The US 30-Year Bond Yield dropped below 2% in August 2019. This is a record low. What does this mean, what are the implications and how should AXIAM investors respond to the news?
Why did the US 30-Year Bond Yield decrease?
Negative market sentiment and uncertainty increases the demand for bonds. Increased demand for bonds causes bond prices to rise and their yield (return) to decrease. If you buy a US 30-Year Bond at its current yield, you would only get about 2% annual return on your investment over the next 30 years.
What are the implications for investors?
Investors can choose between buying shares or bonds. If the yield on a bond is 2% and you could get a 2.58% dividend yield on a stock, it makes more sense to buy shares instead of bonds. Also, the dividend yield will grow in the companies we own, while the yield from a bond stays constant.
Furthermore, the risk-free rate is unlikely to stay low forever; therefore, bond yields are not likely to stay low forever. Purchasing a bond for $10 000 with a 2% yield will pay $200 per year. If the risk-free rate increased from 2% to 4%, the investor would still earn $200 per year, but the value of the bond halves to $5000 should the investor want to sell the bond as the new investor will want to earn at least 4%. A yield of 4% is equal to $200 on $5000.
What does that mean for AXIAM investors?
Our investment philosophy focuses on buying companies that we know and understand and holding onto those shares over the long term. The companies that we own produce free cash flow and have low debt-equity ratios. They are therefore not affected by prevailing interest rates directly in producing free cash flow. Based on this philosophy, we would not consider selling stocks because of prevailing interest rates or market sentiment
What are the implications for the companies we own?
The US 10-Year Bond Yield determines the consumer mortgage rate people pay on their home loans. As the US 10-Year Yield declines, so mortgage interest payments also decline. People refinance their mortgages at lower interest rates when rates fall, reducing borrowing costs and increasing disposable income, thus allowing them to spend more. The companies we own are the beneficiaries of this increased expenditure.
If interest rates stay at this level for the next 30 years, our clients will become exceptionally wealthy as consumers spend more.
Should the interest rates rise, the share prices will decline, the free cash flow will not be greatly affected from current levels as the companies do not carry a lot of debt. The lower share prices will allow us to buy more shares for our clients.
Read more about this cycle in our Investors Meeting 2018 blog.
At AXIAM, we have spent many years growing wealth with an investment strategy inspired by the wisdom of great investors like Warren Buffett. We buy shares in companies that pay regular, increasing dividends, because they own great brands that are known, loved and used around the world daily and we keep them for a long time. Sign up for our newsletter, or contact our fund
management team to invest.