Huge losses going on in Bonds right now!

[vand]

I'm one of the long-term bond investors on this forum. Over the past 18 months my star performer is a fixed interest security. It's at least a 4-bagger over that period, so no, I don't agree that only real-terms losses are guaranteed in bonds. There is almost always something interesting to buy in the fixed interest space. My star performer still yields some 7% or more, so I'm not too worried about a bit of inflation in the short term. If the thing happens that practically no-one on this forum thinks can happen, i.e. inflation drops back again and yields fall then there is still scope for very good profit in fixed interest. One just needs to be sensible about when and how much to buy and sell.


GS

You are surely operating largely in the distressed debt sector then, rather than anything investment grade.. the long term performance in junk bond funds like JNK and HYG shows huge capital losses over time. Maybe you've been good enough and/or lucky enough to largely avoid those bonds that have defaulted, but it is not proven workable passive strategy.

Recently, yes, but if you bought US treasuries as recently as 2018 you had a gain in two years of over 60% which is not to be sniffed at given the S&P went nowhere over the same period.

Similarly if you buy the 30-year UST today and its yield reverts to its long-term moving average in the next 12 months you make some 25%; not saying it's a good time to buy, just highlighting the maths.

GS
P.S. And the point is: don't automatically write off all FI as many do, there are often gems to be found.

In hindsight it's looking like that move from 2018 to 2020 was the final blowoff top of a multi-decade secular bull market, as those gains have all been reversed now.

The FEd has signaled a path of higher rates over the next few years, so there is no reason to expect anything but more downside for treasuries, allowing for the odd technical correction along the way. A this stage the only thing that will reverse this is if it proves that the economy is too fragile to withstand neutral rates and goes into a highly deflationary recession - that may be good for bonds but it will be catastrophic for stocks. Either way, it is difficult to see how a stock/bond portfolio does as well going forward due to the new dynamics at play.

I'm certainly not dismissing high yieldas an asset class, but its important to recognise that it's nothing like buying government bonds. If you are chasing 10% yields in junk bonds then it only takes 1 default out of 10 to wipe out the gains of your survivors. People will always highlight their successes and fail to mention their turkeys. Gems can be found, yes.. but the downside is greater too.

[Gan020]

The challenge is that most retail investors when they bonds or buy 60/40 for example don't actually buy the bonds but by a bond fund.

Imho they don't actually look at the prices of the underlying instruments in the fund and assess the likelyhood of capital gains or losses. They are too focussed on the income.

I would level the same argument at many buyers of stock ETF's as well. They don't sufficiently consider the price of the underlying equities

[JohnW]

so there is no reason to expect anything but more downside for treasuries

Not sure it’s so grim for treasuries. Bond funds can hold their bonds to maturity, and thus get their principal returned whole (except when yields are negative, when at least the loss is known from the outset). It’s only distressed or panicked sellers who get hit from falling bond prices as interest rates rise. And coupons keep flowing in, bigger and better as rates rise (which every bond holder holding the right bonds for their investing horizon should be praying for). Nothing but sunshine ahead!

[JohnW]

The challenge is that most retail investors when they bonds or buy 60/40 for example don't actually buy the bonds but by a bond fund.

What you’re suggesting as an alternative is market timing. I think it’s well established that that’s a tough gig. A majority of active fund managers can’t pull it off, and the amateurs are likely no better.

[dealtn]

The FEd has signaled a path of higher rates over the next few years, so there is no reason to expect anything but more downside for treasuries, allowing for the odd technical correction along the way.

Not true and a fundamental misunderstanding of bond pricing.

Bonds are pricing in a future path of interest rates. Currently that is a series of gradual rises over the short and possibly medium term. Rates will go up, and in hindsight Bonds will be a good investment even if interest rates continue to raise, but by less than that which is currently priced in. Similarly they will be disappointing were rates to rise faster (or further) than currently priced.

It isn't the direction that counts, it is the future outcomes, and future market pricing, compared with the current market pricing, that will determine whether any bond holding is good, or poor (and applies equally in a interest cutting environment).

There is plenty of reason to expect the actual path of interest rates to differ from the current market expectation. There is a probable chance that direction will be bond investor beneficial, just as there is a chance it will be of detriment.

[Dod101]

I am underwhelmed by the great concern expressed by the OP re the future for bond prices. I have held three smallish bond funds for years and have done nothing with them except draw the dividend or coupon or whatever the technical expression is. The capital value drifts up and down but I am simply unconcerned. I do not expect 'huge' losses and certainly right now I am not experiencing huge losses.

Dod

[vand]

The FEd has signaled a path of higher rates over the next few years, so there is no reason to expect anything but more downside for treasuries, allowing for the odd technical correction along the way.

Not true and a fundamental misunderstanding of bond pricing.

Bonds are pricing in a future path of interest rates. Currently that is a series of gradual rises over the short and possibly medium term. Rates will go up, and in hindsight Bonds will be a good investment even if interest rates continue to raise, but by less than that which is currently priced in. Similarly they will be disappointing were rates to rise faster (or further) than currently priced.

It isn't the direction that counts, it is the future outcomes, and future market pricing, compared with the current market pricing, that will determine whether any bond holding is good, or poor (and applies equally in a interest cutting environment).

There is plenty of reason to expect the actual path of interest rates to differ from the current market expectation. There is a probable chance that direction will be bond investor beneficial, just as there is a chance it will be of detriment.

I understand and agree that it's all about expectation. We had inflation "surprise" to the upside, which put interest rate expectations on a heightened path and caused the big selloff in bonds we have in the midst of.

And there is every chance that inflation will continue to "surprise" because the narrative is continually changing. We have shifted from "transitive" "a few years"... what happens if we reach 2024 and inflation is still in the 5-10% range?

There is still a element of markets being backward looking with respect to what to expect from the future. A lot of investors still expect inflation to pass through after a couple of years and things to eventually return to the happy days of 2% targets. It probably isn't going to be that easy.

[dealtn]

It probably isn't going to be that easy.

Which is different to your previously stated "no reason to expect anything but more downside for treasuries".

There are plenty of reasons why it might not be so, despite it not being easy to either predict, or be confident in practice along that journey, to have a successful bond investment. Bond prices can easily move to the upside from here, there is no certainty the path only lies to the downside.

[vand]

The challenge is that most retail investors when they bonds or buy 60/40 for example don't actually buy the bonds but by a bond fund.

Imho they don't actually look at the prices of the underlying instruments in the fund and assess the likelyhood of capital gains or losses. They are too focussed on the income.

I would level the same argument at many buyers of stock ETF's as well. They don't sufficiently consider the price of the underlying equities

Right.

Buying a fund essentially the same as continually buying new bonds, selling them after a year and rebuying newly issued bonds in order to keep your duration the same.

People who believe that by holding the bond directly they don't need to worry about the capital value on the open market are wrong. Eventually that bond will mature.. and then it will be redeemed at par value. In the meantime inflation will have taken a substantial bite out of the purchasing power of that face value of that bond.

So yeah, you happily collected the income and didn't need to worry about the value of your bond, but all the while the purchasing power of the bond was decreasing.

[RockRabbit]

There is still a element of markets being backward looking with respect to what to expect from the future. A lot of investors still expect inflation to pass through after a couple of years and things to eventually return to the happy days of 2% targets. It probably isn't going to be that easy.

Bonds (and bond surrogates) have not reacted consistently to rising CB rates nor increased inflationary expectations, presumably partly due to market imperfections and partly due to the continued belief in 'transitory' inflation. Take for example BP preference shares (eg BP.A - OK not a bond, but with bond like characteristics) which are blue chip, fixed rate instruments (yielding about 5% pa) with no redemption date. While these have taken a minor hit recently, they are still priced higher than most of the previous 10 years. This only makes sense to me if one believes that long term inflation will 'settle down' again at around 2-2.5% long term and that the current inflation burst is indeed transitory. If market long term inflationary expectations do increase significantly, surely their share price (preference) will be hammered? (other prefs, eg ELLA have fallen much more than BP.A, despite BP potentially being 'higher risk' due to Russia exposure?)

[JohnW]

So yeah, you happily collected the income and didn't need to worry about the value of your bond, but all the while the purchasing power of the bond was decreasing.

But you’re overlooking the opportunity to hold inflation linked bonds whose purchasing power keeps up (or down) with the inflation rate. It’s easy to overlook this type of asset which can have a useful place for some folk.

[JohnW]

preference shares (eg BP.A - OK not a bond, but with bond like characteristics) which are blue chip, fixed rate instruments (yielding about 5% pa) with no redemption date.

The cogniscenti can turn off now, but for new investors a couple of distinguishing characteristics of bonds are that they are a contract to borrow money and repay that amount on a fixed date (although some can be recalled early, and similar refinements), and they pay guaranteed coupons (if they don’t default). That preference share has neither of those characteristics: the purchase price may never be returned if the company chooses, and there need be no preferred dividend. Someone correct me if my understanding is wrong.
So preferred shares are surrogates for bonds, as I understand ‘surrogate’, but they’re a horse of a very much different colour.

[vand]

So yeah, you happily collected the income and didn't need to worry about the value of your bond, but all the while the purchasing power of the bond was decreasing.

But you’re overlooking the opportunity to hold inflation linked bonds whose purchasing power keeps up (or down) with the inflation rate. It’s easy to overlook this type of asset which can have a useful place for some folk.

That's true, I haven't talked about Index linked FI yet.

TBH I'm not that knowledgeable about them. There was a really good video from Pensioncraft recently that was very education on them. My limited level of understanding is that the initial payouts from TIPS are always lower than for nominal bonds, but they also rise with inflation, so whether or not they are a better idea than nominal depends on the inflation outlook.

But they are also not a gimme - they are not a guarantee that you won't lose capital. They are still bonds and can go down in an inflationary environment as they have done in 2022 YTD. The US TIP fund is now the same level it was in the first half of 2020, despite an inflation outlook that has swung 180 since then.. I don't really understand why that's the case..

I just wonder if now that inflation is on everyone's radar whether it has all already been priced into the TIPS markets.

[tjh290633]

So yeah, you happily collected the income and didn't need to worry about the value of your bond, but all the while the purchasing power of the bond was decreasing.

But you’re overlooking the opportunity to hold inflation linked bonds whose purchasing power keeps up (or down) with the inflation rate. It’s easy to overlook this type of asset which can have a useful place for some folk.

And have you looked at the interest rates on these? Most are zero or close to and, what's more, they are probably priced above what the inflation adjusted price is.

If your plan is to protect your capital without getting income, you are only achieving one of those objectives. Have a look at https://reports.tradeweb.com/closing-prices/gilts/ for last Thursday's closing prices, and you will not see a positive yield anywhere.

TJH

[simoan]

That's true, I haven't talked about Index linked FI yet.

TBH I'm not that knowledgeable about them...

I don't invest in Personal Assets IT or the other "wealth preservation" trusts, but the commentary in the recent quarterly report is really worth reading, especially with regard to the behaviour of index linked bonds. The section entitled "The way things work: index-linked" is what I'm referring to: https://www.patplc.co.uk/Portals/0/Lite ... 202022.pdf

I personally have zero interest (see what I did there?) in bonds, although I still weakly hold a few preference shares as my only fixed income investments.

All the best, Si

[JohnW]

The section entitled "The way things work: index-linked" is what I'm referring to:

Thanks for the link. As I read it, it’s a market timer’s line of thinking; and why not, since they’re active fund managers.
For simple folk it’s easier, I think. If bond buyers can freely choose between identical nominal or inflation linked bonds (same maturity, credit risk etc), and the nominal is paying 2% yield (because the buyers have priced them at that level), then inflation linked bonds will be priced by the market to yield 0% if the market believes inflation will be 2% until the bonds mature. Both bonds will then provide the same return because inflation is going to boost the zero yield to 2% (equivalent to the nominal bond’s yield). If they weren’t going to provide the same yield, then buyers’ money would move to the better yielding one thus pushing up its price and its yield down until it matches the other bond’s.
When the bonds mature, the inflation linked owner has done better if actual inflation turned out higher than the inflation originally anticipated by the market; and the nominal bond holder will do better if inflation turns out less than anticipated.
You can take a punt on which bonds you think will do better, or you can hold both if you have equipoise, or you can hold more of one than the other if unanticipated inflation or deflation will do the more harm to you. I don’t think it’s as mysterious or uncertain as made out.

[simoan]

The section entitled "The way things work: index-linked" is what I'm referring to:

Thanks for the link. As I read it, it’s a market timer’s line of thinking; and why not, since they’re active fund managers.

I don't understand how this could be market timing? No-one knows the future but you need to form your own opinion of the probabilities of various outcomes, especially if you are a fund manager. The manager makes clear their opinion on future interest rates and inflation outcomes in the report. Then they invest weighted for that outcome. So they are just talking their own book as you'd expect.

It's interesting to note though that they are broadly 40% bonds (mostly US index linked), 40% high quality equities (Microsoft, Alphabet, Visa), and 10% each gold and cash. I have no vested interest in Personal Assets but I recently listened to an interview with the manager which I found really interesting. I guess part of the reason for that, is that along with other well-known investors, he shares my opinion on holding cash during the start of an inflationary period for its optionality in providing better long term returns. Again, that's not market timing, it's just being able to invest money at more reasonable long term valuations which provide better risk/reward.

Anyway, I digress, back to bonds...
All the best, Si

[JohnW]

I don't understand how this could be market timing?

‘Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods.’ https://www.investopedia.com/terms/m/markettiming.asp

‘however, it seems likely that we will see a coming decade that is more inflationary than the last…. For that reason, it seems probable that we experience another U-turn in the not-so- distant future…. points to a future where real yields are more negative – i.e. inflation exceeds the rate of interest, known as financial repression. This is ultimately the only outcome that indebted economies can afford. It is also one in which index-linked bonds should offer valuable protection.’

That’s what I had in mind when I said it read like market timing, as opposed to ‘I think I should hold this much in stocks, bonds, gold, cash etc because it fits my risk appetite and I like to believe those assets won’t always be correlated in their price movements.’

[Hariseldon58]

It’s always worth having an open mind about financial assets, there is a difference between the price that people will pay and the underlying investment.

There’s nothing like an accepted “wisdom” that bonds are totally rubbish to make me take notice !!!

Having been a mathematician I find bonds interesting, as so much about them is known, it’s the market viewpoint of the future that determines the price but not always the value…

Index linked bonds have two main factors driving them, expectations of inflation and expectations about the levels of interest rates, both factors drive prices at the same time and it’s not always clear which is dominant.

Falling prices for bonds mean that coupons can be reinvested at more attractive prices and this will be helpful if your holding period exceeds the duration of the bonds.

The ability to move back and forth between bonds and equities can be rewarding whether this is through rebalancing or judgement calls.

Market timing is difficult but not impossible and the amateur has advantages of not having a fixed mandate or oversight of quarterly reporting etc.

If we see a heavy market fall of 30/40% then a chunk of bonds that have fallen less or even risen will provide options…

[BT63]

There’s nothing like an accepted “wisdom” that bonds are totally rubbish to make me take notice !!!…

Agreed. I don't invest in bonds but the contrarian in me wonders whether there's an opportunity due to investors now believing they are certificates of confiscation.

Link to price of 30yr US bond, the lurch downwards in recent weeks looks like a capitulation:
https://schrts.co/bnqrbzZI

Link to price of 10yr US bond, showing similar 'capitulation' type behaviour to the 30yr:
https://schrts.co/CRbUdhHN

US bond prices are almost back down to the levels seen during the 'Taper Tantrum' when the Fed last tried to wind down QE.
I think we'll probably soon see a 'Powell Pivot' once bond and share prices have fallen a bit further.