1982: “The Treasury sold new 14 percent bonds yesterday at an average yield of 14.56 percent, a record for a new 30-year issue that showed the extreme reluctance of investors to buy long-term bonds even though inflation has subsided.”
2015: “The 30-year Treasury yield fell to a record low [2.295%] Wednesday after the Federal Reserve kept its ‘patient’ guidance, but analysts were conflicted over how to interpret the references to economic growth and inflation.”
1982: “Investment bankers and investment advisers acknowledged that yields of more than 14 percent were attractive compared with recent inflation, but they offered a variety of reasons why investors were not more enthusiastic. Illustrating the slowdown in inflation, the Consumer Price Index rose only 9.6 percent in 1981, down from 12.5 percent in 1980, and is expected to increase 7 percent this year.”
2015: “However, the reference to inflation having declined further below the longer run objective [2%]…is an admission of inflation moving in the wrong direction, even if they still consider the move transitory…”
1982: “Why buy the long bond when the future is so uncertain and higher returns are available in the money markets?” Mr. Reid asked.
2015: “Treasury yields show traders are pricing in deflation…”
Lawrence here: Things have changed since 1982. Then the fear was inflation, and the Fed aggressively raised short-term rates to combat it, which inverted the yield curve (meaning short-term rates became higher than long-term rates). If, as an investor in 1982, you thought that past was prologue and that inflation would continue to run rampant for decades to come, you doubtless would have avoided a 30 year yield of almost 15%. However, when inflation did eventually subside and interest rates fell in corresponding fashion, the 30 year bond outperformed just about every asset class over the subsequent three decades, and you would have missed out.
Now, in 2015, the fear is global deflation. As the Economist points out, investors in Europe are so worried about deflation and uncertainty regarding the future that they are literally paying governments to take their money.
Obviously, nobody knows what the future holds. However, as history shows, when you assume that the trends of the last few years will persist forever, you can miss out on tremendous if not altogether obvious long-term opportunities. As Ben Carlson noted, returns on long-term bonds starting at such low yields have been less than stellar.
For sake of comparison, let’s look at current dividend yields versus Treasury yields. Last week, we wrote that the S&P 500, with potentially bullish implications, yields more than the 10-year Treasury. Then, after yesterday’s selloff, Bespoke Investment Group noted that 24 of 30 Dow Jones Industrial components have higher dividend payouts than the 10-year. Unlike the fixed rates on their Treasury counterparts, stock dividends can be raised (certainly, they can also be cut), and the good news is that, in 2015, dividend payouts could set another record.
I have been wrong thus far in anticipating higher rates the last few years, and, as a result of keeping duration in client bond portfolios short, we have missed out on benefiting from the recent plunge in long-term yields. However, I think it would be foolish to assume that inflation will remain subdued forever, and if the Fed’s target of 2% inflation is reached, the paltry 2.295% yield on 30-year Treasurys will offer scant protection.
