I was delighted to attend the first annual iShares Global Macro Debate on 5/6/2013, and walked away from the experience very enlightened in several topical areas of focus regarding the markets, and implications on and via ETFs.
To those unfamiliar with the event, the debate itself is brand new, and preceded the wildly popular iGNITE conference sponsored by iShares’ Connect program, that targets investment firms that are in the ETF Managed Solutions space. Something that was rather new to me, and an immediate attention grabber for attendees of the debate, was the “dynamically updating” text message survey polls that the iShares folks invited attendees to participate in. Reinforcing the role of technology in the investment world, and more specifically pertaining to the ETF investment world and managers of ETF portfolios that were in attendance at the debate, attendees had the chance to voice their views about potential year end price targets in the SPX, the endurance of QE programs and potential end dates, China’s slowdown, the situation in Japan in terms of the roaring equity rally and steep depreciation of the Yen, and demographics for instance using text messaging.
Typo-free text messaging on a Samsung Galaxy S3 or an iPhone for instance can be a little tricky especially in a compressed time period where poll results are dynamically updating before your very eyes, but it was an enjoyable and informative exercise for me and I am sure the investment manager attendees, to see where peer expectations are in regards to current major investment themes. This, coupled with vibrant interaction with some of the leading third party managers of ETF portfolios who were in attendance and supplied a number of thought provoking questions to the panelists, made for a very productive day for all.
Leading off the Macro Debate on the topic of “U.S. Equity” was well known Tobias Levkovich of Citi (Chief U.S. Equity Strategist), whom quickly pointed out that the VIX at current levels has historically not been a good indicator in regards to investment sentiment, and attempting to trade on the VIX at these levels would give the investor essentially “no edge” here. He also without pause pointed out that the S&P 500 Index has already risen through his 1615 year end price target here in May of 2013, which helped us to briefly reflect on the impressive and fleet-footed run U.S. equities have had thus far this year. Tobias made the comment, which I am fairly certain resounded with the ETF portfolio manager attendees, that in gauging investor sentiment he would rather know “what you are doing?” as opposed to “what you are feeling?”
For example, if investors are buying stocks that have historically displayed low volatilities over time and generate steady and above average dividends (USMV, iShares MSCI USA Minimum Volatility, Expense Ratio 0.15%), if those same investors are saying “we are very bullish in U.S. equities,” there is a disconnect here between what they are actually doing in the marketplace versus their intended sentiment. I.E., extreme bullishness would typically be played out buying historically higher beta segments of the marketplace, with little desire for exposure to companies that pay dividends, opting more for growth over value.
Next page: ‘Panic/Euphoria’ model
Thus, Levkovich mapped out his “Panic/Euphoria Model”, also known as the “Other PE Model”, which made for some interesting analysis in terms of “where we were” and “where we are” currently in terms of real investor sentiment measured outside of the limitations of the VIX. During Levkovich’s presentation, a quick rewind in my mind had me recalling the third anniversary of the notorious Flash Crash which occurred on May 6th of 2010. Secondly, rewind the clock five years from today to the spring of 2008 and we were embroiled in the worst financial crisis that the markets have ever seen, and the full effects of the contagion had not shown themselves completely for many months to come. “Decoupling” was mentioned by Tobias, which was one of the catch phrases of yesteryear during the 2008/2009 crisis, a term barely mentioned anymore in investment circles and media just five years later. It makes one wonder that if today’s investment catch phrases such as “Sequestration” and “QE” will be distant memories and no longer entirely relevant five years from now in 2018.
Following Levkovich’s presentation, Barry Knapp of Barclays (U.S. Portfolio Strategy) continued the debate on the state of the U.S. equity markets and immediately pointed to the action since the Fed began the implementation of their post financial crisis programs. He stated that the “valuation of stocks with bond-like characteristics have richened considerably while the parts of the equity market most leveraged to growth are little changed.” Such an observation is hard to deny, given the price appreciation in stocks in sectors such as Health Care, Utilities, and Consumer Staples and related ETFs, and once again these comments had me thinking about the immense asset growth that has occurred in USMV since its debut in late 2011, having grown to $3.5 billion in AUM while focusing on the historically “low volatility” segment of the equity markets, and quickly becoming a household name among managers of ETF portfolios.
Taking us on a trip down memory road, Knapp stated that the last time the Fed capped interest rates at 2.5% back in 1948; stocks that historically had high dividends posted very strong returns. Because history should not be ignored, I immediately considered some of the high yield equity offerings from iShares that should be relevant to this discussion, such as DVY (iShares DJ Select Dividend, Expense Ratio 0.40%) and HDV (iShares High Dividend Equity, Expense Ratio 0.40), which own names including Lorillard (LO), Lockheed Martin (LMT), Chevron (CVX) and in the case of HDV, AT&T (T), Johnson & Johnson (JNJ), and Microsoft (MSFT). Not to be lost when one thinks about high yield equity investing through ETFs, relatively newer, and smaller offerings from iShares also crossed my mind at this juncture in the presentation, including IDV (iShares Dow Jones EPAC Select Dividend, Expense Ratio 0.50%), DVYA (iShares Asia/Pacific Dividend 30, Expense Ratio 0.49%), and DVYE (iShares Emerging Markets Dividend, Expense Ratio 0.49%) which are relatively new to the marketplace and perhaps should be on radars especially of those ETF portfolio managers that have an international equity focus in their methodologies.
Knapp moved along and spoke a bit about Japanese central bank intervention in the marketplaces historically, which of course is very timely given the massive inflows we have seen this year in EWJ (iShares MSCI Japan, Expense Ratio 0.51%), adding $4.2 billion in AUM YTD.
Next page: The housing market
What then captured my attention was a discussion about credit impairments in the U.S. financial system and the struggles that first time homebuyers are experiencing in actually obtaining mortgages. This explains concisely why we are seeing daily headlines about home ownership currently at a seventeen year low here in the U.S., and it is no secret to anyone that there is a very robust and active apartment/rental market out there in many metropolitan areas. ETFs like REZ (iShares FTSE NAREIT Residential Index, Expense Ratio 0.48%) immediately came to mind as the ETF has certainly benefitted from these conditions (trading at an all- time high currently). Tight credit conditions have caused many would-be home buyers to essentially not qualify for mortgages for one reason or another, and since one has to live somewhere, the apartment rental market continues to be leaned on heavily.
Continuing to discuss the mortgage lending conditions in the U.S. currently, Knapp stated that mortgage lending is “loosening but remains historically constrained” as well as pointing out that “real estate loans are growing at the slowest pace in post-war history.”
During the Q&A wrap up from this first segment, Levkovich reminded us all that in today’s markets, “Debts and Deficits” are the topics of the day and the center of most fears among market participants, as opposed to say the markets of the 1970s where unemployment and inflation were instead the source of such fears. As with industry/conference panel discussions like this it always helps to tie in the investment themes being discussed with “ways to play” via relevant ETFs. Here, we were reminded to consider the following: ITOT (iShares Core S&P Total U.S. Stock Market, Expense Ratio 0.07%), USMV (iShares MSCI U.S. Minimum Volatility, Expense Ratio 0.15%), IVV (iShares Core S&P 500, Expense Ratio 0.07%), and HDV (iShares High Dividend, Expense Ratio 0.40%).
The second panel of debate consisted of a presentation from Eric Beinstein of J.P. Morgan (U.S. High Grade Research and Strategy) whom illuminated the audience on the High Grade fixed income market, and the fact that today, we have a “built in demand” as he put it for such bonds from insurance companies, pensions, and other market participants that have a mandate to buy such securities. Beinstein also reiterated several times during the discussion that the high grade fixed income segment has had strong technicals in place for the past several years thanks to this built in demand and persistent bids from market participants such as the aforementioned types. As Beinstein put it, “life insurance companies have been buying corporates as structured securities mature and decline as a share of their portfolios.” Furthermore, Beinstein pointed out that having the Fed as an active market participant purchasing bonds, coupled with banks having excess liquidity currently, plus the dynamic of life insurers purchasing bonds has created this strong technical situation in terms of supply and demand in the high grade segment.
A giant takeaway for me from Beinstein’s presentation was his demonstration of Bank Deposits versus Loans in both the U.S. and Europe. In the U.S. deposits at banks have steadily climbed from 2005 to 2013, but loans after a drop-off during the financial crisis in 2008/2009 have not recovered, and are stagnating at best at the moment, falling well behind the level of deposits currently. In Europe however, it is a much different picture. During the same time frame, bank loans outstanding have always been greater in value than deposits in banks, and continue to maintain that spread currently although the gap is narrowing to some degree. Relevant ETFs that came to mind given these dynamics were…..
In summarizing the High Grade bond market, Beinstein concisely labeled it as “supported by strong technicals and okay fundamentals,” while banks have “record capital, record liquidity, and record regulation,” in terms of “levels” of the aforementioned three items.
Adam Richmond of Morgan Stanley (Head of U.S. High Yield Strategy) followed Beinstein’s presentation, and was very precise in stating right off of the bat that he and his firm are waiting for a “better entry point” in the High Yield Credit market. HYG (iShares iBoxx High Yield Corporate Bond, Expense Ratio 0.50%) immediately came to mind as the fund is currently trading at its highest levels since before the financial crisis enveloped the markets, while seeing its assets under management swell to north of $16.2 billion. Richmond then further stated that the position of his firm is that “beta is now rich in high yield” while “hedging is cheap”, and this resounded with me since we have seen an uptick in HYG options activity for the past several quarters, mainly consisting of put buying, presumably from long holders of the underlying ETF whom may be concerned with a potential pullback in bond prices. Concisely wrapping up his presentation, Richmond pointed out that the market in terms of high yield, is “vulnerable to disappointment and big outflows,” and thus that would lend credence to the recent periodic put buying that we have seen in HYG, and managers that are operating in this space if not willing to pull the plug on their high yield positions should at least consider protection via put options. This thorough discussion surrounding both the high grade, and the high yield segments of the fixed income markets left the debate attendees pondering several ETFs in these spaces, namely LQD (iShares Investment Grade Corporate Bond, Expense Ratio 0.15%), HYG (iShares High Yield Corporate Bond, Expense Ratio 0.50%), IBCE (iShares 2023 Investment Grade Corporate Bond, Expense Ratio 0.10%), and QLTC (iShares B-Ca Rated Corporate Bond, Expense Ratio 0.55%).
The following panel on China was co-quarterbacked by Donald Straszheim of ISI China Research, and Noah Weisberger, Managing Director of Goldman Sachs. Attendees were elucidated in terms of the geographical situation in China at the outset by Mr. Straszheim first and foremost. A map of China was displayed with two hundred fourteen dots representing cities in China with more than 1 million inhabitants. He went on to point out that the infrastructure build out in China started in the coastal cities, and has slowly made its way inland, leading to an obvious concentration in these dots in Eastern, coastal part of the country including cities such as Tianjin, Shanghai, and Hangzhou to name a few. Relevant ETFs that came to mind during this discussion were ECNS (iShares MSCI China Small Cap, Expense Ratio 0.60%), MCHI (iShares MSCI China Index, Expense Ratio 0.61%), FCHI (iShares FTSE China (HK Listed) Index, Expense Ratio 0.72%), EEMV (iShares MSCI Emerging Markets Minimum Volatility, Expense Ratio 0.25%) and of course the mammoth FXI (iShares FTSE China 25, Expense Ratio 0.72%). Straszheim went on to point out that Chinese investors are currently embroiled in a “speculative mania in housing” mainly because of the lack of alternatives in investing (the Shanghai equity market continues to be distrusted by many and bond yields are unappealingly low).
Mr. Straszheim spoke about the current situation in terms of energy consumption in China, and enlightened us in that 70% of the country is still reliant on Coal energy, contributing to less than optimal environmental and air quality conditions. Only 5% and 1% respectively were said to be reliant on Natural Gas and Nuclear energy, which clearly set the stage for growth in those two energy sources in years to come in China. The investment themes here seem clear to me, involving trends including Clean Energy, Alternative Energy, and Infrastructure that will obviously be areas of focus in Chinese equity investing for years to come. In wrapping up his segment of the debate, Straszheim pointed out that a topic of major importance remains “how foreign firms are treated in China”, in regards to multi-nationals potentially operating in China as he cited some struggles that have occurred in the past here.
Next, Noah Weisberger of Goldman immediately tackled a question that has confounded many here in the trailing one and five-year periods as China’s equity market has stagnated in comparison to Developed Markets. He stated that “market perceptions of China growth have declined dramatically, reflecting the Developed Markets/Emerging Markets economic divergence. For it is no secret in 2013 that China has suffered in terms of asset outflows due to stagnant equity performance (FXI -$1.3 billion in net flows) and this ripple has certainly affected broad Emerging Markets ETFs like EEM (iShares MSCI Emerging Markets, Expense Ratio 0.67%) which is China heavy (17.87% of the portfolio) and has seen $2.4 billion leave the fund this year. It is Weisberger’s belief that “EM equities have priced in a lot of cyclical damage already”, and in the equity markets we have seen quite an impressive rise in China based equities since the middle of April, with FXI for instance rallying a significant 11% during this timeframe. Both EWZ (iShares MSCI Brazil, Expense Ratio 0.60%) and EWZS (iShares MSCI Brazil Small Cap, Expense Ratio 0.60%) also came to mind throughout this China discussion, with Brazil being a lead exporter to the country.
The two speakers left us considering the current realities in China, in that there is no Google or Facebook for instance in China, due to restrictions of personal freedoms in terms of social media. China also typically has the desire for their own national companies to become the dominant force in particular industries, which also creates a formidable barrier to entry for companies that are based outside of China whom are looking to set up operations there.
Next page: Japan
The following panel discussion focused on strategy in Japan, and both Nicholas Smith of CLSA (Japan Strategist) and Daragh Maher of HSBC (FX Strategist) spent some time speaking to us about such. Mr. Smith drew parallels from today’s situation in Japan to the 1930s central bank policies (Takahashi Korekiyo’s fiscal stimulus), and investment interest in the country has clearly been invigorated in the past several months after the implementation of such acts. EWJ with its $4.2 billion in asset inflows thus far in 2013 clearly jumps out to most portfolio managers considering the space, but we are also careful to examine ITF (iShares TOPIX 150 Index, Expense Ratio 0.50%) and SCJ (iShares MSCI Japan Small Cap, Expense Ratio 0.53%) following this stimulating discussion. One of the main takeaways from Smith’s discussion was that the further decline in the Yen that has occurred over the past several months is driving an export surge in Japan that has still not fully materialized. In his words “The export boom is yet to come.”
Daragh Maher of HSBC followed Mr. Smith’s presentation pointing out that he favored buying the Yen at current levels and cited a general lack of Yen bulls in the marketplace right now from an analyst standpoint (he mentioned, including himself, that there were precisely “two”). This compare/contrast between these two capable analysts was especially helpful for those, myself included, whom until recently have not focused much on the Japanese equity market, and much less on the interlinked dynamics between central bank policy, the Yen currency, and the reciprocal direction of the equity market itself. ETFs that were topical to this discussion include EWJ (iShares MSCI Japan, Expense Ratio 0.51%), ITF (iShares S&P/TOPIX 150, Expense Ratio 0.50%), SCJ (iShares MSCI Japan Small-Cap, Expense Ratio 0.53%), FEFN (iShares MSCI Far East Financials, Expense Ratio 0.48%), and IFAS (iShares Asia Developed REIT, Expense Ratio 0.48%).
Following the refreshing discussion on Japan, we were next treated to an enlightening discussion in regards to Demographics, chaired by Dick Hokenson (Global Demographics) of ISI International Strategy and Investment and Larry Hatheway (Chief Economist) of UBS. Hokenson mentioned the differences in current demographics that exist today, and called the conditions of families having fewer children as a “Population Implosion.” Hokenson also emphasized “human capital” as the driver and irreplaceable component of the world’s growth and innovation, which I found to be a very strong and sensible argument. Furthermore, he pointed out in the U.S., and something that is readily observable to those willing to take the time to notice, that there is an increasing number of sixty five and older members of the population that are still in the workforce. “The fear of getting old” is the motivating factor according to Hokenson, and not a desire or need for more money, and much of this seems linked to the research that has been done on Alzheimer’s over the years which emphasizes continued, if not a slowdown in work related activity for those as they get older in order to fend off the effects of the disease.
The title of Hatheway’s presentation was fitting, “Demographic Determinism? Not Exactly.” Very powerful tidbits of information were supplied during this discussion throughout, including one where the audience learned that the average life expectancy in the U.S. in the year 1900 was forty seven years old. Fast forward the clock to today, and Hatheway pointed out that among young children in the U.S. today, half of them will live to see their 100th birthdays. These are simply stunning and resounding projections and speak volumes about the progress in the world of modern medicine as well as within the education of the population in terms of matters of health. Hatheway also pointed out something that undoubtedly was and is on the minds of the ETF portfolio managers in attendance, and that was that poor public policy has contributed to massive rises in healthcare costs. The verdict here, is clearly not out given the recent unveiling of Obamacare and yet unknown repercussions. ETFs that deal with demographic trends as well as separately in Health Care, came to mind during this segment, including IXJ (iShares Global Healthcare, Expense Ratio 0.48%), IYH (iShares U.S. Healthcare, Expense Ratio 0.48%), FM (iShares MSCI Frontier 100, Expense Ratio 0.79%), IXUS (iShares Core MSCI Total International Stock, Expense Ratio 0.16%), as well as IBB (iShares Nasdaq Biotechnology, Expense Ratio 0.48%).
To wrap up the Global Macro Debate was a presentation on U.S. Economics, kicked off by Ethan Harris of Bank of America Merrill Lynch (Global Economist). Harris initially pointed out four observations regarding the near term implications of what he sees in the current economy: “1) Healing from the 2008/2009 crisis 2) Washington calms down 3) Three (small) growth engines and 4) Low inflation = forceful FED.” Harris went on to reiterate a point that was made in an earlier panel discussion as well, which is that banks have gigantic amounts of capital in reserves at this juncture, but lending and spending both remain weak. I am sure that many of the portfolio manager attendees would agree that painful scars from 2008/2009 are still very fresh in many cases, and thus one is likely not surprised when they hear these facts in terms of how large banks are managing themselves in this environment.
Neal Soss of Credit Suisse (Chief Economist) then joined the discussion, pointing out an interesting dynamic in today’s environment which shows that both state and local employee jobs have been shrinking due to “no money” being in the system to pay for such positions. “Income Inequality” was also mentioned as the next possible macro variable that folks should consider as a reality in the current environment, and supporting charts were supplied accordingly. Soss concluded mentioning what we learned in an earlier panel, and that is that humans are getting older in terms of median ages projected in 2030 versus median ages reported in 2000, which seems to be a function of declining birthrates as well as humans simply living longer lives as time goes on. ETFs topical to this discussion included TIP (iShares TIPS Bond, Expense Ratio 0.48%), AGG (iShares Core Total U.S. Bond Market, Expense Ratio 0.08%), FLOT (iShares Floating Rate Note, Expense Ratio 0.20%), and ITB (iShares U.S. Home Construction, Expense Ratio 0.48%).
Thus, the first annual iShares Global Macro debate concluded, and everyone in attendance was wowed with concise, yet powerful full scale explorations of several major macro topics (from a group of wonderful experts I might add) that are on the minds of not only investment managers, but in many cases, the average investing citizen. Honored to be a part of the discussion as an attendee, I was even more-so thrilled to see countless investment parallels drawn throughout the day via topical ETFs, which I am sure was refreshing to each and every portfolio manager attendee.
For more information on Street One ETF research and ETF trade execution/liquidity services, contact Paul Weisbruch at pweisbruch@streetonefinancial.com.
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