|Aug. 18, 2014 6:15 PM ET
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Inflation fears are nowhere to be found.
Sovereign ten-year yields at levels associated with recessions.
High stock market valuations may be overlooking the bond markets' message.
Across the globe, government bond prices, as seen across the ten-year maturity spectrum, remain at extremely high levels, with yields at corresponding low levels. Examples are easy to find. The ten-year yield in Japan is 0.50%, in line with the 0.48% level in Switzerland. In Europe, the ten-year yields in Germany, the Netherlands, France and Sweden are now below 2.0%. More surprisingly, the ten-yield in Spain is 2.45%, very close to the US rate of 2.39%. Yields in the US are now at low levels last seen some 18 months ago. Currently, the ten-year yield in Canada is just 2.04%, well below the rate offered by the US ten-year securities.
The economic slowdowns in Japan and Europe are well-publicized, with Germany and Italy reporting contractions in their latest quarters. The forced bailout of one of the largest banks in Portugal has served to remind European investors that safety concerns make government debt the most attractive arena in the current environment. Japan is suffering from a negative consumer reaction to recently increased sales taxes. In China, many observers doubt that the overall economy will attain the 7.5% growth rate in 2014 that the central government officials maintain is a still a reasonable goal. Clearly, fixed income investors are seeking the safe, reliable "return" of capital, while forgoing a larger return on capital. We are seeing buyers' panic in a "melt-up" market in government bonds, and safety concerns trump all other goals. Inflation expectations, the enemy of fixed income investors, are missing in action as the bond markets broadcast loud and clear "we see no inflation anywhere."
Equity and fixed income investors need to examine the government bond markets closely to think through the message of these record low yields. If these markets are flashing a "recession is coming" warning light, most of the world's equity markets are ignoring the message. In the U.S. market, for example, the S/P 500 Index is up over 6.0% this year, following a 32% increase in 2013. History tells us that this low-rate environment leads to an economic slowdown, or, if the economies recover, to a severe bond market correction. It is highly unlikely that these ten-year yield patterns will continue if inflation reappears or growth targets are raised. Similarly, if these ten-year low-yield markets continue, then economic forecasts will turn more negative, and equity markets will begin to discount slowdowns that will negatively impact corporate earnings and the equity markets. Markets can remain extended for longer periods than investors first imagine, but the underlying economic forces will eventually prevail, leading to inflation and growth (good for the stock markets initially) on the one hand or material slowdowns in growth that will lead stock markets to correct. Investors are well advised to monitor the ten-year government markets closely to seek clues about what these markets are saying about the prospects for inflation and global economic growth.