Flight to Safety Is a Trip to Nowhere

Cryptic remarks by Fed Chair Janet Yellen this week regarding future rate hikes caused the stock market to dither, but lit a fire under the bond market. The yield on the 30-year Treasury bond dropped from more than 2.75% last Friday to less than 2.50% when Yellen admitted during congressional testimony on Wednesday that “There would seem to be increased fears of recession that is resulting in rising risk premiums.”

Translation: confidence in economic growth has dropped so far that only Treasuries, no matter how low the yield, are safe enough for many investors. Just eight months ago, before China devalued its currency and triggered stock market drops around the world, you could get 2.49% on a ten-year Treasury note. Now, you have to go out another twenty years in time to get the same return.

I can’t imagine committing my money for thirty years to anything in exchange for an annual return of only 2.5% (other than making a “sweetheart” mortgage loan to one of my kids to buy their first house, but even then it would be painful).

Although the Treasury bond offers the certainty of principal protection, it does so under the flimsiest of pretenses. In a world with absolutely no inflation now or later, an interest rate of 2.5% doesn’t sound so bad. But knowing inflation will return long before that thirty year maturity date arrives, you (or your heirs) may very well get less principal back in terms of purchasing power.

If you really do have a thirty-year time horizon and only care about getting your original investment back plus an annual yield of 2.5% along the way, I have a short list of common stocks all with dividend yields of at least 2.5% and an IDEAL score of at least 8 (on a scale of 0-10) that should be worth much more several decades in the future than they are now. They’re in the subscriber section below.

So, if you had to choose one or the other, a thirty Treasury bond yielding 2.5% or this ten-stock portfolio with an average yield of 3%, which would it be? That may seem to be a laughable proposition, but that is essentially the question the global financial markets are asking us right now. Viewed in these terms, even the most pessimistic investor would have to grudgingly admit that the stock portfolio will ultimately blow away the bond well be before the thirty year time limit is up.

Even an investor with the absolute worst possible timing, jumping into the stock market at its peak in 1929 just before the onset of the Great Depression, would have gotten all his principal back less than 30 years later (as measured by the Dow Jones Industrial Average). That being the case, why does the market periodically present us with these seemingly “no-brainer” choices? It’s because the fear of feeling emotional pain from near term paper losses outweighs the rational satisfaction from realizing actual gains much further down the road.

So what the bond market is really asking us now is, how low are you willing to go (in terms of yield) to eliminate that emotional pain? And even though 2.5% is historically low, that number could go even lower if a major geo-political event flares up or China’s economy weakens much further. On Thursday during the second day of her testimony Yellen even entertained the theoretical possibility of negative short term interest rates if that is what it would take to keep the economy from collapsing. Let’s hope that day doesn’t come, but if it does then we will find out just how low some investors will go to make the pain go away.