According to the National Bureau of Economic Research, the U.S. economy broke a record for its longest expansion ever Monday July 1, 2019. Economic expansion has continued for more than 10 years. Growth is now in its 121st month since the Great Recession. And the market keeps rocking upward!
As we go to print, markets are establishing new highs. The US economy grew at a rate of 3.1% in the first quarter, and is projected to grow through the rest of the year. Life is good. To quote Alfred E. Neumann (Mad Magazine), “What, me worry?”
Unfortunately for us, it is our job to worry, while balancing it with a healthy optimism about the future, lest we become too bearish. You would be correct to assume this means looking for signs and portents to give us insights into market risk. And there are plenty to see.
To start, bonds have experienced generous returns as interest rates have fallen (prices rise when rate fall), with 10-year US Treasury bonds recently trading below 2.0 %.
The so-named yield curve has inverted, meaning short-term interest rates are trading above long-term rates. Economists consider this a potential recession indicator, as the appetite by investors for low risk bonds is elevated. The Federal Reserve Bank is now indicating it may ease short-term rates during the remainder of the year, as its economic forecasting models signal increasing weakness. Federal Reserve bankers and economists don’t like inverted yield curves.
Before I put you to sleep with further talk about yield curves and interest rates, I beg patience. It is an increasingly confounding state of affairs as the global economy slows, yet markets race to establish new highs. We have been here before – it usually signals a change in trend, but not when or how much of a change to expect.
To begin, German 10-yr bonds now trade at a yield of -0.33 %! This was last experienced after the Great Recession of 2008. That such a phenomenon has once again raised its head is troubling. Why, in a rational world, would you ever expect a bank to pay you interest on a mortgage?
Per the wonderful Wizards of the Wall Street, there are somewhere in the neighborhood of $13 Trillion in global bonds trading with negative interest rates. What a treat – you get to pay some government for the privilege of “investing” in their bonds? Who needs a wealth tax when simply purchasing AAA-rated bonds extracts money from your wallet?
What are the tea leaves telling us? In the usual case it means the global economy is slowing down and may be headed for the proverbial brick wall of a recession. Some say we are already there.
IT’S A MIXED MESSAGE
If market metrics are correct, equities are overvalued and should be taking a pause. Instead, we are experiencing a melt-up.
The fact is global central bank authorities are keeping the money spigot flowing in the face of darkening economic clouds. They can’t afford not to – most western democracies are running big fiscal deficits and no politicians seem willing to vote to reduce spending. Fiscal discipline – in the words of a New York cabbie – fugetaboutit! In the meantime, productivity expanding technology continues to moderate inflationary pressures, allowing interest rates to remain low, and the money to flow.
This gusher of cash is serving to fuel price appreciation in financial assets – money has to flow somewhere. The power of easy monetary policy to stimulate the economy has waned in recent years, but governments still need to raise cash. As a result, holders of financial assets get richer, while everybody else complains about the distribution of wealth. This is a simple way of saying that politicians and central bankers can’t handle the truth, as it will cost them their jobs.
AND THEN THERE ARE THOSE IPOS (INITIAL PUBLIC OFFERINGS)
It is a disconcerting fact that this year’s wave of IPOs now exceeds the number last set in FY 2000, when money-losing tech and internet stocks were the thing. It was all about clicks and eyeballs rather than profits, leading to the Tech Crash of 2001. It is with a sense of nervous déjà vu that we recall those tumultuous years.
Some of these IPOs are eerily reminiscent of that time. Uber and Lyft annually burn billions in cash yet received huge valuations at their respective IPOs. And then there is Chewy.com (CHEW). Heck, I love dogs, but CHEW goes public after losing $1.2 billion last year at a valuation between $13 Billion and $17 Billion, depending on the day? Somebody cue the Twilight Zone theme music, we’ve been time-warped to a party in 1999.
I fail to understand the hyper-valuation of a business model which consists of a website, a building full of cloud servers, and an online ordering process. Isn’t that what Amazon and Wal-Mart, and so on, already do so well? Hmmmm…
While the markets seem overvalued by some measures, market timing is not a strategy. A sound financial plan leads to the proper long-term asset allocation so you can stick with it through the volatility that always comes. Let us do the worrying. Then buy low.