Bond ladders are a way of creating your own adjustable-rate income stream, by buying a series of bon...
Are We Really This Gullible on Bonds?
03/29/2013 9:00 am EST
Although the sentiment on bonds seems to be turning more bullish, Stephen McKee of No-Load Mutual Fund Selections & Timing isn’t convinced.
With all of the talk about secular (five to 20 years) bull and bear stock market cycles, the question also may naturally arise whether the same pattern may be observed in the bond market.
The answer is yes.
It is a little tricky to talk about bonds, unless we keep in mind that bond prices and yields move inversely. When interest rates drop, bond prices go up because it makes the cash flow—the income stream—from the bond payments more valuable. When rates go up, prices fall because the payments become less valuable compared to other more recently issued bonds.
Eventually, however, in both cases—whether the price was at a premium or a discount—the price converges with its par price, normally 100, at maturity.
From 1900 through the present, there have been two secular bull cycles and two secular bear cycles, when we measure this by US Treasury Bond yields. In 1900, the yield was approximately 3%. It peaked in 1920 at about 5%. Yields fell continuously until 1940 when they dipped slightly below 2%.
Bonds then went sideways for about 12 years, then began their long ascent to peak at 15% in 1982. That was Fed Chairman Paul Volcker’s answer to stomping out inflation. It worked.
And it is still working. Yields have fallen steadily from those lofty levels to sub-2% again over the last 30 years. It’s been quite a history, starting in 1900 from a 20-year bear market (lower prices and higher yields), a 20-year bull market, 12 years of sideways, then a 30-year bear market, and now the current 30-year bull market.
Even though duration has surpassed 100 years, there are still only two cycles of both bear and bull. Yet general conclusions can be drawn. The present 30-year bond bull market is getting old, but we know the Fed will maintain its low-interest policies another year or so. It is also clear that rates are at historic lows.
For strategy, when bonds shift from bull to bear, it will be time to change one’s approach. Bond funds will not be the way to invest. With a bond fund—unlike an individual bond—you are never assured of getting your principle back. There is no bond fund par price.
So, like stocks, cycles exist in bonds, and things do change.
Given the recent whipsaws (short-term buy and sell signals), it’s not surprising that the bond model is back to bullish. But I remain neutral.
With the historic lows and the aging 30-year secular bond bull market, the question has to be asked: how much lower can 30-year bonds drop in yield. 1%? Really? Who will buy a 30-year bond yielding 1%?
Right now, the main factor impacting a change in lower bond prices and higher yields is the housing recovery. Prices have stabilized, and housing starts are up. 2012 saw the most houses built in four years. Yet supply of previously owned housing is at a ten-year low.
The Fed is pinning its yield targets to the unemployment rate, which is still dropping. So, we should expect further cross-currents in the months ahead.
Related Articles on BONDS
SPDR Citi International Government Inflation-Protected Bond ETF (WIP) seeks to provide results that ...
A broad range of asset classes are priced for perfection and are particularly vulnerable should the ...
We already own quite a bit of preferred shares issued by Annaly Capital Management (NLY), but I'm re...