The dust is settling. After the various panics that rocked the early part of the year, mainly due to a slow-down in China and the developing world as a whole, Brexit put another shock to the system. Markets panicked and everyone became even more risk averse. But with just a little bit of time we can see that even more than we predicted at the start of the 2016 one thing has become obvious by mid-year – the United States is the only solid place for any kind of investment in the world.
It’s still a tough fight to get the money to where it does the most good, at the risky start-up end of the economy. And there are plenty of signs of fear running amok more generally, expressed in the price of gold. But there is little doubt that the US is the place to be – all the moreso with Brexit.
The Barataria call at the start of the year was generally right, if a little timid. The stock market wound up moving more or less sideways through the early part of the year, marked by large swings as investors worked to sort everything out. The S&P500 is now up about 5% for the year as it has all worked out after the second quarter. Even the Brexit drop has been recovered without incident as investors realized that yes, the US is even more the place to be now.
The one bad call? A year ago, Barataria called for gold to go down below $1000 per ounce on its way to a long-term valley around $650. While it’s clear that the price of gold is still little more than an index of fear in the investment world, there is a lot more fear than we anticipated. Since we made that call, gold smartly bounced off of $1000 per ounce on its way up to roughly twice the long-term prediction. Ouch!
As awful as this prediction turned out, the call for lower rates on long term treasuries was right on, if a bit cautious. Last year’s yield on the 10yr of 2.5% was matched by an all time low of 1.3% recently as money from around the world sought a safe harbor. Since treasuries were first sold in 1792 at the behest of Treasury Secretary Hamilton they have never yielded as little as they do today.
For a historical figure long dead, Hamilton sure can still sing and dance.
Where does this leave us? Money is still coming into the US from all over the world looking for a “safe harbor”. It’s driven by fear abroad far, far more than it is by confidence in the US. That’s the problem which presents itself as an opportunity.
The longest term Treasury, the 30yr bond, typically tracks at a rate about 1-2% higher than the year over year growth in GDP. You can see that in this chart going back to 1973, the time which we always focus on as the point where the relationship between labor and capital broke, creating the world of money that is largely independent of the economy it should be investing in.
If you focus a bit tighter on more recent trends, we can see that the correlation between the 30yr and the economy is even less tight today. But bondholders should still see a net 1-2% over GDP as their reward for parking their money, er, investing in the US.
Today, the rush to buy long term treasuries has pushed the yield on the 30yr down to 2.2%, which is about 1% below growth in GDP. With all the chaos around the world, this appears to be a secular feature – meaning not quite permanent, but lasting long enough that it becomes “the new normal”.
Bond markets around the world are hopelessly screwed up. This includes about $10 trillion in government bonds from Japan and Germany, among other places, yielding negative interest. Bond holders are willing to pay for the privilege of parking their idle money in these instruments. This is the definition of fear all around. It also makes our 2.2% look incredibly strong.
While there is good reason to fear our $18 trillion public debt, long term bond rates below the rate of GDP growth tell us that it is much more manageable than ever before. While it’s critical to remain prudent and not bust the budget, the time is right for substantial public investment in infrastructure.
That money has to be put to work somewhere. If it won’t go into small companies that will create jobs, the government should do what it can.
Currently, treasury actions feature about $30B per month in 10yr bonds and $10B per month in 30yr. The more we can move our debt to these long term instruments the more we can lock in a low rate that will keep our current debt manageable for a generation. This removes any pressure to pay it down and puts the focus on what we can do to start growing our way into the debt. If there is little appetite for private investment, public investment will have to do.
It’s not as though there isn’t a lot to invest in, either.
So where the Barataria predictions for the start of this part of the year appear to be reasonably close, there is still a lot of investment needed. The money is flowing to the government rather than to those who can do the best work with it. If life hands you lemons you make lemonade, after all.
And that’s how Hamiton and Beyoncé are the real forces to be reckoned with – not just in entertainment, but in investment as well.