Global financial conditions are about as good as they can get. Stock markets are hitting new highs. May has been the busiest month for IPOs in a decade. Lending conditions are easing. Many central banks are again cutting rates while others are still buying up assets as part of their massive quantitative easing programs. Although yields on US government debt have edged up, yields on corporate debt have kept coming down, leaving credit spreads as tight as they have been since before Lehmanâ€™s collapse. US high yield debt is now below 5% for the first time ever. The global stretch for yield has brought emerging market yields down to levels usually associated with developed markets â€“ and in some cases lower.
For borrowers, the drop in interest rates is great news. With mortgage rates so low, housing affordability remains at all-time highs. Corporate issuance has been booming, and even cash-rich companies like Apple are borrowing with rates this low. And Brazilâ€™s Petrobras is about to offer the biggest emerging market bond issue ever.
For central bankers, while low rates can be good for growth and asset prices, some policymakers are starting to voice some concerns about the risk of a new credit bubble forming â€“ but not enough to signal that they intend to reverse course any time soon. The most Ben Bernanke has said is that the Fed is â€śwatching particularly closelyâ€ť for signs of excessive risk taking. Meanwhile, the flood of liquidity is set to get even higher, thanks to the latest rounds of easing led by Japan. In this environment, all asset prices could go higher. According to Lipper, US fund flows are still strong for both stocks and bonds.
For investors, the asset allocation environment is shifting. With bond yields already pancake flat, bond prices are close to being capped out: there is not much more yield to reach for, at least for fixed income. The Barclayâ€™s Aggregate Bond Index has already been lagging the S&P 500 since last November. As the global economy regains momentum and inflation begins to turn up, investors should consider shifting into assets with better total-return prospects like stocks, commodities, and real estate.
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Warren Hatch, PhD, CFA
Chief Investment Strategist
McAlinden Research - a division of Catalpa Capital Advisors, LLC