“Bond Yields Hit Record Lows” is a title that has been used repeatedly because Treasury yields are falling below previously unimaginable levels. First, the yield on 30-year bonds has dropped beyond 2%; then, last week, the 10-year benchmark fell 1%.
Some market veterans also remember bond market records at the opposite end, when long-term government securities surpassed 15% in the early 1980s. And even fewer craned their necks to declare that after more from three decades of rising yields and falling bond prices, investors should no longer run away from bonds.
Today, some of these precocious and precocious bulls still believe that investors should continue to hold their bonds even after yields plunged to 0.74% for the 10-year note or 1.29% for the stock. 30 years in a mad flight towards quality because of fears concerning the impact of the coronavirus.
Others see more risk in these low yields, if yields were to reverse their recent and surprising decline.
If you don’t cover a wallet with treasury bills right now, you’re just stupid.
A. Gary Shilling, the economist and author of the newsletter, is one of the original super bonds and remains positive about long-term treasury bills. “I have never bought yield bonds,” he said. “I have always bought them for the same reason as stocks, for the appreciation of prices.” He professed not to care about their performance as long as it went down, which meant their prices would go up.
In the early 1980s, Ed Yardeni predicted “hat size” yields somewhere between 7% and 8%, about half the peak levels of the time. Today, the founder of Yardeni Research expresses his wonder at the existence of “ring size” bond yields. He admits having borrowed the expression “hat-sized bond yields” from Van Hoisington, who manages the institutional accounts and
Wasatch-Hoisington US Treasury
funds (ticker: WHOSX).
Lacy Hunt, chief economist at Hoisington Investment Management, still considers the downward trend in bond rates to be intact.
Long-term interest rates are the product of real return (what remains after adjusting for inflation) and inflation expectations, he explains. Both have been declining for more than two decades. Inflation expectations followed by the University of Michigan consumer survey have fallen to a record low.
Real rates, on the other hand, have fallen steadily, due to the slowdown in economic growth, which in turn is the result of the accumulation of debt, which, according to Hunt, has been a drag on growth rather than ‘a stimulant. Japan and Europe, where short and medium term rates are negative, are more extreme examples.
In a mild recession, Hunt sees inflation fall by 200 to 300 basis points (or two to three percentage points). With the core deflator of personal consumption spending, the Federal Reserve’s preferred inflation indicator that omits food and energy costs, which is currently increasing at an annual rate of 1.3% in the past three months, all type of slowdown will cause deflation, with a proportional drop in interest rates.
But as rates move towards the lower bound of zero, Hunt says the evidence shows it is counterproductive for the economy. “The banking system and other intermediaries cannot function with such puny yields and yield spreads,” he says.
Sure, yields can go up and produce short-term volatility – which Hoisington investors can expect during certain periods, Hunt warns.
It’s a risk that’s especially acute now, says Jim Kochan, a bond market veteran who is an assistant professor of finance at the University of Wisconsin in Milwaukee, and a former chief fixed income strategist in the division. Fargo Asset Management.
“Investor psychology feels almost the opposite of 1979-1981,” says Kochan. Nowadays, investors demand bonds at 1% or less, just as they avoided them at 14% to 15%. What is not well understood is the bond calculation which makes them so much riskier now.
More specifically, a 30-year bond has a duration of 23 years, which makes it much more volatile for the same change in interest rates as in the past, when yields were higher. A 100 basis point increase in yield would mean a 23% drop in the current price of long-term treasury bills. Conversely, if the 30-year yield were to go from 1.5% to 1%, it would produce a gain of 10 to 12 price points – “it’s not something I would count on,” says Kochan. .
As a result, he advises investors to look for cash equivalents, such as money market funds or treasury bills, even if it means missing a last drop in bond yields.
Additionally, he notes that stock dividends offer higher returns than bonds, including debt from the same company in many cases. It also seems more tempting for Dan Fuss, vice president and bond manager of Loomis Sayles, whose experience dates back six decades. This was the case last year, when he said he was buying
(T) common shares
Fuss is now less tempted by corporate bonds, the main staple in his portfolios, in part due to a lack of liquidity in the market. Instead, he focused on short-term treasury bills, despite their low yield, hoping to be an opportunistic buyer of lower-priced bonds.
Long-term treasury bills are also unattractive to David Kotok, chief counselor for Cumberland. The return on the S&P 500 Index of 1.86%, he believes, should provide a return over the next three decades that is significantly higher than that of T-bills, albeit with much higher volatility.
Kotok does not want to put all of its customers’ eggs in one basket, however. For their fixed income portfolios, new money is headed for cash, although it will only gain about 1%, rather than 1.5% before the Fed’s rate cut by 50 basis points last week. “This is strictly valuation; I don’t want to hold 10-year bonds with yields below 1%,” given the risk of prices dropping as a result of yield reversals, says Kotok.
Yet other bond veterans argue that insurance, rather than income, is the reason to own risk-free government securities. Robert Kessler, who heads the Denver asset manager with his name, said, “If you don’t hedge a wallet with T-bills right now, you’re just stupid.”
Write to Randall W. Forsyth at [email protected]