Here’s a challenge: See if you can find any thoughtful, successful, experienced and honest investors who think that bonds are an attractive place for money. Is there a doubt in anyone’s mind that bonds are bad investments today? How many luminaries do I need to quote? Warren Buffett? “Now is a terrible time to buy bonds.” Jeremy Grantham? “We are literally running out of superlatives to describe how much we hate bonds.” Or perhaps Jim Grant? “The Fed has somehow managed to take the income out of fixed income and the yield out of high yield.”
Over the last 30 years, interest rates on 10-year Treasury bonds declined from a high of nearly 16% to a low of 1.5%. Bond funds generated abnormally high returns—so high that they often competed with traditional growth investments. This was the golden age of fixed income: Bonds generated competitive returns as they hedged portfolios against stock market volatility. I think that we can all agree that those days are over—and bond investors are now scratching their heads while searching for an intelligent direction.
Bill Gross is a rarity in the investment world: a bond manager who ponders publicly whether he and his competitors just had an amazing run of good luck: “All of us…, yeah—me too, have cut our teeth during perhaps a most advantageous period of time, the most attractive epoch that an investor could experience.” This kind of humility from someone who really does know what he’s doing is why his observations have value.
His observation, moreover, is that the wind was at investors’ backs for the last 50 years—a result of a steady expansion of credit. But he warns us that the return to GDP from each dollar of credit has been diminishing at an increasing rate so that we are quickly approaching the juncture where “investible assets pose too much risk for too little return.” While Gross isn’t suggesting that investors not own bonds, to his credit he is on the record that they diversify elsewhere.
Investors are listening. Since the end of May, according to the Investment Company Institute, they have liquidated over $100 billion of their bond fund holdings, $40 billion more than they sold at the height of the financial crisis in 2008—and the fourth largest drawdown of bond fund assets in history. The expectations of professional investors also are negative. According to a recent survey by Bank of America-Merrill Lynch, 57% of global fund managers are underweight bonds, and fully 97% expect long-term rates to be higher over the next 12 months. That is as close to unanimity as you will ever see in a legitimate survey, and reflective of the growing consensus that bonds are now hazardous to our financial health.
You don’t have to be an expert to conclude there’s a lot more upside than downside for interest rates, and for bondholders; that there’s a lot more risk than yield. Even after one of the sharpest rises in interest rates in years, yields remain pitifully low. The boomers are starting to retire and they are desperate for income. If bonds can’t generate what they need, they are willing to look elsewhere—and Wall Street is ready and able to provide solutions for disaffected investors.
I began “Investment Sense” as a quarterly newsletter 20 years ago to reframe investment issues where public perception was either overly simplistic, short-sighted or just incorrect. My goal was (and is) to help investors look more critically at their assumptions so that they can make healthier decisions and become better investors. To that end I offer two suggestions: