Stocks, Treasury yields sing, “I’ll tumble for ya.”       

Brian Nick

The last week’s market highlights:

Quote of the week:

“There must be some way out of here,” said the joker to the thief.
“There's too much confusion, I can't get no relief.
Businessmen, they drink my wine, plowman dig my earth.
None of them along the line know what any of it is worth.”
– Bob Dylan, “All Along the Watchtower”    
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Midyear Outlook :
  • U.S. economy: Late cycle but no recession
  • Global economy: Still looking for a bottom    
  • Policy watch: Easy monetary policy to offset restrictive trade policy  
  • Fixed income: Volatile interest rates but no breakout in either direction 
  • Equities: Get defensive, stay invested 
  • Asset allocation: No longer “risk on,” but still prefer emerging-market bonds  

Fixed income: There are some positives to negative yields                 

Sweden is famous for many things, including its ruggedly beautiful landscape, pop music superstars, commitment to clean energy and, thanks to IKEA, its contributions to home design.  Economists and market professionals also recognize Sweden for the Riksbank, its innovative central bank. In July 2009, to counter the economic slowdown caused by the global financial crisis, the Riksbank became the first central bank to adopt a negative interest-rate policy. Rather than pay interest to commercial banks on their overnight deposits, it charged them for holding funds, hoping they would make loans instead of losing money. The European Central Bank and Bank of Japan also currently charge commercial banks for the privilege of caretaking their cash.    
While below-zero rates remain relatively rare among central banks, below-zero yields have become commonplace in global fixed-income markets. Indeed, the market value of negative-yielding debt now exceeds $16 trillion globally, representing about 30% of the world’s total investment grade bond market. Although headlines have focused on the causes of this phenomenon, there’s been far less emphasis on the recent performance of these bonds. 
Some, like German Treasuries (yielding –0.1% in January and –0.76% as of August 15) have delivered attractive total returns (+7.2% in euro terms for the year to date). Heavy demand for Germany’s debt—considered Europe’s safest—has pushed its price up and its yield down. Such performance highlights a key point: Despite negative yields, investors don’t “lock in” losses unless they hold the bonds to maturity.
These securities may also offer diversification benefits, as they don’t move in lockstep with other asset classes. Since July 1, for example, Germany’s DAX stock index has fallen 7.7% amid concerns over global growth and the German economy, while German Treasuries have gained 7.2%.
Will U.S. rates join the “subzero club”? We don’t think so. Yields in part reflect economic growth, and the U.S. economy has been outperforming the eurozone and Japan, where negative yields prevail. Moreover, the U.S. Treasury is issuing far more debt than those countries. To the extent negative yields result from demand exceeding supply, they’re less likely to occur when supply is also on the rise.

Equities and fixed income begin singing the same tune 

For much of the year, the stock and bond markets appeared to be singing from different song books.   
How so? Despite concerns over the U.S.-China trade war and slowing global growth, the S&P 500 Index rose 20.2% for the year to date through July 31, its best seven-month start to a year since 1997. Europe’s STOXX 600 Index (+14.4%) and MSCI China Index (+12.4%) also rallied during that time. These gains came despite a slowdown in the global economy, reflecting investor optimism about the future.
The bond market, in contrast, seemed downright pessimistic on the prospects for growth. The yield on the bellwether 10-year note fell from 3.24% on November 8, 2018, to 2.02% on July 31, 2019. (Bond yields and prices move in opposite directions.) Meanwhile, the spread between the 3-month Treasury bill and the 10-year note inverted, declining from +89 basis points (0.89%) in early November to -6 basis points by the end of July. Such inversions have preceded every U.S. recession in the past 50 years. Because potential bad news for the economy often translates into good news for bonds, U.S. Treasuries realized a healthy 5% gain between January and July.    
Diversified investors with exposure to both equities and fixed income were undoubtedly pleased with this performance but were making money “on borrowed time,” in our view. History has shown that the two asset classes rarely move in tandem for long. Indeed, their two-part harmony began to hit sour notes this month amid a series of events and economic data releases that raised global recession fears:
  • President Trump threatened a 10% tariff on $300 billion of additional Chinese goods. This was to be on top of the 25% tariff already imposed on $250 billion worth of imports from China.
  • China reported that its manufacturing sector contracted for the third month in a row in July, and industrial production plunged to a 17-year low. Chinese retail sales also missed forecasts.
  • Germany’s economy, the largest in the eurozone, shrank 0.1% in the second quarter, and economic sentiment deteriorated further.
Against that discouraging backdrop, safe-haven assets like Treasuries continued to rally. So far in August, the 10-year yield has fallen 47 basis points, reaching a three-year low of 1.52% on August 15 before edging up to close the week at 1.56%. Also on August 15, the yield on the 30-year Treasury bond closed below 2% for the first time in history.
And whereas stocks were able to avoid a “purple haze” despite global growth fears, they now may be taking those fears to heart. The S&P 500 remained in negative territory for the month even after rebounding 1.4% on August 16.
The week ended with the University of Michigan Consumer Sentiment Index hitting a dissonant chord, as it fell to its lowest level of the year. Survey respondents expressed concerns about the U.S.-China trade war and the likelihood of a recession. Time will tell if consumers—and financial markets for that matter—will change their tune. 
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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