President Kanye West Is More Likely Than the Treasury Bull Market Keeping Its Pace

Where do you go when yields all fall down?

Investors are bound to see declining returns from bonds, according to Deutsche Bank AG. 

"Currently the fixed income derivatives market suggests only a 20 percent probability of total returns from ten-year treasury bonds exceeding merely the dividend yield on the S&P 500 over the coming decade," writes a team led by Analyst Rineesh Bansal. "Even less likely is that bond returns will match their own performance of the last ten years – in fact based on bookmaker odds, it is more probable Kanye West will occupy the White House come 2020."

With no disrespect to the rapper, why are investors so pessimistic on debt securities' prospects? It's not the size of returns that suggests the trend is unsustainable, but rather, the composition of those gains. After all, the total annualized real return of a portfolio invested in on-the-run 10-year Treasuries has been 3.7 percent over the last decade, "the same as the previous decade and in line with the average of any ten-year period over the last 40 years," notes Bansal.

In 2006, only about 20 percent of Treasuries' long-term returns were attributable to capital gains rather than collecting coupon payments. However, in the last 10 years, capital gains' share of U.S. Treasury returns has more than doubled. At the same time, the portion of equity investors' returns linked to share-price appreciation has waned in favor of dividend income.

The changing composition of returns from these asset classes suggests the two are in the midst of something of an identity crisis, writes Bansal, echoing strategists such as Fundstrat's Thomas Lee who have remarked that equities are the new bonds.

KAYNE BOND
Source: Deutsche Bank

Bansal estimates that 10-year Treasury yields would have to fall "well below" -2 percent by 2026 to match the past decade's performance. The market is expecting them to reach the same number, he says — but with a positive sign in front of it.

"For bonds that means annualized total returns of 1.4 per cent in the next ten years, their worst performance in over 40 years," he says. And Bansal isn't the only one to note the waning appeal of government debt.

In a July note to clients, Morgan Stanley Chief Cross-Asset Strategist Andrew Sheets wrote, "On our group’s long-run return models, buying a 10-year Bund today is roughly equivalent to buying the S&P 500 in November 2000."

It's worth noting, however, that in recent years the fixed-income market has experience a number of phenomena previously thought to be impossible — helped on their way by central banks whose easing policies show little sign of ending. The best example, perhaps, was when the entire Swiss yield curve sank into negative territory earlier this year.

A surge of relatively price-insensitive demand for these safe assets and the near-certainty of continued central bank sovereign-debt purchases to support advanced economies should bolster the appeal of a long bonds/short President West trade.

In a 2013 interview, West himself quipped, "Nobody can tell me where I can and can't go." Government debt has also taken that message to heart.

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