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2019 Q3 Commentary - Bond Bears Eat Crow Again

The death of the bond bull market has been forecast and written about by financial market pundits for no less than 10 years. The rallying cry of, “interest rates have only one way to go and that’s up”, has been heard so many times it bled into the consensus thinking of many investors.  And yet, the bond bull market continues apace pushing bond prices higher and interest rates lower. How can this be? Like it or not, we live in a relative world of interest rates. During the 3rd quarter, the amount of NEGATIVE yielding debt globally reached a new high of 17 trillion dollars.  In a world where many investors are willing to pay bond issuers for the privilege of buying their debt, a positive interest rate seems downright quaint thereby fueling demand for U.S. debt. This coupled with concerns about slowing global growth, a trade war with China, and heightened political uncertainty have helped to put a firm cap on rates.

Falling interest rates were reflected in the market winners and losers for the 3rd quarter. Interest rate sensitive sectors such as utilities and REITs did very well, outperforming technology and growth-oriented stocks. And to the surprise of most, the 20 year Treasury bond vastly outperformed the overall U.S. stock market as measured by the S&P 500 by over 7% for the quarter. This was clearly not what most were expecting just a year ago as the following excerpt from the Wall Street Journal explains.

                “Around a year ago, many investors believed the era of low yields was finally coming to an end. Yields on U.S. government debt stood at multiyear highs above 3%, deposit rates were rising and investors were expecting the European Central Bank to begin raising interest rates for the first time in years.”

In fact, the exact opposite has occurred. Global growth has clearly slowed, central banks are once again loosening monetary policy and investors are beginning to contemplate if negative rates are in store for the U.S. About a year ago, a hedge fund manager we follow coined the phrase “Buy bonds, wear diamonds”. Meaning, he believes bonds were/are setup for a significant rally that many are not anticipating and will produce outsized returns versus many other asset classes. Thus far he has been correct. Whether that continues is another matter altogether.

Strategy

Recent economic data in the U.S. has begun to soften. While it is generally accepted that the manufacturing sector in the U.S. is in a recession, the far larger services sector of the economy has remained resilient until recently. The most recent September ISM non-manufacturing report fell to 52.6% from 55.3% the prior month. While a reading over 50 indicates businesses are growing, the index has fallen 8 points below its post 2008 recession peak of 60.8% achieved last fall. In addition, the employment gauge dropped to a five-year low of 50.4%, barely above the cutoff point that separates net hiring from net layoffs.

But fear not, central banks have taken notice. Over the past three months, there have been 33 interest-rate cuts by global central banks, which compares to 19 rate hikes in the third quarter of 2018. In addition, at the end of September 2018, the 10-year U.S. Treasury yield was above 3% and it is about half that level today. Consequently, the valuation of stocks to bonds is more attractive and roughly 60% of stocks in the S&P 500 index now have a dividend yield higher than that of the 10-year U.S. Treasury yield. And it seems very likely that the U.S. Federal Reserve is set to lower short-term interest rates once again when they meet in late October.

Given the ongoing crosscurrents of slowing global growth and heighted trade tensions juxtaposed against global central banks loosening monetary policy to ease financial conditions, our mantra remains proceed with caution. While it is clear growth is slowing, it is also clear that central banks are growing increasingly concerned and are acting forcefully to prevent further slowing. While no one can predict if they will succeed, we do hope that financial conditions continue to ease going into 2020.

As always, we remain committed to helping you achieve your financial goals.

The opinions expressed herein are those of PYA Waltman Capital, LLC (“PYA Waltman”). The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. This information shall not constitute investment advice or a recommendation to buy or sell any security or service. 
PYA Waltman Capital, LLC, is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about PYA Waltman including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request. PYA-19-31