Sunday , 25 June 2017


Believe It or Not: U.S. Treasuries Could Be Best Performing Asset Class in the Next 1-2 Years – Here's Why It's Quite Possible

So says the Macro Economist (http://macromusings.com/) in edited excerpts from an article* posted on Seeking Alpha under the title Making A Case For U.S. Treasuries .

 Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.

The article goes on to say, in part:

1. Sub-par Global Growth

Global GDP has now been below trend since the fourth quarter of 2011. Real growth should be around 3% per year. Sustained periods above this threshold have generally been good for global growth proxies like commodities and emerging markets, while sustained periods below have seen an outperformance in defensive sectors and a bid to bonds.

Click to enlarge

Source: World Bank

2. Commodities turning down again

Indeed, the current cycle appears no different with the commodities peak clearly coinciding with the faltering global growth that began in 2011.

The downturn in commodities is signaling another downshifting of global growth which puts a floor on bond prices.

3. Equity markets no longer provide an alternative

While global growth and commodities peaked in 2011, equities have been a source of strength. Global earnings have been in a slow, downward trajectory since 2011. As one would expect, earnings declines have been most pronounced in the EAFE, whereas the U.S. has been a bastion of strength.

The different earnings trajectories of the various global regions has been reflected in the relative share price movements, with the U.S. outperformance particularly pronounced over the past 18 months.

Thus far, the global earnings slowdown can be described as a soft-landing, but this was also the case in 2008 when global growth was stronger than the U.S. Today, we see a role reversal, as it now appears the U.S. earnings cycle is turning. U.S. Treasuries are one of the few alternatives against slow growth and earnings declines.

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4. The U.S. macro-economy is tipping over

In some ways, the U.S. economy has supported the rest of the world. The U.S. still accounts for 50% of the capitalization of the MSCI World index and U.S. GDP is around 25% of the global total. Our economic growth and U.S. companies’ profitability since 2009 has been a positive driver for global risk assets but it appears the U.S. economy could be succumbing to the global malaise, compounded possibly by internal fears over the consequences of future austerity aka “The Fiscal Cliff.” This shows up first and foremost in capital investment, which appears to be hitting an inflection point.

Capital investment decisions by CFOs are long-horizon decisions. Clearly, U.S. executives see something amiss. Once inflection points occur, they last for a couple of years, and can be vicious as we saw in 2007-2008, or virtuous as we have seen in the past three years.

A turn in U.S. capital investment, and the knock-on effects, will have further negative ramifications for global risky assets and likely provide a floor on bond prices.

The sliver of good news is that given the upturn in housing (albeit from depressed levels), it’s possible the U.S. can avoid recession even if the rest of the world slips into it. The odds of a major growth scare in 2013 have now increased and markets generally tend to be anticipatory, with the first leg of a bear market usually occurring very fast and approaching losses of 20%. This can only be good for bonds.

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Also, if you’re wondering where the 30-year JGB stands, I’ll do one better and show you the 40-year bond, which as recently as 2010 hit 1.6% and currently stands just above 2%.

Source: Bloomberg

We are reticent over having any stock allocation at this point, given the nosebleed valuations we see in the defensive sectors. For instance, as investors have chased high yield investments, they have pushed the S&P500 Utiliities index to its highest price:sales and profit margin ratio since our data set began in 1993.

We’ve thrown in the towel on the effectiveness of any further QE in elongating the business cycle, and for our traditional defensives versus cyclicals trade to work (on the basis of valuation and crowdedness), and have moved into a fully defensive posture shunning anything that is remotely related to positive global growth. While we like to trade tactically, this is a fundamental view, and represents the bias from which we expect to be trading for some time.

Conclusion

Our preferred fixed income investment is TLT. Contrary to the view of sell-side strategists, we think TLT is positively asymmetric at this point. Central Bankers have been able to cause a lot of volatility in the equity markets since 2011, hence making shorting high beta assets a dangerous game, but they cannot change the business cycle and the smart money appears to have strong hands in bonds.

Throughout these massive interventions to create inflation, TLT has been incredibly resilient, telling us that deleveraging forces are stronger than any Wizards behind the Curtain. That’s the hallmark of a true bull market.

[Before taking any action based on the article above please read this follow-up article on Seeking Alpha for a different point of view on TLT.]

*http://seekingalpha.com/article/956851-making-a-case-for-u-s-treasuries

Editor’s Note: The above post may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.

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