There's no simpler way to say this: These markets don't make sense any more.
As Canada's leading stock index flirts with 15,000 again, despite the severe commodity-price slump ravaging our resource-rich economy, our 10-year government bond yield fell below 1 per cent.
It's disorienting. Equity rallies are supposed to reflect optimism about the earnings potential of businesses. But paltry global economic growth is making it harder for many companies to make money.
As for bonds, they're normally purchased for safe, stable returns. So many investors now clamour for government debt that they're often willing to pay to hold these securities, resulting in $11-trillion worth of debt with negative yields globally. (Bond prices and yields move in opposite directions.)
Because there's been such heavy demand for bonds, their capital gains are through the roof. To date this year, an index of British bonds has gained a stunning 16 per cent, and the country's 10-year bond yield fell to an all-time low of 0.51 per cent this week.
In other words: The stock market is suggesting the picture looks good.
The bond market says the opposite. Global markets have lost all sense of normalcy.
That's as problematic for investors as it is for powerful decision makers, including central bankers. Markets rely on well-worn principles and rules that are quickly being abandoned. What we desperately need is to restore our historical benchmarks – or, at the very least, establish new ones.
In the bond market, government debt serves as the bedrock. We wouldn't know if BCE Inc.'s debt is cheap or expensive if we couldn't compare its yields to those on risk-free Government of Canada bonds.
In equities, ratios such as the price-to-earnings multiple have long been relied on for valuing stocks. For relatively stable sectors such as consumer products, shares with a P/E multiple above 15 times – or a price a share of more than 15 times earnings a share – were thought to be expensive.
Judging by that standard, now would be a good time to short the S&P 500 because it's trading at 20 times earnings. Except it isn't that simple any more. After rounds and rounds of quantitative easing, the world is awash with money. Maybe stocks – and especially dividend-paying stocks – are worth premium valuations if benchmark bonds are paying paltry yields.
This new order presents all sorts of puzzling questions. What counts as a decent coupon on a riskier high-yield bond any more? Should bond buyers scrap their old investing strategy and start playing fixed-income securities like volatile commodities?
What's really scary is that this way of thinking has spilled over to the broad economy. Finance has always had people willing to take wild bets – that's what makes a market. Central banks, though, rely on supposedly tried-and-true economic benchmarks.
For example: It used to be that the U.S. Federal Reserve assumed that an unemployment rate below 5 or 6 per cent would send inflation skyrocketing, forcing the central bank to hike rates. Earlier this year, though, unemployment in the United States fell to 4.7 per cent and inflation still barely shows a pulse. Does Janet Yellen hold off on hiking interest rates? Or should she spend more time worrying about what a decade of low rates will do to asset bubbles?
It's only going to get harder from here. Should target inflation really be 2 per cent in a world where technology is making everything cheaper? Do our current beliefs about the labour market make sense as baby boomers retire? Last year, Canada had more people over the age of 65 than under 15 for the first time.
We can't expect the transition to a new economic and financial reality to be a calm one. Humans are prone to being irrational – financial markets prove this over and over. We need a North Star to start guiding us again.
That's likely going to require someone who is willing to shift to a more normal monetary policy – and perhaps inflict some necessary pain to get us back on track. In the 1980s, when interest rates were double digits, it was then-Federal Reserve chair Paul Volcker who demanded a return to normalcy – no matter the cost. His decision to jack up interest rates exacerbated a nasty recession, but it also spurred a nearly 20-year bull run. Such courage is in short supply today.