The economy is showing signs of strength and lower bond yields are not a sign of economic weakness, according to a Rothschild Wealth Management letter to investors reviewed by ValueWalk.

Economy Rothschild

Rothschild: Investors favoring safer plays

Recently investors have favored high quality, safer plays, especially after a spring correction in biotechnology and internet equities, the report, written by Rothschild Managing Director Mark Tavel, noted. But the big surprise in 2014 occurred in May, when the “remarkable rally in bonds” took place. The 10-year Treasury began the year with a yield close to 3%. At the end of May, the rate had fallen to 2.6%. perhaps most interesting in the bond rally, strength was not confined to quality as non-investment grade debt also gained in price and declined in yield.

Bond prices move in the opposite direction of economic growth, the report noted, indicating a weaker economic outlook.  “The severe winter led to GDP contracting in the March quarter, which is consistent with falling interest rates,” the report noted. “But the first quarter now is almost ancient history. The economy is rebounding – yet interest rates continue to march lower. Should we be worried about economic growth, upon which our positive case for equities is based?” the report asked.

Rothschild: Current quarter will be good for corporate profits

Providing an answer, the report acknowledged the economic data “is not universally good. But we remain confident that the current quarter will be a good one for growth and corporate profits,” the letter said. “A number of economic indicators already reported are flashing green. Banks are lending at a strong pace to business; wages and salaries are growing at a greater than 4% annual rate in the private sector; and rail traffic is strong.”

The report indicated that Rothschild does not believe low bond yields that dropped in May are a sign of economic weakness ahead, as yields are down on a global basis. “Why buy the sovereign debt of shaky European economies when U.S. Treasuries are available with very competitive yields?”  The U.S. deficit is shrinking quickly, the report notes, reducing the supply of bonds, and inflation is benign. “Much of the world still has sluggish growth driving down other countries’ interest rates. Finally, Mr. Putin’s antics have probably contributed to a “flight to quality” and safety.”

Rothschild: Consumption growing at a fast pace

On the consumer front, the letter noted consumption is growing at the fastest pace in two years, despite a weak April, which the letter indicates may have been affected by Easter as they made the bull case. “Unemployment insurance claims are at a seven-year low. The Index compiled from Purchasing Managers is at a very high reading, connoting strength in manufacturing. Corporate profits grew 3.4%, despite the GDP contraction. The tone on management calls for Q2 and the rest of the year was upbeat, although still restrained.”