“It’s hard to make predictions, especially about the future,” Yogi Berra famously said.
The S&P 500 pushed to a new high last week and the yield on the 10 year U.S. Treasury Bond dropped to the year’s low May 15—confusing signals. Ordinarily, a rising stock market anticipates higher economic growth, and higher interest rates usually follow. Now, we are seeing just the opposite.
Through the articles that follow, light is shed on these confusing signals.
Below-normal interest rates are here for a long time to come. Since Fed chairman Ben Bernanke retired in January he has held private discussions, sharing his wisdom and predictions, with those able to foot the bill. His remarks have been passed along to the news media by some of those in attendance. His main message: “There is just too much slack remaining in the economy to support a rise in interest rates.” Indeed based on expectations embedded in trading markets, investors have in recent months tempered expectations of rate rises in the years ahead, as reported by Reuters.
Volatility has disappeared from the economy and markets. “A decade ago, the business cycle was an endangered species. Recessions in the rich world had become rare, shallow and short; inflation was predictably low and boring. Economists dubbed this the ‘Great Moderation.’ Such talk, naturally, ended abruptly with the financial crisis. But obituaries of the Great Moderation may have been premature. Since America emerged from recession in 2009, its growth, although low, has been as stable as during the Great Moderation’s heyday, from the early 1980s to 2007, judging by the volatility of quarterly gross domestic product and monthly job creation. That, in turn, has pushed the gyrations of stock and bond prices to their lowest levels since 2007…which helps explain why the stock market hovers near record highs and yields on Treasuries near historic lows.” A caveat: long periods of stability are ultimately destabilizing. “The big question is whether the return of the Great Moderation has also prompted a return of the sort of risk-taking that produced the crisis.” According to a Goldman Sachs report, “any threat of a systemic crisis is far off because new regulations have made it much harder for banks and investors to lever themselves.” The Economist (registration required)
The New Neutral. Pimco annually conducts an in-house gathering of experts to form a construct for navigating global markets over a horizon of three to five years. From this year’s forum they conclude interest rates will be kept low by central banks far into the future. Pimco dubs this “The New Neutral.” An investment implication is that asset prices are fair with low growth and low interest rate expectations. Pimco even goes so far as to say that the expectation of low rates far into the future is not fully priced into asset markets, which allows for a margin of safety that reduces downside risk and minimizes bubbles.
And in case you missed it, click here to read last week’s blog post which discusses the mixed economical signals and investor uncertainty.
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J. Mark Nickell & Co.
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