A few times per week at 7:30 a.m., business journalists, still rubbing their eyes between yawns, receive embargoed economic information at Statistics Canada’s media room in Ottawa. They type up short stories before the switch is flicked: fibre cables light up, and the information is released publicly to traders and portfolio managers around the world at 8:30 a.m. Eastern.
Most of the time, the reporters’ yawns reflect the data: building permits slightly up or down, inflation stable, another trade deficit. But once in a while, in the locked media room, a reporter will holler, “Raise those interest rates!”
The question for investors is what to do with economic data that, since the financial crisis, has been coloured by false starts and global stagnation. Reading the tea leaves isn’t getting any easier amid turbulent market reactions to data and geopolitical events.
For Tom O’Gorman, portfolio manager and director of fixed income at Franklin Bissett Investment Management in Calgary, a surprising U.S. or Canadian economic release can push markets far enough that a bond or currency order will be filled. But he and his team are looking for evidence of longer-term shifts, not trading opportunities. O’Gorman, who’s been paying attention to jobs numbers and inflation in Canada and the U.S., says when surprising data comes through on his Bloomberg terminal, it does at the very least spur conversation.
“We have all these chat rooms with the dealers and the traders, and the rate side, the currency side. Everybody’s putting out their comments—‘Oh that’s a great number,’ ‘A horrible number’ or ‘That headline looks strong but the underlying details are weak’—and we’re discussing it on our desk,” O’Gorman says. “But we’re long-term investors. We have a long-term horizon. If we haven’t done anything [to position ourselves] prior, it would have to be a big change versus expectations for us to be trading on the number.”
Like others in active management, O’Gorman and his team position their portfolios in advance of key data releases to reflect expectations. The firm has developed precise yield ranges predicting where they see government bonds trading. As bond managers, their world revolves around interest rates, and they use their yield ranges to position for rate risk against the FTSE TMX Universe Bond index.
Changes in economic or corporate fundamentals can nudge their position to the top or bottom of their range, indicating that it’s time to rebalance.
“If you’re more toward the lower end of that range, we’re probably lowering our interest rate exposure and becoming more short-duration to the index, and vice versa at the high end of the range,” O’Gorman says. “We’re not technical, tactical, minute-by-minute day traders.”
Nonetheless, one might say the interest rate cycle is to fixed income managers what weather is to a farmer: farmers pay very close attention to local conditions and all their influences.
A giant puzzle
“It’s almost easier to say what I’m not watching,” says Walter Posiewko, fixed income senior portfolio manager for RBC. “We’re in the business of putting together a giant puzzle here, and the puzzle is made up of numerous pieces. None of them are usually in line with each other. There’s data that goes up, there’s data that goes down. There’s geopolitics.”
Big events like the Brexit vote can create a false sense of doom in markets, and it’s important not to panic. Posiewko says he typically wants to see at least three months of economic data before calling what he’s seeing a trend.
The RBC portfolio manager is closely monitoring data important to the BoC and the Fed. For Canada, that means employment and trade data, and for the U.S., inflation and employment. He’s looking for signs of new trends, especially for the interest rate cycle in Canada or the U.S. Where he sees signs of one, he’ll research the data to try to confirm it.
If Posiewko started to believe Canada’s economic growth was climbing sustainably, for instance, from its current annualized pace of about 1.3% to a higher rate of 2% or 2.5%, he would test his theory using other data like wages, consumer prices and job creation, and look to see whether the growth was national or regional.
“We rebalance when we see there’s a fundamental shift in the outlook,” Posiewko says. “One data series is not going to cause us to run to a new allocation, or a reallocation, or a reconstruction of the portfolio. We have to see something fundamentally shift. It has to be a trend. Portfolios are like ocean liners; they don’t move on a dime. Economies don’t move on a dime.”
David Tulk, chief Canada macro strategist for TD Securities, is on the front lines of the data sought by portfolio managers. A strategist with the bank’s rates and foreign exchange research group in Toronto, Tulk provides research to portfolio managers, clients and those on the trading floor.
Global growth fund managers want data that helps them understand a U.S. economy that appears to be doing well but at times looks fatigued, he says. “That’s certainly one frequent question. The other is waiting for China to collapse, and what kind of catalyst might warrant that type of development,” Tulk says, referring to China’s credit boom and growth in shadow banking.
The analyst is also watching data that helps him interpret underlying slow GDP growth, he says. Among his key indicators are inflation expectations, as measured by the Federal Reserve Bank of New York, the University of Michigan and others. The reading is important for judging risks to future growth.
“If inflation expectations fall, that becomes a very difficult cycle to break out of,” he says. “If you want to buy a car and you know it’s going to be cheaper in three months, it’s a perfectly rational decision to hold off on that purchase. The problem is, if everyone thinks that way, everything stalls.”
Christine Tan, CIO and senior portfolio manager of emerging markets for Excel Funds, takes a macro view of data, focusing on the biggest emerging markets as well as the Fed, ECB and BoJ. That’s because their actions have the highest impact on the global cost of capital.
With an internal team as well as subadvisors based in local markets, Tan closely follows data coming from major EMs like China, India and Brazil.
In China, she watches PMI, a measure of manufacturing and services health, for its indications of wage growth and consumer spending, as well as its impact on commodity prices. A second important Chinese indicator for Tan is the government’s loan growth data, she says, a signal of money flowing through the system and a multiplier on economic growth.
While the data is important to her understanding of EMs, she takes a longer-term view, and wouldn’t trade on the data. She instead tries to find areas of long-term growth that are less sensitive to economic shifts, pointing to her investments in areas like health care, education and infrastructure.
“The evolution of an economy, in my opinion, is very predictable,” Tan says.
“Some countries might take a slightly longer detour along the way, but whether it’s Indonesia, [the] Philippines, Thailand or Colombia, I’m seeing a lot of the same things. As governments get wealthier, they start to spend more and more on things like clean water.”
Perhaps even more important than economic data is geopolitics. Brazil’s surprise election in 2014 led Tan to rebalance her portfolio significantly.
“There was a high indication that the government would change and that there would be a pro-business opposition party that would win the election. There was a lot of excitement. I was overweight Brazil,” she recalls. That was because both her team and her subadvisors in Brazil expected Aécio Neves’s business friendly opposition party to become the government. No one expected the presidential election, held that October, to be the tightest race since 1989, and so close that a second-round runoff vote needed to be held, electing incumbent Dilma Rousseff as president.
“By and large, if it’s 50 PMI versus 52 or 49, I don’t really make a change, but I do make changes when it’s a big change to the outlook, like Brazil,” Tan says. “The macro [of the election] really caused me to go to a big underweight—as in not even 2%.”
For Andy Blatchford, who covers the Statistics Canada media lockups for The Canadian Press, the task is a reminder that he’s among the first to see valuable information.
“There’s a small group of journalists in a room with no access to the outside world,” he says. “We’re holding information that could move markets.”
Not your everyday headline data
Employment, CPI and GDP regularly make headlines. Some might even say it’s overvalued. What data is undervalued?
What: Inflation expectations
Why: The country’s collective expectations about where prices will go are being watched very closely. Central banks, for instance, view expectations as an important factor for the inflation outlook.
When: With the world watching the Fed, this makes U.S. inflation expectation data key. The Federal Reserve Bank of New York releases a monthly survey of consumer expectations, as does the University of Michigan.
The latest: The Federal Reserve Bank of New York’s August survey showed American consumer expectations rebounded, rising to the highest reading this year after falling to almost a record low the previous month.
What: China bank debt
Why: Ultimately, PMs and economists want to know of the risks of credit default in China.
When: The IMF releases an annual “Article IV” report on China. Firms like Fitch Ratings and PwC also issue regular reports on China’s banking sector.
The latest: In September, CLSA Ltd., a brokerage and investment firm, estimated bad debt in China’s financial sector, saying the country’s shadow banking practices could involve losses of US$375 billion. In shadow banking, credit products are booked as investments as opposed to loans, allowing banks to report higher capital adequacy ratios—potentially overstating their stability.
What: Citigroup Economic Surprise Index (CESI)
Why: This index, which tracks economic data relative to expectations, is a powerful, consolidated reading of economic performance. There are separate indexes for Canada, the U.S., Europe and other regions.
When: The index adjusts with each economic data release. If the data exceeds economic forecasts, the index rises, and vice versa when the data fall short.
The latest: In the U.S., a string of negative data had in 2014 sent the index far below zero. It showed a negative reading through 2015, but moved into a positive position this summer.
by Simon Doyle, an Ottawa-based financial writer.