clear exit strategy for safely dismounting this dangerous beast. That is a fundamental predicament….

What should the United States do? First, common sense and not confrontation is the best means to exploit Putin’s political weaknesses. By threatening Russia, his public will rally around Putin. This does not mean granting concessions. It means being smart not petulant. It also means shifting NATO’s strategy to local defense based on a “porcupine” posture with emphasis on Stinger-like anti-air and Javelin anti-vehicle missiles all reinforced by alliance capabilities to blunt Russian cyber, propaganda, intimidation and other non-conventional forms of war.

Second, the United States needs to dial back on belligerent rhetoric. By all means plan for “full spectrum war.” But do not use a PR bullhorn to announce what is being done. Teddy Roosevelt applies — speak softly but carry a big stick….

Source: Why Russian President Vladimir Putin will fail – UPI.com

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Why would the Fed raise interest rates when the economy is slowing?

10-Year Treasury yields have rebounded off their all-time low, shown here on a monthly chart, but remain in a secular down-trend. Only recovery above 3.0 percent (a long way off) would signal that the long-term down-trend has reversed.

10-Year Treasury Yields

The 5-year breakeven inflation rate (5-year Treasury Yield – 5-year TIPS yield) suggests that the long-term outlook for inflation is low. But growth in Hourly Non-Farm Earnings and Core CPI (excluding Food and Energy) has started to rise.

5-year Breakeven rate & Hourly Non-Farm Earnings Growth

One would expect the Fed to be preparing for another rate increase to tame inflationary pressures. But there are still concerns about the strength of the recovery.

Growth in estimated total weekly Non-Farm Earnings has been declining since early 2015; calculated by multiplying Average Hourly Earnings by Average Weekly Hours and the Total Non-Farm Payroll.

Estimated Weekly Non-Farm Earnings

If we examine the breakdown, growth in the Total Non-Farm Payroll is slowing and Average Weekly Hours Worked are declining.

Non-Farm Payrolls & Average Weekly Hours

Not what one would expect from a robust recovery.

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