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These are the headwinds currently facing investors in bonds. While these headwinds have so far been so light as to not garner much attention, I do not believe this to be the case much longer.

Not The Same As The Old Year

January 11th, 2018 by Kurt L. Smith
  • Happy 2018 to you and yours! I hope 2017 was a good year for you and may 2018 be wonderful.

    One always tries to keep the wind at your back and this appears to be the consensus with investors. Optimism is extremely high and the business press (and stock market performance) reflects this sentiment.

    This is the definition of trend. To be the trend it must show general tendency AND it needs to continue long enough to get noticed. The trend is your friend because you are an investor, not a trader. The trend can provide you sound grounding to make decisions as well as a framework for what may come.

    These past several months we have discussed the next move in the continuing trend for bonds as well as a change in the trend for stocks. Bonds hit their high in price (low in yield) on September 8th. Since then, rates have slowly risen, while I believed they would move up faster. The ten year US Treasury was 2.01% in September, a 2.47% high in November and a new 2.50% high in December. Two year treasuries were 1.25% in September, 1.78% higher in November and a new 1.92% high in December and 1.97% this past week.

    The reason I continue to write about bond yields is because it is important to know the trend. I marked the end of the bond bull market back in 2012. Buyers of long-term bonds back in 2012 invested in low yields, their current bond value is less to boot as rates have risen and bond prices have fallen.

    While most investors did not buy all their long-term bonds in 2012, the premise of owning a well performing bond portfolio would be difficult when the bond market trend is toward lower bond prices. Not only would one own low yielding bonds for a long time, but one would be reminded by the underwater prices for the bond until the bond eventually (finally) matured.

    These are the headwinds currently facing investors in bonds. While these headwinds have so far been so light as to not garner much attention, I do not believe this to be the case much longer. This is why we continue to monitor the progress of the Ten Year US Treasury note. At 2.50%, the note is but a few basis points away from the 2.64% high, a three year high and highest since the all-time low of 1.32% on July 6th, 2016 (all per Bloomberg).

    It was this all-time low for the ten year treasury (all-time high price) that prompted me to write a few weeks later “If you liked the bond market rally this year then I think you will really enjoy the stock market which appears to be gathering steam (August 2016 newsletter, also online).” At about 18,600 at the time the Dow Jones Industrial climbed to 23,500 level in the November letter where I marked my trend turn. The November level was about a 25% gain from August 2016 and the Dow continues to move ahead, crossing 25,000 this past week.

    Markets have always been markets (they go up and down) and sometimes the larger trend lasts decades. When it comes to Bonds, those days are over and have been over for many years. This is important for stocks as well. While not exactly correlated, both stocks and bonds began their multi-decade Bull market in proximity of one another in 1980 and 1981 respectively, marking their next (first) peaks in 1987 and 1986. How long after 1980-1981 did it take before investors became convinced something Bullish was happening? Likewise, I never expected the Bear Markets to be recognized quickly either.  My call of 2012 may be one of the few in the universe and here we are over five years later.  Stock market investors will probably not have that type of time.  Stocks can reverse many years of gains quickly as stock investors learned in several swoons over the past thirty years.  Hence my November call to step aside.

    The advantage you have is the ability to invest in a bond market that is truly different from all others. Bonds for a bear market? Yes, we have a strategy for that. Need a trillion dollars’ worth? Sorry, you are out of luck. Scale works when the trend is fully developed. At the early stages of trend change, scale will generally hurt you as others fail to see the change (doing nothing new) and later attempt to exit all at the same time.  Again, it helps to be ahead of consensus because selling, either bonds or stocks, can be an ugly proposition once sentiment changes.

    It is the sentiment change that worries me the most about the markets.  At five plus years of rising rates the consensus continues to be that these rates are low.  Only a flesh wound, as Monty Python fans will recall.  But at some point they will matter and be noticed.  We don’t need to predict when (we have a worthwhile strategy) but we certainly need to follow what the markets are saying.  Bonds are in a bear market and the stock market trend will change.  I have you prepared bond-wise; I have you prepared stock-wise.

    I wish you the best for 2018 but it is incumbent upon you to make sure the wind is at your back.

    Midland, Texas GO

    Standard & Poor AA+  Fitch AAA

    Due 3/1 Dated 1/15/18 Maturity: 3/1/2043

    Sale Amount: $51,555,000

    1 2019 5.00% 1.54%
    2 2020 4.00% 1.66%
    3 2021 3.00% 1.73%
    4 2022 5.00% 1.77%
    5 2023 5.00% 1.85%
    6 2024 5.00% 1.95%
    7 2025 5.00% 2.03%
    8 2026 5.00% 2.15%
    9 2027 5.00% 2.25%
    10 2028** 4.00% 2.41%
    11 2029** 4.00% 2.54%
    12 2030** 4.00% 2.66%
    13 2031** 4.00% 2.73%
    14 2032** 5.00% 2.58%
    15 2033** 3.00% 3.12%
    16 2034** 4.00% 2.97%
    17 2035** 5.00% 2.76%
    18 2036** 5.00% 2.76%
    19 2037** 5.00% 2.79%
    20 2038** 5.00% 2.80%
    21 2039** 5.00% 2.82%
    22 2040** 3.25% 3.34%
    23 2041** 5.00% 2.87%
    25 2043** 5.00% 2.90%

      *Yield to Worst (Call or Maturity) **Par Call: 3/1/2027

    Source: Bloomberg

    This is an example of a new issue priced the week of 1/8/18

    Prices, yields and availability subject to change


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