Realistic Expectations for Long Bonds

[buddtholomew]

All that knowledge and only in High School...
That was my initial reading haha

[barrett]

All that knowledge and only in High School...
That was my initial reading haha

Yeah, pretty clunky wording. Sorry about that. He was actually my 7th grade Chemistry lab partner (always droning on about inverted yield curves and convexity!).

[buddtholomew]

Barrett, I hope you make a decision you are comfortable with soon. It weighs on the mind...nice day outside going to play football with my 8 year-old daughter.

[sophie]

I'm still buying long bonds, although I'm sticking with bond funds like TLT for now.

I have also noticed that disparity between US and European bond prices, and I don't understand why international investors aren't piling into US bonds. Perhaps they are and this is the reason why the bond yield curve is flat beyond 10 years. If European bonds drop further, it's possible this effect will increase.

The other reason is that what we know about the future (Fed planning to increase rates) is already factored into bond prices. If you notice, the last couple times the Fed raised rates, T bill prices didn't change much.

Maybe the criterion should be whether long bonds could increase enough to trigger a rebalance - this would require them to double in price while the rest of the portfolio drops. No reason why that couldn't happen. If long bonds got to the point where doubling in price would require a historically extremely unlikely event, like yields going negative or < 1%, that would make me stop buying them.

[Tyler]

I think the problem is that the PP hasn't really been tested in a situation where bond yields are on a long-term upward trend. The period prior to 1981 doesn't really count in my eyes because the U.S. was just coming off the gold standard, and the skyrocketing gold price helped the PP immensely. Nobody really knows whether the PP will be able to keep up satisfactorily against a long-term bond price-decline headwind.

Keep in mind that the initial gold correction after Bretton Woods was repealed ended in December 1974. Gold fell about 50% off of that high over the next three years before the late-70's spike kicked in, so I think it's reasonable to attribute everything from 1975 on to normal gold behavior in a fiat currency market.

Long-term treasury rates skyrocketed in the late 70's and returns were appropriately pummeled. Starting in 1975 they saw a 10-year real return of -1% a year even with coupon payments topping well into double digits. The worst timeframe was the 5 years starting in 1977 when long term treasuries lost 10.4% a year in real terms. Talk about painful! I can only imagine the bond scream room snail mail threads back then.

So yes the skyrocketing gold price helped the PP immensely when bonds cratered but I would not attribute it to coming off the gold standard. It's just what gold does when financial chaos hits and it has come to the rescue more than once. Even if long term bonds lose money for the next decade just like they did starting in 1975, the PP is much better designed than most other portfolio options to ride that scenario out without worry.

[stuper1]

Tyler, I certainly hope you are right about gold prices in the 1970s. That would be wonderful, if accurate. An alternative viewpoint could be that prices ran up quickly, pulled back a bit, and then continued running up until 1981, but still based on gold trying to find an equilibrium price after being artificially priced for so long.

[Tyler]

For reference, here's the gold price history since 1971:



You can see that the volatility picked up in 1972 when Bretton Woods ended. Prices jumped through Jan '75 before calming down for the next 4-5 years. Pay particular attention to the red nominal line between '75 and '79. That seems like a reasonable equilibrium to me.

(As an aside, people like to attribute the entire rise between '72-'75 to coming off the gold standard while forgetting that inflation spiked from 3% to over 11% in that timeframe. I don't doubt that the market finding the right level for gold after it had been held down for so long accounts for a good percentage of gold performance over that timeframe, but I think it's naive to believe it's 100%).

Now something definitely happened in 1979 or so to shoot gold through the roof before slapping it back down by 1983. I don't disagree that multiple factors may be at play, but I'd argue that inflation spiking from about 7% in 1978 to 14% in 1980 before retreating all the way back to 3% in 1983 was a major factor. How else would you expect gold to react in that situation? Attributing the entire rise to Bretton Woods seems silly to me.

[sophie]

Desert is right: backtesting is useless is in this situation because this exact scenario has never happened before. But keep in mind: the PP assets don't exist in a vacuum, and you have to consider how all four assets will react to a given scenario. Any guesses on likely scenarios? here's mine:

1) Bond rates continue to rise but very slowly, nudged along by a conservative Fed. Bond prices will fall slowly enough that coupon payments will limit losses. Stocks will continue to do well. Gold will stay flat. The PP will chug along at 4-5%/year and inflation will stay around 2%. The PP will look increasingly unattractive. Investments will continue to shift more and more toward stocks, which will turn out badly when the next big stock market correction comes along.

2) The Fed gets a bit impatient and hikes interest rates too fast. Bond prices will drop accordingly (but won't crater). The stock market will get jittery between the interest rate situation and concerns about the deficit, and the market will pull back. Gold will run up just long enough to provide a nice rebalance opportunity. Sort of like February's pullback but durable enough to take advantage of.

3) The financial system/house of cards gets itself into trouble again. Drastic shifts in asset prices will occur, like 2008 but maybe with a different mix. PP holders will look like geniuses.

I figure that long bonds won't set the world on fire unless #3 happens, but they also won't lose much. It's not a huge price to pay for protection, if you want it. It wouldn't be unreasonable to limit bonds to 15-20% of the portfolio, just enough for said protection in scenario #3 but low enough that the long interest rate rise won't damage returns much. I'm also leaving new money in funds like TLT in retirement accounts, so that you get the benefit of increased interest payments as the yields increase.

[ochotona]

On macrovoices.com there is a great podcast with Jeff Snider on why long bond rates are not going to go much higher, and he doesn't think we've seen the low in interest rates yet. https://www.macrovoices.com/

[ochotona]

On macrovoices.com there is a great podcast with Jeff Snider on why long bond rates are not going to go much higher, and he doesn't think we've seen the low in interest rates yet. https://www.macrovoices.com/

On the other hand, Julian Brigden thinks the bottom in LT yields is in. New podcast. https://www.macrovoices.com/

Julian dropped a gem early in the talk... watch the 100 month moving average on 30 year Treasury yields. The yields have not busted above that line for decades.

[ochotona]

On macrovoices.com there is a great podcast with Jeff Snider on why long bond rates are not going to go much higher, and he doesn't think we've seen the low in interest rates yet. https://www.macrovoices.com/

On the other hand, Julian Brigden thinks the bottom in LT yields is in. New podcast. https://www.macrovoices.com/

Julian gave out a gem early in the talk... watch the 100 month moving average on 30 year Treasury yields. The yields have not busted above that line for decades.

[ochotona]

On macrovoices.com there is a great podcast with Jeff Snider on why long bond rates are not going to go much higher, and he doesn't think we've seen the low in interest rates yet. https://www.macrovoices.com/

On the other hand, Julian Brigden thinks the bottom in LT yields is in. New podcast. https://www.macrovoices.com/

Julian gave out a gem early in the talk... watch the 100 month moving average on 30 year Treasury yields. The yields have not busted above that line for decades.

Where can you chart the 100 month MA?

If you have a pay account at Stockcharts.com, you can do it. below is the chart from Julien Brigden. The green line is the 100 month MA. The 435 week moving average works, too, for free on Stockcharts.com. Symbol is $UST30Y. It shows if we break above 3.25% on the 30 year, it will be the first time that moving average has been broken in 33 years.

[jhogue]

What a cool chart!

Looks like an advertisement for EE bonds (3.53% guaranteed at 20 years).

[jhogue]

Desert,

Perhaps I should have been more explicit:

The current iteration of EE bonds was initiated in May of 2005, featuring a doubling of purchase price at 20 years, or 3.53% p.a., tax deferred and free of state and local taxes.

Some people on this forum have said they would never even consider buying EE bonds for PP “deeper cash” because they can’t envision “locking up their cash for 20 years” to get that doubling effect. Presumably, they fear inflation and/or rising interest rates because “interest rates have no place to go but up.”

Ochotona’s chart notes that the 100 month SMA since 1985 comes in at 3.2577% p.a., with not much volatility as I read it. That means to me that holders of EE bonds since May 2005 have done OK. To be sure, they didn’t get rich quick buying and holding EE bonds, but they didn’t lose their shirt in a speculative bet on interest rates either.

Happy Easter everybody!

[jhogue]

1. Yes, lower rates have certainly benefited EE bond holders. To put it in more concrete terms: If you bought EE bonds at 3.53% in 2005, you would have to be able to find a Treasury note of seven years’ maturity today, yielding more than 8%, in order to exercise your option to sell your EE bond (and buy that seven year 8%+ Treasury at a net profit). Not going to happen—unless you are so personally desperate for cash you have liquidated everything else in PP Cash.

2. You are certainly correct that there has been a significant appreciation in long bond values during the period shown in ochotono’s chart. No doubt about it, long bonds have certainly lifted permanent portfolios—mine included. Have long term interest rates finally turned a corner and started heading upward? The only correct answer to that question is that nobody knows for sure. It is difficult to imagine the kind of massive deflation that it would take to force long term dollar interest rates to go negative from here (thereby lifting LTT values still higher), but the recent examples of the euro and Swiss franc certainly suggest it is not entirely out of the realm of the possible.

[jhogue]

1. Investors sometimes mistakenly believe that you are permanently “locked in” for 20 years when you buy an EE bond. However, should current interest rates climb high enough, you always retain the option to trade any EE bond for a better performing Treasury at 0% cost. (Just don’t forget that you will have to pay federal taxes on accrued interest).
For the chart I use to manage EE bond “swaps” for Treasurys over time,
see moda’s “EE Bond Phantom Return Analysis”
viewtopic.php?f=4&t=1760&p=148025&hilit ... df#p148025
I suppose I should note once again that using savings bonds is an optional deviation from Harry Browne’s passive strategy for PP Cash. You run no additional risk in terms of safety, stability, and liquidity by holding savings bonds instead of a Treasury MMF for some portion of your PP Cash, but you do have to actively manage savings bonds in order to maximize yield when you purchase and minimize tax consequences when you redeem them.

2. Today’s article in the Wall Street Journal, “Foreign Demand Curbs Treasury Yields,” is a reminder that rates for all maturities of U.S. Treasurys are significantly impacted not only by US government borrowing, but also foreign central banks’ demand for dollar-denominated securities to fund their trade surpluses with the US. In the past few years strong foreign demand has played an important role in dampening the anticipated rise in Treasury interest rates. Demand for dollars is also stoked by global markets in commodities like oil, which trades almost exclusively in dollars, regardless of the nationality of either the buyer or the seller. Fun and exciting to be the world’s reserve currency, isn’t it?

[Xan]

you always retain the option to trade any EE bond for a better performing Treasury at 0% cost

What does that mean? Please elaborate.

I believe he's saying that if short-term rates increase, you can always cash out your EE bonds without penalty (although with taxes) and then buy short-term T-bills instead.

In other words, you're not trapped at a rate that looks high now but might not in the future.

[jhogue]

Xan,

You won’t be buying short-term T-bills to replace your EE bonds with this strategy. Let us say you bought a $10,000 EE bond ten years ago. Checking moda’s chart, if today’s rate rose to over 6%, you should exercise your option to redeem your EE bond ($10,000 + 0.1% annual interest ) and then buy a ten year 6% Treasury note for $10,000 to get the same double-your-money effect (guaranteed $20,000 at 20 years).

Moda’s break-even interest rate curve begins to rise ever-more steeply after about ten years. What that means in effect is that you have to check current interest rates against your EE bonds for their first five to ten years more frequently. After ten years, it becomes increasingly unlikely that interest rates could rise high enough to trigger an EE bond redemption. As I stated, these new iteration EE bonds first available in 2005 now have just 7 years to reach their 20 year double-your-money mark (2025). You would not redeem them today unless you could find an offer of a 7 year Treasury with a yield to maturity of at least 8.19%.

Note that savings bonds belong in PP Cash, not PP Bonds, because they are not marketable and therefore do not have the volatility that Harry Browne wanted from LTTs. All of their appreciation comes from interest, not the interest + capital gains of LTTs. Used properly, however, they can give you a more profitable and robust Treasury barbell over time.

[Xan]

Got it. That makes sense.

[boglerdude]

Deflationary Forces Will See 30-Year UST Going To 2%: Shilling
https://www.bloomberg.com/news/audio/20 ... g-jfo8f3p9

Shilling appears to have less of agenda than other pundits. Or maybe thats my confirmation bias, he makes me feel better about being a cowardly investor

[I Shrugged]

Shilling has been right on bonds for something like 30 years. I have made good money by believing him, well before the PP.

[barrett]

Not sure where to post this so I'll just resurrect this old thread...

We used to discuss at what level of yield would people start selling off their long bonds. Are we there yet for any of you? As I write this, the yield has just dipped to 1.25% (!!!!). Any sellers? Thanks.

[dualstow]

Not sure where to post this so I'll just resurrect this old thread...

We used to discuss at what level of yield would people start selling off their long bonds. Are we there yet for any of you? As I write this, the yield has just dipped to 1.25% (!!!!). Any sellers? Thanks.

Hey, it’s barrett!

I sold a bunch of long bonds prematurely (last year), thinking they’d never get better than breakeven.
Repurchased some EDV and bonds before all this drama, luckily, but not enough.
Now I’m getting close to selling “purposely prematurely” because I *would* be close to a rebalancing point if I had those bonds.
What to buy? stocks and CDs.

[Tyler]

Not sure where to post this so I'll just resurrect this old thread...

We used to discuss at what level of yield would people start selling off their long bonds. Are we there yet for any of you? As I write this, the yield has just dipped to 1.25% (!!!!). Any sellers? Thanks.

If anything, the record low rates make me appreciate the role of long term treasuries in the PP even more. They're primarily driven not by the interest rate they pay but by changes in interest rates, and because of bond convexity they're more responsive than ever. That may not be appealing for portfolios that use bonds as ballast against stock volatility, but for portfolios like the PP that balance multiple volatile assets the low rates actually help.

Here's a quick primer: https://portfoliocharts.com/2019/05/27/ ... convexity/

[dualstow]

If anything, the record low rates make me appreciate the role of long term treasuries in the PP even more. They're primarily driven not by the interest rate they pay but by changes in interest rates,

It's both, right? When I first logged on here, Craig said that the long bonds were good for paying living expenses. (He must have a lot of bonds). I primarily thought about yield until, like you wrote above, interest rates changed.
Suddenly, I found I was holding bonds with a yield that looked pretty attractive compared to the rate for most instruments.

The other difference is that you can't sell someone your savings account. You can't sell your (non-brokered) CD or savings bond for a profit, even if the yield is decent. You can sell your treasury bonds.

So now the yield is just one marker of many of how great the value of the bond could be.