“It’s difficult to make predictions, especially about the future."
- Danish Proverb
When this particular Danish proverb was sourced in the 1940s, it is hard to imagine an economist predicting that Denmark’s bonds would yield negative 0.49% in 2019. That’s right, for the privilege of handing over your hard-earned money to Denmark, and many other major European countries, you are guaranteeing yourself a negative return for the next ten years. For returns of just 2% every year, you can lend to Greece, which has required international bailouts three times in the last 10 years. For investors casually watching what has occurred in global bond markets this year, it is difficult to understand the forces behind such low, or negative, bond yields.
Traditionally, the level that a bond yielded offered a fairly reliable future estimation of inflation, growth, and the credit quality of whoever issued the bond. When investing money for a predetermined period of time, investors expect to be adequately compensated for the aforementioned risks. If investors knew that inflation would average 10%, or economic growth would be equally high, they would not likely be satisfied with a bond return of just 1%. Similarly, when lending to an entity with a questionable history of repayment, common sense would suggest a higher return for risk taken. Yet the proliferation of negative yields today indicate that investors are very pessimistic about growth and inflation, or they simply don’t care about credit risk. Are investors piling into 100 year Austrian debt (up 80% this year) because the sky is falling and we are about to enter a global recession or crisis?
From our viewpoint, the reality is much more nuanced. Central banks around the world have kept rates at historically low, or negative, levels in an effort to stimulate lending and encourage consumers and companies to borrow. A lack of inflation has also enabled Central bankers to keep rates depressed. For instance, gas prices have been stable due to an abundance of supply in the U.S. and relatively low geopolitical risk in the middle east. Regardless of the paltry return prospects, institutional investors still need to hold bonds due to pension obligations and regulations requiring banks to hold ‘safe assets’. All of this has resulted in a record push into fixed income investments, ultimately leading to high prices and low yields.
Lastly, the scars of 2008 financial crisis still remain fresh in investors' minds. The specter of an equity market correction has prompted a flight to safety within bonds, as investors don’t want to be fooled again when the next recession hits. Despite strong year to date equity returns, global stock funds have seen a net outflow of $4 billion this year while global bond funds have seen an inflow of $244 billion. This flight to safety has occurred during one of the best quarters for growth for the U.S. economy in the last year. To be sure, the continued uncertainty over global trade remains a significant risk and the trend towards escalation, rather than resolution, certainly concerns us. However, we would caution investors to take recent activity within the bond market as a function of central banks working to keep financial conditions favorable for future growth and not necessarily a signpost of imminent gloom.
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The opinions voiced in this material are for general information only and are not intended to provide specific investment advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.