Are You Ready For The End Of This 35-Year-Old Bull Market?

Are You Ready For The End Of This 35-Year-Old Bull Market?During the roaring 1920s, it seemed you couldn’t go wrong with stocks.

Years of rising stock prices created the mindset that there was never a reason to sell. Investors flocked to stocks, believing they could only go up. So, when the stock market started to crash in 1929, most investors thought it was just another great buying opportunity.

Frederick Allen described the investment environment in his book, “Only Yesterday: An Informal History of the 1920s”:

“As people in the summer of 1929 looked back for precedents, they were comforted by the recollection that every crash of the past few years had been followed by a recovery, and that every recovery had ultimately brought prices to a new high point. Two steps up, one step down, two steps up again – that was how the market went. There was really no reason to sell at all. The really wise man, it appeared, was he who bought and held on.”1

After peaking in 1929, the stock market plunged nearly 90%, leading into The Great Depression. Those who “bought and held on” lost their shirts.

That same mindset is playing out right now. Only this time it’s happening in the bond market.

Yes, Bonds Can Go Down
Bonds have been rallying for 35 years now. This bull market has created the perception that you can’t go wrong investing in bonds.

The chart below shows the yield on 10-year Treasury bonds going back to the 1960s. As you can see, yields peaked in 1981. And, they’ve been trending downward since then.

When rates decrease, new bonds that are issued pay less interest than those that are already outstanding. Those outstanding bonds become more valuable. Their prices increase because they have higher interest rates than the new bonds that are coming to market.

In other words, yields and bond prices move in the opposite direction. This means the prices of bonds have been rising for the past 35 years. This uninterrupted bull market has created a mindset that you can’t lose money with bonds.

10-Year Treasury Constant Maturity Rate (1962-Present)

Source: Board of Governors of the Federal Reserve System (US), 10-Year Treasury Constant Maturity Rate [DGS10], (retrieved from FRED, Federal Reserve Bank of St. Louis, May 10, 2016.)

Compare that to the ups and downs of the stock market over the recent decades, and it’s easy to understand why investors have flocked to bonds. Why gamble your retirement money in the stock market’s rollercoaster if you can just park your money in “safe” bonds?

The reality, however, is that investors are potentially taking more risk in bonds than ever before. With many major central banks implementing negative interest rates, such as the European Central Bank (ECB) and the Bank of Japan (BOJ), many bonds are now offering negative yields. Bloomberg reports that yields on $7.8 trillion of government bonds have been driven below zero.2 This massive position is vulnerable to any minor increase in interest rates. According to data compiled by Bank of America Corp., a half-percentage point increase would result in a loss of about $1.6 trillion in the global bond market.3

Bill Gross, who runs the $1.3 billion Janus Global Unconstrained Bond Fund, is arguably the best bond investor ever. He recently said that a tiny move in 30-year Japan government bonds, for example, could wipe “out an entire year’s income.”4

Several years ago, one MarketWatch commentary stated it this way, “Unless a hundred years of financial history are meaningless, bonds must go down.”5

The Best Way To Manage Interest Rate Risk
Despite all the red flags, investors’ sentiment towards bonds remain positive. In fact, Mark Hulbert, a senior columnist at MarketWatch, recently reported that bond “bullishness” is at a record high.6

Many retirees have poured trillions into bonds to produce income to fund their retirement. But, what happens if interest rates start to move higher? How will baby-boomers react if they open their statements and see significant losses in their bond holdings?

To be clear, we’re not saying you should sell all your bond holdings. After all, yields could keep moving even lower. But, I think that it’s important to manage the risk of higher interest rates in the future. And, one way to possibly manage that risk is to consider investing in short maturity bonds. When interest rates start moving higher, bonds with longer maturities will experience a much sharper drop in price than those with shorter maturities.

Until the next Daily Pfennig® edition…

Tim Smith
Vice President
EverBank World Markets, a division of EverBank