U.S. equities consolidated on the week while global equities were mixed. When categorized by market cap, small to mid-size companies generally outperformed large companies on the week. Bond prices squeezed into an ascending wedge which suggests the possibility of higher prices in the near term.
It is striking that bond market participants appear unconcerned about the possibility of future inflationary pressures. Interestingly, there are several bits of information to suggest they may be justified in their belief. Although inflation concerns have been raised at various times since 2008, inflation has yet to show up in a significant, sustained way. Data as expressed through the Federal Reserve’s Trimmed Mean PCE moderated in June to a 12-month forward number right around 2% which is not suggestive of out of control inflationary pressures. It will be interesting to see how the July Trimmed Mean PCE number comes in. A stable number in July would be the best data-based evidence that the recent strong uptick in inflationary pressures was indeed transitory.
Why does inflation matter? If one is a bondholder, inflation is a concern because interest rates typically have to rise the in face of inflationary pressures. Bond prices generally move inverse to interest rates. If inflation rises and interest rates rise, the price of bonds goes down. If one holds bonds in a balanced portfolio, investors could experience losses in the bond portion of the portfolio.
What does this all mean for purchases of new bond positions? Perhaps the best way to think about a bond investment relates to the yield one receives at purchase. If the bond investment is yielding 2% at purchase, then over a long time horizon total return on that investment will tend to converge on 2%. This is not always the case and can vary dramatically based upon the bond investment purchased, however, it is not a bad way to think about bonds generally. The problem at this point is that yields are in the vicinity of their lower bounds. They have very little room to fall and thus this brings into question the value proposition of making a new bond investment today. On a real basis, the situation is a little worse. A bond investment yielding 2% over the long term with inflation running at 2% means an investor makes no money on a real basis. Since the goals of most investors require that their portfolios grow on a real basis, a new bond investment might not be suitable even though there are still some diversification benefits.
– Best Regards
Cory Haupt
Click Here to sign up to receive the market notebook in its entirety each week.
