Earlier this week, I posted this poll on Twitter:
30 year Bond bull market is over
— Barry Ritholtz (@ritholtz) April 23, 2018
The results surprised me, mainly because they were closer than I had expected. Despite the flirtation of 3 percent yields on the 10-year Treasury bond, many folks don’t believe the multi-decade run of lower interest rates has ended.
Some of the commentary I have seen focuses on rising yields, but there’s more, most notably:
- Fixed-income investors want higher yields;
- Bonds offset equity volatility in a portfolio;
- Treasuries behave very differently from stocks;
- Interest rates reflect the state of the economy;
- Yield-curve inversions have been greatly exaggerated.
Let’s consider what each means:
No. 1: Yield. Buyers of Treasury bonds typically expect to receive a return on their capital in excess of inflation. (If they want capital gains from bonds, they should speak to someone like Howard Marks of Oaktree Capital Group about buying distressed fixed-income assets.) How they position themselves in the rising rate environment will determine how successful they will be.
As the Federal Reserve raises rates, the short end of the yield curve has risen, as one would expect. The long end of the yield curve has risen as well, perhaps on expectations of faster inflation. My question is: What will the real, inflation-adjusted yield of Treasuries be once the monetary tightening cycle is done? Will Treasuries offer protection from the loss of future purchasing power? The answer depends on so many factors that making accurate forecasts is basically impossible.
Those who have been complaining about low yields and financial repression need to find something new to whine about.
No. 2: Portfolio composition. As investors allocate money among different assets, they face a complex question: What sort of expected returns are you looking for, and what sort of risk and volatility are you willing to accept in the pursuit of that performance?
We know stocks are much more volatile than Treasuries and investment-grade corporate bonds. We also understand the impact of that volatility on investors’ ability to stay with whatever their financial plans are when markets turn into a carnival ride.