The current multi factor economic downturn being witnessed in the world is showing many divergent and interesting phenomena that are rarely witnessed. While in the United States of America thirty-year bond yields have been falling on account of heightened China-United States trade war-like situation. The falling world growth outlook is forcing companies world over to postpone growth expenditure slated for the next couple of years and are instead distributing the surplus cash at hand as dividends. The effect of the same is that the dividend yields the world over have been witnessing a substantial rise.
The S&P 500 index is the headline index of the stock markets in the United States of America. It is representative of the largest five hundred companies listed on the stock exchanges in the United States in terms of market capitalization. The index more often than not is seen as a barometer of the American business prowess, as most of the companies on the index have multinational operations. It is also a great example of how globally integrated the American economy is and how the movement of this index impacts the movement of other comparable stock indices around the world. The index, for all its above characteristics, is used extensively as a benchmark to gauge the performance of many an index fund and other such investment vehicles that invest in the stocks listed in the United States of America. During 2018 and 2019 the index has delivered a good performance despite the looming depressing economic headwinds prevailing across the world. Most of the companies on the index have not only delivered a good financial performance but have also doled out significant sums in the form of dividends. In fact, the dividends paid out for this year have been a record of sorts having left investors cash-rich and flush with funds. This move it seems is in consonance with the federal reserve’s efforts to provide a boost to the American economy ahead of a subdued economic period by lowering interest rates and the corporations playing out their part by distributing surplus funds.
The 30-year US treasury bonds are amongst the longest-term gilt-edged debt instruments trading in the US markets. The yields on these instruments are directly impacted by economic and political events like the United States- China trade war or the change in interest rates announced by the Federal Reserve. The prices of these bonds and their yield curves are thus regarded by many as being the barometer of the American economy. The Federal reserve in the recent past has lowered the interest rates unexpectedly in response of the impending global economic downturn allying fears that, despite a good run in the recent past, the economy of the USA might be entering a period of sustained weakness. This along with the other economic headlines from around the world has push up the prices of bonds in the US markets indicating that the market is in favour of safe assets which means that the economy is headed towards an impending weakness. However, towards the end of October 2019 there has been news that informal agreements have been reached between United States and China which could ease the tensions related to the trade war between the two countries to some extent and could have an impact on the weakening of bond yields. The overall forecast regarding the world economic environment remains as it is, with the easing of tensions between United States and China having a mild ameliorating effect.
The situation in the rest of the world is not very different than what is happening with S&P 500 and US 30-year treasury bond yields. Across the Atlantic the FTSE 100 index of the London Stock Exchange has also been delivering a steady performance since the past two years while the economy of the United Kingdom has been sliding on account of the uncertain environment caused by the pre-effects of Brexit. There also the Bank of England has adopted a relaxed monetary policy, and most of the companies on the Footsie have declared generous dividends with some even doling out special dividends. The same is also the case with other major European countries like Germany and France. The situation on this side of the Atlantic will continue to remain the same until sometime after Brexit has been delivered, before any improvements can be expected. The yields of thirty-year treasury bonds in the United Kingdom have also seen a marginal fall in recent months indicative of an advancing economic weakness.
However, what’s unique this time around is that the thirty-year bond yield is actually coming down below the S&P 500 dividend yields. This is a rare event and has not been witnessed since the 1950’s when severe long-term bearish sentiments were registered in the bond markets which prevailed for almost two decades. This time around a repeat in the same phenomenon could very well be an indication of an impending long-term weakness in the bond markets which, should it happen could lead to devastating consequences.
However, not all the circumstances that could lead to such a scenario are present, the most important of them being that there has to be an increased volatility in a certain marketplace that could justify the increase in bond yields because of reduction in bond prices. Back in the 1950’s such a phenomenon was observed when bond markets had a long trailing volatility more than that of the equity markets which justified the weakness then. This time around however, this situation is not present at all, the equity markets have witnessed increased volatility in the past one and half decades, first during the 2008-11 economic crisis and now during the present China-United States trade war-like situation and Brexit situation in Europe. On the other hand, the bond market situation has been quite stable, with little volatility observed in the past two decades.
Given the above it seems that the occurrence of this rare phenomenon would not be long lasting or have any adverse effect on the bond markets in the USA. On the dividend yields of S&P 500 companies as well, there is now increased anticipation that the companies that have paid good dividends this year may not be able to sustain it for 2020 or further ahead.
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