Equity dividend yields exceed government bond yields

Government bond yields have fallen so much over the last few years that we are now seeing an unusual phenomenon.

From the Buttonwood column in The Economist:

Buy bonds for income and equities for growth. That is what many a financial adviser will tell you. But it isn't really true any more. According to Citigroup, the dividend yield on the equity market is higher than the 10-year government bond yield in Australia, Canada, France, Germany, Japan and the UK. In the US, the two yields are neck-and-neck but equity investors can get an extra cashflow boost from buy-backs.

The current pattern contrasts with that of the last 50 years, when equities usually yielded less than government bonds because of the potential for the dividends to grow.

It is, however, similar to the pattern in the first half of the 20th century, when equities also tended to yield more than bonds.

So the big question for investors is; are we going back to the 1970s and 1980s? Or will markets look more like the first half of the 20th centuty? If the former, sell the bonds as fast as you can. If the latter, then this seemingly strange relationship will last. Equities may turn out be the best income provider.

Global stocks touch record high but bonds may be set for crisis

Global stocks fell on Thursday, but not before touching a record high.

The MSCI All-Country World Index rose to 434.4, an all-time high, but fell thereafter to close 0.1 percent lower at 432.88.

The S&P 500 closed 0.2 percent lower.

The STOXX Europe 600 was the outperformer on Thursday, jumping 1.0 percent to its highest level since July 2007.

Meanwhile, US Treasuries followed their equity counterparts down on Thursday even as US consumer prices fell 0.7 percent in January, their biggest drop since January 2008.

The fall in US Treasuries comes amid concerns over another possible crisis in the bond market.

“The risk in bonds has gone up,” Francesco Garzarelli, London-based co-head of macro and markets research at Goldman Sachs Group Inc, said in a Bloomberg Television interview on Thursday. “The sensitivity to small changes in yield expectations from here will command very sizable price swings, and I just think that makes fixed income a very dangerous asset class.”

Stocks rise on Yellen comments, Greek deal

Stocks rose on Tuesday.

In the US, the S&P 500 rose 0.3 percent to a new record high after Federal Reserve Chair Janet Yellen indicated in testimony before the Senate Banking Committee that an increase in interest rates is unlikely before mid-year as inflation and wage growth remain too low.

In Europe, the STOXX Europe 600 rose 0.6 percent to a seven-year high. Greece’s ASE Index in particular surged 9.8 percent after eurozone leaders approved a bailout extension for four more months.

The hard part for Greece is still to come though.

“The conditional agreement to extend the current program is just the first hurdle in a long race,” Maria Paola Toschi, global market strategist at JPMorgan Asset Management, wrote in a note to clients on Tuesday. “We expect the negotiation process to continue to blow hot and cold.”

Indeed, in a letter to Jeroen Dijsselbloem, president of the Eurogroup of finance ministers, IMF Managing Director Christine Lagarde expressed doubts about Greece’s reform plan, saying that it is “not very specific” and does not convey “clear assurances” that key reforms will be implemented.

Does austerity pay off?

As Greece's plan to tackle its economic problems goes before eurozone finance ministers for approval, the question remains whether austerity as demanded by the latter is the right approach.

While many economists argue against it, saying that it curbs economic growth, an analysis by Benjamin Born, Gernot Müller and Johannes Pfeifer concludes that austerity does pay off in the long run. Its conclusion:

Our results have important implications for policy.

• First, whether austerity is painful in the short run depends on the level of fiscal stress.

As spending cuts cause little harm under benign initial conditions, it is advisable to prevent fiscal stress from building up in the first place. Admittedly, more often than not policymakers will have missed this opportunity. As a result, austerity is likely to be painful in the short run and the temptation to renege on debt obligations increases. Because market participants understand this, they demand a higher default premium. A naïve observer may therefore conclude that austerity “is not working”. In this regard, however, our analysis offers a second important insight:

• If policymakers and the electorate show sufficient resolve, carrying through with austerity will eventually be rewarded by better financing conditions. Austerity pays off in the long run.

Greece gets deal, markets rally

Eurozone finance ministers reached an accord on Friday to keep funds flowing to Greece. Bloomberg reports:

Talks in Brussels between officials from the 19 euro-area finance officials concluded Friday evening with an agreement to extend aid to Greece for four months.

“We agreed on four months under conditions,” Austrian Finance Minister Hans Joerg Schelling told reporters after the meeting. Greece must submit a list on Monday of measures it will undertake in return and “the institutions check whether the list is sufficient,” he said.

Markets rallied on the news. The S&P 500 rose 0.6 percent to a record high, reversing an earlier drop of 0.6 percent. Futures on the Euro Stoxx 50 rose after the STOXX Europe 600 had closed at a seven-year high earlier during trading. The euro rose 0.1 percent versus the US dollar.

While one European crisis is relieved, even if only temporarily, another crisis continues to simmer.

On Friday, Moody’s Investors Service cut Russia’s credit rating one level to Ba1, below investment grade, as the conflict in Ukraine and plunging oil prices curb growth and erode financial stability. Moody’s also has a negative rating outlook on the country.

Goldman: Oil to stay low

Among the many analysts who think that the decline in oil prices over the past few months is mainly due to excess supply is Goldman Sachs.

From Bloomberg:

Goldman Sachs released an intriguing analysis on Wednesday that shows what many already suspected: The big culprit in the oil crash has been an abundance of oil flooding the market. A massive supply shock in the second half of last year accounted for most of the decline. In December and January, slowing demand contributed to the continued sell-off. Goldman was able to quantify these effects...

The big take-away: “[T]he decline in oil has been driven by an oversupplied global oil market,” wrote Goldman economist Sven Jari Stehn. As a result, “the new equilibrium price of oil will likely be much lower than over the past decade.”

US stock market closes in on record high

Stocks rose on Tuesday. The STOXX Europe 600 rose 0.6 percent while the S&P 500 jumped 1.1 percent to come within 1.1 percent of a new record.

Optimism that Greece will reach agreement on a new debt deal with its creditors helped boost markets on Tuesday. Three-year Greek bond yields sank 163 basis points to 19.46 percent while its ten-year yields dropped 50 basis points to 10.24 percent.

Meanwhile, yields on 10-year US Treasury notes rose two basis points to 2 percent, an almost four-week high.

However, commodities fell on Tuesday. West Texas Intermediate crude oil fell 5.4 percent while copper fell 1.1 percent.

Market volatility may rise with impending Fed hike and increased debt

Markets mostly rose last week but bonds fell as expectations for an interest rate hike from the Federal Reserve increased after a strong employment report in the United States.

The MSCI All-Country World Index rose 2.5 percent last week, its biggest weekly gain since October. In the US, the Standard & Poor’s 500 Index’s rose 3.0 percent. The STOXX Europe 600 Index rose 1.7 percent to the highest level since 2007. The MSCI All-Country Asia Pacific Index rose 0.6 percent.

Also rising last week were oil prices. Brent crude climbed 9.1 percent to cap its biggest two-week rally since March 1998. West Texas Intermediate rose 7.2 percent.

In contrast, bonds fell last week. The yield on the US two-year Treasury note rose 19 basis points to 0.65 percent and the yield on the 10-year note jumped 32 basis points to 1.96 percent. German 10-year bunds also fell last week, with the 10-year yield climbing seven basis points to 0.38 percent.

Helping to push bonds down was a strong US employment report. The Labor Department reported on Friday that nonfarm payrolls increased by 257,000 in January. Average hourly earnings rose 0.5 percent, the most since November 2008.

Following the employment report, futures traders priced in a 27 percent chance that the Federal Reserve will raise interest rates at its monetary policy meeting in June, up from 18 percent on Thursday.

As a rate hike from the Federal Reserve becomes more imminent in coming months, market volatility could increase.

This is especially so since the global economy, according to a report from the McKinsey Global Institute published last week, is now more leveraged than at the time of the global financial crisis seven years ago.

“From 2007 through the second quarter of 2014, global debt grew by $57 trillion, raising the ratio of global debt to GDP by 17 percentage points,” the report said in its executive summary. It concluded that “absent additional steps and new approaches, business leaders should expect that debt will be a drag on GDP growth and continue to create volatility and fragility in financial markets”.

Indeed, another report last week, this time from the Bank for International Settlements, suggested that the dramatic fall in the price of crude oil over the past few months may have been exacerbated by high debt levels in the oil sector.

“One important new element is the substantial increase in debt borne by the oil sector in recent years,” the report said. “The greater debt burden of the oil sector may have influenced the recent dynamics of the oil market by exposing producers to solvency and liquidity risks.”

Strong US employment report sends Treasury yields up

The US employment report on Friday was strong. Bloomberg reports:

A 257,000 January increase in employment capped the biggest three-month advance in 17 years and delivered the strongest wage gain since 2008, figures from the Labor Department showed Friday in Washington. The unemployment rate rose to 5.7 percent from 5.6 percent as the prospect of finding work lured hundreds of thousands into the labor force.

US Treasuries fell following the report. The yield on the two-year note rose 13 basis points.

Commodities rose, with the Bloomberg Commodity Index adding 0.2 percent and oil rising over 2 percent.

However, stocks fell, with the S&P 500 falling 0.3 percent.

Futures traders priced in a 27 percent chance that the Federal Reserve will raise interest rates at its policy meeting in June, up from 18 percent on Thursday.

ECB stops accepting Greek bonds as collateral

The European Central Bank announced on Wednesday that from 11 February, Greek sovereign debt will cease to be eligible as collateral for its liquidity operations.

The Governing Council of the European Central Bank (ECB) today decided to lift the waiver affecting marketable debt instruments issued or fully guaranteed by the Hellenic Republic. The waiver allowed these instruments to be used in Eurosystem monetary policy operations despite the fact that they did not fulfil minimum credit rating requirements. The Governing Council decision is based on the fact that it is currently not possible to assume a successful conclusion of the programme review and is in line with existing Eurosystem rules.

The decision by the ECB came too late to affect European markets on Wednesday but in the US, the S&P 500 fell 0.4 percent.

Markets rise for second day on positive reversal

Stocks rose for a second consecutive day on Tuesday. The MSCI All-Country World Index added 1.4 percent, as did the S&P 500.

Sentiment in stock markets improved as oil prices rose. Brent crude advanced 5.8 percent on Tuesday while West Texas Intermediate rose 7 percent.

The euro gained as much as 1.7 percent to $1.1534, the biggest advance since October, after the Greek government retreated from a call for a debt writedown.

Safe haven assets fell, with yields on 10-year government bonds rising 12 basis points to 1.78 percent in the US, four basis points to 0.35 percent in Germany and eight basis points to 0.366 percentin Japan.

A post at the WSJ MoneyBeat blog quotes Frank Cappelleri, an executive director at Instinet and the resident market technician, as calling this week's stock rally “a classic positive reversal”.

“A combination like this often often kick-starts additional upside,” Cappelleri wrote, noting that the same pattern appeared in mid-January and led to a quick 3.8 percent jump.

The rally after the reversal may not be sustained though. After the rise in mid-January, the market turned right back down, culminating in the low hit on Monday.

US stocks lag in January as European stocks look better on ECB action

Stock markets saw mixed performances in the first month of 2015.

In the United States, the Standard & Poor’s 500 Index fell 3.1 percent in January. The fall last month extended its decline from a record high on 29 December to 4.6 percent.

The STOXX Europe 600 Index surged 7.2 percent in January. However, a 6.7 percent fall in the euro against the US dollar last month cancelled most of the gain.

The MSCI All-Country Asia Pacific Index rose 1.8 percent in January, its firstly monthly gain since October.

The US stock market has underperformed at a time when earnings forecasts are being cut. According to a report from Bespoke Investment Group, the percentage of companies cutting earnings forecasts so far this earnings season has exceeded those with upward revisions by 8.6 percentage points, the widest margin in six years.

US stocks also fell despite the Federal Reserve saying after its monetary policy meeting last Wednesday that it “can be patient in beginning to normalize the stance of monetary policy”.

In contrast, the announcement by the European Central Bank the previous week that it would be buying at least 1.1 trillion euros of sovereign bonds and other debt securities as part of its quantitative easing programme helped push stocks up.

Indeed, a report by The Wall Street Journal on Friday suggested that Europe may be the place for investors to pay more attention to.

It noted that the ECB’s move will help lower interest rates and thus the borrowing costs for European firms. It also helps to push the euro down, making European exports more competitive and boosting revenues for European exporters.

The report said that according to Morgan Stanley, based on the cyclically adjusted price/earnings ratio, European stocks are trading at a valuation discount of nearly 40 percent compared to US stocks even as earnings are expected to grow faster at 10 percent in 2015 compared with 6-8 percent for US stocks.

The Wall Street Journal quoted John Manley, the New York-based chief equity strategist at Wells Fargo Asset Management, as saying: “Recently, we seem to be running out of reasons to dislike Europe, and for us that signals that it’s time to buy.”