The greatest bull market in the history of markets keeps chugging along, as long-term bond yields continue their perpetual slide. As of Wednesday, the yield on the benchmark 10-year Treasury note was a mere 1.38%.
This is a bit confusing for some people because the U.S. economy seems to be in relatively good shape. Gross domestic product in the second quarter is expected to increase 2.4%, wages are growing at 3.4%, the ISM non-manufacturing number just came in at 56.5, jobless claims are at 40-year lows. Yeah, there are some worrisome trends out there, but the broader picture doesn’t seem to mesh with such low interest rates.
If we step back and look a the global picture, it all starts to make more sense. The U.S. bond market is stuck in a global vortex of 0% rates. Thanks to weak growth in China, Europe and Japan, global central banks have cut rates in an effort to spur growth. This leaves savers earning virtually nothing on their cash in a weak environment in which longer rates also don’t yield much. And on a relative basis, the U.S. looks like a high-yield safe haven. Which is why foreigners are piling into U.S. Treasury bonds, exacerbating the decline in rates.
What’s so interesting about this is that U.S. markets appear relatively buoyant when compared with those abroad. The S&P 500 is just shy of its all-time high and the purchase-only index for U.S. real estate prices is at a record. And a big part of that is due to relative economic strength combined with low yields, which has forced investors into other assets.
What’s even more interesting is that this environment appears (at least in my view) to be ripe for a financial-asset bubble. That is, as weakness abroad drives yields lower in the U.S., stocks and real estate look increasingly attractive. Stocks have clearly benefited from this “reach for yield,” as have certain types of higher-risk bonds.
But we haven’t seen the big boom in real estate yet (with the exception of, maybe, San Francisco). But could we be there? I am not certain, but here in Southern California the chatter is starting to get a little crazy again. As rents rise rapidly and future returns on stocks and bonds just don’t look that great, many people are turning to real estate.
The other day I was talking to one of the most rational and intelligent guys I have ever known. I was talking about all of this and how absurdly low mortgage rates are. He said: “Yes, that’s why you buy a house in today’s market and then go out and buy another one.” Now, this is an Ivy League econ PhD talking here, not your average stripper circa 2006 from “The Big Short.”
When rational people start saying irrational things, my ears perk up. And it makes me wonder (still) if we’re not on the precipice of something that looks a lot more like 1999 than 2008. Add it all together and it makes you wonder: Are we ripe for a big financial-market bubble, thanks in large part to foreign economic weakness? It might seem paradoxical, but don’t discount that risk.
Cullen Roche is the founder of Orcam Financial Group LLC, a financial-services firm that offers low-fee asset-management, private-advisory, institutional-consulting and educational services. He is the author of “Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance,” “Understanding the Modern Monetary System” and “Understanding Modern Portfolio Construction.”