July 2016


Government central banks, like the US Federal Reserve, control short “overnight” interest rates and the printing of money. In order to stimulate an economy, a central bank may loosen monetary policy (i.e. lower interest rates and print money) in order to boost investment activity and exports. Many countries continue to do this.

In recent months Australia, India, Indonesia, South Korea, Taiwan and Turkey lowered their interest rates. Hungary lowered overnight interest rates to negative 0.05%. Negative overnight interest rates remain in Denmark, Japan, Sweden, Switzerland and the European Union (EU).

Low overnight interest rates, money printing, high regulatory requirements and low investor confidence has raised the demand for perceived higher quality government bonds. In turn, this has led to record low government bond interest rates. Worldwide, about two-thirds of all outstanding government bonds offer an annualized total return of less than 1%.

In recent weeks, German ten-year bond yields moved below 0%, Japanese government bonds maturing in less than 17 years yield less than 0% and nearly all Swiss government debt has a negative yield. Even France has $1 trillion of debt outstanding with a negative yield.

Low rates combined with the uncertainty over future membership of the European Union results in money flowing to safe-havens like the US. In turn, yields on US Treasury debt have fallen below 1.4% and 2.2% for 10-year and 30-year bonds.


With the unexpected British vote to leave the EU (Brexit), global stock markets sunk for two trading days before rebounding. The British voted against European centralization, regulation, taxes and immigration. The UK remains in favor of global trade.

While Britain’s government may follow through with an official request to leave the EU, this process should take more than two years. During this time, Britain still benefits from EU trade treaties and might negotiate a compromise with the EU.

Representing 3% of global economic activity, Britain is three times more economically important than Greece, Iceland and Ireland combined. However, the British economy may continue to grow through this perceived crisis, albeit at just 1%. Whereas, Greece, Iceland and Ireland had recessions during their crisis.

Unlike Greece, Britain has its own currency. Mostly due to the Brexit vote, the UK Sterling has lost 16% of its value vs. the US dollar in the last twelve months. When a similar currency move happened the previous year (6/2014-6/2015 Euro fell 18%), Europe benefitted from more competitive exports and record tourism. At a 1.33 pound to dollar exchange rate, it is an attractive time to visit England.

Similar to Brexit, the US presidential election media coverage also creates uncertainty and volatility. Due to the internet, smart phones and tablets, information and misinformation will be constant. As the uncertainty disperses, the domestic economy and equity markets may strengthen.


Several stock markets have produced lackluster returns over the last twelve months. US large-caps returned positive 3.5%, US small-caps negative 6.5%, the remaining developed world (EAFE) negative 9.7% and the emerging markets negative 11.2% Part of the uninspiring returns are due to declining corporate profits. In calendar 2015, S&P 500 corporate profits (earnings per share) fell 11%, marking the first annual decline since the financial crisis. Fifteen points of the decline were due to lower energy prices resulting in lower profits for energy companies and their suppliers. Another six points resulted from the strong US dollar making US exports less competitive. Without these two influences, S&P 500 profits would have risen 10% in 2015 rather than falling 11%.

Later this year, energy price declines should annualize (meaning energy prices could be higher year over year). Some other commodities are rebounding with gold near a three-year high and lithium regularly achieving new records.

Despite a 2.5% headwind from energy, currency and inventory rebalancing, the US economy continues to grow at a slow pace. First quarter growth of 1% should accelerate as the year progresses.

While energy companies like Exxon and Chevron can influence overall corporate profits, the consumer makes up 69% of the US economy. The US consumer has benefitted from the 54% decrease in oil costs over the last two years ($105.74 WTI per barrel at the end of June 2014 to $48.33 on June 30, 2016). This has lowered home heating and gasoline prices.

Interest expense remains low with 30-year mortgage rates at 3.5%. Meanwhile, if the consumer wants a job, it is available with many national retailers unable to fill positions at rates above minimum wage. Already this year, many labor unions have demanded and received meaningful wage increases.

With a stronger consumer, stabilizing commodity prices and easier comparisons, second quarter S&P 500 profits should rebound both sequentially and year-over-year. Third quarter and fourth quarter corporate profits are likely to set new records. As US corporate profits rebound, domestic stock indices may produce better returns.


In line with many other developed markets, US dividends yields are greater than bond yields. For only the third time in history, the S&P 500 dividend yield is greater than the US ten-year Treasury yield. In the calendar year after the first two occurrences, the S&P 500 index returns were positive and many Treasury bond returns were negative.

Global uncertainty combined with low long-term interest rates continue to be excuses for the Federal Reserve to maintain overnight interest rates close to zero. Bank five-year certificate of deposit (CD) rates remain close to zero. This leaves fewer investment options for retirees, pension funds and other investors who need investment income.

Inflation was kept in check with declining commodity prices and zero wage growth. As commodities and wages start to recover, there is little to offset the broad price increases in education, food, healthcare, housing and travel. At today’s low interest rates, many bonds with positive interest rates may still produce a negative return after inflation and taxes.

Corporate fundamentals, health and dividend policy drive long-term stock returns. Today, many large corporations can issue ten-year debt with an after-tax cost under 2%. This can be used for acquisitions, expansion or retirement of higher cost debt. Low cost financing combined with a likelihood of accelerating corporate profit growth makes numerous stocks attractive today.

When selecting stocks, it is important to focus on companies with growing revenue, profits and cash generation. Preference should be given to companies that can fund acquisitions, internal expansion, dividends and any share repurchases with excess cash flow from corporate operations. Companies that combine all of these features (growing cash cows) are rare and may provide superior long-term returns.

Some retirees can live off the dividends of growth stocks while allowing the principal to remain invested long-term. While the stock market will always have volatility, the right mix of growth stocks may overcome the compounding of long-term inflation and generate a rising stream of cash income.