MARKET UPDATE MAY 8TH, 2019

History can be very useful in making predictions of future events. I tend to seek historical data to get a “big picture” view in looking at the markets. Not only is it interesting, it is also very useful as a guide for uncertain times. My goal is to find the opportunities in current events, and history is a good way to find wisdom that I do not or cannot possess.
The equity markets have dropped over the last few days with all the talk of tariffs. Normally, we don’t see this type of “in your face” negotiation within the public sector. Markets tend to value assets on the low end of uncertainty. Because of this, long term investors tend to do well investing or simply maintaining their exposure during uncertain times. When things get figured out and the uncertainty goes away, more times than not the outcome is better than what is priced into the market. Because of
this, I am not overly worried about the tariff talks and continue to be very focused on fundamentals. I think more important than tariffs is how low interest rates remain given a very long economic expansion. The Federal Reserve has backed off of raising short term interest rates even though the economy is doing well enough that the Fed thought as recently as January, short term rates could be much higher than seen today. The result of the recent rate hikes is a 10 year treasury yield that has dropped to 2.45% as of this morning. Over the past 90 years, the 10 year treasury yield averaged about 2.6% above inflation according to a 2015 report by Morningstar. This would put the 10 year treasury at about 4.6% given today’s inflation figure. If the 10 year treasury were to go back to the average, this would be negative for long term bond investors. Because of this, I am using shorter term bonds for fixed income exposure. The shorter the duration of a bond, the less volatile the bond is to changes in interest rates.
With the 10 year treasury yield virtually the same as the 1 month treasury yield, the U.S. is looking at a flat yield curve. Flat yield curves have historically been recognized as a barometer of a soon to be slowing economy which is more than likely why the Fed stopped raising short term rates. For stock investors, a slowing economy has favored “value stocks” due to the higher cash flow component “value stocks” give investors as a trade-off for lower earnings growth. These type of stocks do better if earnings growth slows and a flat yield curve has been used as a sign to move toward value stocks. Because the 10 year treasury yield is so low compared to the historical average, it is hard to know if the yield curve is correct in predicting a slow down or is simply a “grand illusion” being masked by the high demand for treasuries as a “safe haven” for investors around the world. There continues to be an unusual amount of foreign debt denominated in U.S. dollars and treasuries would be a good place to park currency during this time. Because of this, it is wise to continue to have exposure to both growth and value stocks because in investing, there rarely is one right answer. I read in today’s Wall Street Journal (Wednesday, May 8, 2019) that Bristol-Myers Squibb Co. sold $19 billion of 10 year bonds at 99.175 cents on the dollar with a 3.4% coupon. I calculate this debt at a cost of about 3.5% per year for Bristol (excluding underwriting fees). It is reported Bristol is using the proceeds for a buyout of Celgene, a very successful biotech company. My guess is the leadership in Bristol feels confident they can pay for the debt servicing with the cash flow generated from Celgene and have some left over for short term profits while completely owning Celgene for long term value. This is just one example of corporate America attempting to take advantage of the low interest rate environment. We are also seeing a historically unprecedented amount of corporate stock buy-backs. With such historically abnormally low interest rates, it seems to me the best way to take advantage of this is by investing in company stock that generate high levels of growing cash flow. These companies can either accumulate assets or simply buy back their own stock using the debt market at very favorable terms. This is a “big picture” view of interest rates and the markets. With that said, there will be hundreds if not thousands of reason not to be invested and many of them will turn out to be correct for short term investors. For longer term investors, markets move very quickly to news both good and bad. With interest rates seemingly being too low on a historical standard, we may get a chance to see inexpensive leverage in the corporate sector helping the returns stock investor’s experience. With the right research and proper diversification, being a shareholder may be a way to take advantage of this low interest rate opportunity. 
The last time the U.S. has seen interest rates stay this low compared to inflation was in the 1940s and 1950s. The stock indices did very well during that time while bond markets did not do as well on an inflation adjusted basis when compared to other historical periods. I have looked at the raw data during this period many times and have always wondered why the markets outperformed this way for such a long period of time in what was seemingly a very difficult time in the world. I believe part of the reason was the very low interest rate environment that private markets were allowed coupled with the many distressed sales or plain lack of supply the world was able to produce during that time gave opportunities for investors in private markets. It provided liquidity to capable entities in a time of distress. Companies, many owned by shareholders, were able to have access to the debt markets at historically favorable terms and grow in that environment. The U.S. and the world are much different places than they were in the 40s and 50s, but like we saw at that time, the world is once again struggling with the burden of debt and U.S. interest rates are low
when compared to inflation. Only time will tell if interest rates continue to be stubbornly low while the world’s debt situation gets under control. If this takes decades to resolve, this may turn out to be another good environment for stocks and not so good for bonds when both are adjusted for inflation.
I hope this gives you a better understanding of my thoughts and some good information to consider.
Please let me know if you have questions or would like to discuss.
Best to all,
Richard

This information was taken from resources we consider accurate but cannot be guaranteed. The
information is our personal view and should not be taken as a prediction of the future.