Recap 2015-02-12


GS on HY Energy Defaults: Given structural differences with today’s post-shale environment, past default cycles in the Energy sector are an imperfect guide to the current one, and we do not expect defaults among US E&Ps to reach the same levels seen in the mid-1980s. For one thing, today’s Energy sector has important compositional differences to the 1980s. Integrated oil companies formed the bulk of the Energy space in the 1980s, while today’s HY market is dominated by E&Ps (8.5% of the market and a little more than half of the high yield Energy sector). We think today’s HY E&Ps will prove surprisingly resilient in their ability to weather low oil prices without large-scale defaults (more on this below). Our baseline view is for a modest rise in defaults, mainly concentrated among E&Ps with low-quality assets and weak balance sheets. Our year-end forecast of 3.2% for high yield defaults (from 1.9% currently) implicitly accounts for the prospect of rising defaults in the Energy sector. E&Ps and Servicers represent roughly 10.5% of the high yield market according to the Yield Book Citi index. If one assumes that 10% of those subsectors default while the rest of the market follows a more benign trajectory, it is hard to see high yield defaults meaningfully overshooting our forecast. And even if defaults push the 12-month default rate to the neighbourhood of 4%, that would still be close to the long-run average of the high yield market.

Interesting white paper from GMO on what drives active equity manager underperformance vs the index:

If investment managers were each following independent investment strategies, we would expect roughly half of these managers to outperform (gross of fees) in any given period. The data, however, suggests that it is far more typical for either two-thirds of managers to outperform, or for two-thirds of managers to underperform. Almost everyone wins, or almost everyone loses. This strongly suggests that there are some common factors that drive the performance of the typical manager and that these factors ultimately heavily influence their success or failure.

Because the data is broadly representative of the universe of institutional U.S. large cap equity managers, the explanatory factors are not likely to be found in the form of sector biases, value versus growth, or anything else that amounts to taking active positions within the benchmark. After all, for every active manager that is overweight a sector there is another who is underweight. Rather, the explanation must come from some systematic exposures that are taken by the majority of managers that amount to out-of benchmark allocations. To keep things as simple as possible, we will focus here on investments in non- U.S. stocks, investments in small cap stocks, and cash holdings.

It is not uncommon for managers to have several percentage points of their portfolio allocated to each of these asset classes, and therefore underperformance from any of these will act as a drag on the performance of the overall portfolio. To get a sense of the magnitudes involved, we can see from the exhibits that in the 12 months ending September 30, 2014 the S&P 500 beat both international and U.S. small cap stocks by around 10% while outperforming cash by 20%. If a manager were to have had 5% of his portfolio in non-U.S. stocks, 5% in small/mid cap U.S. stocks, and carried 1% in cash, then he will have effectively started with a deficit of 120 bps versus the benchmark. That is a lot of ground to make up from stock picking within the S&P 500 alone. To help understand the longer-term influence of these out-of-benchmark allocations on overall manager performance, we constructed a very simple index that counts the number of our style factors that have been helping managers at any point in time..

In fact, we can do somewhat better and attempt to “explain” the data. To that end we have set up a simple three-factor model in which we regress the performance data for U.S. large cap managers as plotted in Exhibit 1 against the contemporaneous rolling 12-month returns of each factor as plotted in Exhibits 2 through 4. Using the results of this regression, we can estimate the percentage of managers that would be expected to outperform at each point in time given only the relative performance of our three factors. The predicted and actual data are overlayed in Exhibit 6. The conclusion to be drawn is that a very large proportion of the historical variability of large cap managers’ ability to add alpha is explained by our simple three-factor out-of-benchmark model.


  • "We had an intense discussion, constructive, covering a lot of ground, also making progress, but not enough progress yet to come to joint conclusions” said Jeroen Dijsselbloem (head of the Eurogroup). Per Greece’s finance minister: “Now we are proceeding to the next meeting on Monday. We hope that by the end of that one, there is going to be a conclusion in a manner that is optimal both for the perspective of Greece and our European partners”. According to Reuters (citing sources), Greece is confident of reaching a deal w/Europe but will not extend the current bailout program.
  • BOJ Is Said to See Extra Stimulus Counterproductive for Now, and that consumer sentiment would be hurt by a further drop in the Yen – BBG. A comment from an unnamed BoJ official caused the spike lower in $yen overnight to 118.74. The official said the BoJ sees any extra stimulus as counterproductive for now. There is speculation it was Morimoto who made the comments and he opposed QE at the onset.
  • the Riksbank cut the repo rate by 10bp to -0.10% and re-installed its +/- 10bp bands in the fine-tuning operations. Second, it lowered its conditional interest rate path further, postponing initial tightening from 3Q to 4Q 2016 and lowering the 4Q-17 end-point by 17bp to 1.28%. Third, the Riksbank announced asset purchases; it will buy domestic government bonds for the sum of SEK 10bn, with the purchases being spread over three days (26 Feb, 5 Mar and 12 Mar).
  • After an all night negotiating session, a deal was announced early this morning that is aimed at stopping the violence in eastern Ukraine. The deal, which comes into effect Feb 15, calls for both sides to withdraw heavy weapons and takes steps to provide greater autonomy to the separatist regions in the east. Not all the details are known at this time (and there appears to be some disagreement over geography and precisely defining the separatist regions while fighting continues). There hasn’t been any talk on the part of European of Washington officials of dialing back any sanctions against Russia (although many European capitals are keen to see these restrictions lifted).
  • BoE Inflation Report despite discussions on low inflation rates in the short term, Governor Carney appeared fairly confident regarding the strength of the economy in the medium term.
  • UK RICS Housing Balance declined to 7 vs 12 exp and 11 prev
  • US Retail Sales were weak falling -0.8% vs -0.4% exp. The Control group rose just 0.1% vs 0.4% exp.
  • Jobless Claims rose to 304k vs 287k exp and 278k prev
  • Australia Employment declined -12.2k vs -5k exp, driven by full time employment. The Unemployment rate jumped to 6.4% vs 6.2% exp and 6.1% prev, with the participation rate unchanged at 64.8% versus 64.7% expected.
  • New Zealand PMI declined to 50.9 vs 57.7 prev
  • Japan Machine Orders jumped to +11.4% YoY vs 5.6% exp and -14.6% prev
  • The average number of dealers providing prices for European corporate bonds dropped to a low of 3.2 per trade last month, down from 8.8 in 2009, according to data compiled by Morgan Stanley. – BBG
  • GS: Over the next 2-3 years, we expect a further steepening of the downward trend in age-specific retirement rates because we believe that the unusually high rate of economically motivated early retirements in recent years has likely "cannibalized" some retirements in future years. This should keep the overall participation rate going sideways to slightly higher, despite the continued negative effects of population aging. The result is likely to be a slower pace of decline in the unemployment rate, even as job growth remains sturdy.


  • Fri: EU GDP, US UMichigan Sentiment
  • Mon : US holiday, NZ House Sales, Retail Sales, Japan GDP, RBA minutes
  • Tue: UK CPI, German Zew, US Empire Mfg, NAHB Survey
  • Wed: UK Employment, Earnings, BoE Minutes, US Housing Starts, PPI, FOMC minutes,
  • Thu: