03/26/14   Negative Interest Rates Anyone?

Editor’s Corner

Ron Rowland

Europe is back from the brink, but the European Central bank (“ECB”) is not completely satisfied.  Fears of total financial meltdown that were common a few years ago have been replaced with concerns about deflation, or dangerously low inflation.  On the surface, low inflation or outright deflation doesn’t sound all that bad.  After all, who is going to complain about lower prices?  However, deflation is typically a sign of larger problems that accompany massive economic calamities, such as depressions.

Trying to head off these types of problems, the ECB is considering additional stimulus measures to boost economic activity and create additional inflation.  One tool receiving serious consideration is negative effective interest rates.  Before you get too excited, this does not mean the ECB is going to pay you to borrow money.  Commercial banks move a large amount of cash every day, and any cash not needed immediately will typically be “parked” overnight at the central bank.  Historically, central banks have paid interest on these overnight deposits.  The stimulus under consideration would allow the ECB to charge banks for holding their cash instead of paying them interest – hence the negative interest rate description.  This would force commercial banks to look for other ways to earn a return on their cash, such as maybe even lending it to a customer.

Another measure the ECB is considering is purchases of government and/or private-sector debt.  If this sounds like our own Federal Reserve’s asset purchase program, you are correct.  The goal of such programs is to hold long-term interest rates low and promote lending.  Mario Draghi, the ECB President, yesterday suggested the bank believes the European economy is recovering, but the bank stands ready to promote price stability with aggressive measures.

Investor Heat Map: 3/26/14


The Utilities sector sits atop the rankings for the third consecutive week.  Although it got caught up in the recent market volatility, it managed to come through the week relatively unscathed.  Materials climbed a notch to second place despite the steep price drop for gold mining stocks.  Financials jumped three places to third thanks to a great performance after last week’s FOMC meeting.  Technology shook off weakness among the internet stocks to climb a notch to fourth.  Telecom was the big winner for the week, and its ability to buck some of the negative market action propelled it from last place to fifth.  Meanwhile, Health Care was the biggest loser.  Negative action in biotech stocks pulled the whole sector down, and it plunged from second place to ninth.  Health Care has been trying to regain its footing the past two days and managed to keep its uptrend intact, so don’t count it out yet.  Consumer Discretionary took a hit and fell four spots to last place.  The other consumer sector – Consumer Staples – also fell and is now part of the bottom group.


Dramatic changes in the style-box rankings are apparent this week, but everything could be turned on its head again soon because of the momentum score compression.  The most prominent change is the rise of Value.  For most of this year, the market has favored Small Caps over Large Caps and Growth over Value.  Small Cap Value climbed from fourth to grab the top spot.  Mid Cap Value jumped from seventh to second, and Large Cap Value made a leap from tenth to fourth.  This places the three Value categories in the top four spots.  Only the former leader, Micro Cap, is breaking up their total dominance by hanging on to a third place ranking.  Meanwhile, the three Growth categories have dropped to the bottom.  Mid Cap Growth fell from sixth to ninth, and Large Cap Growth slid two places to tenth.  However, the largest plunge honors went to Small Cap Growth, which managed to fall from its second place perch all the way to the bottom.


Unlike the shake-ups among the sector and style categories, the top five global categories are unchanged from a week ago.  The U.S. still heads the list, and Europe remains the top foreign region.  Canada and World Equity are now tied for third place, and Pacific ex-Japan is close on their heels.  Latin America turned in a spectacular week, with the benchmark iShares Latin America 40 ETF (ILF) gaining more than 7% in the past seven trading days.  This pushed Latin America up to sixth in the rankings while allowing it to register positive momentum for the first time in months.  The U.K. continues its recent slide, falling two more places to ninth today.  China posted a slight price gain since our last update, which resulted in a momentum improvement and a step up in the rankings.  Japan dropped down to last place, completing its eight-month journey from top to bottom.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“We haven’t exhausted our maneuvering room [on interest rates].”

Erkki Liikanen, Bank of Finland Governor and part of ECB governing council on March 26, 2014


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