Friday October 28

Stock prices end the week slightly lower as GDP data showed that growth picked up in the third quarter. The S&P 500 fell 0.3% to 2,126 and the Dow Jones fell less than 0.1% to 18,161. Over the course of the week the S&P and the Dow were down 1.1% and 0.3% respectively. Economic data today showed that GDP in the third quarter rose at a 2.9% annualized rate which beat expectations which called for a 2.5% gain. An employment cost index also showed solid improvement rising 0.6% from the prior quarter and 2.3% on the year. In spite of the stronger growth data the KBW Bank index fell 0.8% while utilities outperformed which seems counterintuitive. On this backdrop rates held steady around yesterdays levels. The 2 year yield fell 1bp to 0.87% and the 10 year yield was unchanged at 1.85%. 2yr vs 10yr bull steepened to 098%. Over the course of the week the 2 year and the 10 year were 2 and 8bp higher respectively. The dollar was weaker on the day against peers. USD fell 0.8% against EUR to $1.0985. USD fell 0.5% against JPY to Y104.73. USD fell 0.2% against GBP to $1.2188. Today’s movements may indicate that markets had been expecting even more bullish data towards growth and inflation expectations given that yields didn’t change much and the dollar fell. In commodity markets oil prices fell. WTI fell 1.9% to $48.77 and Brent fell 1.5% to $49.73. News about the FBI once again probing Hillary Clinton also contributed to volatility in markets today, as it introduces a new round of uncertainty to the elections next week. The VIX rose to 16.21, and stock indices fell from gains to losses. The market for Fed fund futures fell from 74% to reflect a 69% percent change of higher rates by the end of the year after the FBI announcement.

Market based indicators of inflation have shifted this week providing rationale for the selloff in rates. TIPS have been in high demand and have outperformed while yields on other Treasuries have risen. ETFs and mutual funds that track TIPS experienced inflows of $385mm this week which was the highest weekly total since April. Additionally year to date these funds have experienced the biggest inflows since 2011. The 10 year breakeven rate rose to 1.73% this week as inflation expectations rose. After diverging with oil prices at the end of last year and beginning of this year, inflation expectations and oil prices have been moving in lockstep over the last couple of months. On the other hand consumer inflation expectations have been falling possibly as a result of election rhetoric. Recent inflation data has shown that US CPI rose 1.5% in the year ended in September. Other assets such as industrial metals have been rallying as well, and these are also known to be hedges against inflation. Zinc, copper, nickel, and aluminum have all been rising. Some fund managers have also been increasing allocations to agricultural commodities.

The scope of activist investors and private equity firms have converged over the last few years. This comes as more investor money has been chasing fewer opportunities and markets have become more efficient. In this way activist investors have entered into the business of totally acquiring companies. And private equity firms have been increasingly buying minority stakes in publicly traded companies which is similar to what activist investors typically do. Both cases aim to reorganize the operations of struggling companies. KKR has invested in what it calls “toehold” stakes in public companies totaling $1bn over the last few years. KKR earned some profits doing this by acquiring a minority share in EMC before Dell acquired it. KKR also does not want to come across as too hostile given that its investors are well-known public pension funds and therefore has been quick in telling management that it is acquiring interest. Smaller stakes can also help private equity firms lay the groundwork for larger acquisitions.

On the flurry of deal activity this week M&A volume set a new monthly record. This is unusual since it is on the eve of the US presidential election, and companies typically put deals on hold around this time. AT&T set plans to acquire Time Warner for $85bn. Qualcomm plans on acquiring NXP Semiconductors for $39bn. BAT set plans to acquire Reynolds American for $47bn. This month M&A volume hit $248.9bn, and this past week along it was more than $177bn. Both of these numbers set monthly and weekly records. M&A volume on the year has been down 20% from last year’s record pace. It is expected that if Clinton wins the election she will be relatively strict on mergers. Part of the rationale for these deals is given slow economic and sales growth, they are having to look for alternative ways to create value for shareholders. Some of these measures include acquiring rivals and competitors in order to create value. Share buybacks have slowed, and M&A activity is a new way for companies to deploy cash.

Japanese life insurance companies have been buying foreign corporate bonds as a result of low yields. Those companies collectively control $3.3tn in assets and as a result they are closely watched in the investment community. Traditionally they have invested only in yen-denominated assets but they moved in the past to purchase government bonds from international countries. However as those yields have gone to zero they’ve shifted focus to corporate bonds. The 10 year US JGB yields less than 0.0%, whereas the yield on a AAA corporate bond in the US is higher than 2.5%. These strategies face currency risks, as if the yen appreciates relative to USD they are going to have to write down the value of foreign portfolios. Japan Post Insurance even said it would consider investing in private equity or hedge funds.

Friday October 28

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