Tag: episode-1102

ROBERT KESSLER: BULLISH ON TREASURIES TRANSCRIPT

July 4, 2014

The founder and CEO of Kessler Investment Advisors is sticking to his guns and maintains that U.S. Treasury bonds will continue to be a major beneficiary.

Consuelo Mack: This week on WealthTrack, marching to the beat of a different drummer. While most of Wall Street has been preparing for rising interest rates and faster economic growth for years, Great Investor Robert Kessler has stuck to his low interest rate, slow growth theme… Kessler Investment Advisors’ Robert Kessler is next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. How many times in recent years have you heard money managers, financial advisors and economists say that interest rates are about to go up? And therefore advise you to shorten the maturities in your bond portfolios because long-term bonds, treasury bonds in particular are very sensitive to changes in interest rates. When interest rates go up, bond prices decline. When interest rates decline bond prices go up. That sensitivity has worked mostly to bond investors’ advantage over the last 30 plus years. Interest rates on 10-year U.S. Treasury notes, for instance have declined from a high of close to 16% in 1981 to a low of 1.4% in 2012. Treasury bonds have been great investments throughout. The yield has stayed near historic lows ever since.

What happens if rates start to go up? Here’s a chart from Altegris Advisors showing the impact on different types of bonds if interest rates rise one percent.

Prices of high yield corporate bonds would decline about 4%,.. Emerging market bonds would suffer about a 6% hit,… U.S. investment grade corporate bonds would experience a 7% fall ,… 7-10 year treasuries nearly 8%… And long term treasury bonds would plummet more than 16%- ouch!

Many pros have warned of that danger on this program for years now, including most recently Templeton Global Bond Fund’s Michael Hasenstab.

There has been one consistent hold out on WealthTrack over the years, who has stuck with his low interest rate theme and U.S. Treasuries. He is this week’s Great Investor guest. Robert Kessler is the founder and CEO of Kessler Investment Advisors, a manager of fixed income portfolios specializing in U.S. Treasuries, for institutions and high net worth individuals globally. For the 15 years that I have been interviewing him he has correctly predicted that interest rates would fall, then remain low and that U.S. treasuries would perform well. I began the interview by asking him why rates have stayed so subdued for so long.

ROBERT KESSLER: Let me say that I think when we talk about so long, you’re talking about a period of time from the beginning of the ‘80s until now, and so we consider that a very long period of time. The fact of the matter is we had very low interest rates from the early ‘30s until the ‘60s. So this is not an unusual situation, and also in global economies, free enterprise systems, capitalism, there’s always this pressing for lower and lower costs and lower and lower rates. It’s the nature of a good market system which we’re in.

CONSUELO MACK: And productivity and competition and all that stuff. Costs go down.

ROBERT KESSLER: Productivity. All the things that go with it, and there’s a good and bad for that. The good part is that prices come down, and over time generally, if you’re not having a war and you’re not having total fiscal irresponsibility … and in this country we have no fiscal policy, so we’re pretty good on that. So under these conditions there really is no reason to not expect rates to continue to kind of ratchet lower, and though last year I think when I was on this show, one of the prevalent kinds of conversations was this is the end of the bull market in Treasuries.

CONSUELO MACK: In bonds.

ROBERT KESSLER: And in bonds.

CONSUELO MACK: And in Treasuries especially, but bonds.

ROBERT KESSLER: And that’s kind of self-serving for an industry that really when you’re looking at a stock market up 30 percent last year or up six percent in the last month or so, the industry wants to see higher rates because that goes along with higher GDP, and higher GDP kind of gives you a market, an equity market that really can go higher. So if you look at Wall Street and you look at the financial community, the first thing everyone’s going to say is, “Well, things are really getting better,” and by the way, when they get better, rates have to go up. As long as I’ve been dealing with or you and I have been talking, in the Treasury market rates are always going up. I can’t think of a time in the last 30 years or so, whether it’s mortgage rates … mortgage rates in the late ‘80s for instance were around nine percent. If you asked anyone, “What do you think about financing your house this week?” “We better do it now, because rates are going up.” Rates are always going up.

CONSUELO MACK: Right. As far as the investment psyche is concerned.

ROBERT KESSLER: Sure. The real estate industry wants you to buy today because tomorrow the price will go higher.

CONSUELO MACK: So this some marketing ploy?

ROBERT KESSLER: Well, there are very sound reasons. We have, again, a marketplace of competitiveness. We have a marketplace right now in the Treasury market. We’ll talk about the Treasury market where actually the amount of Treasuries are shrinking. We had a deficit in this country of eight or nine hundred billion dollars, and now it’s going to drop to 600 billion. That means we’re going to issue less Treasuries.

CONSUELO MACK: Well, and the Federal Reserve, however, also owns or has been buying 50, 60, 70 percent of Treasury issuance, taking Treasuries off the market.

ROBERT KESSLER: It makes it even smaller in terms of the amount on the market, and the rest of the world looks at the United States. No matter how people may talk about it. We are the reserve currency. We are where you want to place money, and so as countries have grown and certainly countries have grown, regardless of whether they’re in a state of repression or kind of recessions, nonetheless there’s more money out there, and money has to go someplace, and so a huge amount of that comes into the safest, most secure security which is a Treasury. So there are really lots and lots of reason not even counting the fact, which is really important, that on a relative value Treasuries are very cheap right now, and the reason they say …

CONSUELO MACK: On a relative value to other markets that have sovereign debt.

ROBERT KESSLER: Sovereign debt. That’s right. We’re not even a high rate compared to a number of countries in Europe or Japan certainly. The 10-year rate in Japan as of today is around 60 basis points, 0.60. We are 2.60. The Bund which as a normal relationship, normal …

CONSUELO MACK: The German Bund.

ROBERT KESSLER: The German debt. Our normal relationship to the Bund is about 20 basis points over that yield.

CONSUELO MACK: So a fifth of a percentage point.

ROBERT KESSLER: A fifth of a percentage, and that yield happens to be around 1.4. So on a normal basis we would be around 1.6. Here we are at 2.6, and we’re also in a situation where risk assets, equity markets, real estate in London, excess housing in China, all of these places have inherently tremendous risk. The Treasury is interesting because though you perceive … well, what happens if rates go up? The fact of the matter is, no one says you have to do anything.

CONSUELO MACK: The natural order of things is for markets to revert to the mean, and when you’ve had a big rally in a market for almost 40 years then usually there’s a bottom at some point and the market will reverse which is what people are talking about with the Treasury bond market, that it’s rich, that it’s expensive, that it is due for a correction and that rates are due to come up especially with the economy recovery and the Federal Reserve withdrawing its easing program.

ROBERT KESSLER: Let me talk a little bit about the difference between a Treasury and interest rates, because we seem to group all of this together where people have said recently there’s a bubble in the credit market, and the implication is that Treasury yields are too low and, therefore, something has to happen, revert to the mean or whatever thing you want to say. The fact of the matter is there probably is a bubble in the credit market. That is, companies that we would consider risky, high yield, are at the narrowest relationship to Treasuries ever.

ROBERT KESSLER: Okay, that is probably very, very risky. It has nothing to do with the Treasury being there. The Treasury is there for one reason, because there’s no demand for money in the economy. We call that velocity, so all of this money that the Fed, that everyone likes to say, “Oh, they’re printing money,” it has gone into the banking system, and what has the banking system done? Nothing. They don’t lend it. It sits there, and so in an economy that has the kind of employment problems we have, and we have very serious employment problems where student loans have averaged now … 40 million people with student loans have $30,000 or more. In 2007, people needing food assistance … that’s a polite way of saying food stamps … we had 26 million. Now we have 47 million. All of these are known as consumers, and if you don’t have this kind of consumption coming into the market, where is the demand going to come from?

CONSUELO MACK: So Robert, when I talked to you before this and we sat down for this TV interview, you actually said that you thought that things were significantly worse than they were a year ago, and they are dramatically different this year than when we talked a year ago. Now by most measures, other people would look at the economy, for instance, and how business is doing, and they would say actually we’ve had some gradual improvement. We have an energy revolution, an energy renaissance going on. We have a manufacturing renaissance. That in fact the U.S. economy is in relatively good shape, and it’s stable. It’s not great growth but it’s okay growth. So what’s dramatically changed in your mind from a year ago that the rest of us are missing?

ROBERT KESSLER: It’s worse for this reason.

CONSUELO MACK: And what’s worse?

ROBERT KESSLER: It’s worse for this reason. We have never in this world that we live in seen a central bank for 28 countries reduce the rate down to a minus number.

CONSUELO MACK: As they have in the ECB.

ROBERT KESSLER: As they have in the ECB, and that’s Europe.

CONSUELO MACK: Right, in Europe.

ROBERT KESSLER: Europe is sitting with 12 percent unemployment. It’s not even changing, and that’s not counting Greece or Spain or countries in the peripheral area that aren’t improving. If you look at China, every week that goes by there are three or four articles in every single newspaper about the bubble in housing, in excess capacity. Excess capacity is interesting in China. We in the United States have a capacity utilization of around 79 percent, not too bad.

CONSUELO MACK: So we’re using the factories, and the production capacity is at 79 percent of what they could produce.

ROBERT KESSLER: China, 60 percent, an incredible figure. It means there’s so much excess in China, that whether it’s housing, whether it’s employment, whether it’s factory. So you have that on one side, China, Europe on this side. Actually the central bank telling you it’s so serious. When I was sitting with you last time, we were going through the crisis in Europe. Now they’re actually recognizing the crisis in Europe. Then we have the United States which now says more or less Wall Street, the financial community, “excuse me we’re decoupled”. Decoupled means that this country can get along perfectly well without anyone, and we know that that’s simply untrue.

CONSUELO MACK: It’s just not true.

ROBERT KESSLER: So when you ask me, is it better? Sure, it’s better for segments of the U.S. population. It’s not better for the housing industry which looks like it’s turning down, not up any longer, and if you look at employment in housing, we’ve lost a million six hundred thousand jobs over the last five years, and we’re not getting them back. Those are good-paying jobs. Where have they gone? We’ve actually brought it into health care and areas which are lower-paying jobs. So is it really getting better? Silicon Valley certainly is getting better, and certainly the stock market is up, but that belies the point that a vast majority of Americans are not getting higher wages. They’re getting lower wages. The CPI that came out, an interesting number, because everyone went a little bit bonkers over a higher CPI. The Federal Reserve said, “Well, it’s a little noise.” I would suggest that PCE, which is what the Federal Reserve watches, another inflation gauge, is at 1.5 percent. It really hasn’t moved.
I think people are taking a greater … I’m not suggesting people shouldn’t own stocks. I’ve never done that, equities, but they’re taking a greater and greater risk in a marketplace after four or five years where everyone acknowledges this is the weakest recovery in history. But don’t worry; things are getting better. And I would suggest my job isn’t to come on and sell something. I mean, in the Treasury business we can be long or short from our fund, and that’s a trading mechanism.

CONSUELO MACK: Right, and so talk about that because you have been, even though you are a long-term Treasury bull at Kessler Investment Advisors, you certainly have shorted depending on what’s going on in the market. You’ve certainly shorted Treasuries on and off.

ROBERT KESSLER: And I don’t recommend anyone do what we do. I mean, we do it on a professional basis. The purpose of a Treasury shouldn’t be misunderstood to be a trading mechanism, a trading vehicle. The purpose of a Treasury is to know that money will be there and that you’ll get a certain return from it. Believe me. There’s nothing wrong with 2.60, 2.6 percent when money market in Europe is paying minus 0.10 or in the United States paying zero.

CONSUELO MACK: But it certainly is if you’re thinking out 10 years because, again, historically … and correct me if I’m wrong … normally we do have inflationary periods and interest rates do go up and down. So if you’re dealing with your purchasing power, 2.6 percent a year over 10 years seems like a very low rate of return compared to what we’ve had in recent history at any rate, at least in the last three years.

ROBERT KESSLER: And you’re suggesting that over the next 10 years something very positive is going to happen, meaning that prices are going up. Wages will start going up, because …

CONSUELO MACK: That’s the optimist in me.

ROBERT KESSLER: Without wages going up, believe me there’s no consumption. I would suggest to you that this deleveraging process, the mess we got into in 2007, ’08, the consumer, the household that got into this high amount of debt is in the middle of the process of bringing it back down so that there can be consumption. You can’t have …

CONSUELO MACK: So six years in, we’re kind of midway.

ROBERT KESSLER: I mean, it could be four more years. It could be seven more years. I don’t have a clue, but I do know one thing. The risk during that period of time is enormous, and when you step into a market like the equity market, one of the things that you hear, it’s cute. It’s a Wall Street thing. Listen. You know, had you not bought equities over the last four or five years, you missed out on one of the great rallies in the world. Thank you very much, but you forgot to tell me about had I been there in 2002 and ’03 and lost half my money in 2007 and ’08. You just kind of conveniently forgot that part.

CONSUELO MACK: Right. As if we all came in at the bottom.

ROBERT KESSLER: Yeah, we all came in at the bottom which we never do. I certainly don’t. I’m not that smart, and we probably don’t do that. So the risk isn’t that you put all your money. I mean, I’ve heard recently, and we all hear it, now I put even more money in equities. What do you think of that? And the answer to that is when you start hearing that talk, don’t do it. It’s reasonable to be careful, and I’m only suggesting that the Treasury market, and I’m not even suggesting the general credit market any longer.

CONSUELO MACK: So you’re not suggesting the general credit market, so when you compared Treasuries, for instance, to high-yield bonds, so looking at other debt instruments.

ROBERT KESSLER: For a point and a half percent more or half a percent, why are you doing this?

CONSUELO MACK: You mean taking that kind of risk.

ROBERT KESSLER: Taking that extra risk for that, and the risk is enormous because we know for sure that the Treasury will pay off. We know that the worst that can happen if you have a 10-year Treasury is you have to stick around for 10 years. It’s possible that if Robert Kessler is right, rates actually go down substantially from here.

CONSUELO MACK: And that is basically your prediction, is that you think that rates will go down substantially from here. Of course, from two and a half percent, substantially can be half a percentage point or something.

ROBERT KESSLER: I don’t see any logical reason that your European rates, that we’re competing with the Spanish and the Greek and the Italian rates, and they’re right virtually even with the U.S. rates.

CONSUELO MACK: So who’s credit would you rather … ?

ROBERT KESSLER: Who’s credit would you rather have, and why should we be so different than the German rate? We are the reserve currency. So if you say, “Well, I don’t know. I think things will settle down,” you talk about reverting to the mean, reverting which mean? There’s no particular reason why you can’t see rates at one and a half percent considering that rates are zero. You get zero for rates right here. As to whether the Fed is going to raise rates which, of course, Wall Street would always like you to believe … oh, the Fed is always going to raise rates. There’s never a time other than when the market crashes that Wall Street agrees rates are coming down. Other than that, rates are always going up. So my guess is the Fed is correct. They’re not terribly correct on prognosticating where the GDP is, and there’s a reason for that. They are the head banker. What are they going to tell you? Things are not good? They always tell you things are going to be better and, in fact, it tends to be in the last three or four years wrong.

So probably we’ll kind of muddle along. Hopefully we’ll keep doing one to two percent, and that’s probably what we’ll do. Rates will stay at zero, and how long will that be? If we don’t get into trouble, if China doesn’t kind of have a hard landing which is plausible, if Europe doesn’t get into more of a mess than they’re in already, if the United States doesn’t turn down because housing certainly doesn’t look like it’s going up any more. So in this fragile global world we live in, we are not decoupled. We are part of this whole thing, and I would just suggest that the Treasury market is very attractive.

CONSUELO MACK: Rates of return that you get in the stock market, however, over time, and if you’re talking about reinvesting dividends for instance, and there are many companies that have dividend streams that are growing, and if you reinvest them, they basically keep up with inflation. They actually …

ROBERT KESSLER: So let me debunk this. This gets a little …

CONSUELO MACK: So that’s the argument as to why should I settle for 2.6 percent when I can get growing dividends and reinvest them.

ROBERT KESSLER: If you take 2000 to today, so if we just kind of ran numbers, if you had let’s take a zero coupon Treasury, a long-term Treasury, you’d be making an annualized return of around 15 percent. That’s 14 years annualized return.

CONSUELO MACK: Right, which is incredible.

ROBERT KESSLER: Great, well, all right. So the stock market, the equity market, had you done the same thing, three and a half percent dividends reinvested. Not impressive. Okay, for the last four or five years which is the years that we all want to really get crazy about, the equity market would have brought you 22 percent annualized. Fantastic. And that same bond market, if you only took that period of time which is not great, you made around 10.

CONSUELO MACK: Annualized.

ROBERT KESSLER: Ten annualized. So I give you 15 and 10, and it’s not an equity. An equity has what’s known as a down side to it. Is this unlimited period of time on a call. It’s not 10 years. It’s not five years. It’s not 30. It’s unlimited.

CONSUELO MACK: Right. If you hold a bond to maturity, however, you know you’re going to get, and so that’s your point is to hold it to maturity.

ROBERT KESSLER: Well, or not, and we’re talking about just rolling Treasuries over this period of time. If I take it from 1980, it’s going to look the same way. There’s a mystique, a seductive kind of a question with equities, and we all love it. I mean, there’s nothing that’s better than buying an equity when it goes up. It’s when it goes down, and I’m not knocking equities. Believe me.

CONSUELO MACK: One investment for a long-term diversified portfolio. What would you have us all own some of?

ROBERT KESSLER: Buy a long-term zero coupon bond. I mean it more than I meant last year. It wasn’t so terrible this year. Rates right now on the long-term market are roughly three and a half percent. If it goes down to three which I would expect frankly by the end of the year … that’s a good call. I think the end of the year … that would be about an 11, 12 percent return. That’s not a big deal because long-term Treasuries were at two and a half percent going back a year or so ago. If it doesn’t go down, part of your portfolio will be getting three and a half percent, and if you’re a long-term player which everyone says about the equity market … thank you, we’re buying it for the … although when everyone tells you we’re buying it for the long term, it means they’re not making any money, but they’re buying it for the long term. Then you need to buy Treasuries and think of it as a part of your portfolio. I’m not suggesting it’s your whole portfolio. It’s part of your portfolio, and the reason I think you don’t hear that enough is because if you suggest that, you’re also suggesting rates will stay low, and rates staying low means GDP stays low. It means equities are not earning as much money as we’re being told, and so you never sell Treasuries.

CONSUELO MACK: Robert Kessler.

ROBERT KESSLER: Thank you.
CONSUELO MACK: Always a treat to have you, and we will have you back at the same time next year to see if you are right again 10 years later.

ROBERT KESSLER: Thank you very, very much, and it’s my pleasure being here. Thank you.

CONSUELO MACK: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is ignore the crowd and own some U.S. Treasury bills, notes or bonds for their liquidity and security. . .

There are multiple geopolitical hot spots in the world right now, shaking investor confidence. There are economic challenges in many parts of the globe as well and the U.S. stock market is trading at or near record levels. U.S. treasuries are the investment of choice in times of uncertainty and trouble. Having some treasuries in your portfolio can provide insurance and stability.

I hope you can join us next week. We are going to sit down with another contrarian, this time in the stock world. Veteran investor Steve Leuthold explains why he is investing in nuclear energy and China in his new firm, Leuthold Strategies.

In the meantime to see more of our interview with Robert Kessler check out extra on our website. We will also discuss the role of prenups in the WealthTrack Women section of our website. Have a great Fourth of July weekend and make the week ahead a profitable and a productive one.

Back to Top