Our 2015 investment themes are quite similar to our 2014 list that worked well for us. If it ain’t broke, don’t fix it.
The Treasury “bond rally of a lifetime” still seems intact. The “risk on” investment climate for U.S. equities persists, but as in 2014, we approach it with trepidation and with a defensive portfolio position. The U.S. economy is continuing to grow but at subpar rates (Chart 1) while growth in China is slowing, is very sluggish in the eurozone and negative in Japan.
The dollar is reigning supreme (Chart 2) — and 2015 may turn out to be the year of the greenback as almost every other currency declines against the buck, especially the euro and yen.
Commodity prices may drop much further, especially petroleum, while financial problems in Russia, Venezuela and elsewhere escalate severely. Deflation is spreading worldwide and may expand beyond the energy sector to prices in general. And low-quality bonds here and abroad are likely to keep declining as are emerging market stocks.
Here are our 13 investment themes for 2015.
1. Treasury bonds. There are many reasons why we continue to favor long Treasury bonds. Here are 10:
1. Safe haven. Like the U.S. dollar, Treasurys are a safe haven in times of global turmoil and uncertainty, of which there are plenty today.
2. Deflation, extant in many countries (Chart 3) and looming in many others including the eurozone, makes current Treasury note and bond yields attractive.
3. Quantitative Ease, under way in Japan and likely soon in the eurozone, provides money to invest in U.S. Treasurys.
4. Treasury yields are attractive relative to those abroad. The 2.17% yield on the 10-year Treasury note vastly exceeds the 0.54% yield on 10-year German bunds, 0.33% for 10-year Japanese governments (Chart 4) and almost every other developed country 10-year sovereign (Chart 5). With the new round of QE in Japan and impending QE in the eurozone, the BOJ and ECB will be buying more government securities, sending yields even lower. The U.S. government obligation is probably at least as high quality as any of these others, and the rising dollar against the euro and yen enhances the appeal to foreigners of buying U.S. debt. What are we missing?
5. Foreigners are buying Treasurys. In the December sale of $13 billion in 30-year Treasurys, indirect bids, a measure of foreign demand, took 50%. The Fed is no longer adding to its Treasury portfolio but foreigners, as well as domestic investors, are more than replacing Fed purchases. With half of Treasurys owned abroad, it is truly a global market.
6. U.S. banks are buying Treasurys as they move away from lower-quality assets, in part to comply with new rules requiring the biggest banks to hold more liquid assets and 60% of these must be backed by the federal government. Also, in counting towards liquid assets, corporate obligations get a 50% haircut but those backed by the full faith and credit of the federal government get 100% credit.
7. Long Treasurys continue to be attractive to pension funds and life insurance that want to match their long-maturity liabilities with similar duration assets.
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