Transcript Global Government Bond Yields

2015 Spring Symposium
Mark A. Teichner, SVP
Reliance Trust Company
Chief Investment Officer
May 6, 2015
Trust yourself. Rely on us.
World Growth Estimates
Projections for World Growth are below trend, although improved relative to 2014. U.S., Eurozone and Japan are faster, while China has
decelerated. Lower oil prices and monetary policy accommodation are net positives. Global inflation is projected to remain stable with
easy monetary policy as insurance against deflation. In the U.S., a strengthening labor market and low energy prices should encourage
consumption, offset by slower exports due to the strong dollar and moderating energy sector capex.
Source: PIMCO
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Global Government Bond Yields
Effort to stimulate economic activity and prevent deflation through central bank monetary policy initiatives have caused bond yields to
plummet. In a global investment landscape, weakness in foreign currencies and higher relative yields in the U.S. have attracted foreign
investors to our markets, causing real, inflation adjusted yields to move below historical averages.
Source: Haver Analytics
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Bond Yields Relative to Nominal GDP Growth
Over longer periods , the 10-Year Treasury yield has closely mirrored the annual change in Nominal GDP. In the early periods, investors
understated inflationary pressures, while overstating more recently. First quarter Nominal GDP was reported at 3.91%. With the 10-Year
Treasury at 2.11%, there is a 1.8% discount. Investors are not being adequately compensated for current or potential future inflation.
Global excess capacity could cause inflation to remain dormant.
Source: Yardeni Research
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FOMC Projections
The Federal Reserve reduced the central tendency of the longer run unemployment rate to a range of 5.0%-5.2%, suggesting the
Committee will allow the labor market to improve further before worrying about inflation. Headline inflation forecasts were lowered
for 2015, with core inflation forecasts lowered for this year and next. GDP growth forecasts were reduced to around 2.5% in 2015 and
2016 from 2.75% due to the strength of the dollar and impact on net exports. As a result, FOMC members reduced their rate
expectations by roughly 0.50% per year, estimating a year end 2015 rate of 0.625%, with the first hike now more likely in September.
Source: Federal Reserve
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Forward Bond Yields
Bond yields have begun to move higher. Expectation remain for the Federal Reserve to hike rates later in the year, supported by rising
inflation expectations, a gradual tightening in the labor market and the basing in energy prices. Most of the move over the next two years
is anticipated in the short end of the yield curve, while the intermediate and long end of the curve expected to see moderate increases.
Source: Bloomberg
Data as of 5/2/2015
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Don’t Fear the First Rate Hike
Since 1982, equity markets have been favorable both before and after the initial rate hike. In the current cycle, communication is the
key, an attempt to prevent another “Taper Tantrum”. Small cap stocks have tended to outperform large cap stocks during this period,
viewing early moves as attempt to reduce stimulus, not restrict excesses.
Source: FBN Securities
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The S&P has tracked the Fed’s Balance Sheet
The expansion of the Federal Reserve’s balance sheet has influenced financial asset prices. Policies have been successful in depressing
interest rates and encouraging investors to take incremental risk. The removal of liquidity is likely to have a more material effect on
financial asset prices than in past periods.
Source: Raymond James , Factset Research
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Economic Surprise Indices
UNITED STATES
JAPAN
EUROZONE
EMERGING MARKETS
In the U.S., economic reports have been disappointing relative to expectations, while improving relative to consensus in Japan. The
Eurozone and Emerging Markets have shown some recent weakness as well. International equity markets have responded favorably to
these positive surprises in addition to benefiting from the stimulus from their own QE programs.
Source: Citigroup Global Markets / Bloomberg
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Energy Supply / Demand
As a result of slower global economic growth, global production continues to exceed demand, resulting in inventory builds and downward
price adjustments. Global oil inventory builds are projected to average 1.7 million bbl/d through the first half of 2015, moderating during
the second half of the year as demand rises and non-OPEC supply growth slows, particularly in the United States.
Source: U.S. Energy Information Administration
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Future Oil Prices
Experts diverge on where energy prices are headed. Major banks see West Texas Intermediate ending the year anywhere between
$52 to $84 a barrel with Brent from $55 to $90 a barrel. Based on prior recoveries, assuming the bottom in prices were reached in
late March, prices near the middle to upper end of this range appear reasonable over the next year.
Source: Strategas
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Financial Engineering Continues
Corporations continue to be the largest buyers of stock, borrowing in the credit markets at low interest rates and utilizing these funds
plus internally generated cash flow to repurchase shares and increase dividends. Investors have reacted favorably to companies
returning capital to shareholders. A slow growth economic environment has reduced capital spending, causing longer term economic
growth estimates to moderate. IPO activity remains moderate due to activity in the private market.
Source: Strategas Research
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Inflation and P/E Multiples
P/E multiples are above historical medians. However, compared to depressed fixed income yields (10-year Treasury valuation equal to a
P/E of 47.4x) stocks appear relatively attractive. Historically, zero to 2% year over year CPI inflation has been the sweet spot for
valuations. Changes in the earnings outlook and/or inflation expectations are likely to be the biggest drivers of future stock prices.
Source: Strategas
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Bull Market Duration
The current bull market’s 72-month lifespan rates as the fourth-longest among all 23 DJIA bull markets since 1900, and the cumulative
price gain of +179% ranks sixth. From the perspective of historical analogs, the path most similar to the current one was the 1949 1956 bull market. To match that episode, the current bull would need to last another 14 months and top 21,000 on the Dow.
Source: Leuthold Group
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Change in Prices and Earnings
2015 S&P500 earnings estimates have declined from $130 to $118, a result of weakness in the energy sector. Benefits of lower oil prices
have not been reflected in earnings estimates in other sectors. Investors have been willing to look beyond the weakness in the energy
sector, viewing this as transitory. However, investors need to respect the near term divergences. Current earnings estimates remain
below the longer term trend line, indicating room for upward earnings revisions when business / economic conditions improve further.
Source: FactSet / Thomson Reuters
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Mean Reversion in the 2nd Quarter
Recent moves in notable markets, including energy and the dollar, may have further room in the near-term. Ultimately, these look to be
consolidation and counter-trend rather than a change in the prevailing trend.
Source: Strategas
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Preparing for Increasing Market Volatility
After an extended period of low market volatility, influenced by Fed liquidity through QE and ZIRP (Zero Interest Rate Policies),
volatility has been depressed relative to historical averages. Future shifts in interest rate policy will likely lead to heightened volatility
more closely resembling the long-term average. Periods of increasing volatility are generally associated with higher probability of
downside risk. This correlates with defensive sectors outperforming cyclical sectors since mid-2014.
Source: Blackrock / Morningstar
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Historical & Current Valuation Measures
Valuation measures remain elevated relative to long term historical averages, although below peak valuations of the late 19902000 period. Aggressive monetary policy has supported financial asset prices, encouraged financial engineering and shareholder
value oriented activities (primarily issuance of low interest rate debt, share buybacks & M&A) . Periods of low inflation and
interest rates historically coincide with elevated valuation metrics. Valuation alone is not a timing mechanism.
Source: VectorGrader
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International Valuations More Attractive
Comparting valuation levels across developed markets, combined with central bank policies earlier in their life cycle, have caused
investors to prefer international equities over domestic equities. Fund flow data support this current preference. Higher productivity
and entrepreneurial spirit continue to give the longer term preference to investing in the U.S.
Source: Strategas
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Research Affiliates 10-Year Real Return Forecasts
Research Affiliates anticipates returns well below long term averages as a result of low yields / high valuations used as a current
starting point. Slower future economic growth is influenced by the productivity impact of an aging population and the need to
deleverage the enormous debts that nations around the world have accumulated.
Source: Research Affiliates as of 3/31/2015
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Demographics and Equity Valuations
Demographics and life cycle investing patterns have a strong historical relationship with equity values in the United States. The middle age
(buyers) to /older age (sellers) ratio has had a reasonably close fit with multiples through the years. However, improvements in
productivity growth and longer life expectancy may cause investors to draw down their equity holdings more slowly.
Source: San Francisco Fed
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THANK YOU!!
Questions?
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