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Rekenthaler Report

What's Down With Treasury Yields?

Going where no Treasury notes have gone before.


Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Something New
Pretty much everything, it seems. As I write those words, the yield on the 10-year Treasury note is 0.72%, while 30-year bonds are at 1.21%. The cumulative gain for a $1000 purchase of these securities, assuming their proceeds are invested at today’s rate, would be $74.38 for the note and $434.51 for the bond.

To my surprise, the Treasury bond’s hypothetical result doesn’t trail that of every single mutual fund that has posted a 30-year return. Two gold-related funds, two Japanese equity specialists, and one perpetually misguided bear have fared worse. But anything in the mainstream performed far better, as the median profit from a March 1990 mutual fund investment exceeded $6000.

If 2009-12 was a bond bubble, as many argued at the time, what does that make today? The lowest 10-year yield during that stretch was twice current levels; for the most part, yields hovered above 2%. To say that we are in uncharted territory is to understate the matter. The 10-year Treasury began this year paying 1.76%, which was the lowest Jan. 1 figure ever recorded, dating back to, umm, 1790.

The Debate is Over
That makes last decade’s bond-bubble argument incorrect. Even if Treasury yields were to spike dramatically and remain at much higher levels, those who shouted “Bubble!” can’t claim victory. The statute of limitations for that declaration has long expired. The argument was that the blend of the lowest yields in more than half a century, easy-money policies from the Federal Reserve, and rising federal debt seemed sound. (I initially believed.) But events disproved it.

Japan has been an even-more dramatic example, and perhaps one that will illuminate the current U.S. situation. In 2012, Japanese 10-year notes were more aggressively priced than U.S. Treasuries are today. Their yields were similar, but Japan’s national debt, as measured by ratio of gross government debt/gross domestic product, was double that of the United States, and its money was so easy to be free. The Japanese equivalent of the federal-funds rate was zero.

If Treasuries 10 years ago were in a bubble, then Treasuries today qualify as an expanded bubble, and Japanese notes circa 2012 were an expanded bubble that had been further inflated. They were a dirigible. And they have performed just fine. The total return on the 10-year Japanese Treasury hasn’t been high, because how could it be with that yield at a starting point? But it has been steadily positive, as Japanese yields have since fallen, thereby boosting the notes’ prices.

The yield on a 10-year Japanese note is now negative 0.07%, meaning that if I pay JPY 100,000 to purchase that security, I will owe the Japanese government JPY 7,000 along the way--10 annual payments of JPY 700. A lower return than stashing that cash under a mattress, although presumably safer, as a household accident seems likelier than Japan defaulting on its debt.

A Tale of Two Countries
In both the U.S. and Japan, the predictions made from conventional economics failed. (For a prescient discussion of Japan’s marketplace, see this June 2011 interview with a JPMorgan Chase economist.) Money growth in Japan has been moderately high, and positively robust in the U.S., where M2 supply has almost doubled over the past decade. Yet inflation has remained dormant.

It is tempting, therefore, to project that Treasury bonds will continue to confound their critics, just as Japanese bonds did before them. That may well prove true. However, reminds Morningstar’s Eric Jacobson, there are some important distinctions between the two markets. Both countries enjoy the unusual privilege of being able to borrow seemingly limitless amounts without being penalized by bond investors, but, as Jacobson reminds me, for different reasons.

Japan is supported by huge domestic demand. Emotionally scarred from its stock market’s horrific 1990-2010 performance, Japan’s often-elderly investors are happy to own securities that, to paraphrase Mark Twain, will provide a return of capital, if not necessarily a return on capital. In addition, Japan’s sluggish, low-growth businesses don’t consume much capital. Thus, Japan’s money growth tends to be circular. The government issues more money, which finds its way to the Japanese public, which then returns those yen to the government, by buying its newly issued bonds. Ah, symmetry.

The U.S. marketplace is more complex. Treasury demand is international rather than primarily domestic, partly because the dollar effectively serves as the global currency, and partly because the U.S. economy is more dynamic than Japan’s. Even if the dollar were not a strategic asset, the U.S. economy’s strength would support the currency, and thus the nation’s bonds.

Looking Forward
The question thus arises as to how Treasuries will behave at another point in the economic cycle. The current expansion is, shall we say, seasoned, being in its 11th year. Consequently, Treasury prices have for a while now contained the possibility of recession. Even more so, of course, with the disruption caused by the coronavirus, which has the betting markets forecasting a 72% chance of recession this year (up from 65% earlier this week, and 18% on New Year’s Day).

In addition, there has been a dollop of panic--the flight to safety that customarily accompanies stock market meltdowns. The yield on the 10-year Treasury has dropped by a full 50 basis points over the past four weeks, and while some of that movement owes to the increasing likelihood of recession, some stems from a rush to the exits.

In summary, Treasury yields are unappealingly low, but seemingly not irrational. They reflect long-term lessons about the relationship between money growth, interest rates, and inflation that have changed what investors expect from bond yields, as well as short-term factors. The latter makes me unenthusiastic about purchasing Treasuries, because buying what is currently fashionable is no recipe for success. But I would not scorn such a decision.

Youthful Enthusiasm
In December 2009, I published an article entitled “Bad Investment Ideas for 2010,” which was picked up two days later by Business Insider, reprinted verbatim (per a license agreement), but fitted with a new headline: “John Rekenthaler: Stocks Are The Only Good Investment For 2010, Everything Else is a Bubble.”

I had forgotten entirely about that article until I stumbled upon it last week. Oh, dear. The Business Insider headline assumed that the reader not only knew who I was, but also cared what I thought. Come on now. Less amusing was that the headline was accurate; I had indeed portrayed various markets, including high-grade U.S. bonds, as being “bubbles.”

The S&P 500 rose by 12.8% in 2010, so I got that part right. However, in hindsight I should not have so confidently predicted that result, nor been so certain that bond prices were unsustainably high. (In 2013, I retracted that opinion.) Today, I am more cautious. Experience has shown me that as a general rule the bigger the talk, the smaller the insight. This columnist included.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.