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Bond Tremors & some ETFs to avoid


The Days Ahead:
Yellen in front of Congress. Inflation report. Start to earnings season.

Apart from the job numbers, this was a slow week for trading and hard news. We think there’s a lot of profit taking and positioning going on. On Thursday we saw a 1.1% sell off with 90% of the S&P 500 stocks down. But, as we've noted before, this is not a market where all boats float. Since January, the S&P 500 is up 6.5% but 161 companies have seen their share prices fall and 37 by over 20%. We would expect the occasional sell-off. It is summer, after all, and traders often vacate their desks by lunchtime. So much of what we see is more noise than news.


1. Jobs: What do you do if you're running the Fed? You have two things to do: one, stabilize prices at around 2% and, two, keep unemployment around 4% to 5%. You're doing fine on one but the other refuses to budge from well below 2%.  Well, you can change the subject to asset price inflation, declare victory on one target and say the other is just around the corner or just keep the market guessing. And that's pretty much what it’s doing.

Anyway, the jobs report is one of the real “hard” numbers we have and this one is the last before the July meeting. June’s report had a little for everyone:

The headline number was good, some 222,000 and a revision up for April and May. But average hourly earning gains were soft, the underemployment rate rose and 15% of the new jobs were government. Nothing wrong with that but many of those are seasonal jobs.

U.S. Treasuries have been weak recently with yields up from 2.2% to 2.4% in the last 10 days. Some of that is down to the ECB last week hinting at rate rises but then saying they didn't mean it. And some is from the Fed June minutes where they said “…equity prices were high when judged against standard valuation measures.” Now, there’s nothing in their job description about asset prices but they have mentioned it a few times, here and here. So, there is a noticeable hawkish lean.

But one simple explanation for bond weakness here and in Europe is sentiment. Bond prices rose rapidly between March and June, the charts looked overbought and investors took profits. But they didn't move on Friday’s news, which suggests the bond market is struggling with the hawkish sounds from the Fed and the weaker numbers coming through in the economy and can't quite decide which is right.


2. What does it mean for equities if bonds are weak? We'll rely on the “it depends” answer. If we look at the chart below, we can see stocks in the blue line and bonds in green.

Back in 1994, we saw rapid tightening from the Fed, raising rates from 5% to 8%, yet stocks picked up and headed for one of their best performance runs ever. Every other shaded area shows stocks growing despite a weak or flat bond market. So, it can happen. It just depends on the cycle and levels.


3. Dopey ETFs: About a year ago, we wrote briefly about some dopey ETFs out there. Sadly, it seems Accushares VIX down/up (VXDN and VXUP) are no longer with us. Both managed to lose 99% over 12 months ending in October 2016. Here are some recent ones from the Financial Times. And here charted:

The thing to remember about investments like these is i) they're usually based on short-run themes ii) they're very concentrated with the top 10 holdings somewhere between 35% and 60% of the fund and iii) they tend not to stick around.

The ETF field is all about innovation and in funds like these, they’re active funds in all but name. Anyway, if you're thinking about investing in funds like these, you know…don’t.


Bottom Line: Low-level M&A action, some sector rotation and some profit-taking in bonds. There is a lot of background information but nothing with a strong direction. It's fine to wait.

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Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.