Financial Professionals


Q3 Playbook Supplement – Part 2


Additional content support for the Q3 Playbook “State of Confusion” released the week of July 1.

Q3 Playbook: Investment Themes (pages 3-6)

Theme: “Search for Yield” – Confusion (page 3)

“From May 1, 2012 until May 1, 2013, the 10-Year U.S. Treasury traded within a rather non- volatile range between 1.40% and 2.08%. The average yield during that period was 1.74%. On May 5, 2013, it closed at exactly 1.74%. Half the SPX, 250 stocks, offer a dividend yield greater than 1.74%.”

“Almost six weeks later, the U.S. 10-Year yield rose above 2.50%, reducing the number of SPX companies trading above its yield to 159 companies. That figure will be reduced by nearly half to only 81 companies if the U.S. 10-Year yield trades at 3.25%.”

U.S. 10-Year Treasury Yield, May 2012 to July 2013fig1
Source: Bloomberg

“As the yield on the 10-Year Treasury has normalized back toward its four-year average of 2.62%, allocating toward select risk assets based purely on a competitive rate comparison with Treasuries has ended.”

U.S. 10-Year Treasury Yield Last Four Years Average 2.62%fig2
Source: Bloomberg

Theme: “Abenomics” – Clarity (page 4)

“However, late in May, the carry trade began to correct. The Japanese yen started 2013 trading at 86.75 before depreciating to a 103.74 low on May 22. By June 13, it had appreciated back to 93.79.”

Japanese Yen October 2012 to July 2013fig3

“Along with the yen’s unfavorable rally, the Nikkei 225 corrected from 15,942.60 on May 19 to 12,415.85 on June 13, reducing the year-to-date performance for the Nikkei from +50% to only +17%.”

Japanese Nikkei Index 2013fig4
Source: Bloomberg

Theme: “China and Emerging Markets” – Confusion (pages 4-5)

“Financial conditions in the Chinese economy contracted during Q2. May export and import figures were relatively unchanged when reported in June. Between November 2009 and November 2011, the weakest monthly import growth figure was +19.5%; last month a contraction of -0.3% was recorded.”

China Imports, November 2009 to July 2013 fig5
Source: Bloomberg

“I expect that U.S. debt and equity markets can continue to reward investors, even with the Chinese economy muddling along. There will be sectors?in the SPX that correlate with China and therefore underperform. The Australian dollar, down nearly 10% year to date, should continue to be used as a proxy for Chinese growth?and allocated to at underweight.”

Australian Dollar 2013fig6
Source: Bloomberg

“Emerging markets have significantly underperformed in 2013. As I highlighted in the Q2 Playbook, much of the underperformance relates a negative currency impact from a declining yen. The Indian rupee, South African rand, South Korean won, Brazilian real, and Mexican peso are down year to date. Strong currencies have been the hallmark for emerging market inflows over the past few years, somewhat aligned with the “search for yield” thesis.”



Year to Date




South Korea









South Africa



Source: Bloomberg

“Back in 1994, the emerging market indexes peaked and actually traded lower over the next few years while the SPX appreciated significantly throughout the mid-1990s. It just so happens that this coincided with U.S. monetary tightening and a stronger U.S. dollar on above-trend growth. Sound familiar to what we have heard from the FOMC recently?”

Emerging Markets Index (MXEF), 1992 to 1997Fig7
Source: Bloomberg

S&P 500 Index (SPX), 1992 to 1997fig8
Source: Bloomberg

U.S. GDP, 1992 TO 1997 fig9
Source: Bloomberg

U.S. Dollar Index, 1992 to 1997 fig10
Source: Bloomberg

Theme: “U.S. Housing and Services” – Clarity (page 5)

“There is no better example of the long maintained economic theory of “first into a crisis equates to the first out of the crisis” than the U.S. housing and servicing industries. That is exactly what is occurring in 2013 and I expect that this tailwind will remain in place for Q3.”

U.S. New Home Sales, Q2 2008 to Presentfig11
Source: Bloomberg

U.S. S&P Case-Shiller Home Price Index fig12
Source: Bloomberg

U.S. Existing Home Inventoryfig13
Source: Bloomberg

Theme: Gold & Silver – Lesson Learned? (page 6)

“Real interest rates have moved aggressively from negative territory at the beginning of Q2 into positive territory now, not a favorable condition for rising precious metals prices. Global central banks, in particular emerging market economies, have been the marginal buyers of gold the past few years. However, in 2013, as those economies battle capital outflows, weak equity and currency values, and slowing growth, their appetite to purchase has lessened.

Let the lesson of 2013 be learned: gold and silver allocations are warranted in a portfolio at small, single-digit exposure. Precious metals allocations are investments not to be actively managed or traded.

Spot Gold Past 365 Daysfig14
Source: Bloomberg

Past performance is not a guarantee of future results.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.