Weekly Briefing: The Market is Trading Tens for TIPs

A sell-off continued to reverberate across global sovereign debt markets on Friday, pushing yields on the debt higher at the end of a week when investors poured $1.1bn into inflation-protected bond funds, amid lingering fears that inflation will push interest rates higher.

The inflow is the second-largest since the start of 2007, according to EPFR, and the largest since April 2015 and the data chimed with the nervous feel to trade across the market.

(Financial Times)

Carlyle said it aimed to raise $100bn over the next four years, drawing on investor demand for returns after assets overseen by the US private equity group have shrunk for four straight quarters.

The ambitious target, disclosed on Wednesday on the company’s earnings call with analysts and investors, compares with the $169bn Carlyle oversees now, down from $188bn last year. The Washington DC-based group hopes to capitalise on investors turning to alternative investments that may help them generate returns that outstrip stocks and bonds.

Carlyle will seek to invest the new money across financial services, energy and natural resources, US real estate, global infrastructure and private equity fund-of-funds, among other things.

Amassing such firepower indicates that the company may be preparing for a market downturn that could then create buying opportunities. The company already has $54bn of dry powder, and has been putting new money to work cautiously at a time of volatility but still high valuations. It invested $1.6bn in equity in the three months that ended in September, the same amount as in 2015.

(Financial Times)

“Economic weakness throughout much of the world persists and, as a result, most of our end markets remain challenged,” said Doug Oberhelman, Caterpillar’s outgoing chairman and chief executive.

“In North America, the market has an abundance of used construction equipment, rail customers have a substantial number of idle locomotives, and around the world there are a significant number of idle mining trucks…

Caterpillar also sees little signs of improvement next year, saying sales and revenues for 2017 will not be “significantly different” than 2016, which would make it the fifth straight year where it would not record sales growth.

“While we are seeing early signals of improvement in some areas, we continue to face a number of challenges. We remain cautious as we look ahead to 2017, but are hopeful as the year unfolds we will begin to see more positive momentum. Whether or not that happens, we are continuing to prepare for a better future,” said Mr Oberhelman.

(Financial Times)

“Well, labor’s a big part of it. We’re at 5% wage rate inflation – we expect that the comp store sales for the year at 1% to 2%, as we’ve talked about, we’ve been managing through the industry labor pressure and continue to believe, as I said earlier, that we have pricing power in 2017,” Cheesecake Factory’s CFO Douglas Benn

(Markets Business Insider)

The story of the labor market over the past several quarters is that employers looking to hire cheap service labor are having a harder and harder time. Compounding the problem is the fact that restaurants, retailers, logistics firms and distribution centers are fighting over a similar pool of workers. This has pushed wage growth for leisure and hospitality workers to an eight-year high of 4.3 percent.

This wage growth is becoming particularly painful for restaurants, which are struggling to pass along price increases to consumers. This is acute for restaurants because although they provide a service, their competitor (grocery stores) provides a good. The cost of the service would tend to rise with wage growth, even as the cost of the goods would fall because exchange rates and cheaper energy used to produce that food.

(Bloomberg)

There are early warning signs that the steady march upward of drug prices is slowing. That is bad news for drug makers and for all of the health-care companies that have profited from consistently higher prices.

The warning comes from drug distributor McKesson, which reported sales and revenue well short of analyst expectations. McKesson also announced a significant cut to the profit guidance for the full fiscal year, which ends in March.

McKesson and its rivals, Cardinal Health and AmerisourceBergen, are essentially middlemen, and their shares are generally steady performers. So Friday’s 20% decline in McKesson’s shares is quite dramatic, while its rivals’ shares also tumbled.

The selloff was part of a wider downturn in health-care stocks on Friday. Shares ofAbbVie, Amgen and Express Scripts were all down sharply.

John Hammergren, chief executive and chairman of McKesson, blamed the guidance cut, in part, on “further moderating branded pharmaceutical pricing trends compared to previous expectations.” Generic drug inflation is likewise cooling.

(WSJ)

For years, many fund managers haven’t done much managing at all. Rather than painstakingly pick what they believe are the best stocks and avoid those they think are the worst, they shadow the market index against which their performance is evaluated. Here and there, they buy a bit more of this stock and a little less of that one, in what’s known as closet indexing.

But over time, you can’t beat the market by being the market, plus or minus a smidgen. After fees, often around 1% per year, plus trading costs, closet index funds seldom earn outperformance.

To call such chicken-hearted tweaks “active management” is an insult to the great swashbuckling stock pickers of the past like Peter Lynch of Fidelity Magellan or John Neff of Vanguard Windsor, who bought whatever they thought was cheap regardless of its arbitrary weight in a market index.

Not every fund manager can or should seek to stand out so far from the crowd. But, in a world where you can buy the entire stock market through passive index funds charging annual fees as low as as little as 0.03%, why hire an active manager for 30 times that cost unless he or she will be truly active?

(WSJ)

On a common currency basis, EM equities have led developed markets by over 10 percentage points so far in 2016, the widest margin of outperformance since the peak of the last cycle. Valuations have correspondingly risen from their lows at the turn of the year, but crucially they remain undemanding in relative terms. Based on an unweighted average across price‐to‐earnings and price‐to‐book value ratios, EM equity multiples reached 1.09x developed market levels at their relative peak in late 2009, but after the protracted bear market of subsequent years that began 2016 at just 0.64x—a level similar to the early 2000s before the global credit, trade and commodity price boom of the pre‐crisis cycle. At 0.74x today, EM valuations have since recovered only around 20% of this relative de‐rating, and therefore still look moderate by historical comparison (Exhibit 8).

(U.S. Trust Capital Markets Outlook)

On an earnings call with investors Thursday, Alphabet CFO Ruth Porat said the quarterly earnings were driven by growth in both search and YouTube.

“We had a great third quarter, with 20 percent revenue growth year on year, and 23 percent on a constant currency basis,” Porat said in a statement. “Mobile search and video are powering our core advertising business and we’re excited about the progress of newer businesses in Google and Other Bets.”

Advertising revenue for Google during the third quarter totaled $19.8 billion, up 18 percent from $16.8 billion last year. Aggregate paid clicks in the third quarter also increased, growing 33 percent year-over-year, while paid clicks on Google websites grew by 42 percent.

Aggregate cost-per-click decreased 11 percent, falling 13 percent on Google websites and 14 percent on Google network members’ websites.

(AdWeek)