There are few better illustrations of John Maynard Keynes’ oft-quoted observation that markets can stay irrational for longer than investors can stay solvent than the recent history of government debt. 2011, for example, saw plenty of learned articles declaring the 30-year bull market in US treasuries dead – just as 2015 saw plenty saying the same thing of the then 34-year bull market in US treasuries.
And 2016? Now, in the weeks after the UK voted to leave the European Union, we have seen the yields on both 10-year and 30-year US Treasuries hit record lows. That fact comes courtesy of the Financial Times and the handy snapshot of the situation it ran on 6 July – Gilts at new highs; Brexit adds $1.2tn [£900bn] to negative yields club.
The piece quotes some startling numbers from analysts at Citi – that 10 countries now have more than half their government bonds trading on negative yields; that this puts the total negative-yielding universe at $7.5tn; that 35% of Citi’s global government bond index now trades on negative yields; that Swiss yields have turned negative all the way out to 50 years … you get the idea.
In short then, a lot of things have been happening that nobody would have predicted or thought possible even a couple of years ago – one of the results being that, over the first half of this year, gilts returned more than 11% to their investors. That in turn begs the question as to what they might return over the second half of 2016, over 2017 and over the years to come …
Here on The Value Perspective, we tend to steer clear of attempting to tell the future – mainly because it is just not possible. Still, there are clearly some very rational – or at least plausible – reasons why gilt yields are as low as they are today. And why, amid all the post-referendum uncertainty and volatility, they could remain this low or possibly even edge lower.
Perfectly valid reasons why investors might continue buying gilts include fears the UK could head into recession and suggestions by Bank of England governor Mark Carney that UK monetary policy could be tightened even more – for example, through a further cut in the country’s already record-low interest rates or a further round of quantitative easing (QE).
As we implied at the start, the last five years have seen experts calling the top of the government bond market – arguing things could not possibly go on as they had much longer, that QE was exhausted and that, more recently, the trend for investors to accept negative yields was like something out of Alice in Wonderland. Or ‘Bonderland’, as we put it in one of our own pieces in April last year.
And each of those last five years has gone on to show that was not actually the case and that markets can indeed stay irrational for much longer than anyone might ever expect. The UK’s vote to leave the European Union has only given this strange state of affairs a new lease of life – just one more reason why many investors see gilts and other supposed ‘safe-haven’ assets as a good place to park their cash.
But, as the economist Hyman Minsky once wrote: “The illusion of stability of the system will, over time, create its own instability.” And indeed, as we ourselves put it in Bonderland: “Often in finance, when there is a strong consensus something is correct, it can ultimately prove to be very wrong indeed.”
Nothing lasts for ever – especially not bull markets – and eventually something will give. As they cast around for ‘safety’ in a world of record-low and increasingly negative yields, investors might be better advised to step back and take a more holistic view. Those who do so might well be able to make out the widening dislocation versus reason and history.
It may seem inconceivable in the present environment but some day in the not too distant future, when inflation has ticked up – and equities are benefiting from that fact – people will look back with astonishment at a time when those record-low and increasingly negative yields were considered an attractive investment proposition. Who knows – they might even feel like laughing.