Repression on bonds heralds masochism
Almost exactly a year ago, the economists Carmen Reinhart and Belén Sbrancia wrote a path-breaking International Monetary Fund paper about "financial repression". It initially caused many western investors to blink. For while such "repression" has been extensively discussed in emerging markets in recent years, not many people in America knew what this dark-sounding phrase meant. (Answer: "financial repression" occurs when governments engineer a situation in which investors feel compelled to buy bonds at unfavourable rates, ie below the prevailing level of inflation, thus helping to reduce national debt.)
How times change. A year later, the word "repression" is being bandied about at investor conferences across the western world. No wonder. In the eurozone, there are growing signs that governments in places such as Spain and Ireland are "encouraging" - if not forcing - banks and state pension funds to buy public sector bonds, at potentially unfavourable prices.
Meanwhile, in America something just as remarkable is under way: investors are gobbling up government debt at unfavourable rates without needing to be "repressed" at all. This week, demand for 10-year Treasuries was so high - as fears exploded about the eurozone - that the US government sold debt with a record low coupon of 1.75 per cent. And while the nominal yields on 10-year Treasuries, of about 1.91 per cent, are above last year's lows, in real terms they are in negative territory, given inflation over 2.5 per cent.
Anybody buying Treasuries, in other words, is essentially agreeing to subsidise the US government in coming years - unless you believe that deep deflation looms. Call it, if you like, a form of "voluntary" repression; either way, it will almost certainly end up helping the US state, to the detriment of investors.
David Fuller's view This is a topic of considerable interest
to all long-term investors, or at least it should be.
Eoin
produced three graphs on Bloomberg for me this morning, comparing the Total
Return performance of US 10-year Treasuries, the S&P 500 Index and the S&P
500 Dividend Aristocrats over different time periods. Note: Total Return in
this instance means dividend / fixed interest compounding but performance is
not inflation adjusted.
The first
and shortest time period illustrated is from June
2007 to the present. Since these are screen prints from Bloomberg, you may
have trouble reading the differentiation legend but the colours should be clear:
Orange depicts 10-year Treasuries, white the Dividend Aristocrats and yellow
the S&P 500. Clearly, Treasury bonds have been the runaway outperformer
over this period.
This
second graph shows relative performance
since June 2000. Over that period you can see that Dividend Aristocrats
are currently just outperforming 10-year Treasuries, albeit with much more volatility,
most notably in 2008. The S&P 500 Index trails far behind.
This
third graph shows the relative
performance since 1990. Over that period Dividend Aristocrats have way outperformed,
while the S&P 500 is just ahead of 10-year Treasuries.
What
can we conclude from these three graphs? I suggest the following:
1. The
third, longer-term graph is a powerful argument in favour of buying, holding
and reinvesting dividends from Dividend Aristocrats in the same shares.
2. Selling
these Dividend Aristocrats in a market panic is the worst investment decision
one could possibly make. The safest and most sensible timing refinement could
be to allow dividends to accumulate after a good run, so that you can invest
them in the same shares during the next significant sell-off.
3. Even
if the S&P 500 Index trades broadly sideways for a decade or more, punctuated
by a couple of bungee jumps to the downside, Dividend Aristocrats still perform.
The next
question: Do you think Treasury bonds outperformance since 2007 is the new normal
or a temporary outlier?
I agree
with Gillian Tett and favour shares with the proven capacity to increase dividends
and the willingness to do so, particularly if they are also Autonomies.