The third quarter contained plenty of gloomy news for stock investors. The trade wars continued unabated and remain a source of concern and uncertainty for investors and companies. Political uncertainty took center stage once again, as the President faces a fresh impeachment campaign. Most significant to investors, the ongoing flow of economic data is not encouraging. The Chinese economy is unequivocally decelerating and now growing at its slowest pace since 1992. Much of the European region is flirting with recession. The U.S. economy is still faring relatively well, but each signal seems to get slightly worse. There are many reasons to sell stocks, and yet there remains one very strong and compelling reason to own stocks. Given a world offering negligible or negative interest rates, many investors feel that “There Is No Alternative,” that one must own stocks over bonds. This has fueled what investors have come to label the “TINA Trade,” a somewhat desperate push into stocks in an attempt to find any decent long-term return.
Negative interest rates, one remarkable feature of this current climate, first appeared in parts of the world in the middle of this decade. They were a confounding concept then and remain so today. In normal times it has always cost something to borrow money. These are not normal times. In much of Europe and Japan the individual or institution with money to lend receives zero interest and actually has to pay a small amount to lend their money to a borrower. The wisdom of this arrangement is hard to fathom, and such transactions may not stand the test of time. There may be some logic to paying a nominal fee for the right to store one’s money in the relative safety of Swiss Government bonds during times of uncertainty, given that one might make a currency gain on the Swiss Franc. But today negative interest rates exist in many countries, including the troubled economies of Greece and Spain.
Central bankers are working in coordinated fashion to lower short-term and long-term bond rates and squeeze investors out of the relative safety of government bonds. The thinking is that by forcing investors off the sidelines and into riskier investments, economic growth would be stimulated. Investors are being pushed by these low interest rates. They are buying other kinds of bonds that are riskier in nature and, above all, they are buying stocks. In a climate that presents sobering headlines and weaker economic data, the most compelling reason to own stocks is that they are potentially a better investment than most bonds. Stocks may be volatile, but at least they offer the possibility of long-term gain. A bond with a negative yield, held to maturity, does not. As bond yields tumbled in August of this year, investors rushed into any stocks that looked the way bonds used to, i.e. a stable place to store money and earn a reliable, modest return. Investors have particularly favored the shares of consumer staple companies and utility companies, which have long combined relative stability with reasonable dividends. In other moments these shares can seem downright boring and lag the market badly, but right now they are a prized investment. In the third quarter, when the broad stock market barely budged, the generally sleepy Dow Jones Utility Index advanced 9.5%. It remains to be seen whether central bank influence will result in economic growth and help stave off a recession. For the moment, this pressure appears to be simply inflating asset prices, while the global economy continues to soften.
The decline in U.S. bond yields in the latest quarter was shocking, with the yield on the ten-year note plummeting from 2.5% to 1.5%, and the thirty-year bond yield approaching 2%. We have not seen a yield that low in the past forty years. Throwing fuel on the fire, Donald Trump badgered the Federal Reserve to follow Europe and move to negative rates. While the Fed is unlikely to follow his dictates any time soon, such comments put even more fear in the minds of individuals, pension funds, insurance companies, and others who are trying to make long-term financial plans and projections.
We responded in several ways to the plunge in interest rates and weakening economic fundamentals across many regions. In instances where our stock holdings had reached full valuation we trimmed back on those positions. We used some of the proceeds of these sales to invest in a few new stock positions. A brief decline gave us the opportunity to put capital into telecommunications and food companies. These companies provide some dividend flow and are typically more stable than other sectors. We are using them as a substitute for bonds, which remain thoroughly unappealing.
Despite the poor outlook for bond investors, we are only ten months removed from a moment where yields were much higher. A thirty-year treasury bond was 3%, and corporate bonds were above 4%. Conditions can change quickly for investors, even in the relatively calm world of bond investments. In the meantime we are searching for acceptable income alternatives, as outlined above. While our current bond strategy remains one of patience and reticence, we have the flexibility to change our approach if conditions improve.