Along
with the return of sector rotation, another favored strategy among investors
lately has been the return of the long bond trade. Treasuries have outperformed stocks in the
last four months with the iShares 20+ Year Treasury ETF (TLT) adding 12% in the
year to date versus only 5% YTD for the S&P 500 (SPX). Bond yields by contrast have fallen steadily
this year as bond prices have risen.
In
prior years a bond market rally was considered a safe haven trade as investors
flocked to the relative safety of bonds during periods of uncertainty. At this point, however, much of the money
flowing into bonds represents global “hot money” inflows as the promise of ECB
President Mario Draghi to do “whatever it takes” to stimulate the EU economy
has been followed by a loose money policy throughout much of Europe. Investors currently favor U.S. Treasuries
over European sovereign bonds due to perceived safety issues and relative
yields. An argument has been made that
the U.S. is therefore benefiting more from Europe’s monetary policy than Europe
is.
The
big question is to what extent lower bond yields will push mortgage rates
lower? A decline in the 30-year fixed
rate (see chart below) would undoubtedly boost consumer spending via home
refinancing. The lifting impact of the
upcoming 60-year cycle bottom this fall could amplify this effect, assuming
rates remained subdued until then. The
important thing to keep in mind for now is that the rising trend in bond prices
and corresponding decline in yields should be viewed as a net positive for the
economy rather than a negative.
[Excerpted from the May 30 issue of Momentum Strategies Report]
