June 8, 2015


In my commentaries over the last number of years, I have discussed the impact of global central bank policies on both the economy as well as the financial markets.  That has been the primary driver of the movement in asset prices and will continue to be for some time.  Central banks around the world have been cutting interest rates for eight years and collectively have printed over $11 trillion of new money to try to revive economic growth.  This graphic by Bank of America helps to put the magnitude of one side of monetary policy into perspective.



As the central banks have reduced returns on low risk assets with the most aggressive monetary policy in history, money has moved increasingly into riskier assets in search of some return.  As money chases returns in riskier and riskier assets classes, the yields as well as future prospective returns on those assets go lower and lower.  


The central banks should not have entered this game of extreme monetary policy because the deeper they go into this abyss the harder it gets to escape back out.  Targeting asset price inflation to garner a wealth effect; then turning to currencies to gain a competitive trade advantage, and continuing to encourage the massive growth of debt creates all kinds of distortions in the economy and financial markets.  It has also muted asset price volatility which has given investors a false sense of stability and has pushed complacency to greater and greater extremes. 




However, over the past 7 months or so, volatility is starting to emerge in a number of areas of the financial markets.  If this continues to grow and spread to other areas of the market, things may get interesting for the central banks.  So far, volatility has been increasing in the currency markets, commodity markets and more recently the bond markets.  We can look at the recent movement in the yield of the 10-year German Bund.  This is an equivalent of our 10-year Treasury Bond.




If you look at the first 2/3rds of the chart above, you can see that the yield on the 10-year German Bund had been declining due to interest rate cuts in the EU as well as all the new money printed by the European Central Bank.  At the lows in April, you could lock up your money for 10-years in German government bonds at an annualized yield of 0.06%.  That means that if you put $10,000 into those bonds and held them to maturity, you would receive a total of $60 in interest by the end of the 10-year period, or $6 per year! 


Now, look at the end of the chart and you can see a massive reversal.  While the yield is still very low it has jumped by 14 times, or a 1400% change.  This kind of volatility change looks more like an extreme move in a small emerging market country, not something that comes from one of the most mature bond markets in the global financial system.


Next, let’s take a look at 10-year Treasury Bond yields.  While the volatility is much less than the German market, the yields here are moving in the same direction.




The chart above shows that the yield on the U.S. 10-year Treasury Bond has moved from about 1.65% at the end of January to about 2.4% recently. 


As all of the yields around the world collapsed in so many areas of the market, investors have moved into stocks to try to get some return on their money.  If interest rates on “safe” assets like government bonds continue to rise and the Fed starts to raise short-term rates, investors may start the process of reversing this “relative return” trade that has been in process over the life of the 572 rate cuts by central banks since 2008. 




This month, we can keep the discussion relatively short.  It’s the same old game:


-          Debate continues as to whether the Fed will or won’t raise rates this year.

-          Corporations continue to issue debt to buy back stock to engineer earnings per share growth since there is little top line revenue growth.

-          Margin debt continues to expand and now is up to $507 billion which is 50% higher than the last bubble peak in 2007.

-          Capital spending by corporations and productivity continues to be anemic as CEO’s remain cautious about committing capital to longer-term projects.

-          Etc………




The key dynamic to watch right now is in the bond market.  If the recent volatility continues we will likely get some interesting price movements in other markets over the summer months. 


One final note.  The Dow Jones Industrial Average just went negative for the year and the Transportation Average is down over 8% for the year.  The idea behind tracking these two is that many of the companies in the Dow Index produce products while the companies in the Transportation Index deliver those products to the customers.  One sign of a healthy market is when these two indices are trending higher with the Transports leading the way.  Lately, both have started to roll over somewhat with the Transports leading on the downside.  Also, a number of the market breadth indicators have been weakening. 


All the liquidity coming from the central bankers have been the juice for this market for a long, long time.  572… that’s a whole lot of rate cuts… that the world has never seen… an average of one every three trading days…  Wow!  That means a whole lot of rate increases by global central banks to get back to normalized monetary policy and our Fed can’t even take the first baby step of 25 basis points out of fear of what it may do to our economy and asset prices.  Seems like a fragile foundation underneath sky high asset prices to me.



Joseph R. Gregory, Jr.





 Past results are not indicative of future results.  Joseph Gregory is President of Heritage Capital Partners, Inc., a registered investment advisor.  All materials presented herein are believed to be reliable but we cannot attest to its accuracy.  All material represents the opinions of Joseph Gregory.  Investment opinions or recommendations may change and readers are urged to check with their financial advisor before making any investment decisions.  Opinions expressed in these commentaries may change without prior notice.  Joseph Gregory and/or clients of Heritage Capital Partners, Inc. may or may not have investment positions that are in or aligned with any opinions mentioned in these commentaries.  There is risk of loss as well as opportunity for gain when investing in the financial markets.  Investment opinions or positions mentioned in these commentaries are not suitable for all readers and therefore, readers are urged once again to check with their financial advisors before making any investment decisions.