Among the primary asset classes, bonds are supposed to be the boring mini-van and stocks the thrilling sports car.  But over the last few weeks, everyone seems to be hysterical about bonds.  Check out the crazy twists and turns in the recent headlines about bonds:

• The 30-Year Treasury Bond Yield Plunges to an All-Time Low
• The Bond Market Is in a Bubble
• Bonds Are Frickin’ Expensive
• Ex-Fed Boss Says “There’s No Barrier” to Negative Bond Yields
• Bond Markets Are Sending One Big Global Recession Warning
• A Bond Up 65% in 2019

Should mindful investors head for Bond Street or take a detour instead?

The Mindful View of Bonds

Before we try to navigate all the excitement, let’s review the mindful take on bonds and their role in an investment portfolio.

• Bonds have almost always generated substantially worse long-term returns than stocks.
• A bond or bond fund’s current yield is an excellent predictor of future annualized returns for the duration of the bonds involved.
• Bond yields (and expected long-term returns) are incredibly low by any historical measure.  For example, the 10-year Treasury bond yields only 1.5% as I write this post.  In contrast, right now you can easily set up a safe cash savings account that offers 2% interest.
• Traditionally, bonds provide “ballast” in a diversified portfolio, where stocks generate most of the long-term returns and bonds help reduce portfolio volatility.
• Bond ballast is not particularly beneficial for most mindful investors because we care less about routine volatility and more about on long-term returns.
• One exception is that “older” mindful investors can use bond ballast to reduce “sequence of return risks” a few years before and after their retirement date.
• But even in this one case, because bond yields are so low right now, cash can work just as well or even better than bonds as ballast.

With all the recent bond market turmoil, have any of these conclusions changed?

Navigating the Headlines

The finance news can be very misleading.  So, maybe there’s less turmoil than these feverish headlines would suggest.  Let’s examine some of the main concerns about bonds using the four cornerstones of mindful investing: rationality, empiricism, patience, and humility.

Historically Low Yields – People have been concerned about unprecedented low bond yields for quite a few years now.  I first wrote about low bond yields in a 2016 article that included two relevant charts.  The first is from NewFound Research and goes back to 1875.

And the second is from Merrill Lynch, which uses interest rates as a proxy for bond yields and goes back 5000 years!

So, we’ve known about crazy low bond yields for quite some time now.  But the recent dip in bond yields from their late 2018 interim highs seems to have rekindled the frantic headlines.  Here’s a 5-year chart of the 10-year Treasury bond yield.

The 10-year yield has fallen more than 1.5% in the last few months, but it’s still slightly above the July 2016 all-time closing low of 1.38%.  However, the 30-year bond just hit a new all-time low under 2%.

But because long-duration bonds are particularly sensitive to interest rate changes, most investors seeking bond ballast are more interested in funds with around a 7 to 10-year duration.  Accordingly, the most important point is that the 10-year bond yield is still above its all-time lows.

So, we have some new trends developing, but there hasn’t been a huge shift in the bond situation in the last three years.  Keeping in mind that current bond yields usually predict future total returns, the mindful conclusion that bonds will continue to generate inferior returns for the foreseeable future is still valid.  If bond yields continue to fall for another year or two, some short-term gains will be generated as bond prices rise even more in response.  But for long-term investors, those early gains will likely be counteracted by subsequent losses when bond yields eventually rise again and prices fall.

Bond Bubble or Just Frickin’ Expensive – Because bond yields and prices are inversely related, it’s no surprise that bond prices are extremely high.  Longview Economics Chief Market Strategist Chris Watling looked at four common criteria for defining a market bubble: high availability of cheap money, increased borrowing to invest, historically extreme valuations, and a convincing narrative to justify unusually high prices.  He found that pretty much every one of these criteria confirms we’re in a bond bubble.  Defining the “convincing narrative” seems particularly speculative because it’s always difficult to discern the central themes of history in real-time.  In this case, Watling offers the narrative that most developed economies have become addicted to the low interest rates set by central banks.  So, any economic weakness will spur a feedback loop of more interest rate cuts and money printing, which will drive bond prices even higher.

Cliff Asness at AQR looked at two related bond valuation measures: real (inflation-adjusted) bond yield and the slope of the yield curve.  He found that both measures are at 5th percentile lows (indicating high bond prices) for the last 60 years as shown in these two charts.

Only 5% of the time in the last 60 years have these measures been any lower than they are today.

Concerns about bond bubbles today are the latest reverberations of the same concerns that have been around since at least 2016.  Then as now, bonds will possibly continue to generate short-term price gains, which will then likely be followed by counteracting losses and dismal long-term annual returns (for example, in the 1.5% range for 10-year bonds).  This “news” is getting pretty stale.

Here Comes Negative U.S. Bond Yields and A Global Recession – According to these types of articles, “The bond market is screaming [economic] recession”.  One source of the screams is the recently inverted bond yield curve in the U.S.  That’s when short-term bonds have higher yields than intermediate bonds, which is the opposite of the normal relationship.  I won’t get into the details about yield curves here, but if you want to know more about them and why “inverted” ones often presage recessions, here’s a good place to start.

Another source of concern is that more countries in the world are starting to issue bonds with negative yields or are going deeper into negative yield territory.  (I wrote a bit about negative yields and what that means in this article and this article by Vineer Bhansali has a good explanation of how they work.)  Many experts see no reason why U.S. bond yields couldn’t eventually go negative too.

So, we see some reasonable signals that an economic recession might be on the way.  Keeping in mind that no one can consistently predict the future, what does that mean for the mindful investor?  An economic recession usually results in a stock market correction or even a crash.  Central banks usually attempt to minimize the severity of a recession’s impacts by lowering interest rates either before or after the recession starts.

Essentially, the media is highlighting that bonds can be a canary in the coal mine for stocks.  But mindful investors know that recessions and market corrections happen periodically and the stock market has always eventually rebounded to new highs.  The key to winning the game of long-term investing is to keep playing through thick and thin and avoid “panic selling”, which simply locks in your losses.  So, there’s nothing new or actionable here for the mindful stock investor.

Better Bond Returns – While most recent headlines seem to be warnings, some folks are focused on the potential opportunities implied by recent bond price movements.  How have recent bond returns compared to stocks, the favored asset of mindful investors?  Here’s a table comparing year-to-date and 3-year returns of representative intermediate and long-term bond Exchange Traded Funds (ETFs) to the S&P 500 stock index (represented by VOO).  I used a three-year horizon for the second comparison because that’s about how long people have been fretting over low bond yields.

Fund	Average Maturity	2019 Year-to-Date Return	3-Year Annualized Return
Intermediate Bonds – AGG	8 years	8.6%	2.9%
Long-term Bonds – TLT	25 years	23.0%	4.3%
Stocks – VOO (S&P 500)	NA	15.0%	11.4%

So far in 2019 long-term bonds have substantially outperformed stocks.  However, if you had held that same bond fund since mid-2016, you would have received pretty typical bond returns while substantially lagging stock returns.¹  Holding intermediate bonds instead would have generated even worse results.  Further, long-term bonds are more susceptible than intermediate bonds to price declines when interest rates rise.  As a result, chasing this opportunity for higher bond returns adds meaningful additional risks.  Anyone emphasizing bond “opportunities” is assuming that you’re playing a very short-term and relatively risky game that is the antithesis of government bonds as a “safe haven”.

Such short-term speculation is known as “market timing”.  Unfortunately, substantial evidence shows that even the very best investors fail to consistently and successfully time the market.  Headlines that tout short-term bond returns are just click-bait for get-rich-quick schemers, who are the opposite of mindful investors.

A particularly egregious example of market-timing headlines was the Seeking Alpha article: A Bond Up 65% in 2019.  The pseudonymous author “Ploutos” uses the Austrian 100-year bond mostly as an example to explain the concepts of duration and convexity.  A more relevant and boring headline like “An Example of How Duration and Convexity Are Important to Portfolio Construction” wouldn’t have attracted a lot of clicks.

Regardless, Ploutos notes that in September of 2017 the Austrian government issued a century bond with a starting yield of 2.1%.  Assuming that the yield is predictive of the total future return even for very long-term bonds², investing in the Austrian century bond when it was issued would have essentially locked in a dismal return for a hundred years.³  Of course, in all likelihood, most investors in these bonds are playing some sort of short-term market timing game and aren’t planning to lock in a poor return for 100 years.

As a long-term investment strategy, century bonds are probably one of the least mindful investment options on the planet.  The only thing that the year-to-date 65% return on Austrian century bonds tells us is that a few people probably got extremely lucky in the first half of 2019.  And if they don’t sell soon, they’re in for a bumpy road ahead when there’s even a hint of a rumor that interest rates could start to rise.

Conclusions

The investing world is in a tizzy about bonds, but for reasons that are mostly irrelevant to the long-term investor.  As is so often the case, a mindful review of the situation shows us that the mindful investor should simply ignore the hysteria and stick his or her long-term investing plan.

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1 In case you think I’m cherry-picking my performance period here, I also looked at periods going back 4 to 20 years.  And the only time in recent history that long-term bonds generated a superior annualized return to stocks was if you had started investing exactly in the year 2000.

2 I’d guess that many bond experts would agree with this assumption, but some might not.

3 And investing in the same Austrian century bond now offers an even more dismal yield of 0.8% (locking in a similar long-term return consistent with my assumption) because the yield has plummeted as the price has sky-rocketed.