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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?

Bonds / Fixed Income
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January 2017

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®

January 2017
January 2017
January 2017
January 2017