What is the current state of the Bond Market?
From what I know and understand, the Bond Market ended its long run of being in a bull market. I've read that Trump's impending presidency has had negative affect on bonds. Why is that and does it have to do with increasing inflation? Is the bond market dead?
Bond prices are inversely correlated with interest rates (and inflation), meaning when rates go up, bonds go down period. It has nothing to do with Trump, but he will be the scapegoat as would anyone who is in office at the time bonds break "bigly." Actually, the Fed is to blame for taking interest rates artificially down way below historical levels & the politicians who created the 2008 crisis in the first place with free, easy money. Sound familiar?! But what do YOU do going forward is the question.
The long term dropping interest rate cycle for bonds since 1981 is over and the longer term trend for interest rates is up. Therefore, the risk profile for bonds has increased significantly. During the high inflation of the late 70s, long term treasury bonds dropped over -30% in a year! So are bonds safe?! Not always. Sometimes they are very risky and it depends upon the time frame. So, the pie chart telling you that, because you are older you need much more allocated to bonds forgets one very important thing. The markets do not care about your time frame and are on their own time frame. Therefore, you must learn to get in sync with the mid and longer term market cycles as best you can.
Do you need to be more conservative when you are older? Absolutely. But bonds may not be more conservative at any particular time. During the 70s, bonds and stocks both lost lots of money because of high inflation. Precious metals and commodities were the only game in town. Then when Volker began to raise rates to high double digit levels to kill inflation, precious metals were are horrible investment for over 20 years until the early 2000s. And you could lock in long term bonds with double digit interest and capital gains as rates dropped after peaking. So from 1981 until just recently, bonds' risk profile was significantly lower than it is today or especially in the 70s.
Regarding your inflation question, inflation hurts purchasing power and NOTHING is truly fixed but fluctuates. Bonds and their interest payments are denominated in fixed dollar amounts, so you get paid back later in a certain quantity, that if we have high inflation, will buy much less. That means longer term bonds will have more "time" risk and purchasing power risk and be more sensitive to rising rates and/or inflation. So when rates are likely to drop, you want longer term bonds for higher interest and higher capital gains with lower risk. But when rates are likely to rise, to the extent you even want bonds, you want short term bonds with lower interest but lower risk (price fluctuation) to "bide" your time until the dust settles. This is why most pros on Wall Street don't really hold bonds to maturity, that is a story for retail investors. They will invest in longer maturity bonds when rates are going to drop and short on the interest rate curve when rates are likely to go up.
The problem now is that the Fed has taken rates so artificially low, that you can't even get hardly any interest with short or even mid term bonds. This is what the Fed and ECB meant a few years ago when they said they wanted to "force investors into riskier assets." That meant conservative investors looking for yield wouldn't be able to find in bonds and therefore have to look at dividend stocks and REITs. This was also called the "reflation" trade intended to create to 2% target inflation which is pure madness by the Fed.
I will get off my Bully pulpit now but just wanted you to understand as best you could. But in very simple terms, yes, bonds are much riskier now and the long term cycle and bull market in bonds is most probably over. If you plan to invest in bonds, I would use Exchange Traded Funds (ETFs), which is a basket of bonds and if you want or decide to get out, you can with one simple trade. You don't have to get bid-ask auction bids like you do with individual bonds. If/when it hits the fan, smaller investors will get taken to the woodshed on the spread as bonds are normally traded in million dollar blocks. Smaller orders get worse fills.
I hope this helps and I know I dove a little deep, but I wanted to be thorough. You asked a complicated question and I wanted to give you a complete answer. Best of luck, Dan Stewart CFA®
My first suggestion would be to turn off the television when it comes to investing. No one on TV knows where the bond, stock, or any other market is going. Talking heads tend to be talking "their book" meaning how they are positioned. Networks are in the business to increase advertising dollars and not give sound financial advice. My second suggestion is stick to whatever investment process your believe in no matter what the market cycle is. Most investors tend to make their biggest mistakes by being fearful when they should be greedy and greedy when they should be fearful. So if you are a buy and holder, buy and hold. If you are trend follower, follow the trends. If you don't have an investment process, my third suggestion is to hire a financial advisor that has an investment process that matches your goals and personal thoughts on investing.
We believe the Federal Reserve (Fed) has been overly cautious in the face of unchanged fiscal policy and ongoing global challenges. After a December, 2015 trial balloon increase in the federal funds rate, the Fed increased rates again this December. They also telegraphed tighter monetary policy, with the prospect of two to four more increases in 2017. These increases will eventually impact money market interest rates, which in turn will eventually increase earned interest income for savers. More immediately, it will increase interest rates on debt tied to LIBOR or prime rates, increasing interest expense for borrowers. Longer-term interest rates will be more influenced by demand for funds, supply of bonds, and inflation expectations.
While it has been a bumpy 35-year decline in longer-term interest rates, it has been an unmistakable trend. When a trend of that length and importance changes, one has to go back to the so-called drawing board to chart the path forward as existing cause and effect relationships will be altered. One relationship that will not change is how rising interest rates affect the price of bonds. If we are at the beginning of a range-bound trend in longer-term interest rates, bonds lose some of their investment luster. If we are at the beginning of an uptrend in longer-term interest rates, long-term bonds could become one of the worst investments on the planet.
The demise of the bond market has been forecast for some time. Most notably, pundits predicted a spike in interest rates after congressional testimony from Ben Bernanke in May of 2013. In his remarks, the Fed Chairman opened the door to "possible" rate increases. In fact, there was a near consensus that interest rates were on the way up. The press called it the "Taper Tantrum." Indeed, the yield on the ten year treasury increased over 0.70% in the weeks following Benanke's remarks. Of course, the bond market rallied substantially thereafter and, even now, long term rates are a bit lower than they were in the summer of 2013.
I use this illustration to temper your enthusiasm for the conventional wisdom. The US Bond market is pretty much the world's most followed market. There is a high likelihood that all relevant information is factored into the term structure of US interest rates. Sure, there is more room for rates to increase than to fall. The same could be said five years ago, yet, a diversified US bond fund (e.g. the aggregate bond index) has beaten inflation since that point.
That said, you're right to conclude that Trump's promise of large scale infrastructure spending has spooked bond markets. Market based measures of expected inflation have likewise increased. $1 trillion in public works would increase our fiscal deficit dramatically. But these massive infrastructure spends are still supposition. Congress might not cooperate. America might lurch back towards 0% growth causing the Fed to ease back on rates. The dollar is really the only game in town now. Foreign investors may effectively put a ceiling on US interest rates by chasing our comparatively high yields (German 10 year Fund is yield less than 0.25%). Lots can happen.
Bonds should still be a part of your portfolio and constitute a core asset class. Of course, don't expect the high returns going forward that they've generated in the last 35 years. It's fair to shade credit quality and maturity based on some level of market expectation. But don't stray too far from market cap weighted benchmarks. A buy and hold approach is the most prudent long term fixed income strategy.
The demise of the bond market has been written about for over a decade. You may not be aware, but the total value of all bonds in the global market is far greater than the total value of all stocks in the global market. As of the last numbers I have in 2010, the bond market is almost twice the size of the stock market. President elect Donald Trump's impending presidency should have a positive effect on bonds if we see a doubling of GDP growth from recent years. Reporting that there will be a negative effect has more to do with the idea that since we are in a generally rising interest rate environment, and under Trump we will finally get some domestic growth, then rates will rise quickly making bond prices fall. There is an inverse correlation. When there is growth (and subsequent inflation), the Fed will tend to raise rates to slow things down if the growth gets too heated and inflation rises above where the Fed is targeting. It certainly is more like watching paint dry than it is any sudden jerky event. No, the bond market is not dead.