Bonds Are Markets Too

The bond market has been on quite a tear of late. With lower yields and higher prices, bond market articles have been on the front pages of The New York Times as well as other prominent articles in their business section.

Stocks on the other hand ended last month with their sixth consecutive down week. With bonds moving higher in price and stocks moving lower maybe there is something new going on. Perhaps your stock portfolio hasn’t been performing as it once did. Is something new happening?

From our vantage point, there is nothing new going on in the markets. The bond bear market began in 2012. Others may argue with me on this but that gives us a sense of how long a topping (or turning) pattern may take to develop or be fully recognized.

The bond (price) topping pattern or yield bottoming pattern has unfolded over many years already. Perhaps we will see something similar time-wise with stocks, but perhaps not. Perhaps the reason your stock portfolio isn’t performing the way you think it should is because we are in a similar topping pattern currently with stocks. If this is the case, which I believe, the key issue we need to address is one of risk versus reward.

Asset prices are ridiculously high and one bellwether gauge of this is the amount of negative yielding bonds. Earlier this year the amount of negative yielding bonds passed $10 trillion; last month it neared $13 trillion according to TheStreet.com. JPMorgan Asset Management shows that as a percentage of global government debt outstanding todays figures are challenging the 2016 high of about 35%. Think about that, if you can.

Investors are buying bonds because they believe the price will continue to rise thus making their investment more valuable. Bonds are markets too and their prices will behave accordingly and currently that behavior has led to higher prices.

But markets are not one way streets; they are prone to corrections. Corrections always happen, even in markets that have never experienced $10 trillion-plus in high(est) prices, or negative yields.

Such high prices may be a recent phenomenon in bonds but it happens more regularly in stocks. Today’s so-called unicorn stocks look like a nice complement stock-wise to negative yielding bonds. You’re paying a high price, on the hope it goes higher, for an asset that doesn’t have earnings and probably has large losses for the foreseeable future.

While low, yields in the US Treasury market and municipal bond market are not negative. Many long-term bonds have enjoyed some of their best returns in years, though only over the past six months or so. Yet for all the hoopla, both the ten year and thirty year treasury bonds have only retraced a little over 50% of their downward price move from 2016 levels. That’s a lot of hoopla, with performance that could be better. I would attribute this to the bond bear market. You have ups and downs but the downs (in price) are still winning.

As portfolio managers you know your number one goal is to eliminate down periods. Owners of long-term bonds look good lately, but over the past number of years, performance has suffered in the bond bear market.

The strategy of The Select ApproachTM has been quite worthwhile over this same period. My primary concern however is a downward correction of 30% to 50%.

Owners of long-term bonds and stocks are, in my opinion, taking an inordinate amount of risk (down 30% to 50%) for a small amount of reward (low yields). Take a look at this month’s municipal bond spotlight below: College Station, TX general obligations. The twenty year bond has a 3% coupon. If rates hit 5.25% next year for that maturity it would price the bond at 73 versus the 98.533 initial pricing. That’s small compared to Apple’s (AAPL-NYSE) price swing from a 233 high and 142 low over the past year. But it’s Apple! Or is it really GE?

I believe both stocks and bonds to be in bear markets. Whether this topping pattern (what you call it before its down 30-50%) takes many years (like bonds) or not is not important. Your ability to make money going forward is probably becoming more difficult than in the past. And no, the current stock swoon and bond bump is not a benefit of a diversification. Both stocks and bonds are in bear markets so now is the time to move to cash and the alternatives we offer with The Select ApproachTM. There is too much risk with too little reward and even a lot of optimism won’t change that.

College Station, TX General Obligation

Moody’s Aa1    S&P AA+

Due 2/15  Dated 6/18/19  Maturity 2/15/39 Sale Amount $74,510,000

Year Maturity Coupon Yield*

• 1     2020      5.00%     1.45%
• 2     2021      5.00%     1.47%
• 3     2022      5.00%     1.50%
• 4     2023      5.00%     1.52%
• 5     2024      5.00%     1.55%
• 6     2025      5.00%     1.60%
• 7     2026      5.00%     1.65%
• 8     2027      5.00%     1.70%
• 9     2028**     5.00%     1.77%
• 10   2029**     4.00%     1.85%
• 11   2030**     4.00%     2.00%
• 12   2031**     4.00%     2.12%
• 13   2032**     4.00%     2.23%
• 14   2033**     4.00%     2.35%
• 15   2034**     4.00%     2.45%
• 16   2035**     3.00%     2.95%
• 17   2036**     3.00%     3.00%
• 18   2037**     3.00%     3.05%
• 19   2038**     3.00%     3.07%
• 20   2039**     3.00%     3.10%

*Yield to Worst (Call or Maturity) **Par Call 2/15/28

Source: Bloomberg

This is an example of a new issue priced the week of 5/30/19

Prices, yields and availability subject to change