Investors Pursue 'Irrational Quest for Safety'
December 5, 2011
Standard & Poor's famously downgrades its rating of U.S. debt for the first time on Aug. 4. Investors pull out of equities and park their proceeds in ... U.S. Treasury bonds.
The European debt crisis rises to epic proportions. Investors pull out of other fixed-income products and put their cash in ... U.S. Treasury bonds.
Particularly since they notice that former Goldman Sachs chief and New Jersey governor Jon Corzine's big bet on foreign bonds led to the collapse of his would-be-big-bank MF Global.
By the time Thanksgiving approached, 10-year Treasury notes had become the object of "irrational exuberance," in the estimation of T. Rowe Price Chief Executive Brian C. Rogers. Their return was under 2% a year, as a result.
The yield, in fact, dropped to 1.87% on Nov. 23, approaching the record low of 1.67% set exactly two months earlier, on Sept. 23.
By Nov. 28, the yield hit 1.98%. But the point was clear. Corporate and individual investors were in a headlong pursuit of what Rogers would call an "irrational quest for safety."
"That is why the corporate debt levels are where they are," Rogers said at the Princeton Club in New York. That also is why "cash levels are where they are; why the individual investor is content to hold a couple trillion dollars earning one basis point in a money market account. Why people are terrified of risk. Why people are terrified of volatility."
The obvious answer is to bet on stocks. Well-researched choices. But stocks nonetheless. "You can earn a lot more on a blue-chip equity, than on the ten-year Treasury, but that is the world in which we live," Rogers said.
The rush to Treasuries is evidence of a lack of trust in stock investing in general, Rogers indicated. "Much of it comes on the heels of a lost decade for equities and much of it is a function of how investors feel as though the game is tilted against them," he said.
In fact, the value of the Standard & Poor's 500 is down 15% from 2000, according to John D. Linehan, the firm's director of U.S. equities.
Even in a period of supposed economic recovery, "performance of the last year has been pretty punk," Linehan said. The market has its "pedal down, but its tires are only spinning."
The sense that the game is tilted is only reinforced by how political leaders are responding to the nation's financial crises.
"Rarely have we seen, really what I would call such a pattern, such a disturbing pattern of bipartisan inability to deal with a serious issue affecting our nation," he said. "There's a lack of foresight. There's a lack of responsibility, and clearly there's the lack of courage."
If you're an American citizen, an American investor, you want to believe in the country, he said. "But when you look at the data points, it certainly doesn't give you an awful lot of confidence."
Indeed, T. Rowe Price's own Chief Economist Al Levenson, at the same briefing, said "The natural rate of unemployment in our view is closer to 7% than 5%."
This at a time when the nation's unemployment rate, which had been below 5% as recently as April 2008, returned to 9% in April of this year. And has stayed there, through October.
Levenson later amended his comment, to suggest that the "natural rate" long-term was somewhere between 5% and 6%, and the 7% rate was only a revised expectation in the near term.
But Levenson held out little hope for a near-term fix to the nation's economic ills, which appear to be driving investors to the safe haven of 10-year Treasury notes.
There's been no recovery in the housing market, he noted. And there's been no "market to sustain recovery."
He's revised his expectation of annual economic growth in the United States to around 2% in 2012. He had been "closer to 3%"-until the debt ceiling fiasco in August, when partisan bickering led to the U.S. debt rating downgrade.
The potential savior of the economy: the corporation, not the individual consumer.
"Profit margins are high and rising," he said.
But consumers are gaining strength. U.S. households are now paying only 11.5% of disposable income on interest payments, down from 14% in 2007. "That has freed up cash flow for current spending,'' he said. Witness: Strong holiday shopping sales at retail stores over the Thanksgiving weekend.
Yet, the nation is far from out of the woods. The Joint Select Committee on Deficit Reduction failed before Turkey Day to find a way to agree on cutting the nation's $1.2 trillion-a-year flow of red ink.
The Supercommittee, as it came to be called, was anything but super.
"This is an unprecedented slump," Levenson said, by both parties. "I don't think all levels of professional baseball in its history have gone zero-for-1.2 trillion. But that's what Congress did."
The worst part of what lies ahead? Next year is an election year. If the deficit was going to get resolved, now was the time to do it.
If the two parties can't agree on what to do, there's one silver lining, he said. The President George W. Bush tax cuts expire, which would add $200 billion to federal coffers each year.
But the country's economic expansion is still fragile, he said. And is not growing at a rate that will allow it to remain under the debt ceiling that was permitted in August.
"Which means we could be revisiting the debt ceiling before the election, which was not the intention," he said. "So hold on to your hats and be prepared for the silliest of outcomes that you can think of."