Market Commentary - May 2018

The 10 year U.S. Treasury is a debt obligation issued by the United States Government and is important because it's the benchmark that guides other rates, mainly auto and mortgage. The last time the 10 year treasury crossed 3% was during the "taper tantrum" of 2013 when yields spiked from 1.8% to 3% in about a six month period. Both bond and equity markets experienced extreme volatility which led the Federal Reserve to shift course and keep rates lower leading yields to drop sharply and remain relatively low until this year. 

Historically the yield on the 10 year U.S. Treasury has been well north of 4% but has experienced 3% or lower since mid 2011 leaving investors nervous of how things will play out. There are legitimate reasons to be concerned.  The total debt to total equity ratio is at its highest level since 1999 and corporate debt is at its highest level relative to U.S. GDP since the financial crisis. Also, the amount of debt that needs to be refinanced in the next five years hit a record level of $2 trillion ($734 billion of this comes due in 2020 & 2021). In addition, the pace of stock buybacks could slow in the face of higher rates and consumers typically have less disposable cash in the face of higher mortgage, auto and credit card rates. If cash alternatives (i.e. CDs and Government Bonds) start earning attractive yields, investors could sell a portion of their bonds and equities to reduce risk. You can see why some are starting to sound alarm bells.

It is important to remember that markets are not shaped by one or two data points, it is a culmination of many and while the 10 year treasury does deserve attention, so do others. Corporate earnings have been very strong as we are in the midst of one of the most impressive earnings seasons since 2008. Of the companies that have reported earnings in 2018, ~80% have exceeded analyst expectations, which is above the long-term average of 64%. In addition, corporate profits are expected to be the highest since 2011 and cash on U.S. corporate balance sheets are at their highest level. Despite high amounts of debt, corporations seem to be in better financial shape today. Also, the U.S. unemployment rate is currently at 4.1%, which is 50% lower than where it was in 2012 and wage growth has steadily increased the last 6 months. 

In my opinion the most important aspect with rates is the pace at which they increase. If rates spike faster than anticipated along with som other economic event (i.e. political unrest, trade war), then it is anyones guess as to how things will shake out. 

Ara