The US Federal Reserve met last Wednesday. The outcome of the meeting was a bit more hawkish than investors expected. While the Fed originally expected the first rate hike in 2024, the US monetary authority now expects the first rate hike "already" in 2023. In addition, the Fed will soon begin discussing a gradual reduction in monthly bond purchases under the quantitative easing program (tapering). At the same time, the Fed now buys $ 120 billion in bonds, $ 80 billion in Treasuries and 40 billion in mortgage-backed securities each month. In the end, the hawkish tone of the US Federal Reserve sent financial markets down.
The broadest global stock index MSCI All Country World declined by 1.9%. The Central European stock index CECEEUR declined by 2.3%. Overall, however, global stock markets as a whole remain overvalued as our global valuation Z-Score reaches 2.3, which is still close to the all-time high. The average global equity valuation is thus approximately 2.3 standard deviations above the historical average, which is truly unprecedented. Therefore, I believe that equity returns will be rather below average in the next few years. The average annual equities returns, including dividends, over the next five years is unlikely to exceed 5%.
Bonds also fell last week. The broadest global bond index, Bloomberg Barclays Global Aggregate Bond, lost 1.0%, while the average global bond yield to maturity rose by 0.05 percentage point to 1.13%. However, in real inflation-adjusted terms, the average global bond yield to maturity remains deeply negative, currently at -3.0%. Negative real inflation-adjusted bond yields to maturity are referred to as financial repression. The performance of corporate bond indices was also slightly negative.
As for the outlook for bonds, they are just as expensive as equities at the moment, and even more expensive than stocks on a relative basis. Therefore, I believe that the bond returns will be below average in the next few years compared to the average historical trends.
Commodities didn't do well last week either. The S&P GSCI global commodity index declined by 2.3%. However, oil strengthened slightly as the price of the barrel of the North Sea Brent rose 1.1% to $ 74. Gold declined by 5.8% to $ 1,768 per troy ounce.
Hawkish Fed, on the other hand, was a bonanza for the US dollar, which strengthened significantly last week. The DXY dollar index, which measures the dollar's performance against a basket of other major currencies, strengthened by 1.8% last week. Against the euro, the dollar strengthened by 2.0% to 1.186 USD/EUR. Koruna weakened last week. Against dollar, koruna weakened by 2.6% to CZK/USD 21.45 and against euro, koruna weakened by 0.7% to CZK/EUR 25.52.
Chart of the week - Long bonds bull market is over
According to the analysis by the British investment company Schroders, bonds as the global asset class have never been as expensive as they are today. Today's chart shows that currently about 20% of all bonds are trading at a negative yield to maturity. This means that if an investor buys such a bond on the market at the current market price and holds it until its maturity, he will realize a loss with certainty. This is probably the key absurdity of today's financial world, which is, of course, due to the unprecedented quantitative easing or printing of fiat money by key central banks.
The situation even went so far that in recent days, for the first time, the yield to maturity of the Greek government bond with a five-year maturity also fell into the negative territory. At the same time, Greece's indebtedness, according to the government debt-to-GDP ratio, is already exceeding an unprecedented 200%. Furthermore, approximately 60% of all bonds bear a yield to maturity of up to 1% and only approximately 5% of bonds bear a yield to maturity of more than 4%. In 1997, however, the situation was diametrically different, as the vast majority of bonds bore a yield to maturity of over 4%.
In analyzing the global bond market from a long historical perspective, we can say that the global bond bull market began around the early 1980s. Since then, bond yields to maturity have gradually declined, leading to much higher bond market prices. Bond investors have thus made phenomenal returns over the past 40 years. However, this large bull market is now over, as the average global bond yield to maturity, according to Bloomberg, currently stands at only about 1% in nominal terms. Therefore bond yields to maturity have nowhere to fall significantly, or respectively bond market prices no longer have much room to further rise.
At the same time, if we adjust the average global nominal bond yield to maturity by the average global inflation rate, which is currently 4.1%, we get a negative average global real inflation-adjusted bond yield to maturity of -3%. We refer to this situation as financial repression. Therefore, I dare say that the total bond returns will be below average compared to average historical trends in the coming years, and investors will be forced to diversify their portfolios much more.
Investment Strategist at Conseq Investment Management, a.s.