The Sky Is Falling - Again
Advisors Asset Management
By Scott Colyer
June 4, 2012
Last week provided a very scary end to May in both the equity and bond markets. The 10-year Treasury set a new historic low yield and the equity markets ended the week giving back all of its year-to-date gains. European fiscal and banking issues continue to overshadow the slow recovery of the U.S. economy. Of current note, the EU (European Union) and ECB (European Central Bank) are trying to successfully deal with the need to recapitalize the banks of Spain. The danger here is that a lack of a significant plan to deal with banking ills would result in the potential failure of large banks in Spain. The interconnectedness of the European banks would likely cause problems for other banks outside of Spain should a large institution fail. On top of this “rosy” news, the U.S. economy continued to show a slowdown which was indicated by a much lower than expected job creation for May.
In the markets, money continued to flow from the equity markets into the bond markets. High yield has sold off in tandem with equities, which is normally expected. I would remind you that over time we have found the crowd tends to be wrong when assets bubble up a market like we are seeing in the Treasury bond markets. The bears are SCREAMING to leave the risk markets before the bottom drops out. They believe that the meltdown in Europe will cause the United States to fall into recession and markets to fall. They are preaching to place your capital into the safety of the overstuffed Treasury market. If we observe the accuracy of these naysayers, we find that there is actually a negative correlation between the volume of their comments and the size of the investment opportunity. Over the past few years when the bears were shouting the loudest, the bulls should be buying. Could it be the same story this time too?
Does it surprise anyone that the yields in the U.S. Treasury market are touching all-time lows? Given the fact that the Fed is the largest buyer of long-dated securities in a market that is starved for yield, lower yields would be expected. It would appear to us that the Fed is achieving its goal to bring long rates down and frustrate the buyers of Treasuries seeking yield. Remember, the primary absolute rule that investors should always heed, “Never Fight the Fed!” If the Fed is committed to supporting risk asset prices, lowering long rates and driving assets from the Treasury market to risk assets, then we believe you should formulate your investment strategy to get in front of these asset moves. It is clear to us that the Fed is hoarding duration but will not do so forever. When they stop – and they will stop at some point – markets are likely to punish unwary investors who thought they were seeking riskless strategies.
The fact is that monetary policy is globally easier than it has ever been. Quantitative easing has never been applied in such large doses and by so many central banks. Developed and emerging economy central banks are easing as economic activity and inflation pressures ease. Together with the financial uncertainty in Europe it is likely that monetary policy will remain easy for the foreseeable future. Nobody quite knows what the results will be, but we do know that there is a high likelihood of economic recovery as easy money greases economic activity.
Are we at a juncture where we would change our outlook for the equity and bond markets? Absolutely not! We continue to feel strongly that this is a generational buying opportunity for equities. Lower-rated debt also presents value as these markets have corrected recently. Look for Europe to continue to muddle through with successive bailouts. In the end, we feel that it will not crash and burn. Greek elections and EU membership will again become an insignificant part of global economic events. The focus will shift toward the opportunity that the Euro dislocation has given to U.S. companies. It takes some hutzpah to commit capital in volatile markets. Those who do should be well rewarded.
(c) Advisors Asset Management