An Alternative To Money Market Funds
May is behind us and what a month it was!! The S&P 500 declined by 6.6% last month while the Dow Jones Industrial Average fell 6.7% in May. Worries about trade issues with Europe, Mexico and China helped push interest rates to their lowest levels around the globe. As of May 31, the yield on the 10 Year US Treasury was 2.12%. It peaked on October 9 @ 3.26%. So, in less than 8 months the yield has dropped over 100 basis points and may be headed below the 2% level soon.
Despite the extremely low yield on the 10 Year US Treasury, it is still well above the yield offered by other major central banks. For example, the 10 Year German Bund and Japanese JGB both offer negative yields while the 10 Year UK Gilt yields less than 1%!! Keep in mind the all time low yield for the 10 Year US Treasury is 1.35%, reached in June, 2016 after the UK Brexit vote.
In this low yield environment, Savers are being punished while Borrowers are being rewarded. Many fixed income strategists believe the US Federal Reserve will be forced to cut rates during the 2nd half of 2019. In fact, JP Morgan sees the Fed cutting rates a quarter point when it meets at the September and December meetings, a full 50 basis point cut by the end of 2019. Barclays sees the Fed cutting rates by a total of 75 basis points by the end of 2019. The Fed next meets on June 18-19 and they are expected to stand pat at this meeting.
Once the trade issues between the US and its major trading partners subside, it is likely the equity markets will enjoy a strong rally. Many consumers will soon refinance their mortgages, increasing their purchasing power. Many S&P 500 companies will likely follow suit, especially firms paying high dividend yields on their common and preferred shares.
Dividends are paid with after tax cash to shareholders while the interest paid on debt is tax deductible. Thus, a firm that buys back its high yielding shares with newly issued debt should enjoy the double benefit of improved cash flow and earnings per share. The reduced share count should increase earnings per share. Cash flow improves since the new debt issued is used to retire stock and eliminate the generous dividends, previously paid with after tax cash.
The lower rates may also boost Merger & Acquisition activity, especially by Private Equity (PE) firms. By acquiring high yielding common shares in an acquisition, the elimination of the acquired company’s dividend (previously paid with after tax cash), boosts the cash flow needed to finance the acquisition. Plus, the stock market’s drop has made many firms more affordable to acquire.
My weekly radio show is on holiday and will return in September on WWPR 1490 AM. My prior radio shows and newspaper columns are available on our website (www.amescapmgmt.com).
If you are unhappy with the returns now offered by money market funds feel free to contact us.