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Is the multi-decade decline in bond yields finally coming to an end?

The secular trend in government bond yields that began in the early 80s is still showing signs of strength. Every analyst, however, is trying to decipher whether yields will remain low for the next 5 to 10- year period, or whether there is going to be a reversal of the trend. The recent sell-off in U.S., U.K., and German yields, ranging between 30 and 40 bps, has rekindled fears that this is not a cyclical bounce, but more of a reversal of the trend. The report analyses the probability of a reversal versus a continuation of the current yield environment.

Publications

October 2016​

Waiting for light to emerge from the end of the economic tunnel! The Greek economy under the spotlight

This is a comprehensive and detailed presentation of various Greek macroeconomic and financial indicators with underlying comments and analysis. Apart from core macroeconomic indicators, it covers developments in fiscal adjustment, the public debt, structural reforms, and the banking sector

U.S. Equity Style Performance Update The moderate pace of rate normalization helps value stocks to stage a small comeback

The comment analyses recent U.S. equity style performance and provides insights for the future performance of the style spread.

After all, how innovative are unconventional monetary policy tools?

It has been stressed that major central banks have fully appreciated the power of forward guidance, and have been increasingly resorting to it in order to convince financial markets that they have an effective game plan to normalize the global economy, as it is becoming more obvious that policy makers are facing more constraints in the conduct of monetary policy. The aftermath of the global financial crisis was so severe that policymakers had to think out of the box and deviate from mainstream monetary policy tools. Since the end of 2008-beginning of 2009, a number of unconventional monetary policy tools have been employed; quantitative easing, negative short-term interest rates etc. During their introduction numerous analysts argued that the specific actions were unprecedented. But is this true? After all, how innovative are unconventional monetary policy tools?

Will the end of QE amplify the probability of volatility episodes?

A number of analysts are commenting that the fact that major central banks’ quantitative easing programs are gradually coming to an end will have wider repercussions for the global economy and financial markets. Indeed, it is more than rational to assume that the end of large-scale securities purchases will change the way that economic agents assess and project the macroeconomic environment, and investors forecast the future path of their underlying assets.

Widely cited implications include the fading influence of central banks, the return to monitoring economic and market fundamentals, and the financial sector's changing landscape.

The most important consideration, however, is whether the termination of quantitative easing programs will amplify the probability of Minsky moments and/or frequent volatility episodes.

The Bank of Japan is now trying to dazzle markets with forward guidance

The report provides insight on the latest Bank of Japan monetary policy decision, and discusses the implications of the "Yield Curve Control" framework.

September 2016​

How easy U.S. interest rate policy really is?

The aftermath of the global financial crisis in 2008 forced the Federal Reserve to respond forcefully by cutting rates close to the so-called zero bound. Almost eight years after the end of the latest recession, U.S. monetary policy remains extremely loose and accommodative for the stage of the business cycle, at least at face value. Besides using traditional monetary policy tools, the central bank has experimented extensively with quantitative easing programs and has expanded its balance sheet substantially, most probably because policymakers felt that they needed to compensate for the fact that the natural rate oscillated around the zero bound. The asymmetric response to the global financial crisis has led many economists and analysts claim that the Federal Reserve is already behind the curve, as it risked a resurgence in inflation and should have raised key policy rates sooner. Since the FOMC embarked on its latest tightening cycle, few issues have been so widely debated as the sustainability of the current ultra accommodative monetary policy regime. To some the low yield regime induces excessive risk taking and could lead to financial asset bubbles, to others it just a reflection of the decline in potential growth and, thus, in the natural rate. It is thus not irrational to wonder, how straightforward the conduct of U.S. monetary policy is.

The yield curve still remains a reliable predictive tool for macroeconomic forecasters

The term structure of interest rates has long been regarded as one of the most reliable indicators regarding economic recessions. More specifically, economists and financial analysts have monitored the slope of the yield curve in order to assess the probability of an economic recession. Indeed, each of the last seven recessions since 1962 has been preceded by an inversion of the U.S. yield curve. More specifically, every U.S. recession has been preceded by, on average, eight months during which the term spread was negative in the twelve months before its beginning. Currently, the U.S. yield curve is far from inverted, as the term spread is positive, and thus the probability that the U.S. economy will be in recession in the coming twelve months is limited.

According to numerous analysts, the ultra accommodative monetary policy has disrupted market expectations, and, as a consequence, the effectiveness of the yield curve as a forecasting tool has been eradicated.

The report tries to shed light to the debate regarding the predictive ability of the U.S. yield curve, as well as the probability of an economic recession in the next twelve months.

December 2016​

The state of the U.S. economy supports a December rate hike

There was very limited probability that the Federal Reserve would hike rates in its meeting last week, given the proximity of the U.S. presidential election. Nonetheless, the change in the tone of the statement has created expectations that the FOMC has laid the foundation for a December rate hike.

There is indeed solid evidence in incoming data during the last months that indicate that the current state of the U.S. economy could support higher policy rates. The most critical unknown that continues to be of concern is the substantial decline in the natural rate of interest, as well as the debate surrounding its current and short-term projected level.

The report analyses why a December rate hike should not surprise financial markets.

Central banks have managed to keep a lid on equity and bond volatility!

Quantitative easing programs have, to a large extent, isolated the effects of macroeconomic risk and have driven equity and bond related volatility to pre global financial crisis levels.
The report provides insight on central bank action and their effect on market and macroeconomic volatility.

Will the U.S. Presidential Election be a game changer for equity style performance?

In a recent U.S. equity style performance analysis, we stressed that an environment of less aggressive pace of monetary tightening by the Federal Reserve, declining volatility in commodity markets, as well as a better than anticipated U.S. macroeconomic environment, supported a comeback for value stocks, this year, in the U.S. The main conclusion being that an environment of continued monetary laxness and accelerating growth will most likely continue to benefit value stocks. Since the end of October, value stocks not only continued to outperform their growth counterparts, but the margin of outperformance has actually increased.

The primary catalyst that seems to have had a profound effect on investor expectations is the U.S. presidential election, both during the run-up, as well as after the final outcome. The report analyses U.S. equity style performance, as well as equity style sensitivity to bond returns, given the recent rise in Treasury yields.

It’s all about dispersion in the U.S. equity market!

 The U.S. Presidential Election has been a catalyst for higher return dispersion in the U.S. equity market. The primary reason being, that the market now expects that the new administration will promote a set of economic policies that will ‘reflate’ the U.S. economy sooner than anticipated, and will bring about regulatory changes that will benefit specific sectors.

This report provides evidence of the higher equity dispersion underway, and explains why this trend is set to continue.

November 2016​

The small cap rally in pictures

The report provides useful insights on the recent small cap rally.

Global aggregate demand is also critical for the projected path of crude oil prices

The report provides an explanation for the tight correlation between crude oil and equity prices following the Global Financial Crisis, and shows that global aggregate demand is critical for the future path of crude oil prices. 

January 2017​

The Volatility Paradox

By far, the biggest paradox in financial markets during 2016 was the ability of aggregate volatility indices to remain at low levels, despite the presence of a number of elevated economic and political risks that could have induced considerably higher asset price variability.

The report analyzes the specific paradox and provides insights for the future.

February 2017​

Is the multi-decade decline in bond yields finally coming to an end? - Revisited

The secular trend in government bond yields that began in the early 80s is increasingly questioned. Analysts are trying to decipher whether yields will remain low for the next 5 to 10- year period, or whether there is going to be a reversal of the trend. The continuing sell-off in U.S., U.K., and German yields since the summer of last year has rekindled fears that this is not a cyclical bounce, but more of a reversal of the trend. The report analyses the probability of a sustained  reversal versus a continuation of the low yield environment.

The ECB will not be hasty to taper…

The report provides insight on the likely timing of a potential ECB tapering decision.
The aftermath of the global financial crisis was so severe that policymakers had to think out of the box and deviate from mainstream monetary policy tools. Since the end of 2008-beginning of 2009, a number of unconventional monetary policy tools have been employed; quantitative easing, negative short-term interest rates, yield curve targeting are some actions that numerous analysts argued were unprecedented. It is necessary to acknowledge that central banks have been facing a very challenging task, as they have been navigating in uncharted territory, for a number of years. It is not accidental that their approach has been largely experimental, and one of ‘trial and error’, as they have tried to adapt their policy stance to a fundamentally unresponsive, or, in some cases changing, global environment. This is also reflected in the recent monetary policy divergence among major central banks.
As economic fundamentals appear to be improving on both sides of the Atlantic there is widespread talk that the ECB will be increasingly looking for the right timing to unwind its ultra accommodative monetary policy stance. A number of analysts believe that the combination of stronger growth and rising inflation will put additional pressure on the Governing Council to reevaluate its strategy.

March 2017​

New highs for U.S. equity markets - But are valuations expensive?

A P/E multiple ‘fair value’ model suggests that the market is on the expensive side, but within reason
The U.S. Presidential Election has been a catalyst for U.S. equity market performance. The primary reason being, that the market now expects that the new administration will promote a set of economic policies that will ‘reflate’ the U.S. economy sooner than anticipated, and will bring about regulatory changes that will benefit specific sectors. Investors have been positioning for a regime shift in both the economy and financial markets.
In order to get a feeling of the impact of market expectations, or, of the potential effects of the new U.S. administration’s policy agenda on equity market valuation, an econometric framework is employed to proxy and determine the ‘fair value’ of the market, as well as the unexplained component.

The recovery of the Greek economy, once again, at the mercy of political and economic uncertainty

Greece has achieved substantial progress to restore fiscal and external balances, but too little has been accomplished in the area of reforms, so far, to improve global competitiveness, and counterbalance the effects of the austerity‐driven recession. Notwithstanding signs of a clear, but delicate, turnaround and the receding extreme downside risks, the macro and financial situation still remains fragile and challenging. It's not the first time that GDP is picking up, and that market conditions are improving. However, austerity, and, primarily, economic and political uncertainty are still weighing on a rather traumatized economic fabric, as the latest developments clearly show. Moreover, the probability of a return to the capital markets seems limited, as a result of, on the one hand, the fragile economic environment and the inability to restore credit solvency, and, high political risk, on the other. 

How likely is a U.S. equity market correction?

As the U.S. equity market continues its uptrend, reflecting investor positioning for a regime shift in both the economy and financial markets, a number of analysts have gradually become more skeptical regarding a prolonged continuation of the rally, as policy uncertainty remains elevated, market multiples have been expanding, investor sentiment is buoyant, and interest rates are expected to rise further, reflecting the Federal Reserve’s less dovish stance.

 

To assess whether equities can prolong their solid performance an econometric model (Probit model) that combines valuation, interest rate and volatility signals is used.

April 2017​

Financial conditions are crucial for projected economic activity and monetary policy

The report provides insights on the importance of financial conditions for projected economic activity and, ultimately, monetary policy. A series of predictive regressions are run that show that financial conditions indices contain information about the future state of the U.S. economy and, as a consequence, will be a major factor in the FOMC's decision making process.

May 2017​

The use of QE as a monetary policy tool was not a one-of

As the U.S. economy has continued to show signs of improvement, reflected primarily in the underlying labour market conditions and rising inflation, the Federal Open Market Committee’s (FOMC) focus is gradually shifting on the unwinding of the non-conventional monetary policy tools that were deployed during and after the Global Financial Crisis. The use of the Federal Reserve’s balance sheet was decided during a period of extreme and extraordinary economic distress, and many economists believe that its use should be confined to similar types of crises. There are others, however, that assert that the underlying structural changes in U.S. economy will or might require more frequent use of quantitative easing going forward.
If short-term rates remain low by historical standards there is a relatively high probability that if a severe economic downturn occurs the efficacy of short-term rates will once again be limited, as they will re-approach the zero bound. Thus, central bank balance sheet utilization will most likely become a more typical monetary policy tool alongside short term rates.

Confidence in the 'reflation' trade is fading

The U.S. Presidential Election has certainly been a catalyst for financial equity market performance. The primary reason being, that the market expected that the new administration will promote a set of economic policies that will ‘reflate’ the U.S. economy sooner than anticipated, and will bring about regulatory changes that will benefit specific sectors. On the macroeconomic front, a swifter ‘reflation’ of the economy, theoretically, could have direct implications for the projected monetary policy stance, and, if true, would most likely lead to a new monetary regime. It is not coincidental, that Treasury yields have moved significantly higher, during the last period. On the regulatory front, financial sector stocks have clearly outperformed other groups since the Election Day, as investors have been counting on a lighter regulatory environment.
 

It is evident, however, that the initial optimism regarding the policy agenda of the newly elected administration has faded during the last two month period, and financial markets have lost part of their initial positive momentum. 

Watch out for the ‘volatility trap’!!!

Volatility remains low by historical standards, even though economic policy uncertainty and geopolitical risk are at elevated levels. It seems that everyone recognizes their presence and, in some cases, persistence, so far however, it is not reflected in underlying portfolio allocations and, ultimately, in specific asset class performance. Equity volatility, for instance, portrays a very optimistic scenario for the global economy, and is counting on quick resolutions regarding possible political and geopolitical events. Financial markets continue to transmit a counterintuitive message; more sources of risk lead to lower volatility. 

The report analyses the implications and consequences of this volatility regime on investor behavior and projected market performance.

June 2017​

P/E to implied volatility ratio signals that investment mood is becoming too euphoric

The U.S. Presidential election has been critical for U.S. equity market performance, as it had a profound impact on market expectations for a swift ‘reflation’ of the U.S. economy, targeted deregulation, and looser fiscal policy. Positive market sentiment has not only pushed major equity indices higher, but equity valuation as well, raising concerns that the market is overheating.

It is true that on a number of widely tracked valuation metrics the U.S. equity market looks expensive, even though the low level of interest rates is providing some leeway. A less followed metric that has also been signaling that the market is rich, or, at least complacent, is the S&P 500 12-month trailing and/or 12-month forward P/E to implied equity volatility (VIX Index) ratio. Historically, when the ratio was higher than one standard deviation from its long term mean, subsequent equity market performance was weak.

The report explores whether the specific metric contains information about future equity market performance.

The Fed converts unconventional QE programmes to conventional monetary policy tools

The most important aspect of the Federal Open Market Committee’s (FOMC) latest meeting was not the policy decision to change the target range of the Federal Funds rate by 25 basis points, but the communication of the central bank’s plans on the unwinding of the monetary policy tools that were deployed during and after the Global Financial Crisis (GFC), as well as on the use of non conventional monetary policy tools in the future.
 

The report highlights the reasons behind the new policy regime.

Greece - Setting the expectations right

The report analyses Greece’s main gains and losses following the decisions taken in the latest Eurogroup meeting. Moreover, it assesses the probability of Greek Government Bond (GGB) participation in the ECB’s quantitative easing programme, as well as a return to the capital markets in the short term. 

Yet another valuation indicator is emitting warning signals for U.S. equities

The market cap to GDP ratio is yet another valuation metric that is currently signaling that the U.S. equity market has reached overvalued territory.
The report presents a number of variants of the specific valuation metric, as well as its relation to forward returns.

July 2017​

Why is gold shrugging off the rising interest rate environment?

Gold price performance has been up year to date, 7.5%, overlooking market expectations for higher U.S. nominal and real rates, and, in return, a stronger U.S. dollar. The relatively high negative correlation between the precious metal’s price, and U.S. real rates, as well as the dollar, has encouraged investors to expect that as the Federal Reserve’s rate normalization process picked up pace, it would be under pressure. The argumentation seems fair enough, but the current inflation outlook complicates matters. And inflation is not the only complicating factor…Apart from being a natural hedge against inflation, gold is used as a safe haven asset during periods of extreme financial and macroeconomic volatility; the very low levels of current cross asset volatility, given the number of prevailing global risks, makes short and medium term moves more difficult to predict.
 

The report analyses the factors that will determine short and medium term movement in gold price, and explains the primary reason that supports gold, despite the projected rising interest rate environment.

Major central banks are progressively preparing markets for a regime shift

During the last month there seems to be a change in major central bank rhetoric that points to a reversal in their underlying monetary policy stance. More specifically, some central banks have started to signal that the probability of lower policy rates is diminishing (for example, the Riksbank), while others have been pointing to a gradual unwinding of their underlying quantitative easing progammes (European Central Bank), or, even a combination of the two. Moreover, a number of central banks have signaled that most likely they will embark on or pursue further rate normalization. It seems that the Federal Reserve and the Bank of Japan are the central banks that enjoy the highest visibility regarding their projected monetary policy stance among investors. The Bank of Japan will most probably continue its sizeable quantitative and qualitative easing programme, while the Federal Reserve will stay on its underlying “steady” tightening path.

It seems that central banks have an important message for financial markets: “prepare for change”. The timing and the magnitude of this change, however, is still left relatively open, in order to allow for a smooth transition to the new regime.

August 2017​

The dispersion in the U.S. equity market is persisting…

The U.S. Presidential Election had been a primary catalyst for higher dispersion in the U.S. equity market. There was a widespread belief among investors that the newly elected administration would promote a set of economic policies that would ‘reflate’ the U.S. economy sooner than previously anticipated, as well as bring about regulatory changes that would benefit specific sectors of the economy. On the macroeconomic front, a swifter reflation of the economy would have had direct implications for the projected path of economic growth, as well as the projected monetary policy stance. Higher growth would gradually lead to higher inflation, and, as a consequence, to a new monetary regime, meaning a more accelerated path of monetary tightening.

Equity investors reacted to this expected change of the underlying macroeconomic and financial environment, or to the increasing probability of a regime shift, by positioning in stocks, sectors and styles that would most likely benefit under a new regime. To be more specific, the higher observed dispersion was a direct result of the increasing likelihood of a significant deviation from the norm of the last seven year period.

Using sector and style related data, this report provides evidence regarding the persistence of higher equity dispersion in the U.S. equity market, and puts recent market performance into perspective.

Asset allocators are in trouble...

The report presents evidence of the challenging times that asset allocators are currently facing to invest especially in mainstream asset classes (bonds, equities), due to their elevated valuation levels, and provides portfolio strategy, construction, and risk management recommendations.

September 2017​

Factor Investing - Alternative sources of alpha (Part II)

The report analyses the risk/return characteristics of various U.S. style factors  and  explores whether investors can achieve superior risk adjusted returns when applying 'alternative or smart beta' strategies in equity portfolios, as well as extended asset allocation programmes.

Factor Investing - Estimating Factor Exposures (Part I)

The report focuses on the estimation of the factor exposures of widely used U.S. equity indices.  More specifically, the report provides econometric estimates of factor exposures of core U.S. equity benchmarks, such as the S&P 500, S&P 100, S&P 600 Small Cap and Russell 2000 Index.

Factor Investing - Estimating Factor Exposures (Part II)

The report focuses on the estimation of the factor exposures of widely used U.S. equity style indices. More specifically, the report provides econometric estimates of factor exposures of large and small cap U.S. style indices, such as the S&P 500 Value, Growth, Momentum, as well as the Russell 2000 Value and Growth Index. 

Global Style Panorama

A collection of graphs related to developed market equity style performance.

October 2017​

Early warning indicators are close to flashing red for U.S. equities

The research report develops an early warning framework (risk indicator) to assess the probability of a sizeable equity market correction in the U.S. and, by extension, in global equity markets. The risk indicator is currently close to a critical threshold, and, thus, signaling potential trouble ahead.

Eight charts that equity investors should not overlook

The report portrays graphically current areas of concern for global equity investors.

How reliable is the Taylor rule as a policy setting tool?

John Taylor, the Stanford university economist, is currently making headlines, as he is on President Trump’s short list to lead the Federal Reserve. Taylor is mostly recognized for the monetary policy rule he introduced back in 1993 that is intended to both prescribe and describe the Federal Funds Rate, the short-term interest rate targeted by the Federal Open Market Committee (FOMC). Taylor has argued that his rule should also be used for policy setting purposes, and, more specifically, should act as a benchmark for monetary policy decision making. More importantly,  there is widespread belief that a Taylor-led Federal Reserve would adopt or lead to a more hawkish monetary policy stance. If that were to happen, it would be a significant deviation from the current and expected path of U.S. monetary policy and would have significant implications for asset markets.

The report argues that, although the Taylor rule is a valuable, straightforward and rational tool or guideline, it might not integrate all necessary parameters for taking policy decisions in a complex and constantly changing economic environment. In addition, the fact that changing the inputs and assumptions of the model, can lead to a rather diverse set of outcomes, reveals the shortcomings of a ‘mechanical’ rule. The focus is to elaborate on the mechanical nature of the rule, and the implications for policy setting.

November 2017​

Demanding valuations in U.S. and European fixed income reveal 'equity like' segments of the bond market are in a state of bliss

 The report analyses the valuation status of main fixed income asset classes and provides reasons for their current levels