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    Gavekal Research

    The Trouble With Price Level Targeting

    The Federal Reserve is talking about changing the way it targets inflation. Currently it tweaks policy in an attempt to zero in on a specific inflation rate: 2%. Under the framework it is discussing, instead it would aim to hit a price index level consistent with a particular long term average inflation rate. The distinction might sound subtle, but by targeting a price level, the Fed would compensate for any undershooting by attempting to...

    6
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    Gavekal Research

    The Mystery Of The Missing Stimulus

    Since late 2016, the US trade deficit has been widening. Usually, when the US trade deficit expands, the effect is stimulative for the rest of the world. However, this time around there have been no signs that non-US economies are enjoying a resulting pick-up. In this report, KX examines possible explanations for the failure of this longstanding relationship.

    0
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    Gavekal Research

    A Catspaw, Not A Tailwind

    The publication of minutes from FOMC’s January meeting confirmed that the Fed has executed an about-turn in its policy stance and is now in dovish mode. More specifically, the minutes confirmed that the Fed is planning to halt the contraction of its balance sheet later this year, putting an early end to the quantitative tightening that began in October 2017.

    0
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    Gavekal Research

    The QT Endgame

    A voting member of the FOMC said yesterday that the Federal Reserve should quit shrinking its balance sheet later this year. This was the clearest indication yet that the US central bank will end quantitative tightening one or two years sooner than the 2020-2021 estimate put forward by Chairman Jay Powell last July. I suspect Brainard will get her wish.

    2
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    Gavekal Research

    Fear Not The ‘Earnings Recession’

    US earnings growth is clearly slowing. As global growth ebbs and the effect of last year’s US tax cut wears off, 1Q19 will be worse according to US analysts who in aggregate are predicting EPS to fall -1.4%. Some commentators are even declaring an “earnings recession.” Time to take profits for the year and run to the hills? I’d say “no”.

    5
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    Gavekal Research

    A Looser Fed And Tighter Banks

    News flow from the US and beyond over recent months has pointed to an easing of financial conditions. A notable exception has, however, emerged: US commercial banks have stopped loosening lending standards and have started to tighten them—just a touch. I remain constructive, but have gotten more cautious about US risk assets.

    0
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    Gavekal Research

    Video: Conflicting Signals From The US Labor Market

    The US labor market is sending apparently contradictory signals. On one hand the unemployment rate ticked higher in January. On the other, job creation was much stronger than expected. Will looks behind the latest data points to examine the labor market’s underlying trends, and concludes they spell relatively bullish news for the US economy and risk assets over the coming months.

    0
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    Gavekal Research

    Fed To The Rescue

    It was no surprise on Wednesday that the US Federal Reserve promised to be “patient” about further interest hikes and flexible on the pace and extent of its balance sheet reduction. The Fed’s more dovish stance had been clearly signaled in a series of speeches ahead of yesterday’s policy meeting. As Fed chairman Jay Powell explained, with US inflation data subdued and other major economies slowing, it makes good sense for the Fed to take a “wait...

    0
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    Gavekal Research

    Don't Fear Corporate Leverage (Yet)

    With Brexit, the US-China trade war and a synchronous global slowdown, these are anxious times for investors. But apparently, all these concerns pale in comparison with worries about US corporate leverage. According to a BofAML survey this month, corporate indebtedness is the biggest single worry among fund managers. We beg to differ.

    17
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    Gavekal Research

    The Bull Case For US Housing

    As the US government shutdown drags on, US-China tariff talks stutter, the Chinese growth engine slows, global trade slumps and GDP forecasts get cut, the stream of macro-misery in recent days has seemed relentless. On Tuesday, the US National Association of Realtors added its voice to the dirge, reporting that sales volumes for existing homes fell -10% year-on-year to a three year low in December. With new home sales and construction equally...

    10
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    Gavekal Research

    Video: Beyond The Government Shutdown

    As the US government shutdown threatens to enter its fifth week, Will looks back at previous shutdowns to weigh the likely impact on America’s economy and financial markets, against the backdrop of an aging economic cycle, flattening yield curve and tighter financial conditions.

    0
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    Gavekal Research

    A Good News Story From The US

    As the record government shutdown denies Americans vital services and federal workers paychecks, the US has hardly been putting its best foot forward. While we don't expect this political impasse to change the growth trajectory, it does weigh on the market mood. Against such a dour backdrop, we think a good news story from the US economy can be easily missed.

    0
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    Gavekal Research

    Rollover In The US, Not Recession

    This week’s revenue forecast downgrades from Apple and Delta Air Lines and Thursday’s steep dive in the ISM manufacturing PMI only appeared to confirm what market participants already knew: US growth is rolling over. Yet despite the recent sell-off in equities and the further flattening of the US yield curve, we see no recession on the horizon.

    0
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    Gavekal Research

    More Half Full Than Half Empty

    Despite dovish comments from the Federal Reserve about the future trajectory of interest rates, US equities fell further on Wednesday. The S&P 500 has now fallen -14% since early October. Meanwhile, 10-year treasury prices have risen almost 5%. Momentum traders will therefore find good reason to shun equities and add exposure to long-dated treasuries. We suggest doing the opposite.

    0
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    Gavekal Research

    Opportunities Beyond The Death Cross

    November’s payroll report gave investors in US equities reason to cheer on Friday as it suggested reduced inflationary pressure, yet they chose to focus on an escalating row over the fate of a top Chinese telecom executive that is intensifying trade tensions with China. A -2.3% fall in the S&P 500 had the technically-inclined scrambling to glean meaning from a “death cross” as the 50-day moving average fell below the 200-day level. We remain...

    2
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    Gavekal Research

    Don’t Sweat About The Yield Curve

    At least as interesting as the 1.1% rise in US equities on Monday, following the weekend’s news of a three-month US-China tariff truce, was the day’s decline in long-dated US treasury yields and the concomitant flattening of the US yield curve. But was this bond market action good news or bad for investors?

    5
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    Gavekal Research

    Christmas Comes Early

    The most cherished gifts often come in small packets, and investors duly cheered just two small words yesterday by the Federal Reserve chairman. In a speech, Jerome Powell said policy rates were “just below” the neutral level. That was a big change from a month earlier when he said they were “a long way from” the not-too-hot-not-too-cold level. This suggests that the pace of interest rate hikes may lessen, while on the same day data was released...

    0
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    Gavekal Research

    What If Oil Stays At US$50?

    Since early October, oil prices have plunged more than -30%, while the US equity benchmark is down -8%. You don’t have to be Inspector Clouseau to wonder if these moves are related. Since this oil sell-off has unfolded at a time when US economic growth is slowing, my bet is for a negative short-term effect, but a medium term outlook that is fairly cheery.

    0
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    Gavekal Research

    The Drag Of US Housing

    Despite the overall US growth outlook remaining decent, markets have taken on an ugly tone, with US equities having given back their 2018 gains and credit spreads gapping wider. Adding to grim tidings, yesterday saw weak housing data released, which is a worry as the sector often leads the broader US economy.

    16
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    Gavekal Research

    GE Is More Fish Than Fowl

    There is suddenly a flood of commentary speculating that General Electric is a canary in the proverbial coal mine for the US corporate credit market. With investors focused on the troubled conglomerate’s underfunded pension scheme and ailing power business, GE has seen its credit rating downgraded and become a focal point for broader fears that US corporates have taken on too much debt and bought back too much equity. Without taking a view on GE...

    5
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    Gavekal Research

    Credit Availability As An Asset Allocation Tool

    US analyst KX bases his equity calls largely on a Wicksellian model that compares the cost of capital with the returns earned by the corporate sector. We remain comfortable that this “spread” remains favorable for US firms, and so recommend a roughly 70% allocation to equities. Yet even if credit is reasonably priced, there is the question of its availability. For this reason, we watch lending standard measures closely, and just got a benign...

    2
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    Gavekal Research

    Hong Kong Seminar — November 2018

    At Gavekal’s seminar in Hong Kong this week, Yanmei Xie, Arthur Kroeber and Will Denyer presented their latest views on China's economy, trade war, and how to approach asset allocation in the US.

    0
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    Gavekal Research

    Gridlock is Good

    The Democrats have wrested back control of the US House of Representatives, while Republicans have expanded their Senate majority. Hence, the US’s bicameral legislature is set for two years of gridlock. This was the most benign result possible from this midterm election. While largely expected, confirmation is probably positive for risk assets.

    0
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    Gavekal Research

    Hot, But Not Too Hot

    It remains unclear if the US is moderating its approach to trade war, but there are other factors to keep equity investors on edge. Friday’s US payroll report showed average hourly earnings rising to a cycle-high of 3.1%, confirming the picture of a tight labor market. Hence, with 10-year treasury yields just below their recent peak of 3.23%, the question is whether the US economy can weather a higher cost of capital. For now, I think the answer...

    0
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    Gavekal Research

    Strategy Monthly: Yes, We're Still In A Bull Market

    Anatole and Will believe that continued exposure to US equities makes sense, since underlying corporate profitability remains strong. So long as one avoids the most rate-sensitive sectors, US portfolios should be 70-75% in stocks, with the rest mainly in cash. Moreover, they argue that the period of EM underperformance is now done, and emerging markets are poised for a significant rally.

    0
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    Gavekal Research

    US Macro And The Market

    Coming after another bruising week in the market, which saw the S&P 500 flirting with correction territory, down -9% from its late-September high, Friday’s third quarter US GDP report is heartening. Although 3Q’s quarter-on-quarter annualized growth rate of 3.5% was slower than the 4.2% rate recorded in 2Q, it was still strong relative to the expected 3.3% and compared with the US economy’s structural growth rate. While US growth will...

    0
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    Gavekal Research

    Buy The Dip

    “Things are fine now, but they are going to get worse.” This is what I hear from commentators on US growth, from corporate managers talking about profit margins, and from Chinese exporters discussing the impact of the trade war. The same could be said of US financial conditions—they are fine now, but as interest rates rise they will deteriorate.

    3
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    Gavekal Research

    Equities In The Late Cycle (Revisited)

    The stock market volatility of the last week, triggered by fears over rising bond yields, emphasizes how participants now accept that the US economy is in the late phase of its cycle. KX argues this is not a reason to flee US equities, but it does demand a more discerning approach.

    0
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    Gavekal Research

    Time To Rebalance Into Equities

    The S&P 500 is down almost -7% in six days, the biggest drawdown since the -10% decline in the first quarter. It is now below its 200-day moving average, for the first time since April 2nd. Will it bounce back, or is a US equity bear market now upon us? I would bet on the former, but not too aggressively.

    0
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    Gavekal Research

    Still Not Interested In US Bonds

    Wednesday saw the second biggest sell-off in US bonds since November 10, 2016, immediately after the US presidential election. The 10-year treasury yield jumped 11bp to 3.16%, its highest since 2011. However, investors should be wary of treating this as a buying opportunity, for a number of reasons.

    4
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    Gavekal Research

    Rate Rises And The US Stock Market

    For the first time in the long post-2008 cycle, the US has a positive real interest rate. After Wednesday’s 25bp hike in US rates, at just short of 2.25%, the effective Fed funds rate will now exceed the Federal Reserve’s favored core PCE measure of inflation, which at the end of July stood at 2%. In theory, that could change later Thursday with the release of August PCE data. But with the dot plot suggesting another rate hike this year and...

    0
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    Gavekal Research

    The Message From US Housing Construction

    Wednesday saw a soft US housing data release for August, pointing to a coming weakening in residential construction. With the Fed raising rates and 10-year treasury yields well above 3%, equity investors may sniff late-cycle decay. KX shares such concerns, but advises investors to hold their noses for a while longer.

    0
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    Gavekal Research

    Audio & Transcript — Gavekal Research Call September 2018

    In this month’s research call, Will Denyer explains why he is still recommending a 75% equity exposure in a dedicated US portfolio. His call is based on an asset allocation method with three key components, namely, Wicksellian spreads, relative valuation tools, and a duration tool which shows how to divide a fixed income portfolio between bonds and cash.

    0
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    Gavekal Research

    The Signaling From US Autos

    Even as the US economy fires up on tax cuts and government spending, interest rate-sensitive sectors show signs of rolling over. First it was housing, and now auto sales have slid to the lower end of their range after steadily softening this year. Over the next year, the question is less whether autos can boost growth, as how much they will detract from it. The fact that the Trump administration is still considering significant tariffs on...

    2
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    Gavekal Research

    Strategy Monthly: A Simple Guide To US Asset Allocation

    We synthesize four years of work on asset allocation and present a model portfolio built around analysis of the cost of and return on capital; the real rate of return on equities, bonds and cash; and the ideal duration of fixed-income holdings. Today we recommend that US portfolios hold 75% in equities, 25% in cash, and shun bonds.

    0
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    Gavekal Research

    The State Of The US Consumer

    Despite cyclical headwinds and the threat of a welfare-sapping trade war, the US consumer has stayed fairly upbeat. The worry has been that rising tariffs change that situation and hit growth. Hence, news of a trade deal between the US and Mexico is to be welcomed (Justin Trudeau may feel differently). Still, at the end of the day the effect will still be to push up costs that someone must cover. For this reason, as the economic cycle matures...

    0
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    Gavekal Research

    Sound, Fury, Fear And Markets

    Regardless of political affiliation, there seems to be a consensus that yesterday was a bad day for the Trump administration. It is almost impossible to predict the chain of events that will unfold in the coming days and weeks, but the political fallout from Paul Manafort’s fraud conviction and Michael Cohen’s guilty plea will be unabashedly ugly. Whether this latest twist in the drama gripping Washington has broader ramifications for markets is...

    6
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    Gavekal Research

    A Benign View Of US Inflation

    With US inflation now running above the Federal Reserve’s long term target rate, and the US labor market almost as tight as at any time since the turn of the century, the question for investors is not whether inflation will continue to push higher, but how fast it will rise. The distinction is important. Headline CPI inflation came in at a six-and-a-half-year high of 2.9% in July. And in June the overall and core PCE measures that the Fed...

    0
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    Gavekal Research

    The Meaning Of A Flat Yield Curve

    Every US recession since the mid-1950s has been preceded by a flat or inverted yield curve. The fact that the curve is now fairly pancake-like in form and the Federal Reserve is ratcheting up interest rates has investors on edge. On balance, I conclude that the time is right to get out of US banks, but not to be rushing the exits of the US equity market.

    4
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    Gavekal Research

    More Underperformance Ahead For US Bank Shares

    It’s been a tough few months for investors in US bank shares. Since late February banks have underperformed the broader S&P 500 index, in large part on fears that the flattening trend in the US yield curve will compress bank net interest margins and depress earnings. Yet viewed on a longer time horizon, things look different. From the fourth quarter of 2015 until the first quarter of this year (the latest data point), bank net interest...

    0
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    Gavekal Research

    Weighing The Forces Driving The US$

    Where is the US dollar going next? After weakening markedly against other developed economy currencies at the beginning of the year, the US dollar staged a vigorous rebound in April and May. Since then, the DXY US dollar index has essentially tracked sideways. Of course, trying to forecast the US dollar’s moves is frequently a thankless task. Nevertheless, it is important to examine both the bullish and bearish forces at work and to weigh their...

    1
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    Gavekal Research

    US Housing Gets Vertiginous

    There is a lot to like about US housing. Vacancy rates are low, as are inventories of unsold homes. The labor market is tight and wages are steadily rising. At this point of the cycle there has usually been substantial over-building, but not this time. While supply has increased, housing starts have yet to exceed my estimate of the structural rate of household formation. Yet despite these decent enough fundamentals, valuations look stretched and...

    0
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    Gavekal Research

    When To Buy US Equities?

    Last month, Will and KX asked When To Buy US Bonds? This month, they turn their attention to US equities and devise a portfolio asset allocation model that advocates overweighting stocks against bonds when returns on invested capital and earnings yields exceed corporate funding costs. Back-testing gives an impressive historical outperformance at a reduced volatility relative to the S&P 500. But just as important is what the model has to say...

    0
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    Gavekal Research

    Good News Really Is Good News

    The US economic engine is humming, and corporate earnings continue to beat expectations. Data released on Friday showed real GDP grew at an annualized 4.1% in the second quarter. And with just over half the S&P 500’s constituents having reported for 2Q, 83% have exceeded earnings expectations. Yet investors are unimpressed. The US stock market has so far failed to regain its January pre-VIX-spike high, and despite Friday’s strong GDP print,...

    2
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    Gavekal Research

    The Yield Curve As A Recession Signal

    Every time since the 1960s that the US yield has inverted, a recession has followed within 18 months to two years. So it is no surprise that the recent flattening of the curve, which has seen the 10-2-year treasury yield spread fall to just 25bp, is attracting attention. Many observers say the flattening reflects market expectations of weaker aggregate demand ahead. Some argue that the flattening of the curve itself may cause a recession, by...

    0
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    Gavekal Research

    Still Caught In The Cycle

    The June US labor market report released on Friday appears to bear out Federal Reserve chairman Jay Powell’s view, set out in a speech last month, that “there is a lot to like about low unemployment”. Although the headline payrolls number grew by an unexpectedly strong 213,000 month-on-month, the unemployment rate actually ticked higher from 3.8% to 4%, as greater numbers entered, or reentered, the labor market.

    0
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    Gavekal Research

    A Better Fed Model

    The “Fed model” which values US equities relative to bonds is now more than 20 years old. In that time, it has become widely used and has attracted equally widespread criticism. In this paper Will and KX revise the original to iron out some of its flaws, and come up with an improved model which offers greatly superior risk-adjusted returns.

    6
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    Gavekal Research

    The Trade War And The US Cycle

    How will the US administration’s trade disputes affect the US economic cycle? In the worst case scenario, if Donald Trump follows through on all his threats the disruption to global supply chains could be great enough to push the world economy into recession. At this point, the greatest impact flows from the high degree of uncertainty about future actions.

    0
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    Gavekal Research

    The New Model Duration Rule

    Choosing the right level of duration for a bond portfolio is devilishly tough. It is doubly so when the global interest rate environment is shifting. For this reason KX is introducing a new top-down based duration management tool which encouragingly offers superior signaling and can be used across multiple developed economy bond markets.

    2
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    Gavekal Research

    Is The Fed Really Going To Cause A Crisis?

    Is a crisis in US dollar bond markets really inevitable if the Federal Reserve continues on its current tightening trajectory? Some think so, including Reserve Bank of India governor Urjit Patel, who this month expressed his fears in an op-ed in the Financial Times.

    5
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