Dave Moenning

How Bad Will The Big, Bad, Bond Bear Get?

In yesterday’s meandering morning market missive, we talked about the possibility of the bond market entering a big, bad bear cycle and how a great many analysts expect things to get ugly in the coming years for bond investors.

The thinking is actually quite logical. The economy is expected to improve, which will cause inflation to rise. And the bottom line is that the bond market hates nothing more than increasing inflation expectations. Now toss in the fact that the Fed wants to start “reducing its balance sheet” (i.e. selling some of the approximately $4 trillion in bonds and other fixed income securities it owns) and you appear to have a perfect storm for bond bears.

Put simply, the stage appears to be set for a rising interest rate environment, which could be accompanied by additional supply (from the Fed). And since bond prices fall when rates rise, it is easy to see how things could get nasty for the owners of bond funds and ETFs.

But before you run out and start loading up on those levered, inverse bond ETFs in the hopes for some “no brainer” gains for many years to come, it might be a good idea to look back at history and see how the bond market acted during periods of rising rates.

How Bad Will It Get?

To review, bonds enjoyed a 35-year secular bull market cycle from 1981 through July 2016. During this period of time, you may be surprised to learn that according to Bloomberg, the worst calendar year for the Barclays Aggregate Bond Index (the generally accepted benchmark for the overall bond market) was 1994, where the “Agg” lost -2.9%. Then in 1999, the Agg lost -0.8%. And in 2013, the bond market declined by -2.0%. That was it for calendar year declines over the 35-year bull cycle. Terrifying, eh?

But… this was during a secular bull phase. Now let’s go back and look at periods of time when rates were generally rising such as 1955-1959, 1967-1969, and 1972-1981.

A Powerful Chart

To aid in the exercise, below is a powerful chart from Fidelity Institutional Asset Management showing the yield of the 10-year Treasury (the black line) as well as the calendar year returns of the Agg going back to 1940. Note that since the Agg didn’t exist prior to 1976, the returns from 1940 through 1975 are based on Fidelity’s “Synthetic Aggregate” which is made up of 67% intermediate government bonds and 33% long-term corporate bonds.

From my seat, this is a VERY powerful chart that EVERY investor and financial advisor needs to see – and study – prior to making ANY moves in preparation for the upcoming bond bear.


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The first big takeaway is the absolute WORST calendar year the bond market (as defined by the Barclays Agg and Fidelity’s synthetic Agg) has seen since 1940 was… wait for it… -3.2%. Yep, that’s right, the biggest decline in modern history for the bond market occurred in 1969, where the market fell a little over 3%.

Folks, a 3.2% decline is a bad week for the stock market indices, a pretty good reaction to a stock missing earnings, and a bad afternoon for a lot of commodities. But the reality is this is the worst calendar year decline the bond market has ever seen. So, my question is, what the heck is everybody so worried about?

Digging deeper, we find that there have been other tough times to own bonds. For example, in 1955, the synthetic Agg lost -0.3%. Then in 1956, it fell -2.6%. 1958 saw a decline of -1.6% and 1959 lost -0.6%. As such, bond investors saw declines in four out of five years. Ughh.

However, in 1957, bonds rallied about 8%. So, according to my calculator, the cumulative return for the five-year period was somewhere in the vicinity of +2.5%.

Then there was another rough patch for bond investors in the late 1960’s. In 1967, the synthetic agg fell -1.0%. And in 1969 bonds had their worst year ever at -3.2%.

And then there was the 1972 through 1981 period, where the yield on the 10-year rose significantly from about 6% to nearly 15%. And how did bonds do during what can only be described as a horrific period of rising rates and runaway inflation? They rose. Every single year. So, again, what exactly is everyone so freaked out about?

Bonds Will Still Be Bonds

It is also worth noting that one of the major reasons to own bonds in a diversified portfolio (besides the production of income, that is) is bonds (especially government bonds) remain the one asset class that is truly non-correlated to the stock market. I.E. when the stock market tanks as it did in 1987, 1990, 1998, 2000-02, and 2008-09, bonds rose – every single time.

So, unlike developed foreign markets, emerging markets, commodities, real estate, junk, lots of alts, etc., high quality bonds provide a hedge against the big, bad stock market bears, which unlike their bond counterparts, have actually done a great deal of damage to portfolios over the years.

For me, the bottom line here is simple. While the outlook for the bond market can be made to look bleak, I’m not sure there is a whole lot to fret about. Sure, bonds will experience stiff headwinds at times and may even produce record calendar year declines. But even if the Agg doubles its worst year in history, the benefits would seem to outweigh the costs – well, in my book anyway.

Thought For The Day:

May your actions speak louder than your words. May your life preach louder than your lips. May your success be your noise in the end.

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of Trump Administration Policies

      2. The State of the U.S. Economy

      3. The State of Earning Season

Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.

Looking for a “Modern” approach to Asset Allocation and Portfolio Design?

Looking for More on the State of the Markets?


Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

David D. Moenning is an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.

Employees and affiliates of Sowell may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

Advisory services are offered through Sowell Management Services.

Dave Moenning

Are You Prepared For The Big, Bad Bond Bear? (Should You Be?)

Most market analysts will concur that interest rates bottomed out in the summer of 2016. More specifically, after trending lower for approximately 35 years, the yield on the U.S. Gov’t 10-year Treasury Note hit an all-time low of 1.367% on July 5, 2016. And most every bond guru on the planet agrees that unless another global economic crisis hits, last summer’s low is unlikely to be exceeded any time soon.

Now consider the following: (1) U.S. economic growth is expected to continue to improve. (2) Inflation expectations have increased. (3) The Fed has embarked on a mission to normalize rates. (4) European economic growth is surprising to the upside. (5) The U.S. has reached “full employment.” And (6) the new administration’s policies (assuming they are implemented, of course) are expected to give the economy an extra boost. From a macro perspective, it is fairly easy to argue that this combination is bearish for bonds and as such, a big, bad bear market in bonds is likely waiting in the wings.

However, I think it is worth noting that this has been one of the most anticipated market events in history. Everywhere you turn, there is another article, webinar, or fund salesman touting what you need to do to avoid the coming calamity in bonds. And if you recall, this theme has been going strong since the “Taper Tantrum” of 2013 (when Ben Bernanke first started talking about backing off the Fed’s QE programs).

But so far at least, all the hand wringing and teeth gnashing over the big, bad bond bear has been, well… to borrow a line from William Shakespeare, “much ado about nothing.” In fact, the Barclays Aggregate Bond Index sports a cumulative gain of 11.12% since the end of 2013 (through 4/30/17). Thus, I might suggest that all the preparation for the bond debacle has been a bit premature, which, in my business, is another word for being wrong.

So, my first point on this fine Wednesday morning is that while everyone in the game has been busy preparing for the can’t-miss disaster in the bond market, it has actually been business as usual in the bond pits lately. Sure, rates bounced off the all-time lows as inflation and economic growth expectations increased last year. But, c’mon, what did you expect to see with the economy improving?

Long-Term Perspective

Take a look at the chart below. This is the yield of the U.S. 10-year Treasury Note over the last 23 years. As you can see, the trend has been moving from the upper left to the lower right for quite some time!

U.S. Gov’t 10-Year T-Note Yield – Monthly

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What this chart doesn’t show is that rates have actually been in a downtrend since late 1981. And since bond prices rise when yields fall, it is plain to see that this has been a mega bull market.

What is being talked about here is a sea change of epic proportions for the bond market. I.E. a secular bull morphing into a secular bear. And since the last secular shift took place in 1981, folks are expecting this to be a pretty big deal.

The natural progression – and the general consensus in the financial community – is to expect rates to rise going forward. And since bond prices fall when rates rise, this is where all the angst about the big, bad bond bear originates. Never mind the fact that most of the folks shouting from the rooftops about this event have been singing the same song for nearly four years, this time it’s different!

Are You Prepared? (Should You Be?)

Given the simplicity of the macro logic (I.E. a stronger economy means higher inflation, which, in turn, means higher rates – rinse and repeat ad infinitum), it is easy to understand why nearly every fund company and ETF creator has developed products intended to protect investors from the inevitable rising rate environment. After all, given the magnitude of what is expected to transpire, Wall Street has assumed that everyone will need to rework their portfolios to protect themselves from the massive bond bear. Makes sense, right?

As you may have surmised by my hints of sarcasm above, there is a side of this story that many advisors and clients are probably not familiar with. For example, did you know that the bond market has been through this type of sea change before? Did you know that the U.S. has seen prolonged periods of rising rates in the past? And more importantly, do you know how the bond market reacted during these periods?

So, tomorrow we will look back at history and explore what type of downside we might expect to see from the much-ballyhooed disaster on the horizon for the bond market.

Thought For The Day:

Those at the top of the mountain didn’t just happen upon it.

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of Trump Administration Policies

      2. The State of the U.S. Economy

      3. The State of Earning Season

Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.

Looking for a “Modern” approach to Asset Allocation and Portfolio Design?

Looking for More on the State of the Markets?


Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

David D. Moenning is an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.

Employees and affiliates of Sowell may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

Advisory services are offered through Sowell Management Services.