Second Half Outlook

This article was originally published on on July 18th, 2014 at 6:30am EST

Equities in the U.S. look expensive but our debt looks cheap. Overseas it’s the exact opposite.

Despite the fact that yields here in the U.S. are “below historical norms” there is still an enormous global appetite for our debt. The full faith and credit of the U.S. government — the sole issuer of the world’s reserve currency — is still worth a great deal. Even at an annual coupon of just 2.50%, U.S. Treasuries serve as a universal safe haven for investors when things get shaky in the capital markets.

We saw evidence of this Thursday as equity markets were disturbed by geopolitical events in Ukraine (and then Israel). The piddly current coupon did not dissuade investors from piling into Treasuries, the price of which rallied more than a full percent.

Everything Is Relative

Consider the added reward for taking on a bit more risk — investors currently earn a whopping 30 basis points over U.S. Treasuries by lending to Baa2-rated Italy, a country whose outlook was raised to stable from negative by Moody’s earlier this year. Spain only offers an extra 15bps over the U.S. Treasury on its 10-year paper today. The unemployment rate in Spain is closer to 50% than it is to 0%. The opportunity here may not be to invest in Treasury Bonds, necessarily, but to glean from the macro picture that there may still be more downward pressure on our interest rates than many believe.

The traditional metrics — economic growth rates and inflation estimates — can no longer be effectively used to gauge whether our nation’s debt is fairly valued. As I see it there are at least three major factors working against that logic:

1. Federal Reserve intervention/manipulation of both short- and long-term interest rates;
2. The nature of the global debt markets today, and the need for fixed income among funds and governments with enormous pools of capital;
3. Our stock market being at a record high — investors subsequently rebalancing and taking profits — may be forcing capital back to bonds (a “Great Rotation” in reverse).

The slide in European interest rates over the past two years has been fast, if not furious. In spite of continued Quantitative Easing, the yield on our 10-year is significantly higher today than it was two years ago.

Investors can earn exactly twice the annual yield today by buying European stocks (as represented by VGK, the Vanguard European Stock Index ETF) as they can buying European Government Bonds.

We experienced the same phenomenon here in the US back in the fall of 2011 when the S&P 500 was trading around 1100. Its yield — then around 2.10% — eclipsed that of our 10-year Treasury for the first time ever, as nervous investors drove Treasury prices up and yields down. The S&P is more than 75% higher today.

And it just so happens that European equities look good from a technical standpoint, too. Some might argue that European stocks have already had a nice run — up 100% from the bottom in 2009. But looking through a slightly larger lens, we can see that despite its recent success, VGK is still about 40% below its pre-crash levels in 2008 and resting right on its 200-day moving average….

Whereas stock prices of US companies may be fully pricing in the benefits of low interest rates, those across the pond may not yet be:

You can see the dislocation started after the initiation of Quantitative Easing back in 2009 and has become more and more pronounced over the past three years.

“Be greedy when others are fearful, and be fearful when others are greedy.”
-Warren Buffett

Though it may not make much sense from a micro-standpoint, we feel that US Treasuries offer a more compelling opportunity than US stocks right now. And we feel the exact opposite may be the case across the pond…

Have a great weekend and please let us know if there is any way we might be able to help you…

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main

Adam Scott’s profile on can be found here.

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