They Keep Getting These Two Items Wrong...Over and Over Again
So-called "experts" keep getting these two items wrong over and over again: bonds and interest rates. Let's start with bonds.
I've lost track of how many years we've been told that bond yields will rise this year. In fact, this year started yet again with this same prediction. Remember that when bond yields rise, the price of bonds drops. So concomitant with the prediction of increasing yields comes the advice to either sell your bonds or shorten what's called the "duration" of your bond portfolio.
(Regarding "duration," to keep it simple, shortening duration involves holding only short-term, perhaps intermediate-term bonds, definitely not long-term bonds, e.g., the 30-year treasury. Having s shorter duration would protect your principle when the bond yield rises.)
When I say I've lost track of how long this view has held center stage, it's because early on we shorted the long bond, following the advice of those who trumpeted the "inevitable" rise in yields. After all, bonds had been in a bull market since 1980, so the year 2000 marked a 30-year bull, a long stretch for any bull market, although not necessarily for bonds, whose history reveals bull and bear markets of much longer length than you see for stocks and most other items. In any case, we were convinced by the experts, and not just the usual suspects - the usual suspects being the Wall Street economists and investment analysts and portfolio managers of prominent Wall Street firms, firms who managed billions of dollars of institutional and private investments.
(These folks are generally easy to ignore, since they're usually bullish on stocks no matter what's going on in markets. That's because Wall Street makes a lot of money trading stocks. We've discussed this many times, but you'll find a more detailed breakdown of why Wall Street is basically a sales organization in these two pieces we posted two years ago HERE and HERE.)
So even many of those analysts whom we've come to respect and whose work we read regularly to gain insight into the economy and the markets came to boldly assert that buying and holding bonds, especially long bonds, was an act of foolishness if not financial suicide. One of these sources rather publicly declared a few years ago that if the following year bond yields did not skyrocket he would - literally - eat his hat. (I don't know if he did or not, but yields didn't rise, as you may suspect.) By that time, we had ceased shorting the long bonds, after taking a modest profit on our original trade. And this year to date - continuing last year's trend - owning long bonds has been one of the better investments we've made.
As for interest rates, specifically the short rate that is controlled by the Fed, how many times have you heard "the Fed is planning raise interest rates this year." Having suppressed interest rates since 2008, it's inevitable that some day they will actually raised rates. But, again, year after year we hear the same prediction. This will be the year they raise the short-term rate. Really; no kidding. And this year is no exception. This year we've been told that rates will be jacked up in the fourth quarter. We need to adjust our expectations and our asset allocations accordingly. Really; no kidding.
Are you starting to see a pattern here? So far, rather than rise, the yield on the long bond has steadily worked its way lower. And rather than rise, the short-term interest rate remains effectively at zero. Of course, one doesn't assume any pattern will continue ad infinitum, so prudence dictates that the possibility of higher yields and interest rates exists, and one must be prepared for the day when - finally - they really do rise. Just don't be surprised if that day doesn't come this year.
I've lost track of how many years we've been told that bond yields will rise this year. In fact, this year started yet again with this same prediction. Remember that when bond yields rise, the price of bonds drops. So concomitant with the prediction of increasing yields comes the advice to either sell your bonds or shorten what's called the "duration" of your bond portfolio.
(Regarding "duration," to keep it simple, shortening duration involves holding only short-term, perhaps intermediate-term bonds, definitely not long-term bonds, e.g., the 30-year treasury. Having s shorter duration would protect your principle when the bond yield rises.)
When I say I've lost track of how long this view has held center stage, it's because early on we shorted the long bond, following the advice of those who trumpeted the "inevitable" rise in yields. After all, bonds had been in a bull market since 1980, so the year 2000 marked a 30-year bull, a long stretch for any bull market, although not necessarily for bonds, whose history reveals bull and bear markets of much longer length than you see for stocks and most other items. In any case, we were convinced by the experts, and not just the usual suspects - the usual suspects being the Wall Street economists and investment analysts and portfolio managers of prominent Wall Street firms, firms who managed billions of dollars of institutional and private investments.
(These folks are generally easy to ignore, since they're usually bullish on stocks no matter what's going on in markets. That's because Wall Street makes a lot of money trading stocks. We've discussed this many times, but you'll find a more detailed breakdown of why Wall Street is basically a sales organization in these two pieces we posted two years ago HERE and HERE.)
So even many of those analysts whom we've come to respect and whose work we read regularly to gain insight into the economy and the markets came to boldly assert that buying and holding bonds, especially long bonds, was an act of foolishness if not financial suicide. One of these sources rather publicly declared a few years ago that if the following year bond yields did not skyrocket he would - literally - eat his hat. (I don't know if he did or not, but yields didn't rise, as you may suspect.) By that time, we had ceased shorting the long bonds, after taking a modest profit on our original trade. And this year to date - continuing last year's trend - owning long bonds has been one of the better investments we've made.
As for interest rates, specifically the short rate that is controlled by the Fed, how many times have you heard "the Fed is planning raise interest rates this year." Having suppressed interest rates since 2008, it's inevitable that some day they will actually raised rates. But, again, year after year we hear the same prediction. This will be the year they raise the short-term rate. Really; no kidding. And this year is no exception. This year we've been told that rates will be jacked up in the fourth quarter. We need to adjust our expectations and our asset allocations accordingly. Really; no kidding.
Are you starting to see a pattern here? So far, rather than rise, the yield on the long bond has steadily worked its way lower. And rather than rise, the short-term interest rate remains effectively at zero. Of course, one doesn't assume any pattern will continue ad infinitum, so prudence dictates that the possibility of higher yields and interest rates exists, and one must be prepared for the day when - finally - they really do rise. Just don't be surprised if that day doesn't come this year.
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