As we return to work after a holiday weekend, the market reminds us that the ramifications of Brexit will not recede in the short term. Investors continue to seek safe haven investments such as U.S. Treasuries and the risk-off sectors in the equity markets: utilities, consumer staples and telecom. The ten year Treasury yield dipped to a new low on Tuesday ending the day at 1.36% despite the strong U.S. economic news last week. The chart shows how strong the defensive areas of the market have been in 2016.
Domestically, the positive economic news over the last few weeks includes:
· Initial jobless claims remain at all-time lows
· Consumer confidence reached an eight month high in June
· The ISM Manufacturing reading of 53.2 in June was the highest reading since February of 2015 (Any number above 50 means the economy is expanding)
· The ISM Service Sector Index hit 56.5 in June, well into expansion territory
· Wage growth is accelerating
· Mortgage rates remain at low levels
Examining the positives above, most market observers would expect long-term U.S. Treasury rates to be rising but in fact the opposite is happening. Brexit has amplified this phenomenon, creating more uncertainty in the global markets as more central banks are employing negative interest rate policies to try to stimulate inflation and economic growth. This creates more demand for U.S. Treasuries as investors in countries like Japan and Germany still find U.S. yields attractive. Currently over $11 trillion in sovereign debt is negative and as the chart below shows many more countries are close to entering negative territory.
Since the British voters decided to leave the EU, (in a non-binding vote), the ten year U.S. Treasury yield has declined from 1.74% to 1.36%. We can all agree that the political ramifications of Brexit are real, yet the economic and financial consequences are less certain. Until the markets get some clarity on the situation in Europe, the volatility will remain.
Investors, looking beyond June’s strong economic readings in the U.S., are concerned about a global contagion from Brexit. The recent downward trend in yields has resulted in the S&P 500 dividend yield surpassing the 30 year U.S. Treasury for the first time since 2009. Despite that, we are confident this scenario is not like 2009 and therefore our fundamental portfolios remain overweight equities relative to bonds.
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