Fixed Income
Household balance sheets show credit market assets, primarily fixed-income securities like treasury issues and municipal, corporate, and foreign bonds, totaled $3.4 trillion in the fourth quarter of 2014, down $1.8 trillion from the peak in the first quarter of 2009. As a share of total household financial assets, credit market assets account for just 4.9 percent, an all-time low (Chart 5).
Two key factors have contributed to the record low share of credit market assets among household financial holdings. First, substantial gains in equity prices since the March 2009 market low have driven up the total value of all financial holdings and pushed down the share composed of credit market assets. In other words, relative underperformance has contributed to the decline of credit market assets as a proportion of household financial holdings.
Second, households have likely been easing back on buying fixed-income assets. Data from the Investment Company Institute on purchases of bond mutual funds and bond index exchange-traded funds (ETFs) show a significant slowdown in purchases in these categories over the past two years, despite a bit of a rebound in recent months (Chart 5). While it is impossible to identify the buyers, the trends seem to fit with the decline in credit market assets on household balance sheets.
The implication is that household sector purchases of credit market assets such as fixed-income securities, including bonds, may pick up a bit, if for no other reason than the effects of a systematic rebalancing of asset allocations. Yet there’s a dilemma over taking this step. With yields so low and the prospect of Fed interest rate increases coming, the outlook for total returns on fixed income assets remains questionable in the quarters and years ahead.
Commodities
As we have noted in recent Business Conditions Monthly reports (https://aier.org/pertinent-tags/business-conditions-monthly), a strong dollar and weak global growth have weighed heavily on almost all commodity prices. With a focus on the consumer this month, we turn our attention specifically to the impact of agricultural commodities markets on consumer prices for food consumed at home.
Over the past four years, the S&P Goldman Sachs Commodity Index for Agricultural and Livestock commodities has fallen at a more than 9 percent annual rate, though with significant volatility along the way. Despite these declines, the CPI for food consumed at home, i.e., groceries, has risen at a roughly 2.5 percent annual pace over that time.
While many things influence consumer prices, there has been a reasonably strong relationship between agricultural and livestock commodity prices and the CPI for food (Chart 6). If that relationship holds, we would expect to see food price increases slow in coming months.
U.S. Equities
As we have noted, household balance sheets show credit market assets account for just 4.9 percent of total household financial assets, an all-time low. Meanwhile, the share made up of equities has risen to 34.9 percent, about eight percentage points below a 42.8 percent peak reached in the first quarter of 2000, during the technology stock bubble. Today’s level is also well above the low of 10.9 percent touched in the second quarter of 1982.
Similar to the proportional change in credit market assets, two key factors have contributed to the rising share of household financial assets held in equities. Of course, first are the substantial gains in stock prices since 2009, reflecting their relative outperformance of other assets over that period.
Second, households have likely increased the pace of investment in shares. Investment Company Institute data on purchases of equity mutual funds and ETFs show purchases in these categories rose sharply from 2012 through early 2014, though the pace has slowed a bit over the past year (Chart 7). Despite this cooling off and an uptick in purchases of credit market assets, new cash has flowed into equity funds and ETFs at nearly double the rate of flows into bond funds and bond ETFs over the past 12 months.
The implication mirrors that for credit market assets: Purchases of equity assets may slow further if overall household allocations stay imbalanced. The dilemma regarding the future returns on fixed income assets holds, however. With yields so low and the prospect of Fed interest rate increases coming, the outlook for total returns on fixed-income assets is questionable in the quarters and years ahead. As a result, some households may not be very aggressive in rebalancing investment holdings.
Global Equities
As households adjust their preferences for equities relative to bonds, they appear to be adjusting their preferences for domestic relative to global shares as well. For most of the time between 1997 and 2005, net inflows to domestic equity funds and ETFs outpaced inflows to global equity products. However, for most of the past 10 years that trend has been reversed, with global equity funds and ETFs picking up a greater share of new investment than domestic funds. That pattern extended into the latest months, though the differential has narrowed just a bit (Chart 8).
On average over the past five years, the annual difference in fund flows between global and domestic equity products has exceeded $100 billion and tilted away from domestic funds. Over the past three months, that excess has narrowed to about half that annual pace. One possible indication as to whether flows will continue to narrow or reverse trend and widen out again may be the relative performance of U.S. equity markets compared with others around the world. Since 2010, U.S. equities have risen more than 80 percent versus a 16 percent gain in non-U.S. shares. Such outperformance suggests an over-allocation to U.S. equities and may foreshadow slowing inflows in the months and quarters ahead.