Equity markets may not be moving but yields on bonds are starting to tick higher. The yield on the two-year US treasury has risen to 1.47%, and on the ten year to 2.35%, breaking through its 200 days moving average. The selloff in US treasuries is being mirrored around developed markets, the fixed income markets having the worst day on Wednesday for over 2 months. The US dollar is having its best week for over a year. The catalyst for the move appears to be Janet Yellen’s speech earlier in the week, this has been followed up by Donald Trump’s latest attempts to kick-start his tax reforms.
There are over a trillion dollars that could potentially be repatriated back into the US by US corporates. Alarge part of this money is currently being held in US treasuries. The expectation that, should the reforms come to fruition, is that this return of cash will be the next leg of economic growth for the US economy as it finds its way back one way or the other into the broader economy. This should allow the Federal Reserve to once again further normalise interest rates. This is really what should happen to rebalance the economy and provide a more traditional model for investors. Savers will be able to once again feel they can diversify away from equities to gain income.
The Federal Reserve remains divided between hawks and doves, Eric Rosengren the Fed Boston president, in a speech this week expressed the view that rates should continue to be normalised. Mr Bullard, on the other hand, remains more cautious on raising rates further, apparently less convinced by the underlying strength of the US economy. It is fair to say that after a dodgy time earlier in the year economic data from the worlds largest economy has tended to beat expectations. This is likely to be influencing Janet Yellen’s view that rates should be raised again in December.
We have said it before and will say it again, where bonds go equities tend to follow. So far equities have not reacted to the selloff in bond markets, but if the selloff continues in bonds then equity markets will react. As is reported volatility in equities and bonds remains close to historic lows. Bond volatility has recently ticked higher but not by much.
We highlighted recently that sentiment indicators currently look inconclusive. NED Research recently produced some analysis of equity holdings and what that might tell us. Stocks as a percentage of household financial assets at 40% is higher than it was in 2007 but lower than in 2000. Possibly partly reflects the comment we made earlier about current lack of choice.
The conclusion when looking at the picture and comparing it to the market performance is remarkable, but something that we probably intuitively know. When investors are fully invested in stocks, the returns looking forward are poor. When they are underinvested that has been the time the returns have been “superb” according to NED. There you go Warren was right, when everyone is greedy get fearful and when everyone else is fearful get greedy.