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    Gavekal Research

    Avoiding Equity Duration Risk

    Last week, Louis argued persuasively that investors should shorten portfolio duration in response to the prospect of further central bank monetary tightening, the potential threat of rising inflation in 2018, and the stretched valuations of long-dated assets (see Have We Just Glimpsed Growth Stocks’ Achilles’ Heel?). This goes not just for fixed income investors, but equity investors too.

    0
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    Gavekal Research

    Positioning For US Tax Reform

    What’s not to like about tax cuts? Quite a lot as it turns out. Although the final shape of US tax reform has yet to be settled, there are enough common points between the House and Senate bills to allow Will and KX to conclude that the likely tax cuts will prove inflationary, and could prompt a more aggressive stance from the Fed. Despite some undoubtedly positive macro outcomes, the implications for investors are not exactly bullish.

    7
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    Gavekal Research

    Dodging Late-Cycle Refinancing Risk

    By most generally accepted metrics, the US economy is in the late stages of its cycle and any further overheating raises the chances of a recession. The issue is really one of timing. Will Denyer’s Wicksellian model and my US business cycle indicator are both flashing orange rather than red, suggesting that the US is edging towards the recession frontier, but not yet at it. We have both advised investors to dial back on US risk, but are not much...

    2
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    Gavekal Research

    Contradictory Signals On US Corporate Credit Risk

    US high-yield spreads have widened by 39bp over the last three weeks. Nevertheless, by long term historical standards, they remain exceptionally tight, indicating that the bond market is pricing in remarkably little US corporate credit risk. That message is at odds with the tale being told by the US equity market, which is signaling that corporate credit risk is on the rise. Only one of them can be correct. There are good reasons to think it may...

    4
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    Gavekal Research

    Equities When The Dollar Declines

    The US dollar has strengthened over the last couple of months. But the relative maturity of the US cycle, the US dollar’s overvaluation, and the prospect for changes in monetary policy stances outside the US all argue for US dollar depreciation over the medium term. Against this bearish backdrop, KX examines the characteristics of equities that tend to outperform when the US currency is depreciating.

    0
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    Gavekal Research

    The Unconvincing Pick-Up In US GDP

    US third quarter GDP growth came in on Friday at 3% QoQ annualized, much higher than the expected 2.6% rate. The strength of the headline number sparked optimism that the US economy had successfully shrugged off any negative impact from hurricanes Harvey and Irma, and certainly did nothing to discourage equity investors, as both the S&P 500 and the Nasdaq Composite rode buoyant earnings to new highs.

    0
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    Gavekal Research

    US Equity Exposure For The Late Cycle

    The US equity bull run continues even as the US economy issues an increasing number of late cycle indicators. For investors who want to maintain exposure to the stock market but are getting nervous that the economy may soon turn down, KX examines the characteristics that allow stocks to outperform in the late stages of the cycle.

    2
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    Gavekal Research

    Back Away From Buyback Plays

    From a cyclical peak of US$161bn in 1Q16, US corporate share buybacks fell to US$120bn in 2Q17. But although buyback activity is down, it is not out. In the past few weeks companies including Walmart, HP and Allergan have announced new share repurchase programs. The question for investors is whether they should chase these buyback plays.

    0
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    Gavekal Research

    Don’t Count On A Miracle

    Do animal spirits in the US live after all? As profits have picked up, firms’ capital spending has rebounded from contraction territory in 2015-16 to a perky 6.7% QoQ rise in 2Q17. A range of business surveys suggest the trend was sustained through the third quarter. Much is at stake, for if capital spending can break out of its post-2008 range, it is just possible that a productivity surge can follow, lifting underlying economic growth. KX...

    0
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    Gavekal Research

    A Portfolio For The Monetary Cycle

    Every US recession since the 1960s has been preceded by the combination of a fall in true money supply growth relative to real GDP growth, and a fall in the unemployment rate below NAIRU. In this paper, KX constructs a model portfolio which reduces exposure to risky assets in response to these signals, and finds that it offers investors superior risk-adjusted returns.

    3
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    Gavekal Research

    The Real Story With US Inflation

    While hardly ranking as a hawk, Janet Yellen yesterday restated her view that inflation remains a worry. The Federal Open Market Committee as a whole may have last week nudged its 2017/18 inflation forecasts lower, but Yellen continues to argue that weak pricing pressures are transitory. The corollary is that the Fed should stick with its gradual monetary tightening plan. This places her slightly at odds with policymakers like Charles Evans, who...

    2
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    Gavekal Research

    Any US Profits Rebound Lacks Legs

    US equities have rallied to new highs on a favorable liquidity tide, buoyed by hopes for coordinated global growth. But they have also been given a leg-up by an apparently improved US profits outlook, as shown in the second quarter national accounts data. There are, however, compelling reasons to think that an uptick in profit margins cannot last. As 59% of value added by US non-financial corporates went to their workers in 2Q17, these center on...

    0
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    Gavekal Research

    Not That Canadian

    The US and Canadian economies share many similarities due to their geographical proximity, similar level of development and Anglo-Saxon traditions of common law and open political dialogue. So it is curious that each economy’s labor market dynamics are strikingly different. This observation has more than hypothetical significance as workers become hard to find at the right price in late-cycle America.

    5
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    Gavekal Research

    Bank Deregulation Is Not The Answer

    Janet Yellen nailed her regulatory colors to the mast on Friday. In her speech on financial stability at Jackson Hole, the Federal Reserve chair made plain her opposition to any wholesale roll-back of financial regulations introduced in the aftermath of the 2008 crisis. She didn’t mention by name the Financial Choice Act, the attempt currently before Congress to scrap key provisions of the post-crisis Dodd-Frank regulations. But she did address...

    2
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    Gavekal Research

    Can The US Property Engine Fire Up?

    Two years ago banks started to make it harder for US construction firms to borrow and soon after activity began to fizzle. While blame has been pinned on skilled worker shortages and rising costs of both land and materials, KX and Will think financing was the key issue. The good news is that banks seem to be again loosening their purse strings.

    2
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    Gavekal Research

    The Misleading Signal In US Auto Sales

    Trying to tease economic trends out of recent US data releases is a frustrating business. Take yesterday’s figures. Although the ISM manufacturing PMI ticked down a shade in July to come in a fraction below expectations, at 56.3 the number remained firmly in expansionary territory. On the other hand, two classic cyclical indicators of US economic health—construction spending and automobile sales—both came in weak.

    0
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    Gavekal Research

    US Bear Flattening Ahead

    The miniscule change of wording in yesterday’s Federal Reserve statement appears to confirm that the Fed will go ahead and begin to shrink its balance sheet from September. June’s statement said balance sheet normalization would begin “this year”, implying the process would start by December at the latest. Yesterday’s statement altered that to “relatively soon”—and relatively sooner than December suggests September, as the only other meeting...

    0
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    Gavekal Research

    The Eurozone Is Now So Far Behind The US, It’s In Front

    Among the many tricky tasks facing investors is to determine the relative positions of the US and eurozone economies in their respective business cycles. Over the preceding two cycles—the ones that peaked in 2000/01 and 2005/06—the two economies moved broadly in phase, with the eurozone lagging the US by around one year. Estimates from the International Monetary Fund and OECD suggest that that relative position is largely unchanged, with the...

    2
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    Gavekal Research

    Liquidity: More Bad News Than Good

    Gavekal has long maintained that bull markets rest on three pillars: liquidity, valuations, and growth. Now with the Fed set to tighten further in an environment of weak bank credit growth, KX and Will warn that the liquidity pillar which has done so much to support the current bull market in US equities is looking increasingly shaky. That is especially ominous, given that valuations are no longer cheap and catch-up growth is played out for this...

    8
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    Gavekal Research

    Watch US-Eurozone Rate Differentials

    Interest rate differentials between the US and eurozone are wide by historical standards. This is no surprise. The US has enjoyed uninterrupted growth (at least in year-on-year terms) since 2010, and today the Federal Reserve stands as the most hawkish big central bank in town. In contrast, the eurozone slumped back into recession in 2012, and the European Central Bank remains in full-blown easing mode. As a result, interest rate differentials...

    2
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    Gavekal Research

    The State Of US Inflation

    In her testimony to Congress yesterday, Federal Reserve chair Janet Yellen attributed the weakness of US inflation to temporary factors. As a result, the Fed remains focused on tightening policy. However, given that US inflation has consistently undershot the Fed’s target, any further decline will raise concerns that the US business cycle is rolling over.

    0
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    Gavekal Research

    The Payrolls Paradox: Tight Labor But Weak Wage Growth

    As usual the market focused closely on the headline number in last Friday’s employment report, which saw non-farm payrolls come in at a stronger than expected 220,000 in June. As usual, we caution against reading too much into any one month’s figures, for the reasons Anatole has explained so elegantly (see Beyond The March Payrolls Soft Patch). Instead we prefer to take a step back and to attempt to answer the two big questions currently hanging...

    5
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    Gavekal Research

    What Could Turn Around The US Business Cycle? Hint: Not Much

    As often happens, US data is sending mixed messages. Yesterday’s ADP report showed weak job growth in June, despite the latest ISM service sector PMI being decidedly perky. Investing according to the latest high-frequency growth data is a good way to get whiplash. Instead, let’s take a step back and review the US economy’s overall positioning.

    0
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    Gavekal Research

    A Late-Cycle Signal From US Factories

    Determining the exact extent of the US output gap at any point in time is immensely difficult, if not impossible. Earlier this month, KX suggested monitoring four indicators: the gap between actual unemployment and the “natural” rate; real corporate profits; profit margins, and the change of US CPI inflation. Today he adds another indicator to that list: the ratio of factory order backlogs to new orders. By this measure too, the US is running...

    0
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    Gavekal Research

    Calm Sailing For A Reason

    Those with a constructive view of quiescent asset markets say low volatility is justified by the stable economic situation. Others mutter of a looming “Minsky moment”. KX does not rule out a sharp rise in near-term volatility, but says the secular trend is down.

    2
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    Gavekal Research

    Mind The (Output) Gap

    The US economy is offering up conflicting signals. Recent manufacturing survey data has been soft, auto sales have slowed and the rate of job creation has markedly reduced. At the same time, inflation expectations have dipped after their bolt upwards earlier this year. Yet, redirect the gaze and the same US economy shows distinct signs of waddling towards a late cycle denouement with the labor market, in particular, looking tight. Put another...

    2
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    Gavekal Research

    Longer For A Reason

    Could this be the US economic expansion without end? Almost certainly not, but it is starting to break some serious records for longevity. Yet as the expansion gets longer in the tooth, the obvious question is whether it simply withers due to old age. Like Janet Yellen, KX is suspicious of such a deterministic arguments and in this piece says there are very good reasons for economic cycles to be getting longer.

    2
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    Gavekal Research

    Don’t Sweat An Impeachment

    After weeks of ignoring ever wackier White House shenanigans, investors yesterday focused on US political risk. The revelation of memos that seem to offer prima facie evidence of the president obstructing justice means the chance of an impeachment has jumped from improbable to possible. As the government’s investigative machinery cranked up a notch yesterday, US equities experienced their worst day since last September and treasury yields fell...

    2
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    Gavekal Research

    The Headwinds To US Housebuilding

    US home prices are on the up, having climbed 6% over the 12 months to February. Yet housebuilding has failed to keep pace with the rise in prices. Although construction has made a positive contribution to GDP growth over the last couple of quarters, activity has built from a very low base. Housing starts in March were an annualized 1.215mn, with a consensus forecast for April of 1.25mn. Both figures are well below the long term pre-crisis US...

    2
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    Gavekal Research

    Behind Weak US Wage Growth

    After seven steady years of decline, the US unemployment rate fell further in April to a 10-year low of 4.4%—the same as in May 2007 immediately before the onset of the credit crunch. At the same time, the number of job openings has exceeded its 2001 high, emphasizing the increasing tightness of the US labor market. Yet despite this tightening, increases in wage growth have been remarkably modest for this late stage of the cycle.

    8
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    Gavekal Research

    Don’t Bet On Another Bond Bubble

    Recent days have not been good for US treasury bears betting on higher yields. First, Donald Trump’s much hyped tax reform plan proved thin on detail and lacking in credibility. Then Friday’s weak US GDP release for 1Q17 showed an economy facing a notable softening in consumption demand. The one factor offering succor to treasury shorts has been reduced political risk in Europe after a centrist made it through to the second round of France’s...

    0
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    Gavekal Research

    Watch US Money Supply Growth

    Every US recession in the last 50 years has been preceded by a steep fall in true money supply growth, or an outright contraction. So it is worrying that true money supply growth has recently slumped to its lowest since 2008. In this paper KX investigates whether we could be witnessing a false signal, and finds few reasons to be cheerful.

    13
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    Gavekal Research

    US Auto Sales Hit Their Speed Limit

    US auto sales leveled off 18 months ago, and growth has been stalled ever since. Now with interest rates rising and lenders tightening standards on auto loans, KX sees additional reasons to believe that sales have reached their speed limit. Happily, the problems are largely sector-specific, not indicative of general weakness in US consumer demand.

    0
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    Gavekal Research

    After The Health Care Reform Failure

    The Republican drive to repeal and replace Obamacare failed ignominiously on Friday. Together, President Donald Trump and House Speaker Paul Ryan were unable to muster enough support to pass the new health care bill through the House of Representatives. Bowing to reality, they pulled the vote. If there is a positive element to this failure, it is that both the administration and Congress will now shift their focus to tax reform. However, the...

    2
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    Gavekal Research

    The Risk Picture Diminishes

    Yesterday’s 25bp rate rise from the US Federal Reserve was universally expected. The relative dovishness of Fed officials was not. With headline CPI inflation in the US running at a brisk 2.7% in February, ahead of the meeting at least some market participants had been pricing in four rate hikes this year. But after the latest dot plot signaled that policymakers continue to see only three hikes—including yesterday’s—in 2017, those expectations...

    0
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    Gavekal Research

    Don’t Bet on US Manufacturing

    The Federal Reserve seems convinced that strong survey readings point to a strengthening US economy that is becoming self-sustaining. This is the reason that investors are betting with increasing confidence on a series of interest rate increases this year. KX is not convinced that such assumptions are built on solid ground.

    0
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    Gavekal Research

    Calling Time On Bank Outperformance

    Tomorrow Donald Trump is scheduled to address a joint session of the US Congress. Although expected to be long on characteristic bombast, the president’s speech is likely to be short on hard details about his core policies. That shouldn’t be too surprising. Drawing up tax reform and infrastructure spending plans and squaring them away with the Republican majority in Congress will take many months. However, without concrete information to sustain...

    0
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    Gavekal Research

    Are Border Adjustments Protectionist?

    The introduction of border adjustments into the US tax code is by far the most controversial part of the House Republicans’ “blueprint” for tax reform—with good reason. This reform alone would be a game-changer, with many winners and losers. This is why, like all major tax reforms, it faces an uphill battle to become law, and why it may never happen. But the same was said of a Donald Trump presidency, and of Brexit. So, investors still need to...

    5
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    Gavekal Research

    US Inflation: The End Of The Affair

    If there is one consensus view about US markets it is that inflation is ticking up, a tightening cycle is underway and the dollar will again rise. As markets are made at the margin, any hit to these beliefs could push investors into a sharp repositioning. Within Gavekal there is disagreement on this score, with Anatole arguing that US inflation and bond yields are on an upward trend, Charles taking the opposite view and Louis stating that US...

    0
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    Gavekal Research

    Less Than It Seems: US Financial Deregulation

    US bank stocks rallied strongly on Friday on Donald Trump’s promise to tear up much of the Dodd-Frank 2010 financial regulation act. But steering a new act through Congress will not be easy. And while proposals now on the table greatly simplify the existing rules, they do not amount to the wholesale easing of regulations that would be needed to drive a rapid acceleration of bank lending.

    0
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    Gavekal Research

    Border Tax Adjustments In Context

    US president Donald Trump moved a step closer to realizing his “America first” trade policy yesterday, promising a 20% tax on imports from Mexico. However, rather than an outright tariff on imports, it is looking increasingly likely that the new levy will come in the form of a border tax adjustment, as envisaged by the House Republican majority as part of a wider US tax reform program. In theory, border tax adjustments should be trade-neutral,...

    2
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    Gavekal Research

    Do We Need To Worry About The Shrinking US Monetary Base?

    The US monetary base is shrinking, and with Fed officials talking about winding down their bond holdings, it is only natural for equity investors to be concerned. However, as KX explains, the contraction in base money is a technical effect of recent regulatory changes, and the Fed is not yet running down its assets.

    0
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    Gavekal Research

    Tax Reform And The Dollar: It’s Not So Straightforward

    Tax reform is high on the agenda both for US president-elect Donald Trump and for the new session of Congress that began earlier this month. Among the reform proposals that could most affect investors are those advanced by the House Republicans, which many commentators have argued could cause a substantial exchange rate appreciation of the US dollar. In theory—all else being equal—this would be true. But our examination of current exchange rate...

    7
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    Gavekal Research

    The US Equity Dilemma

    On the first trading day of the year, we learnt that the Trump trade remains very much alive. The S&P 500 rose 0.8%, 10-year treasury yields inched up 1.3bp and the DXY US dollar index climbed 0.4%. While investors seem focused on the positive ramifications of a Donald Trump presidency, the year ahead is full of uncertainty—with changes in store for fiscal, monetary, regulatory and trade policies, all of which will occur in the context of a...

    0
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    Gavekal Research

    The Post-Fed Risk Of Sector Rotation

    As expected, the US Federal Reserve went ahead and raised its benchmark interest rate by 25bp yesterday. Less widely expected was the positive tone of the Fed’s comments on the economic outlook, and its slightly more hawkish view on the trajectory of rates, with policymakers now projecting three rate increases next year rather than two. Fed chair Janet Yellen described the changes as “tiny”. But the market reaction—10-year treasury yields rose...

    0
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    Gavekal Research

    Cash Repatriation Won’t Trigger A New Buyback Boom

    With the incoming US administration promising big tax breaks on the repatriation of corporate cash piles held overseas, Wall Street is confidently predicting a renewed equity market buyback boom in 2017. On first hearing, this sounds like a reasonable expectation. For one thing, in recent years US companies have consistently chosen to plough their retained earnings—and a sizable amount of debt—into share buybacks, rather than into investment in...

    0
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    Gavekal Research

    Riding The US Monetary Cycle

    In market conditions that abound with conflicting signals, KX argues that investors should keep a close eye on an adjusted measure of real US money supply growth as an early warning signal of recession, and suggests how a tool based on this measure could make a useful allocation tool for equity managers.

    4
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    Gavekal Research

    A Cautionary Note On US Housing

    After months of anemic activity, US homebuilding picked up in October. This is a welcome development, given that residential construction is a key leading indicator for the overall economy, and that lately it has been close to sending a recession signal (see On The Brink Of Recession). However, the magnitude of the improvement should not be overstated. While housing starts did post the biggest monthly increase since 1982, this is a volatile...

    0
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    Gavekal Research

    The End Of The Goldilocks Scenario?

    Over the last seven years global investors have benefited greatly from a combination of moderate growth and non-threatening inflation, allowing for constantly loose monetary policy. Yet for the US, we are increasingly concerned that, one way or another, this “Goldilocks scenario” is about to come to an end. Here’s why:

    4
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    Gavekal Research

    The Strange Case Of The US Trade Deficit

    The last three years saw the US dollar move from being an undervalued currency to an overvalued one, and yet the US trade balance has barely budged. This contrasts sharply with past periods of dollar strength which produced huge US trade deficits that were a boon to global exporters, and also to financial markets which got a liquidity boost. The fear for emerging economies in particular is that this relationship has broken down and a reliable...

    3
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    Gavekal Research

    The Rising Odds Of A US Recession

    We are on recession watch after yesterday’s release of September’s NFIB small business optimism survey. It was not the headline number which got us worried—that ticked down from 94.4 to 94.1. Rather, it was the significant drop in the job openings component—from 30 to 24, or from a cyclical high to the lowest level in 15 months. This suggests that demand for US labor may be rolling over, which is concerning indeed.

    7
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    Gavekal Research

    Tan Kai Xian & Leonor du Jeu: The US Trade Deficit Conundrum

    0
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    Gavekal Research

    Emerging From The Soft Patch

    Three weeks ago we asked whether the uniform weakness in US data—across manufacturing, services and home construction—signaled the start of a recession or merely a summer soft patch. At the time we concluded that what we were seeing was yet another soft patch. Thankfully, the latest round of data releases appears to confirm that conclusion, with the US economy now emerging from its summer doldrums.

    0
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    Gavekal Research

    The Gavekal Monthly: What Price On A Trump Victory?

    Markets seem sanguine about the prospect of a Donald Trump victory in next month's US presidential election—too sanguine. Expert opinion gives Hillary Clinton a 75% chance of winning. But remember that four months ago in the UK, expert opinion discounted polls showing a strong chance of Brexit, and the experts were proved wrong. And the consequences of a Trump win are so huge and potentially destabilizing that even a 25% chance means...

    0
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    Gavekal Research

    Wicksell's Guide To A Better Portfolio

    With the recent US economic data worryingly soft, and with no convincing drivers of earnings growth to be seen, how should investors position their portfolios? Will and KX set out their methodology for structuring a dynamic Wicksellian portfolio to generate superior returns at reduced levels of volatility, and determine the optimum allocation mix for the current troubled environment.

    7
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    Gavekal Research

    Don’t Count On US Profits Riding To The Rescue

    A funny thing happened to US equities once the dust cleared after the late June sell-off that was sparked by the UK’s Brexit vote. As yields of most income earning assets fell on hopes of yet more central bank easing, equity investors discarded growth concerns and engineered a multiple expansion which drove the market to new vertigo-inducing highs (see Real Yields In The Driving Seat). The big question now is whether a profits boost can keep the...

    1
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    Gavekal Research

    Will & KX: Soft Growth And Volatile Markets

    Will and KX present the quick view on the US economy and financial markets

    0
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    Gavekal Research

    Knowing Whether To Buy The Dip

    With all the current focus on the Federal Reserve and markets, it’s easy to overlook the increasingly ugly state of the underlying US economy. Throughout the long post-2009 recovery, when any one driver of US growth showed signs of stalling, the others continued ticking over nicely, which meant overall growth averaged out around 2%. Recent data releases signal that has now changed. Although none of our key indicators has shown a dramatic...

    4
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    Gavekal Research

    Real Yields In The Driving Seat

    Notwithstanding yesterday’s bounce, the stock market is a nervous place just now. After riding a post-Brexit rebound that saw both the S&P 500 and the Nasdaq Composite scale record highs on minimal volatility, investors are increasingly wondering about the extent of the potential near term downside, not just in the US but around the world

    2
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    Gavekal Research

    The Gavekal Monthly: How Long Can The Rally Last?

    Investors enjoyed a surprisingly upbeat summer with the World MSCI close to an all-time high and emerging markets continuing to benefit disproportionately. Yet with the Federal Reserve sounding increasingly hawkish, earnings looking soft and political uncertainty remaining the order of the day, this Gavekal Monthly focuses on threats to the current benign market mood.

    0
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    Gavekal Research

    The Return Of US Fiscal Policy

    More than three years after the world fretted about the US economy falling off a “fiscal cliff”, there is suddenly much talk of government spending being used to gin up growth. Whatever their many differences, both Hillary Clinton and Donald Trump favour a fiscal expansion, with a focus on upgrading the US’s aging infrastructure stock. At the same time Federal Reserve officials, led by Janet Yellen and John Williams, are arguing for more fiscal...

    3
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    Gavekal Research

    The Fed’s Hawkish Stance

    For those who thought Janet Yellen a dyed-in-the-wool dove, her Jackson Hole speech on Friday gave pause as she endorsed fellow policymakers’ recent statements that the US economy was strong enough to warrant interest rate rises. Markets quickly adjusted. The implication for global asset markets is not altogether encouraging.

    0
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    Gavekal Research

    The Next EM Yield Play?

    With global growth having stabilized and central banks remaining in super-easy mode, the dash for yield is making emerging markets ever more interesting. In recent months a number of our Hong Kong-based writers have advised investors to play this trend through bonds not equities, with Udith chiming in on Monday (see Indonesia: Bet On Stability Not Growth). The question for those who expect this “not too hot, not too cold” phase to persist is...

    7
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    Gavekal Research

    Cheap For A Reason

    By most measures, US equities are not cheap. Yet many investors remain overweight, believing that in a world of ultra-low interest rates and negative bond yields, equity valuations should be higher because future cash flows are now discounted at a much lower rate than in the past. At first glance, the equity risk premium—the expected return on stocks over and above the risk-free rate—appears to support this belief. At more than one standard...

    0
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    Gavekal Research

    Beware The “High Dividend” Lure

    Investors have been piling into US high dividend plays as they offer decent income and a “margin of safety” in an increasingly expensive equity market that, despite soft earnings, continues to make new highs. The chase for yield has been boosted by global central banks’ easing measures which have helped drive bond yields to pifflingly low levels; at the same time the S&P 1500 dividend yield has stayed steady this year at about 2%. Yet any...

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    The Caveat In US Payrolls

    Notions of a US growth scare were apparently banished on Friday with a bullish payroll report for July helping drive US equities to a new high and causing the dollar to rally strongly. Some 255,000 jobs were added—far better than the expected 185,000—while a cycle-high average hourly earnings gain of 2.6% YoY points to strong domestic demand. So how to square this data with the far less cheery 2Q16 GDP report, released last week, which showed...

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    Video: Risks In US High Dividend Stocks

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    The Baleful Influence of Inventories

    The reason US second quarter GDP growth was so disappointing at 1.2% QoQ annualized was a deep contraction in US business inventories, which knocked -1.16pp off the quarterly growth figure. In itself, a fall in inventories need not be such a bad thing for longer term growth. If inventories get run down because companies are unable to keep up with a surge in demand, then a fall in inventories can foreshadow increased investment to expand business...

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    The Gavekal Monthly: Shall We Dance?

    In a world in which the Fed shows no inclination to get ahead of the curve on inflation and in which both the ECB and the BoJ are in full quantitative easing mode, investors everywhere are on the hunt for yield. But the chase is a nervous one. Investors are all too aware that equities and bonds are sending conflicting signals, and that the favorable trends that have lifted most assets over the last six months could be disrupted by a sudden spike...

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    There’s No Need To Fear A Tighter Fed

    While the US Federal Reserve left interest rates unchanged yesterday as expected, it did revise its statement to sound marginally more hawkish. Most notably, it added the line, “Near-term risks to the economic outlook have diminished,” while tweaking its language to reflect recent relatively solid data releases. The market took the announcement in its stride. The S&P 500 ended the day little changed. Yields on 10-year treasuries fell...

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    US REITs And The Rush For Yield

    One of the side effects of negative interest rates and central bank asset purchases in the eurozone and Japan has been a reach for yield which has seen foreign investors rush into relatively high-yielding US assets, compressing yields and spreads to an extent that appears at odds with the late-cycle stage of the US economy. Earlier this month the 10-year US treasury yield set a new low of 1.36%, while US Baa-rated corporate bond yields fell to...

    2
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    The Consumer Alone Can’t Avert A US Recession

    With a strong US job market auguring well for income growth, and healthy household balance sheets, many believe the growth of consumer demand will outweigh dismal exports and weakening capital spending, staving off recession. But close inspection of historical data shows the US can tip into recession even though consumption remains broadly stable.

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    US Auto Sales: Shifting Down A Gear

    At first sight it was worrying last week when June’s number for US automobile sales came in at a disappointing 16.7mn annualized, well below the street’s expectations of 17.3mn. Auto sales are closely followed as a leading indicator of both US consumption growth and the overall business cycle, so at this stage in the cycle, when consumption is the only remaining driver of US economic growth, the undershoot was especially troubling. Worse,...

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    Beyond Brexit, A More Hawkish Fed

    After the Federal Open Market Committee yesterday revised down both its growth forecast and its projection for the future trajectory of US interest rates, market expectations of rate hikes have collapsed. Fed fund futures are now pricing the probability of a July rate hike at just 6%, down from 16% immediately before the FOMC’s meeting. In reaction, the yield on 10-year treasuries has dipped further below the 1.6% mark to 1.56%, the lowest since...

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    Boomerang Kids Won’t Come Back To Hurt US Housing

    Hand-wringing features about “boomerang kids” have become a staple of the US media in recent years. Invariably they tell of a generation that left college with record student debts, only to find themselves looking for work in a depressed post-crisis employment market with little demand for newly-minted graduates. Unable to find jobs matching their qualifications, many ended up serving coffee in Starbucks, or doing other menial work on near-...

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    The Dissonance In Jobs

    This week has seen Gavekal senior partners reach a rare consensus of sorts, with Anatole acknowledging that May’s “pig ugly” US payrolls report upped the chances of Charles’s US recession scenario playing out (see Thinking Dark Thoughts). For me, the report offers a classic mixed signal: on the one hand the slowdown in US employment growth could stem from firms dialing back hiring in anticipation of trouble ahead, or alternatively it could be...

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    The Gavekal Monthly: Risks For Equities—Populism And The Dollar

    Even as markets nudge higher, investors are unnerved by a rising tide of populist politics whose tangible expression will be tested on June 23, when UK voters must choose between Brexit or a less than perfect status quo inside the European Union. Investors are also concerned that the US dollar will strengthen further as the Federal Reserve mulls the question of whether to raise interest rates. In this monthly our writers weigh these big issues...

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    The Next Move In US High-Yield

    At the nadir of the market sell-off in February, the Federal Reserve offered more dovish than expected guidance on its monetary policy intentions and so backstopped the crumbling US high-yield bond market. Since then, high-yield bond prices have rallied back to their early-2015 level with the last month seeing a consolidation. Yet with the chances of a Fed rate hike in June on the up and the fundamentals of the US economy looking less than...

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    The End Of The US Credit Cycle?

    As a reflection of the US economy’s steady if unspectacular recovery, bank loan growth has averaged a solid 7.8% YoY since early 2015. The biggest recipients of this expansion have been commercial and industrial firms followed by real estate developers, with consumer lending sitting some way back. Since 3Q15, however, the Federal Reserve’s senior loan officer survey has signaled a sharp tightening in standards for both C&I and commercial...

    2
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    Risk On? Maybe Not

    Equity and oil prices have rallied in true risk-on fashion since the February 11 market trough, and are now back near their highs of late last year. Given this apparent rebound in risk appetite, one might have expected US government bonds to sell off in equally dramatic fashion, with yields climbing back to the 2.2-2.3% levels seen at the end of last year. Instead, there has been no rebound at all. Today, 10-year treasuries yield 1.75%, much the...

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    US Homebuilders Hit A Speed Bump

    Homebuilding has been a reliable contributor to US growth over recent years. Now tighter lending standards for new construction projects and commercial real estate loans are threatening a slowdown. But, as KX and Will argue, as long as mortgage rates remain low and demand robust, the sector should only hit a speed bump, not a wall.

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    Is US Manufacturing A Leading Indicator?

    There is a commonly held belief that US manufacturing leads the rest of the economy, so it is surely a worry that factory output has been flat since late 2014. And yet the broad economy kept growing—with GDP up 2% YoY in 4Q15, consumption up 2.7% YoY, and home construction by almost 10%. One explanation for this apparent decoupling is the US’s shift to a more service-intensive “knowledge economy” which has rendered metal bashing and more...

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    The Slowdown In Services

    Both the main leading indicators of activity in the US services sector—the ISM services PMI and the Markit services PMI—staged modest rebounds in March. But on the face of it, the pick-up in the headline numbers offers little encouragement for investors. At 54.5 for the ISM and 51.3 for Markit, both measures remain substantially below their 2015 averages of 57.2 and 55.9 respectively. Considering that services make up 70% to 80% of the US...

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    Why US Imports Are Disappointing

    Given the strength of the dollar, it is not surprising that 2015 generally saw US exports contracting, US imports growing, and the trade balance widening. What is more perplexing is that import growth has started to look shaky in the first part of this year. What gives?

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    US Housing: From Great To Good

    The US housing recovery properly kickedoff in 2011 as a confluence of benign factors converged to favor the sector. Yet while housing continues to provide a much-needed positive contribution to US economic growth, recent data points to reduced momentum. After a weak January, homes sales for February, released yesterday, ticked a little higher. Yet over the last year, sales have been choppy and generally flat. The NAHB index also shows...

    2
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    The Fed Is Falling Behind The Curve

    The Federal Reserve surprised no one yesterday when it decided to remain on hold. But the downward shift in its projection of year-end inflation from 1.6% to 1.2%—and the consequent revision of its dot plot to show two, rather than four, rate hikes in 2016—should have raised a few eyebrows. By adopting such a dovish stance, the Fed is in increasing danger of falling behind the curve on inflation, which in turn implies that the risk of sharper...

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    The State Of US Profits

    With the US earnings season for 4Q15 done and dusted it is clear that the glory days of this cycle are long gone: aggregate sales for S&P 500 firms fell -4.0% YoY, profits tumbled -7.5% and margins for the period (not the trailing measure) compressed by -2.2pp to 6.5%. The big drivers of profits were (i) the oil price collapse, (ii) the strong US dollar and its crimping of exporters, and (iii) the tendency for rising wages to erode margins....

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    Back To Climbing The Wall Of Worry

    Just three weeks ago markets were in full-blown panic mode. The S&P 500 was down -10% YTD, 10-year treasury yields were down to just 1.6%, and credit spreads were close to their cyclical highs. Dark clouds seemed to be rolling in on every front—from China, Brazil, Europe, banks, and the energy sector, all compounded by fears the Federal Reserve had made a grievous policy error. Since then, the skies haven’t exactly cleared, yet the S&P...

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    The Gavekal Monthly: Enter Ursus Magnus?

    January was a hair raising month for investors with a deeply worrying combination of falling oil prices, plunging equities and soaring yields for sub investment grade debt. In this edition of the Gavekal Monthly we seek some answers to the “what next” question, kicking off with Charles and Anatole who take very different views on whether a bear market is upon us.

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    High Yield Worries

    Attention may have focused yesterday on the oil price collapse and its knock-on to US equities, but there was also grim price action in the sub-investment grade debt markets—the high yield master index fell back towards its December low, while the CCC-rated index breached that threshold. This pain can be attributed to worsening conditions in the energy sector, where the chance of large scale defaults increases with each lurch lower in the crude...

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    The Gavekal Monthly: The Balance Of Risks

    The new year has been a wild ride so far, with sharp drops in the renminbi, Chinese stock markets, and oil prices leading global markets down. In our first Gavekal Monthly of 2016 we try to make sense of the risks facing investors today. As usual there are some strong differences of opinion: Anatole argues that developed economies are in decent shape, the dollar's rise will soon be over, and equities should post a better performance than...

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    The Shudder In US Credit

    As oil prices tumble and the first US interest rate hike for eight years comes into view, bond investors in the high-yield segment are taking flight. The market was given a foretaste of what a disorderly unwinding of an over-bought US corporate bond market may look like late last week, when two high-yield bond funds suspended redemptions. The worry is that these tremors become an earthquake, making it more costly for all companies to refinance...

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    What To Make Of Wider Credit Spreads

    US credit spreads are ticking up again, driving the Merrill Lynch US high yield index below its early October low yesterday and bringing total returns for the year to date to -3.4%. This renewed widening of spreads raises some important questions for asset allocators and economy watchers. Has the bond market got itself into an unwarranted flap, providing investors with a good opportunity to lock in some elevated yields? Or has the corporate debt...

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    The Gavekal Monthly: A Cloudy Currency Outlook

    The Gavekal Monthly outlines our highest conviction ideas and summarizes the key economic, market and thematic views held by the firm’s partners and analysts. This report is an attempt to answer a question that we are often asked, but find it hard to answer: "What does Gavekal think?".

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    Brace For Lower US Margins

    As the end of the 3Q15 US earnings season comes into view, what stands out is how little things have changed from the last quarter. Alas, corporate America’s financial performance is stabilizing at the weakest level seen since the 2008 crisis—with more than 90% of S&P 500 firms having reported, both revenue and profits came in about -4.5% lower compared with a year ago. This grim performance is partly explained by the ongoing bloodbath in...

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    The US Inventory Problem

    The US business inventory-to-sales ratio (in real terms) is one of our key recession indicators. We have been uneasy ever since it broke to a new cyclical high in May. Since then it has continued to inch higher, and in September, the latest data-point available for the total business sector, it reached a level typically seen only in recessions. Even more worrying, the rise in the inventory-to-sales ratio cannot be blamed on the travails of the...

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    The Gavekal Monthly: A Possible Return Of US Inflation

    The Gavekal Monthly outlines our highest conviction ideas and summarizes the key economic, market and thematic views held by the firm’s partners and analysts. This report is an attempt to answer a question that we are often asked, but find it hard to answer: "What does Gavekal think?".

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    Positioning For A Hawkish Fed

    What have we learned from the world’s largest economy in recent days? It would seem that a fairly hawkish Federal Reserve is ready to raise interest rates in December, while for all its dysfunction Washington has done a deal to keep the US government running for the next two years without threats of a debt default. Considering that two months ago the concern was that the global economy was about to tip into a China-induced death spiral, this...

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    The Ominous Signal In Inventories

    One of the characteristics of a recession is an overhang in inventories, which must then be sold off or written down before growth can recover. The overhang results from overproduction during the final stages of the preceding boom, an unexpected collapse in demand, or both.

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    Position For A Pick-Up In US Inflation

    Everyone agrees that US inflation, if not actually dead, is unlikely to gain a new lease on life any time soon. With oil prices down -48% over the last 12 months and the US dollar up 11%, inflation as measured by personal consumption expenditure is just 0.3%, while core inflation (ex-food and energy) is down to 1.3% year-on-year. What’s more, investors expect no acceleration in price rises over the medium term. The implied breakeven inflation...

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