Week of September 19, 2016
Markets were focused on the impending Federal Reserve meeting and, with no other macroeconomic news to push or prod investors, volatility returned after a record-breaking period of stability in our domestic markets.
In spite of this, the S&P 500 ended the week up 0.53% while the Dow Jones Industrial Average and the tech-heavy NASDAQ Composite were 0.21% and 2.31%, respectively. International markets, however, didn't fare as well. All major international benchmarks, including the Nikkei 225, the MSCI Europe and the Shanghai Composite, were all off more than 2% for the week. This week, we discuss the movement in government bond yields ahead of the Federal Reserve's upcoming meeting as well as our thoughts on the meeting's outcome. We also take a quick look at Italy's attempt to release a 50-year bond. Lastly, we round out the commentary with a look at the physics behind a common nuisance faced by drivers.
Government Bond Yields Rise
The yields on US Treasury bonds were generally up and the markets remained chaotic, characterized by sharp swings driven by shifts in the outlook for central bank policy. Putting things in context, after the second round of quantitative easing years ago, the idea that rates have “nowhere to go but up” has pushed the demand for these bonds. These initial buyers were speculating that an eventual rate increase or additional rounds of stimulus would boost demand further and provide attractive returns for these buyers. However, when central banks fail to provide ‘expected’ stimulus, investor sentiments sour, they exit positions and yields rise as prices fall. This market dynamic has been dubbed a “taper tantrum”. On one hand, central banks are perhaps reaching a saturation point and may not be able to enact the large stimulus measures that have driven demand for government bonds in the past. On the other, the global economy continues to grow at a sluggish pace and equity markets already appear overvalued. We recognize that, should the equity markets correct, such an event could reignite demand for the relative safety of these government bonds and drive yields back down.
Italy's 50-Year Bond
Italy may eventually join the 50-year bond club in an attempt to borrow cheaply while “terming-out” debt, or replacing shorter-dated maturities with longer-dated bonds. In fact, the country had already explored issuing longer-term bonds back in 2015. Italy issued a 20-year bond in April of last year, raising €6.5 billion at a 2.302% yield. We would note that the approach is in line with other European peers. Spain, Belgium and France each raised €3bn selling 50-year bonds in the public markets. What’s more, Ireland and Belgium have even sold 100-year bonds through private placements, raising €100m. What’s in it for the fixed income investors? The short answer is yield. Given the current yield environment in the Eurozone, investors are looking to lock in rates higher than zero and longer term bonds generally pay more than their shorter-term counterparts. Demand for these ultra-long-term bonds has been strong. Indeed, interest rates on all 50-year bonds have fallen as investors have bid up the prices. Yields fall as prices rise, all else being equal.
Fed Likely to Pass on a Rate Increase
Given we are focusing so much on rates and central bank actions, this commentary wouldn't be complete without a brief discussion of the Federal Open Market Committee's meeting on September 21. The broader view is that the central bank will hold interest rates steady in September because the timing of such an increase is too close to the US election and inflation remains stubbornly below the Federal Reserve's benchmark. In reviewing the key indicators to discern the market's anticipation of a potential rate hike, it's a bit of a mixed bag. The US Dollar Index, which tracks the US dollar against a basket of six currencies, rose indicating greater demand for assets denominated in greenbacks. Furthermore, the CBOE Volatility Index, or VIX, spiked last week. Both of these could be signaling that the market is expecting a rate hike. Contradicting the move in the US dollar and the VIX is the increase in rates on government bonds. As we mentioned above, rates on the 10-year US Treasury bond ended the week up, indicating that selling pressure may be taking over and pushing bond prices down and yields up as speculative investors seek returns elsewhere. What's more, the federal funds futures curve, used by market participants to bet on Federal Reserve Policy actions, is pointing to a 15% chance of a rate hike the end of this month. We would be remiss if we didn't mention the elections and their impact on Federal Reserve policy actions. Historically, the Fed has been reluctant to raise rates so close to the presidential election.
Fun Story of the Week
Have you ever rolled down just one window in a car, only to hastily roll it back up because of the mind-numbing throbbing that ensued? The common solution is to open another window but the issue is much more common in today's cars as they are designed to have little to no gaps between various parts and seams. Technically called the Helmholtz resonance, this throbbing noise is an equal-opportunity offender, plaguing economy cars to even the most expensive exotic sports car. The exact cause comes from wind rushing by any flat opening without another opening to vent the air. This is the same phenomenon that makes a noise when one blows over the top of a glass bottle. While opening another window can help, there are other solutions that carmakers have employed. Many makes and models have a shield that pops up on the sunroof to deflect air up and away from the opening. Others still have taken a more high tech approach. Jaguar, for example, has a "comfort stop" option that will automatically open a window just enough so as to not invite the Helmholtz resonance. One only needs to press the "down" button again to override the feature.
Securities offered through Jacques Financial, LLC (JFLLC) a Broker-Dealer, Member FINRA and SIPC.Certain associates of Joseph W. Jacques, CPA, CFPTM are registered representatives of JFLLC. Joseph W. Jacques, CPA, CFPTM and JFLLC are affiliated. Investment advisory services are offered through Jacques Advisors, LLC an affiliate of JFLLC. Tax services are offered through Jacques & Associates Certified Public Accountants, LLC an affiliate of JFLLC.
This newsletter was written and prepared by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Bond yields are subject to change. Certain call or special redemption features may exist which could impact yield.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.
S&P 500 INDEX
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
NIKKEI 225 AVERAGE INDEX
The Nikkei 225 Average Index is a Japanese index that tracks the top 225 companies listed on the Tokyo Stock Exchange. It includes the most liquid Japanese stocks listed in the first section of the Tokyo Stock Exchange. It is price-weighted and yen-denominated.
MSCI EUROPE INDEX
The MSCI Europe Index captures large- and mid-cap companies across 15 developed markets countries in Europe.
SHANGHAI COMPOSITE INDEX
The Shanghai Composite Index is a market index of all stocks (A shares and B shares) that are traded on the Shanghai Stock Exchange. It tracks the largest publicly traded companies in China.
A broadly cited measure of volatility is the Chicago Board Operations Exchange’s Volatility Index, constructed using the implied volatilities of a wide range of S&P 500 index options.
Wall Street Journal, September 2016. http://www.wsj.com/articles/jump-in-yields-raises-fear-of-return-to-bond-market-tantrum-1473682254
Investing, September 2016. http://www.investing.com/rates-bonds/u.s.-10-year-bond-yield-historical-data
Wall Street Journal, September 2016. http://www.wsj.com/articles/divided-federal-reserve-is-inclined-to-stand-pat-1473720501
Wall Street Journal, September 2016. http://www.wsj.com/articles/italian-treasury-sounding-out-investors-on-50-year-bond-1473260474
Investing, September 2016. http://www.investing.com/quotes/us-dollar-index-historical-data
Wall Street Journal, August 2016. http://www.wsj.com/articles/cranky-drivers-battle-the-wub-wub-wub-that-comes-from-cracking-a-window-1470683291