View from the Observation Deck

1. S&P Capital IQ reported that $51.4 billion worth of U.S. mergers were announced so far in 2013 (thru 5/20) in the information technology (IT) sector, up from $17.9 billion at this point last year.
2. S&P estimates that IT deal volume in 2013 will approach $133.9 billion, the highest since 2007. From 2004-2012, the U.S. IT sector averaged $99 billion per year in M&A deal volume.
3. Since 2004, the biggest year for deal volume was the $184.6 billion registered in 2007. The weakest year for volume was the $55.8 billion announced in 2008, the first year of the recession.
4. Information Technology companies in the S&P 500 alone held $437.0 billion in cash and equivalents at the end of 2012, according to S&P Dow Jones Indices.
5. This is an indication that companies have the means to make acquisitions.
6. One of the takeaways from the chart is that technology companies are willing to pay up for acquisitions, as evidenced by the 24.25 average price-to-earnings (P/E) ratio in 2007 (see chart).
7. But they are much less expensive today. The trailing 12-month P/E on the S&P 500 Information technology Index is currently 15.99, well below its 10-year average of 22.07, according to Bloomberg.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Information Technology Index is a capitalization-weighted index comprised of 70 constituents representing the technology sector. 

To Download a PDF of this post, please click here.

View from the Observation Deck

1. Each spring, Dalbar, a research firm based in Boston, releases the findings from its annual study (“Quantitative Analysis of Investor Behavior”) measuring investor returns from mutual fund holdings. 
2. One of the key takeaways through the years has been that individual investors are prone to moving their money in and out of the market at the wrong time, according to Louis Harvey, president of Dalbar.
3. For the 20-year period ended 2012, investors in U.S. stock mutual funds posted an average annualized return of 4.25%, compared to an annualized gain of 8.21% for the S&P 500, according to Dalbar.
4. Unfortunately, that means that the average investor in U.S. stock mutual funds has lagged the broader market’s benchmark index (S&P 500) by 3.96 percentage points per year for the past 20 years.
5. The chart above features net cash flows and total return figures for equity mutual funds and corresponding indices invested in foreign stocks representing both developed and emerging/developing nations.
6. What we find most encouraging about the data is the consistency with which retail investors have committed capital to emerging markets equity funds, especially in 2011 when returns were poor.
7. The International Monetary Fund sees much faster growth in the “Emerging Market and Developing Economies” moving forward. It has a GDP growth rate estimate of 5.3% (2013) and 5.7% (2014) for this category.
8. Its estimates for “Advanced Economies” are 1.2% (2013) and 2.2% (2014).
9. Is it possible that retail investors are actually “playing this one by the book”? We’ll keep an eye on it.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The MSCI World (ex-U.S.) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

To Download a PDF of this post, please click here.

Treasury yields were higher again this week as better than expected economic data early in the week and increasing concerns that the Fed may curtail bond purchases earlier than anticipated trumped soft economic releases Wednesday and Thursday. Yields were higher Monday as retail sales in April increased 0.1% vs. estimates of a decline of 0.3%. Yields were higher again Tuesday on concerns that the Fed may slow bond purchases. Treasury prices went higher Wednesday as industrial production in April declined 0.5%, which was worse than the estimated decline of 0.2% and manufacturing activity in the New York region declined more than expected. Also Wednesday, the Producer Price Index declined 0.7% vs. expectations of a decline of 0.6%. Prices continued higher Thursday as housing starts in April declined 16.5%, significantly more than the estimated decline of 6.4% and the Philadelphia Fed index was lower than expected. U of M Consumer Confidence index increased to 83.7 vs. expectations of 77.9 helping send yields higher Friday. The market will be listening closely to Fed Chairman Ben Bernanke’s testimony next week for any clues about the future of ongoing bond purchases. Major economic reports (and related consensus forecasts) for next week include: Wednesday: April Existing Home Sales (4.98M, 1.20% MoM), Fed Minutes from April 30th -May 1st FOMC Meeting; Thursday: April New Home Sales (425,000, 1.90% MoM), Kansas City Fed Manufacturing Activity (-4); Friday: April Durable Goods Orders (1.50%).

View from the Observation Deck

1. The time period depicted in the chart (379 months) captures the peak in interest rates on 9/30/81 (10-Year T-Note closed at 15.84%) through 4/30/13 (10-Year T-Note closed at 1.67%).
2. In short, it represents the 31-plus year rally in the bond market. While interest rates declined more than 14 percentage points over that span, they did not fall each and every calendar year.
3. Using the average yield on the 10-Year T-Note for every calendar year since 1981, interest rates actually rose in 9 of the 31 years, or 29% of the time, according to data from the Federal Reserve.
4. Interest rate levels help determine the cost of capital for corporations, which can influence earnings. Interest rates on debt instruments, if high enough, can also compete with equities for investor capital.
5. The price-to-earnings ratio (P/E) on the S&P 500 has fluctuated significantly over the past 31-plus years. Based on monthly data points, it peaked at 30.20 on 6/30/99, while its low was 7.31 on 5/31/82.
6. Perhaps more importantly, its average over that span was 17.92, which is higher than today’s (5/15/13) trailing 12-month P/E of 16.23 and much higher than its forward-looking P/E of 15.04. 

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 is a capitalization-weighted index comprised of 500 stocks used to measure large-cap U.S. stock market performance.

To Download a PDF of this post, please click here.

View from the Observation Deck

1. The yield on the benchmark 10-Year T-Note is closing in on the 2.00% mark in today’s trading session. That is approximately half its 4.02% average yield from 2000 through 2012, according to Bloomberg.  
2. For the first time since it began its quantitative easing initiatives, the Federal Reserve appears to be openly contemplating an exit strategy from its current $85 billion per month bond-buying program. 
3. The last time the yield on the 10-Year T-Note closed above the 4.00% level was on 10/14/08. If you look at the chart, total U.S. Treasury issuance surged in 2009, 2010, 2011 and 2012.
4. Normally, when the supply of bonds increases substantially one would expect yields to move higher as well. That did not happen this go around due global growth fears and a sustained intervention by the Fed, in our opinion.
5. A bond’s price typically declines as interest rates rise.
6. Using the 10-Year T-Note as a barometer of what could happen if yields were to rise, a 100 basis point increase in its yield (1.95% to 2.95%) would result in a price decline of 8.67%, according to Bloomberg.
7. A 205 basis point increase (1.95% to 4.00%) would result in a price decline of 16.89%, according to Bloomberg.
8. We believe that any investor who purchased Treasuries because of the Fed’s bond-buying support should monitor the direction of interest rates and any directives from the Fed in the coming months. 

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing.

To Download a PDF of this post, please click here.

View from the Observation Deck

1. Commodity prices, on the aggregate, have declined by 13.8% over the past two years (thru 5/8), as measured by the Reuters/Jefferies CRB Index. The index is down 1.4% so far in 2013.
2. While we only displayed photos (see chart) of four of the commodity components (crude oil, corn, coffee and gold) tracked by the index, there are in fact a total of 19 that capture a broad universe of activity.
3. On a year-to-date basis, very few components are up. The following five are higher: Natural Gas (+18.6%); Cotton (+17.0%); Crude Oil (+4.5%); Coffee (+2.9%); and Gasoline (+2.3%), according to Bloomberg.
4. Many things can impact the direction of commodity prices. Some of them include supply/demand, infrastructure spending initiatives, inflationary pressures and currencies, particularly the U.S. dollar.
5. The U.S. dollar remains the world’s reserve currency. Commodities are still priced in U.S. dollars. Commodity prices tend to share an inverse relationship with the dollar (see chart).
6. When the value of the U.S. dollar falls, foreign buyers gain more buying power when purchasing commodities and vice versa. More dollars pursuing commodities tends to drive commodity prices higher and vice versa.
7. The combination of a stronger U.S. dollar, relatively low inflationary pressures, the ongoing European debt crisis and tempered economic growth in China has dampened demand for commodities, in our opinion. 
8. We believe that while most mining companies’ equity valuations look more compelling today than in 2008, investors might be best served by monitoring the influences we have noted and wait for them to turn for the better.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The Thomson/Reuters CRB Commodity Index is an average of commodity futures prices with monthly rebalancing, while the U.S. Dollar Index (DXY) indicates the general international value of the U.S. dollar relative to a basket of major world currencies.

To Download a PDF of this post, please click here.