Market Digest          
8.1.18          
OBSERVATIONS
Global Bond Indicators: Another Reminder to Proceed With Caution
Long time readers of our Market Digest know that we have been concerned about liquidity in the bond markets for a while. Liquidity is simply a term that refers to the capacity to trade securities without significantly affecting the price. To combat the global financial crisis of 2007-08, central banks around the world supported bond markets through massive injections of capital. But as the Federal Reserve has begun to reduce its $4.5 trillion bond portfolio and the European Central Bank trims its own bond-buying program, bond securities around the world have become harder to trade.

Bid-Ask Spread
The "Bid-Ask" is a term used to describe the difference in the price a trader is willing to sell and the offering price at which a second trader is willing to buy. It's also a useful way to monitor bond liquidity - the smaller the spread between the ask and the bid prices, the more liquid the market is considered.

According to data from MarketAxess, the median bid-ask spread across European corporate debt and emerging-market bonds has widened. This is visible in the chart below (Note EMEA refers to Europe, Middle East and Africa).

Median Bid-Ask Spread Global Debt July 2018


Recent episodes of extreme stress in Italian bond markets serve as a reminder to bond investors that liquidity levels can change rapidly and that as fiscal stimulus  recedes , bond markets are more vulnerable to shocks. After Italy's President vetoed a populist alliance's choice of finance minister, Italian bond yields soared (2-year bond yields rose 1.57% and the 10-year bond yields rose 3.1% in just two days). Remember, prices and yields move in opposite directions; as these yields rose, prices were falling.

How Does This Impact Your Portfolio?
Parts of the global bond market have always had patches of illiquid trading, especially during bouts of financial-market turbulence such as what Italy experienced in the early part of summer. 

It's important to understand that during real high-risk events, no one is able to trade. And this doesn't just apply to bonds in far off places. It can happen in the US and it can happen to exchange traded funds (ETFs) which are commonly thought of as being extremely liquid. But ETFs are only as liquid as their underlying securities and when crisis hits, their bid-ask spread will increase just like any other bond instrument.

The best protection for your portfolio is to utilize the services of an active bond manager. They have the flexibility to position portfolios according to market conditions and should be less likely to get trapped by forced selling at fire-sale prices during times of financial stress.
MARKET UPDATE
Last week stock returns were mixed with large cap equities outperforming their small cap counterparts. Industrial stocks performed well as investors interpreted the trade talks between President Trump and European Commission President, Jean-Claude Juncker, as a de-escalation in tensions. Facebook received widespread attention after the stock fell 19% and erased $120 billion in market value in two days' time. Investors reacted to their earnings report which showed revenue was growing slower than expected (but still over 40% on a year-over-year basis) and expenses were increasing due to their efforts to combat privacy concerns.

Equity Index Returns through July 27_ 2018
Source: Yahoo Finance
ECONOMIC NEWS
> GDP:  The advance estimate released last Friday by the Bureau of Economic Analysis showed real gross domestic product increased at an annual rate of 4.1% in the second quarter. It was consumer spending that drove GDP higher and the strong reading has led to concerns that the economy could be in danger of overheating.

Second Quarter 2018 GDP

> Housing Data: Cracks are appearing in the housing sector. There has not been much punch in the nation's housing data during the spring selling season, and conditions are cooling in the West where double-digit price bubbles were a concern early in the year. Existing home sales were flat and new home sales (shown below) fell 5.3% in June.
 
New Home Sales June 2018


> Interest Rates:   The Federal Open Market Committee met this week and, as expected, kept its federal funds target range at 1.75 to 2.00%. Two rate hikes after this meeting are expected for the rest of the year. However two factors support the possibility of more aggressive tightening: the risk of economic overheating especially after last week's very strong GDP report, and the need to assert the Fed's independence following calls from the Trump administration for the Fed to go slow. 


Federal funds target rate June 2018

THE WATERCOOLER
Fried-Chicken Connoisseurs
Earlier this summer 500 people from across South Korea gathered at a hotel in Seoul, hoping to be certified as the country's foremost experts on fried chicken. 

Chimmelier Test in Seoul_ Korea
Testing day at the Lotte Hotel in southern Seoul [BAEDAL MINJOK, YONHAP]
The annual "chimmelier," or chicken sommelier, test was held by local food-delivery app  Baemin. The test requires knowledge of the 30 best-known chicken franchises in Korea. 

A written portion included 30 multiple choice questions. Some asked simple history questions about the global origins of fried chicken and the oldest chicken brands in Korea, but many required up-to-date knowledge of the latest items from chicken franchises and their marketing campaigns, like celebrity spokespeople and jingle lyrics.

Next came a blind taste test that asked candidates to identify chicken by their brand. A staff member walked in between the desks, refilling Coca-Cola in plastic cups that resembled wine glasses. 

A test on fried chicken may sound ridiculous to some, but the company spokesperson makes a pretty good case for it, saying, " Around 30% of all orders made on the app are for chicken. It's an iconic food that has cultural significance. The basic idea behind the chimmelier certification is that there are baristas for coffee and sommeliers for wine. Chicken is enjoyed more widely, so why doesn't it have certified experts?"

NEW MARKETS. NEW ADVICE.
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