Author Topic: Bearish on bonds  (Read 1366 times)

MustacheAndaHalf

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Bearish on bonds
« on: March 01, 2022, 11:26:23 AM »
The market is reaching "extreme fear" according to CNN's greed & fear index:
https://money.cnn.com/data/fear-and-greed/

US Treasury demand has lowered yields during this panic.  The panic may get worse, but eventually I expect it to subside.  As demand normalizes I expect yields to rise.  The Fed is raising rates several times this year, starting later this month.  The Fed actions will pressure yields to go up.

Overall I expect US Treasury yields to rise, which hurts the performance of existing treasury bonds.  So I'm investing in "bearish" bond funds, "ultra short" or "bear 3x" as they're called by ProShares and Direxion, respectively.

I still hold more passive indexing assets than active, but I view active investment as a way to try and beat the market with money I can afford to lose.  My bearish investments with an expiration date didn't do well, so I'm buying inverse ETFs instead, which allows me to wait and see.

Blender Bender

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Re: Bearish on bonds
« Reply #1 on: March 01, 2022, 07:27:05 PM »
Sounds reasonable to me. Still make sure that you have some SORR/emergency strategy, even if this is keeping working.

MustacheAndaHalf

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Re: Bearish on bonds
« Reply #2 on: March 03, 2022, 07:29:32 AM »
"Oops I did it again" - looks like I timed a local minimum buying on March 1st, as March 2nd brought a rise in bond yields.
TMV +10.40% (duration 19.79), implies +0.175% rise in 20-30 year yields
TYO +4.56% (duration 8.19), implies +0.186% rise in 7-10 year yields

Fed Chair Powell clarified the 0.25% rate hike, so maybe the market has more uncertainty about March than I thought?  All I have to do is wait, and if yields go up, these investments do well.


Sounds reasonable to me. Still make sure that you have some SORR/emergency strategy, even if this is keeping working.
In a 2008 financial crisis scenario my withdrawal rate would stay below 1%.

cool7hand

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Re: Bearish on bonds
« Reply #3 on: March 03, 2022, 07:41:12 AM »
Thanks for sharing!

ChpBstrd

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Re: Bearish on bonds
« Reply #4 on: March 03, 2022, 11:35:38 AM »
Using TLT as a proxy, the "bonds" one would bet against in a rising rate environment did surprisingly well during the rate hiking campaigns of  2004-2007 and in the first 9 months of the rate hiking campaign that started in 2016.

https://www.marketwatch.com/investing/fund/tlt/charts?mod=mw_quote_advanced

I still hold more passive indexing assets than active, but I view active investment as a way to try and beat the market with money I can afford to lose.  My bearish investments with an expiration date didn't do well, so I'm buying inverse ETFs instead, which allows me to wait and see.

I wouldn't characterize leveraged funds that trade futures every day as passive (not saying you are either). To buy into these funds is to hire a helper to actively trade in the futures and swaps markets every day according to an established strategy. This is just as active as if you DIY'ed it. Additionally, one loses some of the optionality to wait out a period of poor returns when one is paying high expense ratios and perhaps contango losses too.

Despite all this criticism, I agree with the overall concept of shorting bonds. The fed is getting waaaaayyy behind the curve. QE is still going on at this moment, even after months of high inflation readings and oil still rising fast at $110/barrel. AND now we're basically committed to only a quarter-point rate hike this month. It may be reasonable to expect that the Fed will have to play catch-up in late 2022 / early 2023.

MustacheAndaHalf

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Re: Bearish on bonds
« Reply #5 on: March 03, 2022, 02:17:29 PM »
Using TLT as a proxy, the "bonds" one would bet against in a rising rate environment did surprisingly well during the rate hiking campaigns of  2004-2007 and in the first 9 months of the rate hiking campaign that started in 2016.

https://www.marketwatch.com/investing/fund/tlt/charts?mod=mw_quote_advanced
The Fed funds rate started 2008 at 4.25% and ended at 0.0%, which greatly boosts the value of existing bonds.  So I understand the 2008 performance.... but my theory of rising rates doesn't explain 2009, where bonds did terribly.  And looking at the rate increases from 2017-2019, I can't explain 2018, either.
https://finance.yahoo.com/quote/TLT/performance?p=TLT

There might be other elements like QE impacting the supply & demand for bonds, so my theory might be wrong.  Appreciate the feedback - I need to look into this.

I might actually close these positions know, and do research later to decide if I'm willing to hold these ETFs.


I still hold more passive indexing assets than active, but I view active investment as a way to try and beat the market with money I can afford to lose.  My bearish investments with an expiration date didn't do well, so I'm buying inverse ETFs instead, which allows me to wait and see.

I wouldn't characterize leveraged funds that trade futures every day as passive (not saying you are either). To buy into these funds is to hire a helper to actively trade in the futures and swaps markets every day according to an established strategy. This is just as active as if you DIY'ed it. Additionally, one loses some of the optionality to wait out a period of poor returns when one is paying high expense ratios and perhaps contango losses too.
That paragraph tries to put my portfolio in context.  I say more of my portfolio is passive than active, so my money is more in index funds than active investments.  I further mention investing money I can afford to lose, which I want others to consider before they try anything similar.


Despite all this criticism, I agree with the overall concept of shorting bonds. The fed is getting waaaaayyy behind the curve. QE is still going on at this moment, even after months of high inflation readings and oil still rising fast at $110/barrel. AND now we're basically committed to only a quarter-point rate hike this month. It may be reasonable to expect that the Fed will have to play catch-up in late 2022 / early 2023.
I believe the Fed member "dot plot" shows an expectation for 4 rate hikes, but we'll know more after this months' FOMC meeting.  I believe the market expects 5-6 rate hikes.  Is there a risk the "catch-up" is already priced in?


ChpBstrd

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Re: Bearish on bonds
« Reply #6 on: March 03, 2022, 08:12:48 PM »
Despite all this criticism, I agree with the overall concept of shorting bonds. The fed is getting waaaaayyy behind the curve. QE is still going on at this moment, even after months of high inflation readings and oil still rising fast at $110/barrel. AND now we're basically committed to only a quarter-point rate hike this month. It may be reasonable to expect that the Fed will have to play catch-up in late 2022 / early 2023.
I believe the Fed member "dot plot" shows an expectation for 4 rate hikes, but we'll know more after this months' FOMC meeting.  I believe the market expects 5-6 rate hikes.  Is there a risk the "catch-up" is already priced in?
The Fed's dot plot has been a notoriously bad predictor of future interest rates since its inception. The catch up would be necessary if inflation persisted in the 7% range (as is being predicted for 2022) while the Fed only ratchets up rates to 1% or 1.25% this year. 

By year two of high inflation and a weak Fed response, the dreaded expectations of future inflation would kick in. Consumers would start hoarding and getting rid of cash, setting off a demand spiral. Political pressure could build to replace Jerome Powell with the next Paul Volker archetype.

I think the Fed is being prudent in not treating 2021's inflation numbers like an emergency. The end of various pandemic stimulus programs in 2022 is in itself a form of QT relative to 2021. In addition to that, the Fed will stop buying bonds and mortgages next month. I don't think anybody knows how quickly the new money from stimulus packages will slowly leak out of the real economy and into the accounts of rich people and foreign governments where it will stagnate and stop affecting prices. "At the rate of the $859B US trade deficit" plus investment inflows is a good guess, but still only approximate because it does not account for a lot of other factors. Thus, nobody exactly knows the effect of stopping stimulus cold turkey on monetary velocity. The Fed is only aiming for its 2-2.25% "neutral" Fed Funds Rate because (a) they want ammo for the next crisis, as the theory goes, and (b) they have literally no idea what the inflation numbers will look like in the 2nd half of 2022. This is uncharted territory.

If the Fed raises rates too fast, or sells too many assets of their balance sheet, we could be back in a struggle against deflation before we know it! OTOH, if the Fed lets inflation expectations become entrenched after a couple of years' inaction, they could set off a spiral and we re-live the 1970's and early 80's. The current explosion in the price of commodities looks a lot like 1973 in its potential to make everything more expensive at a faster rate than the Fed is willing to raise rates. If oil starts heading toward $200/barrel and inflation starts heading to 10%, the concept of quarter-point rate hikes will seem quaint. There are a lot more ways for the Fed to get it wrong than there are for the Fed to get it right.

I wake up in the morning, kneel next to my bed, and pray "Lord, please help me to never, fucking ever, fight the Fed." That's why I have a hard time holding an aggressive stock portfolio right now, and why I'm skeptical of bonds. Such positions might be fighting the fed by this summer if the inflation numbers continue to increase. Bear spreads on TLT seem like a good way to earn a modest speculative return. This approach would also cap potential losses and spread risk more carefully across time. A significant inflation/rates jolt may lie ahead, and I haven't a clue which way it'll go.

MustacheAndaHalf

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Re: Bearish on bonds
« Reply #7 on: March 04, 2022, 12:25:51 PM »
The market seems to be very panicky right now, as reflected in high levels of volatility.  So although I still need to research historical bond performance and the factors that went into them, I think there's a short term profit to be made off market panic - I bought more TMV & TYO today.  So now I hold about 5% leveraged, inverse bonds.

Mohammed El-Erian is chief economic advisor at the parent company of PIMCO.  Back in November 2021, he was lashing out at the Fed for calling inflation "transitory", going so far as calling it the worst Fed mistake of all time.  He wasn't alone criticizing the Fed, and Powell dropped "transitory" later, and we began the climb from 1 rate hike to 4 (now 4-6?) predicted this year.  But from listening to El-Erian and seeing the Fed inaction, I think the Fed will keep going the slow route.  They won't directly respond to 7% inflation, but will raise rates slowly in anticipation of much lower inflation in the future.

To me the significance of "dot plots" (FOMC members polled about expectations) isn't their accuracy, it's their ability to move markets and foreshadow Fed actions.  I'm more interested in market expectations for Fed rate hikes, and those expectations include the dot plots as a source of information.

I think the Fed is waiting out inflation.  Something I've mentioned before that you mention above: when people change habits based on inflation, they create more inflation.  People see their money earning nothing in a bank account, but prices are always rising.  So many people make the logical decision to buy things sooner, which means there's more demand.  That demand makes the supply-demand gap larger, and inflation increases.  Then more people follow that example, and inflation keeps going up.  I don't know how much or how fast that can occur.

MustacheAndaHalf

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Re: Bearish on bonds
« Reply #8 on: March 05, 2022, 04:55:47 AM »
"Oops I did it again" - looks like I timed a local minimum buying on March 1st, as March 2nd brought a rise in bond yields.
TMV +10.40% (duration 19.79), implies +0.175% rise in 20-30 year yields
TYO +4.56% (duration 8.19), implies +0.186% rise in 7-10 year yields
While Tuesday is technically still below Friday's low, it doesn't look like much of "a local minimum" as I called it.  That said, I've actually increased my allocation to TMV & TYO, because I think there's room for panic to ease in the short term.

I think the panic is driven by attacks near a nuclear power plant, and maybe military column (now stalled) headed to attack Ukraine's capital.  Early on most of the losses were military, but shelling and missile strikes on Ukrainian cities keep killing civilians.  So I don't know how bad that will get - and I expect more sanctions are ready if things get worse.  Which means the panic could also get worse.

The Fed meets in less than 2 weeks, so the war in Ukraine could overlap with impacts from that Fed meeting.  If the Fed doesn't raise rates 0.25%, that will impact bond yields.

 

Wow, a phone plan for fifteen bucks!