Stopping Time
By Julien B. Booth
June 17, 2016
The past three months have seen a remarkable recovery in asset (read: stock) prices as bonds were already having a wonderful 2016. We continue to favor bond, and bond-like instruments (munis, preferreds, utilities, REITs) when it comes to return of capital (first and foremost) before return on capital. Ironically, risk-averse securities are trouncing risk-based assets.
The two largest themes that concern us most regard macro trends that are hard to fully quantify, but represent MASSIVE pressures on the interest rate complex: Capital Recycling and Capital Flight.
Capital Recycling: As bonds mature the proceeds are usually reinvested in like bonds. With interest rates far below historical levels, reinvested capital must be paired with new capital to net the same net $cash flow = stronger demand for U.S. bonds.
Capital Flight: The chart below shows the degree of negative-yielding global bonds. Global asset managers (pensions, endowments, etc.) will be forced to allocate money to U.S. bonds vs. negative-yielding European/Japan bonds = stronger demand for U.S bonds.
These are macro trends that will play out over the coming months and years. The ten year U.S. Treasury yield has declined by 21% this year (current: 1.84%). The 10-2 spread has contracted by 16% YTD and 26% over the past year. These are telling moves. See Japan.
The victims of crashing yields are some of the least able to shoulder the burden: pensioners and retirees. They are being starved for yield. See the following Washington Post article concerning a troubling trend that is just getting started – https://goo.gl/wrnJfB. We are likely early on this warning – as the implications will not be realized for some time.
With low rates, pensions cannot meet their return “expectations”. The stock market return assumptions may be even more flawed (starting valuations can be found here – http://goo.gl/U8aPaf). Many a pension will become insolvent. Prepare accordingly.
The inherent asymmetry of fixed income (limited gain, complete loss) forces income/credit security managers to perform comprehensive due diligence and ensure investments remain MONEY GOOD. We created Sixty Guilders Research for this sole purpose.
The Federal Reserve has been overly optimistic on 5/5 of their forecasts.
The 10-Yr Treasury has been telling us for years that the Fed’s forecasts are wrong.
The Federal Reserve has proven time and time again that they cannot accurately forecast the direction of the US Economy. This can be seen by the constant ratcheting down of their views on Change in Real GDP. The 10-year US Treasury is real-time indicator of economic growth and has been trending downward for years.
As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.