The big winners through the first-half of this year have been safe-havens, such as long-term treasuries (+15%), Gold (+28%), and Utilities (+24%). These areas have benefited from a flight to safety amid three corrections over the past year. The first two were in August 2015 and January of this year. Both were related to concerns about slower growth in China, collapsing commodity/oil markets, and Federal Reserve interest rate policy. Markets subsequently recovered and then were hit again by the Brexit related sell-off on June 24th, which was remarkably short-lived. These corrections have kept the S&P 500 in a trading range for the past two years.
Since 2008, the markets have persistently feared another market calamity. Consequently, there have been few points in history where the price of safety has been as expensive as it is today.
As the chart (right) illustrates, government bond yields have been driven to record lows. 10 year treasuries yield 1.37%, 0.83% below the expected inflation rate over the next decade! Yields on 10 year German government bonds are -0.2%!
In another area, the price/earnings ratio of the Utilities sector is now above the broader S&P 500 and even above the more dynamic technology sector, a rare feat indeed. On the other end of the spectrum are cyclically-sensitive companies dependent upon global growth. These areas have been punished by fears of global collapse.
Time and time again the markets have done their best to prove the consensus view of investors wrong. Today’s fearful mood and pessimistic outlook would appear to set a relatively low bar to surprise. With the cheapness found in cyclical areas and the high price of safety, it would appear prudent to avoid an overly pessimistic outlook or shed the cyclically-sensitive areas within portfolios which may have lagged amid recent market volatility.