PrefBlog

The second quarter opened on a sour note:

The deepening rout in once high-flying technology shares sent U.S. stocks tumbling to start the second quarter, as fresh presidential criticism of Amazon.com and retaliatory tariffs from China rattled markets. Gold rose on haven demand.
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Selling was heaviest in technology stocks. The Nasdaq 100 Index lost 2.9 percent as investors continued to offload some of the bull market’s biggest gainers. Amazon, up 50 percent in the past year, sank after Donald Trump renewed his attack on the online retailer. Netflix slid 5 percent, while chipmakers in the S&P 500 plunged 4.3 percent thanks to Intel’s worst day in two years. Bonds erased declines and gold spiked higher as the equity selling picked up steam.
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The S&P 500 Index declined 2.2 percent as of 4 p.m. New York time.
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The yield on 10-year Treasuries was little changed at 2.74 percent. The yield on two-year Treasuries fell two basis points to 2.25 percent.

Trump’s complaints about the “Amazon Washington Post” and his effects on the market look a lot like a precursor to crony capitalism:

Donald Trump has long bragged how his presidency has been a boon to the stock market. His recent attacks on Amazon.com Inc. are undermining that position.
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The online retailer was the biggest drag on the equity benchmark Monday, a position its held for a week as it plunged 12 percent since Axios reported that the president was “obsessed” with regulating the company. That wiped about $75 billion from Amazon’s market capitalization.
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Trump has unleashed a barrage of tweets accusing Amazon of not paying enough in taxes and underpaying the U.S. Postal Service.

As far as Amazon’s postal costs are concerned, I found this exposition illuminating:

The Postal Service is losing money, but its package delivery service is profitable, unlike its letter delivery.

The Postal Service is required by law to cover its costs for delivering competitive products, such as packages for Amazon. The Postal Regulatory Commission, which oversees the service, set the appropriate share of the costs of package delivery at 5.5% a little more than a decade ago.

Since then, the service’s delivery of packages has grown substantially, and the United Parcel Service argued in a submission to the commission in 2015 that a realistic appropriate share of costs for those deliveries should be about 24.6%.

A Citigroup analysis last year found that that difference would amount to about $1.46 per parcel, which might serve as the basis for Trump’s $1.50 figure. An op-ed penned in July by Josh Sandbulte in the Wall Street Journal cited that analysis in arguing the Postal Service’s estimate of costs for delivering packages should be revised. Sandbulte is co-president of Greenhaven Associates, a money management firm that owns FedEx common stock.

In response, US Postal Service executive Joseph Corbett wrote that the op-ed provided an “inaccurate and unfair account,” and that the Postal Regulatory Commission has determined each year that the service is covering its costs for package deliveries.

Corbett asserted the Postal Service’s financial insolvency is the result of its inability to overcome “systemic financial imbalances caused by legal and other constraints,” such as a price cap on revenue-producing products that doesn’t take changes in delivery volumes and costs into account.

The Postal Service’s biggest money problem is that it has billions in retirement obligations to its workers that it can’t afford.

But this could play out in Canada’s favour:

The Trump administration is pushing for a preliminary Nafta deal to announce at a summit in Peru next week, and will host cabinet ministers in Washington to try to achieve a breakthrough, according to three people familiar with the talks.

The White House wants leaders from Canada and Mexico to join in unveiling the broad outlines of an updated pact at the Summit of the Americas that begins April 13, while technical talks to hammer out the finer details and legal text could continue, according to the people. They asked not to be identified because the talks are private.
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The three nations face a challenge to meet the U.S.’s goal because major divisions remain, including on the U.S. proposal for more North American content in automobiles. The White House declined to comment on plans to announce a deal for the North American Free Trade Agreement.

America’s eagerness to strike a deal on its biggest trade pact comes as U.S. stocks tumbled, falling in seven of their last 10 trading sessions on concerns Trump’s protectionism could spark a trade war. The White House in the past month has imposed tariffs on steel and aluminum imports, and announced plans to slap duties on Chinese goods over alleged intellectual-property violations.

And that’s it for another month!

The Bank of Canada has published a useful analytical note by Rohan Arora, Nadeem Merali, Guillaume Ouellet Leblanc titled Did Canadian Corporate Bond Funds Increase their Exposures to Risks?:

Canadian fixed-income mutual funds have grown rapidly over the past 10 years—15 per cent annually compared with 2.6 per cent for equity funds. These investment vehicles direct a growing share of funds from savers to borrowers and now are a large component of the Canadian shadow banking sector (Young Chang et al. 2016). This note focuses on open-ended mutual funds with large holdings of Canadian corporate bonds, a subset of Canadian fixed-income mutual funds.

Canadian corporate bond mutual funds (CCBFs) are more vulnerable than other funds because of the liquidity mismatch between their assets and liabilities: the funds offer daily redemption to investors yet they invest in relatively less-liquid assets (corporate bonds). This mismatch raises concerns that CCBFs may face large redemption requests during periods of stress (Goldstein, Jiang and Ng 2017). Indeed, in 2017, the Financial Stability Board issued policy recommendations to reduce this vulnerability (FSB 2017).
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In this note, we show that CCBFs have more than doubled in number and size since 2007. We also find that CCBFs have increased their exposure to interest rate risk, credit risk and liquidity risk. These results suggest an increase in the likelihood of large investor redemptions with higher potential impact on Canadian fixed-income markets.

At the same time, CCBFs still hold, on average, enough cash and liquid assets to meet redemption requests equivalent to the worst outflows observed since 2007. Overall, we assess that the vulnerability of CCBFs for the Canadian financial system appears to be rising—which warrants close monitoring—but remains low.

Arora (forthcoming) analyzes how Canadian mutual fund performance influences redemptions by investors, while Arora and Ouellet Leblanc (forthcoming) document how CCBFs meet redemption requests. Together, these papers lay the foundation to build stress tests quantifying the likelihood and potential impact of CCBFs’ asset sales on the financial system.

PerpetualDiscounts now yield 5.46%, equivalent to 7.10% interest at the standard equivalency factor of 1.3x. Long corporates now yield a little over 3.85%, so the pre-tax interest-equivalent spread is now about 325bp, a slight (and perhaps spurious) widening from the 320bp reported March 21.

Which way is the wind blowing? It looks like the world’s about to end again:

A selloff in technology shares sent U.S. equity benchmarks lower, with losses accelerating late in the day. Bonds surged on demand for safe havens, pushing the yield on 10-year Treasuries below a key level.

Trade angst weighed on leading tech companies with the Nasdaq 100 Index erasing most of Monday’s gain after a report the Trump administration is considering a crackdown on Chinese investments in technologies the U.S. considers sensitive. Facebook’s woes mounted and Nvidia Corp. spooked investors in chipmakers. The Chicago Board Options Exchange Volatility Index — Wall Street’s fear gauge — spiked.

The equity selling bled into the Treasury market, sending the 10-year yield below 2.8 percent as investors sought havens.
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•The S&P 500 slumped 1.7 percent as of the close of trading in New York.
•The Nasdaq 100 Index fell 3.3 percent, while the Dow Jones Industrial Average slipped 1.4 percent.

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•The yield on 10-year Treasuries declined eight basis points to 2.77 percent.

I hadn’t realized that some US public employee pension funds were so grossly underfunded:

The state hasn’t done a particularly good job running public pensions. According to S&P Global Ratings, New Jersey’s pension funding ratio is the worst in the nation, having saved enough to cover about 31 percent of the benefits that have been promised. The police and fire system is relatively strong by comparison, with about 65 cents for every dollar it’s on the hook for down the road, according to NJ.com.
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States and municipalities from coast to coast are now living with the consequences of the 1990s tech boom, which brought public pension funding levels to 100 percent and allowed politicians to sweeten the pot for union members.

The subsequent bust — and the Great Recession a few years after that — took its toll on the funds backing those promised benefits. The aggregate state and local government pension funding ratio is now 73 percent, up from 67 percent at year-end 2016, according to Patrick Luby of CreditSights, who cites Federal Reserve data.

Some people think the world might not end after all:

U.S. equities surged back from the biggest weekly rout in two years, with major benchmarks climbing more than 2.7 percent on signs that an escalation of trade tensions was beginning to ease.
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The optimism toward U.S. stocks emerged after the limits of the Trump administration’s willingness to embrace protectionism came into view over the weekend. Treasury Secretary Steven Mnuchin told Fox News that he’s “cautiously hopeful” that China will reach a deal to avoid tariffs on $50 billion of U.S. exports, while European leaders demanded a permanent exclusion at the threat of retaliation and a deal was struck with South Korea.
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The yield on 10-year Treasuries climbed four basis points to 2.85 percent.