IB Traders Insight


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Macro

Truth in Numbers


Fed Chair Janet Yellen recently said that the Federal Reserve is "generally pleased" with the U.S. economy.  She did so at the same time she was noting for listeners that the Fed's median projection for the change in real GDP for both 2016 and the longer run had been lowered to 1.8% from 2.0%.

It was lip service at its finest; meanwhile, the updated projections were starkly modest when taking into account some large gains in median household income and household net worth recently reported by the U.S. Census Bureau and the Federal Reserve.

If one took those gains at face value, one might think the U.S. economy is booming.  It isn't, though, because consumers have been more reserved with their spending and because the Fed's monetary policy, which rests on the wealth effect, isn't a one-for-all policy.

Hindsight Not Exactly 20-20

A few weeks ago, the U.S. Census Bureau said median household income in the United States increased 5.2% in real terms in 2015 to $56,516.  That was the first annual increase in median household income since 2007, but notably, it was still 1.6% lower than in 2007.

With the updated data point in hand, the interesting aspect in hindsight is that real personal consumption expenditures increased just 3.2% in 2015 while real GDP increased only 2.6%.

All of the income that was gained, therefore, wasn't spent.  

That's certainly prudent from a financial planning standpoint, but as we have written in the past, the propensity to save one's income -- earned or unearned -- acts as a headwind on the U.S. economy, which thrives on personal spending.

The lesson of the financial crisis for many was to be better prepared for the next crisis.  Hence, personal saving as a percentage of disposable personal income, which was 2.9% in 2007, got bumped up to 5.8% in 2015.

Credit and Blame Where They Are Due

Prior to its most recent Federal Open Market Committee meeting, the Federal Reserve reported that household net worth hit a record $89.1 trillion in the second quarter.

That' a stunning figure and it has been helped along greatly by the rise in stock prices and home values.

Just before the last stock market peak in October 2007, household net worth in the third quarter of 2007 stood at $67.7 trillion.  It would eventually plummet to $54.4 trillion in the first quarter of 2009, so it is plain to see a whole lot of ground has been made up in the interim.

The Fed certainly deserves some credit for that.  Where the blame remains, however, is in the clear understanding that the wealth effect has not resuscitated the U.S. economy in the fashion that was envisioned by Ben Bernanke and his colleagues.

We're not surprised at all by that understanding.  We penned a piece in this column in February 2013*, which was critical of the Fed's intention to target asset prices with its monetary policy.

Our perspective at the time was rooted in the belief that the policy wouldn't hit the mark of achieving escape velocity for the economy because it wasn't enhancing household net worth in a balanced way.  

To that end, research at the time showed only 47% of all U.S. households owned stock, and of the households that did own stock, only 31% had stock holdings of $10,000 or more. Furthermore, the homeownership rate at the time was 65% (it has since fallen to 62.9%), meaning roughly 35% of households wouldn't benefit from any appreciation in home values.

What It All Means

It is good to see median household income going up and household net worth going up.  Those trends are loaded with potential for the U.S. economy, but only if the added income and wealth translates into added spending that drives increased velocity in the exchange of money.

When money starts turning over because consumers have unbridled confidence in their income growth prospects, and investors aren't living in fear of a potential stock market sell-off that might greatly diminish their net worth, then it becomes reasonable to expect higher growth rates for the U.S. economy.

The Federal Reserve might be "generally pleased" with how things are going for the economy, yet that general view looks relative in relation to a generally depressed base of expectations.  

It bears mentioning that when the Federal Reserve introduced its economic projections in April 2011, the central tendency projection for longer run real GDP growth was 2.5% to 2.8%.  Today, it is 1.7% to 2.0% -- and that's after a whole lot more policy accommodation, job creation, median income gains, and wealth accumulation in the interim.

Clearly, monetary policy has helped some, yet something is still amiss in the transmission of monetary policy to the real economy.  It is difficult to pinpoint what that something is precisely.

It isn't one thing, but likely a compilation of factors, including a lack of fiscal support and a lack of confidence in the outlook.  

After all, how confident can a consumer be in the outlook when the Federal Reserve and other major central banks feel compelled this long after the financial crisis to keep pressing the pedal on monetary policy accommodation and keep promising that they stand ready to do more?

The Federal Reserve's latest projections show a median estimate for the change in real GDP of just 1.8% for the longer run

From our vantage point, that's not generally pleasing.  Rather, it's a general admission that animal spirits in the economy are still lacking despite a rebound in median household income and record levels of household net worth.

Ironically, the Federal Reserve's policy of holding rates near the zero bound is helping to keep those spirits caged because it raises concerns about the outlook for consumers, who feel the need to save more of their income to meet any challenges ahead, and concerns for investors who fear a prolonged period of near zero interest rates will invite a repeat of a nasty bear market.

--Patrick J. O'Hare, Briefing.com

Briefing.com subscription services provide streaming market commentary and analysis along with a continuous flow of macro analysis, investing ideas and research reports. Please take a Free Trial of these live services on Interactive Brokers! (IB clients may sign up for a free trial in Account Management.)

This article is from Briefing.com and is being posted with Briefing.com's permission. The views expressed in this article are solely those of the author and/or Briefing.com and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


10948




Macro

The hidden portfolio risk in higher rates


Russ discusses the implications of a higher rate regime for your portfolio. The answer may surprise you.

 

This week, investor attention will once again fixate on the Federal Reserve (Fed). While the central bank is likely to demur this time, it will eventually renew its tightening cycle. However, despite the fixation on this topic, it is unclear that the next few interest rate hikes will have much of an impact on the real economy. It is not even clear that 25 or 50 basis points (0.25% or 0.50%) of additional tightening will have an enormous impact, other than a short-lived bout of volatility, on asset prices.

However, the long term is a different story. A more active Fed may have an enormous impact on how investors build portfolios, a development we may all want to start contemplating today.

In the post-crisis world, bonds have been a poor source of income, but they have been a good source of diversification. In recent years, the correlation between stocks and bonds has been more reliably negative (see the chart below; a negative correlation means stocks and bonds don’t move in sync). Why should this be the case given that over the long term the correlation between stocks and bonds tends to fluctuate?

chart-correlation-v2

In answering that question, it is important to recall that the Fed’s policy rate has remained extremely low for many years, predating the financial crisis, given the persistent slow growth regime. Since 2001, the federal funds rate has averaged just 1.60%; prior to 2001 the average, including the low rates of the 1950s, was around 6%. In this low rate environment, investors have rarely had much reason to “fear the Fed.” Rather than an aggressive central bank, slow or no growth has generally represented the bigger threat to markets.

This is important as the correlation between stocks and bonds has tended to relate to monetary policy, specifically the federal funds rate. Correlations have historically been lower when the Fed has set and maintained a low policy rate. As a rough rule of thumb, when the federal funds rate has been above 2%, the median stock/bond correlation has been 0.19. When the rate has been below 2%, as it has since 2008, the median correlation has been -0.39.

What correlation has to do with diversification

This has significant implications for portfolio construction. While cash is obviously less volatile than bonds, to the extent bonds tend to rise when stocks are declining, bonds may provide a more effective hedge against equity risk. Conversely, if stocks and bonds are moving together, cash is probably the better way to dampen portfolio volatility.

This is borne out using BlackRock’s Aladdin Portfolio Builder, our proprietary risk analytics and portfolio construction and management tool. A typical 60/40 U.S. stock/bond portfolio (with the 60% stocks measured by the S&P 500 and the 40% bonds by the Barclays Aggregate Index) and a 60/40 stock/cash portfolio have roughly the same expected, or ex-ante, risk (about 8.65%). However, over the past five years they performed differently depending upon the nature of the market shock. During the U.S. debt downgrade in 2011, the 60/40 stock/bond portfolio lost money, but still outperformed the 60/40 stock/cash portfolio. The reason: Systematic fears pushed bond yields down and prices up. However, with the “rate shock” in 2013, the stock/cash portfolio lost less as stocks and bonds both fell together on concerns over a less accommodative Fed.

The lesson: The source of the volatility may matter as much if not more than the magnitude. If the source is the Fed, bonds may not provide the familiar diversification that investors have come to rely on.

Russ Koesterich, CFA, is Head of Asset Allocation for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal. Diversification strategies do not guarantee a profit or protect against loss in declining markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results.

©2016 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

USR-10356

This article is from BlackRock and is being posted with BlackRock’s permission. The views expressed in this article are solely those of the author and/or BlackRock and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


10947




Macro

Australia's Biggest Risk: The 'Nutters' in Canberra


RBA governor Philip Lowe needs politicians to do their part to guide the economy through headwinds.

 

Philip Lowe could be excused for wondering what, oh what, he just got himself into. It’s bad enough the new Reserve Bank of Australia governor follows two widely respected predecessors. He’s also settling into the job at a moment of maximum uncertainty for his nation’s 24 million people.

Granted, Lowe isn’t some monetary newbie. From early 2012 until Glenn Stevens left the building last week, Lowe served as deputy RBA head. Yet central banks have long since ceased to be policy democracies, even if we perpetuate the myth. Governors tend to get their way, and get the blame when things go awry. That was true when Stevens replaced Ian Macfarlane in 2006, and it’s even truer since the 2008 crisis and quantitative easing run amok.

RBA policy is now Lowe’s to make or break, and the stakes have rarely been higher for the one major economy that’s avoided a recession for 25 years now. Where Lowe takes things from here also will contribute greatly to the global debate about what central banks can - and can’t - do in an increasingly dynamic world.

In his first outing as governor, Lowe defended RBA board members, arguing they haven’t been a bunch of “nutters” obsessed with inflation at the expense of broader considerations. One could argue that, with all due respect, the real nutters are the lawmakers hurling queries Lowe’s way.

Australia faces quite the economic paradox. Growth at 3.3% year-on-year is well above the developed-nation average, while unemployment is at three-year lows. Trouble is, wage gains also are in the doldrums. It doesn’t help that Australia’s bigger trading partner - China - is slowing, as is its appetite for Australian iron ore, coal and copper. Japan, its No. 2 trade partner, is walking in place, while the U.S. loses altitude.

Amid such headwinds, the RBA is under pressure to cut rates again. Under Stevens, it slashed borrowing costs twice in the past four months in part to cap the dollar. Sydney may be 8,500 miles from Washington, but its fortunes are being whipsawed by ultralow U.S. rates. The same goes for negative rates in Europe and Japan. As a result, the Aussie dollar has been on a tear, surging more than 10% since January (to delve deeper, read our May 7 Barron’s cover story). That’s slamming industries vital to recalibrating growth away from mining to services, including education and tourism.

It’s also reminding elected officials of their role in this tale. Sure, Lowe could push short-term interest rates even lower than today’s record 1.5%. And indeed, this week he won greater flexibility on the RBA’s inflation target constraints should conditions warrant lower rates. Like most major central banks, though, Australia’s faces a diminishing returns problem. Rate cuts might do less to fan growth than bubbles in household debt and property prices. Besides, the Bank of Japan, Federal Reserve and European Central Bank are proving one thing beyond a reasonable doubt: over time, little good comes from pushing rates below 1%.

The good news is that Australian QE probably isn’t necessary “because of the path we’re on,” Lowe says. The bad news is how little Prime Minister Malcolm Turnbull and his ruling party are doing to help the RBA’s cause. Canberra has plenty of fiscal space to act if needed; its $28 billion budget deficit is an enviable one relative to peers. Yet structural reform is far more important. Low productivity, crumbling infrastructure and education and income-tax systems that haven’t kept pace with globalization are deadening competitiveness.

Political paralysis has Canberra lawmakers abdicating responsibility to the RBA in Sydney. Even government officials who understand this standoff seem at a loss to address it. In a sense, 25 years without a recession has lulled Australia into complacency. As Turnbull’s treasurer, Scott Morrison, told Bloomberg recently: “I recognize that in the absence of a ‘recession we have to have,’ or the threat of ‘becoming a banana republic,’ achieving necessary change will be more frustrating and more difficult.”

Morrison favors a 10-year plan to cut corporate taxes to prod executives to boost hiring and wages. Greater success might be had resurrecting efforts of previous governments to tax excess mining profits and carbon emissions to redistribute wealth and pay for diversifying the economy. There’s not a moment to waste, as Standard & Poor’s cuts the outlook on Australia’s AAA credit rating and global headwinds mount.

Central bankers don’t always get things right, of course. But when Lowe ruminates about nutters acting against Australia’s interests, I’d assign far more blame to the gang in Canberra than at RBA headquarters.


William Pesek is Executive Editor of Barron’s Asia. Based in Tokyo, he writes Barron’s Asia’s lead column “Up & Down Asia,” which covers economics, politics, markets and social issues throughout the Asia-Pacific region. He is the author of the 2014 book “Japanization: What the World Can Learn from Japan’s Lost Decades.” Before joining Barron’s, Mr. Pesek was Bloomberg View’s Asia columnist. His columns have appeared in the International Herald Tribune, the Sydney Morning Herald, the New York Post, the Straits Times, and many other publications. Follow him on Twitter @WilliamPesek.

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This article is from Barron's and is being posted with Barron’s permission. The views expressed in this article are solely those of the author and/or Barron's and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


10943




Stocks

It's IPO Friday!


Market Update: As of 11:38 PM EDT

NASDAQ Composite -0.21% Dow -0.25% S&P 500 -0.21% Russell 2000 -0.32%
NASDAQ Advancers: 984 / Decliners: 1183
Today’s Volume: -14%

After four days of gains and record closes for both the Nasdaq Composite and the Russell 2000 indexes yesterday, profit-taking has the markets in the red this morning.  All sectors are lower with consumer discretionary (+0.1%) the exception.  There is no major news or theme in today’s trading and volumes are low.  Treasuries are mostly unchanged, the dollar is up slightly, gold off 0.2%, and crude oil is mixed to lower ahead of next week’s OPEC confab in Algiers. 

  • Speaking of OPEC, ‘production freeze’ chatter has been floating around for at least six months now and general expectations for an agreement has been about zero.  Bloomberg News notes that with Russia and the Saudis’ producing at record levels and restored output expected from Nigeria and Libya, there is a real risk that the global supply surplus could easily triple.  That increases the pressure for OPEC to act, but few (if any) analysts expect the real production cuts that would ensure higher prices.  Nevertheless we may very well get a teaser of an agreement of some sort.
  • M&A chatter is adding some excitement to today’s market: Twitter soars 18% on unfirmed takeover chatter; Imperva gains 21% after Cisco, IBM and others express interest, and exchange operator BATS gains 19% on word that CBOE is interested.
  • This morning Nasdaq welcomes three successful IPOs: Apptio (APTI) priced 6m shares at $16 and opened with a 53% pop.  AC Immune (ACIU) priced an upsized deal with 6m shares at $11 and gains 38%, and Gridsum priced 6.7m ADSs at $13.
  • With Amazon (NASDAQ: AMZN) closing above $800 yesterday for the first time, the company now has a market cap of more than $380 billion. This ranks AMZN as the 4th largest company in the U.S. by market cap and gives the Nasdaq the distinction of having the 5 largest companies by market value listed on our exchange. The 5 largest companies are (in order) are Apple (NASDAQ: AAPL), Alphabet (NASDAQ ;GOOG, GOOGL), Microsoft (NASDAQ: MSFT), AMZN and Facebook (NASDAQ: FB).

 

Technical Take:

European banks continue to face a number of headwinds including low economic growth, negative interest rates, heightened regulatory and legal scrutiny, and low capital ratios.  The low capital ratios is what distinguishes the group the most from their US counterparts which have been much quicker to recapitalize following the ’07-’08 financial crisis.   This difficult environment is reflected in the performance of the EURO STOXX Banks index which includes a broad number of banks across the European Monetary Union (EMU).  As seen in the below chart the index is not that far above the lows from the ’07-’08 financial crisis.  As a matter of fact the European bank index made its cyclical lows in the summer 2012 which recently were tested in July 2016.  The ensuing bounce peaked earlier this month at a cluster of technical resistance around the $100 level represented by the declining 2016 trend line, horizontal resistance at the 100 level, and finally the 40-week moving average.  Until the index can break through this resistance, the risk is for a resumption of the downtrend and possibly a retest of the July lows.  In that scenario the broader market sentiment is unlikely to be positive and talks of additional central bank support are likely to increase.    

Nasdaq's Market Intelligence Desk (MID) Team includes:  

Michael Sokoll, CFA is a Senior Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over 25 years of equity market experience. In this role, he manages a team of professionals responsible for providing NASDAQ-listed companies with real-time trading analysis and objective market information.
Jeffrey LaRocque is a Director on the Market Intelligence Desk (MID) at Nasdaq, covering U.S. equities with over 10 years of experience having learned market structure while working on institutional trading desks and as a stock surveillance analyst. Jeff's diverse professional knowledge includes IPOs, Technical Analysis and Options Trading.
Steven Brown is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over twenty years of experience in equities. With a focus on client retention he currently covers the Financial, Energy and Media sectors.
Christopher Dearborn is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq. Chris has over two decades of equity market experience including floor and screen based trading, corporate access, IPOs and asset allocation. Chris is responsible for providing timely, accurate and objective market and trading-related information to Nasdaq-listed companies.
Brian Joyce, CMT has 16 years of trading desk experience. Prior to joining Nasdaq Brian executed equity orders and provided trading ideas to institutional clients. He also contributed technical analysis to a fundamental research offering. Brian focuses on helping Nasdaq’s Financial, Healthcare and Airline companies among others understand the trading in their stock. Brian is a Chartered Market Technician.

This article is from Nasdaq and is being posted with Nasdaq’s permission. The views expressed in this article are solely those of the author and/or Nasdaq and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


10946




Futures

Blu Putnam Explains Volatility in the Oil-Gasoline Price Relationship


Blu Putnam, CME Group Chief Economist

This video is from CME Group and is being posted with CME Group’s permission. The views expressed in this video are solely those of the author and/or CME Group and IB is not endorsing or recommending any investment or trading discussed in the video. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


10945




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Disclosures

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