The Capital Spectator

Foreign Corporate Bonds Surged Last Week

After a months-long period of treading water, corporate fixed income in foreign markets caught fire last week, posting the strongest gain for the major asset classes, based on a set of exchange-traded funds.

Invesco International Corporate Bond ETF (PICB) has been on a tear since Oct. 10 and extended the rally last week by posting gains in every trading session. By Friday (Oct. 18), PICB closed at a 1-1/2 year high.

Last week’s biggest loser among the major asset classes: broadly defined commodities. After topping the horse race in the previous week, iShares S&P GSCI Commodity-Indexed Trust (GSG) fell back into a familiar pattern of losing in relative and absolute terms in recent history. The fund fell 0.7% for the trading week, its third loss in the past four weeks.

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Other than commodities, everything was up last week, which lifted an ETF-based version of the Global Market Index (GMI.F). This unmanaged benchmark, which holds all the major asset classes (except cash) in market-value weights, rose 0.6% last week.

For the one-year trend, another familiar pattern was reaffirmed last week: the dominance of US real estate investment trusts (REITs). Vanguard Real Estate (VNQ) is now up a sizzling 26.6% on a total return basis for the trailing one-year period. This year’s momentum has been almost non-stop: the ETF has posted a gain in all but ten weeks of 2019’s trading so far.

The deepest one-year loss for the major asset classes? Commodities, of course. In fact, the only case of red ink for the one-year window is GSG, which has shed 14.0% as of Friday’s close vs. the year-ago price.

Meanwhile, GMI.F is up 7.8% for the trailing 12-month period through last week’s close.

Finally, let’s consider how the major asset classes stack up through a momentum profile, which continues to skew positive by a wide margin. The analysis is based on two sets of moving averages for the ETFs listed above. The first compares the 10-day moving average with its 100-day counterpart — a proxy for short-term trending behavior (red line in chart below). A second set of moving averages (50 and 200 days) represent an intermediate measure of the trend (blue line). Despite recent volatility, a clear bullish bias still prevails.

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Macro Briefing | 21 October 2019

IMF predicts China’s economy will continue to slow in 2020: CNBC
Weak exports for Japan and S. Korea highlight global slowdown: Bloomberg
Johnson plans to bring his Brexit deal to a new vote in Parliament: WSJ
Japan’s top central banker outlines new plan to stimulate economy: Reuters
US Leading Economic Index reaffirms slow-growth outlook for US: MW
Is re-steepened US yield curve a bullish sign for economy? Maybe not: Nordea
Latest rally in US stock market leaves S&P 500 drawdown virtually nil at 1%:

Book Bits | 19 October 2019

How Charts Lie: Getting Smarter about Visual Information
By Alberto Cairo
Review via The Economist
His book could not be more timely. Charts and maps pepper traditional and social media more than ever, but there have been few attempts to improve what Mr Cairo calls the “graphicacy” of their consumers. His corrective begins with a chapter on how to read a chart, and this basic notion—that, to be understood, graphs must be read, not merely glanced at—permeates the book. He outlines the essential “scaffolding” of a chart (scales, legend, source and so on), before describing the many ways that data can be built upon it. Only once readers know what a solid structure looks like can they learn to spot a façade.

Homewreckers: How a Gang of Wall Street Kingpins, Hedge Fund Magnates, Crooked Banks, and Vulture Capitalists Suckered Millions Out of Their Homes and Demolished the American DreamBy Aaron Glantz
Q&A with author via
More than 10 years after the housing crash that devastated the economy, people are still debating just what happened. A new book tries to make sense of it all, and whether we’re heading for another disaster. Although the economy and the housing market have made a comeback, homeownership remains low, and fears of another real estate meltdown linger. Aaron Glantz, a prize-winning investigative journalist at Reveal News, set out to explain why, in “Homewreckers: How a Gang of Wall Street Kingpins, Hedge Fund Magnates, Crooked Banks, and Vulture Capitalists Suckered Millions Out of Their Homes and Demolished the American Dream.”

Unbound: How Inequality Constricts Our Economy and What We Can Do about It
By Heather Boushey
Summary via publisher (Harvard U. Press)
Do we have to choose between equality and prosperity? Many think that reducing economic inequality would require such heavy-handed interference with market forces that it would stifle economic growth. Heather Boushey, one of Washington’s most influential economic voices, insists nothing could be further from the truth. Presenting cutting-edge economics with journalistic verve, she shows how rising inequality has become a drag on growth and an impediment to a competitive United States marketplace for employers and employees alike.

Goliath: The 100-Year War Between Monopoly Power and Democracy
By Matt Stoller
Review via Publishers Weekly
An excessive concentration of power in a few hands has undermined the U.S.’s well-being, according to this passionate, ill-focused history of the country’s economic policy. Stoller, a journalist and former Senate Budget Committee analyst, recounts the rise of antimonopoly policy, culminating in the New Deal regime of regulation and antitrust action to tame or break up overmighty banks and corporations. The result, he contends, was a postwar economy of independent farmers, mom-and-pop retailers, and mid-level manufacturers—a paradise of populist, human-scale capitalism championed by Democratic Congressman Wright Patman, who fought epic legislative battles against Wall Street from the House Banking Committee, and about whom Stoller writes admiringly.

When the President Calls: Conversations with Economic Policymakers
By Simon W. Bowmaker
Summary via publisher (MIT Press)
What is it like to sit in the Oval Office and discuss policy with the president? To know that the decisions made will affect hundreds of millions of people? To know that the wrong advice could be calamitous? When the President Calls presents interviews with thirty-five economic policymakers who served presidents from Nixon to Trump. These officials worked in the executive branch in a variety of capacities—the Council of Economic Advisers, the Office of Management and Budget, the Department of the Treasury, and the National Economic Council—but all had direct access to the policymaking process and can offer insights about the difficult tradeoffs made on economic policy. The interviews shed new light, for example, on the thinking behind the Reagan tax cuts, the economic factors that cost George H. W. Bush a second term, the constraints facing policymakers during the financial crisis of 2008, the differences in work styles between Bill Clinton and Barack Obama, and the Trump administration’s early budget process.

The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay
By Gabriel Zucman and Emmanuel Saez
Review via CNBC
The ideal tax rate for the richest 1% of Americans is about 75% — more than twice the current rates, according to the economist advising Sen. Elizabeth Warren on her tax plans.
Gabriel Zucman, the University of California at Berkeley economist who is advising Warren and Sen. Bernie Sanders on their wealth tax proposals, told CNBC Tuesday that there is an “optimal” tax rate for the rich when considering tax policy. The optimal rate would be high enough to maximize revenue from the economy’s winners and reduce inequality, but not so high that it would lead to widespread evasion or reduced productivity among the wealthy.

Why Liberalism Works: How True Liberal Values Produce a Freer, More Equal, Prosperous World for All
By Deirdre Nansen McCloskey
Summary via publisher (Yale University Press)
The greatest challenges facing humankind, according to Deirdre McCloskey, are poverty and tyranny, both of which hold people back. Arguing for a return to true liberal values, this engaging and accessible book develops, defends, and demonstrates how embracing the ideas first espoused by eighteenth-century philosophers like Locke, Smith, Voltaire, and Wollstonecraft is good for everyone.

The Case Against Socialism
By Rand Paul
Interview with author via Fox News
Sen. Rand Paul, R-Ky., saus his new book, “The Case Against Socialism,” will remind Americans why capitalism is the system that economically lifts all boats.
Young Americans have increasingly warmed to socialism because they have forgotten what governments were most closely associated with that system, Paul claimed Monday on “Tucker Carlson Tonight.”

On Trend: The Business of Forecasting the Future
By Devon Powers
Summary via publisher (University of Illinois Press)
Trends have become a commodity—an element of culture in their own right and the very currency of our cultural life. Consumer culture relies on a new class of professionals who explain trends, predict trends, and in profound ways even manufacture trends. On Trend delves into one of the most powerful forces in global consumer culture. From forecasting to cool hunting to design thinking, the work done by trend professionals influences how we live, work, play, shop, and learn. Devon Powers’s provocative insights open up how the business of the future kindles exciting opportunity even as its practices raise questions about an economy increasingly built on nonstop disruption and innovation. Merging industry history with vivid portraits of today’s trend visionaries, Powers reveals how trends took over, what it means for cultural change, and the price all of us pay to see—and live—the future.

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Research Review | 18 October 2019 | Portfolio Design And Analysis

Explaining the Demise of Value Investing
Baruch Lev (NY University) and Anup Srivastava (U. of Calgary)
August 25, 2019
The business press claims that the long-standing and highly popular value investing strategy—investing in low-valued stocks and selling short high-valued equities—lost its edge since 2007. The reasons for this putative sudden demise of value investing elude investors and academics, making it a challenge to assess the likelihood of the return of value investing to its days of glory. Based on extensive data analysis we show that the strategy has, in fact, been unprofitable for almost 30 years, barring a brief resurrection following dotcom bust. We identify two major reasons for the demise of value: (1) accounting deficiencies causing systematic misidentification of value, and particularly of glamour (growth) stocks, and (2) fundamental economic developments which slowed down significantly the reshuffling of value and glamour stocks which drove the erstwhile gains from the value strategy. We end up by speculating on the likelihood of the resurgence of value investing, which seems low.

Low-Volatility Strategy: Can We Time the Factor?
Poh Ling Neo (Singapore U. of Social Sciences) and Chyng Wen Tee (S.M.U.)
August 15, 2019
We show that the slope of the volatility decile portfolio’s return profile contains valuable information that can be harvested to time volatility and market condition. During good market condition, high-volatility portfolio produces the highest return, and vice versa. We proceed to devise a volatility timing strategy based on statistical tests on the slope of the volatility decile portfolio return profile. Volatility timing is achieved by being aggressive during strong growth periods, while being conservative during market downturns. Superior performance is obtained, with a 30% increase in Sharpe ratio and an order of magnitude improvement on cumulated wealth. We also demonstrate that stocks in the high-volatility portfolio are more strongly correlated compared to stocks in the low-volatility portfolio. The profitability of the volatility timing strategy can be attributed to holding a diversified portfolio during bear markets, while holding a concentrated growth portfolio during bull markets.

Predictable End-of-Month Treasury Returns
Jonathan Hartley (Harvard University) and Krista Schwarz (U. of Pennsylvania)
August 20, 2019
We document a distinct pattern in the timing of excess returns on coupon Treasury securities. Average returns are positive and highly significant in the last few days of the month, and are not significantly different from zero at other times. A long Treasury position for just the last few days of each month gives a high annualized Sharpe ratio of around 1. We attribute this pattern to window dressing and portfolio rebalancing. We find evidence in quantities that aggregate insurer transactions contribute to the end-of-month price pattern. In particular life insurers are large net buyers of Treasury securities on benchmark index rebalancing dates.

Protecting the Downside of Trend When It’s Not Your Friend
Kun Yang (PanAgora Asset Management), et al.
July 16, 2019
Simple trend-following strategies have been documented as cost-effective, transparent alternatives to the hedge-fund style Managed Futures strategies. While largely capturing the returns of the Managed Futures industry, those simple strategies may periodically suffer significant losses due to over-simplified trend signals and under-diversified portfolio construction. In this article, the authors show that trend-following strategies with moderate sophistication and better diversification can significantly reduce the downside risk of simple trend-following strategies without sacrificing much upside potential. The authors therefore recommend investors who seek the benefits of cost-effective trend-following strategies to consider adding reasonable complexity to the strategies.
To read the full paper, click here.

Predictive Blends: Fundamental Indexing Meets Markowitz
Sergiy Pysarenko (University of Guelph), et al.
November 29, 2018
When constructing a portfolio of stocks, do you turn a blind eye to the firms’ future outlooks based on careful consideration of companies’ fundamentals, or do you ignore the stocks’ correlation structures which ensure the best diversification? The Fundamental Indexing (FI) and Markowitz mean-variance optimization (MVO) approaches are complementary but, until now, have been considered separately in the portfolio choice literature. Using data on S&P 500 constituents, we evaluate a novel portfolio construction technique that utilizes the benefits of both approaches. Relying on the idea of forecast averaging, we propose to blend the two previously mentioned techniques to provide investors with a clear binocular vision. The out-of-sample results of the blended portfolios attest to their superior performance when compared to common market benchmarks, and to portfolios constructed solely based on the FI or MVO methods. In pursuit of the optimal blend between the two distinct portfolio construction techniques, MVO and FI, we find that the ratio of market capitalization to GDP, being a leading indicator for an overpriced market, demonstrates remarkably advantageous properties. Our superior results cannot be explained by classic asset pricing models.

Multi-Asset Style Factors Have Their Shining Moments
Benoit Bellone (independent researcher), et al.
August 28, 2019
Carry, Value and Momentum factors are said “to be everywhere” according to a growing body of research. As such they may be the most robust styles across asset classes and history. In this research paper, we look forward to clearing up the following questions: how to describe multi-asset styles performance across time and across different market regimes? How multi-asset styles should be expected to behave during alternative phases of the Stock Market cycle? Are cross-asset styles sensitive to volatility conditions? Are there different responses to changes in bond yields? Is there any style likely to be structurally more cyclical or defensive? Eventually, we would like to contribute to the current debate opposing Style Rotation to Diversification: is there a case for more time-varying and concentrated Multi-Asset style portfolio constructions?

Macro Briefing | 18 October 2019

Turkey agrees to temporarily halt military operations in Syria: WSJ
UK Parliament expected to reject Johnson’s new Brexit deal on Saturday: CNBC
China’s Q3 annual economic growth slows to 6.0%–lowest in decades: CNBC
A variety of financial risks from climate change are lurking: SF Fed
Housing starts in the US fell in September after reaching 12-year high: MW
US jobless claims continue to predict labor market expansion: CNBC
Philly Fed’s mfg index shows modest growth for October: Philly Fed
US industrial output’s 1-year trend was negative in Sep–first decline since 2016:

Is Your Investment Strategy Making Unintentional Factor Bets?

Factor investing has become a core part of the investment zeitgeist over the last decade or so, but as a practical matter investors sometimes have a hard time exploiting these risk factors in portfolios. That’s the conclusion of a recent study by BlackRock that analyzes 10,000 portfolios.

That’s a striking if not puzzling revelation when you consider 1) a deep pool of research shows that factor exposures are critical drivers of long-term portfolio risk and return; and 2) investors are, in fact, actively targeting factors. Something’s obviously amiss, although BlackRock’s analysis (and a new interview with one of the study’s authors) provide some insight into the disconnect.

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Let’s start with the research. “In the approximately 10,000 advisor portfolios that we analyze at the security level, we find there are large common patterns and significant exposures to just a few factors,” BlackRock analysts report in “Factors and Advisors Portfolios.”

Advisor portfolios are heavily exposed to economic growth, which is mostly accessed through equities, and could obtain better factor balance by including other diversifiers. Within equities, the only significant style exposure is small size; advisors, in general, can potentially improve returns by harvesting other rewarded style factors. In fixed income, advisor portfolios veer towards shorter duration which can be lengthened in an effort to provide more resilience against economic downturns.

A new interview with one of the paper’s co-authors — Andrew Ang, head of BlackRock’s factor strategies group – adds some context for what’s going on and how portfolio design can be adjusted to improve the effectiveness of factor exposure. “The most surprising insight was that while we have identified a variety of different factors that have historically driven returns over the long-run, investors currently only have meaningful exposure to two of these factors,” he says in a discussion on BlackRock’s blog this week.

Economic growth, a macro factor, is the main exposure, Ang notes. “And they probably have too much exposure to economic growth. meaning that their portfolios might lose more than they intended when the economy slows,” he explains. “Not surprisingly, stocks are sensitive to changes in economic growth, and thus stocks tended to be the primary driver of risk in the portfolios analyzed.”

The second biggest factor exposure is within the equity allocation. Actually, the key observation here is what’s missing. “Investors barely have any style factors” within the equity bucket, he observes.

The only style factor they have meaningful exposure to is low size, or more commonly thought of as smaller companies. However, we were very surprised to learn of the lack of diversification across style factors within the portfolios. Investors could potentially enhance returns or reduce risk by adding meaningful value, quality, momentum or minimum volatility factors.

Perhaps the most surprising finding is that some of the heavy bets on economic growth and low equity size are accidental. Rather, it’s an “unintended side effect of individual fund choices in a portfolio.”

This is no trivial issue, Ang notes, because different equity factors tend to shine or stumble at different points in the economic cycle. As a result, providing clean exposure to specific factors, and adjusting exposure through time, offers, in theory, significant benefits for risk management, which in turn boosts the potential for maximizing risk-adjusted performance.

As an example, the Q&A with Ang offers an idealized timeline of how equity factors can wax and wane over the course of the business cycle:

“Quality and minimum volatility strategies may offer investors the opportunity to diversify their factor exposure while also better positioning their portfolios for the current economic environment,” Ang advises. “As both strategies have historically outperformed in periods of market decline, investors may want to consider using these factors to build resilience into their portfolios.”

The caveat, of course, is that factor investing isn’t science, at least not completely. Like all investment strategies, a fair amount of uncertainty pervades the best-laid plans of engineering what appears to be an informed asset allocation design. Nonetheless, there’s probably no advantage to leaving a portfolio exposed to hefty unintentional factor bets, including bets that inadvertently exclude key factors, which seems to describe a fair number of strategies in the real world, according to BlackRock’s analysis.

The good news is that building a smarter factor allocation is straightforward. The solutions vary, of course, depending on the extent and type of an inadvertent portfolio design. As an example, Ang says “investors may be able to improve the resilience of their portfolio, particularly ahead of a potential economic slowdown, by doing one or two things:

* First, they may consider reducing their exposure to economic growth and increasing their exposure to other macro factors by selling stocks and buying treasury bonds.

* Second, investors can increase exposures to other style factors to add diversification or specifically to those that have done well in the later stages of the economic cycle.

Minds will differ on the details, of course. After all, no one has a monopoly on what will work, or not, for factor allocations in the years ahead. But one thing is clear: allowing your portfolio to drift into an unintentional factor allocation due to oversight is no one’s idea of a high-probability recipe for investment success.

Fortunately, designing and managing factor exposures with a high degree of control and precision is easy via the wide array of surgically precise factor ETFs and mutual funds – see here and here, for example.

Slicing and dicing portfolios based on macro factors – economic growth, credit, inflation, and other factors – is also straightforward. Indeed, some investors intentionally design strategies to focus on these influences directly and exclusively.

Factor investing, in short, comes in a wide variety of flavors. The only glitch: fully exploiting the potential benefits requires paying attention to asset allocation. Call it the Yogi Berra rule for factor investing: You can observe a lot just by watching.

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Macro Briefing | 17 October 2019

House passes broadly supported resolution rebuking Trump over Syria: The Hill
Northern Irish party casts doubt over possible Brexit deal: Reuters
China’s commerce ministry hopes to reach trade deal soon with US: Reuters
Fed’s Beige Book reports “slight to modest” economic growth: MW
Atlanta Fed’s business inflation outlook slips to 2-year low: AFed
Revised GDPNow model estimates 1.8% Q3 GDP growth, slightly below Q2: AFed
US homebuilder confidence rises to 2-year high in October: CNBC
US retail sales fell in Sep, but 1-year growth is still moderate: CNBC

US Bond Market’s Resilience Shines On

The long-running bull market in bonds continues to defy bearish forecasts, as shown by a set of exchange-traded funds. Positive year-to-date performance in all the major corners of fixed income continues to offer a stark counterpoint to analysts who expect trouble.

Long-term corporate bonds continue to lead the field by a wide margin for 2019 results. Vanguard Long-Term Corporate Bond (VCLT) is up 20.9% for the year through yesterday’s close (Oct. 15). The gain far outpaces the broad investment-grade benchmark for US fixed income via Vanguard Total Bond Market (BND), which is ahead by 8.3% this year.

Although VCLT is the clear leader in 2019, all the main slices of the US fixed-income market are posting gains—including five market subsets enjoying performance in excess of 10% this year.

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Despite the bull run, worries persist. Bank of America Securities, for example, warns that the bond market’s exuberance casts a shadow over a staple asset allocation benchmark: the 60/40 portfolio (60% stocks, 40% bonds). “There are good reasons to reconsider the role of bonds in your portfolio,” and raise the equity weight, advises a research note from the bank. “The relationship between asset classes has changed so much that many investors now buy equities not for future growth but for current income, and buy bonds to participate in price rallies,” write portfolio strategists Derek Harris and Jared Woodard.

In a summary of the research, MarketWatch notes:

As global economic growth slows and the population in developed-market economies ages, traditionally safer assets like bonds have grown in popularity and helped create a “bubble” in the bond market that threatens to derail returns for investors who maintain a typical 60-40 split, according to the BofA analysis.

Pessimists point to the return of a positive Treasury yield curve for the 10-year/3-month spread as a possible sign that the tide is turning. This widely followed slice of the yield curve has been inverted (short rates above long rates) for most of recent history since the spring. Over the past three trading sessions, however, the curve is positive again, if only slightly.

But there’s still plenty of debate about whether the bond rally has hit a wall. The bulls point out that the Federal Reserve is still expected to cut interest rates again, potentially offering fresh support for supporting if not lifting bond prices further. Fed funds futures are pricing in a roughly 78% probability that the central bank will announce another cut at the Oct. 30 FOMC meeting.

Meantime, all the bond ETFs listed above continue to post bullish price momentum, based on a set of moving averages. The first metric compares each ETF’s 10-day moving average with the 100-day average — a proxy for short-term trending behavior (red line in chart below). A second set of moving averages (50 and 200 days) offers an intermediate measure of the trend (blue line). The indexes range from 0 (all funds trending down) to 1.0 (all funds trending up). Despite the perceived risks for bonds, all the bond ETFs cited continue to reflect a bullish price trend. Trouble may be lurking, but for the moment the crowd is pricing the bond market for perfection.

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Macro Briefing | 16 October 2019

Warren is focus of attacks at Democratic debate: CNBC
VP Pence, Sec. of State Pompeo in Turkey today to push for Syrian ceasefire: Fox
US indicts Turkey’s 2nd-largest bank on evading Iran sanctions: NY Times
China criticizes House bill that focuses on Hong Kong: Reuters
Doubt hangs over China’s promise to buy more US farm products: WSJ
Brexit talks stall over familiar stumbling blocks: CNBC
Upbeat corporate earnings help raise US stock market to 3-week high: MW
IMF forecasts global growth will slow to weakest pace since financial crisis: BBC
10yr-3mo Treasury yield curve remains positive for 3rd day after run of inversion:

Estimating Recession Risk Isn’t Getting Any Easier

Every recession is different and the next one, whenever it strikes, will likely continue the tradition. As a Bloomberg column reminded last week, the risk factors that may be aligning to deliver the next contraction are an unusual mix.

“This won’t be your father’s recession — if indeed the U.S. ends up tumbling into one,” Bloomberg’s Rich Miller writes.

Traditionally, US downturns are home-grown and household-led, triggered by spikes in interest rates and fueled by the unwinding of financial and economic excesses. None of that is arguably at work this time, at least for now.

Instead, what’s making investors nervous about a recession is a global, geopolitical shock to business sentiment that’s prompting US companies to curb spending amid uncertainties from the US-China trade war to Britain’s potential pullout from the European Union.

The confluence of these changes threatens to make the Federal Reserve’s job considerably more challenging in the months ahead. Simply put, the central bank’s usual bag of monetary tools – starting with interest-rate cuts – aren’t particularly well suited for minimizing the current run of challenges, especially if the economy continues to weaken.

Whatever the triggers for a new downturn, former Treasury Secretary and Harvard economist Larry Summers says US rates will fall back to zero, or lower, in the next recession. Entering a contraction with interest rates already low will pose new challenges. “We’ll have to think about stabilization policy. Institutions are going to have to think about their investment policy in a very different world when we have a black hole, zero interest rate world,” he told CNBC on Monday. “I fear that’s what we’re headed into.”

Learn To Use R For Portfolio Analysis
Quantitative Investment Portfolio Analytics In R:
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By James Picerno

Maybe, although the current macro profile for the US continues to reflect low recession risk, albeit from the vantage of looking into the rear-view mirror based on a range of data published to date. Last month’s business-cycle risk profile reaffirmed that 1) the odds that a recession has started remain low; and 2) an NBER-defined downturn in the immediate future is unlikely.

That’s still a reasonable view, according to this week’s update of the numbers via The US Business Cycle Risk Report. Notably, the newsletter’s primary index for monitoring recession risk – a proprietary mix of several business-cycle benchmarks – estimates the probability that a new downturn has started at roughly 1%, as shown in the chart below.

Growth has clearly slowed recently and so, in theory, the downshift raises the potential for trouble if a new economic shock strikes. Note, too, that near-term estimates of business cycle conditions continue to anticipate that the expansion will remain slow, perhaps even sluggish, for the foreseeable future. But for the moment, the threat that a recession is imminent appears low.

But conditions are constantly in flux and so the key question, as always: What should we focus on to assess a change in recession risk? The short answer: don’t focus. Instead, play it safe and measure macro stress via a broad set of indicators. That’s an unpopular idea in the media, and for many analysts and investors, too. The narrative plays better with a short list of numbers. But as Bloomberg’s Miller reminds, the next recession could be a very different animal than we’re used to. All the more reason not to bet the farm on a handful of indicators that worked in the past.

As with investing, the antidote to uncertainty – particularly when it seems to be higher than usual – is to hedge your bets with a broader sample. In fact, that strategy has worked well since the last recession ended in 2009. As shown on these pages via the monthly business-cycle updates (here and here, for instance), going broad for data analysis has an encouraging record of sidestepping the many false signals we’ve seen in recent years – false signals that have tripped up more than a few business cycle “experts”.

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Macro Briefing | 15 October 2019

Trump announces sanctions on Turkey, demands Syria ceasefire: Reuters
VP Pence headed to Turkey for negotiations: MW
Doubts follow Trump’s trade deal with China: The Hill
EU’s chief negotiator: Brexit deal ‘still possible’: BBC
Turkish lira rises despite Trump’s new economic sanctions on Turkey: CNBC
China’s factory deflation ticked deeper into the red in September: Bloomberg
German investor sentiment remains weak in October via ZEW survey: Bloomberg
NY Fed Mfg Index edges up in Oct, middling growth vs. recent history: NY Fed

Commodities And Foreign Stocks Led Global Markets Last Week

Commodities prices rebounded last week after a run of declines, posting the strongest weekly performance for the major asset classes, based on a set of exchange-traded funds. Foreign stocks were in close pursuit for the performance leadership during the trading week ended Oct. 11.

A key driver in last week’s revival in commodities prices: news of progress in US-China trade talks, which was a factor in boosting crude oil prices – the main component for iShares S&P GSCI Commodity-Indexed Trust (GSG). The fund jumped 2.5% last week, posting its first weekly rise in three weeks.

Foreign equities in developed markets delivered a robust second-place performance. Vanguard FTSE Developed Markets (VEA) rose 2.1% last week, lifting the fund to a level that’s close to a one-year high at the end of Friday’s trading. Emerging markets equities were in third place: Vanguard FTSE Emerging Markets (VWO) rose 1.5% on a weekly basis.

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Quantitative Investment Portfolio Analytics In R:
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The weakest performer last week among the major asset classes: inflation-indexed Treasuries. The iShares TIPS Bond (TIP) fell 1.2%, leaving the ETF near its lowest price for the month so far.

The broad trend for markets generally last week was up, based on an ETF-based version of the Global Market Index (GMI.F). This unmanaged benchmark, which holds all the major asset classes (except cash) in market-value weights, rose 0.5% last week – it’s first weekly gain in a month.

For one-year returns, US real estate investment trusts are still firmly in the lead. Vanguard Real Estate (VNQ) has gained 23.3% on a total return basis – comfortably above the one-year results for the rest of the major asset classes.

Despite last week’s rally, broadly defined commodities remain in last place by a wide margin. GSG is down 15.8% for the trailing one-year period as of Friday’s close. By contrast, all the other major asset classes are posting one-year gains.

GMI.F is also up for the trailing 12-month period, posting a solid 7.7% total return.

Profiling the major asset classes through a momentum lens continues to show that bullish trends prevail for most markets. The analysis is based on two sets of moving averages for the ETFs listed above. The first compares the 10-day moving average with its 100-day counterpart — a proxy for short-term trending behavior (red line in chart below). A second set of moving averages (50 and 200 days) represent an intermediate measure of the trend (blue line). Although these benchmarks have been volatile lately, the majority of markets still reflect an upside bias.

Is Recession Risk Rising? Monitor the outlook with a subscription to:
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Macro Briefing | 14 October 2019

Trump expected to impose new sanctions on Turkey for Syria invasion: Reuters
China requests more talks before signing latest trade deal with US: BBG
Will the latest US-China trade truce boost global growth? Maybe not: WSJ
China will be a factor in Q3 earnings that are starting to roll in: MW
House intel chairman: whistleblower testimony may not be needed: The Hill
Eurozone industrial output rebounded in August: Reuters
Brexit deal remains long shot as Oct 31 deadline nears: CNBC
China’s exports/imports fell more than forecast in September: CNBC
US consumer expectations for real income rises to two-decade high in Oct: UoM

Book Bits | 12 October 2019

After the Crash: Financial Crises and Regulatory Responses
Edited by Sharyn O’Halloran and Thomas Groll
Summary via publisher (Columbia U. Press)
The 2008 crash was the worst financial crisis and the most severe economic downturn since the Great Depression. It triggered a complete overhaul of the global regulatory environment, ushering in a stream of new rules and laws to combat the perceived weakness of the financial system. While the global economy came back from the brink, the continuing effects of the crisis include increasing economic inequality and political polarization. After the Crash is an innovative analysis of the crisis and its ongoing influence on the global regulatory, financial, and political landscape, with timely discussions of the key issues for our economic future.

Capital is Dead: Is This Something Worse?
By McKenzie Wark
Summary via publisher (Verso)
In this radical and visionary new book, McKenzie Wark argues that information has empowered a new kind of ruling class. Through the ownership and control of information, this emergent class dominates not only labour but capital as traditionally understood as well. And it’s not just tech companies like Amazon and Google. Even Walmart and Nike can now dominate the entire production chain through the ownership of not much more than brands, patents, copyrights, and logistical systems. While techno-utopian apologists still celebrate these innovations as an improvement on capitalism, for workers—and the planet—it’s worse. The new ruling class uses the powers of information to route around any obstacle labor and social movements put up.

The 99 Percent Economy: How Democratic Socialism Can Overcome the Crises of Capitalism
By Paul S. Adler
Summary via publisher (Oxford U. Press)
We live in a time of crises – economic turmoil, workplace disempowerment, unresponsive government, environmental degradation, social disintegration, and international rivalry. In The 99 Percent Economy, Paul S. Adler, a leading expert on business management, argues that these crises are destined to deepen unless we radically transform our economy. But despair is not an option, and Adler provides a compelling alternative: democratic socialism. He argues that to overcome these crises we need to assert democratic control over the management of both individual enterprises and the entire national economy. To show how that would work, he draws on a surprising source of inspiration: the strategic management processes of many of our largest corporations.

The Fall of a Great American City: New York and the Urban Crisis of Affluence
By by Kevin Baker and James Howard Kunstler
Summary via publisher (City Point Press)
The Fall of a Great American City is the story of what is happening today in New York City and in many other cities across America. It is about how the crisis of affluence is now driving out everything we love most about cities: small shops, decent restaurants, public space, street life, affordable apartments, responsive government, beauty, idiosyncrasy, each other. This is the story of how we came to lose so much—how the places we love most were turned over to land bankers, billionaires, the worst people in the world, and criminal landlords—and how we can – and must – begin to take them back.

Reluctant Cold Warriors: Economists and National Security
By Vladimir Kontorovich
Summary via publisher (Oxford University Press)
Scholars attribute the collapse of the Soviet Union in part to the militarization of its economy. But during the Cold War, economic studies of the USSR largely neglected the military sector of the Soviet economy-its dominant and most successful part. This is all the more puzzling in that academic study of the Soviet economy in the US was specifically created to help fight the Cold War. If the rival superpower maintained the peacetime war economy, why did experts fail to tell us when it mattered? Vladimir Kontorovich shows how Western economists came up with strained non-military interpretations of several important aspects of the Soviet economy which the Soviets themselves acknowledged to have military significance. Such “civilianization” suggests that the neglect of the military sector was not forced on scholars of the Soviet economy by secrecy; it was their choice.

Invested: Changing Forever the Way Americans Invest
By Charles Schwab
Q&A with author via Worth
Charles Schwab is legendary for making investing and saving for retirement easier for everyday Americans. The chairman of Charles Schwab Corporation and author of several books, he’s releasing Invested: Changing Forever the Way Americans Invest, a memoir about his life and building Schwab into what it is today.

Market Mover: Lessons from a Decade of Change at Nasdaq
By Robert Greifeld
Summary via publisher (Grand Central Publishing)
Former CEO and Chairman of Nasdaq, Robert Greifeld shares stories, insights, and lessons learned from one of the world’s largest stock exchanges, detailing his transformation of Nasdaq from a fledgling U.S. equities market to a global financial technology company.

Tech And Real Estate Still Top 2019 Equity Sector Returns

The US stock market has climbed a wall of worry this year, led by technology and real estate shares. The two sectors have been red hot for most of 2019 and that’s still true by wide margins, based on a set of exchange traded funds.

Technology Select Sector SPDR (XLK), the strongest year-to-date performer, is currently posting a sizzling 31.1% total return through yesterday’s close (Oct. 10). Although the fund has been treading water for the last two months, it continues to change hands just below a record high that was set in July.

Shares of real estate investment trusts (REITs) are a strong runner-up performer this year. Real Estate Select Sector SPDR (XLRE) is ahead by 29.6% this year after factoring in distributions. In contrast with XLK’s recent meandering run of late, XLRE’s enjoyed a relatively consistent, ongoing climb through 2019.

All the major US equity sectors are posting year to date gains, but there’s a wide spread between the leader and the laggard. Energy shares are the weakest corner among the major US sectors. Energy Select Sector SPDR (XLE) is up just 2.2% in 2019 and is struggling to hold to a slim gain.

One analyst sees energy’s weak run this year as a possible value opportunity. “We believe favorable technicals, improving fundamentals with stabilizing business cycle, and ongoing geopolitical tensions in the Middle East could help redirect flows into this universally hated and cheap sector,” Dubravko Lakos-Bujas, chief US equity strategist for JP Morgan Chase, wrote in a research note recently.

Reviewing momentum for US equity sectors continues to reflect an upside bias generally, but recent trading reflects a round of weakness for the short-term profile. The analysis is based on two sets of moving averages for the ETFs listed above. The first compares the 10-day moving average with its 100-day counterpart — a proxy for short-term trending behavior (red line in chart below). A second set of moving averages (50 and 200 days) represents an intermediate measure of the trend (blue line). As of yesterday’s close, the two indicators continue to reflect positive momentum for most sectors. Note, however, that the short-term metric has tumbled recently. So far it looks like noise, but the question remains: Will the intermediate trend (blue line), which remains much stronger, weaken too? If this measure of momentum stumbles, the outlook will suffer.

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Macro Briefing | 11 October 2019

Turkey pounds Syrian Kurds in third day of military offensive: Reuters
Iranian tanker struck by missiles off coast of Saudi Arabia: CNBC
US-China trade talks set to continue on Friday after encouraging start: WSJ
Brussels meeting hints at possible UK-EU deal on Brexit: BBC
Jobless claims fell last week, pointing to ongoing US labor mkt growth: Reuters
10yr-3mo Treasury yield curve briefly turned positive on Thursday: MW
Low headline consumer inflation in Sep suggests another Fed rate cut: MW

US Treasury Market’s Inflation Forecast Slips To 4-Year Low

Ahead of today’s September report on US consumer inflation, the Treasury market’s implied inflation forecast via 5-year maturities quietly ticked down to 1.24% in Wednesday’s trading (based on daily data via The crowd’s estimate of future pricing pressure for 5-year Notes marks the lowest level since February 2016. Although market-based estimates of future inflation should be viewed cautiously, the latest dip is a reminder that a downside bias continues to prevail in this corner of economic expectations.

The market’s inflation outlook via 10-year Notes (calculated as the yield spread on the nominal security less its inflation-indexed counterpart) has also fallen lately, settling at 1.49% yesterday (Sep. 9), fractionally above Tuesday’s level. But the big picture on Mr. Market’s inflation outlook is unambiguous, namely: manage expectations down.

Federal Reserve Chairman said as much yesterday, commenting that low inflation is one of the “longer-term challenges” for US monetary policy. He recognized that not everyone agrees with this analysis. “You may be asking, ‘What’s wrong with low inflation and low interest rates?’” Rightly or wrongly, the Fed is prepared to act to combat what it sees as a disinflation threat.

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Economists, however, aren’t looking for a smoking gun in today’s release on consumer prices for September (due at 8:30 eastern).’s consensus point forecast sees headline CPI edging up to a 1.8% annual change. Although that’s slightly below the Fed’s 2.0% inflation target, it’s not obvious in this data set that disinflation is a problem. Indeed, core CPI (a more reliable measure of inflation’s trend) has been running above the 2.0% target lately and is on track to hold at a 2.4% annual pace through September.

How should we square the divergent inflation profile for core CPI vs. the Treasury market’s outlook? One explanation: the global decline in bond yields (including the rising prevalence of negative rates in some countries) is driving foreign investors into relatively high-yielding Treasuries. In turn, that’s driving US government rates down, for reasons that are less about American disinflation vs. a desperate search for yield around the world and within the US.

Regardless, the Fed is expected to extend its recent run of rate cuts at the Oct. 30 policy meeting. Fed funds futures are pricing in an 85% probability that the central bank will trim its target rate by 25 basis points to a 1.50%-1.75% range in the upcoming FOMC announcement.

The Treasury market certainly appears to be pricing in softer rates ahead. Indeed, the downside momentum on the 2-year yield (widely considered the most sensitive maturity for policy expectations) looks robust, based on a set of exponential moving averages (EMA). As the chart below shows, the configuration of the 50-, 100- and 200-day moving averages implies that investors are still pricing in lower yields for the near term.

Yet judging by the crowd’s expectations for today’s CPI data, the market’s disinflation worries appear a bit excessive. Note, however, that it’s premature to dismiss the potential for a downside surprise, based on Tuesday’s weaker-than-expected report on wholesale inflation for September. Notably, the annual trend for producer prices slumped to a 1.4% rate—the weakest in nearly three years.

A modest outlook for the upcoming third-quarter GDP report due on Oct. 30 is a factor too. Although the median estimate via a recent set of nowcasts projects that that output will hold at a 2.0% increase, one of the inputs into this estimate fell in yesterday’s revision. The Atlanta Fed’s GDPNow model ticked down to a 1.7% rise for Q3 growth.

If economic growth remains subdued, inflation will remain contained and perhaps drift lower. For the moment, however, something approximating the Fed’s target appears likely, give or take. But thanks to a range of geopolitical factors (US-China trade war, impeachment risk, and Turkey’s invasion of Syria), there’s greater uncertainty than usual in the weeks ahead. To quote the Fed’s stock announcement on guidance: we’re data dependent, more so than usual.

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Macro Briefing | 10 October 2019

Turkey invades northeastern Syria; US says it didn’t approve the assault: BBC
Turkey’s Syria invasion ends fight against ISIS: Foreign Affairs
United States’ and China’s top trade negotiators set to meet today: Reuters
US considers a currency deal as part of China trade negotiations: Bloomberg
Fed officials considered rising recession risk at bank’s Sep meeting: The Hill
US Q3 GDP growth estimate slips to weak +1.7% in GDPNow model: Atlanta Fed
Falling German imports in Aug highlight recession risk: Reuters
US job openings fell to a 1-1/2 year low in August: Reuters

US Q3 GDP Growth Expected To Match Q2’s Modest Gain

This month’s upcoming estimate of third-quarter economic growth for the US is on track to stabilize at a modest pace, matching the gain in Q2, based on the median estimate for a set of revised nowcasts. Recession risk remains low for now, but today’s update also reaffirms that a rebound in growth is unlikely any time soon.

The median nowcast is currently anticipating a 2.0% increase in US output for Q3, based on several models compiled by The Capital Spectator. This median matches the 2.0% gain previously reported for Q2. The official Q3 GDP report – the “advance” estimate from the Bureau of Economic Analysis — is scheduled for release on Oct. 30.

Today’s median update reflects a slightly softer nowcast vs. The Capital Spectator’s previous Q3 estimate of 2.2%, published on Sep. 24.

Recent survey data, however, has painted a darkening picture of US economic activity – the ISM Manufacturing Index reflected contraction for a second month in September.

Note, too, that the IHS Markit Composite Index – a survey based indicator that incorporates manufacturing and services data and is used as GDP proxy – points to a sluggish trend.

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“The surveys are consistent with the economy growing at a 1.5% annualized rate in the third quarter, with forward-looking indicators suggesting further momentum could be lost in the fourth quarter,” says Chris Williamson, chief business economist at HIS Markit, in a report published last week.

 But some analysts say that the hard data, reflecting formal economic reports, offer a more encouraging profile. “While the survey data have been steadily disappointing expectations, hard data have been a source of positive surprises,” advises Doug Peta, chief U.S. investment strategist at BCA Research, in a note to clients. “The labor market remains vibrant enough to exert downward pressure on the unemployment rate, and services continue to expand despite the contraction in manufacturing, both here and abroad. The expansion has slowed, but it’s not finished yet.”

Perhaps, but it’s premature to completely dismiss the headwinds. A survey of economists published this week predicts that US growth will fall below 2% next year – marking the slowest trend in three years. “The rise in protectionism, pervasive trade policy uncertainty, and slower global growth are considered key downside risks,” says Gregory Daco, chief US economist at Oxford Economics and survey chair for National Association for Business Economics.

A lot can happen between now and 2020, of course, and so all the usual caveats apply. Meantime, looking at the outlook for the GDP trend through a year-over-year lens suggests that economic growth will stabilize in the immediate future.  The annual change in output is expected to hold at roughly the 2% mark for the near term, based on The Capital Spectator’s average estimate via a set of combination forecasts.

But as a casual review of recent headlines reminds, several potentially crucial risks continue to lurk, including the ongoing US-China trade war and impeachment risk. Exactly how these and other factors unfold is unknown, but this much is clear: the road ahead is unusually cloudy. Based on the numbers published to date, however, there’s still a reasonable argument for expecting that modest US growth will endure for the foreseeable future.  

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Macro Briefing | 9 October 2019

White House refuses to cooperate with House’s impeachment inquiry: WSJ
Poll: 3 in 10 Republicans support impeachment inquiry: The Week
Turkish military begins crossing into Syria: Bloomberg
China remains willing to discuss a partial trade deal with US: CNBC
New IMF chief: global economy slowing due to US-China trade war: NYT
Fed Chair Powell says US expansion is “sustainable”: Reuters
Small Business Optimism Index for US dipped in Sep but still upbeat: NFIB
US wholesale inflation trend falls to 1.4% in Sep, lowest in nearly 3 years: MW