02/17/2021
It is getting increasingly difficult to ignore the signs of market excess. The list has long included absolute measures of stock valuation that are near their historical highs, including Price/Earnings, Price/Sales, Price/Book Value, and Price/GDI. Of course, the counter argument has consistently pointed to the historically aggressive fiscal and monetary support, and the promise of more to come on both fronts. This counter argument has also consistently pointed to the relative valuations of competing asset categories, like bonds and cash, as being so unattractive they offer no competition at all. Last week, this prevailing sentiment led to a record dollar amount of flows into global stock funds at $58 billion. And all of this has contributed to the surge in such speculative plays as cryptocurrencies and the current favorites of the momentum crowd on social media.

But not even the relative unattractiveness of bonds has deterred investors in their quest for yield in a world where it remains hard to find. And now we learn that last week junk bond yields hit an all-time low. Last Monday, the yield on the ICE Bank of America High Yield Index dipped below 4.00 percent for the first time, ending the week at 3.97 percent. With real Treasury yields negative out beyond ten years, an argument can be made that even the after-tax return of a junk bond yielding 3.97 percent is better than what the government will pay. This argument, of course, conveniently looks past the credit quality issues that come with junk bonds.

Those willing to hold their noses also point out that the option-adjusted spread to Treasuries, currently 347 basis points, remains above its ten-year low of 317 basis points back in October, 2018. Little mention is made of the ten-year average of 488 basis points. Although the market’s appetite for anything with yield will help repair even the most damaged corporate balance sheets, it won’t create value where there is none, and will likely just prolong the day of reckoning for some. And just as junk bond yields have been declining, Treasury yields have been rising. The ten-year note ended last week at 1.21 percent, its highest since last February. And in early trading on Monday is yielding 1.24 percent. The trailing twelve-month core Personal Consumption Expenditures (PCE) reading was 1.5 percent in December, meaning the real ten-year yield remains negative. But the nominal yield is now 75 basis points above its low of last July, edging closer to a level where investors may begin to take notice as potential competition for corporate credit.  

Congress and Investors Turn their Attention to Stimulus

With the second impeachment trial of the former president now concluded, Congress will turn its focus to President Biden’s $1.9 trillion stimulus bill. Just a few short weeks ago, the betting was that a package no larger than $1 trillion was likely to pass. But those estimates have risen recently as the process of budget reconciliation, which requires no Republican support to pass, becomes increasingly likely. Estimates for the potential size of this next round of stimulus now hover in the $1.5 trillion range. That would equate to roughly 7 percent of GDP. When combined with the $900 billion stimulus package passed in December, it equates to 11 percent of GDP. These are staggeringly high amounts. And there is a sizeable infrastructure spending bill waiting in the wings. At the same time, the Fed has continued to dismiss concerns about inflation and the tapering of its bond purchases, insisting its focus will be on achieving full employment. In other words, letting things run hot, at least for a while. This policy mix has been the green light for investors to pursue risk with impunity.

Valuations Increasingly Leaving Room for Disappointment

Whether this policy mix achieves the desired economic outcome continues to depend to a great deal on the success of the vaccine rollout. And although progress has been slower than hoped, progress is still being made. In the U.S., 55 million vaccine doses have now been administered, including a second dose for some. Importantly, the pace of the rollout is accelerating. Last week, an average of 1.6 million doses were administered daily. That is up from 0.9 million four weeks ago. Infection and hospitalization rates have come down as well. But roughly 85 percent of population remains uninoculated. And healthcare professionals are now warning of a potential spring vacation spike in infection rates, just as the holiday spike is receding. And the identification of a number of mutations has the healthcare community urging speed in the race to immunize the population.

Wealthy countries are better positioned in this battle. Globally, 98 percent of the population has yet to receive a shot. At the current pace of vaccine distribution, it is estimated that immunizing the entire global population will take five years. Of course, that pace will quicken, especially as more vaccines become available. But the question of when we can expect a return to so-called normal remains, even within the U.S. Investors have voted with their dollars and concluded that the policy mix from Washington will eventually get us to that point, perhaps by the third quarter. But valuations are increasingly leaving little room for disappointment.

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Some of the opinions, conclusions and forward-looking statements are based on an analysis of information compiled from third-party sources.  This information has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. It is given for informational purposes only and is not a solicitation to buy or sell the securities mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the specific needs of an individual investor.
The ICE BofA High Yield Index uses an index of bonds that are below investment grade (those rated BB or below).This data represents the ICE BofA US High Yield Index value, which tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market.
Non-investment-grade (high-yield or junk) securities present greater price volatility and more risk to principal and income than higher rated securities.
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
A 10-year Treasury note is a debt obligation issued by the United States government that matures in 10 years. The 10-year yield is typically used as a proxy for mortgage rates, and other measures.
Personal consumption expenditures (PCE) are a measure of the outlays or how much consumers are spending. The PCE reading is released monthly by the Bureau of Economic Analysis.
Past performance is not a guarantee of future results.
Third party companies mentioned are not affiliated with Ameriprise Financial, Inc.
Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
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