This time last week, I was in Washington, D.C. with my colleagues for the Irrational Economic Summit, preparing for my presentation. On the theme of irrationality, I could think of nothing nuttier than negative interest rates.
I touched on this in The Rich Investor a few weeks ago, but it’s mind-boggling enough to warrant a deeper look.
Spain’s Yield Curve
Consider Spain’s yield curve. You have to go out eight years to find a positive yield.
The Spanish state — which was ground zero of the European sovereign debt just a couple years ago — is now considered “safe” enough to warrant a negative yield. Even at 30 years, the yield is only 1.1%.
When looking at prices rather than yields, had you bought the 30-year Spanish bond six months ago, you’d be up just shy of 40% in capital gains. With gains like that, you’d think that this was a tech stock poised to take over the future.
Spain might not exist as a sovereign state in another 30 years.
Catalonia, the province that includes Barcelona, is in a state of semi-open rebellion. Just this week the Supreme Court of Spain sentenced 12 Catalan regional leaders to between nine and 13 years in prison for an assortment of crimes stemming from a botched independence declaration back in 2017.
Imagine Texas or California declaring independence with roughly half the state population supporting and half against. No foreign powers recognize it, and eventually the federal police step in, arresting the state government leaders. Two years later, it’s still festering. Half the population is still wailing about their right to self-determine being denied and the other half just wanting to get back to their normal lives.
Well, that’s Spain today.
Would you be comfortable lending to a country that was facing a prolonged secessionist movement from one of its largest and richest regions?
Yeah, me neither. And yet here we are.
Demand for bonds has been so artificially inflated by central bank interventions that negative interest rates are not just possible, they’re possible in a country that may be in the early stages of disintegration.
You probably weren’t planning on buying Spanish bonds, and you’d really have no reason to own them unless you happened to own a mutual fund or ETF that dabbled in them.
But the same forces that are pushing Spanish yields into negative territory — central bank meddling, low inflation, demand for income from Baby Boomers, and fears of slow growth or recession — are pushing U.S. yields lower as well.
A Similar Scenario
The U.S. yield curve has been inverted for most of the past year.
Today, it’s not so much inverted as it is flat. One- to three-month T-bills yield anywhere from 1.67% to 1.74%. The 10-year note yield is only fractionally higher at 1.77%, and the 30-year yield is barely half a percent higher at 2.23%.
If you’re an institutional bond manager, you don’t always have a lot of discretion as to what you buy. If your mandate requires you to buy long-dated bonds, then that’s what you’re buying. End of story.
But you and I have a lot more flexibility. No one makes us buy anything. We have freedom to buy what makes sense for us.
At current yields, it doesn’t make sense to buy long-term bonds. You don’t want to put your entire nest egg in stocks either, given that we’re now 10 years into a bull market with prices looking a little frothy.
If you have investment capital burning a hole in your pocket, buy short-term T-bills.
As government securities, there is no credit risk. With the short time to maturity, there’s really no interest rate risk either. You’re clearly not getting rich in them any time soon. But they’re a fine place to park your cash while you’re waiting for a better opportunity to come around.
For an ordinary investor, the easiest way to buy a T-bill is through an ETF such as the SPDR Bloomberg 1-3 Month T-Bill ETF (NYSEArca: BIL). It’s big. It’s liquid. And it yields about 1.7%.
In the spirit of the upcoming Word Series, I’ll wrap this up with a baseball analogy.
When you’re at the plate, you don’t have to swing at every pitch. If it’s a lousy pitch, you take a ball. Better to get to first base on a walk than swing at a pitch you shouldn’t have and strike out.
The market is throwing us a lot of lousy pitches right now. You might connect and hit one out of the park. But you’re just as likely to strike out.
Consider T-bills an easy base to make, with little-to-no risk of striking out.