June 5th, 2012

In the final days of March, Bloomberg Businessweek reported on the devastating effects caused by U.S. Treasury bonds hitting a 220-year low.

During the last two centuries, the global community faced the challenges associated with two major depressions, two devastating world wars, at least three detrimental international panics, all while bouncing back-and-forth between many global economic crises; all followed by the most recent Great Recession.

Yesterday, numerous other sources reported dismal news on what we can expect in the coming years as Treasury yields spiral downwards to new record lows.

On June 1, 2012, the benchmark 10-year Treasury notes yield hit a low of 1.442 percent. That's the lowest it's fallen since the early 1800s. Take a look at how Treasury notes have fared throughout 2012 so far...

*Image courtesy of Bloomberg.

Experts believe the diving Treasury notes yield may be attributed to investor panic as they are unprecedentedly fearful of the situation overseas in Europe. They are moving all of their money out of Europe and into the stock market (or even into German debt; anywhere but Europe). Simply put, investing in U.S. Treasuries is a safer option right now.

According to renowed fund manager John Hussman, another recession is imminent, giving way to lower yields in the weeks and months to follow, and potentially permanently lower yield levels thereafter. It's a grim trend and recent plunges for Treasury bonds “accurately reflect adire global economic picture, but it also leaves little on the table but speculative merit,” says John Hussman.

Since late-February, Dr. Hussman and his colleagues have made estimates of the market's prospective return/risk tradeoff which have “persistently held in the worst 0.5% of all historical observation.”

Hussman continues:

It's always important to emphasize that we try to align ourselves with the averagereturn/risk profile that has historically accompanied the particular set of investment conditions we observe at each point in time, but that the outcome in any specific instance may not reflect the average return, and may even fall outside of what we view as the likely range of outcomes. That said, the awful behavior of the market in recent weeks is very run-of-the-mill in terms of how similarly unfavorable conditions have usually been resolved historically, and there is no evidence that this awful prospective course has changed much. 

When bond prices drop, that means demand has slumped, yet those yields absolutely mustincrease in order to compensate for the decrease in demand. When they increase, interest rates on fixed-rate mortgages increase too. Obviously, when it is more expensive to buy homes, demand for those also decreases and, consequently, the prices of homes go down. The whole ordeal can slow GDP growth and hinder the economic growth of that domestic economy. It's a rather unfortunate situation to say the least...

For those of you who have most of your assets currently invested and unhedged, Hussman believes your best bet is to hope that the prospective market returns move no higher than approximately “8% through the completion of the present cycle, since even touching a prospective return of 10% in the interim would require an S&P 500 in the mid-800's.” Hussman urges investors to pay close attention to these numbers, but fears investors have already forgotten too much after three years in regards to secular lows. They occur once every 30-35 years and the last one was back in 1982.

Hussman concludes:

While we continue to expect a recession, which may very well produce even lower yields, even a small spike in yields is likely to wipe out any further gains from present levels. Even if we're headed toward permanently lower yield levels, which I doubt, we don't expect weekly volatility to decline dramatically, which means that meaningful interest rate swings will remain commonplace, and we'll have opportunities to vary our portfolio duration in response. Strategic Total Return is sensitive both to yield levels and pressures that drive yield trends. Whether the secular trend remains down or turns higher, we expect enough variability in yields to benefit our approach.

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