Ah, the good old days.
Fifteen years ago, you could get a 6.5% interest rate on a five-year certificate of deposit (CD). You could have also received the same rate on a five-year U.S. Treasury note. Consumer-price inflation was running a little hotter then, at 3.5% per anum. Still, these investments offered a real 3% annual average return after inflation (6.5% minus 3.5%).[ad#Google Adsense 336×280-IA]Today, a five-year CD yields around 1.2%.
A five-year Treasury note yields 1.5%.
Core inflation, which excludes food and energy, is running at 1.8% annually.
When inflation is factored in, a five-year CD leaves you 50 basis points in the hole at the end of the year.
A Treasury note leaves you 30 basis points down.
Of course, I’m not factoring in taxes, which further diminishes return.
Because of the dearth of traditionally safe high-yield investments, investors have had to wander out on the risk curve for income. “Risk” is the operative word. To be sure, it can be worthwhile to buy a $20 investment that pays $2 annually in dividends or distributions. That’s a 10% yield. But when that same investment cuts its dividend to $1 and the price drops to $10, the investment is significantly less worthwhile. Yes, the yield holds at 10%, but you’ve paid for the new yield with a 50% loss of capital.
The above scenario has frustrated many income investors over the past year. Older, conservative investors, in particular, have learned risk really is a four-letter word.
Many income investors long for the good old days. Many have had their hopes lifted on expectations the Federal Reserve will move to raise interest rates.
I’m somewhat less hopeful. Despite the chatter on looming higher interest rates, the impetus is to keep them low.
When you look around the world, negative yields (yields below zero) are pervasive. More than two trillion euros worth of eurozone government bonds trade at a negative interest rate. More than 30% of all government debt in the eurozone come with negative yields. In Germany, 70% of all German bonds now trade at a negative yield; in France it’s 50%. Outside of the eurozone countries, Switzerland’s bonds don’t offer a positive yield until you get past 10 years.
This matters to U.S.-based investors. If the Fed were to raise interest rates in the States, you’d see a surge in the value of the U.S. dollar versus the euro and other world currencies. This would create problems for U.S. multinationals. Many have already posted significant losses over the past year on currency translation.
The Fed also remains handcuffed by sluggish economic growth. First-quarter gross domestic product (GDP) was recently revised down to negative 0.7%. Growth for the second quarter will likely post less than 1% (on an annualized rate). Raising rates would further dampen growth prospects.
When you look at the data, you see little motivation for the Fed to move to raise interest rates in the near future. To the contrary, you see plenty of motivation for the Fed to continue to hold rates at these rock-bottom levels.
So, if you want income and yield in this market, you have to accept that it comes tethered to risk. Unfortunately, safe high-yield income – circa 2000 – remains on the distant horizon.
— Steve Mauzy[ad#wyatt-income]
Source: Wyatt Investment Research