Author: Tim Courtney
the Italian Bond Crisis
By Tim Courtney, Chief Investment Officer
If you’ve been paying attention to the financial news cycle recently you may have seen that the Italian financial markets – and bonds in particular – are in a state of turmoil. The 2-year Italian yield1 jumped from negative territory one month ago to over 2.7 percent last week before hovering back around 1 percent in recent days.
Source: CNBC (https://www.cnbc.com/quotes/?symbol=IT2Y-IT)
Most of the recent volatility has to do with political upheaval. Most recently, the development of new government factions has sparked concern that Italy could mobilize on its own “Brexit” movement2, ultimately disentangling itself from the EU and, in the process, the Euro.
This news sent shockwaves through the bond market, resulting in much more violent moves than investors were accustomed to. With little to negative yield, we believe European bonds are among the most expensive assets in the world and priced for perfection, leaving very little room for error. Even the slightest news upset could result in significant volatility, which is what we experienced recently.
On the other hand, European equities are still trading at steep discounts, approximately 30 to 40 percent less expensive3 than those in the U.S. This is because much of the political and economic risks in Europe have been factored into their pricing, which is why the equity market, while still affected, has reacted much calmer in the face of recent political news.
Currently, U.S. equity markets4 are themselves priced relatively high with the expectation that strong economic growth and profitability will continue. So far, recent news has matched those expectations. The U.S. is still viewed as the most stable and trustworthy market in which to invest and it appears 2018 is on track to set new earnings records for the S&P 500 companies.
However, just as with the Italian bond market, higher priced assets have less margin for error. While it doesn’t appear that numbers are softening in the U.S., if we were starting to see surprising and disappointing numbers we would expect prices to adjust lower. This is not dissimilar to what has recently occurred with U.S. bond prices. In July of 2016, the 10-year U.S. Treasury was extremely expensive, yielding only 1.37 percent5. This period capped off a 35 year bonanza for bonds as annual returns from July of 1981 to July 2016 were 8.22 percent annualized for the U.S. Aggregate Bond Index. In the two years since then, the bond index is down 2.32 percent (as of June 6).6
As investors, we should be ready to experience higher volatility following years of very quiet volatility and steadily increasing prices. While it is unlikely that we would see a meltdown like the one going on in Italy, it’s a lesson on how quickly things can change in markets, and why diversification in assets is so necessary.
3 DFA Fund Valuations as of 4/30/2018
6 DFA Returns 2.0
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971