The obvious main driver of markets near term will be the FOMC meeting on Wednesday, September 21. However, the People’s Bank of China’s currency strategy and the Bank of Japan’s intent to raise the pitch of its yield curve are two scenarios that are flying under the radar by comparison. Either could have a more meaningful impact than the Fed.
The Fed wants to raise rates. The data has been soft of late (see Economic bullets below), including wage gains without end demand pick up and capital investment, yet the courtiers are still on the trail talking up an increase again. Just to add the necessary cross-current from the Fed Lael Brainard in a last minute speech in Chicago last Monday said the case was not strong to raise right now. Though Fed fund futures put the odds of an increase in the rate band at less than 20% I can’t help but think they will go. In fact, that’s my expectation. Why? If for no other reason than they must to save face. In the early 90’s when I started in the business they had the profile of a librarian, and frankly, they should assume it again. Can you imagine not knowing (or caring) when the next Fed meeting was?
The PBOC has raised the offshore yuan funding rate (HIBOR) 23.7% from 15.7% in one move in an attempt to halt the shorts on the Yuan. Apparently 6.70 is some demarcation line for the Bank with capital outflows (think Canadian real estate) at high levels. Their currency actions make for interesting times when mixed in with the Fed, especially as Chinese markets are closed Thursday and Friday, and China’s inclusion into the IMF’s reserve currency basket next month. While its a “known” today a mini-devaluation in the Yuan last August caused stock market weakness.
And Japan has been roiling things in its own way with a sudden change in its view of long bonds. The Bank of Japan who has been pushing down yields into negative territory no longer apparently wants such a flat yield curve. This knee jerk change at a minimum shows that their is internal division. The BOJ which owns a large percentage of Japanese equities and JGB’s pulled out some of its support (sold) in the long end recently causing a ripple effect in risk parity models around the globe, and hence equities and government bonds (Corporate bonds have seen a dramatic drop off in holdings by investment banks and market making over the last year. Its a serious topic for another day if we don’t hear about it sooner) Risk parity models assign assets based on risk not typical capital weightings. The most interesting element of the Japanese re-think is that the BOJ will release its latest policy announcement overnight and before the Fed speaks.
While in Canada its seems like the only topic du jour is real estate. What’s caught my attention is the steady, and now historic, rise in debt-to-income. How is it that Canadians didn’t learn the lesson of their US counterparts in 2008? Yes only in Canada
Over the last few months the Fed’s confusing messages and the Brexit “leave” vote have seen strength in pro-cyclicals and weakness in defensive and interest-rate sensitives. The short and longer term charts below of utilities vs. financials are representative illustrations. While its too early too call whether we in fact will see a sustained increase in rates we have been picking up the latter group on weakness for new clients, and general re-balancing purposes, and capturing gains quickly on the former.
The TED spread has been creeping higher (as has VIX), setting the stage for increased volatility in the days and weeks ahead. Incidentally, the US presidential elections add an extra element of caution especially one following a two term president. While not outright bearish we have begun to hedge portfolios (single inverse ETF’s) for just such a period and have raised cash levels.
In the weekly Asset Class rankings equities are holding up though the S&P is slipping and the TSX dropped (USD strength) Of note is the move up together in bullion, the USD and the Euro. All the tables shown are a rolling short term look. We tend to focus on the monthly tables (out in a couple weeks) for persistent portfolio themes. The weekly look helps to handicap changes or continuations in those themes.
In the TSX sector rankings there has been little change in the top 5 over the last few weeks. Of note is the staying power (built up performance) of the metals & mining category and the big fall in energy. I would think they would both be beneficiaries of the pro-growth theme whether it comes to pass in full force or not. At present, its an interesting divergence only.
In the weekly US sector rankings the stand out is the drop in financials. It may be just a near term pullback as markets await the Fed decision (similar to the divergence in metals & mining and energy noted above) An increase in rates is positive for the sector. Biotech, a holding in two core portfolios – The Focus and The Two-Way – is in a strong seasonal period until early October wherein it takes a short term dip and then resumes its strength.
International indices saw a fall for Spain and Italy and jumps for Belgium, Netherlands and Sweden. The Italian drop is of note as its largest bank, Monte dei Paschi, is in trouble (trades at pennies on the Euro) and the rumblings are growing of another leave/stay vote coming out of a constitutional vote called by the PM for October.
The TSX 60 stock rankings display the tug between pro-growth and defensives at the individual stock level. The last couple of months there has been very little persistence outside of a handful of stocks. This churning often occurs as bottoms or reversals are formed.
On the portfolio level we are prepared for a break in either direction of these conflicting themes or a grinding scenario where both have their roles where the pro-growth are traded and the defensives invested in. Our overall strategy is still one of “convexity” or having a mix based on risk not on asset classes. A little more clarity for the next year will occur after the 3 main catalysts – the US Fed, the PBOC and the BOJ – have had their say and markets are fully opened next week.
Robert (Hap) Sneddon, Portfolio Manager