Real Returns in a World of Negative Rates
What signals should equity investors be watching from the bond market? The US yield curve us now fully inverted with 3-month rates above everything out to 30 years. A reliable recession indicator, albeit one with a wildly varying lead time, that some estimate to be on the order of as much as 18 months early. In Japan, yields have been close to zero across the maturity spectrum for longer than most market participants, have been in the market. German 10-year Bunds have negative yields, though as some have observed, current and anticipated capital requirements of a collapsing bank industry in Europe, coupled with a relative lack of securities, may be reflecting a supply/demand issue. Understanding negative yields in Switzerland out to 40 years is harder. Maybe, just maybe, there is a signal from 100 bonds in Austria this signal would be one of no expected inflation and no economic growth.
Gold appears to be a beneficiary of negative rates. Does this suggest that things that one can touch, like land and commodities in general, might also benefit from low rates? The total return on XOP, the oil and gas production ETF, is now negative over the last 15 years. Exxon mobile has now dropped from the short list of 10 largest US stocks, for the first time in, well, a very long time which we have just googled and found out to be ever, the first time ever. China Petroleum is now valued at less than an honest assessment of proven reserves. Oil producers and oil consumers may be headed towards oblivion though we suspect that actual oil in the ground, held by viable well capitalized companies that can stay in business, will deliver an inflation adjusted return greater than zero.
Recent valuations have China Petroleum trading for less than the value of proven reserves according to Bernstein. With a ratio of enterprise value to reserves of less 1, Bernstein reports this company the cheapest among the top 25 oil majors. Is trading at or less than the value of reserves another number to be breached, liked negative rates, or a signal that assets in this space have become too cheap?
US Banks on Sale or Doomed?
Are the major US Banks on sale at attractive prices, or destined towards a long slow death and nationalization? Unlike their Japanese or European peers, US banks were heavily recapitalized following the Global Financial Crisis. The US regulatory framework appears to inhibit new competition and the barriers to entry are high. A rough measure of a boundary value, a concept now increasingly outdated in a world of negative interest rates would be 80% of book value, tangible book value.
Measured is such a fashion, US banks appear to offer some value. Those not in favor of fundamental measures might still be attracted to a company such as Goldman Sachs, now valued at less than Pay Pal. Berkshire Hathaway is struggling this year, weighed down by a weighting of over 20% in this sector.
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