Seems like everyone wants to label something a “bubble” these days. There is a bubble in bubbles. Interest rates have been falling for 32 years now. As rates fall, bond prices rise, and vice versa. It has been a multi-decade bull market for bonds. Unlike stocks, which have no upper price limit, bond prices are theoretically limited on the upside as a function of interest rates and maturity dates. Once bonds mature, any remaining price premium will disappear. With these relationships intact, it is no surprise that predictions of the bond market’s imminent collapse began to appear as interest rates fell to historic lows in 2008.
The “bond bubble” is now well into its fifth year. Investors heeding the warnings of bond market fear-mongers missed an opportunity for substantial gains. The iShares Barclays Aggregate Bond ETF (AGG) generated a cumulative total return of more than 23% since the end of 2008. Shorting bonds since the bubble first appeared has been a losing proposition.
You might be asking how this is possible if interest rates reached historic lows in 2008. The answer is simple – interest rates have continued to trend downward. For any given market, a “historic” level is not an absolute limit. The 10-year Treasury yield fell to nearly 2.0% that year, a level last reached in the 1940s and previously never seen by most investors alive today. Furthermore, the decline did not stop there. Today, the 10-year Treasury yields just 1.7%.
Can yields go lower still? Of course they can. Germany’s 10-year yield is 1.3% and Japan’s is only 0.6%. The secular decline in U.S. interest rates will eventually end. It could happen this week, or it could happen years from now. The bubble may burst, or it may slowly deflate. Accurately forecasting the future is an uncertain endeavor. There is an exception though, anyone buying a 10-year U.S. Treasury today will receive an annualized return of 1.7% (before inflation and taxes) if held to maturity in 2023.
Today’s Sector Edge chart clearly delineates the best and worst performing sectors. Health Care retains its overall lead, with the biotechnology segment providing a large upside boost. Telecom climbed another notch and is now vying for first place honors. Utilities and Consumer Staples round out the top four, giving defensive sectors a definitive leadership role. Strength begins to fall off for the next three categories. Real Estate, Consumer Discretionary, and Financials lag behind the leaders yet are performing better than the broad market indexes. The bottom four Sectors are currently out of the running. Among them, only Industrials managed to post a small positive trend today. Materials, Energy, and Technology are registering intermediate-term downtrends.
A week ago, there was a near 7-way tie for first place in our Style rankings. Today, the strongest five categories have identical scores, producing a real 5-way tie. Remarkably, despite the extremely compressed rankings, the relative strength ordering of the list shows little change from a week ago. The top four are unchanged with Mid Cap Value retaining the top spot. Large Cap Value, Mid Cap Blend, and Large Cap Blend follow. Fifth through seventh places are the same three categories as last week, although their relative order changed slightly with Mid Cap Growth the strongest of the trio today. The four smallest capitalization categories are on the bottom once again.
Global allocations are important performance differentiators in equity portfolios at this time. Overweighting Japan and underweighting Emerging Markets has paid off handsomely this year. Unfortunately, the average global portfolio probably has not reaped the benefits of this because for most of the past 20 years, a higher allocation to emerging markets and lower exposure to Japan was an easy way to add alpha. The top seven places in our Global rankings are unchanged from a week ago. Japan is way out in front, with the U.S., EAFE, and World Equity trailing far behind from a momentum perspective. In the lower portion of the rankings, Emerging Markets and China each moved up a notch as Latin America and Canada fell. Canadian stocks have tumbled in April, pushing Canada down to last place. The collapse in gold prices and related mining stocks are the primary culprits of Canada’s decline.
“This world’s a bubble.”
Augustine of Hippo, Roman Philosopher
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