THE 220 YEAR BULL MARKET IN BONDS
Barry Ritholtz posted this excellent chart (figure 1) earlier that shows US interest rates going back to 1790. As you can see, we’ve had a long history of low rates. In essence, this has been a 220 year bull market! Unfortunately, the recent blip in rates from the 1970′s oil price shock has many of us thinking like gold fish – in the VERY near-term.
(Figure 1)
The brief interest rate spike that the hyperinflationists constantly point to is not a cyclical occurrence. You’ll often see this chart (figure 2) which implies that rates have come down from a great “bond bull market” therefore they are about to go right back up and the bull market in bonds will end and we will all lose our life’s savings in the bond markets. But a long-term perspective (figure 1) shows that this is simply not true. The bond market has been in a 220 year bull market. Despite the myth that bond markets have recently become cyclical the long-term evidence shows this to be entirely false.
(Figure 2)
If you want to take this further, you could take it over the last 4000 years, a la “A History of Interest Rates,” by Sidney Homer. Amazing how high interest rates were in the past. It seems they have come down as economic volatility has declined, and legal structures improved.
What about the fact that they weren’t risk-free when we were pegged to gold?
We could assume that interest rates should have been higher back then, no? Which would mean that the historical average is likely skewed higher than it should be. Thoughts?
The gold peg kept inflation bounded to the supply of gold, so it kept all rates in some band determined by the slow growth of mining… That’s why they only got high in the 20th century. Fiat money economies can and have behaved differently to gold-backed ones.
You’re kidding, right? Your chart shows that, with the 10-year yield today at 2.5-2.6%, it is lower than it has been at any time in that 220-year history apart from a brief (in context) period from the late 1930′s to the early 1950′s. Few who start their yield chart from 1981 — and you are correct, many out there are doing so — claim that yields are going back to 18%. They don’t have to. Merely mean-reverting to the longer-term average of 4.5% will destroy plenty of capital.
Cheers,
Rob
Assuming you are boneheaded enough to have all your assets in bonds at this price and hold to maturity you will lose 2% in real terms per year. That’s assuming you own no other assets (for instance stocks which you should be hedging bonds with and should strongly outperform your bond losses if this is the case), do not ladder your bonds and do no average into your bonds over time….
2% a year? Big deal. Let’s say my net worth is $100K. If I hold til duration I will still walk out with $125K+. Not great in real terms, but comparable to the Nasdaq bubble? Not even remotely close….
These arguments in favor of a bond bubble are all made with very silly assumptions….
My criteria for a bubble is: Will people start jumping out of windows if prices move against them? Hardly the case with a risk-free asset like Treasuries.
Plenty of sheeple scooping up bonds have no idea of the loss of capital potential they are carrying. 1994 is a great example of this risk which crushed bond investors. Seriously, lining up with a crowd to loan money at these rates is goofy to me. google 1994 bond market and read what could happen. If you are a current bond bull and did not yet invest in 1994 you might want to familiarize yourself with this.
I have said on more than one occasion in recent weeks that bonds are overbought here. My only point of contention is with the idea that this is a bubble. It is not.
Bubble is the most overused financial term and should be banned. Instead look at the bond market as too many people leaning one way, and all looking at the same trigger event to bail. I look at the bond market like the oil market at $140+ going to $200. That trade simply ended when they ran out of suckers. No event trigger that I can remember unwound that trade. We could still have the same economy we are in now with the 10 year at 3.50% instead of 2.50%, just because the crowd ran out of suckers. If that happens, those risk free treasuries won’t feel so risk free after all.
That’s my thinking. Maybe a long-term chart of corporate debt would be more enlightening.
And it leads me to believe that the average rate is probably closer to 3.5% or roughly in-line with long-term inflation rate. In which case, we are moderately overbought right now as opposed to this rampant belief that we are in a bubble.
I guess we will see interest rates around 40% as the new rule. A credit card with 90-120% will be common. Think inflation like a sign of recovery from an illness (socialism), and this like the greatest step forward in human evolution (post communism or crony capitalism will be condemned like the nazi’s regimes from the past). This will be a very close call but this is the only way we can have a future.
I cannot read the dates on that first chart. But up until 1913, the value of the dollar was linked to silver and/or gold and inflation rates were very low. So real interest rates would have been in the range of 3-5% for most of the chart. If you assume inflation rates of 2% going forward, then the real interest rate on a 2.5% UST would now be 0.5%. And if you include taxes, the final interest rate might be negative depending on your tax bracket. (Note that there was no income tax on the interest before 1913).
The peak in interest rates was caused by the inflation of the 1970′s. And in 1970, US debt levels were fairly low and the US government didn’t even have a need to inflate. The inflation of the 70′s was purely due to the incompetance of the Nixon, Ford, and Carter administrations.
Now, US debt levels are much higher than in 1970 and are increasing rapidly. For centuries, since Roman times, governments have dealt with excessive debt by inflating or debasing the currency. I see no reason to assume that this time will be an exception. Forget hyperinflation. Even a decade of 70′s-level inflation could reduce purchasing power by 50%. (Compare to 60% losses when the NASDAQ bubble popped).
So whether you choose to call it a bond bubble or not, people who are buying long term UST’s are risking major losses in purchasing power, and getting paid little or nothing in order to assume this risk.
I am the retired Chief Investment Officer of a major asset management firm, who still does some consulting. I have never in the over 30 years I have been in this business heard as silly a conversation as the idea of a Treasury bubble. First, the idea that you can have a bubble in an investment guaranteed to return your initial investment is, let’s just say, a poor use of language. But let’s consider the idea that we are at the lows in government yields (which is actually a bigger assumption than many seem to think, see Japan) and that the treasury yield curve moves up by 200 basis points across the board. Using the Barclay’s Treasury Index, you will see that the modified duration of the Treasury market is about 5.3. Since most of Treasury issues are under 10 years, convexity works in the investor’s favor here, so let’s call the duration for large changes in rates 5. A move of 200 bps therefore costs the investor 10%. Not pleasant, not great, not fun, but not catastrophic either, especially compared to say, a 70% decline in the Nasdaq 10 years ago. Also, not reason to scream about a bubble. And a short term spike in rates of 200 bps with current capacity utilization, high unemployment, and a continuing disinflation, is, shall we say, a low probability event in the short run. And as TPC points out, such an increase would have to be associated with some increase in real economic activity which should be reflected in better performance for the stock segment of your portfolio. It is also worth noting that most of us have benefited from the run in bonds, particularly if you were long any credit risk at all the past 18 months or so and benefited from the spread contraction. From a pure investment perspective, this is just flat out a silly conversation, and so I assume, its real purpose is to make a case for a political agenda. Though it isn’t clear to me exactly what that agenda is, other than to recognize that current policy has at this time not resulted in a meaningful economic recovery. Whatever the case, this conversation has nothing constructive to say with respect to how people ought to be positioning their portfolios.
A 200-year bull market in bonds…wonder what migh logically come after such a long-trending market? Perhaps a multi-decade bear market in bonds? One that is about to start in concert with QE2?