Category Archives: Hot Topic Commentary

Super Mario

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Mario Draghi announced the ECB’s monetary policy actions on Thursday, June 5th, and on balance they were largely as anticipated. Without getting into too many details, the ECB launched a new series of “targeted longer-term refinancing operations”, began to set the stage for certain asset purchases, and lowered a variety of policy rates, including moving the deposit facility to -10 bps. We are not quite at QE in Europe, but they appeared to edge in that direction, and the ECB has made it clear that Deflation is a primary concern for the economy, even though it has returned to modest growth this year.

Credit markets reacted positively to this week’s data, including the ECB actions. Bank spreads seemed to be the biggest beneficiaries, with on-the-run banks tighter by 5-10 basis points. So far this month, we are seeing a complete reversal of last month, with higher rates, a steeper curve, and tighter spreads, especially on the long end. It was definitely risk-on in Europe – in addition to the ECB actions, Standard & Poor’s raised the credit ratings of a number of Spanish Banks, following a hike in Spain’s sovereign rating a week earlier. Rates in all of the peripheral countries in Europe have rallied like Luigi in a go-cart, and are trading at their lowest level in years. Spain and Italy, the two poster children for European chaos, saw rates drop by 20 basis points to 2.6% and 2.7%, respectively – just a hair above levels in the U.S.

The primary market did not wait around to see the data – as usual, the weekly calendar was front-end loaded, as few issuers wanted to take the risk of a bad outcome on the news front. Total supply was about $29 billion, which is a decent week. Large deals included Express Scripts, with $2.5 billion across three tranches, $2.4 billion of shorter paper from American Express, and $2 billion of an AT&T 30 year bond. Most deals are performing well, as most of the spread tightening this week took place on Thursday and Friday. The market is expecting more of the same next week – probably about $25 billion in supply.

There was a range of positive or at least benign data supporting credit markets this week, but we are inclined to attribute most of the rally to the ECB. At least for now, markets are expecting the announced policy measures to act like our own little Yoshi, gobbling up all the bad stuff – slow economic growth, deflation, weak banks – and turn them all into gold coins to toss back to Mario.

Personality Crisis

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Not long ago I had lunch with a friend and we discussed the Myers Briggs test (click here for a definition of the test). He mentioned to me that that he read somewhere that a majority of financial analysts were INTJ—surprisingly one of the rarest of the Myers Briggs 16 personality types (especially among women). For the record I am an INTJ. If you have never taken the test, here’s a link to a free analog version.

While psychological analysis is not the purpose of this post, there is something that has always driven me nuts about this industry. What upsets me is that there is an expectation that a stock market analyst must act a certain way to be successful. This has always surprised me. That’s likely because INTJs like me are among the most independent thinkers of the personality types in the Myers Briggs grid. This might explain why I think “Kiss Alive” is the best live album ever, but I digress…

Why do I feel this way? I am guessing it’s because that New York is the capital of our industry. Don’t get me wrong. I love New York. The Yankees and Giants are my second favorite teams (sorry Boston fans). Having said that, I believe there seems to be some expectation of a hyper aggressive personality type that might not manifest itself in people west of the Alleghenies. I realize that there has to be some degree of fighter pilot attitude amongst us as analysts, after all no one wants to look unintelligent when discussing the markets with clients. But then at the same time, I feel on occasion that we all can use a dose of Minnesota Nice. Oftentimes our worst mistakes come when we make a mistake and try to cover it up with bravado.

One of the best lessons I ever learned in this industry was in my first week on the job. One of the stocks my analyst and I were covering had an unexpected bad quarter. After doing our analysis, my analyst called up one of the biggest holders and started out the conversation with (and I am paraphrasing) “I was wrong on this stock. Here’s where I went wrong, and here’s what I think you should do now.” I was stunned by what came next. Instead of the client becoming angry he said “Thanks for the call. You are the only analyst who has called me on this name. I appreciate that.” Ever since that day I have tried to fess up to bad calls. It not always has been pleasant; and not all investors were as respectful as this one. However, I also found that rebuilding my credibility was much easier than those times I have tried to defend my decision aggressively.

A CFA Candidate’s Perspective

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Each season CFA Society Minnesota invites finance students to learn about the CFA Program by interning with the local society. Students assist society committees with research for their projects, and are encouraged to take on tasks that broaden their skills and industry insight. Augsburg College senior Kyle Louzoun-Heisler will be sitting for Level I next year, and wrote this commentary with the assistance of Freezing Assets contributor Lissa Rurik, CFA. If you’d like to work one-on-one with a future CFA Candidate this season, please contact us to volunteer!

There seems to be a consensus in the literature of the major financial institutions that stocks, despite a five year bull, will continue to make small but positive gains. They seem to agree that low interest rates, low inflation, and an improving economy will continue to support increases in the stock market, albeit small. However, there are risks, including shifting geopolitical climate, the Federal Reserve, and asset bubbles that pose threats to stock market gains. Despite these concerns, the majority of firms recommend a Bull market strategy.

With the stronger stock market many firms suggest investing in stocks instead of bonds in 2014. However, there are strategies to navigate a rising interest environment. The recent climate has many financial firms predicting a higher treasury yield and a steeper yield curve. The Fed is central to this topic because there is reason to believe the fed funds rate will be increased in the future. BlackRock and Ascent are predicting a modest increase in rates to about 3.5%. However, this is largely based on the pace of tapering. And despite the recent fear over the fed raising tapering ahead of schedule, the meeting minutes show no such thing. Both Ascent and Columbia Asset Management recommend investing in shorter financial institutions debt, rather than utilities and industrials, citing a bank’s ability to pay lower interest on deposits and receive higher rates on loans.

In order to gain in a rising rate environment, BlackRock and US Bank are in favor of investing in munis and high yield bonds. Those in favor of high yield bonds cite the investment climate (with the Fed’s quantitative easing, economic improvement, and low default rates) and interest rate risk as the primary reasons to consider those options. Furthermore, as interest rates increase, high yield bonds can protect from that risk. Although last year high yield bonds offered the best return in 2013, BlackRock believes they will be closer to fair value.

In addition to high-yield bonds, BlackRock and US Bank favor municipal bonds as well. BlackRock mentions that March was one of the three best months for munis in 20 years. However, despite these ending, it still makes sense to look at these bonds because of their tax exemptions.

Although BlackRock mentions the Emerging Markets as a potential investment, Columbia asset management recommends it. Columbia believes that investors should stop playing duration defense. Furthermore, credit risk is preferred to duration risk. Like BlackRock, Columbia mentions the possible increase in the yield curve, but they believe that the curve has already taken most of it in. They say that if you want more of an investment-quality bond, corporate and munis make sense, but that if you have longer latitude it makes sense to look at the EM debt. Although EM debt did poorly last year, they believe it will perform better as those economies improve. Columbia believes global demand to increase and thus EM debt values to react favorably. Abbot Downing also believes that EM debt will improve as those markets grow and will be a good long-term investment.

BlackRock and Columbia are asset management firms.
Ascent is a private wealth management firm- subdivision of US bank.

Summertime

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One of the greatest things about the bond market is early close. While our equity counterparts are slaving away until 4:00 ET today, SIFMA has recommended a pre-holiday close of 2:00 ET. There are fewer early closes than there used to be, but we still get to leave early to kick off the summer.

And the livin’ is easy…

You could barely work today in Credit even if you wanted to. Judging from the number of messages we’re getting, it feels like the street has already sneaked away to the Hamptons.

Fish are jumpin….

Supply this week reflected the anticipated exodus – there was about $20 billion in new issue, and the fish did most of their jumping on Monday and Tuesday. Concessions were a bit spotty, with some deals priced to go, and others, not so much. Secondary trading was again a mixed bag, with some weakness showing up in longer-dated bonds. The Enable Midstream deal was a case in point – this midstream gas company is a new issuer, and they brought $1.65 billion across three tranches. All looked to be well oversubscribed, but the 5 year has tightened 6 basis points in the secondary, while the 10s and 30s are a couple wider. It looked like the market was going to jump all over this deal, but ended up throwing some of the catch back.

And the cotton is high….

Spreads are still tight. Even though summer is barely upon us, it’s hard to imagine the cotton getting too much higher. Maybe investors should think about harvesting. There was very little movement in spreads overall, and excess returns month-to-date are slightly negative, driven entirely by the long end. As we doze off in the Adirondack chair, a cool beverage resting on its wide arm, it looks like credit spreads will be stable as far off into the horizon as the eye can see…

…so hush…

The More Things Change, the More They Stay the Same

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Lissa Rurik, CFA, CAIA

Recently some market prognosticators have alluded to similarities between today’s investment environment and that of the mid-1990’s (among others, Liz Ann Sonders at Charles Schwab). Remembering back to that time, the three predominant forces that all strategists addressed in their commentaries were technology (the internet), falling interest rates and globalization (the fall of the Berlin Wall and the rise of the Asian Tigers). Of course, these trends weren’t necessarily independent from one another, and our economy today reflects the continued impact of all three elements.

Globalization continues to progress and expand as places such as Vietnam and countries in Africa replace the former developing markets of China and countries within Latin America. Interest rates have arguably bottomed, but remain low (notwithstanding the vastly increased levels of global debt – another topic for another day). Perhaps most importantly though, technology advances driven by the internet have continued to evolve, encompassing smart phones and other mobile computing devices along with the emergence of the cloud.

As an angel investor I hear many pitches from startup ventures, and I have noted that a significant proportion of new business ideas entail a use of the mobile device /cloud platform model. Some that come to mind include:

  • a system for police evidence gathering, data management and diagnostics;
  • a process for emergency room response and patient data management;
  • online educational assessments and in-classroom diagnostics;
  • health care supply management with wearable bar code apparatus for inventory ordering; and
  • data collection and management for use in preparing environmental impact statements.

Granted, this paradigm has been in play for at least four or five years. But the level of innovation unleashed – as it permeates almost every business field and process – reminds me of the impact those early internet innovations had on that mid-1990’s economy… the productivity enhancements therein, and the consequential investment opportunities that resulted for many years to come.

A recent publication by Berkeley Professor John Zysman encapsulates the importance of the cloud concept. Essentially he finds that the internet was a catalyst for productivity because it enabled a decomposition of sorts in the production and delivery of goods, a reallocation of resource inputs to their cheapest source, and subsequent formations of global supply chain networks. Productivity growth was robust as this occurred. Today, the cloud not only extends the potential for enhanced productivity, but it almost leverages that productivity back upon itself and expands from there.

As noted by Sand Hill Group, the McKinsey Global Institute, and Deloitte Access Economics, the most obvious element of this process reflects the fact that the mobile/cloud platform can be used by anybody, whether consumer, employer, or coder on-the-go, because cloud support can be accessed independent of location and computing infrastructure.   That means we can work while riding a bus, we can collaborate with our colleagues at any place and time, and we can launch a new business with a relatively limited capital investment regardless of that business’s potential for growth.

Zysman’s piece discusses the cloud in its beginning years as a concept of architecture, in other words, a new way of organizing computing, that has now evolved to include implementation features around how those new architectural concepts are put to work.  And as production was deconstructed with the aid of internet, services on the cloud platform can now be segmented into each step, reconfigured and customized into entirely new elements of enhanced value for the user (thus leveraging productivity back upon itself).   Intense resources are now widely available and technological innovation is accelerated by the access and deployment of big data, design tools, analytics, prototyping, and sophisticated logistics and algorithms.  And as the development of applications on the cloud can be decoupled from the infrastructure, it lessens the investment requirements and speeds the time-to-value for any given business or technical innovation.

The investment community in the mid-1990’s pondered the economic importance of the internet with comparisons to the industrial revolution. The truth around that allusion may remain debatable…. However, the innovation and disruption arising as the cloud develops, and the resulting ongoing productivity gains, are at least as impactful to the economy and financial markets today as were those dot.com investment opportunities we all marveled upon two decades ago.   Maybe that’s where the 1990’s mid-bull market similarities align.

Is the innovation of the cloud platform as important as the internet was before it? (Comment below)