Play Cautiously with Vulnerable Markets

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Juega con cautela con los mercados vulnerables
Photo: Guma89. Play Cautiously with Vulnerable Markets

Written by Rick Rieder, BlackRock Chief Investment Officer of Global Fixed Income and portfolio manager for the BGF Fixed Income Global Opportunities Fund.  Rieder argues that monetary policy restrictiveness, fading fiscal stimulus, and growing economic uncertainties leave markets more vulnerable today, and these risks are not to be toyed with.

In the game of Jenga, players take turns removing one block at a time from a tower constructed of 54 blocks. Each block removed is then placed on top of the tower, creating a progressively taller, yet more unstable, structure. The game ends when the tower falls and the loser is the person who made it fall. To us, the 2018 investing regime is evolving much like a late-stage game of Jenga, with the Federal Reserve and Treasury clinically and methodically removing the blocks of stability from underneath the financial and real economy “towers.” Indeed, ongoing rate hikes, Fed balance sheet reductions, and massive amounts of Treasury issuance to finance fiscal deficits are leading to increasing vulnerabilities for both financial assets and the prospects for economic growth over coming quarters. In our view, this vulnerability is evidenced by the recent acute spike in market volatility.

Monetary Policy likely to differ from standard market narrative

The conventional market narrative today surrounds already realized robust U.S. growth and earnings, and an earnest belief that sufficient momentum exists to push a capacity-constrained economy into a mode of overheating that will force the Fed to seek a restrictive policy stance. Our base case monetary policy scenario is far more benign, as increasingly skittish financial markets, along with signs that previous tightening has already started to bite parts of the real economy, suggest to us that the tightening cycle is nearing its end. To be clear, though, we do not think the Fed will mistakenly become too restrictive.

To be sure, third quarter U.S. economic growth remains strong by most measures, but we think there are numerous yellow lights flashing ahead of investors today. For instance, while ‘present conditions’ components of high-frequency survey economic data remain solid, related measures of ‘forward expectations’ have become noticeably weaker. Moreover, the two largest (and most rate-sensitive) sectors of the tangible economy, the housing and auto markets, are showing demonstrable signs of softness. That weakening can be witnessed with declines in mortgage applications, housing turnover, and a reduced rate of home-price appreciation. It can also be seen in a notable decline in used car prices. Finally, the powerful influence of 2018 fiscal stimulus will become a growth headwind in 2019, as temporary measures roll off leaving only the related financing burden behind. As that process unfolds, it’s very likely that the Fed’s judgement of the strength of the economy and the need for further policy rate hikes also adjusts (see graph), an eventuality that markets are not properly discounting now.
 

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Meanwhile, inflation has moved begrudgingly toward the Fed’s desired target, but there is scant evidence of untethered economy-wide price increases. In fact, persistent “misses” in core inflation prints, relative to expectations, are widely brushed aside as “one-off” occurrences, but the reality is that the greatest cost revolution in history (due to technology and demographic forces) is combining with fat corporate profit margins that can handily absorb wage increases. That fact should mute consumer price increases, just as inflation expectations continue to make new generational lows.

And, with real economy vulnerabilities percolating, we see a more acute tightening of financial conditions (FC) than is broadly appreciated. While traditional metrics show that FC are approaching longer run averages, when adjusted for contracting forward equity multiples, a more pronounced tightening is evident. Also, rising yields are driving increased corporate borrowing costs, a late-cycle phenomenon that often leads reflexively to wider credit spreads that in turn risk exacerbating the phenomenon.

What tighter financial conditions mean for markets

Tighter financial conditions have already impacted the global economy as U.S. dollar strength, and declining global liquidity growth, has generated significant turmoil in emerging markets (EM) this year. Many EM countries have witnessed a ubiquitous, and unwanted, currency weakness that has forced onerous policy tightening by their central banks to restore stability. However, this creates yet another headwind to global growth, with worrying implications for non-U.S. developed market (DM) economies that rely on EM growth for economic resilience (such as a good deal of Europe). Indeed, just last week, the International Monetary Fund reduced its global growth forecast for the first time in years.

During October, nascent signs of global growth deceleration and tightening financial conditions have caused volatility to spike anew. Moreover, if price declines across asset classes proliferate further over coming weeks the risk of accelerating retail capital outflows from financial assets would be exacerbated by dangerously thinly traded financial markets. An important tail risk to greater equity market weakness is the potential to rapidly undo the progress that pension funds have made in closing their funding gaps in recent years. The early third quarter backdrop of higher rates and buoyant equities provided a window for pensions to lock in that progress, but the more recent equity selloff, should it persist, would suddenly jeopardize those gains.

Implications for Asset Allocation

All things considered, we’re increasingly convinced that the Fed will not allow the Jenga tower to topple. Instead, we see a looming slowdown in the march toward “normalization” and a subsequent victory declaration regarding the Fed’s dogged pursuit of policy neutrality. Accordingly, we reiterate our enthusiasm for convex, high-quality, front-end rate expressions with immensely attractive carry (such as the 2-Year U.S. Treasury), as these assets have already priced in excessive incremental tightening and provide a portfolio hedge against the unlikely event of a policy mistake. We’ll gradually increase exposure to the belly of the curve (5-Year U.S. Treasury) on a moderate backup from here for an optimal mix of attractive carry breakeven and duration, just as the recent favorable shifts in cross-currency swaps make DM sovereigns expressed in USD newly enticing (note, the USD still remains one of our favored left-tail risk hedges).

We continue to like beta exposures through investment-grade credit expressions; for the combination of attractive all-in yield and satisfactory market liquidity, and also like short duration securitized assets, for their stable and secure cash flows. Finally, U.S. equities are increasingly attractive to own outright at ever cheaper valuations, just as corporate buybacks are set to resume after the third quarter earnings season ends. And for the first time all year, we think that elevated levels of implied volatility are creating tactical opportunities to sell options for incremental portfolio carry. Investors today must remain on guard against the market vulnerabilities we outlined, but at the same time, these very vulnerabilities provide opportunity. After all, no matter how precariously the Jenga tower is leaning, a player can’t win unless they remove a block and carefully place it on top.

Build on Insight, by BlackRock written by Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and portfolio manager for the BGF Fixed Income Global Opportunities Fund

In Latin America and Iberia: this material is for educational purposes only and does not constitute investment advice nor an offer or solicitation to sell or a solicitation of an offer to buy any shares of any Fund (nor shall any such shares be offered or sold to any person) in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. If any funds are mentioned or inferred to in this material, it is possible that some or all of the funds have not been registered with the securities regulator of Argentina, Brazil, Chile, Colombia, Mexico, Panama, Peru, Portugal, Spain, Uruguay or any other securities regulator in any Latin American country and thus might not be publicly offered within any such country. The securities regulators of such countries have not confirmed the accuracy of any information contained herein. The provision of investment management and investment advisory services is a regulated activity in Mexico thus is subject to strict rules. For more information on the Investment Advisory Services offered by BlackRock Mexico please refer to the Investment Services Guide available at www.blackrock.com/mx.

Investing involves risks, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Learn more about how consistent investment performance and low fees are critical to achieving your fixed income goals in today’s environment.
International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.

Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

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 October 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary 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.

Prepared by BlackRock Investments, LLC, member Finra

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States or elsewhere. All other marks are the property of their respective owners. MKTG1118L-649595-2015110

October Spooked Market Participants Universally But The U.S. Economy is Still on a Roll

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Si bien octubre pareció asustar a los inversores, los mercados siguen en buena racha
Pixabay CC0 Public DomainPhoto: Alexas_Fotos. October Spooked Market Participants Universally But The U.S. Economy is Still on a Roll

October spooked market participants universally with US stocks enduring their worst month since the financial crisis. Issues at hand circle around concerns about peak earnings and growth, tighter financial conditions, fears of a Fed policy mistake, a potential credit bubble and selling pressure in crowded trades. Tensions have been further compounded by geopolitical worries, including ongoing trade tensions with China and deteriorating Chinese/US relations; Italy’s budget chaos and fears of a recession; uncertainty regarding the upcoming US congressional elections; and Brazil’s election of Jair Bolsonaro, joining the growing ranks of populists across the world.

The U.S. economy is still on a roll and this is reflected by the outperformance of U.S. equities versus foreign stock markets. More broadly, payrolls are increasing, wages are growing at the fastest rate since 2009, and unemployment is at a 49 year low. Consumer spending is doing well and should get a boost from falling oil prices while global investors continue to be attracted by America’s low tax rate, economic strength, corporate profit growth, and ongoing efforts to achieve less regulation.

There are undoubtedly countless factors that could go wrong with the equity market. With that in mind, much could still go right. Earnings growth rates may be peaking, but earnings are still strong; outcomes in the US midterm elections will be known November 6th, removing the angst over potential outcomes; and the world could be pleasantly surprised following a meeting between Presidents Trump and Xi at the upcoming G-20 summit, easing concerns over escalating challenges between two of the world’s superpowers. With no compass to turn to, we continue to orient ourselves by looking at valuations, which for global stocks look to be at attractive levels not seen for over two years.

One specific investment dynamic I would like to highlight is in regards to the music industry, which are changing fast with Sony continuing to strategically position itself to the benefit of shareholders.  After gaining European Commission approval in late October, Sony will acquire EMI Music Publishing in a $2.3 billion deal without conditions. The EMI acquisition will make Sony the global industry leader with a market share of about 26 percent. Universal Music Group and Warner Music Group are the major competitors in an industry that has now been revitalized by digital streaming services. As a copyright manager, Sony can earn revenues from direct deals with Spottily, Apple Music, Google Play, SoundCloud and YouTube. At the end of October, returning to the creative roots of its original Sony Walkman TPS-L2 in 1979 and as a logical extension of the music business, Sony audio announced that it aimed to regain its leadership position in headphones.

Column by Gabelli Funds, written by Michael Gabelli

To access our proprietary value investment methodology, and dedicated merger arbitrage portfolio we offer the following UCITS Funds in each discipline:

GAMCO MERGER ARBITRAGE

GAMCO Merger Arbitrage UCITS Fund, launched in October 2011, is an open-end fund incorporated in Luxembourg and compliant with UCITS regulation. The team, dedicated strategy, and record dates back to 1985. The objective of the GAMCO Merger Arbitrage Fund is to achieve long-term capital growth by investing primarily in announced equity merger and acquisition transactions while maintaining a diversified portfolio. The Fund utilizes a highly specialized investment approach designed principally to profit from the successful completion of proposed mergers, takeovers, tender offers, leveraged buyouts and other types of corporate reorganizations. Analyzes and continuously monitors each pending transaction for potential risk, including: regulatory, terms, financing, and shareholder approval.

Merger investments are a highly liquid, non-market correlated, proven and consistent alternative to traditional fixed income and equity securities. Merger returns are dependent on deal spreads. Deal spreads are a function of time, deal risk premium, and interest rates. Returns are thus correlated to interest rate changes over the medium term and not the broader equity market. The prospect of rising rates would imply higher returns on mergers as spreads widen to compensate arbitrageurs. As bond markets decline (interest rates rise), merger returns should improve as capital allocation decisions adjust to the changes in the costs of capital.

Broad Market volatility can lead to widening of spreads in merger positions, coupled with our well-researched merger portfolios, offer the potential for enhanced IRRs through dynamic position sizing. Daily price volatility fluctuations coupled with less proprietary capital (the Volcker rule) in the U.S. have contributed to improving merger spreads and thus, overall returns. Thus our fund is well positioned as a cash substitute or fixed income alternative.

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GAMCO ALL CAP VALUE

The GAMCO All Cap Value UCITS Fund launched in May, 2015 utilizes Gabelli’s its proprietary PMV with a Catalyst™ investment methodology, which has been in place since 1977. The Fund seeks absolute returns through event driven value investing. Our methodology centers around fundamental, research-driven, value based investing with a focus on asset values, cash flows and identifiable catalysts to maximize returns independent of market direction. The fund draws on the experience of its global portfolio team and 35+ value research analysts.

GAMCO is an active, bottom-up, value investor, and seeks to achieve real capital appreciation (relative to inflation) over the long term regardless of market cycles. Our value-oriented stock selection process is based on the fundamental investment principles first articulated in 1934 by Graham and Dodd, the founders of modern security analysis, and further augmented by Mario Gabelli in 1977 with his introduction of the concepts of Private Market Value (PMV) with a Catalyst™ into equity analysis. PMV with a Catalyst™ is our unique research methodology that focuses on individual stock selection by identifying firms selling below intrinsic value with a reasonable probability of realizing their PMV’s which we define as the price a strategic or financial acquirer would be willing to pay for the entire enterprise.  The fundamental valuation factors utilized to evaluate securities prior to inclusion/exclusion into the portfolio, our research driven approach views fundamental analysis as a three pronged approach:  free cash flow (earnings before, interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow/maintain the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. Our team arrives at a PMV valuation by a rigorous assessment of fundamentals from publicly available information and judgement gained from meeting management, covering all size companies globally and our comprehensive, accumulated knowledge of a variety of sectors. We then identify businesses for the portfolio possessing the proper margin of safety and research variables from our deep research universe.

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Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to find out what those restrictions are and observe them.
 
Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reflect the manager’s current view of future events, economic developments and financial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.
 

 

Speaking of Investments, Which Afores Stand Out?

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En materia de inversiones, ¿en qué son buenas las Afores?
CC-BY-SA-2.0, FlickrPhoto: Lindsey Turner. Speaking of Investments, Which Afores Stand Out?

To be the best Afore in terms of yields, they have to be good in several asset classes and that allows them to diversify the portfolios. The 4 most profitable Afores for the period 2012-2018 in order of importance are: Profuturo, Coppel, Sura and Citibanamex.

The 10 Afores that exist in Mexico, manage 180 billion dollars that represent 15% of Mexico’s GDP.

The 4 most profitable Afores are characterized by having between 8 and 9 asset classes in which they stand out from a total of 19 assets in which they invest in accordance with CONSAR (page 4).

Afore Profuturo that presents the best weighted performance of its Siefores had 7.60% between December 2012 and July 2018. It stood out for its performance attribution in foreign equity; mexican TIP´s (Udibonos); corporates; mexican treasurye bills (Cetes); foreign debt; Brems and Bondes D; derivatives and other underlying assets, as well as amortization and trading. The specialization that Afore Profuturo has in these asset classes allows it to differentiate itself and stand out among the 10 Afores that exist today. It is important to mention that these asset classes generate value for their portfolios in different weightings as can be seen in the following table:

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Afore Coppel is in the second position with a yield of 7.19%, highlighting in its performance attribution in: foreign equity; mexican TIP´s (Udibonos); corporate bonds; local equity; repo; securitized; Brems and Bondes D; derivatives and other underlying assets, as well as amortization and trading.

CONSAR identifies 19 asset classes in its performance attribution report that in order of importance for its contribution to performance are:

  1. Foreign equity (5 Afores stand out for their results in this asset class)
  2. Mexican TIP´s, Udibonos (4)
  3. Corporates (5)
  4. M Bonos (5)
  5. Local equity (4)
  6. Mandates (2)
  7. Mexican treasury bill, Cetes (4)
  8. Structured (5)
  9. UMS (2)
  10. Repo (7)
  11. Securitized (3)
  12. Foreign debt (3)
  13. Brems and Bondes D (4)
  14. Bondes 182 y BPAs (2)
  15. Commodities (1)
  16. IPAB (3)
  17. Mexican REITS, fibras (1)
  18. Derivates and others underlying (2)
  19. Amortization and trading (8)

These 19 asset classes, the first 4 asset classes account for 85% of the performance of the system, however it is not enough to be good at these asset classes to be the best in returns.

The asset with the highest profitability has been the foreign equity (36% of the weighted yield) which has a limit of 20%. The following three assets are: Mexican TIP´s (Udibonos); corporates and M bonds that each contributed between 16 and 17% to average yield of all the Afore.

It is interesting to note the case of Afore PensiónISSSTE who is good in 7 asset classes and is in 5th place in terms of returns, so seeking to improve their results in one or two more asset classes would help improve their results. In a similar situation is Afore Azteca who is good in 5 asset classes and is in 6th place in yields.

Afore Inbursa is good in 7 asset classes but it is not enough to be placed in the first places since the asset classes in which it is good are not those that provide the highest returns.

The investment teams of the Afores should be strengthened and sophisticated to improve their specialization in the different asset classes to maintain and attract affiliated workers.

Column by Arturo Hanono

AMLO’S Actions Erode Investors’ Confidence in Mexico

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After Mexico’s president-elect, López Obrador, announced that he plans to scrap the most important infrastructure project of the past two decades – the New Mexico City International Airport, the peso had one of its worst days since President Trump’s election and the stock market, which fell 4%, had its worst close in a decade.

According to JPMorgan Chase & Co which lowered its expectations for Mexico, the decision (which followed the mandate of the referendum held on the issue, with minimum participation -only 1,067,859 votes, or less than 1% of the Mexican population), “left investors worried about how he would manage the economy and increases the probability of the central bank raising interest rates.”

Morgan Stanley also reacted by changing its preference of exposure to that country from an overweight to an underweight position due to “the short-term asymmetric risks associated with the free trade agreement with the US and the airport situation.”

According to UBS the issue seems even riskier, since they warn that this dynamic could be used to carry out material changes in Mexico, such as invalidating “effective suffrage, not re-election” or even the central bank’s autonomy. “We see the potential for a public referendum to be approved as a constitutionally valid way of enforcing changes in the future, including possibly extending the six-year presidential mandate. The use of reserves at the central bank (Banxico) could also be subject to the people’s choice,” they point out in the attached report.

AMLO, who will not be sworn into office until December 1st, stated that after the public consultation, “our decision is to obey the referendum mandate, so two runways will be added to the military airport at Santa Lucia, the current Mexico City airport will be improved, and the Toluca airport will be upgraded, so that shortly we will have solved the saturation in Mexico City’s current airport.”  The politician also commented that, “in economic terms, with this decision the Federal Government is going to save, around 100 billion pesos.” Just with the change in capitalization value due to Monday’s fall, Mexican companies lost 17 billion dollars, or more than 341 billion pesos. This means that in just one day, they lost more than three times the savings promised by AMLO.

Meanwhile, President Enrique Peña Nieto informed that Grupo Aeroportuario de Ciudad de México, or GACM, the company in charge of the New International Airport of Mexico (NAIM) project, will continue working on the construction of the new terminal in Texcoco at least until his last day in office, November 30th. Whereas, Juan Pablo Castañón, President of the (CCE), or Business Coordinating Council, said that the consultation lacks legal fundamentals in order to be accepted and warned that if after December 1st the stance continues to be to halt the Project underway in Texcoco, stakeholders will undertake legal actions in defense of the Project, and “in favor of Mexico’s economic development.”

The President, Enrique Peña Nieto, also warned that if the airport is canceled, the next government will have to comply with all its contractual and financial obligations, which includes advancing airport bond payments. According to AMAFORE, Afores investments in the NAICM are assured: “Workers must be calm about their savings, since the instruments used by the Afores for this investment, Fibra-e and Bonds, are backed by the collection of the TUA (Airport Use Fee), that is, by the flow of passengers, so the investment of their savings has enough guarantees to recover the capital plus a yield higher than inflation,” the organism said in a statement.

Adapting To Markets That Change At The Speed Of Moore’s Law

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Adaptarse a mercados que cambian a la velocidad de la Ley de Moore...
Wikimedia CommonsFoto: Pxhere CC0. Adapting To Markets That Change At The Speed Of Moore’s Law

Written by Rick Rieder, BlackRock Chief Investment Officer of Global Fixed Income and Portfolio Manager of the BGF Fixed Income Global Opportunities Fund

Published September 26, 2018

Rieder and Brownback argue that today investors are confronted by massive shifts in the nature of the economy, alongside cyclical and policy uncertainties; making sense of it all is critically important.

Moore’s Law, which states that computer processing speeds should double roughly every two years, proved to be true for a generation and helped to catalyze historical, technological, and social change, as well as remarkable productivity and economic growth. Today, however, new processing-intensive operations have challenged the law’s durability. Fortunately, the revolutionary emergence of parallel-processing chips has created a vast new dimension of computing capability – essentially computer chips that can now multi-task. Thus, simultaneous processing of massive and differentiated data inputs is possible, which has colossally accelerated the evolution of numerous cutting-edge innovations, such as artificial intelligence and autonomous driving, to name but a couple of the higher-profile examples. Similarly, successful investing today requires an ability to look past simple hyperbolic headlines and concurrently process and prioritize numerous thematic influences, many of which are historically unprecedented and are likely underappreciated by conventional wisdom.

From manufacturing to services; Tangible to intangible

High atop our thematic list is the evolving dominance of the “intangible economy” that has radically altered global consumption and investment behaviors, and which is fascinatingly depicted in the recent work by Jonathan Haskel and Stian Westlake, Capitalism Without Capital: The Rise of the Intangible Economy(Princeton, 2017). Ubiquitous human connectivity has dramatically elevated the relevance of digital intangible assets (data, applications, brands, etc.) and given rise to a frenzied corporate focus on their aggregation and monetization. In turn, this is engendering massive amounts of research and development spending, and investment in intangible assets, like social media platforms, apps, etc. that cater to consumers and in many cases hold transformational impacts on the global economy. At the same time, tangible asset investment has long been in decline (see graph).
 

 

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Attempting to value the “capital stock” of digital intangible assets is an imprecise endeavor because the specific pecuniary impacts are difficult to quantify. Consumers are just beginning to understand that data created from their use of intangible products has realizable intrinsic value. For companies, the value of intangible assets are only reflected on balance sheets via acquisitions, or by backing them out from market capitalizations. But the overall societal benefits of proliferating intangible assets are unambiguous. Many corporations now generate enormous cash flows with a stock of ever fewer physically tangible assets. Systemic inventory management has become highly efficient, which reduces the amplitude of the macro economic cycle. Moreover, pervasive connectivity fosters intense price competition that places a secular downward pressure on global inflation rates, a broad and vital positive for the household sector.

Inflation, The Fed and the U.S. Dollar

Another theme worth monitoring is the muddled cyclical inflation outlook and possible policy responses. Specifically, weighty components to the Consumer Price Index, such as energy and shelter, face headwinds associated with steep base effects. Conversely, widespread tariffs would produce an obvious cyclical inflationary shock, just as many industries already face onerous capacity constraints that risk evolving into cost-push type price increases. In total, while markets are fearful of accelerating inflation, we think the Federal Reserve will look through the cyclical noise in deference to longer-term secular constraints.

Instead, we think policy makers will rightly focus on rate hike ramifications for real-economy activity while seeking a nebulous policy neutrality. With solid U.S. growth momentum, the risk of a tightening-induced recession is low at this point, but collateral damage from excessive tightening is very possible. Already, some debt-financed sectors like housing are showing nascent signs of diminished activity. Moreover, the prominent loan market will become exposed to rates that rise above the preset floors embedded into most outstanding loans. Finally, as the U.S. economy becomes more dominated by rate-insensitive, intangible-heavy businesses, extreme Fed rate adjustments away from neutral (up or down) will unfairly penalize very specific economic constituents, like savers and homeowners.

An underappreciated corollary to persistent Fed tightening is U.S. dollar strength (USD), especially when such hawkishness runs counter to the policy stance of other developed market (DM) central banks, as is the case today. Generally speaking, a stronger USD can disrupt the global financial system by tightening USD funding and reflexively lowering non-U.S. economic growth. And, when global liquidity growth slows sharply, as it has this year, U.S. dollar strength exacerbates the onerous consequences already accruing to liquidity-dependent global borrowers. That phenomenon has been visibly evident during 2018, with rolling emerging market (EM) crises posing a widening risk of broader contagion.

Asset Allocation amid growing uncertainty

Divergent financial market influences are equally complex. First, investor conviction has plummeted, severely diminishing market liquidity just as persistent volatility short selling is driving DM implied volatility to new lows. Combined, those two factors represent a systemic vulnerability with potential for forced unwinds into precariously thinly-traded markets. Simultaneously, credit spreads reside at cyclical tights, reflecting robust cash flow-driven leverage metrics. But the emergence of intangible assets means any cyclical decline in systemic cash flows can dent credit metrics rather faster than historical experience, since there are fewer tangible assets to serve as a collateral cushion. Another evolving dynamic is the efficacy of duration as a reliable risk hedge. While historically dependable, hedging with duration has been a counterproductive tool so far this year, but we think that the resumption of disinflationary forces and a full market pricing of near-term rate hikes suggest that risk parity, via short- and medium-dated U.S. Treasuries can be useful again for the remainder of 2018.

In sum, we find that while the range of potential forward scenarios has widened this quarter, the likelihood of a negative outcome has risen meaningfully. Accordingly, we are exploiting highly attractive short-dated fixed-income assets for carry and convex duration, specifically U.S. Treasuries, securitized assets, investment-grade credit, and DM sovereigns swapped to U.S. dollars. We’re staying exposed to equities though cheap upside gamma. Moreover, given the carnage witnessed in recent months in EM debt markets, we’re also layering in hard-currency expressions, and remain long the U.S. dollar as a systemic hedge. Investors today must understand the massive long-term changes taking place in the economy, alongside the cyclical economic fluctuations within them. They must also contend with an increasingly opaque monetary policy path for the year ahead, so we think maintaining a fair degree of caution makes sense, and it positions one well to take advantage of future opportunities.

Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and Portfolio Manager of the BGF Fixed Income Global Opportunities Fund.

In Latin America and Iberia, for institutional investors and financial intermediaries only (not for public distribution). This material is for educational purposes only and does not constitute investment advice or an offer or solicitation to sell or a solicitation of an offer to buy any shares of any fund or security and it is your responsibility to inform yourself of, and to observe, all applicable laws and regulations of your relevant jurisdiction. If any funds are mentioned or inferred in this material, such funds may not been registered with the securities regulators of Argentina, Brazil, Chile, Colombia, Mexico, Panama, Peru, Portugal, Spain Uruguay or any other securities regulator in any Latin American or Iberian country and thus, may not be publicly offered in any such countries. The provision of investment management and investment advisory services is a regulated activity in Mexico thus is subject to strict rules. For more information on the Investment Advisory Services offered by BlackRock Mexico please refer to the Investment Services Guide available at www.blackrock.com/mx. The securities regulators of any country within Latin America or Iberia have not confirmed the accuracy of any information contained herein. No information discussed herein can be provided to the general public in Latin America or Iberia. The contents of this material are strictly confidential and must not be passed to any third party.

Investing involves risks, including possible loss of principal. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Learn more about how consistent investment performance and low fees are critical to achieving your fixed income goals in today’s environment.
International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.
Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.
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 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary 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.
Prepared by BlackRock Investments, LLC, member Finra
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High Yield: The End Of The American Dream?

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High yield: ¿el fin del sueño americano?
Wikimedia CommonsCourtesy photo. High Yield: The End Of The American Dream?

Traditional fixed income investors do not usually like interest rate hikes. As rates go up, the prices of their bonds go down and they reap negative returns in their portfolios. This is where the poorly advised investor learns that fixed income is far from fixed. Only those who maintained liquidity in a large portion of their portfolios will welcome the new opportunities arising from investing at higher rates. But is this anxiety surrounding the rate hikes shared across all asset classes in fixed income? In the case of high yield bonds the higher rates could be a positive thing (if the increases reflect an expanding economy) or a negative thing (if there is a fear that these rate hikes may end up causing a recession).

To date, despite episodes of volatility in the markets, high yield has generally benefitted from the strength of the US economy, the growth in corporate earnings and the low default rate. In spite of the downturn that we have seen so far in October, the high yield indices are still in the black since the beginning of the year, in contrast to the losses seen in the investment grade indices. Without indulging in a simplified generalisation that blurs the distinctions between the many subgroups and components that make up the high yield class, of all the sectors with a weighting of over 3% in the benchmarks, only Homebuilders are wider (note that at the beginning of the year, it was trading very tight).

The high internal cash-flow generation within this asset class has brought a slower rate of new issue origination, which has also been a determining factor in the good performance of high yield. Most new issues this year have been assigned to refinancing the existing debt. There has also been an improvement in credit ratings for new issues, leaning more towards BB bonds and with fewer CCC issues. Credit fundamentals remain strong. Rating upgrades surpass downgrades in the highest ratio since 2011. The rate of defaults within the high yield class is around 2%, compared with a historical average of 5%.

Furthermore, we must not underestimate the increasingly frequent demand from investors who were traditionally focused only on investment grade bonds, such as pension funds or wealth managers, who are incorporating BB tier issues into their portfolios. These investors are not merely “opportunistic tourists”, but rather they are investing in a systematic manner with a view to improving the diversification of their portfolios.

The NAFTA is no longer one of the risks weighing down this asset class. We are left with China, oil, a possible acceleration in inflation and the deficits. So, does this mean the end of the American dream enjoyed by high yield? Historically speaking, high yield bonds have had a negative correlation with Treasury bonds. History also teaches us that credit spreads can remain below average for long periods of time, particularly during periods of positive economic growth and low default rates.

Given the current outlook, in the short term, we do not believe the economic situation will take a turn for the worse towards a recession, which would create a negative credit environment. Although the credit spreads for high yield indices are at low levels from a historical perspective and, in our opinion, there is limited potential for capital appreciation, the coupon offered is sufficiently attractive relative to other assets to justify waiting patiently with a portion of the portfolio invested in high yield bonds. Of course, we cannot rule out a widening of spreads in the short term, caused by a defensive movement and the profit taking in a volatile market if stocks sell off. But this would not be the result of panic selling due to a continuous deterioration of fundamentals.

Column by Meritxell Pons, Director of Asset Management at Beta Capital Wealth Management, Crèdit Andorrà Financial Group Research.

October Spectra: Get Out Of Equities Or Probe The Entry?

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Espectros de octubre ¿Salirse de Bolsa o tantear la entrada?
Wikimedia CommonsFoto: Federal Reserve. October Spectra: Get Out Of Equities Or Probe The Entry?

The leaps made by the stock market indices Dow Jones (DJI), S&P 500 (S&P), Nasdaq Composite (NASDAQ) and Russell 2000 (RUT) on October 15 and 16, seems more like technical reactions due their fall to the 200 day moving average (MA) than signs of recovery.

Benchmarks fell at a mean of 8.60% from their recent all-time highs (RUT, -11.26%; NASDAQ, 9.60; S&P, -6.93%; DJI, 6.62%). RUT continued dropping 4.7% beyond that MA, was the only index that touched and trespassed the MA 300 line and, in proportion, the third in rebound magnitude. What could we understand and wait?

It is October, guys, and you cannot get enthused. Since we have well clear the reasons for the downfall –overprices, continuing hikes of fed funds rate, uncertainty about Brexit, economic and political storm-clouds over the EU, trade menaces, etc. –, and assimilated enough that they will not be resolved neither in the short nor in the medium term, even with the palliative of quarterly reports, it is hard to accept that the increases of those days mean a quick return to historical highs. Technical indicators suggest there are room for additional downs, given the indices didn´t reach the over-sale area. Rebounds could be taken as a breath in the downfall or as a symptom of stagnation.

Judging by the cumulative returns in five, three, one year (from closing to closing of each September) and YTD, it is reckoned understandable that a profit taking, more substantial than previous ones, was intuited or drawn for months. Take a look to these rounded figures:

Historical lessons of October

MexBol IPC index flirted the threshold of 50,000 points in August and September and finally fell in this streak somewhat less than Wall Street references. Therefore, its positive reaction has been tepid, precisely up to the 200 MA line, without shaking the bearish bias. Still, it has left in two weeks half of the points it had won in four months. Needless to say, its performance has been poor: loss of 1% in one year; gain of 1% YTD. 

If we review the behavior of the stock markets in others cycles of FED Funds rate increases, we would see that the pattern of the turn to the upside requires not less than a semester. On this occasion, it would be warned: as long as the results contribute and the other elements do not run aground. Of course, the pattern involves rises and relapses that, this time, if occurred, they would coincide with the crossing from and to the 300 MA, which could be bad for many but interesting for some. If we abide by technical signals, we will assume that this PM marks a harder and decisive floor for Wall Street: if reached and validated, the rebound could inject confidence; if breaks, be careful…

In any case, if the decrease becomes pronounced or laterality happens, the histories of October and the stepped rise of Fed Funds rates would allow to deflate prices and enter the market at attractive levels. Here lies the interesting thing.

Column by Arturo Rueda

The Japanese Passport Is Now the Strongest in the World

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Los beneficios empresariales de Japón van a seguir creciendo (III)
Pixabay CC0 Public Domain. Japan’s “Show Me the Money” Corporate Governance: 3Q update

Japan has overtaken Singapore to claim the top spot on the 2018 Henley Passport Index, having gained visa-free access to Myanmar earlier this month. Japan now enjoys visa-free/visa-on-arrival access to 190 destinations, compared to Singapore’s total of 189. Japan and Singapore have been neck and neck on the index since they both climbed to 1st place in February — following a visa-exemption from Uzbekistan — and pushed Germany down to 2nd place for the first time since 2014.

This quarter, Germany has fallen further to 3rd place, which it now shares with South Korea and France. France moved up from 4th to 3rd place last Friday when it gained visa-free access to Uzbekistan, while South Korea moved from 4th to 3rd place on 1 October when it gained visa-free access to Myanmar. Germany, France, and South Korea all have a visa-free/visa-on-arrival score of 188. Iraq and Afghanistan continue to hold the bottom (106th) spot of the Henley Passport Index, with only 30 destinations accessible to their citizens.

The US and the UK, both with 186 destinations, have also slid down one spot — from 4th to 5th place — with neither having gained access to any new jurisdictions since the start of 2018. With stagnant outbound visa activity compared to Asian high-performers such as Japan, Singapore, and South Korea, it seems increasingly unlikely that the US and the UK will regain the number 1 spot they jointly held in 2015.

Russia received a boost in September when Taiwan announced a visa-waiver for Russian nationals (valid until July 2019), but the country has nonetheless fallen from 46th to 47th place compared to Q3, because of movements higher up in the ranking. The same is true of China: Chinese nationals obtained access to two new jurisdictions (St. Lucia and Myanmar), but the Chinese passport fell two places this quarter, to 71st overall. This is still an impressive 14-place improvement over the position that China held at the start of 2017.

What has been most remarkable in recent years is the UAE’s stunning ascent on the Henley Passport Index, from 62nd place in 2006 to 21st place worldwide currently. The UAE now holds the number 1 passport in the Middle East region.

Christian H. Kälin, Group Chairman of Henley & Partners, commented on these developments: “The Henley Passport Index, which is based on exclusive data from the International Air Transport Association (IATA), is an important tool for measuring not only the relative strength of the world’s passports but also the extraordinary results that states can achieve when they work hand in hand with their global peers to build a more interconnected and collaborative world. China and the UAE exemplify this kind of progress, with both states among the highest overall climbers compared to 2017, purely as a result of the strong relationships they have built with partner countries around the world.”

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Afores will Have to Wait in Order to Invest in International Mutual Funds

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Las afores tendrán que esperar para invertir en fondos mutuos internacionales
Pixabay CC0 Public DomainPhoto: AMAFORE. Afores will Have to Wait in Order to Invest in International Mutual Funds

It had seemed that the beginning of 2018 would mark a big milestone in the way the Mexican Pension Plans, or Afores, invest. At the end of 2017, the ‘Comisión Nacional del Sistema de Ahorro para el Retiro’ (CONSAR), or National Commission for the Retirement Savings System decided, among other things, such as making CERPI more flexible or including SPACs, to include Mutual Funds with active strategies as an additional investment vehicle. This decision was published in the official bulletin in January 2018.

As Carlos Ramírez, President of the CONSAR, commented, “When looking to invest with an international asset manager, we look for better yields and this is what we have seen with the mandates that have paid a good return… Mutual funds are a reflection of the mandates and what we are really doing is opening another option for investing abroad, especially with the small and medium Afores in mind.”

However, in a recent interview with Funds Society, which will be available in the printed magazine this October, Ramírez commented that, unfortunately, this resolution has as yet not been implemented waiting for its authorization in a pending CAR, or Risk Committee meeting, “which would formally give life to mutual funds, and which to date was unable to be held for various reasons. I hope it can be achieved before the end of the administration so that we can see closure on an issue that we have been working on for a long time, which is a very deep analysis of the benefits of Afores being able to invest in mutual funds, and which we hope to be able to complete before this administration ends. It‘s practically ready, all that’s missing is that CAR meeting.”

Meanwhile, Carlos Noriega Curtis, President of AMAFORE, told us prior to the Third Afores Convention that this meeting will most likely not go ahead until the next administration is in power: “If during the transition stage, within the next two months, there is communication between the incoming and outgoing governments, the CAR will meet, if not, it will meet as soon as it is able to do so following the transition.” The executive added that they are watching very closely how the situation develops. “All the information has been prepared. We, as an association, have been supporting the importance, the necessity, and the convenience of being able to invest in mutual funds… we are convinced of this, and we are doing everything possible to achieve it,” concluded Noriega.
 

Asset and Wealth Management Firms Join Forces With CASCAID Americas

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La industria de asset y wealth management se une en CASCAID Americas ¡Ayúdanos a ayudar!
CC-BY-SA-2.0, FlickrPhoto: CASCAID Americas. Asset and Wealth Management Firms Join Forces With CASCAID Americas

CASCAID Americas is another example of the industry turning its attention to supporting others. It’s an initiative set up in 2017 in UK that brings the asset and wealth management community together to raise money for charities.

What is CASCAID Americas all about?

It’s really about bringing people together to support great causes whilst enjoying networking. It’s led by 30-40  Ambassadors – people from around the industry. Ambassadors range from CEOs of asset and wealth management firms to new graduates and Investment 2020 trainees.

On a practical level, Funds Society, with the help of MiP in the UK, sits at the heart of it, helping to organize events and with all the logistics (on a pro bono basis of course).

How do you raise money?

In any way we can think of!  We will have one gala at the end of the fund raising period (June 2019), which is supported by investment firms. This can raise significant sums. Then we have other group events such as a darts evening, fun runs, wine tastings and sporting tournaments. And Ambassadors (and others) also do their own challenges – these are wide-ranging, from running marathons, to swimming lakes, to walking thousands of miles. Anything goes!

What charities do you support?

In 2017, CASCAID UK raised money for Cancer Research UK. The target was £1 million but it managed to exceed £2.35 million. For CASCAID Americas, based on the much smaller size of the offshore industry, we are setting an initial goal of US$150k, though we actually hope to beat our British counterparts, at least on a relative basis. For the 2018-2019 campaign CACSCAID Americas is raising funds for The SEED School of Miami. It’s important to remember that all monies go direct to SEED Miami – CASCAID Americas isn’t a charity itself, it’s just a brand name that acts as an “umbrella” to bring all our activities together.

Why The SEED School of Miami?

We want to help local charities with a strong social impact in our community. The SEED School of Miami definitely fits that bill – as South Florida’s only public, college-preparatory boarding school, it impacts on the lives of the 210 young under-resourced students that are currently enrolled in the program, who spend 24 hours a day in a safe, structured and predictable environment from Monday to Friday —three healthy meals a day; consistent relationships with excellent role models; daily academic challenge and support; and extensive programs in athletics, visual and performing arts, and service. The national results for the SEED schools program speak for themselves. 90% of the students enrolled in 9th grade graduate high school; 93% of these student attend college with full scholarships, and 80% of these students are first generation college-bound students in their families

Can anyone get involved?

Absolutely! Everyone is welcome. If you’d like to get involved with CASCAID Americas, just email alicia.jimenez@fundssociety.com and elena.santiso@fundssociety.com We’re always looking for new Ambassadors and new ideas to raise money.