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Ted Spread Highest Level In Seven Years

You may have seen warnings about the Ted Spread in recent days, along the lines of this blurb from The Wall Street Journal:

A measure of stress in financial markets, whose alarm bells heralded the 2008 financial crisis, just hit its highest level in over seven years.

Spikes In Ted And Stocks

The last three times the Ted Spread spiked was it better to be buying stocks or selling stocks? Recent spikes in the Ted Spread have occurred during sell-offs in the stock market. However, the peaks in the Ted Spread occurred just prior to sharp rallies in the S&P 500.

New Regulations And The Ted Spread

Another factor to consider is the regulatory impact on the ongoing utility of the Ted Spread. From The Wall Street Journal:

But don’t worry. It turns out the so-called Ted Spread might be dead, an unlikely casualty of the recent changes in U.S. money-market regulation… The U.S. Securities and Exchange Commission’s new rules for money-market funds come into effect in the middle of October. They are designed to stop rapid outflows during periods of panic and include abandoning a fixed $1 share price and allowing these funds to impose fees on shareholders who withdraw assets. Funds can also suspend redemptions temporarily.

The Bigger Picture

The recent spikes in the Ted Spread did occur during periods of increasing fear in the equity markets. Therefore, as always, we remain open to all outcomes over the coming days and weeks, including bearish outcomes. This week’s stock market video covers a very rare shift that recently occurred in the financial markets; what could have caused the shift and what does history tell us about the present day stock market?

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

How Helpful Is The Ted Spread?

Indicators that have strong and consistent correlations to the S&P 500 can be helpful. As shown below, the correlation between the Ted Spread and the S&P 500 looks like an 8.0 magnitude earthquake on the Richter scale. Sometimes stocks go up when the Ted Spread goes up; sometimes stocks go down when the Ted Spread goes up.

“The average long-term experience in investing is never surprising, but the short- term experience is always surprising.” – Charley Ellis

The stock market has basically gone nowhere for a while now. According to the sharp team over at Bespoke Investment Group, the S&P 500 has crossed the 2100 level to the upside 25 times over the past 18 months.

Investors can start to get fidgety during these slow periods where stocks seem to fluctuate but not make much progress. The thing is, stock market returns have always been lumpy. Historical returns always look great on paper, but the actual experience of living through them is never really close to the average results. Average is typically the exception, not the rule.

For example, take a look at the S&P 500 and how lumpy the returns have been over time:

A similar pattern emerges when you look at foreign stocks:

And emerging markets:

Over these various time frames these markets returned 9.5%, 9.2% and 10.5% respectively on an annual return basis. What’s not to like about those average results?

But you can see that the path to get to those averages has been anything but easy. Those return streams are extremely lumpy. They include losses. They include those periods when stocks went nowhere for some time. And they also include large gains.

Sometimes the gains last for years on end while other times they’re short lived. The same applies to losses and sideways markets. Markets are a mixture of breath-taking gains, gut-wrenching losses and maddeningly dull periods where they make no progress whatsoever.

There are always going to be good reasons to not like investing in the stock market. Stock returns are inconsistent, they go down, they go nowhere, they don’t go up as much as you would like and they rarely line up with your financial milestones by providing perfect entry and exit windows.

If you’re invested in the stock market for long stretches of time the best advice I have to offer is this — get used to it. This is what happens. So it goes.

Further Reading: Playing the Probabilities

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This post from Ben Carlson (@awealthofcs) originally appeared on A Wealth of Common Sense.

Mitch on the Markets

I’ve received several questions from clients over the last few days regarding China’s currency, the yuan. Almost all of them were some variation of these three: with its acceptance into the International Monetary Fund’s (IMF) ‘Special Drawing Rights’ basket, is the yuan a threat to the dollar’s status as the world’s top reserve currency? If central banks around the world start replacing dollars with yuan at an alarming pace, will it threaten the U.S. economy? Is this just another sign of China taking over the U.S. as a global economic superpower?

When I hear questions like this (which is often), I get the increasing sense that investor bearishness is on the rise. It certainly doesn’t help when the media narrative makes it seem like this IMF decision is somehow the ‘beginning of the end’ for the U.S. dollar. Is this something we should be worried about?

3 Challenges to the ‘Rise’ of China’s Currency

If you’re old enough to be reading this article, then in my view, there’s less than a 1% chance the yuan will overtake the dollar in your lifetime as either (1) the most held foreign reserve currency or (2) the primary currency used for international trade. Simple as that - here are three reasons why.

1. It May Not be Mathematically Possible – according to the IMF, there are about $11.5 trillion in foreign exchange reserves (forex) in the world. Quick note: a foreign exchange reserve is an asset held by a central bank, usually in the form of a sovereign bond (like a U.S. Treasury) or bank notes.  Of those $11.5 trillion, $6.6 trillion are allocated reserves of which about $4.2 trillion are in U.S. dollars. That means the U.S. dollar accounts for over 60% of all allocated currency holdings! China is barely a grain of sand in the forex markets and, while that may change going forward with its status as a global IMF currency, it will be decades upon decades until it can surge to overtake the U.S. 

But here’s where the mathematical impossibility comes in - the U.S. towers over all other countries in terms of foreign reserves because the U.S. has the most available currency assets to trade. We have about $13 trillion tradeable U.S. Treasuries out there, which foreign central banks love to own – it’s the safest, most liquid debt in the marketplace. For the yuan to overtake the U.S. dollar, it would mean that enough yuan and “tradeable Chinese securities” have to be available in the marketplace for central banks to buy it. That’s simply not the case today – there is only around $1.5 trillion in Chinese government debt. Even if central banks wanted to ditch all their dollars for yuan (which they absolutely don’t), it wouldn’t be possible – there aren’t enough yuan to go around.

2. China Doesn’t Have Enough Currency Agreements – as of right now, the yuan is only convertible into six currencies: the USD, the yen, euros, British pounds, Russian rubles, and Australian dollars. If someone in Mexico wants to buy goods direct from China, they have to convert their pesos to dollars in order to make the purchase. If it’s going to become the top currency in the world, it’s got a mountain of currency agreements to make first. Don’t expect that to happen overnight.

3. Capital Controls in China Make it Difficult (and Unattractive) to Access – China still has scores of regulations for how foreigners can invest, who can participate in their stock markets and how the yuan’s exchange rates are set. Additionally, Chinese state debt is not necessarily available for purchase from any central bank – it’s regulated. Capital controls of this scale are not conducive for being at the center of the global marketplace. China needs fairly radical change before achieving that designation, which could take decades if it even occurs at all.

Bottom Line for Investors

Inclusion of the yuan into the International Monetary Fund’s ‘Special Drawing Rights’ basket is simply an acknowledgement of China as a legitimate player on the global economic scale. It reflects recognition that China has developed to the point where it deserves a seat at the ‘global capital markets’ table. For now, though, the U.S. dollar reigns supreme. The weights for the IMF’s drawing basket will be: 41.73% for the U.S. dollar; 30.93% for the euro; 10.92% for the Chinese yuan; 8.33% for the Japanese yen, and 8.09% for the British pound.

Investors need not fear China’s increased participation in global capital markets, nor should anyone read too much into what this means for the dollar. As long as the U.S. remains the largest, most diverse and most sophisticated economy in the world, the U.S. dollar will be the most important currency in the world.

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Ordinarily, when a money manager breaks the trillion-dollar mark, its only a matter of time before people start saying they’ll never be able to keep up the performance that got them there. Vanguard has broken $3 trillion and the wins keep coming. It helps that, aside from reducing tracking error, the funds aren’t really trying too hard or spending too much.

This is a remarkable year for Vanguard’s mutual funds – especially its stock funds and balanced funds – as you’ll see below. This was supposed to be the year of dispersion, where stock pickers’ abilities would finally shine through. Turns out, costs still trumped alpha in the aggregate.

Lots of people are blaming Apple’s surge for the relative underperformance of so many managers versus the broad market benchmarks that Vanguard adheres so closely to. The theory goes that if you were underweight or out of Apple, you didn’t stand a chance given its size and return. Okay, sure.