1) Is the bond bottom finally in?
I’ve been surprised/wrong about how fast the Fed moved this year. And while I’ve been pretty negative about virtually all asset classes all year I’ve been surprised by how badly bonds have performed. That’s almost entirely a function of the Fed moving so fast, but it is what it is. I think they’re making a policy mistake and that they’ll be back at a 2-3% Fed Funds rate in the coming years, but we’re going to have to be patient while things play out. After all, I am constantly harping on the fact that bonds are, on average, 5-6 year instruments so there’s no point in pancking over 1 year performance if you own the 5 year instruments for a specific time horizon in your portfolio. That is the basic point of All Duration investing – match specific liabilities with specific assets and let it all ride. Since you’re covered for “all durations” you can rest easy knowing that you have specific funds for specific needs in life.
But more importantly,, I am excited about bonds for the first time in a really long time. You can get almost 5% on a 1 year T-Bill. That’s phenomenal.1 Even a 10 year T-Note starts to look pretty attractive when you start thinking about the probability of long-term inflation. I mean, what are the odds that inflation will run at 4% or higher for 10 years? It’s especially interesting in the context of crashing goods inflation where shipping rates are cratering, used car prices are crashing, rents are turning, etc. But even just using long-term averages the historical rate of inflation has been around 3% so a 10 year T-Note at 4% starts to look okay when you consider the scenario where short rates fall eventually and that 1 year T-Bill shrinks back to a 2% interest bearing instrument. I wouldn’t be surprised if people look at current rates in 5 years and say “man, we coulda locked in 4% on a 10 year”. But a lot of this is just a bet on how far the Fed feels like they have to move. That, after all, is the primary determinant of interest rates.
But there’s also a powerful mathematical element at work here – duration. The duration of an intermediate T-Note fund is about 7.5 and you’re earning 4% on that portfolio now. So the math here starts to look pretty attractive on a risk/reward basis because Fed Funds futures say the top in FFR will be about 5%. If that’s true then we’re close to the top in rates. So, even if the Fed continues to be aggressive the higher rates play a mitigating force in your principal risk. When we were earning 1% on a 10 year we were bound to lose 6.5% for every 1% hike in rates, but now your buffer is 4%. That’s a far better risk adjusted return and it’s why I always say that the late 70’s were pretty good for bonds – because the rise in rates creates a sort of escape velocity where the higher rates mitigate your interest rate risk.
Anyhow, I still think stocks have the potential to be messy in the coming years as housing unfurls, but bonds (especially shorter duration high quality bonds) are starting to look more and more attractive here. It might not be a bottom because the Fed seems intent on breaking something, but the risk/reward has improved bigly.
2) Mind tricks with bottoms.
My 2 year old daughter is adorable, but behaves like she’s bi-polar half the time. Recently, as we’ve been loading her into the car she has a meltdown when we put the seatbelt on her. It was making it almost impossible to go anwhere because she squirms and screams out of the seat.
I was laughing about this because Daniel Crosby asked Twitter about the best non-scriptural book that materially changed people’s lives. I mentioned Viktor Frankl’s book “Man’s Search for Meaning”. The big lesson being that no one can force you to perceive things in any way other than the way you want to perceive them. So, if a man in a concentration camp, facing almost certain death, can choose to be happy then I’d venture to argue that most of our daily gripes are not nearly as horrifying as we tend to think.
And I use this trick on my daughter all the time because she has no concept of happiness yet. So I started this trick where I put my seatbelt on and pretend to be “stuck”. Being stuck is a happy existence in the context of this trick. It’s fun and cool. So then she wanted to be “stuck” also. And now we always get stuck in the car together. This little trick changed the whole dynamic. And it was all about how she chose to perceive the circumstances. So, thanks Viktor. You saved every car ride I’ll have for many years into the future.
3) The opposite of a bottom is a ceiling?
The long story short is that the debt ceiling isn’t really a true “ceiling”. It’s a self imposed contraint that will perpetually require alterations because past legislation require it. I go into some detail here. It’s only three minutes so give it a watch if you want to understand the operational dynamics at work here.
I hope you enjoy the video.
1 – As I’ve noted in the past, don’t be a dumb-dumb and leave your money parked in cash. Buying T-Bills is super easy and it’s functionally similar to building your own money market fund. So, if you leave your cash in the bank then you’re essentially being charged a 5% annual fee by your bank because they should be investing the cash in T-Bills, but they’re instead earning that income and you’re just foregoing it because, well, who knows? The same goes for those “high yield savings” accounts. Those things are all giving like 2-3% interest and keeping the difference. What are you doing? Stop being lazy and buy the T-Bills on your own or reach out to me and I’ll do it for you.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.