If the economy is so darn good, why are yields so darn low?
January 12, 2020
The S&P 500 just ended the year up +30.4%, yet the yield of the U.S. 10-yield Treasury on December 31, 2019 was 1.92%. This may give one the impression that stocks and bonds are not correlated, as the U.S. Federal Reserve’s easy monetary polices are intentionally implemented to suppress interest rates. Which is a risk. And while we expect some manufacturing data in early 2020 to help, we do not expect 10-year rates will materially exceed a 2.15-2.25% range for the year.
Some would argue that uncertainty is the prevalent sentiment in this market. Not in our mind. We think uncertainty is reflected in volatility and the market has become quite adept at effectively incorporating volatility into asset pricing.
Instead, we think the current market reflects ambiguity in the sense that it’s indistinct and has a significant lack of clarity. On the surface, things just don’t make sense. The data is getting better, but bond yields are not following. What’s going on here?
Digging deeper we are seeing an asymmetry of market expectations that is being mirrored in bond prices. Despite a lot of good economic data, the bond market is worried, and therefore puts greater weight on downside risks than upside for the economy. Think about it. Ask the average investor to name ten good things that could happen to the economy and they might have trouble naming one. But ask about ten things that could go wrong? Start with U.S./China trade tensions, Iran, Brexit, impeachment proceedings and election uncertainty (and the list goes on).
To help hedge these risks investors buy high-quality bonds such as U.S. Treasuries to hedge riskier assets. In turn, the distribution of interest rates skews lower, such that current interest rate levels reflect a valuation of risk premia more than economic fundamentals.
Update on the jobs report, market risks and investment opportunities
Jobs: There was no “consensus” for December, just a range of expectations, but it is important to pay attention to the technicals
Market Risks – Digesting the “Big Four”
Investment themes and opportunities
All data as of January 10, 2020. The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See below for index definitions.
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