Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Tesla Robo Taxis are Coming THIS YEAR! - 16th June 24
Will NVDA Crash the Market? - 16th June 24
Inflation Is Dead! Or Is It? - 16th June 24
Investors Are Forever Blowing Bubbles - 16th June 24
Stock Market Investor Sentiment - 8th June 24
S&P 494 Stocks Then & Now - 8th June 24
As Stocks Bears Begin To Hibernate, It's Now Time To Worry About A Bear Market - 8th June 24
Gold, Silver and Crypto | How Charts Look Before US Dollar Meltdown - 8th June 24
Gold & Silver Get Slammed on Positive Economic Reports - 8th June 24
Gold Summer Doldrums - 8th June 24
S&P USD Correction - 7th June 24
Israel's Smoke and Mirrors Fake War on Gaza - 7th June 24
US Banking Crisis 2024 That No One Is Paying Attention To - 7th June 24
The Fed Leads and the Market Follows? It's a Big Fat MYTH - 7th June 24
How Much Gold Is There In the World? - 7th June 24
Is There a Financial Crisis Bubbling Under the Surface? - 7th June 24
Bitcoin Trend Forecast, Crypto's Exit Strategy - 31st May 24
Zimbabwe Officials Already Looking to Inflate New Gold-Backed Currency - 31st May 24
India Silver Imports Have Already Topped 2023 Total - 31st May 24
Gold Has Done Its Job – Isn’t That Enough? - 31st May 24
Gold Stocks Catching Up - 31st May 24
Time to take the RED Pill - 28th May 24
US Economy Slowing Slipping into Recession, But Not There Yet - 28th May 24
Gold vs. Silver – Very Important Medium-term Signal - 28th May 24
Is Gold Price Heading to $2,275 - 2,280? - 28th May 24
Stocks Bull Market Smoking Gun - 25th May 24
Congress Moves against Totalitarian Central Bank Digital Currency Schemes - 25th May 24
Government Tinkering With Prices Is Like Hiding All of the Street Signs - 25th May 24
Gold Mid Tier Mining Stocks Fundamentals - 25th May 24
Why US Interest Rates are a Nothing Burger - 24th May 24
Big Banks Are Pressuring The Fed To Losen Protection For Depositors - 24th May 24
Another Bank Failure: How to Tell if Your Bank is At Risk - 24th May 24
AI Stocks Portfolio and Tesla - 23rd May 24
All That Glitters Isn't Gold: Silver Has Outperformed Gold During This Gold Bull Run - 23rd May 24
Gold and Silver Expose Stock Market’s Phony Gains - 23rd May 24
S&P 500 Cyclical Relative Performance: Stocks Nearing Fully Valued - 23rd May 24
Nvidia NVDA Stock Earnings Rumble After Hours - 22nd May 24
Stock Market Trend Forecasts for 2024 and 2025 - 21st May 24
Silver Price Forecast: Trumpeting the Jubilee | Sovereign Debt Defaults - 21st May 24
Bitcoin Bull Market Bubble MANIA Rug Pulls 2024! - 19th May 24
Important Economic And Geopolitical Questions And Their Answers! - 19th May 24
Pakistan UN Ambassador Grows Some Balls Accuses Israel of Being Like Nazi Germany - 19th May 24
Could We See $27,000 Gold? - 19th May 24
Gold Mining Stocks Fundamentals - 19th May 24
The Gold and Silver Ship Will Set Sail! - 19th May 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

U.S. Bond Market Investment Strategy For 2011

Interest-Rates / US Bonds Dec 15, 2010 - 06:03 AM GMT

By: Money_Morning

Interest-Rates

Best Financial Markets Analysis ArticleMartin Hutchinson writes: For those seeking greater safety, bonds will be the wrong place to look in 2011.

To understand why, we need to look back more than 25 years - to a time when economic conditions were very different than they are today.


Time Warp
The year is 1982. To keep things simple, let's assume we're in a simplified, hypothetical world in which investors have two choices:

•Stocks.
•And U.S. Treasury bonds.
Unlike our simple hypothetical example, the real economy of 1982 was harsh - and complicated.

Then - as now - the United States was in a deep recession. In November of that year, in fact, the unemployment rate actually hit 10.8%.

There are differences, however. Whereas today the U.S. stock market is fairly close to its all-time high, in 1982 it had been dropping in real terms for the preceding 16 years, and had lost almost three quarters of its value.

Then there's gold. In 1982, gold prices were falling - not rising to record after record, which is the case today. Inflation, too, was falling - and sharply: From 8.9% in 1981 to 3.4% in 1982.

Finally, short-term interest rates were extremely high, far above the level of inflation, though the average for 1982 at 12.24% was well below the 1981 average of 16.39%.

Just as in the 25 years from 1982 you could do better in Treasury bonds than in stocks if you bought long enough maturities (preferably 30-year zero-coupon "strips") so the downside risk in bond investment today is in many cases greater than that in equities.

With inflation declining and short-term interest rates extremely high, the chance for a bond-market rally was excellent. The 30-year Treasury bond yield - which had peaked at 15.32% in September 1981 and was still at 14.30% in June 1982 - had by December 1982 fallen to 10.54%.

And a rally was what investors got. In fact, in the 25 years that followed, the investors in our simplified example who bought Treasury bonds (especially long-maturity bonds such as 30-year zero-coupon "strips") trounced those who chose stocks.

A Forward Look
Fast forward to 2010 - where the situation is almost completely opposite the one that faced investors back in 1982.

The U.S. Federal Reserve has been keeping monetary policy extremely loose for several years (and rather too loose since 1995, I would argue). Inflation is low, but is showing every sign of rising in the years ahead. Short-term interest rates are below the rate of inflation, and will become more so if inflation rises.

Just as in the 25 years from 1982 investors fared better in Treasury bonds than in stocks (again, assuming that they bought long enough maturities), today the forward-looking downside risk in bonds is in many cases much greater than it is in stocks. Indeed, as interest rates rise back toward their historic norms, bonds now seem poised for a long-term bear market.

Naturally, you won't lose much in short-term bonds - but you won't gain much, either.

The two-year Treasury note yields 0.62%, below even the modest rate of inflation - so in real terms, even over the short two-year life of the bond, you will lose money in real terms.

Investing in long-term bonds is much riskier.

Ten-year Treasuries today yield 3.29%. If, in two years, eight-year Treasuries are yielding a mere 5%, you will lose 11% on your investment, plus the effect of inflation.

On a 30-year bond, if rates go from the current 4.4% to 6% in two years, your principal loss would be 22%. Needless to say, if inflation really took off and interest rates went back towards 1982 levels, your principal losses would be much larger.

To make up for the low yields on Treasuries, many investors have taken to buying junk bonds. Issue volume in 2010 is above $300 billion, compared with the previous peak of $162 billion, which was established in 2006.

With junk bonds, the higher interest rate protects you against inflation, but not against a general rise in interest rates. What's more, since junk bonds are mostly issued by overleveraged companies, a general rise in interest rates, even if the economy stays sound, will be accompanied by a surge in defaults as cash flow calculations made on the basis of lower interest rates prove to be overly optimistic.

Thus, by investing in junk bonds, your risk from a rise in interest rates is doubled. Not only will you suffer a loss through a decline in the principal value of the bond, but you also might suffer a bond default.

There are two solutions to this problem. First, if you are seeking the stable yield that bonds offer, you should consider investing in stocks with high dividend yields, taking care to make sure the companies themselves are not overleveraged.

Share prices are much more dependent on the earnings prospects of the underlying company than directly on interest rates, so you are less likely to suffer a major loss of principal simply from an interest rate rise. What's more, dividend yields on shares are often considerably higher than on any but the riskiest bonds - you can find 7% or even 8% yields quite easily, even in today's markets.

Second, embrace a strategy that will enable you to profit from an increase in yields. Invest in an exchange-traded fund that is inversely linked to Treasury bond prices. One such fund is the ProShares UltraShort 20+ year Treasury Bond ETF (NYSE: TBT).

This ETF will rise in price as long-term Treasury bond prices decline. The one problem is that itachieves its position by rebalancing a Treasury bond futures position daily, so if held too long can accumulate "tracking error" causing holders to lose money. However, for a holding in 2011, it offers considerable attractions.

Actions to Take: Investors need to take steps to prepare for the outlook for inflation, interest rates, bond prices and stock prices that we expect to face in early 2011.

There are two ways to do this:

•Through Dividends
•And with an "inverse" bond ETF.
First, in place of the stable yields traditionally expected from bonds, look to invest in stocks with high dividend yields. But in this uncertain and unforgiving environment, take special care to research the companies before you buy their stocks. In particular, make sure the companies themselves are not overleveraged.

Share prices are much more dependent on the earnings prospects of the underlying company than directly on interest rates, so you are less likely to suffer a major loss of principal simply from an interest rate rise. What's more, dividend yields on shares are often considerably higher than on any but the riskiest bonds: Even in today's markets you can find dividend yields of 7%, or even 8%.

Second, position yourself to profit from an increase in yields. Invest in an exchange-traded fund that is inversely linked to Treasury bond prices. One such fund is the ProShares UltraShort 20+ year Treasury Bond ETF (NYSE: TBT).

This ETF will rise in price as long-term Treasury bond prices decline. The one problem is that itachieves its position by rebalancing a Treasury bond futures position daily, so if held too long can accumulate "tracking error" causing holders to lose money. Given the conditions that we expect in the New Year, however, this is a holding that warrants careful consideration for inclusion in your portfolio.

[Editor's Note: If you like the insights that our "Outlook" series provides, but you want to receive this kind of financial-market intelligence throughout the year, you should look at our monthly affiliate newsletter, The Money Map Report.

Each month, the gurus who write for Money Morning get together and identify the very best profit opportunities. And they do that by "following the money" - spotlighting the global moneyflows that point to those new profit opportunities (the best ones available at that particular time).

Sometimes this exercise means "following the money" from one sector to the next. Other times that means moving from one geographic market to another.

To make those moves successfully, investors need a compass or, better yet, a guide. And successful investors will tell you, one of the best guides out there is The Money Map Report.

The Money Map Report employs many of the same experts whose columns you read here each day. The difference is that while Money Morning is news and investment analysis, TheMoney Map Report is dedicated solely to investment analysis.

Our writers use proprietary money-flow indicators to identify and isolate the most timely profit opportunities you'll find anywhere. For more information about The Money Map Report, please click here.]

Source : http://moneymorning.com/2010/12/15/a-bond-investment-strategy-for-the-new-year/

Money Morning/The Money Map Report

©2010 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in