I’m not suggesting that this scenario will play out (nor is the Fed). But I think it might be interesting for investors to think about what the Fed projects could theoretically happen in its 2016 worst-case scenario, as required by the Dodd-Frank annual stress tests:
“The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities…”
“Asset prices drop sharply in the scenario, consistent with the developments described above. Equity prices fall approximately 50 percent through the end of 2016, accompanied by a surge in equity market volatility, which approaches the levels attained in 2008. House prices and commercial real estate prices also experience considerable declines, with house prices dropping 25 percent through the third quarter of 2018 and commercial real estate prices falling 30 percent through the second quarter of 2018. Corporate financial conditions are stressed severely, reflecting mounting credit losses, heightened investor risk aversion, and strained market liquidity conditions; the spread between yields on investment-grade corporate bonds and yields on long-term Treasury securities increases to 575 basis points by the end of 2016.”
“As a result of the severe decline in real activity and subdued inflation, short-term Treasury rates fall to negative 1⁄2 percent by mid-2016 and remain at that level through the end of the scenario. For the purposes of this scenario, it is assumed that the adjust- ment to negative short-term interest rates proceeds with no additional financial market disruptions. The 10-year Treasury yield drops to about 0.25 percent in the first quarter of 2016, rising gradually thereafter to reach about 0.75 percent by the end of the recession in early 2017 and about 1.75 percent by the first quarter of 2019.”
I'm guessing we'll see TLT at that level again this year, maybe even a little higher. One of these years the yield on the 30Y will approach 2%...and just stay there. That is, until the Fed cranks up QE4, which will be my signal to sell.
Lol. I held a large position in AAPL from 2006 to 2012. I missed the peak, but made 8x my original investment. The easy money was made in AAPL a long time ago...
Thanks for the kinds words, dornweg. Once the world reaches peak debt, and I think we're close to that point, I don't know how or if the problem can be fixed, except through painful debt destruction (defaults and partial defaults). I met Lacy Hunt (Hoisington Management) about a year ago and asked him how he thought it would all play out. Lacy is the most brilliant economist I've run across, and I was anxious to hear his answer. When he said, "I just don't know", it sent a shudder down my spine...
I really don’t know. I would imagine massive government interventions (via one-time wealth taxes, debt restructurings, etc.) before things got to that point, but who knows? Looking at Exter’s Inverted Pyramid, I’m comfortable for the time being with US Treasurys (the step immediately before cash and then gold), mainly because I like the income (and the fact that I expect yields to ultimately fall to much lower levels).
Sometimes it’s helpful to take a step back and put US Treasury rates in context. The following are yields for a sampling of global sovereign bonds as of today (first number is 10Y yield, second is 30Y):
Switzerland: -0.31%; 0.29%
Japan: 0.07%; 1.08%
Germany: 0.28%; 1.01%
France: 0.61%; 1.63%
Italy: 1.44%; 2.64%
UK: 1.53%; 2.34%
Spain: 1.55%; 2.84%
US: 1.88%; 2.70%
Of course twenty-five percent of Europe’s sovereign bonds are actually in negative yield territory, but those are generally of shorter duration (generally five years or less, although German bunds are negative out to seven years). Although there are fundamental reasons the rates on US Treasuries remain at historically low levels, one can’t ignore relative value as another compelling reason.
The last time Royal Dutch Shell cut its dividend was in 1945 when the Netherlands had just endured the ?Hunger winter? under #$%$ occupation (just before the end of WWII). So unless we see German Panzers on the horizon, I think the dividend is safe.
Wow, so yahoo will not allow the shortened version of the "National Socialist German Workers' Party" on their message boards. That's kinda funny...
Both Conoco and Phillips Petroleum had a history of cutting/suspending dividends when times got tough. Royal Dutch Shell last cut its dividend in 1945, during the German occupation of the Netherlands during WWII. There are no guarantees in life, but Shell's institutional culture has always been such that the dividend is considered sacred (and its history backs it up).
In the eighties, the price of oil dropped from $30/bbl to $10/bbl and Shell did not cut the dividend. Conoco and Phillips Petroleum both had a history of cutting their dividends in tough times (before the merger and now post-merger). Shell has always had a unique culture regarding their dividend.
Just 3 short trading days later, and those ridiculous spreads between US and peripheral European bonds have collapsed.
As of today (10Y; 30Y):
Italy: 1.72%; 2.83%
Spain: 1.79%; 3.01%
US: 1.75%; 2.58%
We've had at least 6 months of recessionary red flags, so the situation is different than a year ago. Jim Grant, in a CNBC interview yesterday, said that he thought we were already in a recession. I think he may be a little early (bear markets in equities usually occur about 9 months before a recession), but I'm not sure. Treasuries are exactly where you want to be in a recession, though. NIRP, based on what we've seen in Europe, would likely result in even lower Treasury yields. But as I've said many times, a new announcement of QE would be my signal to sell (as it has been for the past 5 or 6 years). In the past, QE in the US (not Europe) has successfully raised inflation expectations (although eventually it won't work any more), resulting in a slow grind upward in rates. And when QE4 is about to end, of course, that will be the time to buy back in.
A yield of 0.25% on the 10Y would imply a yield of around 1.50% (or lower) on the 30Y, so TLT would be more like $160+, but keep in mind that this is almost a Depression scenario, so hopefully it doesn't happen...
Contrary to popular belief, QE has always been negative for US Treasuries. During QE1, QE2 and QE3, long-term rates actually rose (because QE increases inflation expectations and stirs up investors' "animal spirits"). At the conclusion of each iteration of QE, rates fell dramatically within a matter of months. So the lesson is: sell at the first mention of new QE, and buy near its end. Lather, rinse and repeat for the next decade...
It's amazing how much time they've spent talking about negative interest rates during her testimony. This is how the political establishment "prepares" us.