Implications of Brexit!

   Schwaben Blog

June 30, 2016


Monthly Statistics:

  Today Month Ago Year Ago
  30-June-16 30-May-16 30-June-15
S&P TSX 14,100 14,226 14,743
S&P 500 2,093 2,099 2,079
DJIA 17,800 17,807 17,766
OIL $48.50 $48.70  $62.66
USD vs CAD 0.7742 0.7742 0.8303
Gold $1,324 $1,246  $1,172


So far the year 2016 has had no shortage of major events and one event that will go down in the history books is Brexit, short for exit of Britain from the European Union. The markets and the oddsmakers were caught off guard by the U.K.’s historic vote to leave the European Union on June 23. The shocking news sent ripples across the global economy and sent the pound down to its lowest level in 31 years. The equity markets across North America were also down sharply.  After Brexit, Scotland and Northern Ireland, afraid of being left out of Europe, are also preparing for a referendum to leave the UK and stay in the European union. That referendum has already gathered more than 3 million signatures. Whether Scotland and Northern Ireland will stay with the UK or not is still undecided, but the most important outcome of Brexit is that the business investment across the Europe will be dampened due to the heightened uncertainty of the implications of Brexit. London’s image as the financial hub of the world is in danger now as major investment banks and financial institutions are looking to cut jobs there and are planning to set up new branches in Dublin, Luxembourg and Frankfurt to have continued access to the EU nations.

While this is a major event in global economy, it is still unlikely to seriously hurt the US and the global economy.  According to Factset, UK is the third largest generator of revenue for the S&P 500 among the US trading partners, but it’s still pretty small. Sales from the UK make up just 2.9% of the overall revenue of the S&P 500. On the global level, the UK accounts for only 3.6% of global imports of merchandize goods and 4.1% of global imports of commercial services, so even if there is a recession in the UK (which is highly likely), the direct effect on global GDP should be minimal.

When markets are awash with fear and uncertainty, investors tend to run towards the safe haven, usually Gold or US treasuries. This flight for safety pushed the US treasuries almost to the lowest level in four years and strengthened the US dollar against major currencies.  A further strengthening of the dollar in response to global risk aversion would be a problem not only for U.S. growth prospects but also for all the dollar debtors in emerging markets, and could also push commodity prices lower. Also, roughly half of S&P 500 revenues are from other countries and any further appreciation in the USD would dampen the prospects of near term growth in the index’ EPS. At this juncture, the US economy might be strong enough to tolerate the normalization of monetary policy but the global economy is much more vulnerable to the Fed’s moves. After the outcome of the the Brexit referendum a rate hike in July is completely off the table and with the US presidential race in full swing, a September rate hike has very low probability as well. Central bankers across the globe also vowed to take further steps to limit any economic fallout. With additional stimulus expected from Bank of England, Bank of Japan, and European Central Bank, any interest rate hike by the US Fed would send the dollar through the Stratosphere.





Source- Bloomberg, Globe Investor, Financial Post, Market Watch, FactSet, Trading Economics


Is the US Economy Ready for Another Rate Hike?

   Schwaben Blog

June 06, 2016


Monthly Statistics:

  Today Month Ago Year Ago
  06-June-16 06-May-16 06-June-15
S&P TSX 14,226 13,690 14,743
S&P 500 2,099 2,046 2,079
DJIA 17,807 17,632 17,766
OIL $48.70 $42.68  $62.66
USD vs CAD 0.7742 0.7728 0.8303
Gold $1,246 $1,266  $1,172


During the latest Federal Open Market Committee (FOMC) meeting, some of the Fed governors discussed about the possibility of a rate hike in June. The FOMC is keen to further increase the interest rates because they believe that the US economy is showing more signs of sustainable growth with inflation hovering around their 2% target. The unemployment rate has also dropped to 4.7% (lowest in eight years) in May from 5% in April. But this drop in unemployment rate was primarily a result of people dropping out of labor force rather than finding new jobs. 458,000 people dropped out of labor force, either because they don’t want to work or they don’t think that they can land a job. Employers added only 38,000 jobs in the month of May, lowest monthly growth since September 2010.  The unemployment rate is calculated by comparing the number of people who are out of work and looking against the total number in the labor force. If someone is out of the labor force, he isn’t counted.  The dismal unemployment report in May will certainly push back the Fed’s plan for a rate hike soon. According to the CME Fed watch tool, there is only 4% probability of a rate hike during the FOMC meeting in June, compared with 31% in July and 44% in September.

At this juncture, the US economy might be strong enough to tolerate the normalization of monetary policy but the global economy is much more vulnerable to the Fed’s moves. The tightening of the US monetary policy and the liberal monetary policy in Europe and Japan have certainly contributed to the strength of USD and weakness in Euro and Yen. The recent weakness in Euro and Yen hasn’t had a very noticeable effect on the Europe’s and Japan’s exports, but the strength of USD certainly had a negative effect on the earnings of US corporations. Roughly half of S&P 500 revenues comes from abroad and any further appreciation in the USD will dampen the prospects of near term growth in the index EPS. For Q1 2016, 72% of the companies have reported earnings above the mean estimate and 53% have reported sales above mean estimate. The earnings declined by 6.7% on a year-over-year basis. This marks the first time the index has seen four consecutive quarters of year-over-year declines in earnings since Q4 2008. Profits for the S&P 500 also declined by 8.3% (2.9%, if excluding the Energy sector).  Now that the oil prices have recovered by more than 70% from their February lows, the majority of equity analysts believe in a brighter outlook for the index and recommend an average increase of around 6% in the S&P 500 EPS over the next 12 months, with growth in all sectors but Energy. With additional stimulus expected from the European Central Bank (ECB) and the Bank of Japan (BoJ), a rate hike by the Fed will push the USD toward record highs and this will hurt the profitability of US corporations.

Can US Companies Weather a Global Slowdown?

  Today Month Ago Year Ago
  11-Apr-16 11-Mar-16 11-Apr-15
S&P TSX 13,422 13,284 15,383
S&P 500 2,041 2,055 2,092
DJIA 17,356 17,652 18,036
OIL $40.37 $29.02  $68.86
USD vs CAD 0.7755 0.7658 0.8503
Gold $1,258 $1,239  $1,174


Since the beginning of 2016, economists have expressed their pessimistic opinions about the global economies. The US Federal reserve raised their benchmark interest rates in December 2015 for the first time in a decade with a view that the US economy is growing and strong enough to sustain gradual rate hikes during 2016. Since the rate hike, US indices have not performed well and have been flat. Economists and financial commentators are continuously questioning Janet Yellen’s decision to raise interest rates and do not believe that the US economy is ready for another hike in interest rates. According to CME Fed Watch tool, probability of another rate hike in December 2016 is now only 59%.  While the US economy is not performing reasonably well, weakness across European and Asian nations definitely hurts US multinational corporations. At a time when many European nations are facing record unemployment and weak economic growth, European Central Bank has opted for negative interest rates to revive their economic growth rates. Until February, more than $7 trillion of Government bonds worldwide offered negative yields, which means that any investor that bought these bonds and holds them till maturity won’t get all his or her money back. Recent research by Factset showed that companies with more than 50% of their sales within US had positive earnings growth rate but on the contrary, companies with more than 50% of their sales outside US had a decline in their earnings. A strong US dollar and lower energy prices are the main contributors for this decline in corporate profitability. Companies with majority of their sales outside the US had to face losses in foreign exchange, which lowered their profitability. The US Dollar index has increased by more than 20% against a basket of 9 currencies since 2013. Many companies have started to report their earnings for Q1 2016 and so far 22 companies in the S&P 500 have already reported their earnings.  As of today, the estimated earnings growth rate for Q1 2016 is -9.1%, compared with a growth rate of 0.7% for the last quarter (on December 31, 2015). If the index reports a decline in earnings, it will be the first time that the S&P 500 has seen four consecutive quarters of year-over-year earnings decline since December 2008.

While companies’ profitability and indices should move in the same direction, history does not show any such relation. The image below indicates that from 2000- 2009, annual profit for companies grew by 10.3% but the annual stock market returns for that decade were -1%. Conversely, from 2010- 2015 the annual profit for companies grew by 1.5% but the annual stock market returns were 12.8%. Investors should still conduct more research (macro and micro economic) and talk to their financial advisors before drawing any conclusions between earnings growth rate and index movements.

Disappointing Jobs report for the US? Not Really!

   Schwaben Blog

February 05, 2016



Weekly Statistics:

  Today Week Ago Year Ago
  05-Feb-16 29-Jan-16 05-Feb-15
S&P TSX 12,763 12,822 14,384
S&P 500 1,880 1,940 2,044
DJIA 16,205 16,466 17,780
OIL $31.00 $33.20  $68.86
USD vs CAD 0.7202 0.7112 0.8503
Gold $1,174 $1,121  $1,174


Another volatile week for US equities ended with S&P 500 losing more than 3% for the week. The disappointing jobs report released on Friday brought further negative momentum to already fragile markets. But a detailed look into that report brings out some positive takeaways. The jobless rate dropped to 4.9%, matching the Fed’s median forecast for the long-run sustainable level of unemployment or “full employment”, and continuing the most impressive trend in U.S. economic data. It is the first time since February 2008 that the unemployment rate has dropped below 5%.  The hourly wages also rose by 0.5% in January, the largest increase since January 2015 and beating market expectations by 0.3%. The gain in hourly wages will certainly help the US economy move closer to their inflation target of 2%.  The US economy is 70% consumption driven and with extra savings from lower oil prices, consumers will eventually put more money into the economy. So far we have not seen a substantial improvement in consumer spending but as Deutsche Bank recently said in its research report “Lower oil has an immediate impact on energy sector and the positive effects on the economy usually appear with a lag”. Another explanation for lower consumer spending could be that consumers are paying down their debts instead of spending. According to a Morgan Stanley report, consumer balance sheets are in great shape, with the lowest debt-to-disposable income ratio since 2003. As far as earnings recession goes, if we strip out the energy companies from the S&P 500, the blended earnings will improve from -3.8% to 2.2%. This shows that except the energy companies, the US corporations are doing well and are financially stable.

Oil Prices and the US Equities!!

   Schwaben Blog

January 29, 2016



Weekly Statistics:

  Today Week Ago Year Ago
  29-Jan-16 22-Jan-16 29-Jan-15
S&P TSX 12,822 12,389 14,384
S&P 500 1,940 1,906 2,044
DJIA 16,466 16,093 17,780
OIL $33.20 $32.25  $68.86
USD vs CAD 0.7112 0.7081 0.8503
Gold $1,121 $1,098  $1,174


US stocks closed sharply higher on Friday, booking a second straight weekly gain but posting the worst January performance since 2009. The main driver for Friday’s rally was a surprise decision by the Bank of Japan to push a key interest rate into negative territory that could also push the Federal Reserve to ease up on its plans to steadily raise interest rates. Even after this rally, major indices have still lost more than 5% in January. St. Louis Fed President James Bullard recently mentioned that the continuing plunge in oil prices could impact the U.S. central bank’s decision-making process. Oil prices have lost nearly 18 percent in January, and causing worries that the global economy will enter a prolonged slowdown. As of Friday, 40% of the companies in the S&P 500 have reported their Q4 2015 earnings and 72% of those have reported above their mean estimates. For Q4 2015, the blended earnings decline is -5.8% and if the index reports a decline in earnings for Q4, it will mark the first time the index has seen three consecutive quarters of year-over-year declines in earnings since 2009. Out of the 10 sectors in S&P 500, four sectors are reporting year-over-year growth in earnings, led by the Telecom Services and Information Technology sectors, and six sectors are reporting a year-over-year decline in earnings, led by the Energy and Materials sectors. The blended earnings decline for Q4 2015 is -5.8%; excluding the Energy sector, the blended earnings decline for the S&P 500 would improve to positive earnings growth of 0.5% from a decline of 5.8%, a clear indication of the magnitude that the decline in oil prices has had on the indices.

Is S&P 500 set for another decline in quarterly earnings?

    Schwaben Blog

January 15, 2016



Weekly Statistics:

  Today Week Ago Year Ago
  15-Jan-16 08-Jan-16 15-Jan-15
S&P TSX 12,073 12,445 14,384
S&P 500 1,880 1,922 2,044
DJIA 15,988 16,346 17,780
OIL $29.70 $32.88  $68.86
USD vs CAD 0.6889 0.7093 0.8503
Gold $1,089 $1,104  $1,174


Equity markets in the US closed sharply lower on Friday, locking in the worst 10-day start to a calendar year ever, as oil prices plunged and investors worried about slowing growth in the U.S. During the intraday trading, the S&P500 broke the August 24, 2015 low of 1,867 but closed at 1,880. The slowing growth in Chinese economy and correction in oil prices are the main reasons for this rout in equity markets. Now that the global sanctions have been lifted off from Iran and Russia continues to pump more oil to support its flagging economy, oil prices are expected to drop further below their current level of $29. While about $21 billion have been pulled out of equity funds in the past two weeks, the outflow pales in comparison to withdrawals of $35 billion during the August 2015 selloff and $90 billion in August 2011, back when the market was mired in the European sovereign debt crisis. The earnings season for Q4 2015 has already kicked off and 6% of the companies in the S&P 500 have already reported their earnings. Out of those, 78% have reported earnings above the mean estimate and 47% have reported sales above the mean estimate. For Q4 2015, the blended earnings decline is 5.7%. If the index reports a decline in earnings for Q4, it will mark the first time the index has seen three consecutive quarters of year-over year declines in earnings since 2009. While the US economy is growing at a decent pace, the slowing Chinese economy and falling oil prices could bring further correction to equity markets in the short term.

The Good, the Bad and the Ugly of the Fed rate hike!!

   Schwaben Blog

December 18, 2015



Weekly Statistics:

  Today Week Ago Year Ago
  18-Dec-15 11-Dec-15 18-Dec-14
S&P TSX 13,024 12,742 15,417
S&P 500 2,006 2,017 2,089
DJIA 17,129 17,266 17,819
OIL $34.55 $35.56 $68.86
USD vs CAD 0.7165 0.7278 0.8503
Gold $1,066 $1,078 $1,174


The Federal Reserve raised interest rates for the first time in a decade, pointing towards a healthier and a stronger US economy. The board members of the Federal Open Market Committee (FOMC) voted unanimously for this rate hike. The U.S. central bank’s policy-setting committee raised the range of its benchmark interest rate by a quarter of a percentage point to between 0.25 percent and 0.50 percent, ending a lengthy debate about whether the economy was strong enough to withstand higher borrowing costs. Many economists see this rate hike as a vote of confidence in the US economy. The central bank clarified that the rate hike was a tentative beginning to a “gradual” tightening cycle, and that in deciding its next move it would give more importance on monitoring inflation, which remains well below the Fed’s target rate of 2%. A Dec. 9 Reuters poll showed economists forecasting the federal funds rate to be 1.0 percent to 1.25 percent by the end of 2016 and 2.25 percent by the end of 2017. Equity markets applauded the rate hike and rose sharply on Wednesday after the announcement, but markets lost their gains and fell subsequently on Thursday and Friday. The main reasons for the subsequent drop in equity markets are the rising US dollar and falling oil prices falling $35 per barrel (first time in last seven years). Today is a big options expiry day- a day when futures and options contracts expire- which is likely adding to volatility. The chart below depicts the US Fed funds rate, which peaked at 5.25% in 2006 and stayed at almost 0% since 2009.


Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics