BY TYLER DURDEN
FRIDAY, MAY 26, 2023 – 09:30 AM
Authored by Lance Roberts via RealInvestmentAdvice.com,
I received many emails and questions on “why” we are adding the U.S. Treasury bond to our portfolios. The question is understandable, given its dire performance in 2022, where bonds had the biggest drawdown since 1786.
However, there is, as they say, “more to the story than meets the eye.”
A previous survey from BNY Mellon shows that very few people understand the bond market and how it works.
“A BNY Mellon Investment Management national survey on fixed-income investing was stunning: A measly 8% of Americans were able to accurately define fixed-income investments.“
Such is not surprising since the financial media focuses only on the “sexier” side of the business – equities.
However, bonds are necessary from the investment perspective and the economic view. As we have discussed previously, low-interest rates are a function of an overly indebted economy. If rates rise too much, bad things have historically happened.
“The chart below is the interest service ratio on total consumer debt. (The graph is exceptionally optimistic as it assumes all consumer debt benchmarks to the 10-year treasury rate.) While the media proclaims consumers are in great shape because interest service is low, it only takes small increases in rates to trigger a ‘recession’ or ‘crisis’ event.”
Of course, as noted, interest rates reflect economic growth. As economic growth slows and disinflationary pressures present themselves, rates will ultimately track economic growth lower.
A Long History Of Rates & Economic Growth
The chart below shows a VERY long view of interest rates in the U.S. since 1854.
As noted, interest rates are a function of the general economic growth and inflation trend. More robust growth and inflation rates allow higher borrowing costs to be charged within the economy. Such is why bonds can’t be overvalued. To wit:
“Unlike stocks, bonds have a finite value. At maturity, the principal gets returned to the lender along with the final interest payment. Therefore, bond buyers know the price they pay today for the return they will get tomorrow. As opposed to an equity buyer taking on investment risk, a bond buyer is loaning money to another entity for a specific period. Therefore, the interest rate takes into account several risks:”
- Default risk
- Rate risk
- Inflation risk
- Opportunity risk
- Economic growth risk
“Since the future return of any bond, on the date of purchase, is calculable to the 1/100th of a cent, a bond buyer will not pay a price that yields a negative return in the future. (This assumes a holding period until maturity. One might purchase a negative yield on a trading basis if expectations are benchmark rates will decline further.) “
Therefore, it was unsurprising that the recent inflation surge preceded higher interest rates. However, that inflation push was artificial from massive monetary interventions. As monetary inputs fade, disinflation will push yields lower.
Please read more at the below link:
The Treasury Bond – It’s Time Has Likely Come
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