Family Office
Viewpoint: Setting the scene for 2008 fundamentals
It looks as though long-term interest rates are at unsustainably
low levels. Tom Sowanick is CIO of Clearbrook Research, part
of Clearbrook Financial, a Princeton, N.J.-based
wealth-management service provider.
The fundamentals for 2008 are somewhat awkward. First, the talk
about the U.S. falling into a recession is growing louder and
louder. Second, and perhaps more alarmingly, is the reality that
real long-term interest rates are at unsustainably low levels
(see the charts below). |image1|
With the exception of October 2003, real long-term yields are at
their lowest levels in 21 years. It is our view that investors
have pushed Treasury yields to dangerously low levels. Investors
should expect only to earn, at best, the coupon rate in 2008.
Below normal short-term rates do not pose the same negative
total-return prospects as very low long-term yields. |image2|From
a broader perspective, relative value comparisons are also
compromised because of the unusually low nominal and real
interest rates.
Off kilter
Consequently, absolute-return investors will likely shun
long-term debt instruments, regardless of asset class and
quality. Relative-value investors will, however, be enticed to
long-dated corporate, mortgage, and municipal securities in
response to what appears to be generous yield gains in comparison
to Treasury yields. Unfortunately, relative-value gains can
produce mediocre returns when the benchmarks are off kilter, as
is the case now.
Though Treasury-market total returns have been quite competitive
when compared with equity-market returns this year, it is
entirely likely that bond market returns would have been as
little as 3% if the flight to quality had not occurred. Through
the first six months of the year, the Treasury market had a total
return of only 1.1%. From June through 5 December, the returns
jumped to 7.74%.
As we think about the markets in 2008, the prospects for total returns coming from the Fixed-income market look quite bleak. With real yields so low, cash looks like a better alternative to bonds. -FWR
