Friday November 4

Stocks fell today for the ninth consecutive day in spite of gains earlier in the session. The S&P 500 fell 0.2% to 2,085 while the Dow Jones fell 0.2% to 17,888. Over the course of the week the S&P 500 was 1.9% lower and the Dow was 1.4% lower. Economic data today showed that the economy added 161k jobs in October, while the unemployment rate fell to 4.9% and average hourly earnings picked up to 0.4% on the month. While the nonfarm payrolls change missed consensus, average hourly earnings exceeded expectations and both figures were revised upwards as well. All things equal this report was interpreted to be more conducive for the Fed raising interest rates next month. However investors continued to focus on election uncertainty as rates rallied along with haven assets. The VIX remained elevated at 22.90. Falling oil prices continued to weigh on markets. WTI fell 1.2% to $44.12 and Brent fell 1.7% to $45.58. The dollar’s losses this week also reflect political uncertainty down 1.4% on the week against peers. USD today fell 0.3% against EUR to $1.1136. USD fell 0.4% against GBP to $1.2515. USD rose marginally against JPY to Y103.04. Rates rallied on election uncertainty. The two year fell 2bp to 0.79% and the 10 year fell 3bp to 1.77%. The spread between 2yr and 10yr bull flattened slightly to 0.99%. Over the course of the week the 2yr and the 10yr were 6bp and 5bp lower respectively. Gold prices also rose 2% on the week.

Interval funds have risen in popularity this year which may be a function of the global search for yield. The amount of money that asset managers registered to sell investors in interval funds rose 24% compared to last year. These funds invest in illiquid and hard to market securities such as commercial real estate, timberland, farmland, consumer loans, distressed debt, and catastrophe bonds. Since the underlying assets to the funds are much less liquid, the funds themselves need to offer less liquidity to investors to provide some protection for the manager. Interval funds allow investors to liquidate only on certain dates throughout the year which in most cases is quarterly and investors can’t get more than 25% of their money back at a time. On a total level the funds will give back no more than 5% of their total capital at any interval date. As such in the event of a run for the exits it may take up to several years for an investor to get the entirety of his money back. Expenses for these funds are quite high and will total 5.75% for the first year and around 3.45% in subsequent years. Investors therefore will require at least a 7.1% return in order for them to earn a profit.

The election uncertainty has caused some reshuffling for investors. The stock market has declined for the last eight consecutive days for a cumulative loss of 3% over that time span. At the same time money market funds have experienced large inflows as investors look for a safe place to park cash. In total money market funds have received more than $36bn in inflows in the week that ended November 2. This could be an example of investors waiting on the sidelines until the election passes so that they may jump on opportunities that arise given an uncertain outcome. As a result the VIX has risen, and the MOVE index (rate volatility) and currency volatility measures have all hit nearly four month highs. High yield bond funds experienced outflows of $4.1bn. Spreads on a BAML high yield index have risen to +530 up from +470 just a few weeks ago. US equity outflows totaled $3.5bn. At the same time funds that track haven assets such as Treasuries and gold received inflows of $2.3bn and $205mm respectively. Other potential risk events on the horizon include falling oil prices as well as rising interest rates and inflation.

Credit spreads for European banks have fallen above that of large corporations which is abnormal based on historical trends. According to BAML investment grade senior financial debt is yielding around 30bp higher than corporate counterparts. This trend has come about as a result of ECB quantitative easing, which excludes financial debt. This trend is most pronounced in Germany and is also elevated in Italy. This is highly unusual given the business of a bank. Historically banks borrow at low rates and lend to customers at higher rates and pocket the margin. Now monetary policy has thrown that time-trusted business model out the window. Low rates offered directly from the ECB also limit the need for banks to access debt markets. The higher financial – corporate spread could be contributing to the fact that credit growth in the EU has been slowing down. Banks are less willing to give out loans as their margins deteriorate further. Some analysts believe the ECB should address this issue by buying bank debt as part of its QE, however critics argue that it creates moral hazard issues and a conflict of interest.

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Friday November 4

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