We have four interns this year. At the start of their internships, we required that they read “How the Economic Machine Works” by Ray Dalio. The paper discusses how central bankers have certain levers they can pull, such as raising and lowering interest rates and other tools to speed up or slow down the economy.
I told them that I’m thrilled our fixed income strategies are doing well yet the unprecedented central bank experiments have so distorted price discovery that I just don’t know if I should scream or shout. I’m concerned that the Fed has boxed itself into a Keynesian corner.
Last week, we looked at valuations — probable 3, 7 and 10-year forward returns. I think you’ll find the following chart from Research Affiliates, as I did, quite interesting. It shows their forecast for coming 10-year annualized real returns (net after inflation) on various asset classes. RA adds confidence bands around their predictions (the red arrows are mine).
Well, holy cow! Not so good. U.S. Core bonds at less than 1%, U.S. large-cap equities at 1% and 60/40 at 1%. I appreciate that Research Affiliates included confidence bands in the chart. The colored dots are the expected real returns and the vertical line shows the high end and low end of the probable outcome ranges. Results could come in a bit higher or a bit lower from the dots marked by the red arrows (expected outcome).
If you missed it, click here for a link to last week’s OMR for more on current valuations and what they tell us about coming returns (and risk). You’ll find that we pretty much get to the same place.
I also liked the next chart. It shows the starting yields as of June 30, 2016 for various investments. You’ll see that high-yield bonds look relatively attractive and to that end HY has had a great run.
Look at that high yield real yield percentage. I’ve been trading the trend in HY for over 23 years. We know high yield well. Don’t go “all in.” The chase for yield has flooded investor capital into HY bonds and funds. This has enabled companies (I call them zombie companies) to receive funding that they otherwise would not have and at terms that should scare every investor. The next recession will wash them out.
You can find the link to RA’s charts and further commentary here.
By Steve Blumenthal | For charts, analysis, and commentary see the rest of the story in On My Radar: I Don’t Know How to Love Him
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.
