Q2 2019: PFM Quarterly Commentary
Over the last several quarters, we have extensively commented on the dominant role monetary stimulus and global liquidity now plays in determining the direction of asset prices. In mid-2018, we cautioned that the Federal Reserve’s ongoing aggressive tightening of monetary conditions would inevitably pressure investment markets downward, a development which would ultimately reverse the Federal Reserve’s course. After a hair-raising 20% decline in the S&P 500 during the fourth quarter of last year, Fed Chair Jerome Powell publically announced that interest rate increases were on hold for the foreseeable future. Our prediction indeed proved true.
Investment markets around the world responded by moving sharply higher during the first three months of this year and we wondered whether central bankers were planning an encore for the second quarter to support global growth. Fortunately for investors, they did not disappoint.
Members of the Federal Reserve, including Chairman Powell and other Federal Open Market Committee participants, embarked on speaking tours and interviews where they voiced a new willingness to implement future interest rate cuts. Citing potential downside risks to the U.S. economy, ongoing international trade disputes, and a wide disparity in U.S. interest rates compared to those of other developed nations, Federal Reserve members fervently went about making their case.
Not to be outdone, Mario Draghi, Chairman of the European Central Bank (ECB), delivered a second rendition of his famed 2012 “Whatever It Takes” speech on June 18th, reaffirming that the ECB “will use all the flexibility within our mandate to fulfill our mandate” of reaching 2% inflation and sustaining the Eurozone. He promised to deliver additional monetary stimulus in the form of interest rate cuts and additional asset purchase programs, but most notably introduced a plan for a common Eurozone budget to provide additional fiscal stabilization.
While the Fed and ECB prepared markets for further monetary stimulus, other major central banks also took steps to increase liquidity, including the Bank of England and the Bank of Japan. Somewhat surprisingly, the People’s Bank of China did not resort to interest rate cuts, although it introduced additional stimulus by underwriting targeted commercial loans and facilitating other liquidity injections.
Major central banks receive most of the attention because their words alone move markets. However, many lesser known central banks beat their larger brethren to the punch. In the second quarter alone, we tracked fifteen interest rate reductions in countries such as Australia, India, the Philippines, and Malaysia. In smaller markets, Ukraine, Jamaica, Kazakhstan, Angola, Rwanda, and Costa Rica followed suit.
The end result was another wave of excess global liquidity which was easily absorbed by the world’s financial markets. In the U.S. for example, stocks and bonds soared as interest rates plunged. The ten year Treasury bond yield fell 45 basis points (.45%) during the quarter, from 2.45% to 2.00%, after topping out at 3.25% in early October 2018. Domestic 30-year mortgage rates fell sharply to just 3.73% at the end of this quarter from 4.10% three months prior and from 4.53% at the start of 2019. Incredibly, current mortgage rates now sit just 42 basis points above their all-time lows reached shortly after the Great Recession. For any homeowner who previously chose not to refinance their mortgage or was at the time unable to, now is another excellent opportunity.
The drop in domestic interest rates was dramatic, but the decline internationally was even more pronounced. At the start of the second quarter, the amount of international sovereign debt with negative yields totaled $9.89 trillion. Three months later, that sum had ballooned to $12.92 trillion. For example, Austria, Denmark, Finland, France, and Japan had negative yields on government debt with maturities out to ten years. In Germany and the Netherlands, treasury yields were negative on maturities out to fifteen years. Finally, Switzerland’s government debt had negative yields on maturities extending to an astounding thirty years. In laymen’s terms, this phenomenon means that investors are willing to pay interest to governments simply for the right to own their sovereign debt. And with International Monetary Fund Managing Director, Christine Lagarde, nominated to replace Mario Draghi as head of the ECB in October, we anticipate these negative yields in and around the Eurozone to remain and potentially expand; Lagarde and Draghi share similar perspectives on the importance of achieving the ECB’s mandate.
Overall, the second quarter saw the direction of the investment markets heavily influenced by a well-choreographed dovish pivot by central banks, rather than by improving underlying economic fundamentals. This story has been consistent for several quarters, necessitating ongoing commitments from global leaders to maintain and in some cases expand their pro-growth agendas. We anticipate more of the same for the foreseeable future. As the famed investor Marty Zweig once said, “don’t fight the Fed.” Peak intends to heed Marty’s advice.
We always enjoy hearing from you, so please don’t hesitate to contact us should you have any questions, comments, or concerns.
Regards,
Peak Financial Management
Asset Class Quilt of Total Returns
Peak has created a monthly “quilt” of returns to track the performance of the major areas of the investment markets over time: We believe that this table best illustrates the fundamental tenets of Peak’s investment philosophy, namely the futility of predicting which investments will outperform over the short term and the unremitting cyclicality of markets. These truths support our firm belief that broad based diversification over many areas of the world economy is the best path to investment success over the long term.