Parish: Post-QE Fundamentals In Focus

April 28, 2014

Exhibit B: Bonds

Stocks aren’t the only asset class to go through a breakup/makeup with fundamentals—bonds also appear to be following the same trend. This chart shows that Treasury yields are converging toward fair value after a few years of divergence.


Source: Bloomberg as of March 31, 2014

The blue line plots the actual yield of the 10-year Treasury, while the red line shows where the yield should be, based on our Sage Fair Value model. This version of the Fair Value model uses just three variables—GDP growth, inflation and Fed Funds rate—but it’s been pretty reliable, as indicated by a high R-squared. Historically, Treasury yields have reflected broad economic conditions.

The two times the relationships broke down happened to coincide with times of significant monetary intervention: 1994, when the Fed surprised the markets with aggressive tightening; and 2011-2013.

Now, with Fed tapering, the markets are behaving in ways more appropriate to the macro environment.


These are good signs for asset allocators who place heavy emphasis on macro and fundamental analysis.

They suggest that the confounding influence of heavy-handed monetary intervention is subsiding, allowing the markets to resume their historical relationship with macroeconomic conditions. Investors are now in a better position to gauge what effect economic conditions will have on their holdings.

From our perspective, the global macro environment is modestly constructive for risk assets, as indicated by decent global GDP, industrial production, manufacturing and LEI numbers. However, recent tactical indicators have displayed some weakness so far this year. These include U.S. and European economic-surprise numbers, headline risk in emerging markets, and others.

We are closely monitoring conditions to determine the direction of markets for the coming months.

If the weakness proves to be temporary and economic momentum picks up, as we expect, investors may do well holding growth-oriented stock sectors and market caps. For U.S. growth stocks, we like the iShares S&P 500 Growth ETF (IVW | A-92). For mid- and small-cap stocks, we use the SPDR S&P MidCap 400 ETF (MDY | A-78) and the iShares Core S&P Small-Cap ETF (IJR | A-92), respectively.

In our international developed-market allocations, we currently own small-caps in the form of the iShares MSCI EAFE Small-Cap ETF (SCZ | B-89). In our fixed-income portfolios, we own short-maturity high-yield debt in the Pimco 0-5 Year High Yield Corporate Bond ETF (HYS | C) and emerging markets debt in the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY | C-36).

If, however, the global weakness persists, we would look to reduce risk through defensive sector allocations and lower-beta positions. We talked about precious metals, currencies, MLPs and defensive equity strategies in a previous piece on

Admittedly, until the Fed does away with its zero-interest-rate policy and QE altogether, its influence on the markets will continue to resonate. Until then, fundamentals appear to be returning to their traditional place as generally reliable indicators for the health of the capital markets. For us, as for many investors, this is a welcome sign.


Interested in hearing Parish in person? Join Anthony Parish and other macroeconomic strategists in New York on June 26 at our Global Macro ETF Strategist conference. To view the full agenda and registration information, click here.

Sage, an independent investment management firm, serves institutional and private clients with traditional fixed-income asset management and global tactical ETF strategies. Sage began using ETFs in 1998, and today offers a range of tactical all-ETF solutions, including income-focused and target-risk global allocation strategies. Contact Sage at 512-327-3330 or


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