In this month’s edition of “Chartology”, Deputy Chief Investment Officer Dmitriy Katsnelson provides context around today’s low-yield environment.
Welcome to our latest Chartology where we’re going to be talking about yield. It’s a topic that’s been more and more prevalent in the news as of late. It’s been one that we’ve been answering a lot of questions from with clients. So we want to spend a little bit of time today just providing a little bit of context of where we are today relative to the past, and also what that potentially means going forward.
In front of you, you have a chart of the 10-year U.S. Treasury yield going back to 1925. So you’re looking at the Roaring Twenties there, into the Great Depression and World War II, where interest rates were on the decline. After World War II, interest rates began to rise. Into the 50s and 60s, we had Nixon close the gold window in ’71. We had hyperinflation into the mid and late 70s, and you saw interest rates begin to rise, culminating in Paul Volcker raising interest rates pretty aggressively in the early 1980s and basically killing off the inflation concern at that point in time. We’ve seen interest rates be pretty much in a 40-year decline since.
For context here—one, today interest rates are quite low, which show you that, at least over the past 5 or 6 years, we visit this area a couple times, back in 2012 and 2016. We also saw rates sub 2% back in the early 1940s. So although it doesn’t happen often, there have been periods in the past where the 10-year U.S. Treasury was yielding less than 2%. What’s more really relevant for us is what that means for our investors, our clients going forward, in that bond yields tell you a lot about what you should expect from returns in the future.
That’s what you see here with the second orange graph. The orange graph superimposed on the silver one is basically telling you what the subsequent 10-year returns were for in this case government bonds, relative to the starting yield. You can see that these are highly correlated, meaning that if you had a starting yield of around 6%, over the next decade, you pretty much clip 6%, plus or minus a little bit. And obviously you’ll also see here that in 1980, if you were lucky enough to buy 10-year Treasuries at the time, you did quite well. You were annualizing north of 15% at one point.
As we look ahead, although bonds have performed quite well as of late, a lot of that has been price appreciation, not yield. With yields in decline, our forward expectations for bonds are also low. We’ve been talking a lot about lowering expectations for market returns, whether it be stocks or bonds going forward, a lot of that has to do with yields today being quite low. As we look ahead over the next decade, we do not anticipate a repeat of the last 10 years where bonds have outperformed their coupon. We think there’s a limit to how low rates can go. They can go to zero, theoretically even below that, but the absolute expected returns going forward should still be fairly close to what the starting coupon is, what the starting yield is, and today it is fairly low.
Long story short is with yields low, you should reduce your expectations for the future. Yields have been a very good gauge of subsequent returns from investment-grade markets, not only treasuries, but investment-grade corporates and agencies as well, and as we look ahead, we’ve obviously been tempering our expectations. So hopefully you found this Chartology useful.