- Bonds are becoming attractive as investors are flying to safety.
- At one point last week, the yield on a two-year Treasury note was over 5%; that caught the attention of investors.
- A laddering strategy may be your best approach.
Bonds are a safe haven once again as the flight to safety is on. Stocks are under pressure, but some investors are misunderstanding the reason why. Yes, some of this is about risk management, but if that was the case, bonds would have never lost favor with investors. This is more a case of capital flowing where it’s treated the best. And after years of not treating investors well, bonds are treating investors very well.
At one point last week, the two-year Treasury note yield was over 5%. And that seemed to be a psychologically important point for investors. All of a sudden, a guaranteed yield of 5% in the next two years was better than a total return you could get from even the best blue-chip dividend stocks. And it goes without saying that it beats keeping cash in a savings account.
In fact, the attractive yield on the two-year T-note is cited as one reason for the bank run that happened at Silicon Valley Bank, which is owned by SVB Financial Group. Investors pulled their unsecured deposits out and fled to Treasuries. That has sent the yield on the two-year down to 4.043% as demand increases (bond prices and yields move in opposite directions).
So the question of the minds of investors is whether there is still time to buy. The answer will depend on your opinion of the economy.
This is Not a Normal Economy
In a traditional economy, stocks and bonds move in opposite directions. For those that aren’t familiar, let me explain.
When the economy is strong, stocks are more attractive, and bonds are less attractive. That, in turn, causes bond yields to rise as bond prices fall.
The opposite is true when the economy is weak. Stocks tend to be seen as carrying more risk, and bonds less risk. This causes bond yields to fall as demand for bonds (and bond prices) rises.
But that’s in a normal economy. The U.S. has been anything but a normal economy since the last financial crisis – if not before. And the reason for that is the variable that is the issue now: interest rates.
Since the bank bailout of 2008, bond yields have stayed depressed as interest rates stayed at very low rates, historically speaking when the economy was mostly strong. The 60/40 portfolio made no sense because stocks were the obvious choice for growth.
When the pandemic hit, the government printed trillions of dollars to stimulate the economy. Interest rates were taken down to zero. This allowed stocks to stay attractive and bond yields to remain depressed.
But in the last 12 months, the Federal Reserve has increased interest rates from its rate near zero to 5% while the government continues to inject money into the system. This is causing the flight to bonds. It's also making other traditional safe-haven assets like gold attractive again as well.
Is There Still Time to Buy Bonds?
As I write this, the yield on the United States 2-Year Treasury note has dropped sharply. This is normal as demand for bonds is at record highs. But at around 4%, bond yields are still high from a historical perspective.
So, is there still time to buy bonds? It may be, but a lot will depend on the future direction of interest rates. Already, Goldman Sachs (NYSE:GS) is anticipating the Federal Reserve will pause its interest rate campaign. And, even if they don’t pause interest rates, the optics of raising rates by 50 basis points would be poor. That’s because the rise in interest rates was a key factor in the malfeasance at Silicon Valley Bank.
Another factor you’ll want to consider is how long you can tie up your money in bonds. That’s one reason the 2-year was so popular. Investors didn’t want to tie up their money for longer than needed in anticipation that stocks would look more attractive in a couple of years.
But then again, those investors may be betting on a normal economy. This isn’t a normal economy. So if you’re looking at bonds, the best approach may be a “laddering” strategy. This is when you buy several bonds with different maturity dates. As the bonds mature, you reinvest the principal and build your ladder. This will diversify your interest rate risk but may cost you some yield.