Investors have been fleeing to "safety". US 10-year Treasury yields fell to less than 1.5 per cent earlier in June, a level not witnessed since 1946 when interest rates were pegged. German 10-year yields fell to an all-time low near 1 per cent. Some very short-term Federal rates were negative, implying that investors were willing to pay governments considered financially stable for the privilege of holding their money. Global equity markets have fallen sharply.

Investors appear to be far more concerned with the return of, rather than a return on, their money. Since 2008, more than $1tn have been moved from equity funds to bond funds. Similar shifts from equities to bonds have characterised US pension fund allocations.

But does this flight to so-called havens really provide investors with the protection they desire? Or, are bond buyers making a huge mistake that is likely to guarantee them a period of negative real (after inflation) returns? The answer is almost certainly the latter. Bonds today in countries such as Japan, Germany, and the US are more expensive than at any time in history. Bond investors face virtually sure losses and equities are as attractive as they have been in a generation.

We can illustrate the fundamental unattractiveness of bonds with the US market. The buyer of a 10-year US Treasury bond at a 1.5 per cent yield to maturity will receive a nominal return well below the current rate of inflation and below the Federal Reserve's informal target rate of inflation of 2 per cent. Thus, even if inflation does not accelerate, long-term US Treasuries will provide a negative real rate of return. If inflation does accelerate, that real rate of return will be further reduced.

It is important to remember what happened to bond investors the last time that Treasury bond yields were at 1.5 per cent, in 1946. Bond yields remained pegged at low rates until the early 1950s to enable the government to more easily finance the debts from the second world war. Therefore, bond prices remained fairly stable. But moderate inflation reduced the real value of both coupon payments and the face value of the bonds, and bondholders lost considerable purchasing power. And that was only the beginning of the pain.

David Fuller's view It will not have escaped subscribers' attention that for some time many strategists, me included, have been pointing out the relative attraction of high-yielding equities over low-yielding western bonds and JGBs, while warning about risks in the fixed interest sector once the period of central bank financial 'repression' of yields ends. Consequently, the latter part of that message may seem reminiscent of the fable about the little shepard boy who repeatedly called wolf.

Financial history provides numerous examples of market trends which became very overextended, and remained so for a lengthy period, before the eventual dénouement occurred. Meanwhile, bond investors have been riding one of the most profitable investment trends in history so many of them will be reluctant to abandon this strategy until they experience profit erosion as these total return charts for 10-year US Treasuries, JGBs, Bunds and Gilts (note the climactic acceleration for Bunds and Gilts), turn downwards.

See also Eoin's reviews on 1st June and also 10th May 2012, plus his response to an email on German Bunds posted yesterday (subscription registration required for the full reviews).


Profit erosion on these bond positions may occur sooner than expected by the investors who hold them. With yields having reached historic lows recently, how much lower can they go? When bond holders ask themselves the same question, they will begin to vote with their feet unless central banks intensify their financial repression. That is not a sustainable policy.

Evidence of selling due to profit erosion in these bond holdings will become apparent when the progressions of higher reaction lows are broken. You can monitor the total return charts shown above, preferably on weekly charts over 5 to 10 years, in the Library. They can be found in the upper left-hand column of the 'Bond Yields' section, along with total return indices for Swiss, Australian, Canadian, Italian and Spanish 10-year government bonds.

Fullermoney would certainly not invest in any of the government bond markets where financial repression has pushed yields artificially low. Our preference remains for Dividend Aristocrats and high-yielding Autonomies, which Eoin reviews regularly. Yes, some of these have been more volatile than bonds. This can be stressful but is also an opportunity. For those of you investing in equities, sell-offs are buying opportunities.