Breaking up is not that hard to do: Real Estate (RE) classification

Effective September 1, 2016, the Global Industry Classification Standard (GICS®) will undergo its first major change since its inception in 1999.

As a result of the evolving investment landscape, not to mention the global economy, real estate will be carved out of the financial sector. The new 11th sector will primarily contain equity REITs.

All Dow Jones and Russell indices will be unaffected by the change.

MSCI will make the change on Aug 31, but S&P 500 will change on Sept. 16, which is when most sector funds will rebalance.

The Break Up

The financial sector will be split into financials ex-real estate and real estate. After the change, we estimate that the S&P 500 will have a 14% weight in the “new” financials and 3.2% in real estate.

REITS and Real Estate Management & Development, which are currently sub-sectors under financials, will be renamed to form the new sector of “Equity REITS” composed of 28 companies in the S&P 500.

Mortgage REITs will remain within the financial sector given their greater similarity to traditional financial companies; however, they are a negligible percentage of the index.

From our calculations, specialized REITs (35%), retail REITs (22%), residential REITs (13%), and health care REITs (12%) will be the major components of the new real estate sector.

In making this change, we believe that both MSCI and S&P 500 recognize the increasing role of real estate in global equity markets and considerable growth in assets since 2009. In addition, the increasing specialization of real estate firms has made real estate the least correlated sub-group within financials.

Astor’s View

Volatility:  We expect that financials’ volatility will increase because the low correlation with REITs provided diversification.

Dividend Yield: REITs have a higher dividend yield (~3.5%) vs. 2.4% for the financial sector. So, taking out REITs will lower the dividend yield of financial ETFs to between 1.5-2%.

Performance: Financials ex-REITs will have a higher weighting of interest-rate sensitive sub-sectors such as banks, which will be negatively impacted by rate hikes.

Increased Demand: Most U.S. equity funds significantly underweight real estate, especially in value strategies.  Based on a December 2015 JP Morgan report (1), there is pent-up demand of $100 billion for real estate funds, as long-only mutual funds have an average real estate underweight of 2.1%. Plus, new tax incentives for foreign investors in U.S. REITS may drive demand.

Outlook for Banks and Financial Stocks: Banks and financial stocks have more than recovered from the temporary sentiment-driven sell-off led by the Brexit uncertainty as well as concerns about the Fed’s policy stance. Yet financial stocks remain undervalued relative to other sectors, based on estimated P/E 2016, price/book and long-term debt/capital.

Unless economic conditions deteriorate significantly in the next few months, we expect a stable to steeper yield curve and higher rates by early 2017.

 

 

 

(1) J.P. Morgan Research, 17 December 2015, “2016 REIT Outlook: Remain Constructive as Growth/Valuation Stack Up Well and GICX Change Could be Boon; Risk is Rates.”

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

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August Quick Read on the US Economy

My view on the economy is little changed over the month.  I still see the US in an environment of modest economic growth.  A second strong payroll number should quiet the concerns that a period of weakness is beginning.

Our latest reading for the Astor Economic Index® (“AEI”) is still near the highest level posted this year.  I still see the US as currently growing above average. The AEI is a proprietary index that evaluates selected employment and output trends in an effort to gauge the current pace of US economic growth.

usei.long

The payroll number beat expectations for a second month in a row, relieving concerns that any decline in growth is imminent.  There are no obvious signs of weakness hiding in the details and even real earnings are above where they have been in this long, tepid recovery.  Nevertheless, economists do expect payroll growth to moderate as the economy nears full employment, where many believe it is today, so don’t be surprised if average jobs growth in the next year is lower than the last few years.

The “nowcasts”(1) produced by the Federal Reserve banks of Atlanta and New York continue to show stronger growth in the third quarter than in the first half of the year.  The Atlanta Fed is currently forecasting a 3.7% SAAR (seasonally adjusted annual rate) for Q3 2016.  The New York Fed forecast for Q3 is 2.6%.

These forecasts are significantly higher than not only their own respective final Q2 estimates,  but also higher than the BEA’s (Bureau of Economic Analysis) recent release of their preliminary Q2 GDP estimate of 1.2%.

The combination of our proprietary AEI and the “nowcasts” cited above make me somewhat confident that today the US economy is doing fine and would require a shock of some kind to tip us into recession.

How will the Fed react to the passing of the Brexit vote and the bounce from payrolls?

Former Fed Chair Ben Bernanke had a very useful (though a bit wonky) post explaining how the FOMC in aggregate seems to have adjusted its expectations for the near future of the US economy.  The positive news is that the Fed has become more permissive in what counts as “full employment”, meaning the Fed should not be in as much of a hurry to choke off growth because of inflation fears.  On the disappointing side of the ledger, the FOMC seems to think that the US will grow more slowly in the future with GDP growth around 1.8-2% per year where they were hoping for 2.3-2.5% just a few years ago.

The low rate of growth and the continued low level of realized inflation suggest that The Fed sees the natural rate of interest (the level we might expect the Fed Funds rate to gravitate toward over time) to be lower than they calculated it to be before.

The bottom line is that the Fed should see the need to do less tightening to get to a neutral interest rate which may make the Fed more comfortable deferring its next hike.  In other words, lower for longer once again.

Nevertheless, I expect a few Fed speakers to try to remind the markets that they can hike in September, although I still expect a December hike.  To be clear, I do not think that another 25bp would have significant effects on the economy.

Overall, the economy seems to be holding to the same positive but low growth groove it has been in for the last several months.

 

 

(1) “Nowcast” is the GDPNow forecasting model of the Federal Reserve Bank of Atlanta and  “nowcast” is the Nowcasting report of the New York Fed. 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

 The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

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STAR Gazing

We see several themes playing out this year for US domestic sectors, with regards to sector fundamentals, factor selection and the overall direction of the US economy. In our STAR mid-year update, we seek to answer following questions:

  • How have the sector economic fundamentals evolved and how does that guide allocation?
  • So far this year, why are sectors not performing in line with fundamentals?
  • Why is value still underperforming growth & is the reversal expected to continue? Is this related to small caps underperforming large/mega caps?
  • What are the implications of market uncertainty from Brexit, monetary policy, elections etc. for domestic equity?

The Stock Market appears to be placing value on the following sectors in particular; Energy, Materials, Utilities and Industrials – laggards from last year as well as ones projected to perform well in a risk off environment. However, given that we are fundamentally driven, our analysis believes that Economic indicators are pointing toward a weaker growth environment in these particular sectors compared to others such as healthcare, financials and technology.

Our view is that there is a disconnect between the fundamentals and sector performance, implying that the rally is being driven by expanding price multiples rather than economic outlook

Star Gazing Chart 1

Sectors ranked by Composite Valuation Indicators as of June 30, 2016. The ranking shows average of ranks for Estimated P/E 2016, Projected 5-year Earnings Growth, Price/Book and Long Term Debt/Capital. (Source: Bloomberg, Factset) Past performance is no guarantee of future results. See definitions and disclosures here for additional information

 

We believe that as political and economic uncertainty dissipates, the risk-off trades will unwind bringing market performance in line with fundamentals, which could help the following;

  • Value converges in performance to historical patterns versus growth stocks
  • Large caps give way to small and mid-cap leadership
  • Defensive sectors flows subside & market corrects to reflect relative economic strength.

However, as long as the external headwinds remain, being able to pare down overall exposure to equities, in our opinion, reduces volatility and drawdowns in the long run.

StarGazing Chart 2

Sector Economic Index used in STAR for July 2016 compared to July 2015 and July 2014. (Source: Astor Calculations) Past performance is no guarantee of future results. See definitions and disclosures here for additional information

READ MORE HERE

 

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

 The Sector Tactical Asset Rotation Composite is a tactical strategy focused on the generation of returns through shifts in domestic equity sector allocations. The Composite exclusively uses exchange-traded funds (ETFs) and focuses on investing in domestic equities during economic expansions while reducing equity exposure for fixed income and cash in weak economic periods. Prior to May 2014, the Composite previously invested in various other asset classes, including commodities, international equity, and currencies. The Composite includes a minimum 15% domestic equity allocation and does not invest in inverse funds. The benchmark is the S&P 500 Index. The S&P 500 Index is an unmanaged composite of 500 large capitalization companies. S&P 500 is a registered trademark of McGraw-Hill, Inc.

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July’s Jobs Number Supportive of Steady Growth

The July Employment report came in with an upside surprise—255,000 jobs created during the month, which was well above expectations of 179,000. Making the jobs picture even rosier was the upward revision for June, to 292,000 from 287,000.

Strength in the labor market for June and July has helped bring people back into the workforce, which kept the unemployment rate steady.  Average hourly earnings bumped higher by 0.3%, a number supportive for consumer spending.

As we have said previously, we expect the Fed to raise rates one more time—perhaps as early as September. And, as we have also said, given the fact that rates are essentially zero, a small upward move will be of little real consequence, in our opinion.

That said, even a 25 basis point hike by the Fed, would be a vote of confidence for the U.S. economy. The Astor Economic Index®, our real-time snapshot of the U.S. economy, continues to show steady growth.

In the U.S., it’s all been about jobs. And just to put things in context, keep in mind that this is a presidential election year. No political commentary here, just stating the obvious.

The highlights of the July jobs report showed strength in the private sector, which added 217,000 jobs. The public sector added 38,000 jobs; while not a big number, this does add a little push to the tailwind for the job sector right now.

Other highlights from the Employment Report:

  • The unemployment rate stayed at 4.9%
  • The labor force participation rate rose slightly to 62.8% from 62.7%
  • Overly the year, average hourly earnings have risen by 2.6%. Average hourly earnings for all employees on private nonfarm payrolls increased by 8 cents to $25.69.
  • The change in total nonfarm payroll employment for May was revised from +11,000 to +24,000. Over the past 3 months, job gains have averaged 190,000 per month.
  • Sectors adding jobs are professional and business services, health care, financial, and leisure/hospitality.

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

“The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.”  308161-466

The Answer to the Question on Investors’ Minds: Stay the Course

For much of the year, beginning in January when the stock market had its worst start of a new year in history, we’ve been asked periodically why our portfolios haven’t been materially more defensive. The question has arisen at other times during the year, such as in aftermath of the UK’s “Brexit” vote, an event that temporarily took the market lower because of fear and uncertainty, but did not change the fundamentals. Now, some are wondering if the economic expansion could be getting long in the tooth.

Add to that the cable news chorus that, from time to time, warns investors that the next bear market is right around the corner (cable news pundits have called about five of the last two recessions).

And yet, here we sit, at or near all-time highs in equities.

For us, it’s a pretty straightforward proposition, thanks to the Astor Economic Index®, our proprietary, data-driven guidepost that allows us to determine, in real time, the direction and strength of the U.S. economy. Thanks to this “now-cast,” we are able to aggregate a variety of data into a single value, which we compare to historical levels and historical averages to determine whether we believe the economy is expanding or contracting and to what degree of strength or weakness.

The AEI is our answer to “the” question we believe is foremost on investors’ minds: What is the current state of the economy and its implications for exposure to risk assets?

As a robust aggregation of what is occurring across the $17 trillion U.S. economy, the AEI is our guide for determining risk asset allocation. Research shows that when the economy is growing, it is productive to hold risk assets (i.e. equities); when the economy is contracting, risk assets should be reduced. This is not prognostication—it’s now-casting, to capture the current state of the economy.

AEISource:  Astor Calculations

Since the economy turned the corner after the last recession—whether measured by the National Bureau of Economic Research (NBER), the Astor Economic Index®, or even your own “gut feel” of when things got better after the 2008-2009 financial crisis—the economy has been growing. As the AEI chart (above) illustrates, there have been points during this recovery when economic growth has been faster or slower. But at no time since the recovery has the AEI suggested that the expected return on risk assets was negative.

Not that there haven’t been some times of concern, when caution seemed prudent, such as the 2011 debt ceiling crisis and fears of a U.S. government default. But once those clouds cleared, downturns proved temporary and the financial news media’s repeated calls for a bear market were only head fakes.

The caveat, of course, is that some times are riskier than others; from time to time some assets and sectors do better than others. For example, earlier this year a slower pace of economic growth (but growth, nonetheless) suggested that we reduce beta somewhat in our portfolios, which we did.

Nonetheless, as the AEI chart shows from 2012 to the present, generally speaking risk exposure to risk assets (equities) has paid off, with the exception of a quarter or two. Our data-driven, fundamental approach, however, doesn’t attempt to capture short-term moves, quarter to quarter. As we tell clients, our goal is to generate solid, long-term returns, but our discipline is focused mainly on mitigating risk and protecting the downside. We attempt to give investors what we call “a smoother ride” through the cycles. Interestingly, this theme was featured in a recent Wall Street Journal’s report on the desire of investors for “peace of mind” by controlling volatility. When investors know what they want they can pursue their investment goals accordingly. A fundamentally-driven, macroeconomics-based approach, we believe, is the key to staying disciplined in the pursuit of those investment objectives.

For now, the AEI tells us to stay the course with exposure to risk assets. One day, presumably, that will change—and when it does, we will act accordingly.

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

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U.S. Manufacturing Update

The report on Durable Goods today:

  • New orders for Durable goods decreased 4% in June making this the biggest drop since August 2014. The core measure of new orders for non-defense capital goods excluding aircrafts is up 0.2% in June but still down -3.7% YoY.
  • While the overall new orders decline of 4% looks bad, we believe it is not as meaningful as a measure of manufacturing activity. The reported decline is attributable to a -59% change in commercial aircraft orders.
  • The core capital goods number is used by economists as sign of business investment activity. It has been negative since Dec 2015 but the pace of decline has been slowing.
  • This measure tracks private fixed non-residential investment, a measure of business investment which declined for two consecutive quarters (Q4 2015 & Q1 2016) for the first time since 2009.
  • It can be seen as leading indicator, but revisions & volatility may make it less reliable.
  • These numbers don’t fully take into account the uncertainty and the strengthening dollar post-Brexit and we expect next month’s release to reflect further deterioration in business investment activity.

Astor’s View

Since 2014, there has been ongoing weakness in manufacturing sector and US PMIs, led by the domestic energy sector & a strong US $.  We have been seeing gradual recovery in 2016- the July Markit Flash Manufacturing PMI released last week was highest since October 2015.  But, we expect headwinds to remain from political & global markets uncertainty.

Durable goods

Data Source:  Bloomberg

 

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

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July Quick Read on the US Economy

The economic news improved somewhat from my last update.  The labor market looks more solid than it did a month ago and there are some signs the manufacturing sector may have found it footing.  I believe the Brexit vote will likely have only a modest direct impact on the US, but will make all observers less confident of their predictions for global growth.  This summer, the fed may try to convince the market that it will hike again in September, but my guess is that the December will be the earliest.

 

Our latest reading for the Astor Economic Index® (“AEI”) is higher than last month, and at near the highest level posted this year.  I still see the US as currently growing above average. The AEI is a proprietary index that evaluates selected employment and output trends in an effort to gauge the current pace of US economic growth.

Source: Astor calculations

The labor market has been doing its noisy best to upset the stomachs of economists.  June’s payroll number showed a solid recovery from the weak numbers posted for April and May.  That being said, smoothing the series somewhat by looking at year over year percentage change shows that the US economy is still adding jobs but at a somewhat slower pace than has prevailed over the last few years.

The nowcasts produced by the Federal Reserve banks of Atlanta and New York are both still showing stronger growth in the second quarter than the first.  The Atlanta Fed is currently estimating 2.3 SAAR and the New York Fed 2.1.  These are both slightly weaker than last month’s estimate.  Both have been updated since the employment report.

 

The biggest economic surprise of the year has been the vote for the UK to leave the European Union.  At Astor, we were pleased to provide rapid reaction to this event on our blog on the morning and afternoon of the vote.  I think our analysis holds up well: see CEO Rob Stein’s take here and mine here.   As some of the dust has settled, short term implications for the UK economy are seen as dramatic by many economists.  For example, the panel of economists surveyed by Consensus Economics is now forecasting 1.1% growth in 2017, down from a 2.1% forecast last month.  Reductions for growth in the Eurozone are smaller.  Consensus Economics now forecasts 1.4% in 2017 down from 1.6%.  These same economists are not currently seeing significant direct effects on the US or the rest of the world.  The swift resolution of the UK leadership contest (with a new Prime Minister this week as opposed to the September time table originally announced) may offer grounds for optimism that a deal may cut short the period of uncertainty.

 

I see Brexit uncertainly leading to reduced investment by both firms and households as the primary channel affecting UK GDP.  To the to the extent that the uncertainly will have sustained spillovers into the financial markets it could have indirect effects on the US.  For example, the dollar initially rallied after the vote, but is now about the level that obtained in early June.  Should the dollar appreciate against our trading partners, it would be expected to make exporting more difficult.  In my opinion, the largest effect, however, seems to be in government bond yields.  US ten year yields have moved down 25 basis points to a yield of around 1.50% as this note is being written.  While, some of this may be safe haven demand that one can hope will be reversed as a path forward emerges, there are few of the other typical signs of investor fear.  Investors willing to take 1.5% for 10 years may be foreseeing long spell of a worrying lack of attractive opportunities for investment in the US and abroad.

 

When last we heard from the fed, their rate-raising plans were put on hold by the poor payroll numbers in April and May.  Does the decent report for June portend another hiking scare?  I think it is too soon to tell.  My interpretation of their speeches is that for the fed to raise rates they need to be convinced that the labor market is at full employment and that inflation will return to target in the medium term.  The last report has some points for both sides.  If the decision was finely balanced before, then in my opinion the Brexit vote strengthened the doves’ position.  Neither inflation nor the labor market are likely to see a boost because of it, and I imagine the decline in yields has the fed’s attention.  My guess is that a few hawks will try to make the case for a hike over the summer but that the fed will not hike before December.  For what it’s worth, the most common interpretation of rates implied by fed fund futures market sees only a small chance of a hike before the end of the year, as opposed to the situation in January when more than one additional hike was priced in.  A sustained return to the relatively robust labor market we saw over 2014-2015 would increase the likelihood of a hike.

 

Overall, I am relieved the labor market seems to have bounced back from a weak April and May, but I will feel better about the economy if we see this strength confirmed over the next few months.

 

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

 

“The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.”

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