Photo: Peter Foley/Bloomberg
What a year this has been, and it’s only half over.
It seems an eternity ago, in the dead of winter, when we were witnessing the scrums advertised as political debates. From which emerged the presumptive candidates for the Republicans and the Democrats, both of whom are distinguished for eliciting strong passions—mainly negative on the part of their respective opponent’s supporters.
And if published reports are correct, both of the likely candidates now seem intent on choosing running mates who are at least as polarizing. All of which has happened before the conventions and then the seemingly endless general-election campaign—even longer than the baseball season, which now stretches almost to November.
It also seems ages ago that the big global concern for the financial markets centered in Asia, especially China. The seeming exodus of capital from there unsettled currency, credit, and commodity markets. Of the last, oil seemed to be in a virtual free fall with no bottom in sight, dragging down highly leveraged companies that had tapped the junk-bond market for cheap capital when bullishness reigned about the U.S. energy revolution.
Confident predictions of higher interest rates also seem a distant memory—even though they are the finance and economics world’s version of Groundhog Day, recurring every year. Four rate hikes by the Federal Reserve supposedly were in the cards, thus making bonds sure losers, especially those with lengthy maturities. And then there was the seemingly perennial prognostication of TINA—There Is No Alternative to stocks. In a world where cash returns nothing and bonds yield little more, equities were the only source of return.
While the politics remain uncertain, both as to who might be residing in the White House next January as well as which party will control the Senate, the financial expectations have been thoroughly confounded.
The global shock didn’t emanate from Asia, but from Europe, sort of—from the United Kingdom’s vote last month to withdraw from the European Union. And while the Brexit shock initially sliced some $3 trillion from global equity values in the two trading sessions following the June 23 referendum, the rebound has been just as extreme. Indeed, U.S. markets had their best week since last November, and the major U.S. equity averages once again hover within a few percent of their records heading into the U.S. Independence Day holiday. At the same time, bond yields fell to record lows, not just for U.S. Treasuries but for other sovereign bonds, as well. To be sure, the respective moves in the debt and equity markets aren’t unrelated.
The relentless decline in bond yields has provided the wind beneath the wings of the stock market to keep prices aloft.
A perusal of returns for the first half shows an investment world turned upside down. Investors have been turning to stocks for income, while bonds have been the biggest source of capital gains.
With dividends included, the Standard & Poor’s 500 index returned 3.84% in the year’s first six months, according to Bianco Research. Meanwhile, the Treasury’s benchmark 10-year note returned roughly twice that, 7.97%, and the 30-year bond returned more than four times as much, 16.93%—its third-best start of the year on record. Even dowdy municipal bonds did better than stocks, with a 4.33% return.
Within the U.S. equity market, the biggest winners have been the stocks that looked and felt like bonds, such as utilities, telecoms, and consumer staples, providing dividend income, but little if any growth, at steep valuations. Again, that’s a refrain that has been heard before but somehow doesn’t deter investors’ seeking income and stability in a market where both are scarce.
The junk-bond market, battered by its energy exposure, came roaring back with a 9.06% return for the first half, and 16.03% for dicier debts rated Caa. Notable laggards were convertible securities, with a 2.14% return, which suggests better opportunities ahead (see Current Yield).
But the real place to be was Brazil; that is, its stock market, not necessarily the physical location, given the threats from Zika, pollution, and crime ahead of this summer’s Olympics. In a true worst-to-first performance, Brazilian shares returned 46.34%, measured in dollars, vastly better than the 18.51% in local-currency terms as a result of the real’s rebound in the face of recession, inflation, and political upheaval.
Russia was another big winner, gaining 20.43% in dollar terms, more than double the 8.19% in rubles.
This shows how currencies count for investors, often more than what stocks themselves do in local markets. Following the Brexit vote, U.K. shares rebounded with other markets. The pound suffered a record decline, to about $1.32 after touching $1.50 when the initial, errant indications showed the vote would be to remain in the EU.
For the first half, U.K. stocks returned 6.89% in sterling, but in dollars they were down 3.05%—a difference of nearly 10 percentage points. The lower pound served as a shock absorber for the U.K. economy, especially with Bank of England Governor Mark Carney signaling interest-rate cuts to cushion the uncertainty resulting from Brexit. Hit hard were investors in U.K. assets who keep score in dollars or other currencies. Ditto Brits, who face a surge in inflation from higher import costs—long before their nation withdraws from the EU.
For the rest of the world’s financial markets, observes Cliff Noreen, president of Babson Capital Management, the main result from Brexit has been ironically positive. Greater uncertainty has resulted in lower interest rates, which lift asset prices.
ON THAT SCORE, both 10- and 30-year U.S. Treasury securities hit their lowest yields ever, even before Alexander Hamilton was a Broadway sensation or since he was the first U.S. Treasury secretary. According to Tradeweb data cited by The Wall Street Journal, the benchmark 10-year note traded at 1.385% in the wee hours of Friday morning, below the 1.404% closing low of July 24, 2012, during Europe’s debt crisis. The 30-year bond traded at 2.188%, its lowest yield since Jan. 29, 2015, when it was at 2.256%.
As eye-wateringly low as those yields are, they still stand well above those of foreign government bonds. In the midst of Britain’s political and economic upheavals, the 10-year U.K. gilt’s yield slid below 1%, to 0.873%, at week’s end—far under its level when Britannia ruled the seas and much of the terrestrial world and when the Bank of England managed the globe’s main reserve currency, which was backed by gold.
Yields on bonds of governments of other bygone empires also hit all-time lows, with both Italy’s and Spain’s 10-year obligations ending on Friday around 1.14%. France offered 14 basis points (0.14%), which at least was still on the plus side of zero. The benchmark 10-year German Bund traded at minus 12 basis points, while the comparable Japanese security yielded minus 25 basis points.
Bloomberg data passed along by Bianco Research shows that $12.7 trillion—36% of the $35.07 trillion of all sovereign global debt—yielded less than zero, as of June 30, a stat widely noted, but stunning nonetheless. Less noted is that even more, some $14.5 trillion, or 41%, yields zero to 1%, while $5.67 trillion, 16% of the total outstanding, yields 1% to 2%. And just $2.2 trillion, or 6% of sovereign paper, yields more than 2%.
While the Bank of England strongly hinted last week that rate cuts could be coming this summer, prospects for Fed rate hikes faded even further into the distance. Based on Eurodollar futures prices, the U.S. central bank is likely to keep its federal-funds target steady well into next year and perhaps until 2018. (Fed-funds futures don’t actively trade enough that far out to provide a good reading of rate expectations.)
IT IS TAKEN AS A GIVEN that these seemingly preternaturally low interest rates are a result of “financial repression” by global central banks. To be sure, the banks are the main price fixers in what is supposed to be a market economy. But what if zero or less isn’t artificially low?

And what if such rates aren’t necessarily a bad thing?
David Ranson, the head of HCWE & Co. and a confirmed iconoclast, takes issue with the widely accepted nostrums about depressed rates. There are mental, cultural, and institutional barriers to negative interest rates, he writes in a paper for the National Center for Policy Analysis. It’s tough to get one’s head around lending money and getting less back. But, he notes, this has happened for some time in Switzerland, where deflation is well established and, much to the surprise of the Swiss, accompanied by a strong currency.
Moreover, in the wake of the global financial crisis, he estimates that U.S. interest rates also should have moved below zero, to take account of commodity deflation.
So, if prices are falling, “it is natural for nominal rates to be negative,” Ranson contends. Still, Fed Vice Chairman Stanley Fischer strongly averred in a televised interview on Friday that the U.S. central bank would seek to avoid negative interest rates.

Deferring rate increases now would help ensure that future rate cuts could be avoided. All of which suggests that rates will stay low for longer, maintaining their prop under asset prices, but making it even more difficult for pension funds and insurance companies to generate returns that meet their goals.

For the moment, the main focus of the markets and policy makers will be on the June employment report, due out on Friday, even more so than would be usual after May’s dreadfully small 38,000 increase in nonfarm payrolls.

A rise of 190,000 is forecast for June. But that’s what was expected for the prior month, too.

With markets already on edge, any miss is apt to ramp up volatility.