Maximum Bond Upside
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Re: Maximum Bond Upside
If you look at TLT's biggest years, it has always been when rates were ultra low.
It's counterintuitive, but the largest fortunes in bonds have probably been made when rates were very low because the effect of each basis point move is amplified the closer you get to 0%.
I don't think that you realistically every get to 0% on a long bond on a sustained basis, but I think that you can easily bounce between 1% an 2% for many years, as Japan has done, and make a lot of money trading that range.
It's counterintuitive, but the largest fortunes in bonds have probably been made when rates were very low because the effect of each basis point move is amplified the closer you get to 0%.
I don't think that you realistically every get to 0% on a long bond on a sustained basis, but I think that you can easily bounce between 1% an 2% for many years, as Japan has done, and make a lot of money trading that range.
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Re: Maximum Bond Upside
What do you mean? It's not linear? Is this related to the convexity issue?MediumTex wrote: It's counterintuitive, but the largest fortunes in bonds have probably been made when rates were very low because the effect of each basis point move is amplified the closer you get to 0%.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
Re: Maximum Bond Upside
Of course it's not linear.MachineGhost wrote:What do you mean? It's not linear? Is this related to the convexity issue?MediumTex wrote: It's counterintuitive, but the largest fortunes in bonds have probably been made when rates were very low because the effect of each basis point move is amplified the closer you get to 0%.
If bond yields go from 9.9% to 9.8%, it will trigger a smaller move in the bond price than if yields go from 2.4% to 2.3%.
Price moves are dramatically amplified as you get closer to 0%.
Look at the huge returns TLT has provided in its up years in the 2008-2014 period. All of those returns were driven by 100-200 basis point moves in yield (basically bouncing around in the 2.3%-4.3% range). You wouldn't see anything like those gains in a market where LT rates were fluctuating between 9% and 11%.
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Re: Maximum Bond Upside
I think I see what you're saying. Are you saying that the leverage factor actually increases with lower yields so that you're actually making more dollars in absolute terms than at higher yields? Because gains in percentages are useless if they don't match the losses of equites and/or gold in absolute dollar terms.MediumTex wrote: Look at the huge returns TLT has provided in its up years in the 2008-2014 period. All of those returns were driven by 100-200 basis point moves in yield (basically bouncing around in the 2.3%-4.3% range). You wouldn't see anything like those gains in a market where LT rates were fluctuating between 9% and 11%.
Last edited by MachineGhost on Thu Jan 08, 2015 2:34 am, edited 1 time in total.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
Re: Maximum Bond Upside
Yes.MachineGhost wrote:I think I see what you're saying. Are you saying that the leverage factor actually increases with lower yields so that you're actually making more dollars in absolute terms than at higher yields? Because percentage terms are useless if they don't match the losses of equites and/or gold in absolute dollar terms.MediumTex wrote: Look at the huge returns TLT has provided in its up years in the 2008-2014 period. All of those returns were driven by 100-200 basis point moves in yield (basically bouncing around in the 2.3%-4.3% range). You wouldn't see anything like those gains in a market where LT rates were fluctuating between 9% and 11%.
For example, a drop in yield from 4% to 3% might result in a 25% increase in the price of a bond, but a drop in yield from 3% to 2% might result in a 30% increase in the price of the same bond.
Picture a game of tennis turning into a game of ping pong. It doesn't get boring--it gets more exciting because the game gets much faster as the effect of small moves becomes much more important.
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Re: Maximum Bond Upside
Wow, that's really pretty cool! So in theory bonds should infinitely never reach zero? How is it that Switzerland can be having negative yields then? If all it takes is a bidder bidding yields down to negative, how does that affect your premise?MediumTex wrote: For example, a drop in yield from 4% to 3% might result in a 25% increase in the price of a bond, but a drop in yield from 3% to 2% might result in a 30% increase in the price of the same bond.
Picture a game of tennis turning into a game of ping pong. It doesn't get boring--it gets more exciting because the game gets much faster as the effect of small moves becomes much more important.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
Re: Maximum Bond Upside
There are two factors in play here:
1. When the yield on a bond decreases, its duration increases. When its yield increases, its duration decreases. Therefore, like MediumTex said, a drop in yield from 2.4% to 2.3% will have a bigger impact on a bond's price than a drop from 9.9% to 9.8%.
2. Two bonds with the same maturity and the same yield but with different coupon rates will have different durations. The one with a lower coupon rate will have higher duration. As T-Bond yields go down, new T-Bonds are issued with a lower coupon rate (equal to the current market yield for a bond with the same maturity). For example, in July 2012, when yields on Treasuries went extremely low, several 30 year bonds were issued with a 2.58% coupon rate.
Here's a simple example: you have two bonds, A and B, both with a 30 year maturity and a 3% annual coupon rate. Bond A trades at a YTM of 2.5% and bond B is trading at a YTM of 1%. Then bond A has a duration of 20.45 years and bond B has a duration of 22.22 years (I used an online calculator to get this). But it is not true that bond B has more "juice" than bond A. Bond A can potentially drop from a 2.75% yield to 0% and this will result in a capital gain of around 20.45x2.75=56.24% (actually higher, because the duration approximation always underestimates). Bond B, on the other hand, can potentially drop from a 1% yield to 0% and this will result in a capital gain of around 20.22x1=20.22%. So bond A has a higher potential capital gain as well as a smaller potential capital loss (if the yield goes up by 1%, the bond's price drops roughly by its duration).
Imagine it like this- you bought a 30 year bond for 100$ and you intend to hold it until maturity. Each year you get 1$ (coupon payments) and in the last year you also get your 100$ back (the principle). If the bond's price were to rise to 130$ then there would be no point in buying it, because the total gain from it would be:
-130+1x30+100=0
So the bond's price should never rise above 130$. Actually this is a bit imprecise because you may be able to reinvest the coupons into the same bond at a more attractive price, or maybe into an entirely different bond. This way you might get a tiny positive gain. But if you spend the coupons as you receive them then this doesn't matter to you.
If the bond's price is above 130$ then it effectively has a negative yield. If you manage to find a sucker who will buy the bond from you for 140$ then yay, you just got 10$ in profit. But why would anyone do such a thing? Well, I guess one might do that if he thinks he can find a greater sucker who will buy the bond from him for 150$, but my gut feeling tells me that Treasury bonds aren't going to become a Ponzi scheme.
Regarding the negative yields in Switzerland, this is really strange and I have no explanation for it. In Europe it sort of makes sense because the ECB imposed a penalty rate of 0.2% on commercial bank reserves held in its deposit facility. So a bond with a yield of -0.1% looks relatively attractive (smaller loss). But really, no idea about Switzerland.
1. When the yield on a bond decreases, its duration increases. When its yield increases, its duration decreases. Therefore, like MediumTex said, a drop in yield from 2.4% to 2.3% will have a bigger impact on a bond's price than a drop from 9.9% to 9.8%.
2. Two bonds with the same maturity and the same yield but with different coupon rates will have different durations. The one with a lower coupon rate will have higher duration. As T-Bond yields go down, new T-Bonds are issued with a lower coupon rate (equal to the current market yield for a bond with the same maturity). For example, in July 2012, when yields on Treasuries went extremely low, several 30 year bonds were issued with a 2.58% coupon rate.
Here's a simple example: you have two bonds, A and B, both with a 30 year maturity and a 3% annual coupon rate. Bond A trades at a YTM of 2.5% and bond B is trading at a YTM of 1%. Then bond A has a duration of 20.45 years and bond B has a duration of 22.22 years (I used an online calculator to get this). But it is not true that bond B has more "juice" than bond A. Bond A can potentially drop from a 2.75% yield to 0% and this will result in a capital gain of around 20.45x2.75=56.24% (actually higher, because the duration approximation always underestimates). Bond B, on the other hand, can potentially drop from a 1% yield to 0% and this will result in a capital gain of around 20.22x1=20.22%. So bond A has a higher potential capital gain as well as a smaller potential capital loss (if the yield goes up by 1%, the bond's price drops roughly by its duration).
Imagine it like this- you bought a 30 year bond for 100$ and you intend to hold it until maturity. Each year you get 1$ (coupon payments) and in the last year you also get your 100$ back (the principle). If the bond's price were to rise to 130$ then there would be no point in buying it, because the total gain from it would be:
-130+1x30+100=0
So the bond's price should never rise above 130$. Actually this is a bit imprecise because you may be able to reinvest the coupons into the same bond at a more attractive price, or maybe into an entirely different bond. This way you might get a tiny positive gain. But if you spend the coupons as you receive them then this doesn't matter to you.
If the bond's price is above 130$ then it effectively has a negative yield. If you manage to find a sucker who will buy the bond from you for 140$ then yay, you just got 10$ in profit. But why would anyone do such a thing? Well, I guess one might do that if he thinks he can find a greater sucker who will buy the bond from him for 150$, but my gut feeling tells me that Treasury bonds aren't going to become a Ponzi scheme.
Regarding the negative yields in Switzerland, this is really strange and I have no explanation for it. In Europe it sort of makes sense because the ECB imposed a penalty rate of 0.2% on commercial bank reserves held in its deposit facility. So a bond with a yield of -0.1% looks relatively attractive (smaller loss). But really, no idea about Switzerland.
Last edited by Lang on Thu Jan 08, 2015 6:05 am, edited 1 time in total.
Re: Maximum Bond Upside
MediumTex it is great to read your posts again and I hope that you're doing well!
Re: Maximum Bond Upside
I just got an idea. If you want Treasury bonds to give you more upside, look for "stripped" versions of them. A zero-coupon 30 year bond will respond more strongly to changes in yield than an ordinary 30 year bond.
Re: Maximum Bond Upside
Use EDV for convenience.Lang wrote: I just got an idea. If you want Treasury bonds to give you more upside, look for "stripped" versions of them. A zero-coupon 30 year bond will respond more strongly to changes in yield than an ordinary 30 year bond.
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Re: Maximum Bond Upside
My calculations show approximately the same result. Starting with today's 30-yr Treasury yield (2.53%), here is what the bond is worth as the market yield changes:MachineGhost wrote: Looks like its roughly 40-50% upside gain left. 17 * 2.5% = 42.5% or the calculator shows it around 50% extrapolated. That's very interesting! There's not actually enough juice left.
If we are following Japan's playbook, then the 30-year could conceivably fall to their current yield of approx. 1%, which would give you an upside price gain of 40%. On the other hand, if the yield goes back to 4% where it was last year in Jan 2014, the price drops 25%. Who knows which direction yields are headed? If I was forced to guess, I'd say they're going lower, that's the global trend.
It is interesting that the yield on the 30-year has gotten so low. At 2.5%, you can almost get the same yield from a 5-yr CD, although with a much different risk profile.
I have been taking the alternative 'bullet' approach of putting my bond+cash holdings together into a much larger position of shorter-term Treasury bonds. The 5-year bonds give you decent yield (1.5%) plus weak deflation protection. You also get potential capital gains from 'riding the yield curve', since the yield curve is steep here; this is something you don't get from the 30-year bond, since the yield curve is pretty much flat there. Of course, the yield curve is not static, so it's hard to make long-term investment decisions based on it's current shape.
Just for fun, I plotted the bond price changes for even lower starting bond yields, shown by the red dots. Even if bond yields drop to the Japan level of 1%, you can still make 14% as the yield drops to the even lower Swiss level of 0.5%.
Re: Maximum Bond Upside
Austen,
Thanks for posting that! Great info to have & much appreciated.
Thanks for posting that! Great info to have & much appreciated.
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Re: Maximum Bond Upside
Excellent charts, thanks!Austen Heller wrote: I have been taking the alternative 'bullet' approach of putting my bond+cash holdings together into a much larger position of shorter-term Treasury bonds. The 5-year bonds give you decent yield (1.5%) plus weak deflation protection. You also get potential capital gains from 'riding the yield curve', since the yield curve is steep here; this is something you don't get from the 30-year bond, since the yield curve is pretty much flat there. Of course, the yield curve is not static, so it's hard to make long-term investment decisions based on it's current shape.
I have done similar with my duration risk because I'm looking at it from a long-term risk vs reward perspective (and because trendfollowing didn't work during the bear market). But the problem with this approach is you lose the hedging potential. If I recall, T-Bonds were up about 22% last year even though equities didn't correct. If they had and you had a much lower duration, you would have taken on portfolio losses that the HBPP would have not. This is a source of concern to me because I have certain Prosperity exposures that are not immediately liquid to sell in terms of negative trendfollowing (which also has its own emotional pitfalls just as buy and hold does).
Of course, the answer just came to me... you definitely need to risk level the PP if you're going to lower the duration. Fortunately, volatility seems to correspond to duration very well.
Last edited by MachineGhost on Sat Jan 10, 2015 11:04 pm, edited 1 time in total.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet. I should not be considered as legally permitted to render such advice!
- Austen Heller
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Re: Maximum Bond Upside
Checking back in with this thread...international bond yields have gotten even more crazy.
Japan: 30-yr = 1.06%, with everything negative below 10 years.
Swiss: 30-yr = 0.278%, everything negative below 15 years.
Insane. Still lots of upside for holders of US bonds, with the 30-yr at 2.66% and the entire yield curve still positive.
Japan: 30-yr = 1.06%, with everything negative below 10 years.
Swiss: 30-yr = 0.278%, everything negative below 15 years.
Insane. Still lots of upside for holders of US bonds, with the 30-yr at 2.66% and the entire yield curve still positive.
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Re: Maximum Bond Upside
Thank u HB!
Re: Maximum Bond Upside
How much will we make when long bonds reach -1%?
- Austen Heller
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Re: Maximum Bond Upside
Well, I went ahead and updated my previous chart to include negative yields. The red dot represents current market conditions in the US, 30-year bond yield ~ 2.5%, price 100. If yield drops to -1%, then price is 222.Reub wrote: How much will we make when long bonds reach -1%?
*bond pricing calculations performed as described here:
http://www.investopedia.com/university/ ... dbond2.asp
Re: Maximum Bond Upside
So we'll more than double our money? Very good!
Re: Maximum Bond Upside
Haven't read this thread thoroughly, and may have asked this before. But why ever own a neg yielding bond when you can own cash?
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Re: Maximum Bond Upside
If someone will pay you more for that bond than you paid for it.BearBones wrote: Haven't read this thread thoroughly, and may have asked this before. But why ever own a neg yielding bond when you can own cash?
Re: Maximum Bond Upside
Okay, but why would anyone ever buy one?Jack Jones wrote:If someone will pay you more for that bond than you paid for it.BearBones wrote: Haven't read this thread thoroughly, and may have asked this before. But why ever own a neg yielding bond when you can own cash?
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Re: Maximum Bond Upside
Some institutions don't have a choice, right? They can't just stockpile $100 bills.Xan wrote:Okay, but why would anyone ever buy one?Jack Jones wrote:If someone will pay you more for that bond than you paid for it.BearBones wrote: Haven't read this thread thoroughly, and may have asked this before. But why ever own a neg yielding bond when you can own cash?
Re: Maximum Bond Upside
Ah, so STT even worse, so institutions still buy longer term treasuries! Boy I feel stupid.
Back when this forum was in its infancy there were such high level discussions of economics and such things. Now feel like many of the newer folks are asking the same questions all over again and things aren't being discussed as much. Have to search for the answers.
And then theres me. I'm not new. Just ask the same damn rudimentary questions over and over again because I can't remember the answer.
Back when this forum was in its infancy there were such high level discussions of economics and such things. Now feel like many of the newer folks are asking the same questions all over again and things aren't being discussed as much. Have to search for the answers.
And then theres me. I'm not new. Just ask the same damn rudimentary questions over and over again because I can't remember the answer.
Re: Maximum Bond Upside
I don't remember half the things I've posted here.BearBones wrote: Ah, so STT even worse, so institutions still buy longer term treasuries! Boy I feel stupid.
Back when this forum was in its infancy there were such high level discussions of economics and such things. Now feel like many of the newer folks are asking the same questions all over again and things aren't being discussed as much. Have to search for the answers.
And then theres me. I'm not new. Just ask the same damn rudimentary questions over and over again because I can't remember the answer.
Q: “Do you have funny shaped balloons?”
A: “Not unless round is funny.”
A: “Not unless round is funny.”
Re: Maximum Bond Upside
The two words all Treasury bond investors should know: positive convexity.Austen Heller wrote:Well, I went ahead and updated my previous chart to include negative yields. The red dot represents current market conditions in the US, 30-year bond yield ~ 2.5%, price 100. If yield drops to -1%, then price is 222.Reub wrote: How much will we make when long bonds reach -1%?
*bond pricing calculations performed as described here:
http://www.investopedia.com/university/ ... dbond2.asp
In this blog post I discuss the concept along with a couple useful links:
https://web.archive.org/web/20160324133 ... y-and-you/
Links that discuss this concept further:
http://financetrain.com/bond-duration-a ... rt-1-of-2/
http://financetrain.com/bond-duration-a ... rt-2-of-2/
Now the next question is if I would personally buy long bonds in negative yield territory? No, I wouldn't. But as others have stated some institutional investors don't have an option.
Last edited by craigr on Sun Feb 07, 2016 4:58 am, edited 1 time in total.