MARKET COMMENTARY

Distortions Cloud Investors’ Views

It’s better to make prudent investment decisions seeing the economic and market distortions currently at play. We take a closer look.

10.30.2019 - Vincent Tonietto - Vice President, Portfolio Manager

Imagine applying to your bank for a 10-year mortgage and winding up with the bank paying you for placing the mortgage with them.1 You’d probably be scratching your head, knowing this isn’t the normal course of business. You’d be right.

As I write this, Denmark’s reputable Jyske Bank A/S is the only bank (for now) offering negative mortgage rates.2 It’s one example in this new, distorted economic environment—shaped by nearly three decades of declining interest rates worldwide and the unconventional monetary policies, which emerged out of the 2008 Financial Crisis.3 During this quarter, on a worldwide basis, the supply of negative-yielding bonds reached over $15 trillion (US$).4 In most European countries, you can find negative-yielding bonds with up to 10-year maturity rates.5

This prompts the question: Why are central banks around the globe not only tolerating but promoting this environment? What are they trying to achieve? While the US economy continues its precedent-setting expansion, keep in mind it’s been one of the most sluggish recoveries on record. Instead of a rapid climb, picture a shallow, upward stroll. With US unemployment at a record low, you’d imagine inflation expectations would be trending upwards. In fact, the reverse is happening as they continue to slide downwards. Add US/China trade tensions and you can see why monetary policymakers have good reason to be concerned about the global economic outlook.

When central banks face economies drifting into foggy uncertainty, the next natural step is to decrease interest rates. The tricky reality is interest rates haven’t meaningfully increased since the last crisis. There’s not much room to manoeuvre.

It also appears that, somewhere along the way, central banks supposedly developed superpowers—the ability to fix almost anything. It’s simply not true. It’s also not their job. Monetary policy-makers can’t fix all the economic imbalances at the same time without fiscal authorities’ (government policy-makers’) support. For instance, we can see how current US/China trade tensions are reducing the effectiveness of central bank actions.

Distortions on Both Sides

History has shown time and again that equity markets dislike uncertainty. For years now, investors have watched markets respond (upwards and downwards) to the US Federal Reserve’s every move. It’s clear, equity markets love low interest rates as companies can borrow at very cheap rates to finance activities, boost dividends, or buy back shares. Add investors searching for healthier yields, and we’ve seen stock valuations stretched upwards. When disconnected from corporate fundamentals, market moves are influenced more by sentiment than the basics. In other words, equity markets are susceptible to distortions too. Since it’s impossible to determine precisely when such distortions will be reduced, we prefer to remain cautious and focus on the fundamentals.

From our perspective, equity investors who know about the current themes have the advantage of awareness. With that comes choice. You can review your portfolio, revisit your risk tolerance and “know what you own.” Our active management approach integrated with bottom-up stock selection is anchored in fundamental research and analysis that works through broader market distortions. We focus on companies that have been prudent with the “cheap” financing available for years, building their business on solid ground. Avoiding “bad” companies is important during any phase of the cycle, but even more so during any downturn.

 

 

 

 

NOTES:

1 Oliver Telling, “Negative mortgages set another milestone in no-rate world,” Bloomberg, August 19, 2019, https://www.bnnbloomberg.ca.

2 Erik Sherman, “This Danish Bank Is Offering ‘Negative’ Mortgage Rates—Here’s What That Means,” Fortune, August 13, 2019, https://fortune.com.

3 “Interest Rates Have Declined for Almost Three Decades,” Source: FactSet: Tullett Prebon Information, In “Around the World with Franklin Templeton,” https://www.franklintempleton.com.au.

4 Maggie Fitzgerald, “Amount of global debt with negative yields balloons to $15 trillion,” CNBC, August 7, 2019, https://www.cnbc.com.

5 “Government Bond Yields For Selected European Countries,” Source: Bloomberg, In “Around the World With Franklin Templeton,” https://www.franklintempleton.com.au.

 

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