The global market currently believes the financial outlook will get worse, in both the short term or the next 10, 30, 50 years.
If institutional investors price stocks and bonds based on prospects, the market projects a pessimism for the future based on the level at which new government bonds issued by Germany, Switzerland and Japan are trading, as nominal yields have fallen below zero.
Negative yields mean an investor holding such bonds to maturity will receive less money than originally invested in the bond. In such a financial environment, the return of money becomes more important than the return on money, according to a 2015 report by Pacific Investment Management Co.
Market prices reflect an outlook based on new information and developments looking ahead.
I've heard of pessimism. But a pessimist who says not only will things not get better in 50 years, they are going to get slightly worse, now that's real pessimism. Are we that pessimistic? asked Donald G.M. Coxe, chairman, Coxe Advisors LLC, Chicago, in an interview.
For asset owners, such as plan sponsors, endowments, foundations and others with regular obligations to pay, such an interest rate environment is not sustainable for their long-term survival.
Paying up now and receiving less nominal money in the future can be profitable if the price of goods has fallen sufficiently, the PIMCO report states. But such deflationary prospects become too challenging for plan sponsors and their actuaries, as well as other asset owners.
On July 13, Germany sold a 10-year government bond at a -0.05% yield, while Switzerland sold one yielding -0.023% after selling on April 8 a 10-year government bond yielding -0.058%. In March, Japan sold a 10-year government bond yielding -0.024%.
As of June 27, $11.7 trillion in sovereign debt globally traded in negative yields, according to a Fitch Ratings Inc. report. That amount represents 59% of the total outstanding sovereign debt market, according to the Bank for International Settlement figures on the total size of the market. The negative-trading amount rose $1.3 trillion since May 31, based on Fitch data. That increase means investors have become more pessimistic.
Secondary market investors already have been trading in negative yields, based on real interest rates adjusted for inflation.
Ineffective monetary policy and government fiscal stimulus have created conditions for the market's dire outlook. Policymakers must reverse their course and move more to market-based mechanisms and solutions to economic weakness and monetary policy. The market, through negative yields, is telling them to do so. n