Have Income Investors Gone Insane?

by: Reuben Gregg Brewer


Unilever just issued debt with a 0.12% yield.

Ireland is selling 100-year debt with 2.35% yield.

Why is anyone buying this stuff?

I've worried about how low yields have gotten. But I'm starting to get more worried about the sanity of the investors who are buying all of this low yield paper. This is beyond upside down, it's just crazy.

Free money

Unilever (NYSE:UL) is a giant multinational consumer products company. You may not know the name, but you certainly know the brands, which include Lipton, Dove, and Hellmann's, among many others. Generally speaking it's a pretty good company. Revenues have been kind of stagnant for a few years and earnings fell a little in 2015, but for a core holding it's not a bad company to look at by any means.

The shares yield around 3%. Moreover, the dividend has been trending higher for the last five years or so.

But why are bond investors practically giving Unilever free money? Indeed, at a recent bond sale, Unilever sold debt with a yield of just 12 basis points. That's 0.12%. If loaned $1,000 at this rate you'd get, wait for it, $1.20 per year in interest. It would take 80 years or so to generate $100, assuming you reinvested your income each year.

No wonder U.S. companies are heading to Europe to issue debt. McDonald's (NYSE:MCD) is one recent example. According to Bloomberg, a highly rated company should be able to issue debt with yields around 1% (or less, if you look at the Unilever example), where similarly rated U.S. debt would fetch yields of around 3%, a still low number in my book. This looks like a no-brainer for companies that can do it. McDonald's shares, by the way, yield around 2.8%.

Then there's the 100-year debt Ireland just issued. It has a relatively impressive yield of 2.35%. But whoever buys this debt is locking in a pretty awful yield when looked at on an absolute basis for a full century. This isn't a AAA-rated country, and don't forget that it has had to deal with some demons recently, including a painful housing bust.

And then there's struggling miner Glencore (OTCPK:GLCNF, OTCPK:GLNCY). It just issued debt with a 2.25% coupon. It wasn't but a year ago that investors were expecting Glencore to fall into bankruptcy. While the company has done a fine job of shoring up its finances in the face of adversity, I'm sure that a 2.25% yield wouldn't be nearly enough to entice me to buy into this deal. But enough people liked the offer that the size of the deal was increased three times.

I just don't get it

I'd rather own cash, sitting idle in a bank account. First off, I'm not giving practically free money to any company or country, no matter how great it is. And, second, I'm not going to shuffle way down the quality scale, and way up the risk scale, just to find a yield that doesn't make me sick to my stomach. If this is the new normal, to use a phrase that's gone out of style, count me out.

But this is what you get when central bankers push rates to zero and beyond. And for some, I guess, a little yield is better than no yield. At least that's the only reason I can see for investors buying debt in this environment. To be fair, I know some institutional investors have no choice but to hold their noses and by what they can. But you and I don't have to do that...

My fear is what happens when yields head higher again. Market watchers can make all the arguments they want that yields aren't going higher any time soon, but they will eventually move up. Remember that 100 year bond? I'm not a betting man, but I'd be happy to wager that rates will go up at some point before that debt matures. In fact, I'd be pretty comfortable making a similar bet for a 30 year or even a 20 year bond. To be honest, if rates don't head higher by that point, we are all in for a world of economic hurt.

As we all know, one of the key things about bonds is that their value moves in the opposite direction to interest rates. So if rates do move up, the value of all the debt issues with non-existent yields (or just slightly higher) will head lower and lower. And likely in a big way, wiping out any possible benefit the income they generate could offer. Go back to my $1,000 bond yielding 0.12% example. The value of the bond would only have to decline by just $1.20 to kill a year's worth of interest. That's a fall to just 99.9% of face value.

Stay cautious
I may be oversimplifying things, but this ain't right. Something has to give, and when it does, investors that stretched to find yield or accepted piddling yields in exchange for perceived safety are likely to get hurt. There's far more risk in the market than many investors appear to believe.

Wait. The market goes up, and the market goes down; it always has, and it always will. At some point in the not-too-distant future, you will have a good opportunity to invest for income. But right now, you need to tread cautiously.

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.

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