February 2015 Monthly Commentary
In a polar opposite of the scorching rally witnessed in January, 30-year bond yields soared last month, rising 50 basis points in the first three weeks before settling 43 bps higher.
The change in the bullish tone of the market was entirely attributable to the employment report. Naysayers had been ignoring the robust job growth and instead focused on subdued wage gains and the low participation rate, characterizing job growth as lacking in quality. That opinion was difficult to support following the release of the January employment report early in February. In it, payroll growth for the month registered 257,000, well above the consensus expectation of 219,000. Even more surprising was the revision to the December and November reports, which on a revised basis, totaled 329,000 and 423,000, respectively. With such a robust report we were a bit concerned that the February jobs report would give back some of those gains, especially given the lost productivity due to the repeated snow storms endured during the month. That worry was for naught. February witnessed another 295,000 jobs added, bringing the cumulative gain in new jobs to 3.3 million over the last twelve months, with more than one million of them coming in the last ninety days. Moreover, the report noted that the average hourly earnings rose 2.0% over last year’s rate indicating that not only is the economy adding jobs at a robust pace, workers are seeing wages rise. Our expectation is that as the demand for labor continues to rise, wages will begin to rise at an accelerating pace as employers find themselves competing for workers.
While one would think that such obvious economic strength would pressure bond prices lower in anticipation of an imminent rate rise, the opposite has been occurring. Despite pronouncements by several members of the Federal Open Market Committee (FOMC) that they intend to raise interest rates in the foreseeable future, many in the marketplace argue that such a rate rise will not occur this year. We have difficulty understanding that logic. The FOMC continues to implement emergency monetary policy with a zero percent interest rate policy. While they have ended their quantitative easing experiment, the Central Bank continues to reinvest the proceeds of the coupons and maturities of their portfolio holdings back into the market. In doing so, they effectively ensure that the value of their portfolio continues to grow and interest rates remain depressed. The good news for investors is that the distortion continues to drive stock prices higher. Because of the artificially depressed interest rates, corporations are able to borrow in the corporate bond market at very low rates. In turn, they use those proceeds to buy back the equity of their company, while also steadily boosting the dividends they pay to shareholders. CEO’s especially like the buyback option in that it reduces the number of shares outstanding which, de facto, improves the earnings per share by lowering the denominator. When stock prices are changing hands at a reasonable multiple of earnings, the buyback game makes sense. However, buying back at a price to earnings multiple in excess of 20, as many blue chip CEOs do, is folly and may ultimately result in a destruction of wealth for the corporation.