Want A Guaranteed Negative Return?
Here we go again! On Wednesday, August 14th, we watched the Dow Jones Industrial Average (DJIA) drop over 800 points. The previous Monday the Dow ended down over 700 points. But what you may have missed is the sharp downward move in interest rates that has intensified with the recent stock market volatility. What does this mean for your portfolio?
According to an index of bonds calculated by Bloomberg, nearly 25 percent of the debt issued by governments and companies around the world is currently trading with negative yields. This equates to nearly $15 Trillion of bonds trading or issued with negative yields.
So, what does this mean? If you buy a bond with a negative yield or interest rate you are guaranteed to get back less than you invested if you hold the bond to maturity. On top of that, if the bond was issued with a negative interest rate, you receive no income along the way. Basically, you are loaning money to a government or company for the privilege of getting back less than you gave them.
Your first thought may be that these must be short-term bonds. Surely no one would give away their money for years knowing it will yield a negative return. Amazingly, you’d be wrong. As of August 5th, at least ten countries had 10-year bonds and three countries had 30-year bonds with negative yields. Imagine loaning your money for 30 years knowing you’ll receive no interest payments and less of your principal than you loaned initially!!
Why Is This Happening?
After the economic crash of 2008-2009, central banks around the world lowered interest rates to zero. Since then they’ve had a difficult time moving those rates back up. Growth around the world has been less than stellar and central banks have had to keep rates low and be creative in finding ways to keep their economies growing.
One creative measure central banks have employed was to buy up debt that was being issued to keep interest rates low and pump money into the economy. The hope was that this would spur economic growth. This measure created an indiscriminate buyer of bonds who wasn’t concerned about making money on bonds as an investment, but was more interested in keeping interest rates low and the economy flush with liquidity. Another contributing factor may be that investors believe rates could turn even more negative during the next recession, making their slightly negative bonds look like a good bargain.
Why Is This A Big Deal?
We’ve never experienced this much debt trading around the world at negative yields. It defies all our economic and market conceptions about bonds. Despite all the theories, no one is certain why this is happening. As little as nine to 12 months ago, most of the world thought interest rates were zooming much higher, only to see a quick and complete reversal. Matt Dalton, CEO of bond management firm Belle Haven, referred to this phenomenon as “the black hole of negative rates” that has a gravitational pull bigger than any other market concern at this time.
What Does It Mean for You?
So, how alarmed should you be? Maybe a little, but we’ve been here before. In 2016 interest rates went negative for a short period, but then reversed course slightly. Stock markets continued to perform well and our economic growth has continued to be positive.
However, for investors this creates a dilemma. You can get paid little interest for your safe investments or take more risk to get the yield you want or need. Unfortunately, 5 percent government bonds were replaced a while ago by lower-yielding bonds. That trend appears to be intensifying in an historical way. Now is a good time to take a look at the conservative part of your portfolio to make sure you are comfortable with the risk you are taking.