Bob’s Journal for 2/20

The bond bull market is back, at least for a while.

Every time it appears that low market interest rates are in the past, something happens to cause rates to decline.

Just a few months ago, central bankers around the world made it clear that they were more worried about deflation and recession than about rising inflation. The central bankers said that tighter monetary policy was unlikely until sometime after inflation was persistently higher than the current target.

Interest rates started to rise as markets anticipated inflation down the road. The rise in rates ended with the spread of the coronavirus from China to the rest of the world.

Reactions to the spread of the virus are reducing economic activity and are likely to cause a reduction in economic output around the world. Quarantines, reduced air travel, factory and office closings and other changes have reduced economic growth.

Some of this output will be made up later after the spread of the virus peaks and economic activity increases. But not all economic activity will be made up.

Slower growth leads to lower interest rates. Rates for some bonds are at historic lows. The United States last week issued a new batch of 30-year treasury bonds. The bonds sold at a yield of 2.061%, beating the October 2019 low auction yield of 2.170%.

Market interest rates on 30-year treasuries haven’t quite matched their all-time low of 1.941% in August 2019, but they are close. The iShares 20+ Year Treasury ETF (TLT) is almost back up to the price it reached last August.

I don’t expect rates to fall much more, and I wouldn’t chase the recent returns in bonds. For interest rates to continue declining, the virus would have to accelerate its spread and cause a reduction in economic activity exceeding what’s already priced into bonds. If you didn’t sell long-term bonds during last August’s interest rate low, consider taking some profits now.

Is Value Investing Dead?

In the last half of 2019, there were signs that the long period of underperformance of value investing might be ending. Value stocks were starting to do better than the growth stocks that had dominated the bull market since 2009.

However, the surge by value stocks ended quickly. Once central bankers said that tighter money wasn’t in the cards for a while and the U.S. and China reached their initial trade agreement, the stocks of large and growing companies resumed outperforming the rest of the market.

Value stocks have underperformed so long that some long-time value investors engaged in detailed research to determine the causes and answer the question, “Is value investing dead?”

Dimensional Fund Advisors is a leading value investor that offers its funds through financial advisors and manages over $600 billion. Its detailed study concluded that value investing will outperform over the long term.

The firm’s leaders said that as long as there are material differences in market valuation, less expensive stocks will eventually prevail.

Dimensional invests using a rules-based strategy. It engages in detailed research to identify the stock characteristics, or factors, that improve returns and the circumstances in which the factors work best. Then, it builds investment models and follows those models.

The firm said it tweaks its models a bit based on long-term research, not short-term trends, but doesn’t expect to make a significant change in its approach. It’s only a matter of time before the premium earned by value investors returns.

But not all value investors are as confident.

Eugene Fama and Kenneth French are two academics who are consultants to Dimensional and upon whose research Dimensional Fund Advisors bases much of its investment approach.

Fama and French recently completed a detailed review of value investing. They calculated that value investing has recorded its lowest relative returns in decades and its recent performance versus growth stocks is at the lowest point since 2001.

On the key issue, though, the duo didn’t reach a conclusion. They said it wasn’t clear yet whether the excess gains from value investing will be repeated or whether this period of underperformance, which is longer than usual, will come to an end.

Some investors argue that after Fama and French published their groundbreaking work in favor of value investing in 1992, the strategy became too popular. The popularity means that the strategy won’t generate excess returns in the future.

The duo’s original research concluded that there are risks to buying value-priced stocks, so the market over time will compensate those who take the risks with above-average returns. Now, they say the data do not support a clear conclusion that this will continue. We’ll have to wait to see if value stocks turn around at some point.

The Data

Retail sales continue their moderate, steady growth. In January, retail sales increased 0.3%, but December’s sales were revised downward to a 0.2% increase instead of the original 0.3%. Excluding autos, January sales still were up 0.3%. This rate is consistent with the three previous months.

Industrial production took a hit in January, partly due to unseasonably warm weather that reduced utility production. The problems at Boeing didn’t help matters.

January’s overall production declined 0.3%, and December’s production was revised down to a negative 0.4% instead of a negative 0.3%. Manufacturing production was down only 0.1% in January.

The Empire State Manufacturing Survey continues to improve. For February, the survey’s index increased to 12.9 from 4.8. This was well above expectations. New orders and shipments both increased significantly.

The Philadelphia Fed Business Outlook Survey also surged, coming in at 36.7 for February compared to 17.0 for January. Analysts were expecting a reading of about 12.0. This is the highest level since February 2017. New orders were at their highest level since May 2018 and over 50% of firms that responded to the survey reported an increase in new orders.

The Leading Economic Indicators Index from the Conference Board for January also took a big jump of 0.8%, compared to a 0.3% decline in December. The Conference Board said that this indicates that economic growth of about 2% will continue through early 2020.

Home builders remain positive. The Housing Market Index from the National Association of Home Builders (NAHB) declined to 74 in February from 75 in January. The last three months’ readings are the highest levels since December 2017, according to the NAHB.

Builders say demand is strong, but sales still are constrained by high construction and development costs. Major problems are regulatory constraints, a shortage of skilled workers and an insufficient number of lots on which to build.

The housing starts report was mostly positive. Starts in January were 3.6% below December’s level. Even so, the January starts were 21.4% higher than 12 months earlier. This also was the second consecutive month that starts exceeded expectations by more than 100,000. The last time that happened was March 2005. The average number of monthly starts during the last 12 months is at the highest level since before the housing market crash.

Consumer sentiment, as measured by the University of Michigan, continues to be solid. The Consumer Sentiment Index for February was 100.9, up from 99.8. This is the highest level since March 2018. The current conditions component of the index didn’t change much, but expectations for the future improved. Also, net gains in household income and wealth were reported to be at their highest levels since 1960.

Inflation at the wholesale level increased in January. The Producer Price Index increased by 0.5% for the month and 2.1% over 12 months. Excluding food and energy, the PPI still increased 0.5% for January and was up 1.7% over 12 months. For the previous two months, the PPI came in below expectations, so it will take a while to determine if producer prices really are climbing.

New unemployment claims increased by 4,000 to 210,000.

The Markets

The S&P 500 rose 0.27% for the week ended with Wednesday’s close. The Dow Jones Industrial Average lost 0.55%. The Russell 2000 increased 0.17%. The All-Country World Index (excluding U.S. stocks) declined 1.07%. Emerging market equities fell 1.21%.

Long-term treasuries rose 1.51% for the week. Investment-grade bonds increased 0.23%. Treasury Inflation-Protected Securities (TIPS) added 0.47%. High-yield bonds declined 0.14%.

In the currency arena, the U.S. dollar increased 0.64%.

Energy-based commodities rose 2.40%. Broader-based commodities jumped 2.29%, while gold gained 2.94%.

Bob’s News & Updates

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