Income Report Card | November 2017

Author: Nathan Rowader
Date: November 15, 2017
Category: Asset Allocation, Financial Planning
Tags: , , , , , , , , , , ,

Potential Opportunities
for Income

  • Emerging Market Corporate Bonds
  • High-Yield Municipal Bonds
  • International Real Estate

Weaker Opportunities for Income

  • International Sovereign Bonds
  • Treasurys


Bonds Continue to Slide

Historically, September and October tend to be the weakest months for stocks, but this year has been different as global stocks increased by 2.08% in October. The gains were broad based, with Japan increasing by 4.61% following Prime Minister Shinzō Abe’s reelection and emerging markets (EM) increasing by 3.51%. Other major markets gained as well, with U.S. stocks increasing by 2.33% and European equities gaining 0.47%. Small-cap stocks underperformed large-cap stocks, increasing by 0.85% and underperforming the S&P 500. Gains in foreign markets overcame weakness in the euro and yen relative to the dollar, which gained slightly less than 1% compared to other major developed currencies.

Weakness in the bond market continued into October with the global bond market declining by 0.38%—the second monthly decline. Once again, the primary detractor to the overall bond market was the international sovereign bond sector, which fell -0.72%, underperforming international Treasurys which declined -0.12%. The credit markets performed better, with high-yield corporate bonds gaining 0.42%, EM corporate bonds gaining 0.83% and high-yield municipal bonds gaining 0.27%. The 10-year Treasury yield increased to 2.46% in October, decidedly breaking out of a range that had been in place since Q1 2017. While yield pulled back, this environment could be a set up for higher future rates and the continuation of the reflation theme that dominated the latter part of 2016 and the early part of 2017. It is too early to make that an official stance, but we think it is worth watching. Should the 10-year Treasury hold above 2.30% and then advance past 2.46%, it would be wise to consider taking on some inflation-oriented positioning.


The Global Economy Supporting Stocks

The JPMorgan Global Manufacturing Purchasing Managers’ Index (PMI) increased by 0.2 points to 53.5, remaining around the highest level since 2011. Additionally, all but one of the component indices increased with new orders and new exports accelerating the most, hitting multiyear highs. All of this information tells us that the folks controlling the order flow of global manufacturers expect business to expand over the next several months, which would mean the economy would expand as well. The next several readings from this group of purchasing professionals are going to send some signals about the structure of the world economy going forward. Since the 2008-2009 fiscal crisis, the PMI hasn’t maintained readings above 53 for very long, but that doesn’t necessarily mean it has peaked. Prior to the fiscal crisis, the PMI could reach as high as 57, which leaves room for more growth currently. A move toward 57 would perhaps act as evidence of our economy returning to a more normal state. There was another interesting feature of this month’s report: more than 90% of the reporting global economies are registering a reading higher than 50, indicating an expanding global economy. The highest readings are coming from developed European countries, with some weakness from emerging economies due to impact from certain monetary policy changes in the respective countries.

The U.S. employment picture is strong, with the unemployment rate at 4.30%—the lowest point since 2001. Wage growth is also starting to recover, which has been one of the most sluggish economic indicators of U.S. growth. The current level of economic growth is at 3.6%, just below the 4% experienced before the 2008-2009 financial crisis. This also translates to higher economic growth with average forecasted Q4 2017 gross domestic product (GDP) growth at 3.4%—once again another multiyear high. While valuations are stretched for stocks, robust growth could help normalize those valuations. As of right now, there is no reason to pull back on stock allocations.


Looking Back, the Forward

Let’s look at some of our past positioning and recommendations and see how the year is going. This year, we have largely recommended an overweight to stocks, specifically EM stocks, and a tilt toward credit in your bond portfolio, specifically EM corporate bonds, high-yield corporate bonds and high-yield municipal bonds. The overweight to stocks has been a successful call, as global stocks have increased 19.68% for the year ending 10/31/17 while global bonds have gained 5.84% during the same time. EM equities have surpassed global bonds, increasing by 32.26% for the year. Credit has done well with EM corporate bonds, high-yield corporate bonds and high-yield muni bonds increasing by 8.7%, 7.5% and 8.0%, respectively, and all outperforming global bonds. Next, let’s look at how the report card scoring system has worked this year.

Carry for Bonds

A 8.4% 2.1% 5.6%
B 4.4% 1.6% 3.4%
C 5.2% 1.9% 3.6%
D 5.5% 1.9% 2.9%
F 4.5% 3.0% 1.4%
Global Bonds 5.8% 3.0% 1.6%

Carry for Stocks

A -0.5% 6.2% 4.5%
B 12.9% 5.4% 5.8%
C 7.6% 6.4% 3.6%
D 17.2% 5.4% 2.7%
F 27.1% 6.8% 2.4%
Global Bonds 19.7% 3.1% 2.3%

Trend for Bonds

A 8.4% 2.1% 5.6%
B 7.1% 2.1% 5.1%
C 4.4% 1.6% 2.7%
D 2.6% 1.8% 1.8%
F 4.4% 2.8% 1.5%
Global Bonds 5.8% 3.0% 1.6%

Trend for Stocks

A 19.0% 6.5% 2.8%
B 16.9% 6.7% 2.7%
C 7.3% 5.8% 3.9%
D 9.5% 3.7% 4.7%
F 7.3% 7.5% 7.5%
Global Bonds 19.7% 3.1% 2.3%
There is quite a bit to unpack here. The trend and yield environments have been generally synchronous all year as investors have sought out higher yielding bonds. The resulting carry and trend grades give comparable results: investors who bought high-yielding and high-performing asset classes would have been able to handily beat the global bond market while also generating a very high stream of current income. Stocks are a little different. Trend has worked well for stocks, but has mostly kept up with the market, not really outperforming. Meanwhile carry for stocks has been the inverse of what we would desire, which makes sense since markets have shunned value and dividend-paying stocks. When we introduced the report card, it was suggested that an investor could buy a basket of A- and B-rated stock and bond asset classes in order to build a good high-income portfolio. This portfolio would have delivered 9.5% return with a 2.8% standard deviation and a current income of 4.4%. A 50% global stock and 50% global bond portfolio would have delivered a return of 12.8% with a standard deviation of 3.1% and a current yield of 2.0%. Anyone who followed this structure would have underperformed the market, but still generated a great return with a yield more than 2x the benchmark.


A Story with a Twist

Jeremy, the left-coiled brown garden snail, died in October. Jeremy had a genetic mutation that caused his shell to twist to the left instead of the right because all his internal organs twisted left instead of right. Scientists at the University of Nottingham have been trying to explain whether the anomaly was genetic or environmental. To prove it was genetics, Jeremy needed a left-twisting mate, which required a large public outreach via social media. After several years of searching, six left coiled snails were discovered. Jeremy successfully created a brood just days before his passing, but none are left-twisting, leading researchers to believe that it may take several generations for the anomaly to reappear.


To learn more about the methodology visit the Salient Partners blog posting at You can also follow us on Twitter at @nrowader and @NicMillikan for live updates on the Income Report Card.

Report Card: Stocks

Report Card: Bonds

Complete Income
Report Card
U.S. Treasurys Bloomberg Barclays U.S. Treasury
U.S. Investment Grade Credit Bloomberg Barclays U.S. Credit Bond
Municipal Bonds Bloomberg Barclays U.S. Municipal Bond
High-Yield Municipal Bonds Bloomberg Barclays U.S. Municipal High Yield
U.S. High-Yield Corporate Bonds Bloomberg Barclays U.S. Corporate High-Yield Bond
Emerging Market Corporate Debt CS Emerging Markets Corporate Bond
Emerging Market Sovereign Debt Bloomberg Barclays EM Sovereign Bond
International Sovereign Debt Bloomberg Barclays Global Treasury ex-USD
Mortgages Bloomberg Barclays U.S. MBS
Short-Term Treasurys (Cash Proxy) Bloomberg Barclays U.S. Treasury 1-3 yr Term
Global Bonds Bloomberg Barclays Global Aggregate Bonds
U.S. Stocks S&P 500
International Stocks MSCI EAFE
Emerging Market Stocks MSCI Emerging Markets
U.S. Real Estate Dow Jones U.S. Real Estate
MLPs Alerian MLP Infrastructure
Preferred Stocks BofA Merrill Lynch Core Fixed Rate Preferred Securities
Utilities S&P 500 Utilities Sector
International Real Estate Dow Jones Global ex-U.S. Real Estate Securities
EM Infrastructure MSCI EM Infrastructure
Japan MSCI Japan
Europe MSCI Europe
Small Cap Stocks Russell 2000
Global Stocks MSCI All Country World Index

Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

Nic Millikan and Nathan J. Rowader are registered representatives of ALPS Distributors, Inc.

Alerian MLP Infrastructure Index is the leading gauge of large- and mid-cap energy master limited partnerships (MLPs). The float-adjusted, capitalization-weighted index includes some of the most prominent companies and captures approximately 75% of available market capitalization.

Bloomberg Barclays EM Sovereign Bond Index is a rules-based market-value weighted index engineered to measure the fixed-rate local currency sovereign bonds issued in emerging markets as identified by Bloomberg.

Bloomberg Barclays Global Treasury ex-USD Index is an unmanaged index composed of those securities included in the Barclays Global Aggregate Bond Index that are Treasury securities, with the US excluded while hedging the currency back to the US dollar.

Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are U.S. domestic, taxable and dollar denominated. The index covers the U.S. investment-grade, fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities.

Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the USD-denominated, noninvestment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.

Bloomberg Barclays U.S. Credit Index is an index composed of corporate and non-corporate debt issues that are rated investment grade (Baa3/BBB) or higher.

Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC).

Bloomberg Barclays U.S. Municipal Bond Index covers the USD-denominated, long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds.

Bloomberg Barclays U.S. Municipal High Yield Index measures the noninvestment-grade and nonrated U.S. dollar-denominated, fixed-rate, tax-exempt bond market within the 50 United States and four other qualifying regions (Washington D.C., Puerto Rico, Guam and the Virgin Islands).

Bloomberg Barclays U.S. Treasury Index is an unmanaged index of public obligations of the U.S. Treasury with a remaining maturity of one year or more.

Bloomberg Barclays U.S. Treasury Bond 1-3 Year Term Index is an unmanaged index of public obligations of the U.S. Treasury includes public obligations of the U.S. Treasury with a maturity between 1 and up to (but not including) 3 years.

BofA Merrill Lynch U.S. Core Fixed Rate Preferred Stock Index consists of investment-grade, fixed and fixed-to-floating rate U.S. dollar-denominated preferred securities.

CBOE Volatility Index is a popular measure of market risk and is constructed using the implied volatility of S&P 500 index options.

Consumer price index (CPI) is an index number measuring the average price of consumer goods and services purchased by households. The percentage change in the CPI is a measure of inflation.

Credit Suisse Emerging Market Corporate Bond Index consists of U.S. dollar-denominated fixed-income issues from Latin America, Eastern Europe and Asia.

Dow Jones Global ex-U.S. Select REIT Index measures the performance of equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded globally, excluding the U.S.

Dow Jones U.S. Real Estate Index measures the performance of the real estate industry of the U.S. equity market.

JPMorgan Global Manufacturing Purchasing Managers’ Index is a composite index that serves as a global economic indicator by measuring different business conditions in 24 countries, including global manufacturing output, new orders and employment across the global manufacturing sector.

MSCI EAFE (Europe, Australasia and Far East) Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. and Canada.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.

MSCI Emerging Markets Infrastructure Index captures the global opportunity set of companies that are owners or operators of infrastructure assets.

MSCI World Index is a free float-adjusted market capitalization index designed to measure equity market performance in the global developed markets.

MSCI Japan Index is a free float-adjusted market capitalization index that is designed to measure the equity performance of 85% of Japan’s large- and mid-cap segments.

Max drawdown is the percentage of loss that an asset incurs from its peak net asset value to its lowest value.

NASDAQ-100 is a modified capitalization-weighted index that includes the largest nonfinancial U.S. and non-U.S. companies listed on the NASDAQ stock market across a variety of industries, such as retail, healthcare, telecommunications, wholesale trade, biotechnology and technology.

NYSE Advance/Decline Indicator is a technical indicator that charts the difference between the number of advancing stocks and declining stocks on the NYSE in a given market on a given day.

NYSE New Highs/Lows is a technical indicator that charts the highest and lowest prices over 52 weeks of NYSE stocks in a given market on a given day.

Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Russell 3000 Index represents approximately 98% of the investable U.S. equity market.

S&P 500 Financials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® financials sector.

S&P 500 Index is an unmanaged index of 500 common stocks chosen to reflect the industries in the U.S. economy.

Sharpe ratio is a ratio developed by Nobel laureate William F. Sharpe to measure how a fund performs relative to the risk it takes.

Standard deviation measures the degree to which a fund’s return varies from its previous returns or from the average of all similar funds.

Valuation is the process of determining the value of an asset or company based on earnings and the market value of assets.

VIX (the ticker symbol for the Chicago Board Options Exchange Volatility Index) is a popular measure of market risk and is constructed using the implied volatility of S&P 500 index options.

Yield is the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost or on the U.S. government’s debt obligations.

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