CEO Jan van Eck believes investors and companies have been overly cautious in 2016 and should look to potential opportunities in emerging markets.
An Interest Rate Paradigm of Lower for Longer?
Tom Butcher: What strikes you about the year so far, and are people missing anything important from the third quarter?
Jan van Eck: I believe that what we are missing was perhaps the most obvious thing. We have all been talking about interest rates and the Federal Reserve's actions, and the effects on markets for many years now. But in the third quarter, we may have hit the lowest yield on record for the 10-year U.S. Treasury bond (on July 5, the 10-year U.S. Treasury bond yield hit a record low of 1.36%). The 10-year yield fell below 1.5%, and that retested the record low recorded in July 2012, several years ago.1
Right now with interest rates, we are in a paradigm of lower for longer, and many people expect rates to go even lower for many reasons. But what if we have already hit the low? I believe that this scenario is entirely possible.
This issue is important because there has been a big debate about whether negative interest rates have been great for growth. The argument for growth is that negative rates may drive up asset prices, which makes people feel rich and then leads to more consumer spending. But the counter-argument, however, is that negative interest rates are bad for growth, and even U.S. Federal Reserve Chairman Yellen has discussed this. Negative rates can scare people and make them more cautious, and this then reduces economic behavior. I believe that we may have reached the low point with rates, as you can't have negative interest rates forever. We may have hit the low. We think that in four years, it is very unlikely we'll have negative interest rates globally.
10-Year U.S. Treasury Bond Hits Record Low in 3Q 2016
Treasury Yields: 1996-2016
Butcher: If we have hit a low, there really hasn't been a paradigm shift.
van Eck: The real question is: Are we in the United States ever going to go to negative interest rates or be forced to go to negative interest rates? If not, given that negative interest rates may be viewed in the U.S. as not stimulating the economy, then interest rates really might start to rise or at least be stable for some time. I'm not saying that rates are going to shoot up, but just that we may have seen the lows.
Post-U.S. Election Fiscal Spending?
Butcher: What is your opinion of the talk about addressing matters fiscally in the U.S.?
van Eck: There is a significant level of speculation about what the new U.S. president will do, and the thought that there might be increased fiscal spending. We just don't know right now. But if government spending were to increase, it would be hard to imagine that interest rates would decline in that environment. Yes, the potential risks right now are slightly to the upside. As I have said, however, many people are not thinking about this possible change given that we have been in this interest rate lower for longer pattern, and rates have kept going down. People keep piling investments into fixed-income and bond funds. We will just have to see, but it is quite possible that we will look back on this past quarter and say that was the low.
Commodities and Credit Markets Rallied in 2016
Butcher: How does this affect the view you had at the beginning of the year, when you said that 2016 would be a year of recovery for gold and commodities and that fixed-income opportunities existed even in a low interest rate and low yield environment?
van Eck: Yes, those were two views that we had at the beginning of 2016. I have different answers for each. First, we predicted that the commodities bear market would end in the beginning of this year, because typically it takes about 18 months to finish the washout of commodity prices, and that timing put us in the first quarter (Read "January 2016 Investment Outlook" for details). Commodity markets rally for about three years, and right now, we believe that we may be about nine to 12 months into a positive cycle, if this is a normal cycle. Second, credit markets, particularly the high yield sectors, have rallied very strongly in the past six months, and in my mind, they tend to oscillate between being too cheap and too rich. In terms of upside potential, I don't believe that high yield has much further to go.
Caution Has Dominated Investor and Company Behavior
Butcher: There is a certain amount of uneasiness in the market now with the U.S. elections coming up and December's FOMC (Federal Open Market Committee) meeting. What is your outlook for the rest of 2016 and 2017?
van Eck: Let us first take a look back at this year. What has struck me all year - and I have yet to find a good answer - is why have investors been so cautious? Investors have been very cautious this year, and here are some facts to support that. They have redeemed approximately $53 billion out of U.S. equity funds, while investing $225 billion into fixed-income funds. More conservative funds have been getting inflows, and stock funds are experiencing outflows. This trend is being mirrored in ETF flows globally, with more inflows into fixed-income ETFs, even though they represent less than 25% of the overall ETF market.3
Secondly, U.S. companies have also been noticeably conservative. This year, companies have been cutting capital expenditure and giving back cash to investors, either through dividends or stock buybacks. Most remarkably, companies have been doing mergers with cash. In the past 12 months, $400 billion in cash has been used for M&A (mergers and acquisitions), and this represents the highest level by far in U.S. history.4 Lastly, it appears that the stock market has been rewarding companies that are conservative.
An Argument to Stay Invested
Overall, there has been this tide of conservativeness that I don't fully understand. Having said that, looking forward, what we look for in our asset allocation guidance is the three research areas that Ned Davis Research looks at, which are macro, fundamental, and technical. Two out of three are still bullish. I believe we do not have any reason to be highly concerned given the macro environment; interest rates are still low, and I think fiscal policy is okay. Valuations are very stretched, and that tends to concern some commentators, but because technicals are now supportive, I feel that is not the biggest concern. This indicates staying invested.
Most Comfortable with Emerging Markets
Butcher: What opportunities should investors be seeking?
van Eck: I believe that there is one area that we have been giving more attention recently, and that is emerging markets equities, given that these equities have been inexpensive for several years. Finally, the technical support has come in to support these investments. Oddly enough, post-Brexit there has been a flood of investor money moving into emerging markets equities and bonds. Emerging markets, both equities and fixed-income, is an area that we feel most comfortable with when viewed from a longer-term allocation perspective. (Read "Emerging Markets Shake Off Brexit and Emerging Markets Bonds Continue to Rally".)
1 Source: Bloomberg as of 9/30/16.
2 Source: Strategic Insight as of 9/30/16.
3 Source: ETFGI.com as of 9/30/16.
4 Source: S&P Capital IQ as of 6/30/16.
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