When will financial markets provide decent returns?

As this col­umn is being writ­ten on Mon­day after­noon the Dow Jones Indus­trial Aver­age is down by more than 100 points for the day, with two other mar­ket aver­ages, the NASDAQ com­pos­ite and the S&P 500 both show­ing decreases as well. Not to be out­done, bond mar­kets are also get­ting in on the depress­ing action, with the yield on a 10-year Trea­sury note reach­ing a his­toric low of just over 1.40 per­cent. For the var­i­ous stock indices, the fig­ures cited above still leave them in pos­i­tive ter­ri­tory for the year, but the gains could quickly evap­o­rate by year’s end.

And while the yield on var­i­ous U.S. Trea­sury secu­ri­ties is not much to get excited about, at least yields have not yet turned neg­a­tive. While a neg­a­tive yield may seem implau­si­ble, such is not the case. Last week in Ger­many, a two-year note auc­tion posted an aver­age yield of minus 0.06 per­cent, indi­cat­ing that investors were will­ing to get back less than their ini­tial invest­ments after a two year wait. Of course, it is pos­si­ble that present investors antic­i­pate they can still turn a profit even with a neg­a­tive return. How does that work? Should it hap­pen that eco­nomic cir­cum­stances dete­ri­o­rate even more in the euro-zone and rates become more neg­a­tive, cur­rent investors could sell their “high yield­ing” secu­ri­ties — which carry a slight neg­a­tive return — to new investors who pre­fer them to new secu­ri­ties with an even worse neg­a­tive yield. It may sound strange, but it could hap­pen. Or per­haps loos­ing 0.06 per­cent over two years seems like a sweet­heart deal com­pared to the uncer­tainty of things to come.

Therein is a rea­son­able answer to the ques­tion of the week: When will finan­cial mar­kets pro­vide decent returns? When uncer­tainty is largely elim­i­nated so peo­ple and busi­nesses can plan for the future with some degree of confidence.

Over the past five years, huge por­tions of the world’s econ­omy have under­gone a gut-wrenching down­turn and a weak recov­ery, which at times seems ready to hit a stall-out speed. In the first quar­ter, the U.S. econ­omy posted an ane­mic increase in real GDP of just 1.9 per­cent and later this week the sec­ond quar­ter esti­mate is due to be released. Most ana­lysts expect the growth rate to be even more mod­est still, likely some­where in the range of 1.0–1.5 percent.

Last week China issued its sec­ond quar­ter GDP data and this once high fly­ing econ­omy, which tended to boast of growth at or above 10 per­cent, expe­ri­enced a decel­er­a­tion to 7.6 per­cent real growth. While still tremen­dously strong growth by Amer­i­can and Euro­pean stan­dards, it is becom­ing increas­ingly mod­est, with some econ­o­mists sug­gest­ing the Chi­nese gov­ern­ment is putting its thumb on the sta­tis­ti­cal scale to keep the fig­ure higher than what it actu­ally is dur­ing the first half of 2012.

What­ever the exact­ing num­bers may be — whether in Amer­ica, China, or else­where — they are all indica­tive of a world econ­omy strug­gling under the weight of the Great Reces­sion of 2007/2009 and the inabil­ity of pol­i­cy­mak­ers to craft a cred­i­ble plan to end the pain and uncer­tainty which has followed.

Sadly, the pain has spread in a way that vir­tu­ally all major seg­ments of Amer­i­can soci­ety are suf­fer­ing. For many working-age peo­ple the pain has man­i­fested itself in the form of few new job oppor­tu­ni­ties and/or stag­nant wages for fam­i­lies. In the case of retirees, the suf­fer­ing comes from low rates of return on sav­ings, no mat­ter what exact form is used to invest those saved dol­lars (stocks, bonds, CDs, etc.). Since invest­ment income is often a sig­nif­i­cant means of pro­vid­ing sup­ple­men­tary income dur­ing retire­ment, low rates of return have required a throt­tling back of liv­ing stan­dards, as senior cit­i­zens attempt to keep their prin­ci­pal bal­ances from dete­ri­o­rat­ing too rapidly.

Is it any won­der that con­sumers and busi­nesses sit on their hands, wait­ing for seri­ous and long-lasting deci­sions to be made regard­ing the unsus­tain­able deficit/debt sit­u­a­tions of gov­ern­ments around the world? So long as these press­ing issues remain unre­solved, uncer­tainty will remain high, while expec­ta­tions, job avail­abil­ity and finan­cial mar­ket returns remain low.

And unfor­tu­nately no easy, pain­less and sound-bite qual­ity solu­tions (say, from Amer­i­can pres­i­den­tial can­di­dates) will change this unfor­tu­nate real­ity. For bet­ter than half a decade, vot­ers have been fed a steady diet of delu­sions, half-truths and confidence-killing pro­pos­als. If and when vot­ers demand an end to such non­sense, the econ­omy and all that it offers may finally begin to heal.

Dr. James New­ton serves as chief eco­nomic advi­sor to Com­merce National Bank and is an aux­il­iary fac­ulty mem­ber in eco­nom­ics and sta­tis­tics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not nec­es­sar­ily reflect those of Com­merce National Bank or OSU-Marion/Newark.

Posted by Jim Newton on Jul 24 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.