Tuesday April 25

Stocks continue their upward momentum looking ahead to more information about the Trump tax plan tomorrow. The S&P 500 rose today 0.6% to 2,388 and the Dow Jones rose 1.1% to 20,996. The KBW Bank index rose 0.7% while utilities fell 0.1%. Also notable today was the Nasdaq which closed above 6,000 for the first time. The two year Treasury yield rose 5bp to 1.28%. The ten year Treasury yield rose 4bp to 2.31%. Accordingly 2yr vs 10yr flattened 1bp to 1.03%. The dollar was lower against peers except the yen. USD fell 0.6% against EUR to $1.0937. USD rose 1.2% against JPY to Y111.09. USD fell 0.3% against GBP to $1.2833. Oil prices found support after selling off for a few days. WTI rose 1.1% to $49.76. Brent rose 1.4% to $52.32.

Institutional investors have been increasingly looking more towards ETFs to get exposure to the fixed income market. Equity ETFs have been gaining a lot of traction over the last 10 years however now fixed income ETFs are just catching up. ETFs that track fixed income markets received $92bn in inflows last year which was up 50% from 2015. The inflows also exceeded the percentage of growth in inflows into equity ETFs and year to date the trend has continued. Block trades in fixed income ETFs, which are used by institutional investors, have also been on the rise. In 2010 there was just 600 thousand in block trades in fixed income ETFs. In 2016 that number had risen to more than 800 thousand by the average side of the trades. That suggests higher institutional use of those products. Institutional investors like these products since they allow them to make quick adjustments in credit risk and duration. Normally in fixed income markets that would take longer to adjust however ETFs let them buy and sell and adjust much quicker. As central banks around the world become more active investors are going to want to be able to respond to volatility quicker. The largest Treasury bond fund is only 20% of the size of the largest gold ETF however daily trading volume is higher. According to BlackRock 40% of that Treasury fund’s assets are held by institutional investors. Fixed income ETF options have also been becoming more prevalent on ETFs including HYG. That is creating some unease among certain investors who are worried that passive investment isn’t well suited for fixed income markets. The fear here is that the ETFs are far more liquid than the underlying assets and that could create problems in times of volatility or high redemptions in the ETF.

Investors betting against retail have been turning their attention toward large mall operators. Initially hedge funds went long Amazon and sold retail companies. As the next leg of that trade they looked at smaller regional mall operators and shorted those REITs as the tenants suffered. Amazon’s outperformance relative to retailers shows how well that trade has performed as many retail companies have gone bankrupt or closed stores. Shares of smaller regional have also underperformed since the middle of last year, and now hedge funds are setting their sights on larger operators such as Simon Property Group. Those companies have so far fared better than their tenants or their smaller counterparts. In the financial crisis REIT performance was correlated to the performance of their tenants however now that relation has diverged. Equity research analysts remain optimistic on large mall operators based on the number of buy/ hold/ sell ratings. Smaller retailers within malls have been the most negatively affected compared to anchor tenants. That is bad for large mall operators since the small retailers tend to pay much higher rents. Hedge funds therefore hope that as mall operator financial conditions deteriorate along with their tenants they will benefit from a short position.

An important milestone is about to be reached in the debate between active and passive management. Alliance Bernstein writes that sometime around the start of 2018 more than 50% of the assets in US equity markets will be held by passively managed equity ETFs. Some researchers are concerned about the implications this could have for market efficiency and the price discovery/ capital allocation process. However one researcher at Credit Suisse argues that the shift to passive will in fact make markets more efficient since it will be the equivalent to the weak players leaving the poker table. The strong players will remain in the markets and markets will be more efficient since winners need losers. As a result markets will become even less attractive for those who remain according to the CS researcher. At a certain point it will pay for investors to be active however researchers agree that the 50% threshold will probably not be passed again.

Tuesday April 25

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