IB Traders Insight

Macro

GUOSEN Closing Bell (February. 23)

MARKET

Chinese stocks closed lower today, with the benchmark Shanghai Composite Index ended at 2903.33 points. The A share market faltered amid profit taking after rally on Monday, the market narrowed losses near market close. Coal and nonferrous metals sectors led the gains; while media and non bank financial sectors led the falls. Combined turnover for both markets was 572.8 bn yuan, down 4.8% dod.

NEWS

*China will close more than 1,000 outdated coal mines with a combined coal production capacity of 60 million tons this year, the National Energy Administration (NEA) said on Monday. The NEA also called for consolidation through mergers. China will work to digest an excess capacity of coal-fired electricity, by controlling new projects, according to the NEA. The administration also called for better transportation of hydropower, wind power and solar power to avoid waste. (Xinhua)

*Chongqing Baiya Sanitary Products Co Ltd, one of China's biggest sanitary pad makers, plans to list on the Shanghai Stock Exchange, according to documents filed with the China Securities Regulatory Commission. Founded in 2010, the Chongqing-based firm would become the first publicly listed maker of such products in China if the plan was approved. The manufacturer now makes more than 60 percent of its gross profits from its most popular sanitary brand Freemore. Its other product ranges include children's' diapers. The company plans to raise 128 million yuan ($19.6 million) through its initial public offering, according to the prospectus. (Xinhua)

FUND FLOW

Click here for more information about Guosen.

This article is from Guosen Securities Co., Ltd. and is being posted with Guosen Securities Co., Ltd.’s permission. The views expressed in this article are solely those of the author and/or Guosen Securities Co., Ltd. and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8722

Technical Analysis

Arabica Coffee (KC) Bounces Off Daily Chart Downchannel Support

Arabica Coffee (KC) surged higher yesterday, bouncing off downchannel support (on the daily chart).  Weekly and daily RSI, Stochastics and MACD are bottomish.  With some profittaking today to be expected after yesterday's powerful move, and given paring in risk appetite today across my Watchlist markets, I'll be looking to go long intraday in the 1.18-1.2 range.

Arabica Coffee (ICE KC May16) Weekly/Daily/4hr/Hourly

Click here for today's technical analysis on VIX, WTI Crude, Euro Stoxx 50, DAX, Nikkei, A50, S&P500, Nasdaq100, Cocoa, Natural Gas

Tradable Patterns was launched to demonstrate that the patterns recurring in liquid futures, spot FX and equity CFD markets can be traded consistently profitably. Tradable Patterns’ daily newsletter (blog) provides technical analysis on a subset of ten to twelve CME/ICE/Eurex futures (commodities, equity indices, interest rates), spot FX and US equity markets, which it considers worth monitoring for the day/week for trend reversal or continuation. For less experienced traders, tutorials and workshops are offered online and throughout Southeast Asia.

This article is from Tradable Patterns and is being posted with Tradable Patterns’ permission. The views expressed in this article are solely those of the author and/or Tradable Patterns and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8721

Technical Analysis

WTI Crude (CL) Consolidating Above Daily Chart Downchannel Resistance

WTI Crude (CL) powered ahead yesterday, solidifying the break above downchannel resistance (on the daily chart).  On the 4hr chart, CL can be seen forming an ascending triangle, where it appears readying to break above resistance at approximately 34.  Significantly, positive divergence between price and weekly RSI and Stochastics can be seen where the low in price 2 weeks ago equaled the low in January, while the weekly RSI and Stochastics made higher lows.  Weekly MACD is also now trying to positively cross.  While some porfittaking today can be expected, I'll be looking to go long intraday near triangle support (on the 4hr chart).

WTI Crude (CME CL Apr16) Weekly/Daily/4hr/Hourly

Click here for today's technical analysis on VIX, Arabica Coffee, Euro Stoxx 50, DAX, Nikkei, A50, S&P500, Nasdaq100, Cocoa, Natural Gas

Tradable Patterns was launched to demonstrate that the patterns recurring in liquid futures, spot FX and equity CFD markets can be traded consistently profitably. Tradable Patterns’ daily newsletter (blog) provides technical analysis on a subset of ten to twelve CME/ICE/Eurex futures (commodities, equity indices, interest rates), spot FX and US equity markets, which it considers worth monitoring for the day/week for trend reversal or continuation. For less experienced traders, tutorials and workshops are offered online and throughout Southeast Asia.

This article is from Tradable Patterns and is being posted with Tradable Patterns’ permission. The views expressed in this article are solely those of the author and/or Tradable Patterns and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8720

Technical Analysis

VIX (VX) Testing 61.8% Fib Retrace of Jan-Feb Rally

The VIX (VX) slid more than 5% yesterday, breaking below upchannel support (on the daily and weekly charts), and is now testing the 61.8% Fib retrace of the rally from approximately 17.5-29.  The VX is also now testing downchannel support (on the 4hr chart).  With the sharp fall over the last 2 weeks, the weekly RSI and Stochastics are now sloping down.  Nevertheless, with the VX at a key Fib level, the 4hr RSI, Stochastics and MACD bottomish, and the strongest of my Watchlist equity index futures (i.e. S&P500) struggling to reclaim the 50% Fib retrace of the fall from December to February, a bounce in VX over the next day or so can be expected.  A rally towards downchannel resistance (on the 4hr chart) can quickly flatten the daily MACD, and draw in more bulls.  I am flat the VX and have a pending buy limit (to initiate an intraday long) at 21.

VIX (CFE VX Mar16) Weekly/Daily/4hr/Hourly

Click here for today's technical analysis on WTI Crude, Arabica Coffee, Euro Stoxx 50, DAX, Nikkei, A50, S&P500, Nasdaq100, Cocoa, Natural Gas

Tradable Patterns was launched to demonstrate that the patterns recurring in liquid futures, spot FX and equity CFD markets can be traded consistently profitably. Tradable Patterns’ daily newsletter (blog) provides technical analysis on a subset of ten to twelve CME/ICE/Eurex futures (commodities, equity indices, interest rates), spot FX and US equity markets, which it considers worth monitoring for the day/week for trend reversal or continuation. For less experienced traders, tutorials and workshops are offered online and throughout Southeast Asia.

This article is from Tradable Patterns and is being posted with Tradable Patterns’ permission. The views expressed in this article are solely those of the author and/or Tradable Patterns and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8719

Stocks

How Savvy Stock Pickers Can Make Money in China

Morgan Stanley reckons there’s 21% upside for investors who can time rallies in Shanghai stocks.

Well, that’s a relief. China has finally ferreted out the individual responsible for mucking up the management of its stock market and sent him packing. From here on out it should be smooth sailing.

If only. Removing Xiao Gang as head of the China Securities Regulatory Commission will likely change very little about the way things are run. Most of the real decisions are being made well above the CSRC and even the People’s Bank of China, in the even more powerful State Council - which is where Xiao is rumored to be heading - and of course the Standing Committee of China’s Politburo. It’s there that the real deciders are micro-mismanaging China’s economy and markets.

The strategy at the top appears to be to keep performing a schizophrenic policy dance of alternating reform and feel-good stimulus - two steps forward and one step back, cha-cha-cha. While that may mean China’s policymakers are chasing their tails economically, it could bode well for China’s stocks. As strategists at Morgan Stanley advise, it may be time to start hunting for bargains among China-listed shares as China’s consistently inconsistent policies provides investors with a stable pattern for stock-picking.

China’s hot-and-cold policymaking does produce some confusing contradictions, as Andrew Batson at Gavekal Dragonomics explains, like the PBoC’s call for banks to rein in lending to zombie companies as part of a national de-leveraging the day it announced that enlarged landing quotas had produced record bank lending in January.

What China is perfecting, Batson says, is a “muddle-through” strategy: stimulate the economy just enough to avoid painful shocks and buy time for it to grow its way out of a debt bubble that by some estimates has grown to 250% of GDP. Elegantly awkward, it relies on neither a Big Bang reform blitz, nor an all-out rescue by massive government spending and interest-rate cuts.

The muddle-through strategy represents a sort of Solomonic solution to China’s problems: it is, Batson says, the most politically palatable strategy because it pleases no one. But it solves nothing, and propels China further down the path towards a Japan-style deflationary coma.

While that’s something economists have warned China against, equity strategists point out that one of the most important lessons of Japan’s two “lost decades” of near-zero economic growth is that a deflationary economy can still produce impressive stock-market gains. Tokyo stocks enjoyed three of their best ten years since 1980 during Japan’s two lost decades - 2003, 2005 and 1999, when the Topix index gained 24%, 44% and 58%, respectively.

The key is alternating stimulus with what in Japan became known as “extend and pretend” - keeping credit flowing to poorly run, bloated companies in hopes they would survive long enough to clean themselves up. This could prove particularly true for China, where investors have long recognized that stock prices have more to do with government policy than with corporate profitability. As China settles into a similar paralysis, the economy may slip into the dreaded middle-income trap, but stocks could flourish.

Morgan Stanley believes the economic outlook is bleak and the overall index likely to remain trapped between its current level and 3,500, “potentially for several years.” But that still leaves room for 21% upside for investors who can time Shanghai’s rallies. And Morgan predicts China will finally earn admission into MSCI’s widely followed benchmark indexes this year, which would pull more foreign funds in.

Morgan Stanley strategist Jonathan Garner, who correctly predicted both Shanghai’s rally in late-2014 and its peak in mid-2015, now advises clients begin hunting for value among China’s A-shares. After falling 17.5% this year and roughly 45% since its peak in mid-June, to roughly 2,900, Shanghai’s index is now trading at just 11.7 times projected earnings, which Morgan says makes it look cheap compared to global markets and its own historical valuation. Morgan’s analysts see particular value in China’s healthcare, mass-market consumer, clean energy, technology and defense sectors.

Among the many individual names it likes, Morgan recommends China State Construction Engineering (601668.CN), Fosun Pharmaceutical (600196.CN), liquor company Kweichow Moutai (600519.CN), household appliance maker Midea (000333.CN) and Wanda Cinema Line (002739.CN).

But beyond Morgan’s thematic recommendations, this column and other analysts also like Shandong utility Huadian Power (600027.CN), coal transporter Daqin Railway (601006.CN) and carmaker SAIC Motor (600104.CN), all of which trade at only about 7 times their projected earnings.

8718

Technical Analysis

Keys To This Week: CBOE Volatility Index (VIX)

The following is a brief excerpt from this morning’s Keys To This Week report for the US stock market.

Keys To This Week displays and discusses 10 key market factors that are most likely to influence the direction of the US stock market over the next several weeks to several months.  Key #5 of 10 of this week’s report, with the accompanying chart, appears below.

Key #5 of 10: Volatility: CBOE Volatility Index (VIX).  MINOR DECISION POINT, TURNING NEAR TERM BULLISH? 

The highlighted circles in Chart 5 below show that the VIX finished last week 20.53, below its 50-day moving average for the first time since December 8th.  The red highlights show that a sustained move by the VIX above its moving average since December 8th, indicating elevated investor fear, coincided with the recent decline in the S&P 500.  It would take a sustained decline in the VIX this week, below its moving average, to indicate investors have become complacent enough to facilitate a sustainable market rally.

Asbury Research provides investors with a forward looking, strategic forecast of the US financial landscape 1-2 quarters out, and then defines specific tactical and actionable investment opportunities within that larger forecast via a unique and proprietary multi-layered approach that includes quantitative, technical, and behavioral analysis.  Our focus is on the US stock market and market sectors, US interest rates, the US Dollar, and economically influential commodities like gold, crude oil, and copper, but our scope is global as we integrate our database of worldwide inter-market relationships to add breadth, depth and accuracy to our investment conclusions. Interactive Brokers customers can subscribe to Asbury Research in Account Management.

This article is from Asbury Research and is being posted with Asbury Research's permission. The views expressed in this article are solely those of the author and/or Asbury Research and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8717

Stocks

The Best and Worst of the Utilities Sector 1Q16

Sector Analysis 1Q16

The Utilities sector ranks last out of the ten sectors as detailed in our 1Q16 Sector Ratings for ETFs and Mutual Funds report. Last quarter, the Utilities sector ranked fifth. It gets our Dangerous rating, which is based on aggregation of ratings of nine ETFs and 34 mutual funds in the Utilities sector as of January 22, 2016. See a recap of our 4Q15 Sector Ratings here. 

Figure 1 ranks from best to worst eight Utilities ETFs and Figure 2 shows the five best and worst-rated Utilities mutual funds. Not all Utilities sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 20 to 255). This variation creates drastically different investment implications and, therefore, ratings.

Investors should not buy any Utilities ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.

Figure 1: ETFs with the Best & Worst Ratings – Top 5

* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5

* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Fidelity MSCI Utilities Index ETF (FUTY) is the top-rated Utilities ETF and American Century Quantitative Equity Utilities Fund (BULIX) is the top-rated Utilities mutual fund. Both earn a Neutral rating.

Guggenheim S&P 500 Equal Weight Utilities ETF (RYU) is the worst-rated Utilities ETF and ICON Utilities Fund (ICTVX) is the worst-rated Utilities mutual fund. RYU earns a Dangerous rating and ICTVX earns a Very Dangerous rating.

79 stocks of the 3000+ we cover are classified as Utilities stocks, but due to style drift, Utilities ETFs and mutual funds hold 255 stocks.

PPL Corporation (PPL: $33/share) is one of our favorite stocks held by Utilities ETFs and mutual funds. It is the only Utility stock that earns an Attractive rating. Since 1998, PPL has grown after-tax profits (NOPAT) by 10% compounded annually. Over this timeframe, PPL has improved its return on invested capital (ROIC) from 6% to 7%, which is the highest ROIC of all 79 Utilities stocks under coverage. Despite the continued strength of PPL’s business, the stock is only up 6% over the past decade and shares are currently undervalued. At its current price of $33/share, PPL has a price to economic book value (PEBV) ratio of 0.6. This ratio means that the market expects PPL’s NOPAT to permanently decline by 40% from its current levels. If PPL can grow NOPAT by just 3% compounded annually for the next decade, the stock is worth $59/share today – a 79% upside.

Connecticut Water Service (CTWS: $39/share) is one of our least favorite stocks held by Utilities ETFs and mutual funds and earns a Very Dangerous rating. Throughout the history of our model, which dates back to 1998, Connecticut Water Service has never generated positive economic earnings. The company’s ROIC has declined from 5% to 3% over the same timeframe. However, at its current price of $39/share the stock remains significantly overvalued. To justify its current price, Connecticut Water Service must grow NOPAT by 7% compounded annually for the next nine years. While this may not seem like much in terms of profit growth, keep in mind that CTWS has failed to generate economic profits in any year for nearly two decades.

Figures 3 and 4 show the rating landscape of all Utilities ETFs and mutual funds.

Figure 3: Separating the Best ETFs From the Worst ETFs

Sources: New Constructs, LLC and company filings

Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds

Sources: New Constructs, LLC and company filings

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme.

About New Constructs

QUESTION: Why shouldn’t ETF research be as good as stock research? Why should ETF investors rely on backward-looking price trends?
ANSWER: They should not.

Don’t judge an ETF by its cover. Take a look inside at its holdings and understand the quality of earnings and valuation of the stocks it holds. We enable you to choose the best ETF based on its stock-picking merits so you do not have to rely solely on backward-looking technical metrics. 

The figure below details the drivers of our forward-looking Rating system for ETFs. The drivers of our predictive rating system are Portfolio Management and Total Annual Costs. The Portfolio Management Rating (details here) is the same as our Stock Rating (details here). The Total Annual Costs Rating (details here) captures the all-in cost of being in an ETF fund over a 3-year holding period, the average period for all fund investors.

Cutting-edge technology enables us to scale our forensics accounting expertise so that we can cover enough stocks to cover the ETFs that hold them as well. Learn more about New Constructs. Get a free trial. See what Barron’s has to say about our research.

This article is from New Constructs, LLC and is being posted with New Constructs, LLC’s permission. The views expressed in this article are solely those of the author and/or New Constructs, LLC and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8716

Futures

Industrial Metals and Impacts on Stock Index Futures

Scott Nations, CNBC Contributor & NationsShares

This video is from CME Group and is being posted with CME Group’s permission. The views expressed in this video are solely those of the author and/or CME Group and IB is not endorsing or recommending any investment or trading discussed in the video. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8715

Stocks

Nasdaq Market Intelligence Desk - Equity Market Insight February 22, 2016

Market Update:

US stocks are up more than 1% this morning, seeing a bullish carryover from last week’s robust rally. Crude oil is gaining more than 6% on output cutback chatter. All 10 sectors are higher this morning, with Material (2.2%) and Energy (+1.9%) leading the way. DOW +1.23%, S&P 500 +1.3%, Nasdaq 1.4%.

• The CBOE Volatility Index is back below 20 for the first time since early February, suggesting stabilization in the equity market. The Index briefly traded over 30 (on 2/11), for only the 3rd time in the past 6 months. Posted on Bloomberg earlier, when the S&P 500 index fell between 16.5 and 17 times earnings on February 11th, stocks were “too cheap to ignore” according to Oppenheimer’s John Stoltzfus. On the 11th, the index fell to its YTD lows, but has rebounded in the 2nd half of the month, up 7.4% on some deep-value buying.
• The WSJ points out that Toys “R” US will look to refinance $1.6 billion in high-yield bonds, in a test for that market. Yield spreads between highly rated and lower rated companies, which have been suppressed in recent years, have been widening in part to trouble in the energy industry and given broader market volatility. “Junk” issuance is down sharply this year as rates for riskier debt has moved higher. WSJ suggests that Toys “R” Us would rather refinance now rather than face further uncertainty later. Equity investors might view a successful bond offering as a vote of confidence in more stocks generally.

Technical Take:

As of 11:50 AM EST
Nasdaq Composite:
Advancers: 1707
Decliners: 540
Advance Volume: 120MM shares
Decline Volume: 24MM shares
New 52 week Highs (prior close): 23
New 52 week Lows (prior close): 63

Oil is again in the driver’s seat, based on purported supply cuts, but is nonetheless taking equities higher with it. Still, we prefer to see a decoupling from Oil as we believe its rally will ultimately be short-lived. Regardless, the action last week in equities has been met with further buying today but the next impediment comes in the form of what some would call pivotal resistance just overhead. By the end of this week the equity market picture may become clearer in both the short and intermediate terms.   

• After a sharp rally last week on the S&P 500 Index (SPX) from key short term support at 1810 which also held most of its gains then subsequently initial support at 1900 stocks are showing some resiliency. We believe the next test at 1950 will be crucial though where, as we see in the chart below, former short term pivots converge with the 50 day moving average. The ability to make headway above this level could spur a push to the 2000 – 2020 resistance zone. Unfortunately, we are hard pressed to see a scenario where the index can produce significant gains above that next level, but we will wait and see.  
• For the Nasdaq Composite Index (CCMP) we observed a similar sharp rally off of the 4200 level as the index is now headed toward its own resistance level around 4650. In this case this number roughly represents the 2/1 highs and a small congestion zone from mid-January. At the same time the downward sloping 50 day moving average is presently at 4686. Consistent trading above both levels could make a run for as high as 4900 possible.

Nasdaq's Market Intelligence Desk (MID) Team includes:  

Michael Sokoll, CFA is a Senior Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over 25 years of equity market experience. In this role, he manages a team of professionals responsible for providing NASDAQ-listed companies with real-time trading analysis and objective market information.
Jeffrey LaRocque is a Director on the Market Intelligence Desk (MID) at Nasdaq, covering U.S. equities with over 10 years of experience having learned market structure while working on institutional trading desks and as a stock surveillance analyst. Jeff's diverse professional knowledge includes IPOs, Technical Analysis and Options Trading.
Vincent Randazzo, CMT is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over 13 years of experience in equity markets having served in equity research sales and desk analyst roles at major banks. Vincent’s specific expertise is in technical analysis and has been a Chartered Market Technician (CMT) since 2007.
Steven Brown is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over twenty years of experience in equities. With a focus on client retention he currently covers the Financial, Energy and Media sectors.
Christopher Dearborn is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq. Chris has over two decades of equity market experience including floor and screen based trading, corporate access, IPOs and asset allocation. Chris is responsible for providing timely, accurate and objective market and trading-related information to Nasdaq-listed companies.

This article is from Nasdaq and is being posted with Nasdaq’s permission. The views expressed in this article are solely those of the author and/or Nasdaq and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

8714

Fixed Income

The Problems with Negative Interest Rates

Rick Rieder explains why negative rates are more likely to hurt, rather than help, economic and financial stability.

There’s a view in some policy circles that easy monetary policy is good for an economy, and the more stimulus you add, the better.

So, it’s not surprising that amid slowing economic growth, central banks are scooping out even more stimulus on top of their years of quantitative easing (QE) programs and aggressive rate cuts. This latest stimulus is taking the form of negative interest rates, or charging banks to park their cash with the expectation that this will spur lending and economic growth.

Earlier this year, for instance, the Bank of Japan became the latest central bank to move to a negative deposit rate, and the Federal Reserve (Fed) is also taking a look at negative rates, according to Janet Yellen’s recent remarks at a Congressional hearing.

But in my opinion, pressing policy forward into negative rate territory is like offering economies a third sundae. In other words, the negative rates—or high rental costs for money storage—are excessive and more likely to hurt, rather than help, economic and financial stability. Here are a few reasons why:

THE GLOBAL ECONOMY IS EXPERIENCING GROWTH HEADWINDS UNLIKELY TO BE POSITIVELY INFLUENCED BY NEGATIVE RATES

One of these headwinds is an aging population, which is likely to lower the corridor of potential economic growth for many years, especially in developed markets. Case in point: In many countries and regions—including Japan, Europe and increasingly, China—higher numbers of people are drawing from their respective economies rather than contributing to it.

The other headwind is the fact that traditional economic metrics aren’t keeping pace with the influences of rapid technological innovation, meaning the global economy is likely doing much better in reality than what economic numbers are telling us. Just one example of what traditional metrics don’t capture: Technology has dramatically brought down “bad” inflation (i.e. the cost of food, energy and rent), a fact not reflected in traditional U.S. inflation numbers.

NEGATIVE INTEREST RATES FUNCTIONALLY TAKE MONEY FROM BORROWERS AND HAND IT TO NO ONE

Central banks initiated aggressive rate cuts in the immediate aftermath of the financial crisis in order to stabilize the system by reducing excess leverage as quickly as possible. Consequently, a short-term subsidy from savers to borrowers through the interest rate channel made a significant amount of sense at the time.

Now, however, moving to extreme and excessive robbing of savings through charging for storage takes money from savers but doesn’t significantly enhance demand among borrowers. In fact, businesses and consumers may have a lower marginal propensity to spend in uncertain economic times.

In addition, negative interest rates act on the overnight funding rate, or the front end of the yield curve, at a time when few businesses use short-term funding for their borrowing needs. Thus, negative rates seem to merely charge savers and penalize financial institutions through lower net interest margins and consequently, compressed cash flow.

A WEAK CURRENCY IS NO LONGER AN EFFECTIVE STIMULUS STRATEGY

One argument for negative rates is that they weaken, i.e. cheapen, a region’s currency, bringing forward demand. But while the approach of competitively devaluing a currency vs. global counterparts was effective at times historically, it’s likely to be less effective when each country is attempting to cheapen its currency.

In such a scenario, which we’re seeing today, there’s a zero-sum game at hand, only leading to aggressive retaliatory measures and economic and financial system volatility. This, in turn, can further dull corporate and consumer expenditures and economic growth.

NEGATIVE INTEREST RATES CAN HAVE OTHER UNINTENDED CONSEQUENCES

In an environment of negative rates, instead of being charged for saving, savers may attempt to hold their wealth in hard assets such as gold or in large bills in vaults (or under their mattress). Such hoarding, protection and insurance dynamics could create an escalation of black markets and illicit behavior.

IF NOT NEGATIVE RATES, THEN WHAT'S THE SOLUTION?

To be sure, I’m not alone in being concerned about negative rates. The market’s belief in, and tolerance for, these policies seems to be more skeptical today than in the past, as seen in the adverse market reaction to Japan’s negative rate discussion. Of course, it’s one thing to point out problems, and another to offer solutions. So, you’re probably wondering: If I’m not a fan of negative rates, what’s my solution instead?

I believe fiscal policies are needed to address the structural challenges facing the economy, including ones to help workers gain the skills needed in a world of quickly-changing technologies.

In addition, QE monetary policies designed to provide funding to, and dull the pressures on, financial institutions during times of instability and low confidence may also prove quite effective, not least because they target the parts of the yield curve where today’s corporate funding occurs. In recent years, QE programs have shown they can dull volatility in the system, enhancing confidence and unlocking expenditure and investment.

But above all, as we are now seven years from the financial crisis, I believe markets, financial systems and economies need a chance to recalibrate to an unstimulated posture. If central banks continue rolling out untested policies in response to cyclical economic softness and specific regional pressures, they risk doing more harm than good.
 

Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is a regular contributor to The Blog.

 

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