Democrat Senator Joe Manchin from West Virginia holds more sway than most over White House legislative strategy, because he’s one of the few willing to break ranks with Democrat orthodoxy. In his WSJ Op-Ed last week, he argued for a “strategic pause” on Congressional spending. This means his support for the White House’s proposed $3.5TN budget isn’t assured. Manchin sensibly notes that we’re leaving ourselves little fiscal room to deal with future crises, such as a more virulent Covid mutation, terrorist attack or major international conflict. Manchin doesn’t mention Modern Monetary Theory, but it’s safe to assume he’s a skeptic.
Friday’s weak jobs report revealed how investors are regarding the balance of risks. Although it may add a modest delay to the onset of Fed tapering, ten-year yields rose as the yield curve steepened. The payroll data provided some support to FOMC doves, but also strengthens the argument in favor of further fiscal stimulus. Since spiraling indebtedness provokes no discernible economic costs, the threshold for more of the same is falling.
This is what provoked Bill Gross to refer to bonds as “investment garbage” in an interview last week. He’s right, but his warning that ten-year treasury yields could reach 2% in a year is unlikely to cause much concern. Yields have been too low for over a decade, and at 2% treasuries would still represent return-free risk. Japan ($1.3TN), China ($1TN) and our own US Federal Reserve ($5.7TN) are the three biggest in a long list of non-commercial buyers.
No return-seeking investor should own bonds, but avoiding fixed income with stocks and cash retains a link to interest rates, because low yields continue to show the Equity Risk Premium (ERP) still favors stocks. Factset earnings estimates continue to improve. Forecasts for FY 2021 profits have risen 25% since January. Year-over-year EPS growth for 2022 is 9%.
The ERP average over the past two decades is higher than over the past half century. Using more recent history, stocks are still cheap but not outrageously so. As long as earnings continue growing, the main risk will be interest rates. Even Bill Gross is looking for a <1% increase in yields, an acknowledgment that demand is permanently skewed by central banks and other buyers with inflexible mandates. A 2% ten year treasury yield might be a minor shock if reached quickly but would not move stocks into expensive territory.
The risk of foreign selling has gone, since it’s now clear the Fed would step in to offset a sharp rise in yields. In fact, it’s not a huge leap to consider the circumstances under which the Fed might feel additional bond support was necessary. If ten-year yields rose to, say, 3% the FOMC might assess a potential threat to economic growth and employment. Joe Manchin worries about excessive spending driving inflation, but he doesn’t warn of indebtedness driving interest rates punitively high. Perhaps he’s also concluded that the Fed stands ready, just as MMT advocates.
In spite of weaker than expected economic data over the past month, long term yields have drifted higher. The yield curve is too flat, pricing in just over one tightening per year from 2023-25 versus the FOMC “blue dot” forecast of almost twice that rate. Eurodollar futures moved back towards the FOMC’s rate path but remain more sanguine about future rate hikes than even the FOMC doves.
Coincident with the steeper curve, inflation sensitive sectors such as gold and silver outperformed on Friday. Weak economic data make additional fiscal stimulus more likely.
Russia’s central bank warned that if global inflation isn’t constrained the global economy could, “deteriorate drastically and rapidly.” While not a thought leader, it illustrates that inflation is already a global concern.
Bond yields remain constrained between the threat of more spending and the promise of ongoing central bank support if needed. Earnings remain the key driver of returns, and the picture there is positive. Stocks remain the place to be.
To learn why you should worry about inflation, watch this brief video.
The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy, completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)
This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r
Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.
All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
Past performance of the American Energy Independence Index is not indicative of future returns.