The Big Picture

“Da Bears, Da Bulls”  -SNL Super Fans 

I grew up outside of Detroit and I was no fan of teams from Chicago! (Sorry Chicagoan’s) However if you have never seen Bill Swerski’s Super Fans skit idolizing Chicago professional sports teams on SNL it was quite humorous!

Now to Da Bonds!

For several years now I have received concerns from clients as well as colleagues  regarding investments in fixed income. “How can we own bonds in a rising rate environment?” The concern stems around the effect that increasing interest rates have on bond prices. As market rates rise bond prices with fixed interest payments will adjust downward to reflect the present market rate. Another concern we have witnessed is a “chase for yield” due to the very low rates of interest since the financial crisis. This has driven investors into riskier income securities in order to earn more yield. This may not necessarily be the most prudent decision for all investors. 

Year-to-date and specifically over the past few months we have witnessed a good reminder as to why fixed income allocations may add value when equity markets decline, regardless of the expected direction in interest rates. When equity expectations change, our outlook on fixed income generally changes as well. However, not all fixed income is created equal.

Have a Plan and a Process!

From the Trenches

“I wouldn’t own any” -Jamie Dimon, CEO of JP Morgan Chase, on owning Treasury bonds in 2018.

What was Jamie Dimon’s beef with owning bonds? Basically the outlook that interest rates were going to rise. He is a banker, so rising interest rates are in his best interest. He is also a billionaire, so quite frankly he doesn’t need to worry too much about weathering a storm in equities… So there’s that.

So what has happened to interest rates since Jamie’s comment? Back down, yet again. The ten-year treasury interest rate was roughly 3% a year ago and it is  below 2% today. Predictions on the direction of interest rates have been challenging to say the least.

Below are interest rate predictions from economists on the 10 year treasury rate for this year against the actual yield. (source WSJ)

What is interesting about the above chart is not only were there no predictions even in the range of the current interest rate level; but only a few forecasters even predicted that the 10 year yield would fall for the year. Prediction is difficult. 

If you have to forecast, forecast often.

Bottom line: Things change, often times rapidly and unexpectedly. Having a process for identifying changes and adapting to them, not fighting them, is critical. As you will likely lose the fight!

The Weeds

Two consecutive closes above 3.25% equals a breakout from multiyear base. The last man standing is down. July of 2016 was indeed the (interest) rate low.” – Jeffrey Gundlach of Doubleline Capital.

Gundlach, widely considered the new “Bond King”, discussing the 30 year U.S. treasury interest rate. He was projecting (very confidently) that longer term interest rates would continue to rise. Not so fast…

Not owning fixed income during periods of rising interest rates, such as during 2018, was not an entirely unwise decision. However, if equities were the asset class in which capital was shifted, that would have resulted in a materially worse outcome than if the investor simply remained in fixed income! The belief that when fixed income is not performing well then equities must be performing is a dangerous one, and ultimately flawed.

There has been considerable noise around fixed income investing.

I have been asked numerous times over the years Why would we want to own bonds at all? Blanket beliefs such as not owning any fixed income due to the level of interest rates is very much missing the forest for the trees. There is more than one factor to consider in this analysis. For the majority of investors, even aggressive investors, fixed income likely has a place.

N0t all fixed income is created equal.

There are several considerations when selecting fixed income. Too many for me to bore you with in a short post. One consideration involves assessing the current market environment and identifying opportunities in the very areas that broad market analysis is likely missing. Would it surprise many investors to learn that since the Federal Reserve’s policy reversal last year, longer term U.S. Treasury securities have handedly outperformed the S&P 500. And keep in mind they are risk free!

Understanding fixed income’s place in a portfolio is critical as well as understanding the differences between fixed income assets in a given market environment. 

Bottom Line: Fixed income has a place in most investor’s allocations. The trick is to have a process for identifying market environments where an opportunity arises.