FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
July 12, 2016
IN THIS ISSUE:
1. Stocks At Record High, Treasuries at Record Low – Why?
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
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 following is merely something I ran across recently which I found very interesting.
The story goes that some German visitors were in the US staying at a friend’s house in Michigan. One morning, the Germans asked if they could take a day trip to the Grand Canyon. Their host responded, “I don’t think you realize just how big America is.” There’s no way to drive from Michigan to Arizona and back in a day.
The point is, many foreigners visiting the US have no idea how big America is. That’s in part because many live in countries that are a fraction the size of the United States. Conversely, many Americans don’t realize how small most of the countries in the rest of the world are.
And we’re not talking geographically here. This is about the respective size of the US economy compared to that of most other developed countries around the world. As we all know, the US economy is by far the largest in the world.
What you may not know is the fact that our individual US states have larger economies than many developed countries around the world. I doubt you’ve seen a graphic like the one below.
Economist and Investor’s Business Daily contributor Mark Perry recently put together a map of the US with the states’ names replaced with countries that have comparably sized economies. I think you’ll find this very interesting. Take a look at the map.
New York’s economy, for example, is equal in size to all of Canada. California’s is as big as France. The Texas economy is the size of Brazil, which is about to host the summer Olympics (for better or worse). Florida is the size of Indonesia. New Jersey and Saudi Arabia have comparable sized economies. Socialist Norway would fit easily into liberal Minnesota.
Perry’s map doesn’t show this, but you’d only have to combine Texas, Florida and Indiana to have an economy that’s bigger than all of the United Kingdom, which just recently voted to secede from the European Union.
The point is, when someone like socialist Bernie Sanders suggests that the US should be run like Norway or Sweden, someone ought to tell him that those economies are the size of Minnesota and North Carolina, respectively. How ridiculous a suggestion!
And that was the political genius of the Founding Fathers when they set up the Constitution, which was meant to strictly limit the federal government so that state governments, which are closer to their people and more responsive to their needs, could pursue their own economic and social policies as they see fit.
Even now, as the federal government has become obese and overly intrusive, states still must compete with each other to attract and retain workers. States like California that regulate and tax too much find themselves losing population to those that are more business friendly and productive, like Texas and others.
But when the federal government imposes its will on all states, those competitive forces are diminished, which helps explain why federal welfare programs are such a disaster – but that’s a story for another time.
Perry notes something else very important – that most US state economies are far more efficient than their foreign country counterparts. Let’s look at some stats that may surprise you.
- France required 32% more workers to produce the same economic output as California last year.
- Texas and Brazil have comparable economies in terms of GDP, but Brazil had almost 80 million more workers than Texas last year.
- New York state had about half the number of workers as Canada had last year.
And most impressively, Perry points out that the US produces 24.5% of the world’s economic output, but with less than 5% of its population.
So what is it, exactly, that these smaller, inefficient countries have that the liberals want us to emulate to have a successful economy? Not much, I would say!
For all of our problems, the US economy is by far the largest and most vibrant in the world.
Certain Investments Available Only to “Accredited Investors”
The government in its infinite wisdom (or lack thereof) decided decades ago that certain investments may only be offered to “Accredited Investors.” An Accredited Investor is anyone with a net worth of over $1,000,000 (excluding primary residence) or anyone with an annual income of over $200,000 in each of the two most recent years (or joint income with spouse of over $300,000).
Investments that are limited to Accredited Investors are not your typical stock and bond investments such as mutual funds and ETFs. More often than not they are limited partnerships or other creative opportunities, which are not public offerings.
At Halbert Wealth Management, we recently began offering a unique strategy to our accredited clients. However, we cannot share any more information with you about this strategy unless you let us know that you are an Accredited Investor. That’s the rule, like it or not.
If you do qualify as an Accredited Investor, you need to complete our online Investor Certification Formso we can tell you about this exciting investment opportunity. We’ll then send you detailed information including actual performance numbers.
So, don’t miss out on learning more about investment opportunities only available to Accredited Investors. If you qualify, click on the link above and let us know. Feel free to call us at 800-348-3601 if you have any questions.