2016 May Financial Market Update

Transcription

1 Charles Sherry Director, Institutional Education Group Blue Ocean Global Wealth 51 Monroe St., Plaza West 06 Rockville, MD Tel: May Financial Market Update Bond Bulls Defy Countless Obituaries May 31, 2016 It s no secret that interest rates for highly-rated securities remain at rock bottom levels. From T-bills to FDIC-insured savings accounts, earning a respectable return on safe investments has been next to impossible. The same holds true for Treasury bonds. For several years, analysts have been writing the obituary on the 30-year bull market in bonds. To borrow a famous quote from Mark Twain, The reports of my death have been greatly exaggerated. Index May Return %* 2016 YTD Return % DJIA NASDAQ Composite S&P 500 Index FTSE Developed ex North America Index 4 Bond Yields Yield* - % a/o May31, 2016 Yield - % a/o Dec 31, month T-bill year Treasury year Treasury year Treasury Commodities May 31 Price, Monthly Year end 2015 Change* Oil per barrel 5 $ $37.07 Gold per ounce 6 $1, $1, Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC *Monthly: April 29, 2016 May 31, 2016

2 A quick glance at the table of returns for May highlights the yield on the 10-year Treasury has dropped since the start of the year, even as the Federal Reserve boosted its key rate late last year. It s a simple but good illustration that bond investors remain engaged. Remember, bond prices and yields move in opposite directions. So what might be keeping yields on government bonds at low levels? There are several themes that are impacting rates so let s jump in. Economic growth and yields In the broadest sense, slow economic growth in the U.S. and expectations that growth won t be accelerating anytime soon are a big factor see Figure 1. For starters, the yield on the 10-year bond remains near its lowest level in decades. Nominal GDP and the 10-yr Treasury Yield PERCENT Fig quarter annualized average nominal GDP 10-year Treasury yield (quarterly average) Data Source: St. Louis Federal Reserve Last Data: Q But note the close correlation between nominal Gross Domestic Product (GDP), the largest measure of goods and services, and the yield on the 10-year bond, which signals that growth at home is a large part of the bond-yield equation. Before I go on, a quick explanation of the blue line is in order. When GDP is released each quarter, it is reported in real terms, or inflation-adjusted terms. In other words, if you hear a news report that GDP in Q1 grew by an annualized pace of 0.7%,it only includes the change in output and excludes any change in prices.

3 Nominal GDP includes the change in output PLUS inflation. Therefore, if real GDP grew by 0.7% and inflation increased by 1%, nominal GDP would rise by about 1.7%. Taking this one more step, the blue line is simply the average change in nominal GDP over the last 12 quarters. Note in Figure 1 that economic growth appeared to be expanding at a fast clip in the late 1970s and early 1980s. However, most of that growth was simply an illusion, i.e., slow real economic growth plus rapid inflation. Yet, that played a significant role in the surge in Treasury yields, as investors demanded a higher return to compensate for higher inflation. Global rates enter the picture Slow economic growth and very low inflation among the major industrials nations have encouraged central banks to open up the monetary floodgates. This includes the Bank of Japan and the European Central Bank. Consequently, government bond yields in major countries, including those in Japan and several more economically stable countries in Europe, have fallen well below what we have in the U.S. (Bloomberg). Low global rates have encouraged some foreign investors to look to countries like the U.S., which sport relatively higher yields. Figure 2 illustrates average yields in Europe are lower than those in the U.S. 10- Year U.S. Treasury Yield minus the 10-Year Euro Main Benchmark Yield Percent Jan-70 Jan-80 Jan-90 Jan-00 Jan-10 Data Source: European Central Bank, St. Louis Federal Reserve Last Date: May 2016

4 The 10-year Main Benchmark Yield for the Euro Area is an unmanaged index which cannot be invested into directly. Past performance does not guarantee future results. Given that money can easily move across borders today, higher yields at home are likely attracting foreign capital into U.S. bonds, boosting Treasury prices. Since bond prices and yields move in the opposite direction, overseas cash has played a role in keeping downward pressure on yields in the U.S. The Fed effect The Federal Reserve exerts a significant amount of control over short-term rates such as the fed funds rate and T-bills, but it can only hope to influence longer-term bonds. The Fed has kept rates at low levels, hoping low loan rates will stimulate borrowing and spending by businesses and consumers, which in turn would drive economic activity and hiring. Clearly, there are limits to what the Fed can do to boost U.S. economic growth. The Fed did hike the fed funds rate last December by 0.25% to a range of %, the first increase in almost 10 years. But the Fed has explicitly been saying that any future rates hikes are expected to come at a gradual pace. As I ve already mentioned, the Fed cannot control long-term rates, but it s very easy monetary stance has influenced longer-term yields. Low inflation Official measures of inflation, which include the Consumer Price Index and the lesser known PCE Price Index, continue to run at low levels. Given that inflation and inflation expectations remain low, investors are not demanding a premium to hold bonds. Put another way, low inflation is one more factor that keeps a lid on bond yields. Where to from here Today s exercise was designed to shed light on why investors are forced to grapple with low rates. There s not much to suggest we ll see a significant rise in rates in the near term, but any projections that try to forecast where bond yields might be headed are best avoided, as no one has a crystal ball. Few foresaw how long rates would stay low and few have the ability to accurately pinpoint rates in the future. The obituary for the bull market in bonds will eventually be written, but it will be written in hindsight.

5 1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results. 2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results. 3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results. 4 The FTSE Developed ex North America Index is an unmanaged index of large and mid-cap stocks providing coverage of developed markets, excluding the US and Canada. It cannot be invested into directly. Past performance does not guarantee future results. 5 New York Mercantile Exchange front-month contract; Prices can and do vary; past performance does not guarantee future results. 6 London Bullion Market Association; gold fixing pricing; Prices can and do vary; past performance does not guarantee future results. It is important that you do not use this publication to request or authorize the purchase or sale of any security or commodity, or to request any other transactions. Any such request, orders or instructions will not be accepted and will not be processed. All items discussed in this report are for informational purposes only, are not advice of any kind, and are not intended as a solicitation to buy, hold, or sell any securities. Nothing contained herein constitutes tax, legal, insurance, or investment advice. DISCLOSURE: Investing involves risk including the potential loss of principal. No strategy can assure success or protects against loss. Past performance is no guarantee of future results. Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Please note that rebalancing investments may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events will be created that may increase your tax liability. Rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors. Non-U.S. securities markets involve possibly greater risk of political instability and greater currency risk in addition to having been more volatile. These risks can be accentuated in emerging markets. Commodities investments are speculative and involve special risks related to weather and international political and economic developments. Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity. Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the portfolio. Tactical allocation may involve more frequent buying and selling of assets and will tend to general higher transaction cost. Investors should consider the tax consequences of moving positions more frequently. Beta measures a portfolio s volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggests the portfolio has historically been less volatile than its benchmark. Past performance is not a guarantee of future performance. Different investments involve different degrees of risk, and there can be no assurance that the future performance of any investment, security, commodity or investment strategy that is referenced will be profitable or be suitable for your portfolio. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Before making any investments or making any type of investment decision, please consult with your financial advisor and determine how a

6 security may fit into your investment portfolio, how a decision may affect your financial position and how it may impact your financial goals. All opinions are subject to change without notice in response to changing market and/or economic conditions Copyright 2016 Financial Jumble, LLC Blue Ocean Global Wealth All rights reserved.