Believe it or not, the hottest investments in town these days are…drum roll…30-year U.S. Treasury bonds and 10-year Treasury notes.
Why are these plain vanilla government securities, which pay practically nothing and could be vulnerable if the Fed raises interest rates, so popular? The answer explains a whole lot about our current economy, our future economy, and what dividend investors can expect over the next few years.
Why the Popularity?
First, let’s look at the reasons for the demand. The short, simplistic answer is that Treasuries are safe and currently the “least worst” investment available. The slowdown in China has spawned fears of a global recession at worst or a continuation of the limp-along recovery at best, which translates into a battering for emerging-market stocks and the likelihood that developed-market equity prices have either plateaued or are poised for a fall, too. In either case, equities are decidedly not tempting investors.
In the bond market, concerns over an economic slowdown are making riskier assets less attractive as well. Although China has been selling Treasuries to raise cash for its own domestic needs — a phenomenon that raised the specter of higher U.S. interest rates — other foreign investors have jumped into the market, seeing the U.S. as a safe haven. This international demand, as well as rising domestic demand for Treasuries, has more than offset China’s Treasury sales.
As an aside, part of the reason for the greater domestic demand is the repositioning of portfolios in what remains of corporate defined benefit pension plans. Most companies want to get out of the business of offering their employees traditional pensions, and by replacing equities with Treasuries whose maturities are matched to the timing of their pension funds’ liabilities, they tidy up their balance sheets. And by stocking the pension fund with liquid Treasury securities, they also make the pensions far easier to offload to insurance companies whenever they think the timing is right.
But back to Treasury demand. A recent article on Bloomberg.com quotes George Goncalves, the head of interest-rate strategy at Nomura Holdings Inc., as saying that demand for Treasuries is a worrisome sign. Goncalves, whose firm is a primary dealer, or one of the 22 securities firms that are required to submit bids at Treasury auctions, says that demand for Treasuries is a “reflection of [investor pessimism about] the economy as well as their risk aversion.”
Results of recent Treasury bond auctions reveal that the market is pricing in the likelihood that inflation will remain below the Fed’s 2% goal over the next decade. This means not only that professional investors see a sluggish economy ahead for quite some time, but also that the Fed may be increasingly unlikely to raise interest rates anytime soon.
Adding to the gloom, economists in a Bloomberg survey now see a 15% chance of a recession in the U.S. in the next 12 months, which is the highest estimate since 2013.
For Dividend Investors
If we accept what the Treasury market is telling us — very low economic growth over the medium term with a possible economic slowdown coming soon, continued low interest rates and a strong dollar due to foreign demand for safe U.S. Treasuries — what should a dividend investor do?
Safety should be a primary concern. That means avoiding dividend-paying companies whose balance sheets are burdened by debt. It also means favoring companies whose revenue mix tilts toward the domestic versus the foreign, because translating foreign gains into their dollar equivalents will depress earnings.
And while caution is a by-word, it also means using the market’s recent volatility to your advantage. If there is a dividend stock you believe will make a sound, long-term addition to your portfolio, use the occasional market breaks as a buying opportunity.
Image courtesy of hywards at FreeDigitalPhotos.net
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