One of the reasons I chose the investment management business as a career, is that I was fortunate to have been studying economics and Money & Banking, from 1978 to 1982, the period where Paul Volcker chose to try the “monetarist experiment” or money-supply targeting to try and kick the inflation devil that plagued the US economy for most of the 1970’s.
As someone in my late 50’s today (my how time flies), I couldn’t help thinking after this update last week, that a vast majority of Americans have never seen consecutive years where bond yields have risen and bond returns have been ugly.
Charlie Bilello over at Pension Partners has noted that the last two years for bond returns have been two of the worst years since the early 1980’s (presumably Charlie means the Bloomberg Barclays Aggregate Bond Index) but the absolute returns haven’t been that bad.
The 10-year Treasury yield closed at 3.23% on Friday, above the July, 2011, high tick of 3.22% that has held the 10-year in check for years.
With Friday's nonfarm payroll report – including upward revisions to July and August – September ’18 job growth was 220,000, much different than the headline print. Because economic growth remains strong, credit spreads – both high yield and investment-grade – remain well bid. I read last week that high yield credit spreads at +350’ish are now once again testing 2007 heights.
There still isn’t much inflation yet – a whiff of inflation could turn the bond market ugly. Here was my January 4th, 2018 article on “below 4% unemployment." On Friday, the September ’18 jobs report printed a 3.7% unemployment rate.
1994 and 2013 were two tough years for the Treasury market and both were due to stronger economic growth and a change (or expected change) in Fed policy. (Here is an article on 2013 bond asset class returns, while this 1994 Fortune article talks little about bond asset class returns, but rather the big names that were caught off guard by the Fed hikes. )
In 1994, the 30-year Treasury fell 7.7% while the 30-year Treasury fell 14% in 2013. Both are approximate total returns.
Summary / conclusion: Does this article imply we will see a return to the 1970’s? Hardly, However what I do think about is 1987, (and I’m old enough to remember it although I wasn’t in the business then), when the 30-year Treasury started the year at 7.50% and ended 1987 at 10%. However the fateful Treasury yield move was sometime in March or April, ’87 when the 30-year Treasury dropped 10 points in either a month or 6-week period, on sharply rising oil prices. (Back then the US economy and the market watchers were still fighting the last war: the inflation fears of the 1970’s.)
Even measuring the full-year ’87 move from 7.25% – 7.50% to 10%, means that the yield basis point change was roughly 250 – 275 basis points or 1/3rd of year’s starting yield. Since July ’16, the 10-year Treasury yield has increased from 1.33% to Friday's 3.23% close, while the 30-year Treasury yield has risen from 2.10 in July ’16 to 3.39% to finish the week. The 10-year yield has risen 150% from its lows while the 30-year Treasury yield has risen 61%.
In 2013 and per Morningstar data, the Bloomberg Barclays (LON:BARC) AGG fell just 2% on the year. And as of Friday the 10-year Treasury yield is through the early 2014 high tick of 3.04%. Year-to-date, the AGG is showing a -1.60% – 1.75% drop for 2018. Still not enough to make investors nervous.
That may be the lesson for bond investors: we may have years of truly paltry bond market returns and yet no one will notice. Bond portfolios just slowly bleed to death.
After last decade’s stock returns, I’d bet a 10% drop in the AGG would barely get retail investors attention. However the lower absolute yields of the last 10 years has extended duration on equivalent-maturity portfolios and raised the volatility risk of bond portfolios.
Clients have been positioned in Schwab’s higher-yielding money markets, a 5% – 10% weight in the ProShares Short 20+ Year Treasury Fund (NYSE:TBF) (unlevered inverse Treasury ETF) and JP Morgan’s Strategic Income Fund for years. Little credit or duration risk is being taken. These portfolio allocations were a drag on returns for most of the period from 2014 to 2018 until the last few weeks.