Last week the ten-year treasury touched 3.0%, as the economy continues to improve and this quarter’s earning’s season has been quite strong. However, the performance of risk assets did not correspond to this rosy picture. Look what happened to Caterpillar’s stock price when it announced a very strong quarter, but stated that Q1 likely represents the high point of their year (the company’s stock closed down 6.2% on Tuesday).
The ten-year is higher now than it has been since 2011 and S&P 500 earnings are up a whopping 26% so far this quarter compared to the same time last year. Lower taxes, a growing economy and a weaker dollar all have contributed to higher earnings. Still, this torrid pace of growth will end; trees don’t grow to the sky and we don’t expect earnings growth will either.
While the sun may be setting in the eyes of some risk assets, for fixed income investors, the sun is actually rising. High grade fixed income investing is all about income and safety. When you can get a good return over inflation on government bonds, protect principal and avoid significant volatility, it is a bright new day.
The two-year treasury topped out at close to 2.5% last week, the first time it has been this high in ten years! With core inflation (as measured by PCE) of 1.9%, this is a great combination of risk-free income and safety. Add some yield on top of this risk-free rate with high quality tax-free municipals or corporate bonds and it is an even brighter sunny day as a fixed coupon and principal returned at par is a marvelous thing.
Income and safety. The sun is rising, so enjoy the new day!
Sources: Bloomberg, The Financial Times, The Wall Street Journal