As you can see, even despite the recent rate cuts in the U.S., we still remain have the highest yielding 10-year government bond among the largest developed countries. This scale suggests that not only is the U.S. monetary policy appropriate, but it can be argued that there is room for further accommodation. However, some economists will argue that further accommodative monetary policy would leave the federal reserve with little ammunition in the event of a full blow recession. While the “save for a rainy-day jar” approach seems prudent, Global Beta believes monetary policy ought not to be determined based on “what if’” or “could be”. However, as the federal reserve indicated in their recently published December minutes, it does not appear they are ready to take action either way any time soon.
With monetary policy seemingly no longer an uncertainty for the foreseeable future, what does mean for investors?
In a world that is seemingly devoid of yield, Global Beta believes that may in fact be the theme for investment for quite some time. We went back to 1996 to analyze the spread between the dividend yield of the S&P 500 index and the yield of the 10-year treasury bond to determine what kind of relationship that has with the prospect of future returns. Historically, the spread between the 10-year treasury yield and the S&P 500 Index has generally been quite wide (in favor of the 10-year). However, it appears that when that spread narrows, there is a high correlation of future 10 year returns on the S&P 500 index being higher than when the spread is wider. This evidence makes sense as when the spread narrows, that indicates that monetary policy is becoming more accommodative, introducing more liquidity into the market place, enabling investors to utilize that liquidity for riskier investment.
Below is a regression chart illustrating that effect. The chart plots out each month from 1996 through 12/31/19 of what the spread between the 10-year yield and the S&P 500 index dividend yield was and the corresponding forward looking 10-year return: