How many times a week do you read that interest rates have no where to go but up? That bonds are terrible investments and will be crushed by rising rates? And when was the first time you started to hear these stories? If you read pretty much any source of investment news then you’ve been hearing these stories for almost 4 years now and, at least to me, they seem to be constant. Yesterday the latest one I heard was ‘the bond bubble will pop tomorrow’. Oh dear. Well, today I wanted to provide a counterpoint to all the rising rate hysteria and posit that there is something more fundamental going on that has a high potential to keep rates low for a lot longer than most people think.

The contrarian view on rates is that what happened in 2008 is no where near a standard recession, it was a much bigger event, the ending of a long cycle of financial speculation and debt increase by the private sector. The ending of this cycle leads to the next cycle of debt deleveraging and deflationary forces. And add onto to that a large demographic transition as the baby boom generation ages. The last time we saw anything like this in the western world was the great depression. But it turns out the world has seen this a lot more recently. The elephant in the room is Japan. Why more people don’t look at the Japanese experience is beyond me. The Japanese housing and stock markets, their own debt bubble, first burst in about 1990. What has been the Japanese experience on interest rates since that time? The chart below shows the yield on the Japanese 10 yr bond since that time. A great source of Japanese data is here .

Pretty shocking. Its been 22 years since the start of Japan’s financial crisis and rates still show no signs of going higher. If you date the US crisis to a similar time frame, starting 2008, you’re looking at potentially a very long time of continued low rates, we’re talking the year 2030! And how about Japan’s fiscal situation during this period? Japan’s net debt to GDP has increased by 3X during this time, its credit rating has been downgraded at least 4 times and it has skirted with deflation, not inflation, the entire time . This has defied the conventional wisdom for so long at most people just throw their hands in the air and say things like ‘Japan is a bug searching for a windshield’. Gee, that’s helpful. There is something else going in here that merits consideration. I personally think its the deleveraging, deflation, demographic story that the US has more in common than most people think. If you want to learn more about the Japanese situation I highly recommend Richard Koo’s book, The Holy Grail of Macroeconomics . Now, I’m not saying the US is going to follow Japan, there are some fundamental differences. But I do think the conventional wisdom is very wrong and we have a longer period of lower rates in front of us than is expected. And that creates investment opportunity.

The conventional investment stance on rising rates has lost an investor a lot of money or opportunity in the last 4 years, whether it is the aggressive position of shorting treasuries or the conservative position of staying in short maturity bonds. The chart below shows the performance of the long bond ETF (TLT), the short term bond fund (SHY), and of the ETF that shorts the long bond (TBT).

As is often the case, it has paid to be a contrarian. Great, but what does that mean going forward? Of course, that’s the hard part. Personally, while I don’t think rates are going up anytime soon, the fed has made it explicitly clear that rates won’t go up until at least the end of 2014, that doesn’t mean I want to be in government bonds. I think they are expensive even relative to the low growth low inflation environment we’re in. I think the opportunities are better out the credit curve. Investors are getting paid pretty well to take on credit risk especially further out on the maturity curve (i.e. longer term bonds). Long term munis, high yield corp bonds, mortgage bonds, and even investment grade corporates are pricing in higher default risk than is warranted. And even better yet, in this environment, many dividend paying stocks are a good value.

In summary, the conventional view on interest rates is missing something very fundamental. Interest rates a likely to remain low for a lot longer than people think based on the example of the Japanese history of their financial crisis. For investors who understand this it creates great opportunity to at the minimum protect capital and potentially make some good conservative returns.

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14 thoughts on “ A contrarian view on interest rates

  1. Paul, I look forward to reading your posts. I must admit to some of this being over my head but am learning a lot. Any advice you may have for reading material by a novice would be most appreciated. Thanks!

    1. Hey Lou, thanks for the comment. I did a series of 3 posts a while back on a recommended reading list, see here . You can start with the beginners list and go from there. Also, I’d be happy to answer any questions you may have.


  2. Paul, just noticed that you are back posting. I also now think interest rates could stay low or go lower; I was amazed when the 10-year went below 3%, my jaw dropped when it went below 2%, but now I think there is no floor to how low it can go. My take on why is the abysmal state of the economy (perhaps another way of saying what you said) and, given the dysfunctional federal government, general low expectations of improvement any time soon (hope, but not expectations, springs eternal that this November will bring relief). On a brighter note, I recently wrote my first cash-secured put; looks like it will expire un-exercised later this month, and that’s a good outcome. Welcome back, and thanks for the education, information, and ideas you provide.

    1. Nice to hear from you J. Congrats on the put, always good to start with a positive outcome.


  3. Hi Paul, thanks for another great article. What are your thoughts on AGNC and other REITs given your view on interest rates?

    1. Hey Del, I’m planning a post on mREITs after they report Q2 earnings but in general I like the sector. AGNC is a good one but I prefer TWO.


  4. Looking forward to your post on REITs.


    I would not be surprised to see the 10 year go below 1% and the 30 below 2%.

    I have Corporate Bond and CD ladders that I built in years past that are maturing out to 2017. Since this strategy is no longer lucrative, I have been migrating these investments at maturity to “conservative” dividend paying / dividend growing stocks, MLPs, REITS and a few mutual funds, some of which are Bond Funds, e.g. VWEHX, LSBRX, DBLTX.

    I guess I’m a bit old fashioned in that I have this old perspective of having some balance of stocks and bonds. I don’t see how to buy individual bonds and get any return without going out 50 years vs. the 7 max with my old strategy, thus the above Mutual Fund investments.

    Good to see that you’re back.

    1. Totally agree Joe. Yields could go much lower. But like you said, you gotta have a balance of stocks/bonds in this environment. Right now the only way to get any decent yield in bonds, to cover inflation and taxes, is going out the credit curve, like your bond fund choices are doing.


  5. I bought MWTIX two years ago at $10.46. It has ranged between 10.31 and 10.79 in the last year. Current value is 10.78 and current yield is 4.9%. Total annual return for my two years has been 7.5%. Seems to be a good choice for the bond portion of my portfolio.

    1. MWTIX is a good one Del. A multi sector fund in this environment is a good choice. they can go to any sector depending on the opportunity.


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