How the Treasury Rates Can Tell You How to Invest

Five years ago (Spring 2007), if you had told me that the 10-year US Treasury Rate would have been 1.39% (as it was briefly last week), I would have asked how big the meteor was that hit the earth. On the one hand, very low interest rates are a good thing because it presents low cost capital to people and businesses to make it as easy as possible for them to spend or invest in their businesses. On the other hand (which for those of you keeping score would be hand #3), for rates to be that low it tells us that investors are very scared and are effectively stuffing money into their mattresses. Treasury rate goes down when people buy Treasuries. For the rates to keep going down means that people continue to be scared and pessimistic. If five years ago someone were to only look at the Treasury rate, it’d be safe to deduce that some really scary stuff was going on (the last time it did this, Europe was mostly under the control of The Third Reich).

Three and a half years ago (fall 2008) I came to the belief/concern that we were entering into a classical depression. With the economy it’s important to keep in mind that your spending equals somebody else’s income; conversely, their spending equals your income (in a roundabout way). So when people aren’t spending, it causes somebody else’s income to go down. When their income goes down, it causes their spending to obviously go down too. When they don’t spend money, it causes your income to go down. Which causes you to spend less, which causes their income to go down. This is obviously over-simplistic, but that’s in essence what has gone on the past few years.

Every once in a while they do this ridiculous survey of businesses where they ask them why don’t they hire. Some may say because of high taxes or because they don’t know how much Obamacare is to going to cost them, the election, labor union issues, etc. I find it always silly because I highly doubt businesses are actually purposing holding back from making money or investing because of these things. To a business, the decision is simply a weighing of costs, downside risks, and relative certainty of profit. For an established business (which is where most of the hiring comes from), experience makes this come down to one item: demand. Or, sales would be another way to put it. Businesses aren’t expanding, not because of any of these issues, but because they don’t have certainty that there will be buyers on the other end of their investments. As a result, many are just holding tight until they have that certainty.

This is characteristic of a classical depression. Consumers have a hesitant will to spend and because of this businesses have weakened ability to expand. Again, your spending is somebody else’s income and somewhere in the middle is usually a business making the transaction.

This is also why 3 ½ years ago I did not think that we’d have the hyperinflation that everyone was worried about at the time with the Fed’s expansionary monetary policies. No business is going to raise prices unless people are actually buying stuff. Inflation is just another way to say “prices going up”.

Each day it seems that Europe is inching closer to the proverbial fan. We hear of a current Spanish run on the banks. There is serious talk of Greece bowing out of the EU … as there has been for years. Investors, understandably are running into fear instruments. Namely, US Treasury bonds.

How low will the 10 year Treasury rate go is anyone’s guess. If Europe falls apart, expect Treasury rates to go lower, particularly if the dollar suddenly finds itself as the world’s only dominant currency. It is astounding how long this has gone on. 3 ½ years ago I would have guessed that the European mess would have been resolved long ago, but no dice.

A final note that I want to mention is that some of my readers may have been taken aback by my cavalier suggestion that we’re in a classical depression. I still maintain that this is likely to be the best time to invest in stocks for decades to come and that if the market goes down because of Euro woes, it’s becoming increasingly more likely that we’re hitting the ultimate golden point to invest in stocks. Professionally, as a wealth manager, I help people invest. My hardnosed bias is that every investor must have a financial plan before investing. When I work with someone on a financial plan, what I’m looking for is when they are going to spend the money. If you’re in a situation where you’re not living off your investments, then the main thing you need to worry about is figuring out a way to put as much money into the market as possible while having a good method of keeping your head on straight about it. If you can project forward and see that you’re probably not going to be spending your money within 10-15 years, then my feeling is that however much the market gets beat up because of any of this, it’s not going to end up being a long term risk.

On the other hand, buying a 1.39% 10 year Treasury has downside price risk that we haven’t seen in 80 years. I don’t think interest rates would need to rise much to wipe out 10 years of your anticipated interest through price fluctuation. Let me illustrate. The past week the 10 Year Treasury rate rose to 1.58%. It’s tricky to calculate exactly, but for those who bought a 1.39% bond a few days ago, they’re sitting on about a 2% loss. The slight bump in rates wiped out more than one year of yield.

It’s impossible to know where rates will go. It wasn’t long ago that it was shocking that the 10 Year briefly touched 2% during the Financial Crisis before going back up. Few would have guessed that it would go lower. But my guess is that outside of extreme deflation, the 10 Year won’t go below 0%. To guess at a lower bound rate higher than 0%, my imagination tells me that there aren’t a lot of people out there willing to lock up their money for 10 years at a rate less than 1%. The bottom rate is somewhere in there. It may have been 1.39% for all we know and that will be the low point for the next 80 years.

To me, those still trying to make money in Treasury bonds are like a game I used to play at the ocean when I was a kid. The goal was to not get wet. The waves would roll up on the sand and you would chase them back out to the sea before the next one would roll up. The goal was to get as close to the next wave as possible without getting wet. My brothers, cousins, and I would always start this game wearing our clothes naïve that we’d get wet. Inevitably, we’d all be soaking within minutes. As a parent, the lesson I’ve learned is that when your kids are heading to the ocean is that if you can’t stop them, get them in their swimsuits.

To me, investors who are still hanging around in Treasuries are playing this game and nobody’s wearing swimsuits. I have no idea if you’ll be able to get a little further out onto the wet sand, but I do know that most children who don’t stop playing the game will eventually end up soaking wet.

As a financial advisor, the moral of the story is that investors need a financial plan; especially in times like these. Often when I come across new clients seeking a financial advisor, they have this uncoordinated hodge podge of investments that don’t have any rhyme or reason. If we are in a depression, it is not a time to be disorganized and sloppy. The risks on all sides are far too great.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Investing in securities, including stocks and bonds, is subject to market fluctuation and possible loss of principle. No strategy can assure success or protect against loss.

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