Two big certainties in uncertain times
CENTRAL BANKS, BABY BOOM MAKE FOR BIZARRO WORLD
When the Chinese t el l us “May you live in interesting times” ... well, the times are certainly interesting.
We have a very unusual situation on our hands: a six-quarter U.S. profits recession that saw earnings drop 20 per cent and the stock market rally six per cent. That doesn’t happen every day, that much I can assure you — in fact, at no time in the past five decades have we had such an occurrence.
Consider t he “wall of worry” that Mr. Market has had to climb this year.
The U. S. Fed was threatening at the turn of the year to raise rates four times. Still waiting (and given that there are only three meetings left, let’s just say that forecast is now an impossibility).
China was supposed to suffer a destabilizing and “hard” economic landing. Didn’t happen.
Beijing apparently was going to start a global currency war, which created a buzz in the gold market for a while. This never unfolded either.
What about oil? Wasn’t it supposed to break to US$20 per barrel or lower, generate a wave of defaults and banking sector writedowns, not to mention a 60 U. S. cent Canadian dollar?
On June 24, everyone was glued to their screens postBrexit vote and the pundits were calling for the end of civilization. Not only has the U. K. not yet broken its ties with the European Union, Article 50 of the Lisbon Treaty (which is required to start the negotiations of an eventual exit) hasn’t even been invoked.
And who would have ever have thought that the first stock market that would break out following the Brexit vote would be the U. K.’s FTSE 100?
Yet another case of 2016 being a year of expecting the unexpected.
There was a time, no more than six months ago, that the mantra in the market was that the central banks had lost control, were out of policy bullets and had become totally impotent. Looking at what has happened to the U.K.’s cost of capital since the Bank of England eased policy, that mantra is undergoing a rethink, which is one reason why the gold price has not made a new 2016 high in over a month.
Three quarters in a row of negative capex growth? Three straight quarters of contracting productivity? Signs of peak autos and now peak housing? A sputtering consumer and recessionary pressures in the restaurant sector? An ever-populist U. S. election campaign, chock full of Wall Street bashing and anti-free-trade rhetoric, has largely been treated with a shrug of the proverbial shoulders.
So the market has climbed this “wall of worry” and yet, despite all the uncertainty, there are two certainties out there that are having a clear i mpact on relative asset prices.
The first is the central banks, as a group. The Fed may bark about raising rates again at some point, but the balance sheet remains a pervasive and profound source of market support, and the European Central Bank, Bank of Japan, and now the Bank of England have all become more aggressive this year in terms of monetary accommodation.
The size of the “Fab Four” balance sheet is now over 30 per cent of the combined GDP of these countries.
They have taken so much safe yield out of the marketplace that roughly one-third of global government bonds now trade with a negative yield, and three- quarters trade below one per cent.
Looking for two per cent or better, when just six per cent of the sovereign bond market commands a betterthan- two- per- cent yield is not an easy task. To get that, you have to pretty well become an exotic bond trader and move into the emerging market debt universe.
So we know full well that the central banks want inflation — it is the easiest way to default on the record global debt- to- GDP ratio without having to write anything down and generate real losses — and while inflation does remain at bay, that will not be the case indefinitely.
But it is key to know that the central banks will not desist until inflation does come our way. So the shortage of yield is going to remain as acute tomorrow as it is today.
As for the demand for yield, well again, we have this certainty called demographic trends.
No doubt, we are all a year older than this time in 2015, but what makes 2016 really special is that this is the year the first of the throngs of baby boomers turn 70.
There will be an additional 1.5 million Americans turning 70 annually for each of the next 15 years and this is key because this is the part of the investing life cycle where the attention turns away from equities and toward bonds — clipping coupons to fund the retirement years.
Well, they can no longer garner those cash flows from the plain- vanilla bond market ( where 10- year yields average 60 basis points globally), but they can in the stock market (where the twoper-cent-plus dividend yield has not budged even as bond yields have vanished — look at the averages of the past 10, 20 and 30 years and you will see that today’s S&P 500 dividend yield is right in line with the norm).
In fact, while a declining share of the total return in the government bond market is coming from the income component, a rising share of the total return from the stock market is coming from that income stream — the dividend yield and the growth in that dividend.
This has been the case in Canada for some time, by the way — the TSX (with all the fluctuations) is no higher now than it was eight years ago. Yet over that time frame, the total return index is up about 30 per cent. The beauty of the dividend stream.
Make no mistake. The baby boomers have controlled everything in the past six decades from economics to finance to politics. This 78-million-person “pig in the python” controls the bulk of the wealth and the power in society — and they have no student debt!
Look who is running for U. S. president — both The Donald and Hillary are among those early boomers. In fact, a baby boomer has been president all the way back to 1992.
And this group will continue to dominate the demand for yield in a world where central banks will continue to ensure that it will be in short supply, at least as far as the traditional bond market is concerned.
Stocks trading like bonds sounds glib, but this is the result of the Bizarro World the central banks have created. It is also a fact that the stock market has been, and remains, a more efficient way to deliver a cash- flow stream than government bonds.
David Rosenberg is chief economist and strategist at Gluskin Sheff + Associates Inc. and author of the daily economic report, Breakfast with Dave. Follow David and his colleagues at Twitter. com/gluskinsheffinc