DIASTOLE ECONOMIC AND MARKET COMMENT
January 21, 2020
What is a government that is now running annual deficits in excess of one trillion dollars to do? Borrow more money, of course. When the government sells Treasury bills, bonds, and notes (the different names are for different durations), the government is giving a promise to repay to the buyer, while the buyer gives cash to the government. The government needs the cash to help cover its budget shortfall and accumulating debt, and the bond buyer wants the safe income that Treasury instruments provide.
So - everybody is happy, right? Well… a government that needs to keep borrowing money will be adding to its overall debt every year, and will need to sell even more bonds. What if there are not enough buyers? The government can do a couple of things: it can pay a higher yield, hoping to attract new buyers/lenders. This just exacerbates the problem of paying back the bond buyers on time as the debt service (the amount of interest the government must pay to keep current on its debts) increases.
Another thing the government can do is what it just announced it WILL do, which is sell a new kind of debt, in this case 20-year bonds. Not since 1986 has the Treasury sold a 20-year bond. It was already selling bills (short term), notes (medium term, like the ten-year) and bonds (thirty-year). The Treasury wants to sell lots of long-term bonds at low rates, while buyers either want long-term bonds with high yields or short-term bonds (why lock up your money for a long time with a meager yield?).
The Treasury has also toyed with the idea of ultra-long bonds - like 50- and 100-year, but at current interest rates, who would buy them? Thus enters the 20-year bond into the equation. Will it attract buyers/lenders who would rather not purchase a 30-year? Will it attract buyers/lenders by paying a small amount more than the ten-year? We will see.
(One caveat here. Bond yields are actually set at auction. So the effective yield on a bond is an agreement between the Treasury (seller) about how much interest it will pay, and the buyer about how much interest she will accept. It is a little complicated; think orderly haggling.)
I know - TMI. And usually we discuss stocks, which are a little sexier. Sorry!
Net income for the stocks in the Standard & Poor’s 500 has fallen, year over year, for the past four quarters, while earnings per share (EPS) grew about 0.6% for all of last year, and were actually down in the fourth quarter. EPS grew by 23% in 2018, mostly due to the corporate tax cut enacted at the end of 2017. Corporations took their tax savings and bought their own shares, reducing the number of outstanding shares and raising their EPS.
So why did stocks perform so well last year? It certainly wasn’t because of earnings growth. Still, the S&P 500 rose about 29% in 2019. Of the stocks in the index, Apple and Microsoft were the highest flyers, rising 85% and 54% - more than the next eight index contributors combined.
Some analysts think the stock market moved primarily on optimistic sentiment. First the President imposed tariffs on China, starting a trade war, but later ratcheted it back by indicating that he had a “phase-one” deal. He took us out of the JCPOA Iran deal, killed Iran’s second-in-command, but then walked it back after Iran retaliated. Each time, the market ran higher. Is it possible to create problems, announce that they are solved, and push markets upward in relief?
2020 may be a tougher sell. Many analysts are calling for stock market growth of about 5% this year, and many are predicting a shift from growth stocks (higher price-earning multiples and often tech) to value stocks (lower P/Es, higher dividends, and slower growing). Your asset allocation should include both sectors.
Bank stocks deserve some special attention. The big banks (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley) saved about $18 billion on taxes in 2019, after saving $14 billion in 2018. This money was meant to “trickle-down” to regular folks, but in fact the banks cut jobs, slowed their increase in lending, and raised dividends. The effective tax rate of these banks before the tax cut was about 30%. In 2019, they paid 18%.
I know, enough, your eyes are burning! So here’s some good news: housing starts in December reached a 13-year high. That is the result of low mortgage rates and warm weather, and is a strong sign of confidence in the economy. Also in December, retail sales rose by 0.3%, the third monthly increase in a row. Retail sales for all of 2019 were higher by 5.8%.
In a rare bipartisan agreement, the House and Senate have approved the U.S.-Mexico-Canada Agreement (USMCA) trade deal that replaces NAFTA. The President is expected to sign the deal. Mexico has already approved, and Canada is expected to.
Roger Federer will shortly become the first tennis-player billionaire. He has won a record 20 Grand Slam singles titles, but his wealth comes from lucrative endorsement deals with Rolex, Mercedes, and Uniqlo, among others. Federer’s current ranking is third in the world, after Rafael Nadal and Novak Djokovic. He is 38 years old.
For the week ending January 17th, the S&P 500 closed at 3,329, the Dow Jones Industrials at 29,348, and the Nasdaq Composite Index at 9,388 - all record highs. The yield on the ten-year Treasury Note finished at 1.83%. U.S. crude oil cost $58.54 per barrel, N.Y. gold cost $1,558.80 per ounce, and one Euro was worth $1.1091.
Elizabeth E. Cook
News and information presented here was gathered from sources believed, but not guaranteed, to be reliable, including The New York Times, The Wall Street Journal, Business Insider, Barron’s, Bloomberg, The Economist, CNBC, Reuters, and The Associated Press. If you have questions, please call us at 203.458.5220 or reply to this email. Did you know that the average human body temperature is no longer 98.6 degrees, as was first determined in 1869? It is now 97.5, and we are taller, fatter, and live longer. I have a million theories, none of them scientific, for instance, has central heat spoiled us?