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Now is the time to sell. Not because there is something that will yield more or perform better to the upside. At these how-high-is-high prices, you sell to lock in your past performance.

Bonds (Don’t) Move

January 20th, 2021 by Kurt L. Smith
  • Everyone can agree bond yields are low. Another way of saying that is, everyone can agree bond prices are high. But unlike the unhinged high prices of stocks, bonds are tethered to a maturity. The assumption of course being that the bond will be paid at time of maturity.

    This risk of being paid (or not) is usually compared against what many consider to be the risk-free rate of US Treasury securities. Thus, Treasuries represent a non-credit risk option as they are assumed to be paid; the government will simply print more money to redeem them. All other (US) bonds do not have this feature of printing additional money; therefore, they are considered spread products.

    As you know I recommended selling your bond products (mutual funds primarily), marking March 6th as the high-water mark for bonds. To say that March was a volatile month borders on understatement, but we witnessed US Treasury notes and bonds trade at their all-time highs in March.

    The ten-year, Treasury note receives the most attention in the marketplace. For most of 2020 the note yielded less than 1%, again, a low yield in anyone’s book (and a high price). But recently the yield has moved over 1% leading to, well, the focus of this letter.

    Looking at a particular Treasury note, the 1.50% of 2/15/30, the low yield and high price was March 9, 2020 (all Treasury prices per Bloomberg) at .31% and 111-19. Last week on January 12th the note traded at 1.11% and 103-12. The note has lost over eight points (about 7%) in price or about five years of income based on the 1.50% coupon. For those unfortunate to buy at the top, they are simply underwater and may remain so until the note matures.

    Looking at a thirty-year bellwether Treasury bond, here the 2.375% of 11/15/49, we see how duration affects performance. This bond traded at an all-time price high of 140-17 and low yield at .70% on March 9, 2020. Last week, January 12th, the bond traded at 110-29 (1.88%) for an almost thirty-point loss (21%).

    Looking at the larger universe of bonds, such as one of the largest bond mutual funds, Vanguard Total Bond Market Index Fund (VBMFX), we see a different picture. This fund has not only Treasuries but spread products such as mortgages and corporates and probably a sprinkling of taxable municipals as well. This fund traded at 11.63 on March 6th, 2020, a new high of 11.79 on August 4th and 11.48 last week on January 11th; relative stability compared to the treasury performance.

    When a portfolio containing spread products outperforms the risk-free Treasuries, we can say the spread products have become ever more expensive compared to treasures. How high priced are corporates, mortgages and municipals compared to Treasuries? The answer is more!

    How high is high for bond prices? Enough for me to say enough last year. Bond market performance over the past eleven months has not changed my mind. We also know that lower spreads in other bonds means more bonds are expensive.

    Whether down 7% or 21% in treasury prices is just a precursor of the lower prices I expect, only time will tell. But all bear markets, including those of stocks, move to down 7% and down 21% along the way.

    Now is the time to sell. Not because there is something that will yield more or perform better to the upside. At these how-high-is-high prices, you sell to lock in your past performance. Buyers (or holders) of the 2049 treasury bond have seen 20%+ of their value disappear in a year when it seemed rates were low and would remain so.

    Apply the lesson to your portfolio.

    Gregory – Portland Independent School District, TX

    Unlimited Tax School Building Bonds, Series 2021A

    Aaa Moody (Aa1 Underlying)  AAA S&P (AA Underlying)

    Permanent School Fund Guarantee

    Due 2/15   Dated 1/15/21 Maturity 2/15/42

    $99,240,000 Sold

    Years   Maturity     Coupon      Yield*

     1            2022           5.00%          0.13%

     2            2023          5.00%           0.17%

     3            2024          5.00%           0.22%

     4            2025          5.00%           0.29%

     5            2026          5.00%           0.39%

     6            2027          5.00%           0.50%

     7            2028          5.00%           0.64%

     8            2029**      4.00%           0.78%

     9            2030**      4.00%           0.88%

     10          2031**      4.00%           0.96%

     11          2032**      4.00%           1.00%

     12          2033**      3.00%           1.19%

     13          2034**      3.00%           1.27%

     14          2035**      3.00%           1.35%

     15          2036**      3.00%           1.39%

     16          2037**      3.00%           1.43%

     17          2038**      3.00%           1.47%

     18          2039**      2.00%           1.75%

     19          2040**      2.00%           1.80%

     20          2041**      2.00%           1.84%

     21          2042**      2.00%           1.88%

    *Yield to Worst (Call or Maturity) ** Call 8/15/28

    Source: Bloomberg

    This is an example of a new issue priced the week of 1/11/21

    Prices, yields and availability subject to change


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