Worst. Bond. Market. Ever. [2023 update]
Re: 2022: Worst. Bond. Market. Ever?
If you pick a bond ETF that invests in Treasury bonds and maintains a consistent duration, then it is no different then creating a rolling bond ladder of Treasuries (as long as the duration matches that of the ETF). It’s true that with the ETF, you’ll have some expense ratio (E/R), but these days you can find offerings (eg Vanguard or iShares) with very little E/R such that it is negligible.Booglie wrote: ↑Sat May 07, 2022 9:46 amIt is a good comment because with the actual bond, you can let your bonds mature, and you will be paid as promised. Bond ETFs will always sell bonds after a while, so they will never mature. And that's automatic, so they may sell at the worst possible time. Only a handful bond ETFs have a target date, but why hold them and pay a fee when you can hold the bonds yourself?AlphaLess wrote: ↑Sat May 07, 2022 9:35 amThis is not a good comment. Despite your bond showing par value of $100, it's market is below $100, when yields have risen, relative to the interest coupon on the bond.Booglie wrote: ↑Sat May 07, 2022 8:59 am What this period proves to me is that ETF bonds are garbage. If you like bonds, hold the real deal.
As for a quick anecdote, I checked a 5-year bond ETF from another country and compared to holding a 6-year bond (there are no bonds that exactly match that 5-year period) through the same duration. Holding the actual bonds actually gave more than double the return, and taxes are actually lower too.
Also, UNLESS THE ENTITY ISSUING THE BONDS DEFAULTS, holding the actual bonds won't ever give you negative nominal returns, like it can happen with bond ETFs.
If you are building a non-rolling ladder of Treasury bonds for liability matching, then that is a different thing. But you can still approximate it with 2 (or more) ETFs (which can be used to model a blended, dynamic duration).
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle
Re: 2022: Worst. Bond. Market. Ever?
The piece that is missing in this discussion is on of the greatest financial experiments ever conducted (Per Jamie Dimon), QE, direct manipulation of demand for Treasuries and Mortgages in this last go around, multiples more than for the 2008 financial crisis (Per Jerome Powell). One where the people in control admit they didn't really think through properly how they were spending money to support the economy (IMF Director Kristalina Georgieva).grabiner wrote: ↑Sat May 07, 2022 3:43 pmThe rate that the Fed wants to raise is not the relevant rate for a bond investment. The Fed targets a change in the overnight lending rate, which directly affects other very-short-term rates. If you buy a one-month T-bill, you don't care what the Fed will do to rates in July because your T-bill will have matured by then, so your rate should be closely linked to the Fed's rate target. Meanwhile, bond traders are trading long-term bonds at prices which reflect their expectations of economic conditions over the next ten years, including the Fed's planned moves.rich126 wrote: ↑Sat May 07, 2022 7:21 am I'll never understand why someone keeps an investment they were told was going to go down. The FED has made it clear they are raising rates for a long time now. Throw in the fact (well, to me) rates were pushed down way too low last year due to non-financial reasons (covid), it just makes no sense to me unless people really thought the FED wouldn't go through with it.
Now they have announced the rate they want to unwind QE with QT and have stated how fast they will be unprinting money, something they have really never done before.
Per FRM H.4.1 release they have approx. 5.7 T US Treasuries currently, and 2.7 T of mortgages.
as said yesterday...the liquidity technicals are starting to be the big deal:
Jonathan Ferro "Well Mohamed, you mentioned something about passive and I want to go there with you. This is really important. We've had more than a decade of money going into passive strategies, buy the index, sit there, nicely rewarded. That's been the story. Are you saying that we could face something like what EM (Emerging Markets) has gone through periodically, in the United States, almost on a global basis because the amount of money that's poured into that strategy over the last decade. Is that what we are going to unwind, something that big"?
Mohamed El-Erain "Yes, I think people don't realize, when money goes into passive, it pushes up the prices of both good stocks and less good stocks. When money comes out of passive, because the managers have to sell across the board, you pressure good stocks, as well as those that deserve to be pressured. So the good news is you're creating value, that bad news is that value is divorced from the fundementals. So you've got to recognize, you've got to respect the technicals. This is an environment where the technicals, the liquidity technicals are right now in charge, and you've got to respect them." - May 6, 2022
https://www.federalreserve.gov/releases ... nt/h41.htm
Re: 2022: Worst. Bond. Market. Ever?
Because there is no practical limit on inflation. It’s difficult to imagine deflation exceeding 10-20%. Conversely, some of the largest numbers I’ve ever seen written down are about some of the hyperinflation episodes in history.Firefly80 wrote: ↑Sat May 07, 2022 4:16 pmNiceUnparticularMan wrote: ↑Sat May 07, 2022 9:37 am
As a final thought, I will note there are maybe a few of us who don't actually believe it makes sense to try to use bonds to hedge against both unexpected deflation/disinflation and unexpected inflation, and that since you really need to pick one, it makes sense to pick hedging against unexpected inflation.
Please Explain why it’s more important to protect against Inflation then Deflation?
Intermediate term TIPS Funds lost nearly -10% in 2013 in a Deflationary scenario similar to what’s happening with Nominals now.
https://www.globalfinancialdata.com/gfdblog/?p=2382At the height of the inflation, prices were rising at the rate of 150,000% PER DAY.
You don’t have think you’d see hyperinflation here to recognize that there is a real asymmetry between the risks of inflation and deflation. And as a practical matters, since tips can’t go below par they actual provide some defense against bad deflation while providing pretty robust protection against unexpected inflation.
“Conventional Treasury rates are risk free only in the sense that they guarantee nominal principal. But their real rate of return is uncertain until after the fact.” -Risk Less and Prosper
Re: 2022: Worst. Bond. Market. Ever?
McQ, thank you for this thread. Excellent OP
“Conventional Treasury rates are risk free only in the sense that they guarantee nominal principal. But their real rate of return is uncertain until after the fact.” -Risk Less and Prosper
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Re: 2022: Worst. Bond. Market. Ever?
I agree. History has shown that the risk of inflation is at least an order of magnitude greater than deflation.ScubaHogg wrote: ↑Sat May 07, 2022 9:03 pmBecause there is no practical limit on inflation. It’s difficult to imagine deflation exceeding 10-20%. Conversely, some of the largest numbers I’ve ever seen written down are about some of the hyperinflation episodes in history.Firefly80 wrote: ↑Sat May 07, 2022 4:16 pmNiceUnparticularMan wrote: ↑Sat May 07, 2022 9:37 am
As a final thought, I will note there are maybe a few of us who don't actually believe it makes sense to try to use bonds to hedge against both unexpected deflation/disinflation and unexpected inflation, and that since you really need to pick one, it makes sense to pick hedging against unexpected inflation.
Please Explain why it’s more important to protect against Inflation then Deflation?
Intermediate term TIPS Funds lost nearly -10% in 2013 in a Deflationary scenario similar to what’s happening with Nominals now.
https://www.globalfinancialdata.com/gfdblog/?p=2382At the height of the inflation, prices were rising at the rate of 150,000% PER DAY.
You don’t have think you’d see hyperinflation here to recognize that there is a real asymmetry between the risks of inflation and deflation. And as a practical matters, since tips can’t go below par they actual provide some defense against bad deflation while providing pretty robust protection against unexpected inflation.
The Sensible Steward
Re: 2022: Worst. Bond. Market. Ever?
Because Fed rates aren't directly correlated with bond interest rates.rich126 wrote: ↑Sat May 07, 2022 7:21 am I'll never understand why someone keeps an investment they were told was going to go down. The FED has made it clear they are raising rates for a long time now. Throw in the fact (well, to me) rates were pushed down way too low last year due to non-financial reasons (covid), it just makes no sense to me unless people really thought the FED wouldn't go through with it.
The Fed raised rates from 1% to 5% from 2004-2006 and Total Bond Market Index Fund MADE money..
That's a 4% rise in Fed rates, far more than we've seen so far this year.
So it's not automatic that the Fed raising rates means bond funds go down.
And in any case, bonds self-correct... We took the chance they wouldn't go down, but they did, so we lost some money... Now they are paying more interest, so we'll make the money back.
Not that big of a deal.
"The best tools available to us are shovels, not scalpels. Don't get carried away." - vanBogle59
Re: 2022: Worst. Bond. Market. Ever?
So is this a good time to get out of bonds now and buy back in when the yields go up to 5% later in the year? Or is there more more value in holding and rebalancing into equities at some point (e.g, SP500 ~3800) on a relative value basis?
Re: 2022: Worst. Bond. Market. Ever?
So, on average, during the worst bond market declines equities outperformed bonds by an average of 4 percentage points per year?SimpleGift wrote: ↑Fri May 06, 2022 9:58 pm Granted, we're a long way from the end of the year, but looking at the 10 worst years of real, inflation-adjusted bond returns in U.S. history, going back to 1794 (from Professor McQuarrie's database here), it's worth noting how often these were accompanied by substantial real stock losses in the same year (in yellow below):
Not surprisingly, these were mostly years with high inflation, often during post-war periods in U.S. history.
Data Source: McQuarrie database, 1793-2019 ver.2
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Re: 2022: Worst. Bond. Market. Ever?
Interesting thread. Wish I was intelligent enough to understand it.
That said, I'll ask a question: for someone who prefers to keep things simple, is 40 years old, sits at 80/18/2, and wants to retire in 20 years, do I keep my current 18% in Total Bond or do something else with it?
That said, I'll ask a question: for someone who prefers to keep things simple, is 40 years old, sits at 80/18/2, and wants to retire in 20 years, do I keep my current 18% in Total Bond or do something else with it?
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Re: 2022: Worst. Bond. Market. Ever?
So individual TIPS held to maturity are the safest investment available to USD investors. And fortunately, the contractual real returns on TIPS tend to not be much less than the expected real returns on comparable nominal Treasuries. So, it appears normally there is very little cost to adding unexpected inflation protection, other than of course the "cost" that unexpected inflation can go either way and so you are losing out on the possible benefit of nominals if inflation is unexpectedly low. But that is what safety means, you lose both better outcomes and worse outcomes, and end up with a relatively certain and predictable middling outcome.
But that bit about holding them to maturity is an important caveat. If there is any chance you might want your money back before maturity, you now have to account for that risk.
At which point there is no truly safe asset at all over long terms. Which is very important to understand. Meaning as soon as that is the nature of the financial problem you are trying to solve (saving for long periods over which your future spending schedule is subject to varying significantly from your central expectations), you have to recognize that you can't eliminate risk, you can only try to manage it efficiently.
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Re: 2022: Worst. Bond. Market. Ever?
IMHO, if you are looking at a 20 year horizon, I would just sail on and do nothing other than rebalance when necessary. Good luck!
"The quest is the quest."
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Re: 2022: Worst. Bond. Market. Ever?
So you do have to dig into the details, but these days a common structure is there are underlying high-quality assets like short-to-medium bonds, and then an insurance wrapper around the bonds that smooths out the return so as to prevent any sort of NAV losses. So, when rates go up, the rates on the stable value fund will tend to lag equivalent normal bond funds, allowing it to maintain its NAV by more slowly tracking up than market rates. And when rates go down, again the rates on the stable value fund will tend to lag, keeping its NAV from popping up like what would happen with a normal bond fund.Dottie57 wrote: ↑Sat May 07, 2022 3:55 pmBut what are Stable Value funds invested in. Find it difficult to find good information about them. The SVF in my 401k. insurance contracts are involved. But how risky are these?NiceUnparticularMan wrote: ↑Sat May 07, 2022 7:16 amNot to get derailed, but I want to note there are potential alternatives to both nominal bonds and cash, gold, or silver. For example, things like stable value funds, the TSP G fund, or TIPS are alternatives to cash. And diversified commodities funds are an alternative to just gold or silver (obviously precious metals might be part of such a fund).
Overall, then, a stable value fund structured like this should provide an average long-term return similar to the underlying bonds, minus a small amount for the insurance company's profits. But, it won't experience the same NAV swings as an otherwise similar bond fund.
When you think about it, that can be pretty handy for personal investors. But the additional risks include insurance company failure--although typically there is a lot of secondary level coverage, and in many cases you should at least get back the market value of the underlying assets, which limits the downside risk.
There is also risk of your plan sponsor triggering what is known as a market value adjustment. Basically, the insurance company needs to protect itself from some rather obvious arbitrage opportunities that the above structure implies. Some of those protections are built into the plan rules, like usually you can't transfer funds directly between a stable value fund and a bond fund in your plan (although if you also have other accounts, that allows for some interesting possibilities . . .). But at a higher level, the insurance company doesn't want entire plans pulling out in the middle of a period where they are securing a higher NAV than the underlying assets.
So, there are generally rules about plan sponsors needing to give a certain amount of notice before withdrawing. And if your plan sponsor violates those rules, the insurance company will likely have a right to mark the funds down to their actual market value. Again, this isn't a total disaster, but it can be a shock if there is a significant difference at the time between the stable value NAV and the market value.
I think that is a fair summary of a typical stable value fund these days. But every one can be different, so you do need to look into the details if you are going to make a lot of use of one.
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Re: 2022: Worst. Bond. Market. Ever?
Technically, yes. The average annual inflation rate was 11% during the 10 worst U.S. real bond market declines, with bonds returning -17% and stocks -13% on average each year.
But I wouldn't make too much out of this. Suffice to say, when inflation is running high, verging on or into double-digits, that both bonds and stocks have historically suffered tremendously, very often each with double-digit real annual losses. It's a terrible time for most financial assets.
Last edited by SimpleGift on Sun May 08, 2022 8:45 am, edited 1 time in total.
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Re: 2022: Worst. Bond. Market. Ever?
So there are a variety of considerations.Firefly80 wrote: ↑Sat May 07, 2022 4:16 pmNiceUnparticularMan wrote: ↑Sat May 07, 2022 9:37 am
As a final thought, I will note there are maybe a few of us who don't actually believe it makes sense to try to use bonds to hedge against both unexpected deflation/disinflation and unexpected inflation, and that since you really need to pick one, it makes sense to pick hedging against unexpected inflation.
Please Explain why it’s more important to protect against Inflation then Deflation?
Intermediate term TIPS Funds lost nearly -10% in 2013 in a Deflationary scenario similar to what’s happening with Nominals now.
As others have already pointed out, one big one is unexpectedly high inflation is essentially unbounded in ways unexpectedly low inflation largely isn't. So what I would call the tails of the distribution are not symmetric, with the high-side tail stretching out into rather nasty scenarios.
Another is understanding how inflation/disinflation tends to affect other things in a personal investor's life.
One major issue is sticky wages. Wages tend to correlated with inflation, but they can lag behind. On the plus side, during deflationary times, sticky wages can actually provide a lot of help as nominal wage cuts tend to be a line a lot of employers try to avoid crossing, and so your real wages might actually increase. On the minus side, during unexpectedly high inflation period, sticky wages can mean you are constantly getting less real than you expected.
Another is, of course, consumption expenses. Generally speaking, most of these are going to correlate with general inflation (note: a very important exception is fixed-rate debt). So, during times of unexpectedly low inflation or actual deflation, your consumption expenses will usually be tracking below expected, at least in nominal terms. During times of unexpectedly high inflation, they will likely be tracking above expected, at least in nominal terms. And again this a notably asymmetry.
OK, so thanks to things like sticky wages and consumption expenses, most personal investors have natural reasons to be more concerned about unexpectedly high inflation than unexpectedly low inflation. Combine that with the observation that unexpectedly high inflation is essentially unbounded, and there you go.
As a final thought, all this is pretty apparent in financial history, particularly if you expand out beyond U.S. history. It is not that disinflationary/deflationary periods are never bad at all, but usually if personal investors started off diversified, were not overleveraged, and stayed the course, they ended up OK in the end (sometimes even better than OK). On the other hand, there have been many inflationary periods which were essentially ruinous for most personal investors, even the ones who were being as reasonable as possible with their savings given the assets available to them. Indeed, even without some sort of hyperinflation/societal collapse scenario, long periods of unexpectedly high inflation can be really, really bad for personal investors, and at least ruin what seemed like reasonable retirement plans.
So to me, this is not even a very close question. Sure, nominal bonds will do better than comparable IP bonds in periods of unexpectedly low inflation, but I am just not that worried about those periods in contrast to periods of unexpectedly high inflation. Knowing some financial history, the latter are far more concerning to me.
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Re: 2022: Worst. Bond. Market. Ever?
At 20 years from retirement, I don't think it is a big deal if you use something like Total Bond. But 20 years will turn to 10 years, 5 years, and then 0 years, so I would have in place a plan for what you want to be doing by those points.JimmyD wrote: ↑Sun May 08, 2022 7:00 am Interesting thread. Wish I was intelligent enough to understand it.
That said, I'll ask a question: for someone who prefers to keep things simple, is 40 years old, sits at 80/18/2, and wants to retire in 20 years, do I keep my current 18% in Total Bond or do something else with it?
I also don't think it is a big deal to use something different from Total Bond in your position, which can be equally simple. Personally, we have mostly used a combination of a stable value fund and a cash-balance pension for our fixed-income allocation during accumulation, and we also adjusted down our fixed-income percentage and up our equity percentage in light of using those assets.
And one thing I like about that approach is I don't think it requires as much of a transition plan as I think those are good assets for around retirement age too. Maybe more TIPS over time, but I don't think we need to do that as much as if we had been using a lot of nominal bonds during accumulation.
Re: 2022: Worst. Bond. Market. Ever?
I think it's helpful to remember that needing your money back AFTER maturity also creates risk. This is because you'll be reinvesting the proceeds at an (as of now) unknown real rate of return.NiceUnparticularMan wrote: ↑Sun May 08, 2022 7:17 am
But that bit about holding them to maturity is an important caveat. If there is any chance you might want your money back before maturity, you now have to account for that risk.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: 2022: Worst. Bond. Market. Ever?
Correct. Hence the rest of my post:vineviz wrote: ↑Sun May 08, 2022 8:39 amI think it's helpful to remember that needing your money back AFTER maturity also creates risk. This is because you'll be reinvesting the proceeds at an (as of now) unknown real rate of return.NiceUnparticularMan wrote: ↑Sun May 08, 2022 7:17 am
But that bit about holding them to maturity is an important caveat. If there is any chance you might want your money back before maturity, you now have to account for that risk.
Short-term bonds, including short-term TIPs, can't entirely solve this problem either, because of that reinvestment risk.At which point there is no truly safe asset at all over long terms. Which is very important to understand. Meaning as soon as that is the nature of the financial problem you are trying to solve (saving for long periods over which your future spending schedule is subject to varying significantly from your central expectations), you have to recognize that you can't eliminate risk, you can only try to manage it efficiently.
There truly is no "risk-free" solution available for this sort of problem, which unfortunately is the basic nature of the problem most retirees are trying to solve.
Re: 2022: Worst. Bond. Market. Ever?
Thanks to all who have contributed. After Wednesday’s announcement of the April CPI, I’ll redo the 12-month charts in real terms. On a preliminary estimate, there will be the same basic pattern, with April 2021-2022 right up there on the leader board of very bad real returns.
In the meantime, here’s a discussion of why 2022 has felt so bad for some bond holders.
Explanation
There is a straightforward explanation for why these first few months of 2022 have seen such severe declines. Most bondholders are familiar with the idea of duration (technically, modified duration): the sensitivity of an existing bond’s price to an increase or decrease in market interest rates. But duration mostly gets mentioned as an explanation for why long bonds are hurt worse than intermediate bonds (or total bond funds) when rates increase.
People forget that coupon level / yield is an independent input to modified duration: at any maturity, the lower the yield on the existing bond, the greater the sensitivity to a subsequent unit change in market rates.
Yields on long Treasuries were very low when 2022 began. Here is a chart to show the expected price decline on a 20-year bond if interest rates rise one point over the course of one year, as it becomes a 19-year bond (blue bars). BTW, I chose this maturity because 20 years is the targeted maturity for the SBBI long government series.
The effect is even more pronounced with a 30-year maturity (orange bars), given its longer duration.
As you can see, the price drop needed to increase the yield from 1.50% to 2.50% is much larger than the change required to take a 7.5% bond up to 8.5%.
The shock value of 2022 thus stems from two causes. The last time Treasuries yielded as little as 2021 was in the mid-1940s. The increase in coupons from that point was very gradual for a time, mitigating price shock. Likewise, the last time Treasury yields jumped by more than one point (excepting the taper tantrum) was in the 1970s and 1980s, when yields were much higher, and the consequent price declines much less. No wonder bond holders feel gob smacked.
2022 ranks high up on the leader board of bond price declines because it is very rare to see such a steep rise in yields from such a low base. Most of the time, a shift up in rates over a compressed time interval has occurred when coupons were much higher.
And if yields rise further still this year, to 3.75% or even 4.0% on 20+ year bonds? Look out below!
Low coupons redux
Coupon level has one additional impact. At very low coupons, the income received over the year also can’t do much to overcome the price drop. By contrast, as coupon level climbs, and the corresponding price decline shrinks, one can actually achieve a positive total return for the year, despite the yield hike. Here is the chart:
For a 1% jump in yields, coupons above 8.5% will show a positive annual TR. For a more minor 0.5% yield hike (we can only wish), coupons above 5.5% will still achieve a positive total return.
To recapitulate: why has 2022 hurt so bad? Because yields are rising from such a very low starting point.
In the meantime, here’s a discussion of why 2022 has felt so bad for some bond holders.
Explanation
There is a straightforward explanation for why these first few months of 2022 have seen such severe declines. Most bondholders are familiar with the idea of duration (technically, modified duration): the sensitivity of an existing bond’s price to an increase or decrease in market interest rates. But duration mostly gets mentioned as an explanation for why long bonds are hurt worse than intermediate bonds (or total bond funds) when rates increase.
People forget that coupon level / yield is an independent input to modified duration: at any maturity, the lower the yield on the existing bond, the greater the sensitivity to a subsequent unit change in market rates.
Yields on long Treasuries were very low when 2022 began. Here is a chart to show the expected price decline on a 20-year bond if interest rates rise one point over the course of one year, as it becomes a 19-year bond (blue bars). BTW, I chose this maturity because 20 years is the targeted maturity for the SBBI long government series.
The effect is even more pronounced with a 30-year maturity (orange bars), given its longer duration.
As you can see, the price drop needed to increase the yield from 1.50% to 2.50% is much larger than the change required to take a 7.5% bond up to 8.5%.
The shock value of 2022 thus stems from two causes. The last time Treasuries yielded as little as 2021 was in the mid-1940s. The increase in coupons from that point was very gradual for a time, mitigating price shock. Likewise, the last time Treasury yields jumped by more than one point (excepting the taper tantrum) was in the 1970s and 1980s, when yields were much higher, and the consequent price declines much less. No wonder bond holders feel gob smacked.
2022 ranks high up on the leader board of bond price declines because it is very rare to see such a steep rise in yields from such a low base. Most of the time, a shift up in rates over a compressed time interval has occurred when coupons were much higher.
And if yields rise further still this year, to 3.75% or even 4.0% on 20+ year bonds? Look out below!
Low coupons redux
Coupon level has one additional impact. At very low coupons, the income received over the year also can’t do much to overcome the price drop. By contrast, as coupon level climbs, and the corresponding price decline shrinks, one can actually achieve a positive total return for the year, despite the yield hike. Here is the chart:
For a 1% jump in yields, coupons above 8.5% will show a positive annual TR. For a more minor 0.5% yield hike (we can only wish), coupons above 5.5% will still achieve a positive total return.
To recapitulate: why has 2022 hurt so bad? Because yields are rising from such a very low starting point.
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Re: 2022: Worst. Bond. Market. Ever?
Yes! Each asset class serves a purpose.
YTD nominal returns of the 3-fund components:
VTSAX -14.5%
VTIAX -14.2%
VBTLX -10.55%
Cash: +0.2% (assuming a Marcus savings account)
Re: 2022: Worst. Bond. Market. Ever?
NiceUnparticularMan wrote: ↑Sun May 08, 2022 8:11 amSo there are a variety of considerations.Firefly80 wrote: ↑Sat May 07, 2022 4:16 pmNiceUnparticularMan wrote: ↑Sat May 07, 2022 9:37 am
As a final thought, I will note there are maybe a few of us who don't actually believe it makes sense to try to use bonds to hedge against both unexpected deflation/disinflation and unexpected inflation, and that since you really need to pick one, it makes sense to pick hedging against unexpected inflation.
Please Explain why it’s more important to protect against Inflation then Deflation?
Intermediate term TIPS Funds lost nearly -10% in 2013 in a Deflationary scenario similar to what’s happening with Nominals now.
As others have already pointed out, one big one is unexpectedly high inflation is essentially unbounded in ways unexpectedly low inflation largely isn't. So what I would call the tails of the distribution are not symmetric, with the high-side tail stretching out into rather nasty scenarios.
Another is understanding how inflation/disinflation tends to affect other things in a personal investor's life.
One major issue is sticky wages. Wages tend to correlated with inflation, but they can lag behind. On the plus side, during deflationary times, sticky wages can actually provide a lot of help as nominal wage cuts tend to be a line a lot of employers try to avoid crossing, and so your real wages might actually increase. On the minus side, during unexpectedly high inflation period, sticky wages can mean you are constantly getting less real than you expected.
Another is, of course, consumption expenses. Generally speaking, most of these are going to correlate with general inflation (note: a very important exception is fixed-rate debt). So, during times of unexpectedly low inflation or actual deflation, your consumption expenses will usually be tracking below expected, at least in nominal terms. During times of unexpectedly high inflation, they will likely be tracking above expected, at least in nominal terms. And again this a notably asymmetry.
OK, so thanks to things like sticky wages and consumption expenses, most personal investors have natural reasons to be more concerned about unexpectedly high inflation than unexpectedly low inflation. Combine that with the observation that unexpectedly high inflation is essentially unbounded, and there you go.
As a final thought, all this is pretty apparent in financial history, particularly if you expand out beyond U.S. history. It is not that disinflationary/deflationary periods are never bad at all, but usually if personal investors started off diversified, were not overleveraged, and stayed the course, they ended up OK in the end (sometimes even better than OK). On the other hand, there have been many inflationary periods which were essentially ruinous for most personal investors, even the ones who were being as reasonable as possible with their savings given the assets available to them. Indeed, even without some sort of hyperinflation/societal collapse scenario, long periods of unexpectedly high inflation can be really, really bad for personal investors, and at least ruin what seemed like reasonable retirement plans.
So to me, this is not even a very close question. Sure, nominal bonds will do better than comparable IP bonds in periods of unexpectedly low inflation, but I am just not that worried about those periods in contrast to periods of unexpectedly high inflation. Knowing some financial history, the latter are far more concerning to me.
Sticky Wages issue is a Interesting one, but I think it's more applicable in times on Inflation like right now where many of our Wage increases are not keeping up and that's a pain if it continues.
In a extended Deflationary time, there's a very real non-trivial chance that you might lose your job and wage entirely which is far Worse. We don't have to look too far back to observe this. Demand is crushed and standards of living drop.
So for someone who is still working/accumulating I think extended Deflation seems far Worse.
For a retiree with a significant nest egg who is just trying to maintain his purchasing power Inflation is probably Worse.
Re: 2022: Worst. Bond. Market. Ever?
This explanation is just phenomenally insightful and well written.McQ wrote: ↑Sun May 08, 2022 5:17 pm Thanks to all who have contributed. After Wednesday’s announcement of the April CPI, I’ll redo the 12-month charts in real terms. On a preliminary estimate, there will be the same basic pattern, with April 2021-2022 right up there on the leader board of very bad real returns.
In the meantime, here’s a discussion of why 2022 has felt so bad for some bond holders.
Explanation
There is a straightforward explanation for why these first few months of 2022 have seen such severe declines. Most bondholders are familiar with the idea of duration (technically, modified duration): the sensitivity of an existing bond’s price to an increase or decrease in market interest rates. But duration mostly gets mentioned as an explanation for why long bonds are hurt worse than intermediate bonds (or total bond funds) when rates increase.
People forget that coupon level / yield is an independent input to modified duration: at any maturity, the lower the yield on the existing bond, the greater the sensitivity to a subsequent unit change in market rates.
Yields on long Treasuries were very low when 2022 began. Here is a chart to show the expected price decline on a 20-year bond if interest rates rise one point over the course of one year, as it becomes a 19-year bond (blue bars). BTW, I chose this maturity because 20 years is the targeted maturity for the SBBI long government series.
The effect is even more pronounced with a 30-year maturity (orange bars), given its longer duration.
As you can see, the price drop needed to increase the yield from 1.50% to 2.50% is much larger than the change required to take a 7.5% bond up to 8.5%.
The shock value of 2022 thus stems from two causes. The last time Treasuries yielded as little as 2021 was in the mid-1940s. The increase in coupons from that point was very gradual for a time, mitigating price shock. Likewise, the last time Treasury yields jumped by more than one point (excepting the taper tantrum) was in the 1970s and 1980s, when yields were much higher, and the consequent price declines much less. No wonder bond holders feel gob smacked.
2022 ranks high up on the leader board of bond price declines because it is very rare to see such a steep rise in yields from such a low base. Most of the time, a shift up in rates over a compressed time interval has occurred when coupons were much higher.
And if yields rise further still this year, to 3.75% or even 4.0% on 20+ year bonds? Look out below!
Low coupons redux
Coupon level has one additional impact. At very low coupons, the income received over the year also can’t do much to overcome the price drop. By contrast, as coupon level climbs, and the corresponding price decline shrinks, one can actually achieve a positive total return for the year, despite the yield hike. Here is the chart:
For a 1% jump in yields, coupons above 8.5% will show a positive annual TR. For a more minor 0.5% yield hike (we can only wish), coupons above 5.5% will still achieve a positive total return.
To recapitulate: why has 2022 hurt so bad? Because yields are rising from such a very low starting point.
Thank you!
Re: 2022: Worst. Bond. Market. Ever?
[edited May 12 to add Total Bond]
Real Returns
Inflation is the enemy of fixed income investors because it erodes real returns.
Which leads to today’s post: how does the real return received on bonds from April 2021 to April 2022 stack up historically? The formula used is (1 + nominal return %) / (1 + inflation %). Hence, given inflation of 8.3% in the twelve months through April:
-while the nominal return on the Total Bond index was negative -8.70 for that period, the real return was -15.70%;
-similarly, the nominal return on VGLT for that period was negative 12.19%, but the real return for those 12 months was a negative 18.92%.
To start, let’s look at the total bond index, which plays a prominent role in BH discussions of asset allocation. Dashed line shows the 2021-2022 real return.
It appears that 2021-22 has been very bad, but not the worst: some rolls in early 1979 take the crown, and rolls in 1973 and 1980 come close. Put another way, real returns on the total bond index have not been this bad since the last time inflation was this high.
Here are the post-1926 results for 12-month real rolls on the SBBI long government bond. Dashed line marks the April 2021 to April 2022 return.
No crown for 2021-2022 here: several rolls ending in 1980-1981 were worse. And the post-war decline in the late 1940s, when there was another abrupt inflationary surge, was almost as bad. Plus there are several other instances of “pretty bad,” as in the infamous 1994 episode.
I hope BH who own bonds are not surprised to see on how many occasions long government bonds have offered a negative real return on the order of -15% over 12 months.
Next, here are the US results from 1793 to 1973: aggregate bond index before 1897, corporate-only thereafter, January to January rolls only.
Here again, real returns after World War I were clearly worse than 2021-2022 thus far (the inflationary surge that followed WW I predates the SBBI, hence tends to be forgotten; but it was bad). Next, the 1842 returns were a little worse. Last, negative real annual returns on the order of -15% were again not uncommon in this earlier period.
But spun another way, 2021-2022 holds its own as among the worst 12-month stretches over the past 200 years, using the metric of real total return.
As implied in the initial post, US Treasuries were not the safest bonds you could own prior to World War I; go back far enough, and US government bonds would have to be categorized as an emerging market bond. Accordingly, this next chart looks at real returns for British Consols, December to December returns only, based again on results shared with me by Bryan Taylor of GFD.
This longer view puts 2021-2022 in context: yes it was bad, but real returns on the safest bond you can buy have repeatedly been worse: during the disruption of World War I, during the mini-boom / crash of 1825, and during the Napoleonic wars.
Summary
Yes you can lose 20% real, in one year, on the safest bond you can buy. It’s happened before, more than once.
But 2022 isn’t over yet. If trailing 12-month inflation is still at 5%, 6%, or more through, say, August; and if yields on long Treasuries continue to rise, to, say, 3.75% or even 4.0%, with corresponding price declines; then maybe, just maybe, 2021-2022 will go down in the record books for Worst. Real. Bond. Returns. Ever.
Stay tuned!
[Repeated caveat: the analysis is limited to the safest bonds you can buy; Weimar Germany doesn’t count.]
Real Returns
Inflation is the enemy of fixed income investors because it erodes real returns.
Which leads to today’s post: how does the real return received on bonds from April 2021 to April 2022 stack up historically? The formula used is (1 + nominal return %) / (1 + inflation %). Hence, given inflation of 8.3% in the twelve months through April:
-while the nominal return on the Total Bond index was negative -8.70 for that period, the real return was -15.70%;
-similarly, the nominal return on VGLT for that period was negative 12.19%, but the real return for those 12 months was a negative 18.92%.
To start, let’s look at the total bond index, which plays a prominent role in BH discussions of asset allocation. Dashed line shows the 2021-2022 real return.
It appears that 2021-22 has been very bad, but not the worst: some rolls in early 1979 take the crown, and rolls in 1973 and 1980 come close. Put another way, real returns on the total bond index have not been this bad since the last time inflation was this high.
Here are the post-1926 results for 12-month real rolls on the SBBI long government bond. Dashed line marks the April 2021 to April 2022 return.
No crown for 2021-2022 here: several rolls ending in 1980-1981 were worse. And the post-war decline in the late 1940s, when there was another abrupt inflationary surge, was almost as bad. Plus there are several other instances of “pretty bad,” as in the infamous 1994 episode.
I hope BH who own bonds are not surprised to see on how many occasions long government bonds have offered a negative real return on the order of -15% over 12 months.
Next, here are the US results from 1793 to 1973: aggregate bond index before 1897, corporate-only thereafter, January to January rolls only.
Here again, real returns after World War I were clearly worse than 2021-2022 thus far (the inflationary surge that followed WW I predates the SBBI, hence tends to be forgotten; but it was bad). Next, the 1842 returns were a little worse. Last, negative real annual returns on the order of -15% were again not uncommon in this earlier period.
But spun another way, 2021-2022 holds its own as among the worst 12-month stretches over the past 200 years, using the metric of real total return.
As implied in the initial post, US Treasuries were not the safest bonds you could own prior to World War I; go back far enough, and US government bonds would have to be categorized as an emerging market bond. Accordingly, this next chart looks at real returns for British Consols, December to December returns only, based again on results shared with me by Bryan Taylor of GFD.
This longer view puts 2021-2022 in context: yes it was bad, but real returns on the safest bond you can buy have repeatedly been worse: during the disruption of World War I, during the mini-boom / crash of 1825, and during the Napoleonic wars.
Summary
Yes you can lose 20% real, in one year, on the safest bond you can buy. It’s happened before, more than once.
But 2022 isn’t over yet. If trailing 12-month inflation is still at 5%, 6%, or more through, say, August; and if yields on long Treasuries continue to rise, to, say, 3.75% or even 4.0%, with corresponding price declines; then maybe, just maybe, 2021-2022 will go down in the record books for Worst. Real. Bond. Returns. Ever.
Stay tuned!
[Repeated caveat: the analysis is limited to the safest bonds you can buy; Weimar Germany doesn’t count.]
Last edited by McQ on Thu May 12, 2022 4:37 pm, edited 1 time in total.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
Re: 2022: Worst. Bond. Market. Ever?
The Bloomberg Aggregate Bond Index was started in 1976. The worst calendar year return since inception was a loss of 2.9% in 1994.
As of right now, the index is down 10% since the start of this year:
https://awealthofcommonsense.com/2022/0 ... right-now/
As of right now, the index is down 10% since the start of this year:
https://awealthofcommonsense.com/2022/0 ... right-now/
Re: 2022: Worst. Bond. Market. Ever?
Thanks McQ!McQ wrote: ↑Fri May 06, 2022 4:09 pm Summary
It seems clear from a broader view of history that annual returns, from the safest (long) bonds you can buy, of negative 20% or more, are not without precedent. And although 2022 is in the running to become the Worst. Bond. Market. Ever, it still has a ways to go before securing that title on an annual basis.
In short: what isn’t cash can always be trashed.
[Caveat: the universe of interest is confined to “the safest bond you can buy.” Weimar Germany saw much worse declines in government bond prices, but no one could have thought in the 1920s that German government bonds were the safest bond you could buy.]
Fixed Income and bonds are down.
I like CDs but inflation is chipping away.
I like TIPS funds and ETFs but their NAV/price is down. (The payout is sweet.)
What do we do?
I vote best available:
CDs...best deal duration matched
Treasury funds, ETFs, and individual also duration matched
TIPS funds, ETFs and individual also duration matched
Last edited by hudson on Thu May 12, 2022 6:46 am, edited 1 time in total.
Re: 2022: Worst. Bond. Market. Ever?
So the take away is: stay short to maturity.
Re: 2022: Worst. Bond. Market. Ever?
Boy I hope that's not what people are taking away from this year's adventure.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: 2022: Worst. Bond. Market. Ever?
It's too late to change the course now, but intermediate bond funds may be too risky for many. The issue was masked away due to falling yields until 2021.
Staying short to maturity sounds sensible to me.
Re: 2022: Worst. Bond. Market. Ever?
More signals to buy long bonds for me.
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Re: 2022: Worst. Bond. Market. Ever?
I'm buying STIG and NYLT as price moves down.
All the Best, |
Joe
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Re: 2022: Worst. Bond. Market. Ever?
Wrong move BTW, Iam trying to go into most speculative sections of Long bonds.
WFC.PRL or BAC.PRL now have 6.25% with S&P still have 5% earnings yield.
At Earnings of 200/0.0625 gives you 3250 valuation.
In my 401k Oracle 2045 bond is giving me 6%.
Inflation will peak this summer and turn into Deflation.
36% (IRA) - Individual LT Corporate Bonds , 33%(taxable) - schy, 33%(taxable) - SCHD Dividend Growth
Re: 2022: Worst. Bond. Market. Ever?
With trucking and hauling companies sounding the alarms over diesel shortages, as well as food producers sounding alarms over fall prices due to short falls in crop yields, as well as rising costs of supplies to maintain product...I have my doubts. May get some stability over the next month or so but I expect things to kick up again by years end.invest2bfree wrote: ↑Wed May 11, 2022 9:05 pm Inflation will peak this summer and turn into Deflation.
Re: 2022: Worst. Bond. Market. Ever?
Staying short with fixed income seems to be optimal.
I used to think that, but the fixed market went the other way.
I won't be caught short again except for my problem-solving-fund. (.8% in a high yield savings account)
Re: 2022: Worst. Bond. Market. Ever?
Intermediate and long-term bonds have the illusion of being riskier than short-term bonds.Marseille07 wrote: ↑Wed May 11, 2022 8:01 pm
It's too late to change the course now, but intermediate bond funds may be too risky for many.
I hope that the thing that people take away from this year is a better understanding of the distinction between volatility and risk, but perhaps that's merely wishful thinking.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Re: 2022: Worst. Bond. Market. Ever?
Unless you belive the longer yields are gonna fall, isn't staying short ideal? In a rising rate environment the difference between short and long yield tends to be pretty flat.
Re: 2022: Worst. Bond. Market. Ever?
You're describing a speculative bet on future yield curve movements.
That might be profitable, if you're right, but it is incontestably more risky than simply making sure you hold bonds that match your investment horizon.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: 2022: Worst. Bond. Market. Ever?
Equally surprising to many this year, along with the magnitude of the real bond losses, has been their concurrent losses with stocks. In other words, for more than two decades, investors have become used to the mostly negative correlation between bond and stock returns. High quality bonds could be reliably counted on to partially offset stock losses during "flight to safety" and "risk off" episodes.
But history shows that once inflation gets into the 4%-5% range, the correlation has tended to shift positive, with bond and stock returns much more closely aligned (chart below). Higher inflation = higher bond/stock correlations.
Note: Chart shows monthly correlations of S&P 500 stocks and
10-year Treasury returns, 1965-2018. Source: PIMCO
Re: 2022: Worst. Bond. Market. Ever?
I think this is an inappropriate inference.SimpleGift wrote: ↑Thu May 12, 2022 3:56 pm But history shows that once inflation gets into the 4%-5% range, the correlation has tended to shift positive, with bond and stock returns much more closely aligned (chart below). Higher inflation = higher bond/stock correlations.
If you replicate the chart but instead of using inflation on the x-axis you simply use the calendar year of the observation, you get an equivalent result: once the calendar year gets into the 1990 to 2022 range, the correlation has tended to shift negative.
Basically all that PIMCO demonstrated is that stock/bond correlations were higher in earlier time periods (when inflation was also higher) than in later time periods. In fact, they had to add a dummy variable in their inflation model to account for this.
We also add a breakpoint dummy variable (D1997) to evaluate whether inflation and real rates correctly capture the regime shit from positive to negative correlation, which the data in Figure 1 suggest occurred around 1997.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Re: 2022: Worst. Bond. Market. Ever?
A point of clarification, as I've seen quite a bit of confusion on this score, and not only here at BH: true, the Aggregate bond index begins in January 1976. But the Lehman Government / Credit index, which contains everything except mortgages and other asset-backed securities, begins in January 1973. I had occasion to compare the performance of the two during their first ten years of overlap 1976 - 1986, and found little difference in return (see the Appendix to this paper, which is an attempt to extend the total bond index back to 1900: https://papers.ssrn.com/sol3/papers.cfm ... id=3947293). Hence, I always present total bond index results back to January 1973.james22 wrote: ↑Wed May 11, 2022 5:36 pm The Bloomberg Aggregate Bond Index was started in 1976. The worst calendar year return since inception was a loss of 2.9% in 1994.
As of right now, the index is down 10% since the start of this year:
https://awealthofcommonsense.com/2022/0 ... right-now/
Next, I concur with a comment by Tier1, that 12-month rolls give twelve times as much information as calendar year returns, and are more informative particularly when the goal is to pinpoint extremes. I realized this morning that I had omitted to report rolling 12-month real returns on the Total Bond Index in yesterday's post. Because total bond has played such a central role in BH discussions of the bond component of an asset allocation, I'll update yesterday's post to include it in a few minutes.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: 2022: Worst. Bond. Market. Ever?
Buy if we widen the lens and extend the analysis back further, to 1890, the relationship between higher inflation and positive stock/bond correlations still holds — as well as the opposite. The chart below compares the 10-year rolling inflation rate (in green) with the 10-year rolling correlation between nominal stock and bond returns (in blue):vineviz wrote: ↑Thu May 12, 2022 4:24 pmI think this is an inappropriate inference.SimpleGift wrote: ↑Thu May 12, 2022 3:56 pm But history shows that once inflation gets into the 4%-5% range, the correlation has tended to shift positive, with bond and stock returns much more closely aligned (chart below). Higher inflation = higher bond/stock correlations.
If you replicate the chart but instead of using inflation on the x-axis you simply use the calendar year of the observation, you get an equivalent result: once the calendar year gets into the 1990 to 2022 range, the correlation has tended to shift negative.
Note: Inflation rate is on right axis, and the stock-bond correlation is on the left axis.
Data Source: Jorda et. al database
Re: 2022: Worst. Bond. Market. Ever?
The perils of moving to a short duration
Here are some concrete numbers in support of the cautionary note I believe vineviz is trying to convey.
It is December 2001. Mr. Short is still shivering from 911, and dares not think how much worse things might yet get. Even though he is seeking income over a 20-year horizon, for safety he puts his $100,000 fixed income allocation into a 5-year Treasury note, yielding 4.42%, per the SBBI. He’ll roll it over into a new one when it matures.
Mr. Long remains unperturbed. Since he has a 20-year horizon, he puts the $100,000 into a 20-year bond yielding 5.75% (again, SBBI Appendix A)
Mr. Short is appalled by this choice: “you’d take on all that volatility risk for an extra 133 bp in yield?!?”
Mr. Long smiles at him sadly: “I’m not taking on any volatility risk; my confidence is complete that the US Treasury will pay those 40 coupons as they come due and return my principal at maturity.”
Let’s see how the next twenty years would have played out.
At the end of 2006, Mr. Short rolls over into another 5-year Treasury, yielding 4.65% (SBBI). Not so bad; and he’s still antsy, now about war in the Middle East, unsustainable tax cuts driving up the deficit, a housing boom getting out of control, yada yada.
In 2011, even more deeply shaken by the Great Financial Crisis, he rolls into another 5-year, yielding … 0.74%.
In 2016, very worried about the new administration, he rolls into another 5-year, thanking his lucky stars he can now get 1.85%.
In 2021, both Mr. Short and Mr. Long receive their principal back from the US Treasury as agreed.
Here’s how it looks graphically. In the nature of the normal yield curve, Mr. Long earns a little more, year by year. It starts to add up. Then at the ten-year point, his incremental income starts to balloon.
By the end of the 20 years, Mr. Long is ahead by $56,000 of income.
Or put another way, Mr. Short is $56,000 short of where he could have been, if he had matched his bond’s maturity to his planning horizon.
Put yet another way, which volatility risk would you like to control:
1. the volatility of your monthly statements of total account value;
2. the volatility of the income deposited in your spending account?
PS: of course, the 2001 starting point was chosen for rhetorical effect. Results would look different with, say, a 1965 starting point.
And here in 2022 you *know* which is the better analog--right? Don't you?
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: 2022: Worst. Bond. Market. Ever?
Thanks to everyone for doing computations in real dollars, and not nominal.
Does it make more sense to compute rolling returns on a time interval that matches the average effective duration of the bond fund? So for example for Vanguard Total Bond that would be about 6 years? I don’t necessarily see the rationale behind choosing 12 months but maybe someone can enlighten me.
Does it make more sense to compute rolling returns on a time interval that matches the average effective duration of the bond fund? So for example for Vanguard Total Bond that would be about 6 years? I don’t necessarily see the rationale behind choosing 12 months but maybe someone can enlighten me.
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Re: 2022: Worst. Bond. Market. Ever?
I never understood duration matching maturities (above ~8 years) in a low-interest environment as we had prior to this year. Seems like it's better to take longer-term risks in the stock market and use shorter bond durations that accept the reinvestment risk.
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Re: 2022: Worst. Bond. Market. Ever?
So stagflation scenarios can and do happen, in which case job loss combined with inflation is a real possibility. And that is generally worse than job loss combined with declining prices, if you do have any savings on which to draw.Firefly80 wrote: ↑Sun May 08, 2022 7:56 pmNiceUnparticularMan wrote: ↑Sun May 08, 2022 8:11 amSo there are a variety of considerations.Firefly80 wrote: ↑Sat May 07, 2022 4:16 pmNiceUnparticularMan wrote: ↑Sat May 07, 2022 9:37 am
As a final thought, I will note there are maybe a few of us who don't actually believe it makes sense to try to use bonds to hedge against both unexpected deflation/disinflation and unexpected inflation, and that since you really need to pick one, it makes sense to pick hedging against unexpected inflation.
Please Explain why it’s more important to protect against Inflation then Deflation?
Intermediate term TIPS Funds lost nearly -10% in 2013 in a Deflationary scenario similar to what’s happening with Nominals now.
As others have already pointed out, one big one is unexpectedly high inflation is essentially unbounded in ways unexpectedly low inflation largely isn't. So what I would call the tails of the distribution are not symmetric, with the high-side tail stretching out into rather nasty scenarios.
Another is understanding how inflation/disinflation tends to affect other things in a personal investor's life.
One major issue is sticky wages. Wages tend to correlated with inflation, but they can lag behind. On the plus side, during deflationary times, sticky wages can actually provide a lot of help as nominal wage cuts tend to be a line a lot of employers try to avoid crossing, and so your real wages might actually increase. On the minus side, during unexpectedly high inflation period, sticky wages can mean you are constantly getting less real than you expected.
Another is, of course, consumption expenses. Generally speaking, most of these are going to correlate with general inflation (note: a very important exception is fixed-rate debt). So, during times of unexpectedly low inflation or actual deflation, your consumption expenses will usually be tracking below expected, at least in nominal terms. During times of unexpectedly high inflation, they will likely be tracking above expected, at least in nominal terms. And again this a notably asymmetry.
OK, so thanks to things like sticky wages and consumption expenses, most personal investors have natural reasons to be more concerned about unexpectedly high inflation than unexpectedly low inflation. Combine that with the observation that unexpectedly high inflation is essentially unbounded, and there you go.
As a final thought, all this is pretty apparent in financial history, particularly if you expand out beyond U.S. history. It is not that disinflationary/deflationary periods are never bad at all, but usually if personal investors started off diversified, were not overleveraged, and stayed the course, they ended up OK in the end (sometimes even better than OK). On the other hand, there have been many inflationary periods which were essentially ruinous for most personal investors, even the ones who were being as reasonable as possible with their savings given the assets available to them. Indeed, even without some sort of hyperinflation/societal collapse scenario, long periods of unexpectedly high inflation can be really, really bad for personal investors, and at least ruin what seemed like reasonable retirement plans.
So to me, this is not even a very close question. Sure, nominal bonds will do better than comparable IP bonds in periods of unexpectedly low inflation, but I am just not that worried about those periods in contrast to periods of unexpectedly high inflation. Knowing some financial history, the latter are far more concerning to me.
Sticky Wages issue is a Interesting one, but I think it's more applicable in times on Inflation like right now where many of our Wage increases are not keeping up and that's a pain if it continues.
In a extended Deflationary time, there's a very real non-trivial chance that you might lose your job and wage entirely which is far Worse. We don't have to look too far back to observe this. Demand is crushed and standards of living drop.
So for someone who is still working/accumulating I think extended Deflation seems far Worse.
For a retiree with a significant nest egg who is just trying to maintain his purchasing power Inflation is probably Worse.
But sure, the more human capital you have, and the less financial savings, the less acute the imbalance between inflationary scenarios and deflationary scenarios. So while I don't really think people early in accumulation need either, I don't think there is necessarily much harm in such people having a small allocation to nominal bonds versus something like IP bonds.
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Re: 2022: Worst. Bond. Market. Ever?
For people who are liability matching with bonds, this is a valid conclusion--assuming they used the correct form of bond, nominal or IP, given the nature of the liabilities they were matching.
Unfortunately, it is quite clear a lot of people were either using longer nominal bonds to match real liabilities, or were using longer nominal bonds for some sort of short-term purpose like rebalancing, psychological relief, or so on.
Finally, it is important to understand that low-risk can also mean low, or very low, or negative real, returns. Recently high-quality longer bonds were priced so high the expected real returns were very low, or negative. Saying there was very little risk they would provide those extremely low or negative real returns, as long as they were high-quality IP bonds held to maturity is true, as risk is normally defined. But I think a lot of people saw that as just locking in a bad outcome.
And to come back around the circle, I think that led a lot of those people to use longer nominal bonds instead, which if they were high-quality actually had almost equally bad expected real returns, but then a lot more real return risk as well. But it was all too easy for them to overlook what they were doing thanks to those real return expectations not being so transparent, and various people de facto relying on historic real return averages for nominal bonds from periods where bonds were not priced so high (or they got lucky with inflation, or both).
Last edited by NiceUnparticularMan on Thu May 12, 2022 11:27 pm, edited 1 time in total.
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Re: 2022: Worst. Bond. Market. Ever?
So if you are wealthy enough relative to your spending goals, but also very risk-averse, you can rationally use a lot of longer bonds despite high prices and low rates on those bonds, assuming you pick the right kind of bond (nominal or IP).2pedals wrote: ↑Thu May 12, 2022 10:55 pm I never understood duration matching maturities (above ~8 years) in a low-interest environment as we had prior to this year. Seems like it's better to take longer-term risks in the stock market and use shorter bond durations that accept the reinvestment risk.
Like, even if your bonds are expected to lose real value over time, if you are wealthy enough, you don't necessarily need to care about that.
But the higher the prices, and the lower the rates, on bonds, the wealthier you need to be to make this work for a given spending plan.
Re: 2022: Worst. Bond. Market. Ever?
If you have enough wealth you can use good investment judgment.NiceUnparticularMan wrote: ↑Thu May 12, 2022 11:25 pmSo if you are wealthy enough relative to your spending goals, but also very risk-averse, you can rationally use a lot of longer bonds despite high prices and low rates on those bonds, assuming you pick the right kind of bond (nominal or IP).2pedals wrote: ↑Thu May 12, 2022 10:55 pm I never understood duration matching maturities (above ~8 years) in a low-interest environment as we had prior to this year. Seems like it's better to take longer-term risks in the stock market and use shorter bond durations that accept the reinvestment risk.
Like, even if your bonds are expected to lose real value over time, if you are wealthy enough, you don't necessarily need to care about that.
But the higher the prices, and the lower the rates, on bonds, the wealthier you need to be to make this work for a given spending plan.
I like the quote by Jack Bogle:
"Do not let false hope, fear and greed crowd out good investment judgment."
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Re: 2022: Worst. Bond. Market. Ever?
McQ wrote: ↑Thu May 12, 2022 10:37 pm The perils of moving to a short duration
Here are some concrete numbers in support of the cautionary note I believe vineviz is trying to convey.
It is December 2001. Mr. Short is still shivering from 911, and dares not think how much worse things might yet get. Even though he is seeking income over a 20-year horizon, for safety he puts his $100,000 fixed income allocation into a 5-year Treasury note, yielding 4.42%, per the SBBI. He’ll roll it over into a new one when it matures.
Mr. Long remains unperturbed. Since he has a 20-year horizon, he puts the $100,000 into a 20-year bond yielding 5.75% (again, SBBI Appendix A)
Mr. Short is appalled by this choice: “you’d take on all that volatility risk for an extra 133 bp in yield?!?”
Mr. Long smiles at him sadly: “I’m not taking on any volatility risk; my confidence is complete that the US Treasury will pay those 40 coupons as they come due and return my principal at maturity.”
And then there's Mrs. Real, who says: "You are both being foolish, the real value of your money is what matters. The Treasury is issuing these newfangled things they call TIPS and I-bonds. With these you will currently be guaranteed about 3-4% over and above inflation. I can put up to $30K in I-bonds and as much as I want in TIPS and be guaranteed to get 3-4% above inflation for anywhere from 5 to 30 years."
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Re: 2022: Worst. Bond. Market. Ever?
Yeah, the other important premise there was being extremely risk-averse.2pedals wrote: ↑Thu May 12, 2022 11:35 pmIf you have enough wealth you can use good investment judgment.NiceUnparticularMan wrote: ↑Thu May 12, 2022 11:25 pmSo if you are wealthy enough relative to your spending goals, but also very risk-averse, you can rationally use a lot of longer bonds despite high prices and low rates on those bonds, assuming you pick the right kind of bond (nominal or IP).2pedals wrote: ↑Thu May 12, 2022 10:55 pm I never understood duration matching maturities (above ~8 years) in a low-interest environment as we had prior to this year. Seems like it's better to take longer-term risks in the stock market and use shorter bond durations that accept the reinvestment risk.
Like, even if your bonds are expected to lose real value over time, if you are wealthy enough, you don't necessarily need to care about that.
But the higher the prices, and the lower the rates, on bonds, the wealthier you need to be to make this work for a given spending plan.
If you treat that just as a matter of taste, then it is what it is.
But if you treat it as something subject to some critical evaluation--I would tend to agree with you that level of risk aversion is not necessarily consistent with good judgment.