The Yield Titans….
As investors, we look to place our investment where we hope to receive an income (a yield) or a capital appreciation or both on the initial investment, over a period of time. In recent times however, the fixed income asset “tool box” would likely not have contained long dated sovereign bonds. The reason for this is that yields from these bonds were at historically low levels (See the US Treasury 10 Year Bond Yield in the chart below).
Recently, however, an interesting observation can be made on the movement of US 10 Year bond yield over the last three months. It has grown by 12.4% over the past 2 months and at date of writing the current yield of the US 10 Treasury bond stood at 2.62%. Compare this to the average (forecast) yields on the Dow Jones Index and US500 equities indices offering 2.4% and 2.3%. To further contextualise this analysis, the US (FED) interest base rate currently sitting at 1.3% and US inflation rate now sits at 2.1%.
That means if you deposit your hard earned money in the bank, the interest rate and the capital will be eroded by inflation. If you purchase a US 10 Year treasury bond, you will receive a net (Real) yield on your investment of 0.5% better than had you placed the cash on the markets which you can expect to receive a net yield of 0.4% ignoring capital appreciation. These returns are before costs of trading are incorporated.
Why is this important? Well, US equities exemplified by the Dow index have been trading bullishly since March 2009 resulting in year on year record breaking market valuations being achieved. At the end of 2017, the combined market capitalisation of the Dow Jones Industrial Average (DJI) was an eye watering $6,873,564.2M. In 2018 already, the DJI has jumped in value by 4.3% adding an additional $295,563M to the valuations contained within bringing to adjusted total combined market value of companies contained on the index to $7,170,139M. To put this into context, the total market capitalisation of the DJI at the end of 2009 was ca. $3,499,645M.
These astronomical valuations reflect the sentiment of investors who sought their yields from equities when bond yields were falling and deposits were erosive and which, in an improving corporate and economic climate made perfect sense. As a result, it leads many professional investors to view these markets as overvalued when compared to their long term averages and likely to proceed with caution.
So, with the US Treasury 10 year bond yield, edging closer towards the desirable 3%, might we soon see a movement in investor’s monies from equities and a correction in this long running bull equities market? At Lifetime Financial Planning, we pay close attention to such subtleties.
If you would like to hear more about how we manage these difficult investment environments please feel free to contact us via the website.