As the yield on the 30-year U.S. Treasury note plunges to another all-time low in this morning's trading, the reality of the inversion in the bond markets is upon us. As of this writing, the yield on the 30-year U.S. Treasury bond (1.94%) is below the yield on the 3-month U.S Treasury bill (1.99%.) I have mentioned in prior Forbes columns that an inverted yield curve is a pronounced negative for stocks, and, in fact, the previous two 3-30 inversions (ending in December 2000 and April 2007) presaged major market meltdowns.
It’s not all about the stock market, though, please do not forget that. The previous 3-30 inversions were wonderful buy points for bonds. According to NYU's valuation guru, Aswath Damodaran, the total return on the 10-year U.S. Treasury note was 5.57% in 2000, 15.12% in 2001, 10.21% in 2007 and a sizzling 20.10% in 2008. The S&P 500 turned in several of its worst annual performances in that time period, including 2002's 21.97% plunge and 2008's now-legendary 36.55% decline.
So, it's not enough to just sell stocks, as I advised in this Forbes column, you really should be buying bonds here. You might be asking yourself “Really? I should be locking in a 1.93% interest rate for a security with a thirty-year maturity. Isn't that extraordinarily low by historical standards?” It sure is.
For the 20-year period measured in the St. Louis Fed’s FRED's database from 1981-2001, the yield on the 3-month Treasury bill stayed consistently above 2%. Obviously old-timers will tell you about the double-digit three-month T-bill rates in the 1980s. Also, from November 2004 until January 2008, the yield on the 3-month T-bill was above 2%.
So, yes, I am advocating "locking in" a rate on a security for 30 years that has rarely prevailed for a security that expires 29.75 years sooner. It's time for safety. As we head into an election season, be prepared to hear all sorts of ignorant blather about U.S. national debt and deficits, but I am firmly convinced that the chance that the U.S. government defaults on its debts remains steady at 0.0%.
But, it's not just return of capital, investors should be ignoring the talking heads on CNBC who blather on endlessly about "FANG stocks" and realize that bonds are producing terrific returns on capital.
The main long-bond ETF, iShares 20+ Year US. Treasury Bond ETF (TLT,) has posted a sizzling 21.6% gain year-to-date. It hasn’t just been the long-end of the Treasury curve that has provided capital gains for investors, either. iShares 7-10-year bond ETF, IEF, has produced an 11.1% gain year-to-date, and even iShares 3-7-year ETF, IEI has produced a solid 6.6% gain this year.
Again, these are for securities that also return 1.5% to 2.% in dividends (the captured interest payments from the underlying bonds) and have, by my estimation, zero risk of default.
So, I believe this bond market rally will continue. The Western world is vastly underestimating the damage done to the Chinese economy—which, as I noted in this Forbes article, is massively leveraged—from the trade war. You can focus on the S&P 500 and “Fortress America” companies as much as you want, but please don’t ignore the fact that S&P 500 earnings have declined on a year-on year basis in both quarters thus far in 2019.
So we have an earnings recession coupled with increased—and accurate, in my opinion—fears of an imminent global recession. That is a bond market player’s dream scenario. Do not ignore it. Lighten exposure to equities and increase exposure to fixed income.
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