Sunday, June 30, 2013

A Look At The Emerging Markets Asset Class

One area of the global equity markets that has experienced a significant correction this year is the emerging markets. As the below charts of one, five and ten year returns indicate, the emerging market space (EEM, VWO) has significantly underperformed the U.S. market (S&P 500 Index) for one and five years, but maintains a large performance edge for ten years. Importantly for investors then is determining whether this recent correction is an opportunity to increase exposure to the emerging market space or not.

From The Blog of HORAN Capital Advisors
From The Blog of HORAN Capital Advisors
From The Blog of HORAN Capital Advisors

A recent research report published by Fidelity Investments, Secular Outlook for Global Growth: Challenges and Opportunities, outlines some key factors for investors to evaluate for various countries. A large part of the long term future growth potential within a particular market is based on a country's GDP growth expectations.

From The Blog of HORAN Capital Advisors

Population growth and productivity growth are key factors that contribute to a country's overall GDP growth potential. With respect to population growth, the report notes difficulties in comparing one country to another due to differing life expectancies. In summary though, Fidelity notes:
"Working-age populations have risen rapidly for several decades, but almost all countries will experience slower growth and receive less of a direct demographic benefit over the next 20 years. Mature countries such as Japan and parts of Europe—with the U.S. as a notable exception—will experience outright declines in working-age population. In general, growth will be faster in the developing world—Latin America, Africa, emerging Asia, and the Middle East—although China’s demographics are not as constructive (emphasis added)."

From a productivity standpoint the report notes three categories that are key drivers of productivity growth: people, structure and catch-up potential.
  • People: "The greater the human capital, the more productive the economy. According to our human capital index, which incorporates measures of educational and scientific achievement as key drivers of future innovation and adoption of new technologies, human capital accumulation over the past two decades should boost global growth in the next 20 years. Human capital tends to be higher in the world’s wealthiest regions, such as the U.S., Japan, and northern Europe. South Korea has the highest human capital ranking, and several emerging economies—including China, Turkey, Thailand, and Vietnam—have also made great strides..."

    "On balance, young populations in the developing world—such as Mexico, Colombia, and the Philippines—will benefit from a maturing phase. Formerly maturing countries—such as China, South Korea, and Thailand—will be disadvantaged as their populations enter the aging phase. Already aging societies—such as Russia, Germany, and Japan—will feel the most negative effects on productivity as their demographics deteriorate further (as noted in the below chart)."
From The Blog of HORAN Capital Advisors
  • Structure: "Complex economies tend to be more competitive, use technology more effectively, and have better business climates and more nurturing institutions (source: Hausmann, Hidalgo, et al.). As a result, higher complexity typically means higher productivity. Greater variety and more sophisticated products in a country’s output signal a more complex economic structure. For example, Japan has the highest complexity ranking, while a number of African countries rank very low. Complexity should contribute slightly to higher global growth over the next 20 years as increasingly complex emerging economies—such as South Korea, China, Hungary, and Thailand—offset stagnating complexity in the most advanced economies."
  • Catch-up Potential: "In theory, less advanced economies should grow faster than more mature economies, thanks to their ability to grow off a lower base, adopt existing technologies, and catch up or converge to the higher income levels of developed countries. In practice, however, this convergence does not occur automatically but is conditional on other factors, such as the people and structure of an economy."

    "Once we account for these other growth determinants, catch-up potential has been—and will continue to be—a positive contributor to global GDP growth. After the rapid growth in recent decades of larger developing economies, such as China, India, and South Korea, higher per capita incomes now leave less catch-up potential for the next 20 years. While smaller poor economies in Africa and other regions will still benefit, catch-up potential will generally contribute much less to global growth."
    If an investor's time horizon is three to five years (or longer), data would seem to support that some emerging or developing economies will be leaders in global growth. As with individual stocks, the direction of the growth rate plays a key role in a country's potential return as well. As the GDP charts earlier in the post show, GDP growth in countries like China and India having been slowing recently. This decrease in the growth rate can cause short term market disruptions. Also, as the ten year performance chart above shows, emerging markets have done quite well relative to U.S. equities, but are emerging market indices mean reverting?If so, the dangers of catching a falling knife are certainly present.

    From The Blog of HORAN Capital Advisors

    There are many additional factors one most consider, such as financial data quality, the political stability or lack there of, etc. However, it does appear some of the emerging economies do offer return opportunities for investors, albeit, these markets are likely to remain more volatile than developed market equities. It is estimated that the emerging markets will continue to capture a larger share of the world's GDP and at some point this will likely have a positive impact on emerging equities.

    From The Blog of HORAN Capital Advisors


    Secular Outlook for Global Growth:
    Challenges and Opportunities

    Fidelity Investments
    By: Irina Tytell, PhD, Senior Research Analyst
    Lisa Emsbo-Mattingly, Director of Asset Allocation Research
    Dirk Hofschire, CFA, SVP, Asset Allocation Research
    June 2013

    Sunday, June 16, 2013

    Interest Rate Policy To Impact The Dollar And Commodity Related Industries

    All eyes have been on the Federal Reserve recently as talk of tapering of the quantitative easing programs was introduced by some Fed governors. An outcome of reducing the QE influence on the economy would likely be a move higher in interest rates. In fact, the yield on the 10-year Treasury recently moved higher from the 1.60% area to the 2.20% level as a result of the tapering comments. If this gradual reduction in QE is implemented, interest rates are likely to normalize at a higher level. Rising yields are not necessarily bad for the economy; however, higher rates are likely to have an impact on the value of the U.S. Dollar and commodity prices. There are a number of factors that influence the value of a currency, interest rates though, have a direct impact on a country's currency. As interest rates rise, the dollar tends to strengthen.

    From The Blog of HORAN Capital Advisors

    With this strengthening, downward pressure is placed on commodity prices. Some commodities, like oil, are impacted more by the strengthening of the US Dollar as oil is transacted in Dollars around the world. As an example, an oil company in say Norway would receive more Krone for every Dollar converted back to the Norwegian currency in a strong Dollar environment. Because the Norwegian oil company is getting a currency benefit in the exchange, downward pressure is placed on the price of oil. Certainly a country's fiscal situation, along with other factors (Purchasing Power Parity), will impact a currency's value.

    From The Blog of HORAN Capital Advisors

    For an investor then, a question becomes what is the impact of a potential rise in interest rates on commodities and commodity centric firms. Also, why is the dollar strengthening? Is the economy strengthening thus resulting in a higher demand for oil? Is this placing downward pressure on energy and commodity supplies which would translate into higher energy prices? The yellow colored line in the above chart represents the energy sector exchange traded fund XLE. It is pretty clear that energy firms are highly correlated with the move in energy prices. If U.S. Dollar strengthening translates into lower oil prices, the energy space could come under downward price pressure.

    As the below chart shows from a technical perspective oil prices have moved into a tight pendant pattern. Technically, it isn't clear from the chart in what direction oil prices might move, only that it could break hard in one direction or the other.
    From The Blog of HORAN Capital Advisors

    Other direct commodity plays have come under significant price pressures this year as well. Many differing variables are impacting these commodity prices. For the coal related industries (KOL), the significant discoveries of natural gas in the U.S. due to fracking is lessening the demand for coal. Also, lower commodity prices may be indicative of slowing economic growth rates in some of the emerging economies.

    From The Blog of HORAN Capital Advisors

    Both the materials sector and the energy sector have been some of the weaker performing sectors in the market this year. Up until last month, the better performing sectors had been the more defensive and higher yielding ones like health care and consumer staples. We discussed the potential rotation out of these sectors several weeks back with materials and energy beginning to outperform the broader market at that time.

    From The Blog of HORAN Capital Advisors

    Be it right or wrong, the market will be laser focused on the Fed's statement Wednesday in an effort to gain a better understanding of the future direction of interest rate policy. As noted in the link to Scott Grannis' article at the beginning of this post, higher rates are not necessarily a bad omen for the economy. However, future interest rate policy will likely influence these commodity related sectors.

    Friday, June 14, 2013

    Where Does A Top Bond Manager Invest His Personal Funds?

    Note, Google Reader shuts down for good on July 1st. If you read our content via Google Reader the following link outlines RSS reader alternatives.
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    Now the article:

    In a recent interview between Stephen S. Smith, co-portfolio of the Legg Mason B.W. Global Opportunities Bond Fund (GOBAX), and Consuelo Mack of WealthTrack, Steve explains where he has allocated his personal investments over the past few years. His investment of choice has not been bonds.

    Wednesday, June 12, 2013

    Emerging Market Investments Unable To Find A Bottom

    One investment asset class that seemed to be favored by many investment advisers at the beginning of the year was emerging markets. When the crowd highly favors a certain type of investment, investors should be wary of following this crowd behavior. At the beginning of this year, InvestmentNews surveyed advisers and found the following,
    "...more than half the advisers surveyed by InvestmentNews at the beginning of the year said they planned to increase their allocation to emerging market stocks. No other equity asset class was cited as often. About a third of the polled advisers said they planned to increase allocations to emerging market bonds, the most of any fixed-income asset class."
    From The Blog of HORAN Capital Advisors

    Since the beginning of the year, emerging market investments have generated poor returns for investors as noted in the above chart. The chart shows the divergent spread between the performance of the emerging markets index (EEM) versus the S&P 500 Index (SPX). The S&P 500 has outperformed EEM by nearly 24 percentage points on a year to date basis.

    As the InvestmentNews article notes, emerging market bonds were another favored asset class at the beginning of 2013. I suppose the investing community thought if investors like emerging market equities, they will certainly be attracted to emerging market high yield bonds. So Blackrock's iShares came out with an emerging markets high yield bond index, EMHY. As the below chart details, the performance has been anything but stellar. The top three countryweightings for EMHY are:
    • Turkey: 16.75%
    • Venezuela: 14.75%
    • Philippines: 9.93%
    From The Blog of HORAN Capital Advisors

    The recent protests in Turkey have raised questions about the future growth opportunities in that country and investors have sold investment assets tied to Turkey.

    The options trading firm, Schaeffer’s Investment Research, Inc., recently noted in their trading floor blog the  divergent views surrounding EEM's recent "death cross" chart formation.

    The "pro" view: Emerging Markets Are Ready To Show Some Strength
    The "neutral" view: Is this the End of Emerging Market Underperformance?

    Given the recent underperformance of emerging markets, this may present an attractive entry point into this asset class. However, investors need to keep in mind, emerging markets have a large performance advantage over the broader U.S.equity market (S&P 500 Index) over the past ten years. I only note this in the event investors believe in the "reversion to the mean" theory

    From The Blog of HORAN Capital Advisors

    At the end of the day, the growth in the emerging markets will be tied to the economic growth prospects for these emerging market countries relative to the developed markets. What makes these allocation decisions more difficult today are the currency influences that are being manipulated by the central banks' around the globe and their respective quantitative easing programs. The article, The Currency Carry Trade, DBV and Risk, provides some insight into these currency issues.

    Chasing Yield Has A Downside When Interest Rates Rise

    As interest rates have moved higher, as evidenced by the below chart of the 10-year treasury yield, yield related investments have come under significant downward pressure. The below chart shows the 10-year treasury yield rising from 1.63% in early May to 2.19% at today's close.

    From The Blog of HORAN Capital Advisors

    Rising rates have had a negative impact on REITs. Investors that were chasing yield in this low interest rate environment are now experiencing the downside in these investments when market interest rates rise.

    From The Blog of HORAN Capital Advisors

    The above chart was sourced from the website, Institutional Imperative, and the article examines the valuation metrics of REITs. It is a worthwhile read for investors that are searching for yield.

    The spike in interest rates has also resulted in investors selling their investments in bond funds. The below chart shows bond funds experienced their first weekly outflow of the year. EPFR and Deutsche Bank report this outflow was the largest outflow ever.

    From The Blog of HORAN Capital Advisors
    Source: Quartz

    Below is a chart collection of other yield sectors that have been negatively impacted by the recent rise in market interest rates.

    From The Blog of HORAN Capital Advisors

    Updated (6/12/2013. 9:03 AM): Including chart of preferreds:

    From The Blog of HORAN Capital Advisors

    It would appear the market might be sending the Fed a message that it wants QE to continue unabated. The recent hawkish tone from some Fed members and the comments about "tapering" of the QE programs seems to have certainly spooked the investors.

    Sunday, June 09, 2013

    Fickle Investor Sentiment

    One common trait of individual investors during the equity bull market run since November is restraint. Based on the American Association of Individual Investors sentiment survey, investor bullish sentiment fell over six percentage points to 29.47% for the weekly period ending June 6th. This follows a thirteen point decline in the prior week after moving up by over ten points during the week of May 23rd. This two week decline in bullish sentiment occurred during a period when the S&P 500 Index experienced a 5% correction on an intraday price basis.

    From The Blog of HORAN Capital Advisors

    Equity prices began turning higher at the end of the day on Thursday once the market (S&P 500) hit the technically important 1,598 level. The positive momentum carried through to Friday following the nonfarm payroll report. It seems the individual investor is anything but "all in" with their equity exposure.

    Sunday, June 02, 2013

    The Hindenburg Omen Is Triggered Again

    Friday afternoon one technical indicator, the Hindenburg Omen, seemed to dominate the discussion of a number of market pundits.

    The blog at provides the following criteria in order for the indicator to be triggered,
    "Hindenburg Omen: Created by James Miekka, the Hindenburg Omen warns of potential weakness in the stock market. There are three criteria to activate the omen. First, NYSE new highs and new lows must both be more than 2.8% of advances plus declines. Second, the NY Composite is above the level it was 50 days ago. Third, the number of new highs cannot be more than double the number of new lows. The activation period is good for 30 days. Once active, a sell signal is triggered when the McClellan Oscillator moves below zero and negated when the McClellan Oscillator moves back above zero."
    Below is the chart detailing the criteria triggering the Omen.

    From The Blog of HORAN Capital Advisors

    Although the analyst in the CNBC video implies the Hindenburg Omen hasn't been triggered in a few years, it was last triggered in April. We wrote a post on our blog in August of 2010, The Real Facts About The Recent Hindenburg Omen Trigger, when it was triggered then. Since that August 2010 date, the market has enjoyed one of its better bullish advances. 

    From The Blog of HORAN Capital Advisors

    I believe Chip Anderson's comment at the conclusion of his chart analysis is appropriate for investors to take to heart.
    "Given that this is the second time in two months that this signal has occurred, ChartWatchers would be well advised to look for additional signs of technical weakness in this market."

    Saturday, June 01, 2013

    Remember Those Two Week Market Declines?

    A seemingly rare occurrence has taken place with the close of trading on Friday. The S&P 500 Index has declined for two weeks in a row. The last time this occurred was in November of last year. This is a testament to how strong the market advance has been so far this year.

    From The Blog of HORAN Capital Advisors

    The sectors that have been the weaker performers during this pullback or consolidation have been the traditionally more defensive ones, e.g., consumer staples, utilities, telecommunications. Also, the indices that are focused on dividend paying stocks have underperformed the broader market (S&P 500) as well.

    From The Blog of HORAN Capital Advisors

    From The Blog of HORAN Capital Advisors

    From The Blog of HORAN Capital Advisors

    As noted in several prior blog posts, investors seem to be chasing the higher yielding dividend paying stocks, viewing them as potential bond substitutes. This heightened interest in the dividend payers has pushed the valuations of many of them to stretched levels. With a little market weakness it appears these investors are finding out these dividend payers can be volatile also and they are reducing their position sizes.