It has been close on a decade since the global financial crisis. Investors have viewed the subsequent experiments in printing money and slashing interest rates down close to zero that followed afterwards as an aberration – and one that is bound to end in tears. Indeed, this week’s sharp sell-off in the markets will be taken by many as the first sign that they were right. But hold on. What if interest rates are not that low after all?
That’s what a fascinating new paper from the National Bureau of Economic Research in the US claims. The researchers looked at bond yields over the last 50 years that were adjusted for inflation and tax. Most models just ignore those factors, especially the tax, which is just assumed to be background noise that makes no real difference to returns. The results are surprising.
Interest rates aren’t all that low
Back in 2006, the yield on a 20-year Treasury bond was 5%, but in 2016 the same bond only promised a return of 2.2%. Big difference, right? Not once you take other factors into account. The inflation rate had dropped from 3.2% to 0.7%, meaning that real rates of return were 1.8% and 1.5%, respectively. In the US the average tax rate is 25% and crucially that is levied on nominal rather than real returns. Crunch those numbers and investors were only making actual returns of 0.5% in 2006. In 2016 they were making actual returns of 1%. In other words, twice as much. Adjusted for real-world factors, interest rates were not exceptionally low after all. They were just higher than before the crash.
Going back further, returns in 2016 were higher than they were in 1966 and 1956, although lower than they were in 1986 or 1996. The point is that rates of return fluctuate, but right now they are not far outside their normal boundaries.
A blip in a long-term bull market
Over the past few years many investors have built a narrative around the idea that we are witnessing a vast bubble. Rates are so low that the bond market has risen to ridiculous highs. Cheap money has been pumped into assets from property to equities to commodities. The global economy is being kept afloat on a tidal wave of speculation and froth.
The one thing we know about bubbles is that they eventually burst, everyone loses a tonne of money and the economy is plunged into a new recession. It might be this year or next year, but it is only a matter of time before this one goes the same way – or so the consensus goes.
This new analysis suggests that view is wrong. We are not witnessing an artificial bubble. With inflation and tax rates where they are, rates of 2% or so may well be about right. There is no reason to expect them to climb back to 5% or 6%. The bond market may be repriced a little over the next few months, but there are no grounds for expecting a major crash. And equities may even just be at the foothills of a long bull market, rather than teetering on the edge of a spectacular 2008-style crash.
Who’s getting what
► Footballer Cristiano Ronaldo is set to receive a €9m raise on his current deal at Real Madrid, according to Spanish sports newspaper Marca. This will see him take home a salary of €30m before bonuses.
► Motability Operations, a charitable scheme providing taxpayer-funded cars for the disabled, paid chief executive Mike Betts £1.7m last year including bonuses, reports the Daily Mail. He was also awarded a further deferred bonus of £263,000 for his work in 2017, due to be paid in 2020. Motability Operations receives around £2bn per year from the Department for Work and Pensions and has built up a cash surplus of £2.4bn. During his 15 years at the helm, Betts has earned a total of almost £15m.
► The chief executive of Network Rail, Mark Carne, announced his retirement this week and will step down later this year. Carne, who is Britain’s highest-paid public servant, received a total of £820,000 last year, including a £50,000 bonus.
► Tesco is to appoint Charles Wilson – the CEO of wholesaler Booker – as the new head of its UK arm, on a base salary of £575,000, an annual bonus of up to 200% of salary and an annual performance share-plan award of up to 225% of salary. Tesco will complete a merger with Booker next month. This week the supermarket chain was hit by an equal pay claim that could result in a £4bn bill.
Nice work if you can get it
Players for the Philadelphia Eagles will get a bonus of $112,000 each for their victory over the New England Patriots in the Super Bowl last weekend, according to CNBC (see page 44). Players in both teams had also already earned $79,000 for their first two play-off wins ($28,000 for the divisional round and $51,000 for the conference championship). The losing Patriots players will receive $56,000 for the final game, taking their total bonuses from the play-offs to $135,000.