Traditionally, fixed income was a boring asset class; limited to widows, orphans, and the elderly who are looking for a steady income that they could rely on. Over time, investment banks turned it into one of the most exciting asset classes in the market. Today I wonder if the term “fixed income” is at all appropriate to describe an investment that costs you money instead of earning you some.
Nobody doubts the fixed part, it is the income part that has me wondering. Yields are at historical record lows. Three of the top five 10-year benchmarks are currently negative: Germany, Japan, and Switzerland, while only the UK and US are yielding anything albeit 0.7% and 1.4% respectively.
The entire Swiss curve – that is 0 to 50 years – is underwater; while the German and Japanese curves have negative yields for every single maturity up to 15 years. But sovereigns are not the end of the story: for the first time, we are starting to see negative corporates: Johnson & Johnson (NYSE:JNJ), General Electric (NYSE:GE), and Altria (NYSE:MO) traded negative as early as last month. The current tally is much larger.
At the International Capital Markets Association (ICMA) annual general meeting in 2008, the then President of the European Central Bank, Jean Claude Trichet, during his keynote speech joked that rates were so low, that soon we would see zero coupon perpetuals issued at par… well! 8 years, a major financial crisis, and several government debt crises later, that feels more like a prophesy than a joke.
No room to maneuver
As mentioned in my earlier article How Low Can You Go? keeping interest rates at crisis levels is extremely dangerous, since the central banks will not be able to rely on this tool should a crisis develop. Yet every central bank across the world has failed to increase rates in the last 6 months despite improving global economic indicators.
So, where is the yield?
In stocks! out of all places. Some Dow components are yielding over 4%, plus a potential capital appreciation. There are only 6 out of the 30 Dow stocks that are yielding less than 2%, with the vast majority in the 2-4% range. As early as one week ago, there were a few companies yielding in excess of 5%, and with cheap money available everywhere it is not unlikely that massive leverages are taking place at many investment houses. This increases the likelihood of a catastrophic crash in equities should rates increase dramatically over the next few years. This is probably one of the reasons rates have been so depressed lately, and why stocks have been outperforming.
Just remember: A rising tide lifts all boats, but…
Only when the tide goes out do you discover who’s been swimming naked
Warren Buffett
With this I bid you goodbye for the rest of the month. See you in August!