ultra low / negative interest rates in Germany

[lordmetroid]

I don't think it is pointless at all. Bonds are there to hedge against deflation which I am sure we will see now in 2016 as the debt and QE bubbles will be popping. When everything tanks the best asset is the fixed income, cash and bonds because everyone else will loose their shirts.

[Libertarian666]

Hello Craig
thanks for tuning in. I actually bought & read your book
I fully agree with you on the pointlessness of holding 1% 30yr EUR bonds.

I was thinking of replacing the bonds with more of the other elements for the time being (stocks, gold, cash 33% each).
I am sure others have thought of this before me.
Has anybody done any sharpe ratio calculations, return calculations etc on this yet?

--
Of course Merkel's immigration policy is insane. I have to live in the midst of this, unfortunately.

Yes, except (if I recall correctly) you could fairly easily migrate to another country in the EU, or even Switzerland for that matter. Is that not true?

[Pfanni]

Yes, I could migrate myself. But I have a decent job, friends, family, etc here.

Off topic
I think Europe has kind of lost its will to live. It has become an old-age home. The old geezers favor capital gains over wage gains. With rates this low, the logical thing to do would be to invest in the future, especially replacing crumbling infrastructure. But people in the old-age home are too scared to ignite inflation, so they prefer 50% youth unemployment in Southern Europe.
What we would need in Germany for example are new bridges, subway lines, railroads - all these mega structures haven't been built anew since the late 70s. We are actually eating up or destroying our capital base. Large parts of the countryside still have no fast internet. I know many towns where people still use modems. There's nothing else available. In 2016! In a G7 country!
I see no reason anymore to invest in Europe. Public spending, especially on welfare (=consumption, not investment), >50% of GDP. By textbook definition, this must be called socialism. Extremely high taxes on labor (40% directly, then add 19% sales tax if you spend the money you earned = >50% tax on labor), relatively low taxes on capital gains (26.xx%).

[Austen Heller]

Pfanni,
I find your comments extremely interesting and insightful.  I am in the US, where I only get part of the story about what is going on over there.  I really had no idea it was getting that bad for you all in Germany.  I hope you and your family can stay safe.

[economicsjunkie]

So in the US, if interest rates get to the point of diminished returns, maybe swap out 10 year bonds instead of 30? Or even shorter? 5-7 year? What do people think?

If/when long Treasury bonds go below zero I may consider switching to top grade long term corporate debt instead. This would be as orthodox an alternative as I can think of, since HB himself recommended investing in long term corporate bonds instead of LTT's if you have moral issues with investing in government bonds.

[economicsjunkie]

Pfanni,
I find your comments extremely interesting and insightful.  I am in the US, where I only get part of the story about what is going on over there.  I really had no idea it was getting that bad for you all in Germany.  I hope you and your family can stay safe.

Yea, I was just there in September/October to visit family (I was born/raised in Berlin). What's going on over there is SURREAL. Many people over here have little to no idea. There is anecdote after anecdote about little towns of a few thousand residents getting flooded with a few thousand refugees living on taxpayer money. Example: http://www.hna.de/politik/friedland-geh ... 45570.html (Town of 1200 residents gets 4000 refugees).

What could POSSIBLY go wrong?

[Pointedstick]

So in the US, if interest rates get to the point of diminished returns, maybe swap out 10 year bonds instead of 30? Or even shorter? 5-7 year? What do people think?

If/when long Treasury bonds go below zero I may consider switching to top grade long term corporate debt instead. This would be as orthodox an alternative as I can think of, since HB himself recommended investing in long term corporate bonds instead of LTT's if you have moral issues with investing in government bonds.

I have done this myself, and currently have my long bond holdings split 50/50 between treasuries and top-rated corporate debt. They are highly correlated and the corporates yield 4.5% or more, which is very nice. If rates drop really low, I plan to switch entirely away from treasuries, and if rates on those fall really low as well, I plan to swap them out for intermediate-duration bonds.

[Pfanni]

Thanks for all the comments and ideas.

On corporate bonds, I am not so sure this is a good idea. Bond market history is littered with clusters of defaults.

We study corporate bond default rates using an extensive new data set spanning the 1866–2008 period.
We find that the corporate bond market has repeatedly suffered clustered default events much worse
than those experienced during the Great Depression. For example, during the railroad crisis of 1873–1875,
total defaults amounted to 36 percent of the par value of the entire corporate bond market.
Source: http://www.nber.org/papers/w15848.pdf (an interesting read by the way)

If you have bad luck and you're going to hit that water vein of amassed corporate bond defaults, which implies that the stock markets will also be in dire straits, you gonna destroy your portfolio. Replace railroad crisis with oil price crisis.... 

------
The refugee situation has actually become untenable in Germany.
I can speak of Berlin only, but there are spots emerging where crime is rampant and at night it's like police has been disestablished (RAW Gelände, Görlitzer Park, Kottbusser Tor...). Not John Carpenter's Escape From New York-style yet, but moving in that direction. Migrant gangs selling drugs, fighting for supremacy (Arabs vs. Africans etc.) - again it's not yet Bloods vs. Cribs, but it is not business as usual anymore.
I would strongly advise against taking the subway after 11 p.m., especially if you are a woman - you're asking for trouble.
I don't blame refugees in general, even if they are economic migrants. They have a right to pursue happiness. They smelled our political weakness when it came to border patrol, so they took advantage of it.
I blame our old age-home politicans, our old geezers at the command bridge who avoid any change or tough decision making. All they want is lock in their capital gains. They already bought their house thirty years ago, it is paid off. They don't care if it becomes unaffordable to buy a home for people in their 30s. To me, the core problem in our aging society (Germany has the worst demographics in the world together with Japan & Italy) is this conflict of interest between the old and the young (preferment of capital gains over wage gains).

[Pointedstick]

Your perspective on capital gains vs wage labor as an allegory for Europe is fascinating to me, Pfanni. Thank you very much for sharing it. Another lens for this conflict is populists vs elites, since most people earn their living via wage labor, whereas elites earn their living via purchase and ownership of assets that produce capital gains.

In a lot of ways, I feel like we in the USA have the opportunity to save ourselves; both Trump and Sanders seem to presage a re-alignment toward the populist wage laborers and their interests. Most of us personally may be harmed in some way should the tide turn against us elite asset owners and capital gains collectors, but ultimately I think it would be good of the country. People like us who are clever, intelligent, and privileged enough to reap substantial capital gains will be fine. It's the people who are not suited for anything but wage labor who we should really be worried about, especially because a goodly number of these people are armed and they control the basic infrastructure of civilization.

[murphy_p_t]

So in the US, if interest rates get to the point of diminished returns, maybe swap out 10 year bonds instead of 30? Or even shorter? 5-7 year? What do people think?

If/when long Treasury bonds go below zero I may consider switching to top grade long term corporate debt instead. This would be as orthodox an alternative as I can think of, since HB himself recommended investing in long term corporate bonds instead of LTT's if you have moral issues with investing in government bonds.

I have done this myself, and currently have my long bond holdings split 50/50 between treasuries and top-rated corporate debt. They are highly correlated and the corporates yield 4.5% or more, which is very nice. If rates drop really low, I plan to switch entirely away from treasuries, and if rates on those fall really low as well, I plan to swap them out for intermediate-duration bonds.

1. Aren't corporate bonds callable...so the protection you expect will disappear when needed most?
2. Aren't the price of corp bonds "inflated" in the similar way you are concerned that T-bonds are? IE, don't the corp rates move in tandem with T-bond rates?
3. It seems you assume that there's a limit to how low rates can go (zero bound?)...which has been shown to be false in Europe...are you concerned your proposed action is based on flawed assumptions?
4. Are you concerned about violating HB rules on predicting future and incorporating market timing?

Coming from someone who is pleasantly surprised to not have lost money investing in bonds back in 2011, thinking they were overpriced then..

[dualstow]

I never thought about switching from long-term treasurys to shorter ones before, but if it really gets to the point where I need to abandon my 30-year's, I suppose I would move to 7- or 10-year notes.  I wish Harry were alive to comment on this situation.

As for corporate bonds, yes it's true that Harry mentioned in his radio show that you could buy them in lieu of treasuries if you have moral concerns -- we all know how moral Exxon Mobil and Goldman Sachs are. However, I only own those in my Vp and I think I'll keep it that way. (VCIT, mid-term corp bond etf).

[craigr]

I was thinking of replacing the bonds with more of the other elements for the time being (stocks, gold, cash 33% each).

That's a possibility and I've thought about that as one option if U.S. bonds do the same. It won't be as good in deflation, but if bonds are paying 1% anyway, then most of the juice is gone from that asset.

My (Christian) family wanted to help this guy but we terminated the contact as soon as we heard about his criminal activities.
The other one is a very nice person, also from Libya.

Please don't let them do this. They don't know what the real story is, who these "refugees" are speaking with, or what they may do if they get desperate. Stay safe:

http://www.dailymail.co.uk/news/article ... -girl.html

Maybe ask your family if their assistance enabled these people to stay in the country and participate in the sex assaults on New Years? Or maybe someone is going to be robbed, raped, or assaulted by these people that they helped? Is it Christian to enable your enemies to invade your country and attack the countrymen?

I would personally be working with groups to roll out the Unwelcome Mat and not offer any assistance to them whatsoever.

You will always be a net drain on society. Of course, we don't want to kick them out either, with Islamic State taking hold around the town of Sirte.

There are plenty of Muslim countries that are safe that these rapefugees can go to instead. Europe can't adopt the entire African continent and remain Europe. Pathological altruism is going to be the ruin of Western countries.

It just gets back to one of my core beliefs that people, culture and investing cannot be separated. People are not interchangeable cogs in an economy.

If the people and culture goes bad, then the investment will go bad along with the country. Germany needs to get it together and get some people in there that can take action necessary to preserve their way of life. Low bond rates are going to be the least of their worries if things don't change.

[Libertarian666]

Thanks for all the comments and ideas.

On corporate bonds, I am not so sure this is a good idea. Bond market history is littered with clusters of defaults.

We study corporate bond default rates using an extensive new data set spanning the 1866–2008 period.
We find that the corporate bond market has repeatedly suffered clustered default events much worse
than those experienced during the Great Depression. For example, during the railroad crisis of 1873–1875,
total defaults amounted to 36 percent of the par value of the entire corporate bond market.
Source: http://www.nber.org/papers/w15848.pdf (an interesting read by the way)

If you have bad luck and you're going to hit that water vein of amassed corporate bond defaults, which implies that the stock markets will also be in dire straits, you gonna destroy your portfolio. Replace railroad crisis with oil price crisis.... 

------
The refugee situation has actually become untenable in Germany.
I can speak of Berlin only, but there are spots emerging where crime is rampant and at night it's like police has been disestablished (RAW Gelände, Görlitzer Park, Kottbusser Tor...). Not John Carpenter's Escape From New York-style yet, but moving in that direction. Migrant gangs selling drugs, fighting for supremacy (Arabs vs. Africans etc.) - again it's not yet Bloods vs. Cribs, but it is not business as usual anymore.
I would strongly advise against taking the subway after 11 p.m., especially if you are a woman - you're asking for trouble.

Of course there is a simple, costless way to reduce such a crime problem to a small fraction of its current size.

Too bad the politicians will never consider it and the population is (so far, anyway) too ignorant and/or frightened to make the politicians consider it.

[Libertarian666]

Most of us personally may be harmed in some way should the tide turn against us elite asset owners and capital gains collectors, but ultimately I think it would be good of the country.

I didn't realize I was so honored as to have met one of the "elite asset owners"! You certainly do a good job camouflaging your protected compound as a middle-class residence!

[Pointedstick]

The machine gun turrets are hidden in underground silos.

Most people own no financial assets or practically no financial assets, are extremely cash-poor, and derive most of their net worth, if any, from the value of their home. In retirement most will be completely dependent on social security or a public or private pension for their ongoing expenses. Most of us here are instead working towards or have already achieved some sort of financial independence provided by our investment assets. We are the elite. We're not as elite as, like, Michael Bloomberg or George Soros, but we're still the elite. No sense in denying it. What percentage of the membership of this forum would you guess has a liquid net worth in the 90th percentile for their age? 80%? 90%? 99%?

http://www.fool.com/investing/general/2 ... -comp.aspx

[Libertarian666]

The machine gun turrets are hidden in underground silos.

Most people own no financial assets or practically no financial assets, are extremely cash-poor and derive moth of their net worth, if any, from the value of their home. In retirement most will be completely dependent on social security or a public or private pension for their ongoing expenses. Most of us here are instead working towards or have already achieved some sort of financial independence provided by our investment assets. We are the elite. We're not as elite as, like, Michael Bloomberg or George Soros, but we're still the elite. No sense in denying it. What percentage of the membership of this forum would you guess has a liquid net worth in the 90th percentile for their age? 80%? 90%? 99%?

http://www.fool.com/investing/general/2 ... -comp.aspx

Yes, I knew about the predominant "home equity" portion of "net worth". Personally, even though my "home equity" is theoretically $50K or so, I can't get at it without selling (or remortgaging), so I don't consider it as part of my portfolio.

That aside, I imagine you are right that most of the forum members are way ahead of the average. But as far as our being "the elite", I guess I would consider "the elite" anyone who doesn't have to worry about their standard of living declining after retirement or disability. I'm not in that category, although I'm pretty sure that we won't end up living in a cardboard box.

[lordmetroid]

In times of deflation, indebted corporations may go bankrupt, that was why Harry Browne liked the government bonds because they can always print some more money to pay the bond holders.

[economicsjunkie]

I never thought about switching from long-term treasurys to shorter ones before, but if it really gets to the point where I need to abandon my 30-year's, I suppose I would move to 7- or 10-year notes.  I wish Harry were alive to comment on this situation.

I've seen this suggestion here a couple of times now. If low/negative interest rates are of concern here, then why in the world would a switch to a shorter duration be sensible, where interest rates would be even lower/more negative?!

[ochotona]

I've seen this suggestions here a couple of times now. If low/negative interest rates are of concern here, then why in the world would a switch to a shorter duration be sensible, where interest rates would be even lower/more negative?!

The issue is the risk of changes in the market price of the bond due to interest rate changes.

{picks up HP-12C Financial Calculator}

Let's say you buy a new 30 year Treasury for $10,000, and the coupon rate is 0.5%. The Present Value (PV) of that bond, if the market interest rate is 0.5% is just $10,000. You pay $10,000, you get your 0.5% interest for 30 years, and in 30 years you get your $10,000 back.

If the market interest rate increases to 1.0%, your PV of the bond just fell to $7548.26. You just had a -24.5% change because of a 0.5% change in the interest rate. Your bond has to sell at a discount in order for it to be attractively priced for someone to buy who might just as well buy a new 30 year bond paying 1%, not the old 0.5%.

That's what long bond investors are so freeking scared of.

[economicsjunkie]

I've seen this suggestions here a couple of times now. If low/negative interest rates are of concern here, then why in the world would a switch to a shorter duration be sensible, where interest rates would be even lower/more negative?!

The issue is the risk of changes in the market price of the bond due to interest rate changes.

{picks up HP-12C Financial Calculator}

Let's say you buy a new 30 year Treasury for $10,000, and the coupon rate is 0.5%. The Present Value (PV) of that bond, if the market interest rate is 0.5% is just $10,000. You pay $10,000, you get your 0.5% interest for 30 years, and in 30 years you get your $10,000 back.

If the market interest rate increases to 1.0%, your PV of the bond just fell to $7548.26. You just had a -24.5% change because of a 0.5% change in the interest rate. Your bond has to sell at a discount in order for it to be attractively priced for someone to buy who might just as well buy a new 30 year bond paying 1%, not the old 0.5%.

That's what long bond investors are so freeking scared of.

Correct, the longer the duration the more volatile the bond. And?

[ochotona]

Correct, the longer the duration the more volatile the bond. And?

The answer to your question is people will go to shorter duration in order to lower the volatility, because they may give up a tiny bit of coupon, but they avoid huge capital loss potential. You asked the question.

[dragoncar]

I've seen this suggestions here a couple of times now. If low/negative interest rates are of concern here, then why in the world would a switch to a shorter duration be sensible, where interest rates would be even lower/more negative?!

The issue is the risk of changes in the market price of the bond due to interest rate changes.

{picks up HP-12C Financial Calculator}

Let's say you buy a new 30 year Treasury for $10,000, and the coupon rate is 0.5%. The Present Value (PV) of that bond, if the market interest rate is 0.5% is just $10,000. You pay $10,000, you get your 0.5% interest for 30 years, and in 30 years you get your $10,000 back.

If the market interest rate increases to 1.0%, your PV of the bond just fell to $7548.26. You just had a -24.5% change because of a 0.5% change in the interest rate. Your bond has to sell at a discount in order for it to be attractively priced for someone to buy who might just as well buy a new 30 year bond paying 1%, not the old 0.5%.

That's what long bond investors are so freeking scared of.

So you rebalance into more bonds.  Then the rate drops .5%.  Where are you now?

[lordmetroid]

I've seen this suggestions here a couple of times now. If low/negative interest rates are of concern here, then why in the world would a switch to a shorter duration be sensible, where interest rates would be even lower/more negative?!

The issue is the risk of changes in the market price of the bond due to interest rate changes.

{picks up HP-12C Financial Calculator}

Let's say you buy a new 30 year Treasury for $10,000, and the coupon rate is 0.5%. The Present Value (PV) of that bond, if the market interest rate is 0.5% is just $10,000. You pay $10,000, you get your 0.5% interest for 30 years, and in 30 years you get your $10,000 back.

If the market interest rate increases to 1.0%, your PV of the bond just fell to $7548.26. You just had a -24.5% change because of a 0.5% change in the interest rate. Your bond has to sell at a discount in order for it to be attractively priced for someone to buy who might just as well buy a new 30 year bond paying 1%, not the old 0.5%.

That's what long bond investors are so freeking scared of.

You can argue the same principles for any of the four assets, it all depends on the current economic climate. There will always be one asset that is out of favor for some reason or the other.

With deflation looming on the horizon as the QE and debt bubble is about to pop, I actually look very favorably upon bonds, even with these low interest rates. Because a 0,5% yield will be a heck of a lot better than gold who will depreciate in value thanks to cash becoming more and more scarce and valuable. As well as stocks which may never recover for the next few decades alike Japan because the companies will have a hard time making the bottom line as they need to pay off their debt financed assets that bought at the top of the bubble and not generate any growth.

[Libertarian666]

With deflation looming on the horizon as the QE and debt bubble is about to pop, I actually look very favorably upon bonds, even with these low interest rates. Because a 0,5% yield will be a heck of a lot better than gold who will depreciate in value thanks to cash becoming more and more scarce and valuable. As well as stocks which may never recover for the next few decades alike Japan because the companies will have a hard time making the bottom line as they need to pay off their debt financed assets that bought at the top of the bubble and not generate any growth.

As Ben Bernanke noted some time ago (http://www.federalreserve.gov/boarddocs ... t.htm#fn18), central banks can prevent deflation in any country by printing money. Of course the eventual result of this policy will be the destruction of the currency, but they believe that they can stop in time to prevent that. In my opinion, people are starting to realize that printing money is exactly what the central banks are doing and will continue to do, which is why gold has started to move up recently.

[Lang]

So far central banks have had little luck with preventing deflation...