What Have the Bond Markets Been Up To?

First of all, I hope this finds you well. We say that a lot, but it has such a deeper, intense meaning today, doesn’t it? In any case, I truly hope you and your families are safe.

As for our family, we’re doing just fine. I actually think our middle child, Lexi (6), is going to go back to school far ahead of where she was when they dismissed! She’s been cranking through the math workbooks that Mom got her.

I’ve got so many things I want to talk about that I think are important right now. Don’t worry, I’m only going to focus on one topic here, but it was a struggle to figure out what I wanted to address tonight.

Ultimately, I’ve decided to talk about the bond markets as the stocks markets have, understandably, been getting all the attention. Other topics you can expect in coming days and weeks are: precious metals and gold miners, big picture overview, coronavirus metrics you may not have seen yet, deflation vs. inflation, my market timing strategies’ performance results through this historic decline (preview: they have fared very well).

I want to talk about bonds tonight because there have been some interesting developments. I spoke with several investors and advisors before this all began that felt they were well-protected as they would say, “Don’t worry, I have some bonds in the portfolio.”

First of all, I’m guessing they still had far too much stock exposure, but, besides that, I’m willing to bet they had a lot of different types of bonds that didn’t necessarily help them a whole lot in the current situation. I’ll explain, but, first, let’s recap my views on bonds over the last two years. This will provide helpful context for the discussion.

These are quotes from some of my prior commentaries. For those of you who are new to our little community here, you can find all my previous commentaries on my website: https://melottefa.com/blog/

“Another bullish factor [for investing in Treasuries] is simply that other assets are far more overvalued so any sign of trouble or a loss in risk appetite from investors causes folks to flee to safety in the form of stable, liquid Treasuries.” – January 22, 2019

“Because I believe we are very late in the economic and market cycles, I am avoiding high-yield / junk bond funds. The reason for this is that high-yield / junk bonds tend to be highly correlated with stocks especially when stocks are stressed. This means you don’t get the diversification benefits you need from your bond investments when you most need it because both high-yield bonds and stocks decline together.” – March 19, 2018

“Over the last couple months, I’ve also gone so far as to shift away from investment-grade corporate bonds in favor of U.S. Treasury bonds. The result is a very high-quality bond sleeve with a heavy tilt to Treasuries. Treasuries tend to hold up much better than both high-yield and investment-grade corporate bonds when stocks are falling.” – March 19, 2018

“The more debt a business, government or individual has, the more fragile they become. Greater debt equates to greater vulnerability to economic slow down/recession, rising rates, and/or loss of income to competitive pressures. So it’s not advised to load up on highly-indebted companies in the last innings of a growth cycle.” – March 22, 2018

“One of my predictions has been, and continues to be, that there will be stress in the corporate bond markets leading to a potential USD dollar shortage and potentially a large appetite for “safe” assets like US Treasurys.” – October 31, 2019

“These dynamics make zombie corporations extremely fragile and susceptible to even small declines in profit margins and revenue potentially resulting in waves of layoffs and defaults…” – October 31, 2019

“Everything discussed above helps explain why, last year, I reallocated all clients’ bond portfolios away from corporate bonds and towards Treasuries.” – October 31, 2019

It should be clear that I have stayed away from high yield / junk bonds and even investment-grade corporate bonds in favor of Treasuries the last 1-2 years. How has that worked out? Was my theory correct? Luckily, we don’t have to speculate. The proof is in the pudding.

Here are the year-to-date returns of intermediate-term Treasury bonds in blue (Symbol: IEF), investment-grade corporate bonds in orange (Symbol: LQD) and high yield bonds in red (Symbol: HYG) through today’s close:

High yield bonds have lost about 20% so far this year. However, it’s expected that those would perform poorly in a period where the U.S. stock market has lost about 30%. After all, as I quoted above, high yield bonds are highly correlated to stocks so they aren’t a great buoy in times of stress. Nobody should be surprised by how they’ve performed this last month.

What’s perhaps more astounding to some is that even investment-grade corporate bonds lost over 16%! Investment-grade corporate bonds didn’t protect you at all during this historic stock market crash!

But, Treasuries did exactly what I expected them to do. They made over 8% in less than three months! “Boring.” “Safe.” Treasuries.

One reason investment-grade bonds are doing so poorly is because investors are finally realizing that many investment-grade bonds may get downgraded to junk. I’ve discussed this dynamic in detail about how over-indebted many of these corporations are and how they’re barely hanging on to their investment-grade status.

I discussed how the lowest rung of the investment-grade space is more bloated than it’s ever been and, based on historic leverage ratios, most of those bonds should be rated as junk right now! My prediction has been that when the economy slowed many of these bonds would get downgraded to junk status.

Additionally, investors are pricing a greater risk of default between both investment-grade and high-yield bonds.

So, how was your portfolio positioned? Even if your portfolio was relatively “conservative,” how did it hold up? Was the bond sleeve of your portfolio primarily invested in Treasuries or was it invested in “Total Return” bond funds, high yield bond funds and “Strategic Income” funds? The bonds you owned made a huge difference on how well you’ve fared so far during this panic.

Is it time you consider hiring the advisor who predicted (1) the potential for sharp, severe declines in the stock market due to excessive leverage and extreme valuations, (2) urged investors to take a more conservative approach to their portfolio for the last couple years and (3) correctly identified the various risks within the bond markets and proactively allocated away from corporate bonds to Treasury bonds, which turned out to be exactly the correct approach?

If you’re managing your portfolio on your own, or working with another advisor, now is the time to review if that still makes sense. Is your current advisor really up to the task? Do they really have the deep knowledge and expertise of the markets, economics and history to help you with the extremely important task of managing your portfolio and guiding you through retirement? Are they just doing what someone else tells them to do and regurgitating talking points from others that they really don’t understand? Are you truly in the best hands? You get one shot at doing this right.

I am here to help and I have the capacity to help. I manage just 44 households, which means I am able to provide a lot of custom service and hand-holding. Most relationship managers at other firms will have between 100-400 clients (depending on the firm, average client size, etc…). You don’t want an ‘investment factory” in times like this. You need a boutique advisor who has deep expertise and is also nimble enough to quickly make adjustments without layers of bureaucracy.

Kindest Regards,
Ken

Disclosures:
Past performance is no guarantee of future results. All investments maintain risk of loss in addition to gain.

Data from third-parties is believed to be reliable but accuracy is not guaranteed. Much of the data used to interpret the markets and forecast returns are often at odds with each other and can result in different conclusions. Many different factors impact prices including factors not mentioned here.

This is NOT investment advice but merely a general commentary. Individualized investment advice cannot be provided until a thorough review of your unique circumstances and financial goals is completed. Positions discussed herein are reflective of the past and not necessarily indicative of current or future positioning as that is reserved for clients only. Portfolio strategies can, and will, change without notice.