FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
July 12, 2016
IN THIS ISSUE:
1. Stocks At Record High, Treasuries at Record Low – Why?
2. Investors Typically Don’t Buy Bonds & Stocks at the Same Time
3. We Often Forget How Huge the US Economy Really Is
4. Certain Investments Available Only to “Accredited Investors”
Stocks at Record High, Treasuries at Record Low – Why?
As I reported in my Blog last Thursday, US Treasury yields fell to record lows last week as global uncertainty remains high in the wake of the UK’s “Brexit” decision and growing fears about European banks, China, etc.
Investors worldwide flocked to the safety of US Treasury securities, and to a lesser degree to US stocks, citing fears of a global recession sparked by a widely expected economic slowdown in Great Britain and Europe – which may or may not happen.
Keep in mind that as Treasury yields move lower, the price of the bonds moves higher.
The 10-year Treasury Note plunged to below 1.37% intra-day on Tuesday of last week, an all-time low. The yield on the 30-year Treasury Bond fell to 2.14% on Tuesday as well, also a record low. The yield on the UK 10-year bond (gilt) fell to a record low of 0.78% a week ago, while the 10-year German bund yield tumbled to negative 0.18%.
Meanwhile, the major US stock indexes have rebounded strongly from the plunge following the Brexit vote in the UK and are at or near new all-time highs. The S&P 500 Index on Monday eclipsed its prior record high of 2,131 and closed at 2,137. As this is written, the Dow Jones Industrial Index is also at a new record high. What a comeback after the two-day Brexit plunge!
The sharp swing higher for stocks late last week and on Monday was sparked in part by the June jobs report on Friday which showed the US created 287,000 new jobs last month, far above the pre-report consensus of 175,000. This quelled nagging fears that the labor market was beginning to sputter after the May report showed a measly 11,000 new jobs were added.
Friday’s unemployment report delivered a powerful jolt to investor confidence, which helped to erase all of the stock market losses from the rout sparked by the UK’s decision to exit the European Union in the June 23 referendum.
It’s not often that we see stocks at or near record highs at the same time we see Treasury yields at all-time lows. So what’s going on?
Traditionally, we see falling interest rates when the economy is slowing. And you would think that record low interest rates would signal an economy that is tanking. As for stocks, we would expect to see strong equity markets when the economy is strong, and record high stock indexes when the economy is rocketing higher.
Yet we don’t see any of those things today. The economy is lackluster at best with GDP growth this year expected to be only about 2%. Based on most current forecasts, the US economy is not expected to slip into recession, or soar to 3% growth, in the coming year.
The point is, we wouldn’t normally expect interest rates to be at all-time record lows or stocks to be at or near all-time record highs in the current environment. The key word is “normally.” There is nothing normal about the current situation we find ourselves in.
Investors Typically Don’t Buy Bonds & Stocks at the Same Time
While most investors have money allocated to stocks and bonds, in normal circumstances we rarely see investors buying stocks and bonds at the same time. Yet it’s happening more and more frequently over the last year.
Bonds are considered a safe haven, especially when conditions are uncertain or there is a perception of high risk. Bond prices move in the opposite direction of yields, so today’s increased appetite for the perceived safety of bonds is driving yields lower and lower.
Stocks on the other hand, are favored when investors’ risk appetite is higher. While many analysts agree that US stocks are over-valued, some say very over-valued, demand for US equities continues to grow this year.
According to Dow Jones data, the S&P 500 has closed at a record high and the 10-year Treasury has closed at below 2% at the same time only once in the last 40 years. That was back in 2013 when the US economy was still recovering from the financial crisis, aided by aggressive quantitative easing from the Federal Reserve.
One big reason for today’s record high stocks and record low Treasury yields is the ongoing concern over the global economy and increasing forecasts of a global recession later this year. Add to that the recent Brexit vote in the UK and growing fears that other EU nations may follow suit before long.
And then there are the growing worries about embattled Italian banks and lingering concerns about sluggish growth in China, the world’s second-largest economy – both of which are fanning fears of deflation. These are just some of investors’ biggest concerns. All in all, it makes for a scary world for investors.
Another reason is the fact that negative interest rates are rapidly spreading around the world. In a report released last week, interest rate strategists at Bank of America Merrill Lynch (BAML) predicted that ultra-low interest rates are the “new normal” in global markets.
More specifically, they reported that of the government bonds currently offered by developed countries, apprx. 33% now trade at negative yields.This can be explained in large part by a growing appetite from foreign investors who are eager to gobble up Treasuries in a world where nearly $12 trillion in debt now offers negative yields.
BAML also reported last week that the US Treasuries make up nearly 50% of positive-yielding government bonds now available to investors worldwide. While US Treasury yields are at a record low, they are still positive, and thus foreign demand is accelerating.
The BAML analysts also pointed out that European and Japanese investors are being pushed out of their domestic sovereign bond markets by their own central banks that are gobbling up bonds as part of their unprecedented quantitative easing (QE) programs. Those investors are increasingly looking to US Treasuries and American stocks as well.
Another way to think about this market dynamic is a popular acronym that Wall Street has adopted lately:“TINA” for There Is No Alternative. In other words, in a world rattled by the prospect of anemic global growth and negative interest rates, both US Treasuries and stocks are benefiting because they are theonly game in town for many.
The BAML analysts predict that Treasury yields will continue to fall and that US stocks will continue to rise (of course they are always bullish on equities). And so do the preponderance of forecasters. Bullish sentiment is about as high today as it ever gets.
But keep in mind that, while most market forecasters are predicting that Treasury yields will continue moving lower, buying bonds at today’s record high prices is a very high risk play. The same could be said for buying stocks at today’s lofty levels.
We Often Forget How Huge the US Economy Really Is
I’ll round-out this E-Letter with something that has nothing to do with today’s main focus on record low Treasury yields and record high equity prices. The