Every once in a while, I am prompted to ask the question, “How long can this go on?” I asked that in 1987 when interest rates went up 40% yet the stock market, which was also up 40%+ was still going up; I asked it in 1999 during the tech bubble when valuations seemed not to matter anymore and in the 2000s when people just kept on increasing their borrowing on credit cards, second mortgages, etc. and then even retirement plans. Now I am asking that about low rates on the safest of bonds.
On January 2nd, US Treasury rates were:
90 day 0.08%
1 yr 0.15%
5 yr 0.76%
10 yr 1.86%
20 yr 2.63%
Source: US Treasury
All but the 20 year rate are below the rate of inflation. In effect, investors are losing money by buying treasuries at current rates. This cannot be a long-term condition, but one with a finite shelf life that I think is now expired.
Similarly, the rate on the Moodys’ AAA seasoned corporate bond yield index is 3.77%. The long-term average is 7.47% (Source: Y Charts). Even on high-yield debt the spread between high yield debt and treasuries is very small.
The question is then, what do you do with bond money right now? In just the first two trading days of 2013 the best general bond funds like the PIMCO Total Return Fund lost 0.5%. How much more might they lose this year?
Point 3 is that retail investors, afraid of stocks, have been pouring money into bonds since 2009. Rarely, is it a good idea to follow the retail investor. They have a very predictable record of putting the most money into things near their top.
I have some ideas on where to put that bond money but when an asset class is poised to lose money, where to put it instead is not the first decision. Getting out of a money-losing situation and putting it into cash is the first item on the agenda, then we can talk about where it might be better invested.
Bonds have traditionally played the role of volatility dampener in a portfolio. That may not be the case in 2013.