Bond Investors Beware, History Is Not On Your Side

by: Mycroft Friedrich


Shows that government bond yields are at multi-century lows in Europe.

Explains that when interest rates eventually rise, bond investors' principals could be hurt substantially.

Talks about the reversion to the mean.

Last week, I wrote an article for Seeking Alpha addressing the various concerns I have about the current overvalued market environment. You can link to that article by going here titled 'Some Concerns That Have Me Worried About The Overvalued Markets In 2015'. In that article, I addressed the following, using charts to give a visual presentation of the facts:

  • The fall of inflation and the great rise in deflation, where 40% of the world's economies are currently suffering from the latter.
  • Since the 2008 market crash, there have been massive build-ups at the world's key central bankers to the tune of $10 trillion.
  • How a majority of public companies have been buying back stock, hand over fist, as fast as they can with a great majority of each company's cash flow being dedicated for that purpose alone. Not only that but some companies are even borrowing money to buy back stock in order to keep shareholders happy.
  • Displayed 20 commodity charts showing how each commodity displayed has gone down by double digits from its peak price over the last 18 months.
  • Discussed how NYSE margin debt is at all-time highs and currently surpasses the margin debt levels of the last market tops of 2000 and 2007.
  • Explained how investors are still fearlessly investing in stocks, despite analysts' expectations of negative year on year growth in earnings across all classes of US stocks.
  • Discussed how the US dollar has erupted +24.4% in less than a year and that there is no way that US multinationals will ever be able to hedge properly against such a scenario and should suffer when each reports this quarter.
  • Talked about the unfortunate result of central bank stimulus and its (in my opinion) negative effects on Global 10-year government bonds that are currently selling at some of the highest levels in principal and lowest yields in history.

This article addresses the last bullet point, as Bank of America Merrill Lynch's (NYSE:BAC) researchers recently published a report detailing the historical bond yields of some of the largest European economies. The researchers didn't just go back a few years, but in some cases went back almost 500 years to get the data. Bond yields are the return an investor gets from holding the debt of a corporation or government. Before we show you the historical charts, I thought it would be a good idea to first publish the current yields on the 10-Year Government Bonds for most of the major economies of the world, so you know where we stand right now from a yield perspective.

Source: Bloomberg

As you can see from the table above, yields are very low right now as evidenced by five countries actually having yields lower than 0.50% and Switzerland having a negative yield on its ten year. Even more worrisome is the situation in Germany, where the government there is paying its bond holders negative yields on many of its bonds and you would have to go out to 8 years in maturity before one actually gets paid a positive yield.

So why are government bond yields at all-time lows and why are investors in Germany and Switzerland willing to accept negative yields? The reason for that is fear. Investors are so fearful that they are willing to accept negative yields in some cases just to park their money someplace believed to be safe. As a result, (in my opinion) bonds are twice as overvalued as stocks are and for investors to think of them as a safe haven or a flight to safety option is an illusion.

But to truly understand how overvalued government bonds are right now, you need to go back in time and see how this current period relates to past ones. So here are some charts, which made the hairs on the back of my neck stand up when I first saw them, as I could not believe my eyes.






So there you have it, five historical charts that speak volumes as to how overvalued bonds are and clearly show how dangerous it is to be a bond investor right now. Even scarier is the fact that the European Central Bank under Mario Draghi, started buying government debt on March 9, 2015 bringing life to its 1.1 trillion-euro ($1.2 trillion) QE program announced back in January 2015. Therefore, history is telling us that bond yields are the lowest in recorded history and that instead of addressing that issue and raising rates, the European Central Bank will be throwing more fuel on the fire.

Obviously, for the ECB to take such drastic actions in the face of the facts presented in the historical charts above, clearly shows that conditions must be even worse in Europe than many economists and investors think. So going forward why would anyone be investing in European bonds right now as clearly the writing is on the wall. Do investors think that the current leadership in Europe is much smarter than all those who came before them? Investors these days (unfortunately) are led by an uncontrollable obsession for yield and income and are making drastic investment decisions, where too much risk is taken for very little potential reward. I thought that the sub-prime crisis would have taught investors to do more due diligence prior to investing, but again that unfortunately is not the case.

In conclusion, no one can tell you the exact date when markets will correct or by how much, but if you are a bargain hunter like I am, there are times to fish and times to mend the nets. Right now, is obviously a time to mend the nets as investors are ignoring the facts that history presents clearly in the charts I presented above. It is hard at times to be in a large position of cash (as I am now 76%) and to be a contrarian, but those who survive serious market corrections and bear markets are the ones who use logic and common sense and always keep a little powder dry.

The stock and bond markets usually punish those who know not what they do and at some point yields will have to go up again as we have a reversion to the mean. At that point, investors will be selling older bonds and buying newer bonds with higher yields, so the higher yields go, the more principal will be lost by those holding older bonds. Those getting close to negative yields on European government bonds are risking a great deal of principal for very little future rewards.

Can negative yields go lower for an extended period of time? Sure, but eventually there will be a reversion to the mean and those invested in bonds will feel the most pain as one's principal gets hit every time yields rise. Therefore, if we are at historic lows in yield, then there is a long way to go up for yields to get back to the mean. That clearly tells us that bond investors could lose a large chunk in principal by the time everything gets back to the mean. So prospective bond buyers and current bond owners beware as history is not on your side on this one.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.