No Significant Yields and Not for Years

No Significant Yields and Not for Years

By Mark J. Grant

September 10, 2020

Notice: The following passage has been reposted with explicit permission from the original author.

Of all of the variables that move the markets, of all of the politics, trade tensions, and new technologies that push our investments, there is one that is going to be a constant for years, and that is interest rates. I have been around long enough to witness high yields and bond vigilantes and spikes in interest rates, for one reason and another, but that is now all behind us. I repeat and repeat loudly:

All Behind Us!!!

The Federal Reserve Bank of the United States was once a player in the bond markets. Now it is the dominator, controller, and fixer of U.S. interest rates, as they hold rates down to protect the financial condition of the government, that they represent. I am not arguing with our new reality, as our pandemic continues, but today I am stating that our “Borrower’s Paradise” will have a profound effect on the markets, and the ways that both people and institutions invest, for many, many, years to come.

There is a storied history of the central bank of the United States. In each case, it should be noted, and then noted again, that the Fed is a creature created by Congress. The first central bank was initiated in 1791 and then closed by Congress in 1811. The second go-round for an American central bank was conceived in 1816 and it was again closed down by Congress in 1836. The next central bank was formed in 1837 and lasted until 1863. Then we had another rendition of a U.S. central bank that lasted from 1863 until 1913. Each one of these central banks, I point out, was established, and maintained by Congress, until they were shut down for a wide variety of reasons.

Our current Fed was established in 1913 by the Federal Reserve Act. We consistently talk about the twin mandates of “maximum employment” and “stable prices” but these mandates, in the Federal Reserve Act, come “after” the stated objective of the Fed:

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy’s long-run potential to increase production…”

-Federal Reserve Act, Section 2A

There is much talk about the Fed’s “Independence” and the current structure of our central bank allows the Governors and President quite a bit of “Independence” as long as Congress accepts it and does not change their structure, or mandates, which they can, at will. This is very important to understand presently with our swirl of political rhetoric that could translate into action after our upcoming elections. I would state that whoever wins in November that low interest rates, historically low interest rates, will likely be demanded by our next President and the Congress as one methodology of holding down the country’s borrowing costs.

Having said this then, we are in a “Fixed-Income Investor’s Hell,” for the foreseeable future and this is going to radically alter the tried and true methods of investing for individuals, corporations, banks, mortgages companies, endowments, and pension funds. It is now not just the control of Treasuries and Agency securities but control of corporate bonds, high yield bonds, ETF’s and possibly in the future closed-end funds or equities that could be mandated by the Fed in their attempt to control the entire investment platform. I leave nothing out here. After the Fed’s recent moves, in my view, anything is possible.

What a historically low interest rate environment does, in fact, is move everyone to more risky investments. When bond yields, which are certainly less risky, due to the capital structure, don’t suffice to support incomes, lifestyles, or pension benefits, then more risk must be taken to achieve any kinds of decent returns. It is my opinion that it is not the Robinhood App, or other new investors, that is driving the stock markets but seniors, retirees and various institutions, such as insurance companies, that are literally being dragged and forced into the equity markets on the hope and a prayer that appreciation will off-set the lack of yield.

In our current environment Cash may be King, to offset any equity market correction but, at the same time, Cash is in the lowest rank, to provide any kind of return. Cash at the bank, in your securities accounts, in any money market fund, is just the side of worthless for providing any income, and in much of Europe and Asia it is even worse as the lender pays the borrower to take his money.

All of this, when carefully considered, is the most radical change to investing that I have seen in my forty-six years on Wall Street. Regulations, for insurance companies and other institutional investors, are likely to be substantially changed by all of this, as a decent fixed-income return can no longer be found in the bond markets.

Remember that stock dividends, or ETF dividends, or closed-end fund dividends, are still dividends and they float at the mercy of some Board of Directors. This is not the case, at all, with bonds, debt, and consequently, the safety of investor’s money is in a much higher risk position with much greater consequences. Yet, we still must go on and try to protect our assets, and make some money, and so closed-end funds, as one example, do provide some double-digit yields but they are complicated, and you have to know what you are doing.

“Preservation of Capital” still remains as the first through tenth of Grant’s Rules. This is the most difficult time in memory to preserve capital now, as more risks have to be constantly taken to get any kind of return. Caution, continuing reflection on the risks you are undertaking, is certainly advisable in our present circumstances. If things do turn for the worse, you might even see the Fed, or the Treasury, issue certain kinds of bonds with one yield for people over 65 and another yield for those that are younger.

It may be all well and good to “live in interesting times.” It is another thing, entirely, to survive them.

Original note by:

Mark J. Grant

Chief Global Strategist, Fixed Income

Managing Director

B. Riley FBR Inc. & B. Riley Wealth Management