When are sovereign bonds no longer safe?
Global Yield Curves, 10-28-16. Source: Bloomberg
For decades people have invested in stocks for growth and in bonds for safety. But the global financial crisis and its economic aftermath have changed that. Now sovereign bonds around the world have extremely low yields. 30-year bonds in the US yield just over 2.5%, and that’s the highest yield anywhere. You can get higher yields in emerging markets, but those come with currency, credit, and inflation risk.
There have been two prior periods with low nominal bond yields like this one: the 1890s and the 1930s. Both were times of restrained economic growth following a financial crisis. Both were also periods of populist sentiment and public hostility to bankers. “Burn down your cities,” William Jennings Bryan intoned, “and they will spring up again; but destroy our farms and the grass will grow in the streets of every city in the country.”
To be sure, today’s economy differs significantly from that of the ‘30s or 1890s: the service sector is much larger, the government plays a much bigger role, and monetary policy is more flexible—we’re no longer on a gold standard. Also, the economy is more diversified. But the decline in nominal yields is striking: after the prior two crises, yields remained depressed for at least 20 years.
Source: Credit Suisse
For investors, this is important. A prolonged period of very low rates means that traditional asset allocation models won’t work the way they used to. Robo-advisors and passive strategies may be well-intentioned, but they’re not the solution in a sustained low-yield environment.
Times change, and investors need to change with them. If we want to reach our financial goals, we’ll need to be more creative.
Douglas R. Tengdin, CFA
Chief Investment Officer