Bond bull market is over

[dealtn]

Jwdool wrote:
Once that data hits the CPI figures (which is already has), we could see long dated gilts returning to 2.5%-3.5% rates - hence presenting a great opportunity to secure >5% on the short end and ~4.6% on the long end.



It could. It could be a lot worse. In which case you want an appropriate return for running that risk.

So lets assume inflation drops back to the target of 2% in say 2 years time, certainly not impossible. Under that scenario you appear to feel a long dated gilt yield of 2.5% to 3.5% is appropriate. (That would normally look too low to me, but whatever). So what is the current 2 year forward implied yield for long dated yields currently?

If, as I think is likely, inflation falls back to 2% within 2 years (if not a lot sooner), then the purchase of low coupon, long dated gilts will perform very well. I'd expect to see e.g. the 0.5% 2061 series climbing from ~28.8 today to perhaps the mid-to-high 30s as forward inflation expectations return back to pre-pandemic levels.

Of course there is the risk that inflation re-accelerates - but frankly that will hit all assets classes as rates move higher. When it comes to the long end, the issue is about central bank/ government credibility in tackling inflation on an on-going basis.

Right now, the two issues to focus on are i) have we reached the peak of inflation and will it come sustainably back to target (I think the answer to that is yes - given the plethora of domestic and international data and ii) can we rely upon government/ central banks to remain credible on long term inflation control (I think the answer is also yes).

Given that, buying long dated gilts at current prices as part of a balanced portfolio represents attractive opportunity.

OK. So I ask again what is the current 2 year forward yield on those long dated gilts? What do you think it should be? What is your expected return, and the risk it might not happen. Do you have an attractive enough risk reward strategy (let alone factoring in the sub real return in the first 2 years)?

If you don't know, or aren't interested, then I suggest you are gambling and not investing.

[Jwdool]

Long dated gilts are earning around 4.5-4.7% (on a tax free basis - if you look at discounted issues). This compares with 4.9-5% for higher coupon 2 year notes. In short, there isn't much difference. An investor interested in locking in 4.5%+ returns on a risk free, tax free, long term basis - would be interested in the long end as part of a balanced portfolio. I don't think you can call that gambling unless the purchases are being made with a view to trading the securities prior to maturity.

[Lootman]

Long dated gilts are earning around 4.5-4.7% (on a tax free basis - if you look at discounted issues). This compares with 4.9-5% for higher coupon 2 year notes. In short, there isn't much difference. An investor interested in locking in 4.5%+ returns on a risk free, tax free, long term basis - would be interested in the long end as part of a balanced portfolio. I don't think you can call that gambling unless the purchases are being made with a view to trading the securities prior to maturity.

You can lose an awful lot of money playing with long-dated bonds.

Many investors reckon that US treasury bonds are the safest securities on the planet. But look at a chart of the US Treasury 10-30 year Bond ETF, ticker TLT. This hit a high of around $170 just 3 years ago. Today it is at about $92.5

The "world's safest investment" lost nearly 50% of its value in just 3 years!

[Jwdool]

I accept long end bonds can lose a lot of value. The 2061 0.5% Gilt is currently trading at 27p having been issued at 100p only a few short years ago. What I am suggesting is that for those investors looking for long fixed income returns, there are a lot of gilt options available as part of a balanced portfolio - that will provide fixed coupons in the order of ~4.9% for 20-30 years - and providing these are held to maturity - the income element won't be effected.

Obviously it is a painful experience looking at the capital value of gilts when rates rise. So if you invest £100k today for a £4900 annual return - you are going to feel rather sore if the capital value of your investment falls to £50000 and you could have earned £9600. If, however, you close your eyes to the capital value - and you are happy/ satisfied to earn a nominal return of £4900 (accepting inflation or hoping it tracks the target rate), then its not such a terrible investment - regardless of what happens to rates afterwards.

[dealtn]

I accept long end bonds can lose a lot of value. The 2061 0.5% Gilt is currently trading at 27p having been issued at 100p only a few short years ago. What I am suggesting is that for those investors looking for long fixed income returns, there are a lot of gilt options available as part of a balanced portfolio - that will provide fixed coupons in the order of ~4.9% for 20-30 years - and providing these are held to maturity - the income element won't be effected.

Obviously it is a painful experience looking at the capital value of gilts when rates rise. So if you invest £100k today for a £4900 annual return - you are going to feel rather sore if the capital value of your investment falls to £50000 and you could have earned £9600. If, however, you close your eyes to the capital value - and you are happy/ satisfied to earn a nominal return of £4900 (accepting inflation or hoping it tracks the target rate), then its not such a terrible investment - regardless of what happens to rates afterwards.

If you think a real long term return of 2.5%, assuming an inflation return approximating the MPC target isn't such a terrible investment (despite the volatility and risk inflation could turn out worse) we must have very different thresholds on what is an acceptable risk adjusted return.

[Jwdool]

A real return of 2.5-3% over a long period is what I would expect from a low-to-no risk investment. If you want a higher return, which is fine, you need to take additional risk - the investment universe is a spectrum - but for many, who don't like much or indeed any risk - I'd argue the long end of the gilts curve is still pretty attractive. I can see the arguments strengthening towards deflation over the next 12-24 months.

It takes around 18 months for interest rate increases to feed into the real economy. 18 months ago, BoE base rates were 0.5% (Feb 2022). We are only now seeing the effects of the initial increases feeding through (PMI this week is a good example along with declines in retail sales). We've got 18 months and ~5% additional tightening to come through. I could see the 30 year comfortably back below 3.5% before the end of 2023.

[richfool]

There are corporate bond funds out there paying 10+%, - e.g. NCYF. I'm thinking that the right time to pick some up, or top up, could be just as the BOE makes its September interest rate decision, if not between now and then.

[dealtn]

A real return of 2.5-3% over a long period is what I would expect from a low-to-no risk investment. If you want a higher return, which is fine, you need to take additional risk - the investment universe is a spectrum - but for many, who don't like much or indeed any risk - I'd argue the long end of the gilts curve is still pretty attractive. I can see the arguments strengthening towards deflation over the next 12-24 months.

It takes around 18 months for interest rate increases to feed into the real economy. 18 months ago, BoE base rates were 0.5% (Feb 2022). We are only now seeing the effects of the initial increases feeding through (PMI this week is a good example along with declines in retail sales). We've got 18 months and ~5% additional tightening to come through. I could see the 30 year comfortably back below 3.5% before the end of 2023.

But you are taking that additional risk. Ask any of the pension funds experiencing the last year or so. You are bearing volatility risk and duration risk, even if you intend to hold until maturity.

[1nvest]

The 2061 0.5% Gilt is currently trading at 27p

So in 37 or so years, matures at 100p having paid a 27p price, 3.7 gain factor, around 3.6% annualised capital gain. That is tax exempt, so would require another who paid 20% tax to earn a 4.5% gross. And that excludes the (taxable) income, 0.5% face value (on 100p price) = 1.85% relative to the 27p price, but where that is taxed (so at 20% basic rate taxation = 1.48% net) and is nominal, so the income will decline in real terms over time. Not great, but not bad either. If you dropped the interest payments into a stock accumulation fund, perhaps within a SIPP, as and when they were paid/received that could combine to end up with a reasonable amount by the time the bond matured. Relatively tax efficient, and fully protected no matter how much were 'deposited' (no £85K protection limit).

Wouldn't but it myself, as I don't have 37 years. But for a 30 year old, £50K now might buy a £100K+ annuity in real terms in 37 years time at age 67, as a supplement to their state pension. Maybe even enough to double up the amount of income that otherwise might have been received if only the state pension income were available.

[GoSeigen]

Sorry, reviewing the thread and should have replied to this ages ago but for some reason it didn't happen.

The bond bull market is over you say! I guess that explains why bond funds, especially longer duration ones, are down 30 or 40% from their peaks over the last year or two? I.e. a very firmly established bear market.

No I didn't say that. I said the secular bull market is over. Big difference. It's not about a year or two, it's about a decade or two, or more.


GS

[88V8]

Sorry, reviewing the thread and should have replied to this ages ago but for some reason it didn't happen.

The bond bull market is over you say! I guess that explains why bond funds, especially longer duration ones, are down 30 or 40% from their peaks over the last year or two? I.e. a very firmly established bear market.

No I didn't say that. I said the secular bull market is over. Big difference. It's not about a year or two, it's about a decade or two, or more.

I don't think many people can imagine investing over that period, particularly the demographic we have on here but we look forward hopefully to revisiting this thread in 2033.

Currently I'm piling into prefs, but my time horizon is probably nearer two years than two decades.

V8

[1nvest]

The bond bull market is over you say! I guess that explains why bond funds, especially longer duration ones, are down 30 or 40% from their peaks over the last year or two? I.e. a very firmly established bear market.

Of interest to me is whether the bear market is over rather than the bull market (I'm talking bonds broadly here, not specifically government and not specifically UK). I have more bonds than I did two years ago, but simply as a long term diversifier, hopefully anti-correlated with equities to some extent. They looked useless in this respect two years ago, but now look more plausible.

But I expect most have noticed the bull is over by now......

Isn't that more the natural cycle, long periods of mild declines in yields (progressive bull), short periods of rapid rise in yields (rapid bear). Saw-tooth. Whether we're still in the bear phase or not ??? In the US some are backing up the truck to load into TIPS (Index Linked Gilt like), where they can buy into a fixed 4.5% 30 year SWR with no risk (TIPS ladder). Whilst that might not be the bottom (end of bear) the attraction for some is appealing.

The 1970's bear was unusually deep, that facilitated a extended bull period as yields declined from double digits down to recent near 0%. Other historic bears weren't anywhere near as deep.

Gold is somewhat similar, prolonged periods of plateau, inter-spaced with short periods of steps. Stretching elastic, periodic snaps once the conditions become over-stretched.

[1nvest]

I accept long end bonds can lose a lot of value. The 2061 0.5% Gilt is currently trading at 27p having been issued at 100p only a few short years ago. What I am suggesting is that for those investors looking for long fixed income returns, there are a lot of gilt options available as part of a balanced portfolio - that will provide fixed coupons in the order of ~4.9% for 20-30 years - and providing these are held to maturity - the income element won't be effected.

Obviously it is a painful experience looking at the capital value of gilts when rates rise. So if you invest £100k today for a £4900 annual return - you are going to feel rather sore if the capital value of your investment falls to £50000 and you could have earned £9600. If, however, you close your eyes to the capital value - and you are happy/ satisfied to earn a nominal return of £4900 (accepting inflation or hoping it tracks the target rate), then its not such a terrible investment - regardless of what happens to rates afterwards.

Gilt price appreciation gains are tax exempt, interest payments aren't. Better perhaps to opt for target date maturing bonds, and de-risk inflation i.e. index linked Gilts. https://www.yieldgimp.com/index-linked-gilt-yields and TG58 recent 66p price (actual price of whatever inflation adjustment), 0.125% yield ... and near insignificant taxable income/interest, most of the the gain being price appreciation (66p to 100p as the bond nears maturity + inflation on top). In effect to buy £10,000 of 2058 spending power cost just £6,600 of present day money.

Repeated over multiple maturity dates (ladder) and you might have £10K/year of inflation adjusted income having cost < £10K each of present day money, where inflation offset is guaranteed and potentially very tax efficient (4% net of 20% tax = 5% gross i.e. other less tax efficient alternatives require paying out a significant higher rate to compare to a tax efficient/exempt).

Long term nominal Gilts and both the value (£100 maturity) and interest ... are eroded by inflation. Whilst the higher earlier years taxable interest is a overhead.

[GoSeigen]

Sorry, reviewing the thread and should have replied to this ages ago but for some reason it didn't happen.


No I didn't say that. I said the secular bull market is over. Big difference. It's not about a year or two, it's about a decade or two, or more.

I don't think many people can imagine investing over that period, particularly the demographic we have on here but we look forward hopefully to revisiting this thread in 2033.

Currently I'm piling into prefs, but my time horizon is probably nearer two years than two decades.

V8

I can. I first started investing in gilts in 2006ish and sold the last of them around 2020. Anyway, that's not the point. The point is, the trend is your friend: if you invest against the secular trend it will always be an uphill struggle. You may get lucky, you may congratulate yourself on a few percent return but IMO you'll miss out on great opportunities elsewhere and spend ages waiting for gilts to come good while the value of the investment is inexorably eroded by inflation.

LOL, I was once the greatest proponent of gilts. How times change!

GS

[NotSure]

Sorry, reviewing the thread and should have replied to this ages ago but for some reason it didn't happen.

The bond bull market is over you say! I guess that explains why bond funds, especially longer duration ones, are down 30 or 40% from their peaks over the last year or two? I.e. a very firmly established bear market.

No I didn't say that. I said the secular bull market is over. Big difference. It's not about a year or two, it's about a decade or two, or more.


GS

And the more time that passes, the more I am inclined to agree with you.

I have some short duration bonds, and the yields are just about compensating for the drop in capital value as each month passes, but long duration ones (the time scales you are commenting on) still look scary risky to me.

[RockRabbit]

And the more time that passes, the more I am inclined to agree with you.

I have some short duration bonds, and the yields are just about compensating for the drop in capital value as each month passes, but long duration ones (the time scales you are commenting on) still look scary risky to me.

If long duration bond yields scare you, then other long duration assets (including property and equity) should terrify you! (given much of their rise over the last decade or two was on the back of falling bond yields, both nominal and real).

[GoSeigen]

And the more time that passes, the more I am inclined to agree with you.

I have some short duration bonds, and the yields are just about compensating for the drop in capital value as each month passes, but long duration ones (the time scales you are commenting on) still look scary risky to me.

If long duration bond yields scare you, then other long duration assets (including property and equity) should terrify you! (given much of their rise over the last decade or two was on the back of falling bond yields, both nominal and real).

Other places may differ, but in the UK there was no rise for shares over the past 20 years, and minimal for property over the past 15 years. I'd say the rises occurred before that, followed by a long period of consolidation.

Besides, it's common for equities to move in the opposite direction to bonds. With various shares returning 10%pa to investors the duration risk really is not that worrying anyway.

[tjh290633]

If long duration bond yields scare you, then other long duration assets (including property and equity) should terrify you! (given much of their rise over the last decade or two was on the back of falling bond yields, both nominal and real).

Other places may differ, but in the UK there was no rise for shares over the past 20 years, and minimal for property over the past 15 years. I'd say the rises occurred before that, followed by a long period of consolidation.

Besides, it's common for equities to move in the opposite direction to bonds. With various shares returning 10%pa to investors the duration risk really is not that worrying anyway.

While the indices have been relatively unmoved, many shares have risen since 2000. There are plenty of examples.

What has also happened is the failure of many dot com shares from that era and the suffering of shares in the 2008 GFC, from which many have failed to recover.

Conflating indices with individual shares seems to be a common misconception.

TJH

[NotSure]

I don't think many people can imagine investing over that period, particularly the demographic we have on here but we look forward hopefully to revisiting this thread in 2033.

Currently I'm piling into prefs, but my time horizon is probably nearer two years than two decades.

V8

I can. I first started investing in gilts in 2006ish and sold the last of them around 2020. Anyway, that's not the point. The point is, the trend is your friend: if you invest against the secular trend it will always be an uphill struggle. You may get lucky, you may congratulate yourself on a few percent return but IMO you'll miss out on great opportunities elsewhere and spend ages waiting for gilts to come good while the value of the investment is inexorably eroded by inflation.

LOL, I was once the greatest proponent of gilts. How times change!

GS

I would guess you did rather well in gilts over that period, as in achieved considerable capital gains.

On the other hand, for me, FI in general is more about reducing volatility. I am quite new to all this investing stuff (naïve) but I basically avoided FI in general staying 100% equities (why buy an instrument - LTBH - with effectively zero YTM?)

Though I take on board your point regarding a secular bear, I now hold a little FI (mainly shorter duration, commercial, EM). I am not expecting it to shoot the lights out, just to provide safeish yield (modest nominal gains with low volatility). Would you consider FI to have no place in a balanced portfolio or is your view more nuanced?

[GoSeigen]

Would you consider FI to have no place in a balanced portfolio or is your view more nuanced?

I'll buy gilts again when I feel comfortable with them. Other FI also can be bought if the price is right, e.g. been buying INVR and WBS recently. Short gilts look okay as the yield curve is assisting. A few years out and you face the difficulty of climbing up the curve, i.e. yields rise as maturity approaches giving an unpleasant headwind. Long gilts are a double-edged sword: yes there may be sharp gains but equally there may be sharp losses or just years of grinding out a tiny real yield. Where is the joy in that? Since this thread began the markets have agreed. The yield curve has flattened handing a loss to longer bonds with yields rising some 50bp while the short end has eked out a positive result in nominal terms but probably still a real-terms loss with yields higher now than back in early August.

Nothing is static with investing. I will post again as and when my attitude to FI changes materially. Until then gilts and FI will only have a small allocation for me.

GS
Disclosure: I still have a holding valued about 30% of non-leveraged net worth in FI from historical purchases. Most of that is MBSR yielding about 7.5% which I am loathe to sell in large quantities given the above-inflation yield. The remainder is a long-held non-performing corporate bond which is too illiquid to sell, and small amounts of non-standard PIBS and prefs also bought at lower valuations.