The Magazine Cover Indicator: It May Not Be Not a Low Rate World After All

by: Michael Panzner

As with other large-circulation magazines on sale at newsstands across the country, BusinessWeek's cover often highlights a theme designed to stimulate widespread awareness and appeal to impulse buyers. More often than not, the subject matter revolves around a controversial or popular topic that has recently gained traction in newspapers, on television, and at other media outlets, although exclusive breaking stories do occasionally feature in the top spot.

Every once in a while, though, the editors of BusinessWeek (and other mass market publications, for that matter) will suddenly "identify" a long-running theme that has garnered especially widespread acceptance, label it as the wave of the future, and boldly pronounce this "fact" on the cover of the magazine. Unfortunately, those occasions have often served as bell-ringing moments of sorts, signaling that circumstances are poised to swing the other way.

0708covdc With that in mind, the most recent issue of BusinessWeek, with a cover story entitled "It's a Low, Low, Low, Low-Rate World," should give pause for thought.

Wait a minute—weren't long-term interest rates supposed to be a lot higher by now?

When the rate on the 10-year Treasury bond plunged from 6.5% in early 2000 to an average of 4% or so in 2003, the explanations were easy: tech bust, recession, weak capital spending, low inflation, steep rate cuts by central banks around the world. The low rates seemed perfectly normal—and sure to reverse on a dime when conditions changed.

Since then, plenty has changed. The Fed has hiked short-term rates by more than four percentage points. The global economy grew by 5.1% in 2006, the second-strongest performance in 25 years. Europe and Japan have recovered. Even tech spending seems to be on the rise, judging from Cisco Systems Inc.'s (NASDAQ:CSCO) strong earnings report on Feb. 6. And yetand yet!—10-year Treasury rates have risen only three-quarters of a percentage point. Real rates, which adjust for inflation, have barely budged.

It isn't only a U.S. phenomenon. Ten-year euro bonds are yielding around 4% today, no higher than in 2003, despite much faster growth in the region. Real rates in the euro zone are up only a bit.

Borrowers, of course, are deliriously happy. Even the shakiest companies are seeing their debt costs plunge. The spreads on triple-C rated bonds and lower—the junkiest of junk—are at a record low 4.7 percentage points over ultrasafe Treasuries, compared with the previous record of 5.2 percentage points in 1997, according to Merrill Lynch & Co. (MER)

Most remarkably, the craziness isn't likely to stop anytime soon. The low cost of capital is probably going to last "five to seven years," says Samuel Zell, who as chairman of real estate firm Equity Office Properties Trust [EOP ] watched bidders wield cheap debt in a fight over his company. (Blackstone Group, with a $39 billion bid, won out on Feb. 7.) James W. Paulsen, chief investment strategist at Wells Capital Management (NYSE:WFC), sees an even longer horizon: "This could be a prolonged cycle where the cost of capital is low [for] 10 or 20 years."

It is, indeed, a low, low, low-rate world.

Or maybe not. With central bankers around the globe growing increasingly worried about inflation, regulators pushing for much tighter standards following a period of explosive growth in "affordable" lending, upheaval in the subprime finance sector driving up the cost of credit for higher-risk borrowers, evidence that at least some central banks are losing their appetite for longer-term U.S. bonds, and a technical pattern that suggests a multi-decade downtrend in rates is drawing to a close, the odds are high that the infamous "magazine cover" indicator, first described by Paul McCrae Montgomery, president of Montgomery Capital Management, will again mark a major turning point.