Long-Term Swiss Bonds Offer Negative Yields

I would rather buy gold than a government-issued bond with a negative yield. And I’m no cheerleader for bullion as a long-term investment.

You may have seen the news earlier this week out of Germany–their ten-year bonds briefly dipped below the 0% yielding threshold. Switzerland, not wanting to be outdone, now has a negative yield on thirty-year bonds that will mature in the late 2040s.

This is what economic madness in real time looks like.

It is a fact of life that institutions–be they public or private–will engage in transactions or offer you terms that on a deal that will make it nearly impossible to create wealth. Always remember this: The existence of a financial product should never give rise to a presumption that it is an “investment.”

Anytime you spend your money with the hope of creating a subsequent surplus, you must always ask yourself: At what price, on what terms, and with what range of probable outcomes am I subjecting myself to?

Microsoft can’t make the LinkedIn acquisition better than repurchasing stock unless: Linkedin’s cash flows soon double while costs remain steady, and then cash flows grow in excess of expenditures by around 18% annually for ten years.

The purchase of any kind of fixed debt instrument, held to maturity, can’t build wealth unless the interest rate payments exceed the inflation rate. If you buy a Switzerland bond, the only way you can create “wealth” over the next thirty years is if there is a three-decade long deflationary spiral. Even modest, teensy tiny 1% inflation? Too bad, you’re destroying your own wealth.

Wealth is preserved if the interest rates match the inflation rates on bonds held to maturity.

And wealth is squandered and destroyed when inflation runs higher than the amount of interest payments you collect from now to a bond’s maturity.

The only way the purchase of a short-term German or Swiss bond can be excused is if: (1) they are purchased for liquidity purposes, or (2) as some part of plan for near-term spending. If you’re a German buying a house in the next year, or a Swiss citizen putting together an emergency fund, the negative interest is just an unpleasant but necessary cost of doing business.

But if you are someone looking at fixed income as part of an investment strategy, you should not be looking at the bonds of nearly any sovereign government (or most corporations) right now. In The Intelligent Investor, Graham said that any investor should never let his bond holdings dip below 25%. That advice has psychological value; if the thought of portfolio declines of 30% is something you cannot withstand, then Graham still has relevance today.

But he was writing in a world of 4% and 5% interest payments in the United States at a time when inflation hovered between 3% and 4%. Bonds were, in effect, creating wealth even though the rate of wealth creation was slow. But those aren’t the terms that are being offered today. If the 1890-2010 inflation rate of 3.4% holds as the reality for this century, then the purchase of any bond yielding below that point will slowly but surely destroy your wealth.

The good news, though, is that you only have to find one intelligent place at any given time to put your new money. I’m currently preparing an article on Diageo (DEO) which has gotten very cheap as it approaches $100 per share. Large beer companies have always made families rich. The trick is just trying to find a decent price. Diageo is offering that now. Someone who punches an order for $10,000 in long-dated Swiss bonds will have $4,000 in 2046. Someone who buys 100 shares of Diageo for that same $10,000 investment $359,000 or thereabouts in 2046. You look at ticker symbols and you can easily get lost in the haze of how they all seem the same, but they represent drastically different claims on underlying assets which in turn lead to drastically different consequences over the long term.