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Perspectives from Above the Noise -- Week of October 8th, 2018

Perspectives from Above the Noise -- Week of October 8th, 2018

October 08, 2018

Worst Week in a Month. U.S. stocks fell in tandem with bonds on Friday, capping the S&P 500 with its worst week in a month, as a selloff in Treasuries sent yields to seven-year highs. Bond prices slid as fallout persisted over Federal Reserve Chairman Jerome Powell’s comments that solid economic growth will eventually prompt the central bank to raise rates to cool an overheated economy. Investor sentiment also weakened amid speculation the latest payrolls report opens the door for rising interest rates.

Weekly Performance. For the week, the S&P 500 fell 0.95%, the Dow Industrials slipped just 0.04% and the tech-heavy Nasdaq Composite sank 3.18%.

Mixed Jobs Data. September payrolls rose by 134,000, widely missing projections for 185,000 as Labor officials cited hiring disruptions caused by Hurricane Florence. Average annualized hourly wages ticked down to 2.8% from 2.9%. On the bright side, upward revisions for the prior two months added 87,000 jobs, helping lift the three-month average to 190,000. The unemployment rate fell to 3.7%, the lowest since 1969.

Consumer Discretionary Falls Most. Seven of the 11 major sector groups ended negative last week, led by Consumer Discretionary (-4.37%) and Real Estate (-2.71%). Communication Services and Technology both fell by 2.20%. Energy (+1.86%) and Utilities (+1.86%) gained the most, followed by Financials (+1.59%).

Selloff in Treasurys. Treasury securities extended declines on Friday, sending the yield on benchmark 10-year Treasury notes up 4.6 basis points to 3.234% and up 17.2 basis points on the week. The U.S. Dollar Index weakened a second day on Friday, slipping 0.13% to end the week at 95.624. WTI crude oil prices climbed 1.5% last week to $74.34/barrel, despite a 1.7-million-barrel weekly build in U.S. oil stockpiles.

 What We’re Reading

Higher Rates Spurs Bears

Mixed Oil Catalysts

China Getting Nervous?

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 Week’s Economic Calendar

Monday, October 8: No major releases;

Tuesday, October 9: Small Business Optimisms;

Wednesday, October 10: Producer Prices, Wholesale Inventory & Trade;

Thursday, October 11: Consumer Prices, Hourly/Weekly Wages;

Friday, October 12: Import/Export Prices, University of Michigan’s Consumer Sentiment.

 Market Watch
Dow Jones-0.04%-0.04%8.58%6.99%16.13%
S&P 500-0.95%-0.95%5.95%9.52%15.28%
Russell 3000-1.33%-1.33%4.82%9.10%14.47%
MSCI EAFE-2.34%-2.34%-0.81%-3.74%0.33%
MSCI Emerging Markets-4.49%-4.49%-4.34%-11.82%-7.09%
Barclays Agg Bond-0.94%-0.94%-1.05%-2.53%-2.10%
Barclays Municipal-0.58%-0.58%-0.80%-0.97%-0.29%
Barclays US Corp High Yield-0.44%-0.44%2.05%2.12%2.43%
Bloomberg Commodity2.04%2.04%2.13%-0.03%4.51%
S&P GSCI Crude Oil1.47%1.47%1.90%23.01%46.37%
S&P GSCI Gold0.79%0.79%-4.23%-7.92%-5.31%
Source: Morningstar
Chart of the Week
Caution on High Yield Corporate Credit
View larger image »

High yield bonds are fixed-income obligations of lower credit quality, which therefore offer investors a premium for taking more credit risk. This premium, or "High Yield Spread", is expressed as the difference in yields (effective interest rates) between high yield and comparable safe bonds. The amount of spread demanded by investors as compensation for additional risk is an effective market-based metric of evaluating bond default risk and economic strength.

The average high yield spread historically has been just over 5%, but as can be seen from the chart above, investors will demand higher risk premiums in difficult economic times. This occurs as the risk of bond defaults, which lead to loss of principal, increases. In 2008, high yield spreads peaked at 21.8%, and they neared 9% during 2016's growth scare market.

Over the last two years high yield spreads have narrowed, as economic growth has stabilized. This risk premium hit a post-recession low of 3.16% last Wednesday, before rebounding to 3.29% on Friday. The current level of bond defaults is low, so the spread is sufficient to cover near-term default risk. However, a high yield spread this low is typically only observed in late stages of an economic expansion. In our view, should economic growth slow, this spread may increase sharply from its current lows, which may push high yield bond prices lower. For this reason, we recommend a measure of caution when investing in high yield bonds.

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The Bloomberg Barclays US Aggregate Bond Index, which was originally called the Lehman Aggregate Bond Index, is a broad based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government–related and corporate debt securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency) debt securities that are rated at least Baa3 by Moody’s and BBB- by S&P. Taxable municipals, including Build America bonds and a small amount of foreign bonds traded in U.S. markets are also included. Eligible bonds must have at least one year until final maturity, but in practice the index holdings has a fluctuating average life of around 8.25 years. This total return index, created in 1986 with history backfilled to January 1, 1976, is unhedged and rebalances monthly.

The Bloomberg Barclays US Corporate High Yield Index measures the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below, excluding emerging market debt. Payment-in-kind and bonds with predetermined step-up coupon provisions are also included. Eligible securities must have at least one year until final maturity, but in practice the index holdings has a fluctuating average life of around 6.3 years. This total return unhedged index was created in 1986, with history backfilled to July 1, 1983 and rebalances monthly.

The Bloomberg Barclays US Municipal Bond Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. Many of the subindicies of the Municipal Index have historical data to January 1980. In addition, several subindicies based on maturity and revenue source have been created, some with inception dates after January 1980, but no later than July 1, 1993. Eligible securities must be rated investment grade (Baa3/BBB- or higher) by Moody’s and S&P and have at least one year until final maturity, but in practice the index holdings has a fluctuating average life of around 12.8 years. This total return index is unhedged and rebalances monthly.

The Bloomberg Commodity Index is a broadly diversified index that measures 22 exchange-traded futures on physical commodities in five groups (energy, agriculture, industrial metals, precious metals, and livestock), which are weighted to account for economic significance and market liquidity. No single commodity can comprise less than 2% or more than 15% of the index; and no group can represent more than 33% of the index. However, between rebalancings, group weightings may fluctuate to levels outside the limits. The index rebalances annually, weighted 2/3 by trading volume and 1/3 by world production.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Introduced in 1993, the VIX Index has been considered by many to be the world's premier barometer of investor sentiment and market volatility.

The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ.

The MSCI All-Country World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The SMCI ACWI consists of 46 country indexes comprising 23 developed and 23 emerging market country indexes. The developed country indexes include: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the Uninted States. The emerging market country indexes included are: Brazil, Chile, China, Colombia, Czech Republic, Eygpt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

The MSCI EAFE Index is designed to measure the equity market performance of developed markets (Europe, Australasia, Far East) excluding the U.S. and Canada. The Index is market-capitalization weighted.

The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. It is a float-adjusted market capitalization index.

The MSCI Europe Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance in Europe.

The MSCI Pacific Index captures large and mid-cap representation across five Developed Markets (DM) countries in the Pacific region. With 470 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The NASDAQ Composite Index includes all domestic and international based common type stocks listed on The NASDAQ Stock Market. The NASDAQ Composite Index is a broad based index.

The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe and is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.

The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market.

The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe and is a subset of the Russell 1000 Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap represents approximately 31% of the total market capitalization of the Russell 1000 companies.

The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry grouping (among other factors) designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.

The S&P GSCI Crude Oil Indexis a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark for investment performance in the crude oil market.

The S&P GSCI Gold Index a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark tracking the COMEX gold futures market.

West Texas Intermediate (WTI) is a crude oil stream produced in Texas and southern Oklahoma which serves as a reference or "marker" for pricing a number of other crude streams. WTI is the underlying commodity of the New York Mercantile Exchange's oil futures contracts.

The U.S. Dollar Index is a weighted geometric mean that provides a value measure of the United States dollar relative to a basket of major foreign currencies. The index, often carrying a USDX or DXY moniker, started in March 1973, beginning with a value of the U.S. Dollar Index at 100.000. It has since reached a February 1985 high of 164.720, and has been as low as 70.698 in March 2008.