The Wall Street Journal recently published an article titled How You Can Survive a New Era in the Bond Market. The article suggests that investors adjust their bond allocations to tilt more towards high-yield (aka junk) bonds (both corporate and municipal) and global bonds, which tend to yield more than U.S. bonds. This advice resonates with an Op Ed by Burton Malkiel, famed author of A Random Walk Down Wall Street, at the end of 2013.
The case against bonds is straightforward. The best estimate for the expected future return from bonds is their current yield. If you hold a bond until maturity, your total return will be very close to the current yield. There are nuances to this rule. With high-yield bonds, you should expect a total return that is a bit less than the current yield due to the fact that some of these bonds will probably end in default. With bond funds, you don’t necessarily end up holding individual bonds until maturity, so the correspondence between current yield and expected return is a bit weaker. Nonetheless, with current yields as low as they are, bond investors should not expect attractive returns from most bond classes.
With the U.S. government failing to reach agreement on budgetary issues and on raising the debt ceiling, there is considerable discussion of what this would really mean. From what I have read, the issues are quite straightforward. If the U.S. government does not raise the debt ceiling, the Treasury will not have sufficient funds available to meet all of its obligations, starting sometime in mid-October. For the time being, many government workers have been furloughed and services suspended. Continue reading →
The yield of an asset is a key component of predicting future returns. This is true for the yield on Treasury bonds as well as the dividend yield for stock indexes. The yield on aggregate bond indexes is considered a good proxy for future expected returns. The dividend yield of broad stock indexes has been shown to provide significant value in predicting future stock index returns. In both cases, low yields tend to predict high future returns, and vice versa. These arguments that yields predict returns are not without critics, especially for equities. Continue reading →
The financial media loves a catch phrase and, with the apparent emotional hook of the ‘fiscal cliff’ diminished, we needed a new one. The current best candidate is the so-called ‘Great Rotation.’ The idea here is that investors, finally and completely fed up with the dismal returns from bonds, are going to move heavily back into equities. This is the ‘Great Rotation.’ When I Google the term, there are 820,000 search results. Not bad for a phrase that was invented in October 2012 (in a research note from Bank of America, apparently). Continue reading →
Jason Zweig at the Wall Street Journal published a disturbing article that deserves more attention. The basic story is this. A number of banks sold a complex financial product to retail investors who have subsequently lost quite a bit of money. Here is the basic pitch that was apparently made to individual investors in 2012. You are going to buy an investment product that is currently invested in bonds and is producing 8% in income per year. The performance of this product is tied to the stock price of Apple, however. In exchange for the high income, you take on the risk of a decline in Apple’s stock price. These products were sold when Apple stock was soaring, so a fair number of people apparently saw this as a favorable bet. With the stock down more than 30% from its peak, many of these investors have lost a considerable amount of money. Read Zweig’s piece for more details. These products have a number of variations and he discusses one specific structure. Here is another. The title of Zweig’s article, How Apple Bit Bondholders, Too, gives the impression that bonds were responsible for these losses. This is not the case, but the title serves to illustrate the subtlety of the problem. Continue reading →
I have been struggling to understand a problem that I am going to refer to as the ‘yield paradox.’ Yields for individual asset classes look low. The 10-year Treasury bond is yielding about 1.9%, and 30-year Treasury bonds are yielding a similarly paltry 3%. The S&P 500 is yielding 2.1%, which is very low by comparison to historical levels. Investment-grade corporate bond indexes are yielding less than 4% (see LQD, for example, at 3.8%). Given that the official rate of inflation for 2012 was 1.7%, these yields mean that investors are getting very little yield net of inflation. The very low yields on bonds and on stock indexes is a direct result of the Fed’s actions in holding interest rates at historical lows via Quantitative Easing. We have not yet gotten to the paradox. Continue reading →
The price of a share of Apple (AAPL) is almost 30% below the high that it set back in September 2012—about five months ago. Even before its peak, the price of Apple shares had already made it the most valuable company in history. In those heady times, Apple shares reached $702. Today, they are at $503. Even today, however, Apple remains the largest single holding in the S&P 500 at about 3.6% of the total index. It is mind boggling to consider that the market value of the most valuable public firm in history could decline by 30% in five months, without some sort of catastrophic event. But this is the situation and there are some lessons to be drawn. Continue reading →
Editor’s Note: John Graves has been an independent financial advisor for 26 years. He is one of the two owners of The Renaissance Group, a Registered Investment Advisor based in Ventura, CA. John’s book, The 7% Solution: You Can Afford a Comfortable Retirement, was published in 2012. When I read this book, I was impressed with John’s approach and thinking and I recommend it as a good read. I contacted John and asked if he would consider contributing to this blog. After we bounced around some possible topics, he sent me the following piece that describes his process for designing income plans for retirees. Continue reading →
In general, I ignore the spate of market predictions that experts issue at the start of each year. There are exceptions, and after reading Jason Hsu’s outlook for this year, I am pleased to recommend it to readers. Dr. Hsu is the Chief Investment Officer at global money management firm, Research Affiliates. I found his article both insightful and appropriately skeptical of all forecasts. How can you not appreciate a money manager who starts his prediction for the year ahead with John Galbraith’s quip that “the only function of economic forecasting is to make astrology look respectable”?
I am going to mention a few of the elements of Hsu’s outlooks and add some thoughts. Hsu first examines the drivers for bonds and then equities. I will follow this structure. Continue reading →