June 20, 2016: A World of Debt

Jun 21, 2016 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, July 11, 2016. You can also find the re-balance calendar for 2015 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

A World of Debt

So far this year, diversification into international stocks and bonds has proven to be beneficial. For example, year to date, MyPlanIQ’s portfolios have relied on international and emerging market bonds to deliver stock comparable (or better) returns. The other asset that helps some of our portfolios is commodities, which has been long depressed. 

In this newsletter, we look at global debts more closely. 

Bonds outperformed so far

Year to date, even though US stocks and other country stocks have wobbled, US bonds (especially long term Treasury/government bonds), international debt based assets have done better: 

Index ETFs performance (as of 6/20/2016):
Index ETFs YTD
Return**		 1Yr AR 3Yr AR 5Yr AR
BWX (SPDR Barclays International Trs Bd ETF) 10.2% 8.4% -0.3% 0.0%
EMB (iShares JPMorgan USD Emerg Markets Bond) 7.8% 7.4% 4.3% 5.3%
IEF (iShares 7-10 Year Treasury Bond) 6.6% 8.1% 4.0% 4.8%
VWO (Vanguard FTSE Emerging Markets ETF) 4.3% -15.4% -2.5% -3.5%
VTI (Vanguard Total Stock Market ETF) 2.4% -0.9% 9.9% 12.2%
VEA (Vanguard FTSE Developed Markets ETF) -2.6% -10.0% 1.3% 2.8%

US dollar weakness helped too: 

US dollar vs. international bonds (as of 6/20/2016):
Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR
UUP (PowerShares DB US Dollar Bullish ETF) -5.5% -1.7% 3.2% 2.4%
BWX (SPDR Barclays International Trs Bd ETF) 10.2% 8.4% -0.3% 0.0%
EMB (iShares JPMorgan USD Emerg Markets Bond) 7.8% 7.4% 4.3% 5.3%

UUP (PowerShares DB US Dollar Bullish ETF) tracks US dollar index (DXY). 

But in the meantime we know:

  • German bund yields are now negative.
  • Euro benchmark rate is 0.
  • US 10 year Treasury yield is 1.67%, approaching to the lowest point in the last 10 years. 

Equities have been weak

From 360° Market Overview, 

Global Stocks Trend (as of 06/20/2016)

Description Symbol 1 Week 4 Weeks  13 Weeks 26 Weeks 52 Weeks Trend Score
Brazil EWZ 4.27% 7.91% 4.46% 35.54% -15.05% 7.42%
Russia RSX 3.18% 5.23% 4.85% 20.84% -3.58% 6.11%
Canada EWC 0.08% 3.32% 5.1% 16.83% -8.01% 3.46%
Belgium EWK 1.57% 1.85% 3.96% 1.68% 1.03% 2.02%
US SPY 0.23% 1.82% 2.08% 4.13% 0.24% 1.7%
South Africa EZA 3.14% 8.45% 1.01% 11.56% -17.05% 1.42%
Taiwan EWT 3.2% 7.19% -0.64% 7.44% -10.63% 1.31%
India INP 1.84% 6.3% 3.56% 2.02% -8.66% 1.01%
South Korea EWY 2.09% 5.14% -0.6% 2.19% -6.05% 0.56%
Australia EWA 1.77% 1.4% -0.66% 7.4% -7.84% 0.41%
United Kingdom EWU 5.18% 2.08% 2.72% 2.53% -13.38% -0.17%
Singapore EWS 2.49% 4.29% -2.28% 4.29% -14.08% -1.06%
France EWQ 2.8% 1.13% -0.21% 0.35% -10.57% -1.3%
Malaysia EWM 1.0% 1.0% -5.05% 7.02% -10.76% -1.36%
Switzerland EWL 2.02% 0.66% 2.4% -0.82% -11.4% -1.43%
Japan EWJ 2.19% 1.04% 1.65% -2.99% -9.31% -1.48%
The Netherlands EWN 1.27% -0.79% -2.24% 2.17% -10.35% -1.99%
Germany EWG 3.15% 1.39% 0.04% -2.82% -13.34% -2.31%
Hong Kong EWH -0.1% 3.65% 0.15% -0.36% -15.76% -2.48%
Austria EWO 2.1% 0.13% -3.81% -2.64% -9.26% -2.7%
Mexico EWW 2.63% 0.04% -6.56% -2.07% -14.49% -4.09%
China FXI 1.49% 5.76% -0.95% -6.65% -27.66% -5.6%
Spain EWP 3.85% -1.06% -3.51% -4.43% -23.35% -5.7%
Italy EWI 5.29% 1.36% -4.63% -13.48% -24.16% -7.12%

This is a reversal of last year: with US dollar down, many countries’ stocks in their own local currencies have been down even more this year. Global growth is anemic at best. 

Debt fueled global growth

The following figures are courtesy of Financial Times: 

The numbers are for the end of Q3, 2015. Debts have only become even worse since then. The major economic bloc US, Eurozone, China and Japan all have over 200% debt/GDP ratio. Even though the above figure looks like scary, one has to understand that debt to GDP ratio is not a good measurement for indebtedness. What’s more crucial is the debt service cost, or debt interest payment to total revenue received. It’s relatively easier to obtain total revenue for government debt service: it’s really just total tax received. However, when it’s much harder to estimate total corporate revenue (in this case, profit) and household income. 

In fact, the U.S. net interest payment in 1995 was $232.1 billion or 17 percent of revenues. In 2014, the net interest payment was $229 billion or 8 percent of revenues. Despite the ominous debt to GDP headlines, net interest payments are the same as 20 years ago. The low net interest payment is of course mainly helped by the historically low interest rate. 

However, when we turn our attention to economic growth, which is the primary factor for equity/stock market, we are seeing a worrisome picture. In 2015, total debt in the United States increased by $1,912 billion, but the US economy expanded by only $599 billion. Similarly, in 2015, China’s total debt (including so called social financing) had a more than 15 trillion renminbi gain ($2.3 trillion) but its GDP rose only 4 trillion renminbi ($614 billion). Or one dollar debt only boosted 25 cents GDP.  All is in the current ultra low interest rate environment. 

Debt can not be increased indefinitely and interest rates can not be low forever.  When this happens, such debt fueled unproductive growth will falter!

To summarize, central banks in the world have been racing to the bottom to keep interest rates ultra low. This has fueled a very unproductive debt growth. In such an environment, one has to be tactical and be prepared for the eventual growth stall/deceleration. Our Tactical Asset Allocation(TAA) strategy can be nimble and take advantage of temporary asset rises (such as international/emerging market bonds recently). It’s hard to see the world will be back to a super growth period like 2003-2007 without going some fundamental change. For that, one should adopt a tactical stance for at least some portion of investments. 

Market Overview

Markets have been fixated on the upcoming Brexit (Britain’s referendum to exit Euro zone) vote. At the moment, all low interest rate friendly assets such as bonds, gold and REITs have maintained their uptrend while stocks are on edge. However, with stocks being at an elevated overvalued level and interest rates bing at a ultra low level persistently, markets direction can change fast. It’s a fool’s game to predict the outcome. The best is to stay on course.

For more detailed asset trend scores, please refer to 360° Market Overview. 

We would like to remind our readers that since the financial crisis in 2008-2009, we have not seen substantial structural change in the U.S., European and emerging market economies. Economies have heavily relied on low interest debts. Capital might be misallocated to unproductive investments and consumption. U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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