Last week the yield on ten-year Treasuries dropped below 1.5 percent, which is an all time record low. This was brought about by two factors—the continuation of the debt crisis in Europe and concerns that the U.S. economy is slowing.
For those who are borrowers the further decline in interest rates is good news. Mortgage rates are highly correlated to the ten-year Treasury, and mortgage rates have also been falling to record lows. For example a 15-year conventional mortgage has an interest rate just below 3 percent, and the 30-year mortgage is between 3.5 to 3.75 percent. Jumbo mortgages, which are typical in this market, are higher of course, but they too have declined. For those who do have equity in their homes this should provide a good opportunity to refinance a mortgage at a lower rate.
While the employment report last Friday was a disappointment with only 69,000 new jobs being created, I do not believe this is a signal of a major slowdown in the economy. Rather, it appears the economy is still in a slow to moderate growth phase, as these numbers tend to bounce around on a month-to-month basis.
Other pieces of economic data recently reported do not give a negative outlook. For example the household survey for employment, also reported last Friday, showed an increase of 442,000 jobs, though this survey can be volatile month to month.
Car sales for May remained considerably higher versus prior year’s numbers, implying decent consumer demand.
Assuming employment remains fairly steady, housing demand should improve with the record low interest rates. In many markets throughout the country, owning is less expensive than renting on a monthly basis. In addition, a new wave of refinancing should be an added boost for household spending.
While low interest rates are a positive for a borrower, they are a negative for a saver. With inflation at approximately 2 percent, and with money market yields near zero and ten-year Treasuries at 1.5 percent, clearly a saver is losing ground.
Currently the dividend yield on the S&P 500 is approximately 2.5 percent, which is well above the ten-year Treasury yield. In recent decades dividend yields have rarely been higher than Treasury yields.
Some people may be willing to accept lower yields with Treasuries versus stocks because of lower volatility. For somebody with a short-term outlook that is a reasonable perspective. However, for a long-term investor you are giving up more than the current shortfall of income. For example someone who purchases $10,000 in a ten-year Treasury will receive interest payments of $150 per year for each of the next ten years.
For the investor in stocks, assuming dividends grow at a modest rate of 5 percent per year, the investor will receive $250 in year one, but over $400 per year in year ten, because of the growth from dividends.
The recent market drop is certainly creating unease among investors. However, as we have seen in recent years markets over time do recover. The problems in Europe will certainly not be settled any time soon, but the bad news has been widely disseminated.
Few people can time the market very well, so it is best to maintain your normal asset allocation. Certainly having some bond investments in a portfolio is prudent, but with record low interest rates, I would refrain from buying longer term bonds.