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Sevens Report 4.30.14

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Sevens Report 4.30.14

Sevens Report Analyst Tyler Richey Featured on the WSJ’s Market Watch Discussing The Action in Gold and Oil Futures

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Links to both articles here: Gold set for a 3% weekly loss; copper rebounds and Oil gains, on track for an up week in a down month

Money is Rotating out of Bonds, Here’s One Group of Stocks that Should Benefit.

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Riding The “Great Rotation”

The “Great Rotation” is a clever name given to the expected move by investors out of fixed-income investments and into equity investments over the next few years as the bond market continues to decline.

But, like most major trends in the markets, this rotation has been slow to materialize (people have been looking for it since January/February).  But, after bond yields spiked higher in June, talk of the “Great Rotation” is back on—especially following the highly publicized $9.6 billion outflow from the PIMCO Total Return Bond Fund in June.  But, while that grabbed all the headlines, PIMCO wasn’t the only company seeing investors move out of flagship bond funds.

Outflows from fixed-income firms in June were widespread:  $14.2 billion from PIMCO, $9.8 billion from Vanguard, $6.4 billion from BlackRock and $5.3 billion from Fidelity (data according to Morningstar).

I have no idea whether this rotation out of bonds and into equities is going to be “Great.” (I don’t presume to be that smart—there are many nuances to consider in people’s asset allocations, not the least of which is a retiring baby boomer generation).  But, whether the rotation is “Great” or not, I do think we will see some rotation, and there may be an opportunity to make money off of that over the coming quarters in the asset-management space.

Keep this in mind:  Since 2009, fixed-income fund flows have been approximately $1.25 trillion, or five times the amount of the preceding five-year period (2004—’09). Conversely, equity fund inflows since ’09 were just $250 billion, which is one-third the amount of money taken in by equity funds during the ’04-’09 period.  So, if we just assume a simple reversion to the mean, you can make the case for equity asset-management shops to outperform over the coming months and quarters.

As a result of this, we should then expect potential underperformance of “bond-heavy” asset managers, and outperformance of “equity-heavy” asset managers, as over time money continues to move out of bond funds and into equity funds.

We’ve already started to see this divergence occur.  Equity-heavy managers like Affiliated Managers Group (AMG), T. Rowe Price (TROW) and Waddell & Reed (WDR)—which have the heaviest mix of equity Assets Under Management compared to debt—are at or near 52-week highs. Meanwhile bond-heavy managers like Franklin Resources (BEN), Legg Mason (LM) and, to a lesser extent, BlackRock (BLK) have underperformed.

But—I am not really a single-stock guy and it’s somewhat simplistic analysis, so I would strongly suggest doing some more homework on these names before doing anything. But, I do think these names are at least a starting point to craft a strategy (either getting long the “equity-exposed” AMs, short the “debt-exposed” AMs, or a pair trade of both).

Finally, the “equity”-focused names are all at or near 52-week highs, so in the short term they are overbought. You may want to wait for a correction (which we might get on a bounce in yields).  But, I don’t think we’ve missed the boat on this trade, seeing as the actual “rotation” hasn’t even really started yet.

To Taper or Not to Taper – that is the question, and Wednesday will be key.

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Here’s the Need to Know This Week:

Last Week

The narrative surrounding the global economy didn’t really change all that much last week, despite the data being pretty disappointing.

Domestically, the spike higher in weekly claims to 360k was the biggest disappointment of last week, as the decline claims of the past month was one of the better things going in the economy.  Almost as disappointing were both the Empire Manufacturing and Philly Fed indices, which both turned negative. Again, these are watched because they are the first looks at May data—so they imply that regional manufacturing activity remains sluggish.  Even housing data was mixed this week, as starts missed expectations (although permits rose so call it a wash).  Finally, readings on inflation were also low, with year-over-year CPI coming in at 1.1%, well below the 2% Fed target.

Things weren’t much better internationally.  French, German and EU Q1’ 13 GDP all missed expectations, the German ZEW business sentiment index missed, and Chinese retail sales, fixed-asset investment and foreign direct investment all either met reduced expectations or were lower than estimates.

But, the takeaway is that none of that matters at this point.  The market isn’t really concerned about second-tier economic data (which all of last week’s reports were) and the only thing the market is focused on economically is the domestic jobs market and global PMIs, and specifically what effect those readings  will have on central bank’s policies.

But, the reason I’m pointing out this weak data is to make everyone aware that there are signs the economy is still not responding to central banks accommodation—so there remains no economic foundation on which the markets can rely  should central banks actually become less accommodative.  When that occurs, and despite the tapering talk it’s still a way off, we could see a bit of an air pocket in markets—so keep that in mind when thinking about positioning.

This Week

This week is all about Wednesday and Thursday morning.  As we know, the market is currently obsessed with WWFD (What Will the Fed Do) and we should get a lot more color on that this week.

First, and most importantly, Bernanke speaks before Congress at 10 a.m.  Multiple Fed presidents (including some doves) have recently expressed a desire to start “tapering” QE as soon as this summer.  But, this is still the chairman’s Fed, and the market will closely be watching his commentary to see if he is on board with the upstart movement to “taper” QE sooner than later.

Later Wednesday the Fed minutes from the most recent meeting will be released, and again the markets will be looking to see how extensive the discussion surrounding “tapering” QE was, and how many Fed presidents expressed “concern” about the potential negative effects of the current program.

Undoubtedly Bernanke will say during his testimony the Fed will remain data-dependent, so the third most important event this week will be the May flash PMIs, released Thursday morning (Chinese and EU flash PMIs will be released Wednesday night/early Thursday respectively).  Also Thursday morning, the weekly jobless claims will be monitored to see if the big jump we saw last week reverses itself (if it doesn’t, the market will take a lot more notice of it this week).

Finally, April durable goods are released Friday (although by that point people will be pretty exhausted and likely headed to the beach a bit early before the long weekend.

Steepening Yield Curve a Bullish Sign for Bank Stocks

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As you probably know, the banking sector has been one of the best performing of the year (up 28% year to date). I think it’s safe to say that the banks have probably become a bit overbought here, and that a correction of some sort is due. So, if you’re not already long the banks, it would be foolish to buy them here.

But, that short term overbought situation aside, one of the things that has been happening lately, that is very bullish for banks, is that the yield curve has been steepening for the first time in a while.

The difference in yield between the 10 year government bond and the two year government bond has risen sharply so far this year, and that speaks directly to banks “Net Interest Margin.“

As you probably know, banks make money by borrowing short term at low rates, and lending long term at high rates. That difference is called the Net Interest Margin, and that’s the profit the bank earns.

Well, as the yield curve steepens, the net interest margin of banks increases. So, despite the potential of a decline in the short term, the underlying fundamentals are turning more positive for banks, and a decline in the banks should be viewed as a long term buying opportunity.

Finally, while a steepening yield curve is bullish for bank stocks, there is actually an ETN that you can buy that actually rises as the yield curve itself steepens. The ETN symbol is STPP. Seems like there’s an ETF (or ETN) for everything these days.