U.S. Treasuries are watched by all market participants, because the U.S. Treasury market is the largest bond market in the world. Therefore, U.S. Treasuries are the benchmark by which other bond markets in the world trade by.
The U.S. Treasury department issues debt obligations. These range in various lengths, from very short-term to very long-term. Debt that has an obligation of less than one year is called a “bill.” Debt obligations from one to 10 years are called “notes” and debt obligations that are longer than 10 years are called “bonds.” The 10-year Treasury note is important, as many other interest-bearing securities are priced off this heavily traded security. Since many investors around the world watch the rates of the 10-year Treasury for signs of economic strength or weakness, it is vital for all investors to be aware of the interest rate environment.
I think it’s interesting how people, including the mainstream media, discuss an issue without truly understanding what it really means. It seems that skimming the surface is good enough these days, as no one seems to want to dig a little deeper.
One example is the recent reports from Chinese Premier Li Keqiang, who stated that the Chinese economy must grow at least 7.2% per year in order to limit the unemployment rate at four percent. (Source: “China Premier warns against loose money policies,” Reuters, November 5, 2013.)
As we all know, the Chinese economy is extremely important. As the second-largest nation in the global economy, its ability to manage the Chinese economy and prevent it from weakening further is quite important.
China’s Premier warned against creating even easier monetary conditions within the Chinese economy, as additional money printing could lead to even higher levels of inflation. Currently, the total credit supply is now in excess of $16.4 trillion (or 100 trillion yuan), approximately twice the size of its entire Chinese economy.
With the global economy still quite weak, China has had trouble exporting. It is now trying to transition the Chinese economy from export-led to domestically oriented, reducing its reliance on the global economy.
At least, that’s the story on the surface…
Here’s what troubles me: the Chinese economy is slowing, we all know that, yet all of its money printing so far has led to a total amount of credit supply twice the size of its entire economy.
So, what has all of this money printing really done?
It’s caused people in the Chinese economy to react by … Read More
Whenever I’m asked what I think has the biggest potential impact not only on the stock market, but also on our way of life, I always point to the continued increase in government debt.
Over the short term, the Federal Reserve has attempted to stimulate the economy partially by buying U.S. Treasuries. Under normal monetary policy, the Federal Reserve only directly impacts short-term interest rates. To reduce long-term interest rates, the Fed began buying U.S. Treasuries, pushing up the price and lowering the yield.
Over the short term, we can look around today and notice that the sky is not falling. However, as government debt continues to pile on, approaching $17.0 trillion (which doesn’t include unfunded liabilities), at some point, this will impact not only U.S. Treasuries, but also our entire economy.
Part of the reason that U.S. Treasuries are still in demand worldwide is that the U.S. dollar remains a reserve currency. There are benefits from a logistical standpoint in conducting business using the reserve currency to also use U.S. Treasuries for investment purposes.
However, as I’ve mentioned in other articles, large investors in U.S. Treasuries, such as China, are increasingly calling for a new global financial system that relies less on the U.S. dollar.
That sentiment alone should shock the politicians into action and make them realize that our biggest lenders, the ones buying our U.S. Treasuries, are questioning our ability to manage the rising pile of government debt.
The most recent data from August was that China actually reduced its holdings in U.S. Treasuries to a six-month low, according to the U.S. Department of the Treasury. (Source: … Read More
There are two ways to look at interest rates: as an investor and as the company issuing debt. As a consumer, you obviously know that higher rates mean higher expenses. Well, the same goes for businesses; they have to evaluate the expected return when it comes to long-term investing versus the financing cost of the debt.
While interest rates have risen substantially over the past couple months, they’re still at extremely low levels historically. My belief over the past year has been that we are about to embark on a reverse course in interest rates over the next five to 10 years.
Over the past year, many companies have taken on additional debt by issuing bonds to help allocate their long-term investing goals with the current interest rate environment. This is actually a very astute business planning strategy.
While many people who have been looking at long-term investing might view more debt as being bad, they’re really not looking at the big picture. If a business can achieve a rate of return greater than their financing costs, this is a positive for shareholders. However, if the Federal Reserve begins adjusting monetary policy, this will create an upward move in interest rates—a move that I’ve been forecasting for some time.
What does this mean for stocks?
Let’s go back to that initial goal of creating shareholder value.
If you are a business owner with a project that can create an eight-percent return on capital and your interest rates are five percent, that difference is the increase in equity for shareholders (three percent). However, if interest rates rise to eight percent, or … Read More
Savers have had a difficult time finding suitable places to allocate capital from which they can derive income. I’ve previously warned against allocating new funds to the investment strategy of U.S. Treasuries, as this would likely be the worst investment over the next decade.
Now, it appears that investors are increasingly coming to the same conclusion that I stated several months ago in these pages: U.S. Treasuries are set for a significant drop in price.
The investment strategy over the past couple of years for U.S. Treasuries has been built on several factors, including fear from another stock market crash and weak economic activity in the U.S.
One has to remember, there are only a few possible outcomes for U.S. Treasuries as an investment strategy. If economic growth were not to re-accelerate, the current high level of monetary stimulus could eventually lead to inflation. Considering U.S. Treasuries were yielding extremely low levels at the time I initially warned my readers, the inflation rate over the next decade would erode any yield from U.S. Treasuries.
If the Federal Reserve was successful and the U.S. economy began to rebound, investors would adjust their investment strategy and sell U.S. Treasuries—because higher interest rates would soon follow. They would also allocate capital to other assets that would have a higher expectation of return.
Only if the U.S. economy entered a period similar to Japan’s extended deflationary spiral would U.S. Treasuries outperform other assets. When creating an investment strategy, and considering the stated intent by the Federal Reserve to prevent such a deflationary spiral, the investment strategy of simply buying U.S. Treasuries for the long … Read More
When it comes to long-term investing, one factor that needs to be considered is that the dividend yield can provide a large portion of the total return. While everyone likes to pick the highflier that will move up a tremendous amount, the truth is that having a portfolio of stocks that continually increase their dividend yield can help increase total returns of a portfolio.
It is expected that for 2013, S&P 500 companies will pay out at least $300 billion in dividends. This is an even higher amount than the $282 billion paid in dividends for 2012. (Source: Demos, T., Russolillo, S., and Jarzemsky, M., “Firms send record cash back to investors,” Wall Street Journal, March 7, 2013.)
Long-term investing that incorporates companies issuing a stable and increasing dividend yield over time can help mitigate the gyrations of the market.
Not only are corporations flush with cash and looking to pay an attractive dividend yield as compared to U.S. Treasuries, but companies are also buying back record levels of shares.
According to Birinyi Associates Inc., in February, corporations announced a total of $117.8 billion in share buybacks, the highest monthly total since 1985.
Generally speaking, both share buybacks and issuing a dividend yield are positive for long-term investing. However, I do worry that companies are buying back shares at levels that are elevated.
I think it would be far more beneficial for long-term investing if corporations had a flexible approach regarding paying back cash. Meaning, when the stock price declines, corporations should then accelerate share buybacks, and when their share prices are up significantly, corporations should increase their dividend yields…. Read More