Central Bank Policy…2017 Outlook: Fed Still Behind the Curve

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By some measures, the Fed has been behind the curve since mid-2014, in not gradually raising its policy rate.1 Granted the Fed chose to delay initiating its hikes until unemployment fell below its 5% target in Q42015, while maintaining concerns over historically low core inflation. Despite a second quarter-point hike now after a one year pause, the Fed finds itself even further behind the curve than at this time last year. Even under an accommodative rules-based policy rate, December’s rate should be closer to 2-2 1/4 and not 0.75%. As it stands, real policy rates (minus core inflation) are -1%, when full employment and 2% GDP growth would imply a 0.6% neutral real rate as a minimum. If real GDP growth continues above 2.5% as Q4 is trending, then the neutral rate would approach 1%, still significantly below the 2.1% neutral rate average in the 20-yr period up until the GFC.


We think that neutral Fed real rates (FF rate minus PCE deflator) should hover between 0.6% and 1.2% (1stdev of 15 year trend where natural rate r =1.3x g and g has fallen 0.5% over last 10 years) over the next few years. If core inflation creeps up to 2.0% over the next year, from 1.65% now, then the Taylor-rule FF rate target would rise to 2.50%. In addition, CPI is likely to reach 2.3% next year from 1.7% currently, with crude oil alone adding 40bps at current prices. As CPI exceeds core inflation, neutral real rates would likely increase from 0.6% to 1.2% bringing the target FF rate to 3.1% by December 2018. Clearly the risk is on the upside!


Though long-term real rates were negative as recently as Q3CY16, they are now 80bps and should reach 110bps by the end of 2017.2 Should the CPI exceed core inflation by more than 50bps, then we expect term premia to rise from 22 bps now to 100bps+, pushing 10 year treasuries to as high as 4.2% by the end of 2018 (see Chart p.12). In fact, ‘Greenspan’s conundrum’ could very easily end up becoming ‘Yellen’s conundrum’ (if reappointed to a second term), as the market, being significantly ahead of the fed would likely push 10 yr yields to 4% long before the fed finishes ratcheting up its hike path through 2019, ending the current recovery.


Finally, if the Fed drains off $2trn in excess liquidity over the next 4 years (contrary to its current stated intention), real long term rates could rise an additional 60-120bps. However, attractive swap rates (Chart 6) should ensure that overseas demand limits the rise, while demographics will continue to favour strong demand.

Implications

  • The Fed has been leading the central banks’ rate cut race to the bottom and must begin to redress policy rate misalignment (Charts 12, 14)
  • Confusing and contradictory FOMC guidance may call for implementation of rules-based policy rates (p.10)
  • Inflation is likely to pick up faster than current Fed path indicates, leading to a ratcheting up in rate hike forecasts. Expect four quarter-point hikes in 2017 and 2018 (Charts 8, 9)
  • The Fed is likely to see significant intervention from Congress should it not begin draining excess liquidity over the next four years (p.3)
  • Though real long-term rates and term premia should rise over the next few years, demographics and overseas demand to limit the slope (Chart 7)
  • Chair Yellen’s allusions to a return to Greenspan’s ‘high pressure economy’ are misplaced (p.20)
  • Policy rates are like lighter fluid or kindle for a fire; they will help start the fire but this does not provide long-term growth. If anything, excessively low short-term rates
    encourage business to increase leverage and thus volatility as ROA peaks (Chart 15).

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What Worked Asia - 17 Feb 2017 - More than 400 names moved on Volume in Asia this week

What Worked Large-cap names and Value did well in China this week as low Debt to Equity names were hurt. Hisense Kelon Electrical Holdings is up 17% and Beijing Enterprises Clean Energy is up 15%. Nothing stood out in Hong Kong.  Names down over the last month bounced up in South Korea. EO Technics is up 12% and Hankook Tire is up 8%. In Taiwan there was a slight selloff in Size and Quality names. Win Semiconductors is up 24% and General Interface Solution is up 13%.

In India there was a slight move into Size and away from high Beta names. Tata Motors is down 11% and Advanced Enzyme Technologies is down 12%. Growth names were hurt in Singapore this week. Hutchison Port Holdings is down 13% and Japfa is down 4% this week. Low PBR and Momentum names did well in the Philippines this week.

Who Moved – A very high 404 names moved on volume this week. All the volume spikes were spread across the region. However a quarter of the volume spikes came in the Financial Sector. On the positive side, PT Medco Energi Internassional is up 64%, Goldin Financial Holdings is up 50% and Formosa Sumco Technology is up 40%. On the other side, Luen Wong Group is down 28%, PChome Online is down 15% and Season Pacific Holding is down 18%.

Summary

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What Worked Japan - 17 Feb 2017 - Low PE did well this week, Large-cap continues to underperform

What Worked – After not really working since the end of last November, low PE name did well this week. Toyo Tire & Rubber (5105) is up 25%, MinebeaMitsumi (6479) is up 19% and DMG MORI (6141) is up 14%. High Dividend Yield names also did well this week. DIC Corp (4631) is up 7%, NSK (6471) is up 6% and Toda (1860) is up 6%. Large-cap names continued to underperform and have been beaten up since last June.

There have really only been three weeks since last June when large-cap name have outperformed. Large-cap names that were down this week were Toshiba (6502) down 23%, Iida Group (3291) down 11% and Nikon (7731) down 10%. There was also a slight move into high Beta names. High Beta names have quietly been outperforming since the beginning of the year. Mitsui Mining and Smelting (5706) is up 19% and Tokio Marine Holdings (8766) is up 5%.

Who Moved – 42 names moved on volume this week. The volume spikes look to be spread across all sectors. On the positive side, Toyo Tire & Rubber is up 25%, Mitsui Mining and Smelting is up 19% and MinebeaMitsumi is up 19%. On the other side, Iida Group (3291)is down 11%, Nikon is down 10% and Asics Corp (7936) is down 9%.

Summary

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What Worked Australia - 17 Feb 2017 - Forward PER showing good results

What Worked – PER has been providing some solid outperformance over the last 2 months (since mid-December 2016), and continued into this week. Although the last couple of weeks this signal has been somewhat ignored, the cheapest names in the market by forward PER have generated more than 5% outperformance, while the most expensive names have generated -3.2% excess returns over the benchmark. Forward PER had a horror run through 2015, and was a bit of a roller-coaster ride through 2016, but the trend seems to be to the positive at the moment.  Low PER names doing well this week included Qantas Airways (QAN, +3.0%), Whitehaven Coal (WHC, +2.9%) and St. Barbara Limited (SBM, +4.3%), while the more expensive side saw a number of names posting losses for the week - NextDC (NXT, -5.6%), Nanosonics (NAN, -1.9%) and Domino’s Pizza (DMP, -12.3%) among them.

 While very short term momentum (the generally reverting kind) was flat this week, 3M month momentum continued to be sold off this week, making it the worst performing over the last month. While the 3M laggards hovered around the benchmark, it was the winners over the last 3 months that have sold-off heavily. Over the last month the top names measured by trailing 3M momentum have lost out -3.8% to the benchmark. Names down this week include Galaxy Resources (GXY, -7.8%), DUET Group (DUE, -2.1%) and Bega Cheese Limited (BGA, -3.9%). 12-Month momentum on the other hand has been providing some solid performance figures over the last month, and continued to do so this week with Resolute Mining (RSG, +7.2%), Fortescue Metals (FMG, +6.3%) and Mineral Resources (MIN, +1.6%) all continuing to maintain their spots at the top of the index’s 12 month winners table.

Who Moved – A lot of names moved this week on volume – 29 out of the 200, one of the biggest percentages of the market in a while. Names off this week backed by significantly higher than normal volumes include Primary Health Care Limited (PRY, -16.2%), Domino’s Pizza (DMP, -12.3%) and IOOF Holdings (IFL, -7.6%); while in the winner’s circle South32 Ltd (S32, +5.9%), SIMS Metal Management (SGM, +3.9%) and Computershare (CPU, +4.1%) topped off the names in the black on volume this week.

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Summary

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What Worked Asia - 10 Feb 2017 - Value (PBR) and Beta did well in Asia ex this week

What Worked –Value, particularly low PE, and Beta dominated in China this week.  Guangzhou Automobile is up 14% and Greenland Hong Kong Holding is up 13%. To a slight lesser degree PE and Beta also were strong in Hong Kong. NewOcean Energy Holding is up 43% and Country Garden Holdings is up 20%. In South Korea, PBR continued to dominated. PBR is clearly the strongest factor in South Korea over the last month. SK Networks is up 16% and LS Corp is up 13% this week.

Low PE names did well in Singapore. Oxley Holding is up 18% and Yangzjiang Shipbuilding is up 7%. Low Debt to Equity names did not do well this week in Singapore. Beta and low PBR names did very well in Malaysia. DRB-Hicom is up 6% and UEM Sunrise is up 6%. Large-cap names did well in Taiwan after a good selloff the previous week. In India nothing really stood out this week.

Who Moved – 305 names moving on volume this week. A good number of the volume spikes came in Taiwan and India. Almost half of the volume spikes came in the Finance and Electronic Technology sectors. On the positive side, PT Bank Rakyat Indonesia Agroniaga is up 55%, NewOcean Energy is up 43% and TPK Holding is up 38%. On the other side, Korea Zinc is down 15%, Korea Aerospace Industries is down 11% and SK Materials is down 9%.

Summary

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What Worked Japan - 10 Feb 2017 - Beta and Price Momentum continue to drive the market

What Worked – High Beta and short-term (3-month) momentum names continued to do well this week. Over the last month, these two factors have driven the market. High Beta names that outperformed this week were Ibiden (4062) up 20%, Asahi Glass (5201) up 10% and Taiyo Yuden (6976) up 9%. Momentum names that did well this week were Disco (6146) up 19%, Yahoo Japan (4689) up 17% and Nippon Electric Glass (5214) up 12%.

Low PBR names also did well this week. Low PBR name have not done this well since the end of November last year. Other Value factors were pretty much insignificant this week. Low PBR names that outperformed were Kobe Steel (5406) up 9% and Sankyo (6417) up 7%. Growth continued to not work. Growth factors have consistently not done well since the middle of December last year. Yamaha (7951) is down 12% and Teijin Limited (3401) is down 8%. ROE / ROIC names also continue to not do well this year.

Who Moved – 42 names moved on volume this week. On the positive side, Ibiden Co (4062) is up 20%, Disco (6146) is up 19% and Yahoo Japan (4689) is up 17%. On the other side, Yamaho (7951) is down 12%, Teijin Limited (3401) is down 8% and Kaneka Corp (4118) is down 7%.

Summary

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What Worked Australia - 10 Feb 2017 - Beta and Momentum still off

What Worked – This week saw the longer term momentum signals continue to peel off returns made over the 3-12 months, while names that lost over the last week bounced a little, the winners from last week also saw additional gains. While names up opver the last three months did see a slight uptick, the numbers this week were being driven in large part by a pickup in the names down over the last 3 months – with bottom of the market picking up +3.0% outperformance this week. Names down over the last 3 months that saw market beating returns this week included Bellamy’s Australia (BAL, +11.9%), Aconex (ACX, +6.8%) and Mayne Pharma (MYX, +9.8%). Names up over the last 3 months that sold-off this week included Galaxy Resources (GXY, -7.6%), QBE Insurance (QBE, -2.8%) and Downer EDI (DOW, -2.3%).

Earnings Revisions also saw very negative numbers this week – not driven by a sell-off in the higher revision names, but rather buying into the names with poor revisions, over both the 1 month and 3 month periods. Names showing terrible forecast earnings revisions over the last month that picked up this week included Transurban Group (TCL, +5.1%), Resolute Mining (RSG, +7.5%) and Saracen Mineral Holdings (SAR, +9.6%). High beta names also saw selling pressure this week, going against the positive direction of the market overall. High beta names such as Santos Limited (STO, -3.5%), Beach Energy (BPT, -4.0%) and BHP Billiton (BHP, -3.0%) all finished the week lower.

Who Moved – 12 names managed to move on substantially higher than normal volumes this week – back up in line with the long term norm. On the positive side, Seven Group Holdings (SVW, +16.4%), CIMIC Group (CIM, +10.7%) and Premier Investments (PMV, +8.5%)  all finished higher backed by strong volume, while Genworth Mortgage (GMA, -17.4%), Tabcorp Holdings (TAH, -7.7%) and James Hardie (JHX, -5.0%) all finished off weaker.

Please take a look and let me know if we can do anything else.

Summary

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What Worked Asia - 03 Feb 2017 - Large cap names were hurt across the region this week

What Worked – With Chinese New Year this week, not a lot stood out in China / Hong Kong. In South Korea, there was a good sell-off in high Beta names and a slight move away low PE names. High Beta names that were hurt were Jeil Pharma is down 19% and AmorePacific Group is down 10%. Large-cap names took a big hit in Taiwan this week. Eclat Textile is down 11% and POYA International is down 6%.

To a lesser degree large-cap names also did not do well in Singapore. Frasers Centrepoint is down 4% and Ascott Residence Trust is down 4%. In India, low PBR and high Beta names did well this week. The low PBR name outperformance looks to be concentrated in the Financial sector. Vijaya Bank is up 31% and Bank of Maharashtra is up 16%. Large-cap names were also hurt in the Philippines this week. GT Capital Holdings is down 6% and Bloomberry Resorts is down 5%.

Who Moved – 78 names moved on volume this week. More than half of the volume spikes came in India this week. On the positive side, China Oriental Group is up 49%, Idea Cellular Limited is up 42% and C.banner International Holdings is up 21%. On the other side, Jeil Pharma is down 19%, Bharti Infratel is down 16% and Hyundai Wia Corp is down 11%.

Summary

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What Worked Japan - 03 Feb 2017 - Slight move away from high Beta names and into Quality

What Worked – Slight sell-off in high Beta names and names with a high % of Institutional Investors this week. Both factors turned positive this week after three weeks of underperformance. High Beta names that did not do well were Nippon Steel Glass (5202) down 15%, Konica Minolta (4902) down 12% and Mitsubishi Heavy Industries (7011) down 11%. Names with a high % of Institutional Investors that went down were Hokuriku Electric (9505) down 11%, Tokyo Ohka Kogyo (4186) down 11% and Fuji Heavy (7270) down 10%.

Low Debt to Equity names did well this week. Looking back, low Debt to Equity name have not done well since the middle of last December. This week Canon Marketing Japan (8060) is up 13%, Chugai Pharma (4519) is up 11% and Itochu Techno-Solutions (4739) is up 8%. There was also a slight selloff in low PE name this week.

Who Moved – Despite Chinese New Year this week 32 names moved on volume. On the positive side, MonotaRO Co (3064) is up 25%, Yakult Honsha (2267) is up 15% and Start Today (3092) is up 14%. On the other side, Kakaku.com (2371) is down 22%, NEC (6701) is down 17% and Capcom (9697) is down 13%. All moved on strong volume.

Summary

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What Worked Australia - 03 Feb 2017 - Short term reversal, Beta hit

What Worked – This week saw most of the values signals flat and without direction, bringing the average performance for value metrics over the first month of 2017 to slightly down, but not much off flat. While momentum has had a reasonable run for the start of the year, this week saw a reversal in the shorter-term momentum metrics, while long term (12 Month) momentum continued to run, producing a compound return spread over the last month of +4.6%, compared to the benchmark return of -1.9%. Names up strongly last week that reverted this week included Sandfire Resources (SFR, -2.5%), Orocobre Limited (ORE, -13.6%) and Altium (ALU, -2.0%). This was a little one sided though, with names down last week also not faring well this week. This contrasted with the long-term momentum names who continued their run this week. Amongst these were Resolute Mining (RSG, +8.4%), Fortescue Metals (FMG, +2.0%) and Downer EDI (DOW, +9.4%).

Size also performed well this week, although it was driven by an underperformance in the small cap space rather than larger end of the benchmark doing anything special. OFX Group (OFX, -23.3%), Virtus Health (VRT, -16.7%) and Aconex (ACX, -48.3%) all down heavily this week. Beta also saw a selloff this week, but not really being driven by the small cap space. Some big, high beta names also took a hit this week, amongst them were Santos Limited (STO, -2.9%), Whitehaven Coal (WHC, -2.4%) and Origin Energy (ORG, -2.5%). On the other side of that trade though, low beta names produced more positive returns than negative this week.

Who Moved – 14 names from the benchmark moved on volume this week, and only one of those managed to end the week higher. Woolworths Limited (WOW, +0.5%) was the only name that inched higher on significantly higher than normal volumes, while the other side of the market was somewhat more brutal. Aconex (ACX, -48.3%), Virtus Health (VRT, -16.7%), Orocobre Limited (ORE, -13.6%) and Ansell Limited (ANN, -9.9%) all lost big this week, and all backed by very high volumes.

Please take a look and let me know if we can do anything else.

Summary

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