Monthly Markets Memo - October 2019
by Dan Zalipski, CFA
The Federal Reserve cut interest rates for the second time in 2019 this past September. The Fed reiterated its desire to extend and sustain the current expansion while citing the U.S. economic outlook as favorable.
Federal Reserve Chair Jerome Powell stressed the institution will remain data dependent going forward while acknowledging more rate cuts may be needed should economic activity meaningfully slow. Despite these proclamations, the CME FedWatch Tool indicates a 71% chance for one additional rate cut during October’s FOMC meeting near the end of the month.
The U.S. is not the only country whose central bank is cutting rates this year. At least 19 other central banks have cut rates in 2019 as the global economy looks to fend off slowing conditions. As rates are pushed down across the world, investors seeking yield are left with less and less options. Nowhere is this more evident than within the developed world where some of the largest economies are not only grappling with low interest rates, but negative interest rates.
Negative interest rates may seem like a foreign concept, but they are a very real aspect of today’s bond market. About 25% of all bonds in the world are now yielding less than zero. Most of these issues, about 70%, are originating in Europe and Japan. Investors are buying these bonds at a price that is higher than what they would be receiving in principal and interest should they hold the bond to maturity. By not rewarding savers with interest, the system is attempting to stimulate consumption in regions of the world with too much saving and not enough spending. Governments could step in to pick up the slack but lack the appetite or political will to do so as memories of the global recession linger.
As global yields pushed lower throughout the year, prices increased resulting in strong returns. For the first 9 months of the year, the Bloomberg Barclays Global Aggregate Bond Index returned 6.32%, over three times the five-year annualized return of 2.00%. While the returns are impressive, they are on the extreme end of what would be considered a typical and expected outcome for the asset class, especially in an environment of low rates and low inflation. With low rates expected to persist for some time, there are concerns surrounding the potential impact on future returns.
Bonds, and the income or yield they provide have been a consistent contributor to the average 60/40 portfolio (60% stocks 40% bonds) for decades. The outsized returns they’ve produced year-to-date have certainly boosted the performance of your average portfolio. Unfortunately, this trend is not expected to continue. When considering the current dynamics surrounding trends in today’s labor market and monetary policy, money managers and analysts are forecasting lower-than-average expected returns over the next 10 years. According to Blackrock's capital market assumptions, the average 60/40 portfolio is expected to earn between 4% and 4.5% annually over the next ten years, before accounting for inflation. Those numbers should be sobering, as they are significantly less than historical averages, but it is also important to recognize that 10 years is a long time to forecast. Any number of developments could push these estimates either up or down. With the weak forecasts and challenging dynamics, investors have the potential to benefit from active managers who can seek out opportunities in sectors and regions that may be overlooked on the passive side of the equation.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to, nor does it represent or reflect, transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.