Treasury Yields at 60-Year low: Skip the Flight to Safety

The yield on 10-year Treasury bonds reached 1.9 percent Friday, the lowest yield since 1951, when the Federal Reserve abandoned a policy to keep yields below market levels (quantitative easing isn't just for today's central bankers - their granddads did it too).

The last time Treasury yields were this low, the postwar economic boom was getting cranked up. This time the low-rate environment coincides with a widespread fear that the postwar boom is ending and about to be replaced by a period whose hallmarks will be reduced wealth and security and greater apprehension.

The latest development stoking anxiety is the unfolding European financial crisis. With Greece teetering on the brink and Spain, Portugal and Italy teetering only a bit less, it was the main topic at the weekend meeting of the Group of 7 industrialized nations.

When investors agree to take 1.9 percent a year for a decade, it has to be the fear talking. Such a yield factors in more than a chance of prolonged deflation, a condition only present during an economic depression. It factors in the near certainty of it, even though deflation and depression are extremely rare events, occurring maybe once or twice in a century.

Investors are so afraid of an economic or financial collapse that they are willing to lock up their money for 10 years just to have it all there at the end. Even at that, it will lose buying power if inflation averages a very low 2 percent over the decade. With prices for many industrial and agricultural commodities showing signs of having reversed multiyear downtrends, such a long run of very low inflation seems unlikely, even if deflation flares up at some point. (Here are the thoughts of fellow MoneyWatcher Allan Roth on the extremely low Treasury yields.)

Treasury yields below 2 percent are historically rare and make little sense under reasonable economic scenarios. Compared to assets that investors could own instead, Treasury bonds seem like terrible value too. As noted in a recent post, the stock market offers higher income, with a dividend yield of nearly 3 percent on the Dow Jones industrial average.

Some blue chips pay three times as much in dividends as the 10-year Treasury pays in interest. AT&T (T) yields more than 6 percent. Incidentally, the dividend yields of all four publicly traded companies that still have the AAA credit rating that the Treasury recently lost are well above the 10-year Treasury yield: Johnson & Johnson (JNJ), 3.5 percent; Automatic Data Processing (ADP), 3.0 percent; Exxon Mobil (XOM), 2.6 percent; Microsoft (MSFT), 2.4 percent.

Unlike Treasury bonds, which will be worth no more or less than face value in 10 years, blue-chip stocks offer the prospect of dividend and share price growth. Sure, they also carry a risk of loss, but as long as it's not a catastrophic loss as part of a deflationary depression, a basket of high-yield blue chips is likely at least to maintain its level of dividend payments; that should keep shareholders happy while they wait for prices to recover.

Not that there is much to recover from so far. Corporate America has continued to make good money amid the troubling economic and financial conditions; strong earnings growth and the recent plunge in the market have left stocks trading at cheap valuations. Besides, as the older post pointed out, the rare occasions in which the market's dividend yield has exceeded the 10-year Treasury yield have marked significant bottoms for stocks.

There are two main types of risks that investors face - the risk of loss and the risk of missing an opportunity. By owning bonds that pay more miserly interest than at any time in 60 years and shunning stocks that carry bargain valuations, pay dividends at rates significantly above those of Treasury issues and have continued to show healthy earnings growth amid a testing economic backdrop, investors buying Treasury bonds here may be taking on both kinds of risk at once.