What is going to happen in the next few years? Where will markets go in the new decade that kicks off with 2020? What is the best way to position a portfolio for, say, the six-year window from 2020-2025?
This is an incredibly important question. Getting it right — or wrong — could mean the difference between a well-funded retirement and risk of ruin.
The question looms large because of scenario divergence, meaning there isn’t just one plausible scenario for what could happen in markets between now and 2025. There are at least three. And the outcome implications for each are wildly different.
This is what makes the portfolio aspect a challenge. If you are positioned for scenario “A” between now and 2025, but scenario “B” or “C” plays out instead, your portfolio won’t perform anywhere near as well as it should. Worse still, the wrong positioning could lead to painful portfolio declines.
Nobody knows for certain what will happen between now and 2025. It’s simply impossible to be sure. There are too many unknown variables, such as:
- The winner of the 2020 U.S. presidential election (and what the winner’s policies will be);
- How the U.S.-China trade war will resolve (if it resolves by 2025 at all);
- Whether the UK, Europe, China, or Japan will face a new financial crisis;
- How central banks will respond to the next crisis;
- Whether a new geopolitical crisis will erupt (Iran, North Korea, etc);
- Whether the U.S. economy or the global economy will go into recession;
- And many more.
The good news is, we have something better than certainty. We have probability analysis, and the skills to interpret data with the help of algorithms and software.
What this means is that, instead of falsely proclaiming we know what is going to happen between now and 2025 — because again, it’s impossible to truly know — we can build models based on the divergent scenarios that could play out.
Then, once we’ve determined what to look for, we can use a combination of algorithms, software, and real-time observation to determine which scenario is taking hold.
If you imagine the scenarios for what happens between now and 2025 as racehorses on a track, it’s kind of like handicapping the Kentucky Derby — except this “derby” lasts six years rather than two minutes.
Today, we’ll look at a dark scenario for what could happen between now and 2025. Next week, we’ll consider a much more bullish scenario.
Again, both of these scenarios (and others) are plausible. Which one comes to pass is a matter of the big unknowns — the ones we know of, plus others that are hidden — and how the story unfolds.
The dark scenario can be captured in a question: “What if U.S. long-term rates go to zero?”
When bond prices go up, the yield (or interest rate) goes down. This is not a correlation, but rather a mechanical relationship. When investors buy bonds and push the prices up, that buying pressure pushes the yield down simultaneously.
That is why recessions and downturns are associated with rising bond prices and falling interest rates. Bonds are seen as a “safe haven” when things are bad. At the same time, low long-term interest rates are like a gloomy weather forecast. Their presence suggests weak growth or even no growth at all ahead.
In all of recorded history, U.S. long-term interest rates have never gone to zero. The chart below, via Y-Charts, shows the interest rate on the U.S. 10-year treasury note dating back more than 50 years.
In 2016, the U.S. treasury 10-year note got down to 1.37% — an all-time low.
But what if it goes even lower in the future? That’s a real possibility, according to JPMorgan Chase analyst Jan Loeys.
“There’s a serious probability that in the next three years, U.S. Treasury yields are at zero, if not negative, and the whole market is sitting at zero and negative yields,” Loeys told Bloomberg.
The “zero and negative-yielding world is like a sand trap,” Loeys added. “The quicksand scenario is a process, not an event, a slow bleed that could take three or four years.”
There is already an estimated $13 trillion to $14 trillion worth of sovereign debt with “negative” yield, meaning the interest rate has fallen below zero. The idea is that, as the rest of the world struggles, the United States could succumb and get sucked into this vortex.
If this happens, it would mean a U.S. recession or a global economic recession, and quite possibly both. It’s a dark scenario because, if it does occur, it means that growth has stalled and gone into reverse, and that central bankers have lost control.
U.S. rates at zero could also indicate a major “flight to safety” into U.S. treasuries, due to the mechanical relationship we explained earlier. When bond prices go up, yields fall.
If something frightening happened in the world — like the threat of a shooting war with Iran — investors could pile into the safe haven of U.S. treasuries so aggressively that their buying would make prices skyrocket. This, in turn, could push the yield below the 2016 lows (and towards zero).
There are different assets that could benefit from the “U.S. long-term rates at zero” scenario. A big determining factor would be whether it happened quickly, as with a geopolitical shock or new financial crisis, or slowly, as with a slow-rolling downturn leading into a global recession.
But regardless of what happens, the biggest benefactors of the “rates at zero” scenario would likely be the following three assets:
- Gold (physical gold and ETFs)
- Gold stocks (and gold stock ETFs)
The reason for this is because, in a world where U.S. long-term rates go to zero, investors will be scared and central bankers will be in flat-out panic mode.
If things get bad enough for the 10-year to hit zero, you can be sure that new and aggressive central bank stimulus programs will be rolled out. There would be more talk of “whatever it takes” and “helicopter money” and so on, as central banks struggle with a phenomenon known as “pushing on a string.”
In an environment like that, the probability is very high that faith in fiat currency — almost all forms of fiat currency — would be badly eroded as central bankers fire up their metaphorical printing presses.
In a situation like this, gold would shine as both a form of crisis insurance and an “alternative sovereign currency” that can’t be printed. Gold stocks would benefit via sharp gains in quarterly profitability (more profit in every ounce of gold they sell) and a big upward jump in the value of below-ground reserves.
Bitcoin, meanwhile, would benefit from its role as a sovereign store of value (this is the killer use case for Bitcoin) and as a portable and globally recognized form of “digital gold.”
This scenario is real, and could play out over the next few years. If it does, we’ll want exposure to the big winners in such a paradigm — and we’ll want to avoid the industries and sectors that are badly exposed.
But this isn’t the only scenario that could play out between now and 2025. There are others with dramatically different implications. Next week we’ll look at another one.