The Bond Market Takes Center Stage

by | Sep 4, 2019 | Recent Commentary |

 

  • Is the growing “consensus” that’s calling for recession correct?  Not in our view.  The leading/coincident indicator ratio tends to plunge consistently for long periods of time in the lead-up to recessions, unlike the three instances of sideways movement we have seen since the Great Recession (see graph below).  So far, the leading indicator data does not look recessionary to us.

Source:  Bespoke Investment Group

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  • The S&P 500’s 200-day moving average is a good long-term trend gauge.  As the graph below shows, it has been trending sideways for more than a year now, which is indicative of the back and forth market we are in.  The bull market has lasted over 10 years, but the gains have come in three waves with three sideways periods mixed in.  We are stuck in one of those sideways periods right now.  Notice the plateaus coincide with the flat periods of the previous graph.  For now, as the economy goes, so goes the stock market.

Source:  Bespoke Investment Group

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  • Diversification works.  The volatility in stocks last month was offset by a strong bond market.  A traditional 60/40 split (stocks/bonds) was down only 0.6% in August (measured using the S&P 500 and the U.S. Aggregate Bond Index) – not bad, given the sharp equity gyrations.  For the past 12 months, the 60/40 portfolio returned about 5.5%, better than the 2.7% from stocks.

The Bond Market Takes Center Stage

Why Interest Rates Plunged Last Month

100 Year U.S. Treasury Bonds?

The bond market had a strong year last month!  Long-term Treasuries (20+ year maturities) advanced about 10% while intermediate-term notes rose about 4%.  The 10-year Treasury yield is now less than 1.5% with the 30-year under 2%.  What is causing this new found love for bonds?  It comes down to three primary reasons:

    1. Increasing fear of a recession.  More and more investors are hopping on the recession bandwagon.  Their expectation is that rates will go even lower.  It is also a safety trade for bearish equity investors.
       
    2. Foreign demand.  With negative interest rates prevalent now in many countries, foreign investors can’t get enough of our bonds that actually have a positive yield.
       
    3. Low inflation.  Core inflation is still running below 2%.  Will the Fed continue to lower rates until inflation rebounds to help prevent a deflationary spiral (like Japan has experienced for 30 years)?

 
With interest rates this low there has been talk of the U.S. Treasury issuing 100-year bonds.  Treasury Secretary Mnuchin said issuing ultra-long U.S. bonds is “under very serious consideration.”  Our view is that this would be a prudent move.  This may be a once-in-a-lifetime opportunity to lower interest expenses by trillions of dollars over the next decades.  The Trump administration could refinance the $17 trillion of publicly held debt.  Refinancing the debt now could be one of the largest debt-reduction strategies ever implemented.  And yes, there likely would be adequate demand for such bonds from institutional investors-mainly insurance companies and pension funds.  No one knows how long rates will stay this low but eventually they should rise.  Refinancing the debt would be a wise insurance policy.