18 BARRON’S March9,
which meant their prices would be
headed higher.
In the early 1980s, Ed Yardeni
forecast “hat size” yields, somewhere
in the range of 7% to 8%, or about
half the peak levels of the time. Now,
the founder of Yardeni Research ex-
presses wonder at the existence of
“ring size” bond yields. He acknowl-
edges that he borrowed the “hat-size
bond yields” phrase from Van Hois-
ington, who manages institutional
accounts and the Wasatch-Hoising-
ton U.S. Treasury fund (ticker:
WHOSX).
Lacy Hunt, Hoisington Investment
Management’s chief economist, still
sees the trend toward lower bond
rates as intact.
Long-term interest rates are the
product of the real yield (what’s left
after adjusting for inflation) and infla-
tion expectations, he explains. Both
have been coming down for more than
two decades. Inflation expectations
tracked by the University of Michi-
gan’s consumer survey have declined
to a record low.
Real rates, meanwhile, have been
moving steadily lower, owing to
slower economic growth, which in
turn has been the result of the buildup
of debt, which Hunt contends has
been a drag on growth rather than a
stimulant. Japan and Europe, where
short- and intermediate-term rates are
negative, are more extreme examples.
In the event of a mild recession,
Hunt sees inflation falling by 200 to
300 basis points (or two to three
percentage points). With the core
personal consumption expenditure
deflator, the Federal Reserve’s pre-
ferred inflation gauge that omits
food and energy costs, currently
rising at a 1.3% annual rate in the
most recent three months, any kind
of downturn will result in deflation,
with a commensurate decline in in-
terest rates.
But as rates move toward the zero
lower bound, Hunt says the evidence
shows it is counterproductive for the
economy. “The banking system and
other intermediaries can’t function
with yields and yield spreads so
puny,” he says.
To be sure, yields can rise and pro-
duce volatility over the short-term —
which Hoisington’s investors may ex-
pect during some periods, Hunt warns.
That’s a risk that is especially acute
now, says Jim Kochan, a bond-market
veteran who is an adjunct professor of
finance at the University of Wisconsin
at Milwaukee, and formerly chief
fixed-income strategist at Wells
Fargo’s asset-management arm.
“Investor psychology feels almost
the complete opposite of 1979-81,”
Kochan says. These days, investors are
clamoring for bonds yielding 1% or
less, just as they shunned them at 14%
to 15% then. What’s not understood
well is the bond math that makes
them so much riskier now.
Specifically, a 30-year bond has a
duration of 23 years, which makes it
far more volatile for the same change
in interest rates than in past eras
when yields were higher. A 100-basis-
point rise in yield would mean a 23%
decline in the current long Treasury
bond’s price. Conversely, if the 30-
year yield were to fall from 1.5% to
1%, that would produce a gain of 10 to
12 points in price—“which is not
something I would count on,” Kochan
says.
As a result, he counsels that inves-
tors seek cash equivalents, such as
money-market funds or Treasury
bills, even if it means missing a final
move down in bond yields.
Moreover, he notes that stock divi-
dends offer higher yields than bonds,
including the debt of the same com-
pany in many cases. That also looks
more tempting to Dan Fuss, Loomis
Sayles vice chairman and bond man-
ager whose experience stretches back
six decades. That was the case last
year, when he said he was buying
AT&T(T) common shares for the
Loomis Sayles Bondfund (LSBRX).
They yielded more than the telecom
company’s debt.
Fuss has now been less tempted by
corporate bonds, his portfolios’ main
staple, owing in part to a lack of li-
quidity in the market. Instead, he has
been emphasizing short-term Trea-
suries, despite their low yield, in
hopes of being an opportunistic
buyer of bonds at lower prices.
Long-term Treasuries also hold
little allure for David Kotok, head of
Cumberland Advisors. The yield on
the S&P 500 index of 1.86%, he fig-
ures, ought to provide a return over
the next three decades vastly better
than the Treasury long bond, albeit
with significantly more volatility.
Kotok doesn’t want to put all of his
clients’ eggs in one basket, however.
For their fixed-income portfolios, new
money is being directed to cash, even
though it will be earning only about
1%, rather than the 1.5% before the
Fed’s 50-basis-point rate cut this past
week. “It’s strictly valuation; I don’t
want to own any 10-year bond yield-
ing less than 1%,” given the risk of
price declines from a reversal in
yields, Kotok says.
Yet other bond veterans contend
that insurance, rather than income, is
the reason to own risk-free govern-
ment securities. Robert Kessler, who
heads the Denver-based asset man-
ager bearing his name, says, “If you’re
not hedging a portfolio with Treasur-
ies right now, you’re just being silly.”B
Sticking
With Bonds
Even as They
Near Zero
These longtime bond bulls say
Treasuries still offer insurance
and some price appreciation.
But there are risks.
Source: Bloomberg
1990 ’95 2000 ’05 ’10 ’15 ’
0
2
4
6
8
10%
How Low Can It Go?
Over the last 30 years, the yield on the benchmark 10-year Treasury note has fallen from above 8% to less than 1%.
10-Year Treasury Yield
“If you’re
not hedging
a portfolio
with
Treasuries
right now,
you’re just
being silly.”
Robert Kessler
“B
ond Yields Hit Record
Lows” is a headline
that has been used
repeatedly as Trea-
sury yields fall below
previously unimagi-
nable levels. First, the
30-year bond yield fell past 2%; then,
in the past week, the benchmark 10-
year note crashed through 1%.
A few market veterans also recall
bond-market records at the opposite
end, when long-term government se-
curities topped 15% in the early 1980s.
And even fewer stuck their necks out
then to declare that, after more than
three decades of rising yields and fall-
ing bond prices, investors should no
longer shun bonds.
Today, some of these early and pre-
scient bond bulls still think that inves-
tors should continue to hold on to
their bonds even after yields have
plunged to 0.74% for the 10-year note
or 1.29% for the 30-year bond in a
manic flight to quality due to fears
over the impact of the coronavirus.
Others see more risk in these low
returns, if yields were to reverse their
recent, stunning decline.
A. Gary Shilling, the economist and
newsletter author, is one of the origi-
nal bond superbulls and remains posi-
tive on long-term Treasuries. “I never
bought bonds for yield,” he said. “I
always bought them for the same rea-
son as stocks, for price appreciation.”
He professed not to care about their
yield as long as it was headed lower,
By RANDALL W. FORSYTH
w018_p2bw069000_0_w01800_1________xa2020_01.pdf 109-Mar-20 13:40: