Bonds !!!

[Radagast]

Historically, bonds and equities were less correlated but the FED/Treasury has changed it all in the recent past and they have become more correlated, so how that works out is TBD.

That is not correct. From 1940-2000 bonds and stocks became increasingly correlated to the point that people seriously asked why bother with bonds at all, as they appeared to be lower return versions of stocks. 2000-2020 were actually an unusual period of strong negative correlation, unprecedented since the Great Depression and if anything stronger than then.

That's not what the fixed income specialists at PIMCO say:

"Presumably, many believe the historically negative stock-bond correlation reflects the degree to which bonds will effectively hedge against a significant equity market sell-off, as happened in the 2008 global financial crisis."
https://global.pimco.com/en-gbl/insights/viewpoints/does-the-stock-bond-correlation-really-matter

The 1926-2019 stock/bond correlation varies from 0.07 (monthly) to 0.21 (5 year) according to this research:
https://www.statestreet.com/content/dam/statestreet/documents/Articles/Stock-bond-correlation-full-paper.pdf
This source reports the average annual correlation in this period as 0.11. Intuitively, since we know it has been more like -0.6 over the past twenty years, the correlation in 1926-1999 must have been notably higher than 0.11.
So I disagree with your correction, although I'd be open to data showing the correlation is high.  For a U.S. investor, bonds provide much better diversification than international equities.  That's why traditional advice is to have a mix of stocks and bonds.

The top DuckDuckGo result contained this
https://www.grahamcapital.com/Equity-Bond%20Correlation_Graham%20Research_2017.pdf

They weren't as highly correlated like most stocks are, but a +0.5 correlation is a lot more than the -0.5 or less we have had the last 20 years. Though a note is that in a crisis, there was still a flight to safety that resulted in negative correlation even in times of general positive correlation. Eventually something will change and stocks and bonds will go back to being positively correlated.

My statement came from something I was reading about a few years ago, I don't remember what all my sources were. Correlations are not consistent across time. From 1960-1990 international stocks would likely have been better diversifiers, but I don't have anything to back that up (I suppose I could go googling but meh).

[rudged]

I don't think I will ever buy bonds.

I'm in my late fifties and pursuing the path of a SWAMI, i.e. I like my job (professor) and can continue working as long as I am able.

Following J L Collin's advice, I have everything invested in equities while I am working. He advocates shifting some of your wealth to bonds when you enter the wealth preservation stage, i.e. stop working. And he points out the reason for doing so, namely in the absence of regular contributions to your investments, the ride will be more volatile.

In my situation, retirement will be a relatively short period of time after I stop working in my early seventies. I will be eligible for Social Security and that will cover most of my expenses, because I have no debts. I anticipate a shortfall between my estimated SS and my expenses of about $1,000 per month.

I have every reason to believe required minimal distributions from my retirement plans will cover this shortfall given how much I've saved so far. In other words, I won't be choosing to sell when I perceive the market is up or down (as if one ever has the ability to do that at the time). Instead, I will compensate, once I can determine that the required minimum distribution was during a bear market, to purchase additional index stock funds when they are on sale.

I think the emphasis that is so often placed on owning bonds reflects an assumption that the retiree either has a relatively small nest egg and must take extra precautions to preserve it against black swan events OR it presumes the individual is pursuing a very early retirement, e.g. thirty or forty years of "retirement."

[vand]

I don't think I will ever buy bonds.

I'm in my late fifties and pursuing the path of a SWAMI, i.e. I like my job (professor) and can continue working as long as I am able.

Following J L Collin's advice, I have everything invested in equities while I am working. He advocates shifting some of your wealth to bonds when you enter the wealth preservation stage, i.e. stop working. And he points out the reason for doing so, namely in the absence of regular contributions to your investments, the ride will be more volatile.

In my situation, retirement will be a relatively short period of time after I stop working in my early seventies. I will be eligible for Social Security and that will cover most of my expenses, because I have no debts. I anticipate a shortfall between my estimated SS and my expenses of about $1,000 per month.

I have every reason to believe required minimal distributions from my retirement plans will cover this shortfall given how much I've saved so far. In other words, I won't be choosing to sell when I perceive the market is up or down (as if one ever has the ability to do that at the time). Instead, I will compensate, once I can determine that the required minimum distribution was during a bear market, to purchase additional index stock funds when they are on sale.

I think the emphasis that is so often placed on owning bonds reflects an assumption that the retiree either has a relatively small nest egg and must take extra precautions to preserve it against black swan events OR it presumes the individual is pursuing a very early retirement, e.g. thirty or forty years of "retirement."

To say this with the certainty of someone who expects stocks to handily beat bonds over the timeframe you are talking about, but it's entirely within the realms of reasonable possibility that bonds will outperform equities between now and your retirement date. The few times the market has been this expensive the subsequent 10-15 year period has been poor, and there have been long multi-decade stretches where bonds have outperformed equities.

I don't advocate for anyone to put 100% in bonds, but the same is true of stocks. Diversification is your friend when the future is unknowable.

[rudged]

I don't think I will ever buy bonds.

I'm in my late fifties and pursuing the path of a SWAMI, i.e. I like my job (professor) and can continue working as long as I am able.

Following J L Collin's advice, I have everything invested in equities while I am working. He advocates shifting some of your wealth to bonds when you enter the wealth preservation stage, i.e. stop working. And he points out the reason for doing so, namely in the absence of regular contributions to your investments, the ride will be more volatile.

In my situation, retirement will be a relatively short period of time after I stop working in my early seventies. I will be eligible for Social Security and that will cover most of my expenses, because I have no debts. I anticipate a shortfall between my estimated SS and my expenses of about $1,000 per month.

I have every reason to believe required minimal distributions from my retirement plans will cover this shortfall given how much I've saved so far. In other words, I won't be choosing to sell when I perceive the market is up or down (as if one ever has the ability to do that at the time). Instead, I will compensate, once I can determine that the required minimum distribution was during a bear market, to purchase additional index stock funds when they are on sale.

I think the emphasis that is so often placed on owning bonds reflects an assumption that the retiree either has a relatively small nest egg and must take extra precautions to preserve it against black swan events OR it presumes the individual is pursuing a very early retirement, e.g. thirty or forty years of "retirement."

To say this with the certainty of someone who expects stocks to handily beat bonds over the timeframe you are talking about, but it's entirely within the realms of reasonable possibility that bonds will outperform equities between now and your retirement date. The few times the market has been this expensive the subsequent 10-15 year period has been poor, and there have been long multi-decade stretches where bonds have outperformed equities.

I don't advocate for anyone to put 100% in bonds, but the same is true of stocks. Diversification is your friend when the future is unknowable.

Thanks for your reply. The previous posts give a lot of reasons to be dubious that bonds will rise, particularly in the near future with so much government spending going on. If inflation starts to get out of hand, I expect the first response will be to increase, not decrease, interest rates. I note further that SS serves as a fixed security and investing in index funds provides plenty of diversification (see Collins' Simple Path to Wealth on this point).

In any event, my planned strategy does _not_ depend my having any insight into whether the markets for either bonds or stocks will rise or fall. Read back over my original post - it never once mentions any belief that stocks will rise relative to bonds. It is precisely because I am ignorant of the future that I plan to compensate for changes rather than predict.

[vand]

I don't think I will ever buy bonds.

I'm in my late fifties and pursuing the path of a SWAMI, i.e. I like my job (professor) and can continue working as long as I am able.

Following J L Collin's advice, I have everything invested in equities while I am working. He advocates shifting some of your wealth to bonds when you enter the wealth preservation stage, i.e. stop working. And he points out the reason for doing so, namely in the absence of regular contributions to your investments, the ride will be more volatile.

In my situation, retirement will be a relatively short period of time after I stop working in my early seventies. I will be eligible for Social Security and that will cover most of my expenses, because I have no debts. I anticipate a shortfall between my estimated SS and my expenses of about $1,000 per month.

I have every reason to believe required minimal distributions from my retirement plans will cover this shortfall given how much I've saved so far. In other words, I won't be choosing to sell when I perceive the market is up or down (as if one ever has the ability to do that at the time). Instead, I will compensate, once I can determine that the required minimum distribution was during a bear market, to purchase additional index stock funds when they are on sale.

I think the emphasis that is so often placed on owning bonds reflects an assumption that the retiree either has a relatively small nest egg and must take extra precautions to preserve it against black swan events OR it presumes the individual is pursuing a very early retirement, e.g. thirty or forty years of "retirement."

To say this with the certainty of someone who expects stocks to handily beat bonds over the timeframe you are talking about, but it's entirely within the realms of reasonable possibility that bonds will outperform equities between now and your retirement date. The few times the market has been this expensive the subsequent 10-15 year period has been poor, and there have been long multi-decade stretches where bonds have outperformed equities.

I don't advocate for anyone to put 100% in bonds, but the same is true of stocks. Diversification is your friend when the future is unknowable.

Thanks for your reply. The previous posts give a lot of reasons to be dubious that bonds will rise, particularly in the near future with so much government spending going on. If inflation starts to get out of hand, I expect the first response will be to increase, not decrease, interest rates. I note further that SS serves as a fixed security and investing in index funds provides plenty of diversification (see Collins' Simple Path to Wealth on this point).

In any event, my planned strategy does _not_ depend my having any insight into whether the markets for either bonds or stocks will rise or fall. Read back over my original post - it never once mentions any belief that stocks will rise relative to bonds. It is precisely because I am ignorant of the future that I plan to compensate for changes rather than predict.

Note that I did not mention anything about yields falling back to allow bonds to rise again.  Stock returns by themselves could easily disappoint on an absolute basis from this point.

JL Colins advice is good in you are invested during a secular bull market, but very poor if you are investing throughout a secular bear.

[maizefolk]

To say this with the certainty of someone who expects stocks to handily beat bonds over the timeframe you are talking about, but it's entirely within the realms of reasonable possibility that bonds will outperform equities between now and your retirement date. The few times the market has been this expensive the subsequent 10-15 year period has been poor, and there have been long multi-decade stretches where bonds have outperformed equities.

I don't advocate for anyone to put 100% in bonds, but the same is true of stocks. Diversification is your friend when the future is unknowable.

There certainly have been long periods where bonds outperformed equities.

Predicting future investment returns from the present is a fraught and possible fruitless process, but if one were to attempt it, it seems to be missing half the picture to look only at equity valuations and predict they will under perform their historical averages in coming years without also looking at current low bond yields in predicting whether or not they might also under perform their historical averages in coming years.

The S&P's P/E ratio is the 3rd highest it's been in the 150 years for which we have data. Even after the incredibly sharp run up in yield (by the standards of bonds) over the past two months, US treasuries are currently at yields they'd never touched ever until 9 years ago. German bonds yields are more negative than they'd ever been prior to 2019. UK bonds are at levels never seen prior to 2016.

I don't know whether any of that is meaningful or not, but it would seem like either one should use both P/E ratios and bond yields to try to predict the future or neither.

[rudged]

Note that I did not mention anything about yields falling back to allow bonds to rise again.  Stock returns by themselves could easily disappoint on an absolute basis from this point.

JL Colins advice is good in you are invested during a secular bull market, but very poor if you are investing throughout a secular bear.

Thanks for your reply, to which I have to ask when have we had a secular bear market (aside from the period immediately preceding the Great Depression)? Collin's Chapter 7 The [Stock] Market Always Goes Up provides a nuanced rationale for why faith in equities is justified in the long run.

If you agree with Collin's general perspective, then investing completely in equities makes a lot of sense when you are gainfully employed and making regular contributions to your plans, which have the effect of smoothing out the volatility.

So the question becomes, what do you do when you are no longer making regular contributions? There are two situations to consider: 1. You are independently wealthy and don't need the income. If so, the best long term strategy is to stay invested, particularly when there is a bear market. 2. You must sell either because you need the money or you have to legally to satisfy the minimum distribution requirement.

With regard to the latter, one way (Collins advocates) to mitigate volatility is to introduce bonds. This seems to rely on the presumption that the bond market is inversely correlated with the stock market. Another way, he mentions later in the book, is to compensate by buying stocks when the market is down. In essence, you avoid the adverse consequences of selling by buying your own stocks back. This is an option for those who don't have to live on the proceeds from the sale of stocks. I fall into this later situation because when I sell, I will be doing so to satisfy a required minimum distribution, not some perception on my part as to whether the stock market is rising or falling.

My strategy ignores what is going on in the bond market. I suppose in retrospect for some periods of time this might have resulted in a lower return. This has to be balanced against the fact that in other periods of time the bond market has not done better, and crucially, I won't know which I am in at the time. 

[MustacheAndaHalf]

If inflation starts to get out of hand, I expect the first response will be to increase, not decrease, interest rates.

Not according to the Federal Reserve:

"The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time."
https://www.federalreserve.gov/newsevents/pressreleases/monetary20210317a.htm

[maizefolk]

Personally I wouldn't consider inflation getting out of hand to mean the same thing as "moderately exceeding 2%".  I'd put moderately exceeding 2% as 2-4% and getting out of hand at >5%. But that's the danger with nonquantitative terminology. "Moderately exceeding" and "getting out of hand" can mean radically different things for different people.

[MustacheAndaHalf]

As quoted in my prior post, the Fed has twin goals of inflation and maximum employment.  My guess is they'd allow 2-3% inflation while unemployment continues to drop, since that satisfies both their goals at once.  I don't know at what point inflation fears outweigh their other goal of maximum employment.

I believe inflation has been below 2% for a decade, so if you add up all the gaps to 2%, you could make a case that inflation averaging means making up for those gaps and letting inflation run over 2% for years.  Also, with inflation being so low for so long... maybe it will continue?  The counter-argument being the Fed's estimate of +6.5% GDP growth this year... so maybe that provides more of a chance for inflation.

[maizefolk]

Agreed. Although maximizing employment is a tricky one. Labor force participation has been trending downwards since the 1990s.* So if the goal is to let the economy run hot until we hit 1990s levels of employment relative to population, that's an awful lot of inflation. And like the decades of low inflation, we don't really have a good explanation for why the economy is creating jobs for a smaller and smaller proportion of our potential workforce (I certainly have my own ideas, but there is no broadly accepted consensus). I'd consider it an open question how close we can back to something resembling historical periods of maximum employment.

*It's been declining a longer if you look only at men in the labor force. Through the 1990s the larger effect of more and more women entering the workforce more than counterbalanced the impact of more and more men dropping out of the workforce.

[vand]

I don't know whether any of that is meaningful or not, but it would seem like either one should use both P/E ratios and bond yields to try to predict the future or neither.

It just means that we should expect lower returns across both bonds and equities. 

- Future Bond returns are 90% correlated with their current yield. We pretty much know what a bond is going to return (nominally) over its entire duration.

- Future Stock returns (over 10 yrs) are about 45% correlated with their valuations . Judging stock returns is harder as there is no dominant correlating factor, but valuations are still the best guide we have.

We've had such a long stretch of overperformance that a period of underperformance is overdue and should be expected. You can't keep overperforming forever and headwinds are now much stronger for equities that could bring about that underperformance.

Some modellers think the S&P could easily return nothing over the next decade. Here is one that I follow that predicts 0.5% nominal 10yr returns: https://alephblog.com/2021/03/12/estimating-future-stock-returns-december-2020-update/

So you can see why I say that it's entirely possible that the 10yr note could outperform the S&P over the next decade. I don't want to sound perma-bearish because don't think that's true, but it's possible that US bonds will outperform US stocks over the next decade but any combination of US stocks/US bonds will lose purchasing power..

[maizefolk]

Unfortunately trying to visit the link you posted throws a security error for my browser at the moment. Not sure what the issue is there.

In any case, yes I agree with you that current bond yields are more predictive of the future returns of an investment in bonds than current P/E ratios are of the future returns of an investment in stocks.

Where we disagree (I think) is that I believe that generally having bond returns beat stocks by a meaningful amount over a decade long time frame is the result of both a very good decade for bonds and a very bad decade for stocks. While I also agree with you that sooner or later the stock market will crash* my concern is that, while there is certainly the potential for stocks to have an exceptionally bad decade (March 2021 to March 2031), I don't see any way for bonds to have an exceptionally good decade (March 2021 to March 2031) given where yields are at presently.

*That's never been a wrong prediction at any point in history up until now

[vand]

Unfortunately trying to visit the link you posted throws a security error for my browser at the moment. Not sure what the issue is there.

In any case, yes I agree with you that current bond yields are more predictive of the future returns of an investment in bonds than current P/E ratios are of the future returns of an investment in stocks.

Where we disagree (I think) is that I believe that generally having bond returns beat stocks by a meaningful amount over a decade long time frame is the result of both a very good decade for bonds and a very bad decade for stocks. While I also agree with you that sooner or later the stock market will crash* my concern is that, while there is certainly the potential for stocks to have an exceptionally bad decade (March 2021 to March 2031), I don't see any way for bonds to have an exceptionally good decade (March 2021 to March 2031) given where yields are at presently.

*That's never been a wrong prediction at any point in history up until now

I'm not necessarily predicting a stock market crash, but I do expect valuations to adjust down over the course of the next decade... a crash is probably the easiest way to get there, but who knows how it will unfold, maybe it will just be a series of failed rallies with the market going mainly sideways for a decade or more.

Asset prices don't exist in isolation from one another; stock prices factor in bond prices, and as they are considered riskier they are usually priced to deliver higher expected returns over the long run. But it doesn't need a particularly "good decade for bonds vs bad decade for stocks" scenario for bonds to outperform over that sort of timeframe.  Long term real return on stocks is around 6% vs long term real return on long dated treasuries of around 4%, but a decade of bonds beating stocks would not be that unusual.

I played with PortfolioVisualiser comparing a 100% US stock vs 100% US LT bond portfolio. For some starting months around 1980-81 Bonds beat stocks all the way up to 2012-13, ie 31-32 years! If you extend it to the current day, there were several points where total stock return was less than 1% ahead of the total bond return (that's 1% total portfolio value, not 1%pa excess return), with the most recent being March 2020.

If we had daily data available then I'm pretty confident that we would be able to find a holding period between 1981-2020 where bonds had outperformed.

Yes, of course I am cherry picking the most favourable period for Bonds in well recorded history here, but that is the point - to illustrate just how long it can take before the expected natural order exerts itself.

Stocks v Bonds since Sept 1981:

[vand]

another way to summarise that last chart: The stock market has returned almost twice the bond market since September 1981, and just about ALL of that outperformance has come in the last 11 months.

Crazy crazy stuff.

[maizefolk]

I played with PortfolioVisualiser comparing a 100% US stock vs 100% US LT bond portfolio. For some starting months around 1980-81 Bonds beat stocks all the way up to 2012-13, ie 31-32 years! If you extend it to the current day, there were several points where total stock return was less than 1% of the total bond return (that's 1% total portfolio value, not 1%pa excess return), with the most recent being March 2020.

If we had daily data available then I'm pretty confident that we would be able to find a holding period between 1981-2020 where bonds had outperformed.

Yes, of course I am cherry picking the most favourable period for Bonds in well recorded history here, but that is the point - to illustrate just how long it can take before the expected natural order exerts itself.

Stocks v Bonds since Sept 1981:

I agree 1981 was a great year to have invested most of ones net worth in bonds. US treasuries were yielding 14%. I thought you and I agreed up thread that the long term return of bonds is much more predictable from their current yields than current valuations are the long term returns of stocks?

But it seems to me like you're putting a lot of emphasis on your prediction of poor returns for stocks based on a relationship to valuation which is extremely noisy at best, and then ignoring the much less noisy relationship (current bond yields and future bond returns) which already tells us bond returns going forward are extremely unlikely to come anywhere close to those observed in 1981 (or in fact the returns of investing in bonds any year prior to 2010).

[vand]

I played with PortfolioVisualiser comparing a 100% US stock vs 100% US LT bond portfolio. For some starting months around 1980-81 Bonds beat stocks all the way up to 2012-13, ie 31-32 years! If you extend it to the current day, there were several points where total stock return was less than 1% of the total bond return (that's 1% total portfolio value, not 1%pa excess return), with the most recent being March 2020.

If we had daily data available then I'm pretty confident that we would be able to find a holding period between 1981-2020 where bonds had outperformed.

Yes, of course I am cherry picking the most favourable period for Bonds in well recorded history here, but that is the point - to illustrate just how long it can take before the expected natural order exerts itself.

Stocks v Bonds since Sept 1981:

I agree 1981 was a great year to have invested most of ones net worth in bonds. US treasuries were yielding 14%. I thought you and I agreed up thread that the long term return of bonds is much more predictable from their current yields than current valuations are the long term returns of stocks?

But it seems to me like you're putting a lot of emphasis on your prediction of poor returns for stocks based on a relationship to valuation which is extremely noisy at best, and then ignoring the much less noisy relationship (current bond yields and future bond returns) which already tells us bond returns going forward are extremely unlikely to come anywhere close to those observed in 1981 (or in fact the returns of investing in bonds any year prior to 2010).

Both stocks and bonds are priced to deliver mediocre returns in the next decade, only stocks moreso now imo.  Stocks are at 1929/1999 valuations. On both those occassions returns over the next decade were not good.

Note that I say "priced to". No guarantee that's how it's going to play out, especially on the stock side.  US stocks especially do have a history of overperforming from lofty valuations. The 2000s should have been a disaster - instead, they were merely poor, so maybe I'm too pessimistic on the outlook for stocks, but I can't ignore the valuation factor.

[maizefolk]

Both stocks and bonds are priced to deliver mediocre returns in the next decade, only stocks moreso now imo. 

Here, I think is the crux of our disagreement.

I agree with you that (if valuation and yields have predictive values) both bonds and stocks are set up for below average returns going forward.

However, yields bonds are farther outside of their historical range than are stock valuations, and bond yields are much more correlated with future bond investment returns than stock valuations are correlated with future stock investment returns, so I would argue that, if it's possible to predict future investment returns, bonds are set up for a much worse decade than stocks. You are looking at the same data and analysis and coming to the opposite conclusion (that stocks are in for a worse decade than bonds).

[vand]

Both stocks and bonds are priced to deliver mediocre returns in the next decade, only stocks moreso now imo. 

Here, I think is the crux of our disagreement.

I agree with you that (if valuation and yields have predictive values) both bonds and stocks are set up for below average returns going forward.

However, yields bonds are farther outside of their historical range than are stock valuations, and bond yields are much more correlated with future bond investment returns than stock valuations are correlated with future stock investment returns, so I would argue that, if it's possible to predict future investment returns, bonds are set up for a much worse decade than stocks. You are looking at the same data and analysis and coming to the opposite conclusion (that stocks are in for a worse decade than bonds).

Well it depends how what valuation methodology you are using.  CAPE10 suggests the market is not quite as expensive as 1999, but by some others like price to book or Buffett indicator we have exceeded dotcom levels. Stocks lost 3%pa in real terms in that decade as valuations readjusted and at many points were down much worse.

Whatever way you look at it the market is expensive and so future returns face a heavy headwind. Whether or not you think the readjustment will be as bad as it was during 2000-2010.. pretty much a wash at this point I'd say. Even if stocks manage to eke out better returns than bonds, its likely they'll only do so with a much bumpier ride, so not exactly a ringing endorsement of an all-stock strategy.

[maizefolk]

And interest rates on bonds are at levels never before seen in the historical record until about a decade ago (USA) or the last couple of years (most other developed nations).

[vand]

Yes. The future looks mediocre for bondholders too.

Only time will tell how it plays out, and it will be interesting to revisit this and perhaps similar threads in the future to see if any of these scenarios come to pass.  But it is crystal clear to me that most investors are putting too much expectatiom on stocks continuing to deliver above average returns from an already sky high starting point today.. expectations like that are rarely fulfilled.

https://www.cnbc.com/2020/08/12/millennials-expect-the-highest-investment-returns-despite-coronavirus.html

[MustacheAndaHalf]

The market more often ignores CAPE10 than abides by it - and that's the best measure available, which tells you something.  A Vanguard white paper studied the correlations between various signals and future stock returns.  Here's the top 3 correlations:
CAPE 10, 0.43 correlated
P/E, 0.38 correlated
Government debt/GDP, 0.23 correlated
http://fairwaywealth.com/wp-content/uploads/Vanguard-Research-11-30-2014.pdf#page=7

All the other signals they measured (dividend yield, GDP growth, 10 year treasury yield) had less predictive power than the above signals.  Also worth noting that the CAPE 10 was historically high for years before the dot-com crash... it predicted it every year, for many years, until it was right one year.

An example I've mentioned before is Fed Chair Alan Greenspan's "Irrational Exuberance" speech in Dec 1996.  If you invested when he made that speech, and waited years until the dot-com crash, you made a +26% profit.  Switching to cash to avoid that crash did do better.. by just 3%, with a +29% total return.
https://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm

[ChpBstrd]

This is among the best discussions I've ever seen on MMM, so thanks for that.

The Shiller earnings yield (1/ShillerPE) is 2.9% for stocks, and 10-year treasuries yield 1.62%. Both seem abysmal and dismal, but the number for stocks may not reflect future returns in the same way the treasury yield does. I'll make the best case I can make for stocks, but I simply cannot make sense of the bonds.

Note that in post-recession years, the S&P 500's earnings growth tends to leap above 20%. 2003, 2004, 2009, and 2010 were banner years for earnings growth. The average of the growth rates across those 4 years is 97% per year! When stocks post growth rates >20% for a couple of years in a row, it tends to make our judgments about PE ratios and Shiller multiples obsolete quickly. I.e. even if one buys at a post-recession time with a horrible PE ratio, the subsequent fast growth has always made up for it. And that historical note is about times when the government didn't drop thousands of dollars in the bank accounts of hundreds of millions of people.

https://www.multpl.com/s-p-500-earnings-growth

If the S&P's earnings rise from the 2020 number of $98.25 back to the 2019 number of $139.53, that would be an earnings "increase" of 42% and even this seemingly high number would not be outside historical norms. If the index's price didn't move, its PE ratio would go from 39.4 to 27.73, a drop of about 30%. Suppose we have another year of 20% earnings increases in 2022 - again this is not a historically unusual 2 years post-recession number. Our earnings are now $167.44 and if the S&P's price didn't move the PE would be 23.11, a drop of about 17%.

Suppose the price did change, and we settled at a PE ratio of 30 for the S&P500 in 2022. The S&P in 2022 would be (167.44*30=) 5,023, a price increase of 29.3% even as the PE ratio decreased by 24% in only 2 years! 

https://www.macrotrends.net/1324/s-p-500-earnings-history

All this reiterates what we learned in accounting class: Earnings are the tip of the iceberg and in percentage terms they are highly sensitive to modest changes in income and expenses. Net profit margins for S&P500 stocks tend to be around 10-11%. Stated another way, earnings have 10x to 11x leverage to changes in income and expenses. This is the case for explosive post-recession earnings growth.



If we think of recessions as periods of major cost-cutting, efficiency-investments, reductions in typically-wasteful mergers, layoffs of less-effective employees at the same time the market is flooded with talented and hungry candidates, reduction in compensation expenses for stock options, retention of dividends, etc. then we can see recessions for what they are: the foundations for a period of faster earnings growth. I'm particularly excited by early reports that 30-40% of office workers will stay working from home. The reduction in corporate costs and increase in economic productivity from this one pandemic-inspired change will rival the introduction of the personal computer in the mid-1990s and drive earnings growth for a decade - not a joke, dead serious.

But again, I can't explain why anyone would buy treasuries yielding 1.62% but a national bank hedging its currency or dollar denominated debts, or perhaps a euro or yen vs. dollar carry trader.

[tooqk4u22]

Chpbstrd - like your analysis and agree with it from a historical context but this recession wasn't a business cycle one, it came and went buffered by trillions.   I also can't make a case for bonds, long ones anyway, and yeah my cash and equivalents are losing to inflation a bit but I sleep well and at the moment it's like an insurance premium.   Again, long duration, no frigging way!

As for the market, Sure long term over decades it will revert (P/E or other metrics).  Tech software and hardware spending has been brought forward.   T&E spending will increase.   Hiring will pick up....bad for earnings short term.   

As for WFH, not sure how that will go.   But if 30-40% stay at home that will be bad for supporting industries - restaurants, real estate, clothing, office services, and so on.   That could be good for earnings short term but not so good for economy.   Maybe even deflationary, not good for stocks.   

Personally, I think office will be back to 80-90% by end of year.   Our whole system is based on watching over people.....I if I can't see you work then you must not be working.   

[Radagast]

To address the topic, I currently allocate about 5% of our assets (technically 8% or 1/12 of our tax sheltered accounts, excluding SO's 401K, but I say 5% for simplicity) to the extreme duration treasury bond fund ZROZ. I got two solid, bordering on epic, rebalances out of it last March. Then I didn't touch it until October, when I began to slowly buy back in with regular contributions. My target allocation is screaming to rebalance back into it wholesale, but I will just make regular purchases over the year because I don't know where the bottom is and DCA is a very effective tool for catching the bottom of highly volatile low return assets.

I also sporadically keep money in VWAHX. It often gets used for intermediate term money, so the amount can fluctuate by a lot. I would like to make it a full part of our asset allocation but that is probably dreaming.

[vand]

Even as US inflation is hitting its highest level in 12-13 years, the bond market seems to have completed a W bottom and is heading back up..

A perfect example - perhaps - of markets moving to discount future expected events so that by the time the bad news makes the headlines its all in the price and we're ready for a reversal?

[ChpBstrd]

Even as US inflation is hitting its highest level in 12-13 years, the bond market seems to have completed a W bottom and is heading back up..

A perfect example - perhaps - of markets moving to discount future expected events so that by the time the bad news makes the headlines its all in the price and we're ready for a reversal?

…or another counterpoint to the financial media’s narrative that YoY Prices Are So Much Higher than during the deep deflationary episode that occurred 12 months ago. Bond buyers are thinking long term and their analysis goes a lot deeper than merely comparing 12 month monthly price indexes.

[tooqk4u22]

Even as US inflation is hitting its highest level in 12-13 years, the bond market seems to have completed a W bottom and is heading back up..

A perfect example - perhaps - of markets moving to discount future expected events so that by the time the bad news makes the headlines its all in the price and we're ready for a reversal?

…or another counterpoint to the financial media’s narrative that YoY Prices Are So Much Higher than during the deep deflationary episode that occurred 12 months ago. Bond buyers are thinking long term and their analysis goes a lot deeper than merely comparing 12 month monthly price indexes.

Partly.  The reality is the everybody, including the Fed, should be benchmarking to 2019 and earlier and basically ignoring 2020.

Rates are depressed bc of the Fed still buying and more so bc of foreign buyers where their domestic bonds are still negative. 

We do have inflation running hotter that is more than transitory but long term we will likely get back to fighting deflation due to demographics and technology. 

[ice_beard]

No!!

Not now at least. 

[RobertFromTX]

In my opinion, individual investors should not hold short-term bonds/treasuries. Those are for foundations/banks/funds etc that have to by charter/law.

[AnxietyFly]

My IPS includes bonds in the plan. I have no plans on deviating from the plan based on the inflation fears. 

[vand]

Came across some really interesting data analysis of Bonds and their ability to predict inflation.

Standard orthodoxy is that, as the income from bonds is fixed, bondholders have to be vigilent against inflation and the bond market has at least some insight into the path of future inflation.

However, the history of the bond market basically dispels that myth.

https://www.piie.com/blogs/realtime-economic-issues-watch/bond-yields-are-not-good-predictors-inflation

Basically, bond yields correlate most highly with the past, not with the future. Bond holders have no idea what future inflation is likely to be, and their guess for the future is based on the rear view mirror of how the past was.  Thus, at inflexion points in history when inflation changes to disinflation or vice versa, bonds have been grossly mispriced.

Makes you think that Bonds, as of 2020-21 may once again be seriously mispriced in relation to the inflation that is about to happen.

[GuitarStv]

Since i've started investing, bond yields have been atrocious. I see a spot for bonds in my portfolio in other circumstances, but right now I'd rather have the cash than tying the cash down for essentially an equivalent-to-cash return

People keep saying that bond yields have been atrocious . . . but I've held bonds (as a bond fund - mix of corporate and government bonds) for the past twenty years and while yields have been well below that of my stocks over the same time, they have averaged out to being just under 7% a year.

[franklin4]

It's great to hold bonds when rates are falling, which they have for the last 20 years. They aren't so good when rates are going up though.

[GuitarStv]

It's great to hold bonds when rates are falling, which they have for the last 20 years. They aren't so good when rates are going up though.

You should never hold bonds because you want to get rich, regardless of rates going up or down.  You hold bonds because you want something that doesn't move in lock step with your equities.  As part of a sensible rebalancing strategy, this forces you to sell high and buy low at regular intervals.

All I was saying about rate of return is that bonds aren't anywhere near as bad as people in this thread seem to be making them out to be.  It's beating returns from holding cash by a pretty significant margin.

[habanero]

they have averaged out to being just under 7% a year.

What bonds do you hold in your fund? The Bloomberg US corporate bond index has had total return of 5.5% annualized over the last 20 years (which I also guess is more than what most would guess it to be....). As the index has been steadily going upwards for the same 20 years returns from a buy-as-you-go would have been significantly lower and there has been very few opportunities to "buy the dip" as there hardly has been any (largest ist during the GFC when it fell around 15%). The US Treasury total return index for comparison has returned 3,7% annualized over the same period - also with close to zero occations for buying any dip.

On the other side, bond indicies are a LOT more complicated than equity indices

[vand]

Since i've started investing, bond yields have been atrocious. I see a spot for bonds in my portfolio in other circumstances, but right now I'd rather have the cash than tying the cash down for essentially an equivalent-to-cash return

People keep saying that bond yields have been atrocious . . . but I've held bonds (as a bond fund - mix of corporate and government bonds) for the past twenty years and while yields have been well below that of my stocks over the same time, they have averaged out to being just under 7% a year.

But they won't return that much going forward. I'm comfortable saying that its impossible that any investment grade fixed income will return anywhere near 7% when junk bonds are today below 5%.

[habanero]

I just bough my first bond fund! Granted, I have some funky stuff that has most bond characteristics (guaranteed minimum return, pays out a sum yearly from regular retirement age till I die) but I cannot sell it and the value of it doesnt fluctuate with the bond market or any other market for that matter.

Not that I have great faith in returns from bonds at the moment, but I'm soon gonna need something to rebalance into if equities keep going higher. The non-market part has been in cash up to now as the yields have been pretty much the same as bonds and with zero credit or duration risk, but time to get some bonds I guess. As I live in TinyCoutry(TM) the bond fund universe is pretty small as I need it to be either domestic names or FX hedged back to local currency. And I don't really want much duration risk at the moment so I've bought some with a 3y maturity profile currently yielding a whopping 2.1% for a portfolio of investment-grade bonds. I can also get something tracking the Barclays Global aggregate with an FX hedge but a dration of around 10 with bit over 2% yield isn't what Im most keen on these days so prefer to keep the duration shorter.

Not quite as dire as it can be elsewhere as our local rates market is already pricing in quite a few hikes the coming year(s) and the inflation rate is (at least for now) also quite a bit lower than in the US - our headlie CPI is around 3.5% but ex electricity its at 1.2% YoY so not that bad (yet!).

[vand]

Bonds have started 2022 absolutely awfully.

And also with yields rising, we are again seeing the flight from growth to value stocks.  This may be a theme that runs throughout 2022 with the inflation continuing to be higher than most of us would like to see.

I halved my bond weighting last year as inflation started to rise, and see no compelling reason to go back in. The case for bonds is very difficult to make when real yields are so deeply negative.

[vand]

I dunno if it's appropriate to call this a crash... but it seems like the bond selloff is accelerating to the downside.

Yields rising all the time.

10yr note now at 1.353%
30yr note now at 2.146%

The bond market is clearly signalling something different to the mainstream narrative of interest rates being held "as low and possible for as long as possible".

Barely a year later..


10yr note now at 2.48%
30yr note now at 2.54%

a BIG jump in yields today.

The yield curve looks suspectible to inversion across any number of points -- Look how that spread between the 10yr and 30yr has narrowed!

[vand]

https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value_month=202203

03/24/2022   0.16   0.31   0.52   0.96   1.55   2.13   2.35   2.37   2.39   2.34   2.63   2.51

3yr 5yr and 7yr ALL higher than the 10yr

[The 585]

BND has been getting SLAMMED lately. I've stuck to my 80/20 asset allocation, but do I continue stick it out? Will BND ever stop falling?!

[vand]

BND has been getting SLAMMED lately. I've stuck to my 80/20 asset allocation, but do I continue stick it out? Will BND ever stop falling?!

Look at long dated funds like ZROZ, TLT and EDV. They've lost amounts that wouldn't look out of place alongside a large stock market crash.

We've been talking for ages now about how bond funds could suffer some serious losses in the face of an inflationary environment coupled with rising interest rate.. it seems that scenario is now unfolding before us, and yet fixed income investors are still holding onto their bonds like they can't quite believe it's actually happening given how it was always talked about and never came to pass...

At the end of it all when bondholders have had their purchasing power cut by 2/3rds they will be like  "oh yeah, so that's what they were talking about.. I read the words but didn't really understand the implications... silly me..."

[The 585]

BND has been getting SLAMMED lately. I've stuck to my 80/20 asset allocation, but do I continue stick it out? Will BND ever stop falling?!

Look at long dated funds like ZROZ, TLT and EDV. They've lost amounts that wouldn't look out of place alongside a large stock market crash.

We've been talking for ages now about how bond funds could suffer some serious losses in the face of an inflationary environment coupled with rising interest rate.. it seems that scenario is now unfolding before us, and yet fixed income investors are still holding onto their bonds like they can't quite believe it's actually happening given how it was always talked about and never came to pass...

At the end of it all when bondholders have had their purchasing power cut by 2/3rds they will be like  "oh yeah, so that's what they were talking about.. I read the words but didn't really understand the implications... silly me..."

I'm still working, so do I stick to my AA and keep buying bonds as they fall? Is that a good approach?

[blue_green_sparks]

I guess they are expecting inflation to be back to 2 or 3% maybe next year sometime. That could be a good time to pick up some bonds if and when that happens.

[ChpBstrd]

BND has been getting SLAMMED lately. I've stuck to my 80/20 asset allocation, but do I continue stick it out? Will BND ever stop falling?!

Look at long dated funds like ZROZ, TLT and EDV. They've lost amounts that wouldn't look out of place alongside a large stock market crash.

We've been talking for ages now about how bond funds could suffer some serious losses in the face of an inflationary environment coupled with rising interest rate.. it seems that scenario is now unfolding before us, and yet fixed income investors are still holding onto their bonds like they can't quite believe it's actually happening given how it was always talked about and never came to pass...

At the end of it all when bondholders have had their purchasing power cut by 2/3rds they will be like  "oh yeah, so that's what they were talking about.. I read the words but didn't really understand the implications... silly me..."

I'm still working, so do I stick to my AA and keep buying bonds as they fall? Is that a good approach?

Inthe short term it depends if you believe interest rates have a lot higher to go or whether a recession will come and stop rates from rising. The “rates are going to rise someday” sentiments expressed in this thread were the easy part compared to guessing what happens next.

If you lack a crystal ball to guess the above question, rebalancing will optimize the path for you.

[PDXTabs]

In the short term it depends if you believe interest rates have a lot higher to go or whether a recession will come and stop rates from rising. The “rates are going to rise someday” sentiments expressed in this thread were the easy part compared to guessing what happens next.

If you lack a crystal ball to guess the above question, rebalancing will optimize the path for you.

Yup. Knowing that something is coming and timing it are two different things. I correctly predicted the 2008 meltdown and lost money because I got the timing wrong. Now I just stay all in with my asset allocation (which happens to be 100% equities).

[MustacheAndaHalf]

I had several reasons for selling off my risky assets (aggressive growth stocks, leveraged calls) back in December, one of which was expecting more Fed rate hikes.  Back then the market expected 0.5% in Fed rate hikes even though inflation was 7%.  I wouldn't consider that an efficient market!

I had something like a short position on bonds for most of March using inverse bond ETFs.  After the 5yr/10yr inverted, I was worried what might happen with the 2yr/10yr.  Rather than wait and lose money, I sold.  While it has not happened yet, a 2yr/10yr yield curve inversion would signal an elevated risk of recession.

[The 585]

Well, I'm kicking myself because over a year ago everyone was moving their bonds into other options, and I thought, "yeah right, that's market timing, how do THEY all of a sudden have a crystal ball?" So I stuck to my AA plan, like I've heard time and time again for my decade-long working career.

And everyone was right. I still don't really understand how this was so predictable, but if it is, can any of you crystal ball guys tell me if BND is going to keep taking a beating? If not, I'm gonna keep staying the course and shovel more money into it according to my AA..

[tooqk4u22]

Well, I'm kicking myself because over a year ago everyone was moving their bonds into other options, and I thought, "yeah right, that's market timing, how do THEY all of a sudden have a crystal ball?" So I stuck to my AA plan, like I've heard time and time again for my decade-long working career.

And everyone was right. I still don't really understand how this was so predictable, but if it is, can any of you crystal ball guys tell me if BND is going to keep taking a beating? If not, I'm gonna keep staying the course and shovel more money into it according to my AA..

Predictable as in a matter of if vs when