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AAM Viewpoints – U.S. Markets and Negative Yielding Debt


Much has been written recently about whether the U.S. economy is on the brink of a recession and if that will feed into the idea that the United States could be headed into the global negative interest rate environment.


Regarding whether we are headed into a recession, the question really is when we will head into a recession. Approximately a month ago, the U.S. Treasury 2-Year/10-Year Yield Curve inverted. This “inversion of the yield curve” spurred a mountain of “breaking news stories” saying the recession was finally going to hit. As a result, the equity market declined for a few days, but has since rebounded. The historical data shows that if this temporary inversion truly is the indicator, it takes a about a year or longer for the recession to take hold; besides history shows the largest gains in the equity markets come during this period between the inversion and the recession. Also important to note, in the last 80 years every recession has been preceded by an inversion, but not every inversion has been followed by a recession. All this said, bull markets do eventually come to an end and this current bull market is the longest in history.


Another reason, we believe the bull run will not end tomorrow is the economic data – specifically jobs and housing.


Initial Jobless Claims came in at 208k (k=thousand), which was up slightly over the preceding month but still trending lower over the last 10 years. Initial jobless claims track the number of people who have filed for unemployment benefits for the first time, which can be viewed as an indicator of how well the economy is doing. If this number is low that indicates there are plenty of jobs and thus a stronger economy.


Initial Jobless Claims over the last 10 Years


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Source: Bloomberg


Another indicator is the housing market. There have been recent articles on the housing market slowing down. If you are talking New York or California, maybe it is. That could be the result of the great run in those regions that have already been experienced, or maybe it could be the flight out of high tax states. Either way, the rest of the country, overall, seems to be doing well. Existing home sales rose 1.3% from the previous month to a seasonally adjusted 5.49 million – the highest level since March 2018, as buyers benefited from lower mortgages rates. Housing starts were up 12.3% over the prior month to a seasonally adjusted 1364k units in August which is a 12-year high.


Another piece of data that would indicate that the economy is still strong is the JOLTS (Job Openings and Labor Turnover Survey) data. JOLTS is a survey done by the U.S. Bureau of Labor Statistics to help measure the job market. Although the job openings dropped by 31,000 to 7.22 million, these unfilled job openings are still running near highs over the last 15 years. These 7.22 million job vacancies are 1.15 million greater than the number of unemployed people looking for jobs. This greater number of vacancies vs. unemployed people might lead to higher overall compensation by employers to compete for candidates which could be interpreted as potentially inflationary. Additionally, the quits rate, people leaving jobs, is the highest it has been since April 2001 suggesting a strong job market allowing people to change jobs for presumably a better situation.


The other topic that has been discussed is the possibility of the U.S. bond markets following their global counterparts and issuing debt at negative interest rates. This has received more attention as the talk of an economic recession increases. The global economy currently has approximately $15 trillion in negative-yielding debt.


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Source: Bloomberg


We are not sure how this is good for the economies involved. We understand the college philosophical argument, but do not get the reality of it. You buy a bond for x amount and get less money back at maturity. On paper, the idea is the investor plays the currency angle. We just do not see an investor knowingly doing this. We would assume they would stay in cash or invest in another asset class such as dividend-yielding equities. The average dividend yield for securities in the S&P 500 is 1.91%, the Dow Jones Industrial Average (DJIA) is 2.27%, and the Russell 3000 average is 1.85%.


The buyers of this negative-yielding debt seem to be primarily the central banks, among certain others that may need to invest. However, central banks really do not have to answer to anyone. They get their cash to buy this negatively yielding debt by printing money. They do not care about returns or being questioned.


Back to college, if you flood the market with money, chasing the same amount of assets, that could be argued as inflationary which we believe is their intent. So, current holders of these currencies may be at a relatively high market risk. Even if you buy into this idea of negative-yielding bonds, we do not believe this strategy has worked very well in the past.


Please see a very insightful viewpoint by AAM’s Scott Colyer on this topic: AAM VIEWPOINTS – THE JAPANIFICATION OF THE GLOBAL ECONOMY


All this aside, the 10-year U.S. Treasury bond yield has put in a triple bottom in 2012, 2016 and this year. It could be argued rates will rise given the overall health of the U.S. economy.


costas3_093019


Source: Bloomberg


Is there an end to the U.S. equity bull market? Yes, of course, the question is, “When?” Does the United States follow global markets and issue negative yielding debt? In our opinion, no.


There are two sides to every story and two sides to every market; as always consult your financial advisor before investing.


 


CRN: 2019-0912-7665R


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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