Tags: interest | rates | treasury | bond

Don't Sweat Interest Rates — Watch This Instead

Don't Sweat Interest Rates — Watch This Instead

By    |   Friday, 04 May 2018 08:18 AM

Frankly, I couldn’t care less about 10-year Treasury yields hitting 3 percent.

It’s just one of those meaningless headline numbers designed to scare you into reading the latest financial clickbait. Three measly percent. Whoop-de-doo.

You know what 3 percent is after accounting for our official inflation rate of about 2.3 percent? About a 0.7 percent real return. You know what you’re paying federal taxes on? The entire 3 percent return you get before inflation is taken into account (called “nominal return” in Wall Street speak).

The one small solace is that US government bonds aren’t taxed at the state and local level. Yet once economic reality and the taxman is taken into account, there’s little real return on bonds right now. That’s a 10-year government bond in a nutshell. It’s a wash compared to cash under the mattress at best (find a better hiding spot if this applies to you), and if inflation really picks up, it’ll get worse.

And, of course rising bond yields mean falling bond prices. So that 3 percent yield, if it keeps ticking up, means that anyone buying bonds now will be locking in a price loss. Sure, the bond will get redeemed at par eventually. But you’re better off buying a bond below par for the combination of higher yield and a chance for appreciation, even if you have to hold to maturity.

I know, I know. Bonds have been a great investment in the past 30 years, just as with stocks. If you bought bonds in the early 1980’s, you could have locked in yields in the teens and had huge price appreciation along the way. I don’t see a 30-year bond bear market brewing, as others do. But I do see lackluster returns on government bonds far off into the horizon, even if they show nominally higher yields.

The fact of the matter is, the higher interest rates go, the more likely the economy is in for some tough times. At higher rates, the cost of financing our existing government debt will explode.

Back in the days of the financial crisis, when central banks first cut interest rates to near zero, the cost of total government borrowing went down, even as trillions of dollars in new debt was created. That’s why there will be insurmountable political pressure to keep interest rates at a level high enough to attract investor interest, but low enough to keep governments from blowing the budget on debt payments.

So what matters more than just interest rates?

The yield curve. That is to say, a curve plotting the interest rates of various government bonds at various maturities. A 30-year bond should yield more than a 10-year bond, to make up for the extra risks of holding a bond for 20 additional years. A 30-day bond has near zero risk, and should be priced appropriately. A healthy yield curve takes all this into account, and the yields get bigger as time progresses.

But the spread of that curve can change. Right now, the yield curve is narrowing. That’s not a red flag, but it’s an important yellow one. If enough investors are uncertain enough about the future, the changing yield curve may even invert—where longer periods of time have a lower interest rate than shorter ones. An inverted yield curve has proven to be the most historically accurate indicator of a recession within the next 12-18 months.

That’s the indicator to watch.

But remember, a recession doesn’t mean you need to sell out of everything and move to cash, gold, guns, or anything that can be stuffed under a mattress. First, it’s killer on your back. And, second, being too fearful means missing out on potential investment opportunities. A lot of folks sat out the market for years after the financial crisis, missing the extreme values at the low.

What’s an investor to do? Maybe start with an income-oriented investment that’s bond like but isn’t a bond. For instance, I picked up hundreds of shares of AT&T (T) in the past week following the company’s post-earnings slide. I don’t expect this to act like a major growth play by any means.

But in the past few years, shares of the company have dropped to the low $30’s where they are today, only to rally from there. And with a dividend yield close to 6 percent, I can get a return nearly double that of a 10-year Treasury bond.

Unlike a bond, stocks can change their payouts. AT&T’s dividend has been gradually increasing over the years. That rising dividend trend may not continue forever, but for a heavily regulated telecom operation, again, I’m not expecting huge growth. It’ll be another story if they can get the regulatory approval to buy more content-related assets, but that story has years to play out.

The bottom line is, a 3 percent Treasury yield, in and of itself, doesn’t tell you much. Other trends matter, and looking at yields in a vacuum isn’t helpful. Consider the yield curve, and look for opportunities to buy bond-like investments instead of bonds—unless you can get a bond substantially under par value and are willing to hold to maturity.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

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Consider the yield curve, and look for opportunities to buy bond-like investments instead of bonds—unless you can get a bond substantially under par value and are willing to hold to maturity.
interest, rates, treasury, bond
Friday, 04 May 2018 08:18 AM
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