Reducing Long‐Term Bond Rating to Bearish 1: Strong Economic Outlook

Investing Environment Review and Outlook – Volume 25

Reducing Long-Term Bond Rating to Bearish 1: Strong Economic Outlook

We cut the Long-Term Bond rating this month to a bearish 1 from a 2 based on the continued sharp improvement in our economic outlook indicators to 62 from 50 in March, and 25 in December.

Consensus Negative

As we noted last month, consensus economic expectations were already negative due to the Q4 stock market decline, persistent headlines about the China trade war, and Brexit uncertainty. Confirming these worries, on March 20th the Fed indicated no further hikes this year. In response, investors bought bonds, driving the 10-year yield down 0.30% to 2.41%, below the 3-month T-Bill rate for the first time since 2007. This yield curve inversion pushed economic expectations even lower due to recession headlines. As the FT reported, “there is deep anxiety about the health of the global economy.”
However, our economic outlook indicators show otherwise (chart 1). For instance, the yield curve inversion is indeed generally negative for the economy, but it has since reversed course after just two days. More importantly, our economic outlook indicators improved, predicting a stronger economy ahead. This change is driven by higher stock prices and commodity prices, both of which are effective leading economic indicators. For instance, from the December low, the S&P 500 is up 22% and China’s Shanghai Composite Index is up 31%. Over the same period, crude oil is up 46%. In prior cases when the economic outlook indicators were this strong, long term bond prices declined as 10-year yields moved higher, often before the economy itself improved.
If the economy is near a turning point, the sharp drop in bond yields seems confusing. Our research identified two similar cases, and they marked turning points for bond yields with a 1.35% move higher in 2003 and 1.70% in 2010, over 5 and 6 months respectively (chart 2). Those moves translated into roughly 6% declines in the Barclays Aggregate Bond index.
Despite the lower rating, bonds remain a key piece of any portfolio for risk control through diversification. Of the three benefits bonds offer investors: capital gains, interest income, and portfolio stability through low correlation with stocks, the last two apply regardless of the direction of interest rates. A smaller allocation to, or shorter maturity of, bonds are ways to lower the risk from rising interest rates but still capture these benefits.

 

Presidential Cycle: Bullish for Q2

S&P 500 returns during the 3rd year of a presidential cycle were historically positive with a 21% average annual return (2x the norm) and no down years since 1950. This is likely due to fiscal or monetary stimulus applied by the incumbent party. The intention would be to boost the economy before the election the following year. Second quarter returns (April through June) in the 17 prior cases since 1950 were up an average of 5.8%, 4x the 1.4% average for all other years. 88% of prior cases were higher vs. just 62% for Q2 in all other years (chart 3).

Our equity rating remains a bullish 5. Due to the improvement in the economic outlook indicators, we cut the long-term bond rating to a bearish 1 with the expectation that long-term rates will rise. Commodities remain a bullish 4 and gold a bullish 5. Please contact me or your advisor with any questions.

IMPORTANT DISCLOSURES

This review and outlook report (this “Report”) is for informational, illustration and discussion purposes only and is not intended to be, nor should it be construed as, financial, legal, tax or investment advice, of Brenton Point Wealth Advisors LLC or any of its affiliates (“Brenton Point”). This Report does not take into account the investment objectives, financial situation, restrictions, particular needs or financial, legal or tax situation of any particular person and should not be viewed as addressing any recipient’s particular investment needs. Recipients should consider the information contained in this Report as only a single factor in making an investment decision and should not rely solely on investment recommendations contained herein, if any, as a substitution for the exercise of independent judgment of the merits and risks of investments.
This material is based upon information obtained from various sources that Brenton Point believes to be reliable, but Brenton Point makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated and are subject to change without notice.
This Report contains certain forward looking statements opinions, estimates, projections, assessments and other views (collectively “Statements”). These Statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward looking statements and projections. Brenton Point makes no representations as to the reasonableness of such assumptions or the likelihood that such assumptions will coincide with actual events and this information should not be relied upon for that purpose. Changes in such assumptions could produce materially different results. Past performance is not a guarantee or indication of future results, and no representation or warranty, express or implied, is made regarding future performance of any financial instrument mentioned in this Report.
Any benchmark shown herein is shown for illustrative purposes only. No index benchmark is available for direct investment. It may not be possible to replicate the returns of any index, as the index may not include any trading commissions and costs or fees, may assume the reinvestment of income, and may have investment objectives, use trading strategies, or have other materials characteristics, such as credit exposure or volatility, that do not make it suitable for a particular person. This is not an offer or solicitation for the purchase or sale of any security, investment, or other product and should not be construed as such. References to specific financial instruments and to certain indices are for illustrative purposes only and provided for the purpose of making general market data available as a point of reference only; they are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities. Investing in securities and other financial products entails certain risks, including the possible loss of the entire principal amount invested, as the value of investment can go down as well as up. You should obtain advice from your tax, financial, legal, and other advisors and only make investment decisions on the basis of your own objectives, experience, and resources.
Brenton Point accepts no liability for any loss (whether direct, indirect or consequential) occasioned to any person acting or refraining from action as a result of any material contained in or derived from this Report, except to the extent (but only to the extent) that such liability may not be waived, modified or limited under applicable law.
This Report may provide addresses of, or contain hyperlinks to, Internet websites. Brenton Point has not reviewed the linked Internet website of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for your convenience and information, and the content of linked third party websites is not in any way incorporated herein. Recipients who choose to access such third-party websites or follow such hyperlinks do so at their own risk.
All marks referenced herein are the property of their respective owners. This Report is licensed for non-commercial use only, and may not be reproduced, distributed, forwarded, posted, published, transmitted, uploaded or otherwise made available to others for commercial purposes, including to individuals within an institution, without written authorization from Brenton Point.
Source of data and performance statistics: Bloomberg L.P. and Factset Research Systems Inc.
©Brenton Point Wealth Advisors LLC 2019

Sign up!

Sign up for our monthly newsletter and get the lastest news and research from our esteemed advisors here at Brenton point. Right into your inbox!