Retirees And Diving Bond Yields

by: Bill Gunderson


Central banks all over the world are pulling out all of the stops to try and stimulate their economies.

Japan and Switzerland now have negative rates on their 10-year bonds, and Germany is on the verge of going negative.

What is the bond market telling us, and what are retirees supposed to do?

Central banks all over the world are pulling out all of the stops to try and stimulate their economies. Meanwhile global bond yields are diving. Japan and Switzerland now have negative rates on their 10-year bonds, and Germany is on the verge of going negative. What is the bond market telling us, and what are retirees supposed to do?

Investors consider bonds to be a safe haven. When a storm starts to brew on the ocean, captains point their boats toward the nearest safe harbor until the storm passes. This is one of the messages that the global bond market is giving us. Global investors continue to fear a global economic slowdown. This is not a new fear however; fear of a global slowdown has been in the news daily for the last several years. Yet, the U.S. bull market, now over seven years old, continues to march on.

When too many captains make the run for that safe harbor, anchorage space can get expensive. Or when travelers try to get a motel room in advance of a coming blizzard, out on the open highway, they find that demand is high and prices are too. Global investors have been driving down global bond yields for the last several years. This is not a new phenomenon. But how low can they go???

Now the problem is exacerbated by Central Banks driving down yields by interest rate cuts. To make matters even worse, many of those central banks are also buying those same bonds. This is really driving bond prices higher and interest rates lower.

Look at chart of the Japan 10-year bond below. It is now below the line. Japan now offers a -0.14 interest rate to investors in its bonds.

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Invest $10,000 in a Japan treasury today and it will be worth just under $9,900 10 years from today. I doubt that they will throw in a toaster with this offer! But wait, Japan is not the only country now offering negative rates. Switzerland is offering rates that are even more negative than Japan! I wonder what the TV advertisement for that sounds like?

Not to be outdone by Japan, the Swiss are offering -0.45% on their 10-year bond. That turns $10,000 into about $9,600 over 10 years. But Switzerland is considered to be one of the safest harbors in the world. That is why the demand is so high, and the bonds are so expensive.

It is like staying at the Hilton as opposed to the Budget Inn out there on those icy roads. You have to pay up for the added comfort and safety.

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As of now, Japan and Switzerland are the only two countries offering these negative rates, but Germany is not far behind.

The yield on the 10-year German bond fell all the way down to 0.02% on Friday. At that rate you will make a whopping $18 over the next 10 years on your investment of $10,000. At least that is enough to buy a toaster. Never mind inflation.

Germany is also considered to be one of the safest harbors on the planet. Click to enlarge

It almost seems inevitable that yield on the German 10-year bond is going to go negative at some point in time. It is just about there now. But, as you can see from the charts of the Japan, Swiss, and German bonds, diving interest rates are not a new phenomenon; this has been going on for several years.

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Japan's rates have been falling for the last 30 years. So have Switzerland's rates.

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Believe it or not, there was a time when you could earn over 10% on your savings in Germany. Not anymore.

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Now retirees have to depend more and more on already strained government programs for income in their golden years. Meanwhile, governments around the world continue to take advantage of cheap rates to borrow, and borrow, and borrow while savers continue to take it on the chin.

It is downright frightening to hear former Fed Chairman, Alan Greenspan, state in a most anxious way that the U.S. economy needs to grow by an annual rate of about 5% per year to just keep up with entitlements! Otherwise a catastrophe is looming on the horizon.

Something has to give at some point in time and it won't be pretty. Do we really want retirees to be more and more dependent on governments that don't know how to balance a checkbook? Does this not change the whole asset allocation model for retirees? How can bonds continue to be the biggest portion of your nest egg, when the yolk is not there anymore?

No wonder that money is flowing into more risky assets like REITs and utilities these days. But now they are also getting more and more expensive, as those motel rooms disappear.

But before we point our finger at governments around the world, let's look at our own backyard. Interest rates in the U.S. have fallen from 16% to 1.6% over the last 35 years.

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Our Fed just recently moved off of a Zero Interest Rate Policy that it had kept in place since 2009! Our Fed was also in the bond buying business for several years competing with investors trying to earn a decent yield on their savings.

Debt in the U.S. also continues to grow and grow and grow while the promises continue to increase almost by the day.

Remember the good ol' days when an investor could earn 16% on his or her savings? It was good to be a saver back then, but it was awful to be a borrower. There is obviously a happy medium in there somewhere.

The pendulum has obviously now swung to the other extreme. It is much better to be a borrower than a saver. No wonder there is so much debt piling up on balance sheets all over the world.

Countries are lowering rates to try and stimulate their economies. Is it working? Japan's GDP continues to fall despite negative rates.

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Despite the most negative rates in the world, the Swiss economy also continues to fall.

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The German economy also continues to move down along with its interest rates. Could there be a "Gexit" vote someday?

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If these low interest rates continue to not stimulate economies, the last place that countries have to turn is more government spending. That would throw even more gasoline on the fire of the growing mountain of debt. The printing presses would have to continue to churn.

No wonder the market sold off late last week on global growth concerns. Economies around the world are seemingly being backed into a corner. Watch for the call of more and more globalization as the problem continues to mount.

Meanwhile, there are big nationalism moves taking place in the United Kingdom, Germany, France, and the United States. Nationalism is obviously the opposite of Globalism, and the two sides do not like each other very much. At times it gets so bad that riots can break out.

It will come to a head in England on June 23, when the people vote to stay or leave the European Union. If the U.K. leaves, it could set off an exodus of countries like France, Italy, and others. This would make the globalists quite angry indeed.

If you believe the polls, the exit side is ahead by 10 points. But, if you believe the bookies, there is a 72% chance that they stay. I would go with the bookies. So what are investors, and especially retirees to do in today's volatile investing environment?

I am an active money manager, so I am obviously biased against passive management. But, I believe that being passive in a world that is anything but passive is dangerous. Passive management involves index investing and asset allocations that rebalances mildly on a periodic basis. That rebalancing is based on the investor's age, not circumstance in the world.

When the next bear market comes along, the asset allocators will ride the stock portion of their allocation right over the falls, just like they did in 2001 and 2009. The only difference this time around is that they can blame it on the robots instead of the advisors.

When inflation eventually starts to kick in from a bulging toxic mountain of burning garbage called debt, the asset allocators will ride the bond market right into the ground. Asset allocators have not seen a bear market in bonds for quite some time. The robots are programmed to buy more and more debt all the way down as they "rebalance."

Many investors have been lulled into a false sense of security that they are in good hands with the robo-advisors. Look at how much money they are saving in fees! Many of those same investors were also told that those mortgage-backed securities would help boost the yield of their portfolios in a "safe way."

I do not see this tidal wave like move into robotic asset allocation ending up well. I have seen too many boats that were on auto-pilot, crash into the rocks because there was not a captain keeping his eye on the waters that lie ahead; in addition to the auto-pilot that was driving the boat.

Right now, the U.S. stock market continues in its eighth year of the third longest bull market. It is still the best place to be invested. But there will come a time when those inverse funds will come in handy. Inverse funds are not even on the menu of the robots.

At some point in time, all that debt will lead to runaway inflation. I would not want to be a bond holder at that point in time. But, for now, bonds continue to go higher as interest continue to drop. This is not sustainable, however.

As far as income for retirees go, I currently have a diverse mix of dividend-paying stocks, exchange traded funds, and closed-end funds that offer the possibility of capital appreciation on top of the yields that they sport. I bought the closed-end funds when they were trading at a discount to their net asset value. There are many to still choose from.

In addition to this, I actively manage my accounts. We are at the helm each and every day watching for that growing mountain of debt to become too great for countries to handle.

We continue to watch for that inevitable next recession in the U.S. What will the robots do then? The next recession will lead to the next bear market that could easily take more than half out of retirees' portfolios. Wall St. can blame it on the robots this time around.

Today, active managers have more tools at their disposal than ever before. We now have inverse funds on almost any asset class that you can imagine. If Europe goes in the tank, then EUO will soar.

If the U.S. bond market starts to go south, then PST will come in handy. Do the robots or asset allocators ever hedge your portfolio with PST? Do they even know about it?

And when, not if, the DOW goes south, DOG will go north.

My weekly newsletter gave a BUY SIGNAL on the market back in late March of 2009. That buy signal remains in place today.

That is because S&P 500 earnings have been growing every year since then. As of now, earnings are expected to grow by 10% next year vs. this year. This will keep the U.S. market going up until those expectations change, or the market gets too expensive.

When earnings of the S&P 500 begin to shrink and the next recession begins to kick in here at home, the next bear market will be underway. What are the robots going to do then? I cannot guarantee that the active managers will get out of the way with time to spare, but we will do our best to spot the signs before it is too late.

In the meantime, I am not going to depend on auto-pilot to get me safely to my destination.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.