In regards to last Sunday’s post Bond Bubble Thoughts, reader Mal emailed this article titled “The Treasury Bond Bubble: A Survival Guide for Investors:”
Concerns have been escalating lately about the possible risks of investing in Treasury bonds. Just how bad is that risk, and what should investors do about it?
The most ominous warning came from Tobias M. Levkovich, U.S. equity strategist at Citigroup. In a note to clients on Monday, Levovich said he had found a “startling” correlation between equity returns in the period from 1990 to 2005 and Treasury bonds since 2000.
“It would suggest that the tremendous money flows into bond funds could end with similar losses to that which transpired for equity investors who poured cash excessively into stock funds back in 2000,” Levkovich wrote. He was referring, of course, to the dot-com crash, when the Nasdaq index declined 46% from September 2000 to January 2001.
Rates Can Only Go Up From Here
Writing in The Wall Street Journal on Tuesday, Jeremy Siegel, a finance professor at the University of Pennsylvania, and Jeremy Schwartz, director of research at WisdomTree, a sponsor of exchange-traded funds, warned that investors in bond funds are “courting disaster,” and made the same comparison to the 2000 tech-stock bubble.
Siegel and Schwartz said that if 10-year Treasury bond rates, now at 2.8%, rise to 4%, the capital loss on bonds will be more than three times the current yield. They said there was no doubt that interest rates would rise as government programs to care for the baby boomer generation kick into gear.
So what’s an investor with a bond portfolio heavily invested in Treasuries, which have the cachet of being the world’s safest investment, supposed to do now? Some investment advisers recommend coming up with a long-term plan and sticking to it despite the marketplace’s short-term ups and downs.
Consider Good-Quality Corporate Bonds
But even with a long-term strategy in place, investors can tweak their portfolio to avoid a potential disaster.
Marilyn Cohen is a fund manager at Envision Capital Management, a Los Angles fixed-income investment management company, and the author of Bonds Now!, a bestselling guide to bond investing. She urges investors with large investments in Treasury bond funds to “take some or all of your gains off the table.”
Instead of government debt, she says, investors should buy individual bonds, mainly corporate bonds rated BBB+ and above, which she says have a decent “spread,” or a positive interest rate difference, over Treasury bonds.
By buying individual bonds, she says, investors can lock in maturity and yield, and can avoid the problem in some bond funds of a declining dividend caused by investors stampeding into the funds, forcing the fund managers to buy lower-yielding securities.
“I would stay out of the Treasury market because the yields are too painfully low, and I would be very selective in buying good-quality corporate bonds, which are in an unbelievable sweet spot,” Cohen says.
The story is always the same. Concerns over a bubble, whether equities or bonds, are voiced, and the usual menu of solutions is offered as shown above. Even comparisons to certain similarities in the tech bubble of 2000 are noted.
However, sadly, none of these gentlemen quoted in this story has apparently learned anything from the last decade along with its two bear markets.
There is a time to be in and a time to be out. Why go through the mental agony and exercise of trying to decide whether certain bonds/bond funds/ETFs have a better chance of surviving a potential rate hike when and for whatever reason it occurs.
You’ve heard this before, so it here it is again. Simply follow the trends and implement a 5% trailing sell stop for all bond fund/ETF positions.
There is no guesswork involved and should this economy, against all expectations, continue to slip and slide, while bonds are continuing to rally, you will be the beneficiary.
If this current rally comes to an end, the trend reverses and triggers your trailing sell stops, then fine. You know exactly what your risk will be and chances are that you will be selling before most anybody will have figured out that a trend has ended.
Isn’t that a lot easier than trying to follow the so called experts, who have no more knowledge than you as to what the future will bring?