Might rising rates hit LTTs more softly than we fear?

Discussion of the Bond portion of the Permanent Portfolio

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Might rising rates hit LTTs more softly than we fear?

Post by Pointedstick » Sun Jul 05, 2015 11:29 pm

I was thinking about rising rates today and started to wonder if maybe LTTs might not get clobbered like we're all fearing, at least not in the short term.

Consider this: with rates so low, it's widely accepted here that risk-averse investors have jumped into the stock market in search of yield. This is a dangerous situation because these people don't want to be in stocks; they would prefer fixed income. So let's say Yellen makes the fateful announcement and LTT rates jump. On one hand, prices will fall. But on the other hand, won't a huge amount of people currently holding stocks they don't like sell them and buy bonds that are giving rates closer to what they find reasonable? I think it's quite possible that this flood out of stocks and into bonds could keep bond prices from falling as much as we fear, especially if the exit from stocks becomes a self-fulfilling prophecy and the market slumps due to all the selling, prompting people to buy even more LTTs in their flight to safety.

Thoughts?
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Re: Might rising rates hit LTTs more softly than we fear?

Post by MachineGhost » Mon Jul 06, 2015 12:58 am

Pointedstick wrote: I was thinking about rising rates today and started to wonder if maybe LTTs might not get clobbered like we're all fearing, at least not in the short term.

Consider this: with rates so low, it's widely accepted here that risk-averse investors have jumped into the stock market in search of yield. This is a dangerous situation because these people don't want to be in stocks; they would prefer fixed income. So let's say Yellen makes the fateful announcement and LTT rates jump. On one hand, prices will fall. But on the other hand, won't a huge amount of people currently holding stocks they don't like sell them and buy bonds that are giving rates closer to what they find reasonable? I think it's quite possible that this flood out of stocks and into bonds could keep bond prices from falling as much as we fear, especially if the exit from stocks becomes a self-fulfilling prophecy and the market slumps due to all the selling, prompting people to buy even more LTTs in their flight to safety.

Thoughts?
You're assuming that hiking up the Federal Funds Rate will have any direct affect on the long end of the yield curve.  If there is an effect, it won't be on yields; it'll be people panicing because they believe as you believe that any hike is bearish and is instant "Tight Money" without looking into the operational reality.  When QE ended which was clearly a direct monetization of the long end of the yield curve, bonds tanked for the rest of the year.

So who the fuck knows what will happen.  I've reduced my duration if only because I don't trust stupid people.  If I'm proven wrong, then its yet one more reason to stay completey agnostic with the PP.  Just can't win.
Last edited by MachineGhost on Mon Jul 06, 2015 1:01 am, edited 1 time in total.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Mon Jul 06, 2015 6:35 pm

Historically short term rate increases effected the longer end only 50% of the time when short term rates were raised 1% or more.

It is no better than a coin toss to guess

over the last 40 years, we have seen a dramatic cyclical decline in interest rates. Yet, there were almost as many years when the federal funds rate increased  as there were years of decline. Yet, we only had one year (from 1973 through 2014) when the intermediate bond index produced negative returns.

BUT NOW WE HAVE THE OPPOSITE ISSUE.

short term rates have not increased but long term rates have.
Last edited by mathjak107 on Tue Jul 07, 2015 7:06 am, edited 1 time in total.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by Longstreet » Tue Jul 07, 2015 2:10 pm

Again, I apologize for asking the obvious, but one of HB's basic tenets is to not invest in something you don't understand.

MachineGhost states, "I've reduced my duration".  Common sense tells me that means he has shortened the average time frame for his bond pool to mature.  How does he do this 1) assuming he originally bought bonds that mature in 30 years and normally sells them in 10 years, but instead does not sell the bonds after the 10th year and holds them longer before selling, 2) puts new money in and buys bonds that mature in 20 or 25 year instead of a 30 year maturity, or 3) either reduces his bond allocation or puts more money into cash or short term bonds?  Is this correct?  Doesn't it take considerable time to effectively shorten your duration using these methods?

Also, many posters reference bond ladders.  I assume that means you buy, for example, 5 bonds maturing in 30 years, 5 bonds expiring in 25 years, 5 bonds expiring in 20 years, then continually rotating your holdings, adding new bonds periodically with longer maturities and selling existing bonds after holding them for a pre-determined period, is this correct?

Finally, I've never bought a bond - just bond funds.  The only way I can "reduce my duration" would be to overweight a ST bond fund (cash), or counterintuitively not rebalance my LT Treasury if the amount falls below 25%

Am I on the right track?

Thanks 
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Re: Might rising rates hit LTTs more softly than we fear?

Post by MachineGhost » Tue Jul 07, 2015 6:49 pm

Longstreet wrote: MachineGhost states, "I've reduced my duration".  Common sense tells me that means he has shortened the average time frame for his bond pool to mature.  How does he do this 1) assuming he originally bought bonds that mature in 30 years and normally sells them in 10 years, but instead does not sell the bonds after the 10th year and holds them longer before selling, 2) puts new money in and buys bonds that mature in 20 or 25 year instead of a 30 year maturity, or 3) either reduces his bond allocation or puts more money into cash or short term bonds?  Is this correct?  Doesn't it take considerable time to effectively shorten your duration using these methods?
Door #3, Monty!

Laddering isn't in reference to the bonds, but CD's for the cash.  You can do it two ways.  Stack 'em five deep at the 5-year level if the early break penalty still leaves the net yield higher than the yields on a regular 1,2,3,4,5 year CD or just buy individual 1,2,3,4,5 year CDs. 
Last edited by MachineGhost on Tue Jul 07, 2015 6:51 pm, edited 1 time in total.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by economicsjunkie » Tue Jul 07, 2015 9:11 pm

I think this one will answer the original poster's question if he hasn't read it already:

https://www.hedgewise.com/blog/marketco ... 8-1982.php
Insight #1: The long-term bond yield will not move in-line with short-term rate changes

Insight #2: The effect of changing yields on bond returns will depend heavily on the speed of the changes.

Insight #3: Bond market yields are based on expectations. If everything continues to go exactly as expected, yields may not change at all.

Insight #4: The slow-changing nature of long-term interest rates, compounded with the receipt of coupon payments over time, mitigate the impact of bond losses in a bear market.

Insight #5: A period of unexpectedly high inflation often has a negative impact on the economy as a whole, depressing real growth and creating the risk of recession. This mitigates changes in the bond yield.

Insight #6: The worst bond crash in history happened over the course of 10 months and resulted in a net loss of 17%. It is extraordinarily unlikely that we will witness something worse in the near future.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by ozzy » Wed Jul 08, 2015 11:38 am

Thats a good article from Hedgewise.  I also believe that LTTs wont be clobbered by rising rates over the long run.  I think its a lot of worry over nothing.  No doubt LTTs will decline temporarily, but stocks and gold will likely pick up the slack.  They always have.

Plus, if your LTTs are in a fund like TLT or VUSTX, and you re-invest dividends, it lessons the negative impact.
For example, see chart below.

Image

Notice how even when yields (orange line) rose (e.g. years 2009, 2013) the bond funds (VUSTX in black, TLT in brown) only declined temporarily.  And their declines never made a new low.  It was always a higher-low. 
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Wed Jul 08, 2015 1:32 pm

a 40 year bond bull market made everything okay in the past . the jury is still out on this now with interest rates eventually going to start the trend towards normal.

big difference if that is the case  .

how many years out of those 40 were spent going up ?

I bet not  many
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Re: Might rising rates hit LTTs more softly than we fear?

Post by economicsjunkie » Wed Jul 08, 2015 1:53 pm

mathjak107 wrote: a 40 year bond bull market made everything okay in the past . the jury is still out on this now with interest rates eventually going to start the trend towards normal.

big difference if that is the case  .

how many years out of those 40 were spent going up ?

I bet not  many
Don't underestimate how long interest rates can stay low or even go lower.

There once was a long term treasury bull market that lasted from 1790 through 1945 :)

http://www.pgm-blog.com/wp-content/uplo ... drates.jpg
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Wed Jul 08, 2015 2:11 pm

would you make that bet today  ? just look how much higher rates were back then too.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by economicsjunkie » Wed Jul 08, 2015 4:45 pm

mathjak107 wrote: would you make that bet today  ? just look how much higher rates were back then too.
Actually at the bottom rates were lower than they are now (1.7% for 10 yr T-Bonds in 1945).

Yes, I think it's conceivable, but of course I wouldn't bet the farm on it.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by MachineGhost » Wed Jul 08, 2015 5:12 pm

economicsjunkie wrote: There once was a long term treasury bull market that lasted from 1790 through 1945 :)

http://www.pgm-blog.com/wp-content/uplo ... drates.jpg
Diff between now and then is that the currency can devalue to offset inflation, so that's good for the gold in the PP.  I would never want to go back to a "gold standard" and be eaten alive by inflation or deflation ever again.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by MachineGhost » Wed Jul 08, 2015 5:15 pm

economicsjunkie wrote: There once was a long term treasury bull market that lasted from 1790 through 1945 :)

http://www.pgm-blog.com/wp-content/uplo ... drates.jpg
    1790-1902: erratic yield fluctuations and then a sustained decline in yields to below 3%.
    1902-1920: the First Bear Bond Market, yields rise from 3% to 5-6%.
    1920-1946: the Great Bull Bond Market, yields decline from 5-6% to below 2%.
    1946-1981: the Second Bear Bond Market, yields soar from 2% to above 15% during 1981.
    1981-today: the Greatest Bull Bond Market, as yields tumble from 15% to 1.5% today.

Keep in mind this is just 10-year.  The outcome is far worse for 20-30 year.  I think we have enough history here to know which way the wind is going to blow next.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Wed Jul 08, 2015 5:45 pm

from just a performance standpoint when you look at a total accumulation period which spans not 10 or 15 years but 25-40 years the performance of the pp in comparison to wellesley income  or a 60/40 mix was way below them .

that was with a 40 year bull market in bonds  and 30 year bonds which act as leveraged bonds.

so if the performance as an accumulation vehicle was so much less with the wind at its back how do you think it will do when it has a strong headwind and those leveraged bonds now hurt instead of help.

just keep that in the back of your mind. when those rates trend back , which eventually they will and it will be very different than it was prior . gold has done little and may continue to do so and 25% in equities may not be enough to tread water long term with that  head wind.

i can't predict but just something to keep in mind if you are trying to grow a nest egg and not just preserve money.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Wed Jul 08, 2015 6:13 pm

MachineGhost wrote:
economicsjunkie wrote: There once was a long term treasury bull market that lasted from 1790 through 1945 :)

http://www.pgm-blog.com/wp-content/uplo ... drates.jpg
    1790-1902: erratic yield fluctuations and then a sustained decline in yields to below 3%.
    1902-1920: the First Bear Bond Market, yields rise from 3% to 5-6%.
    1920-1946: the Great Bull Bond Market, yields decline from 5-6% to below 2%.
    1946-1981: the Second Bear Bond Market, yields soar from 2% to above 15% during 1981.
    1981-today: the Greatest Bull Bond Market, as yields tumble from 15% to 1.5% today.

Keep in mind this is just 10-year.  The outcome is far worse for 20-30 year.  I think we have enough history here to know which way the wind is going to blow next.

i find it amazing how fast you are right there with the numbers.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Thu Jul 09, 2015 1:00 pm

todays self off in TLT and treasury's are an example of what you could face if rates continue upward. TLT  was down  the equal to a 300 point drop in the dow .

there is a reason many knowledgeable investors are switching to bond funds  with short durations.

I have about 10% in vanguard total bond but all the rest is in vanguard short term bond , fidelity floating rate  and vanguard  inflation proof short term bond.

I am insulating myself as much as feasible from big rate risk .

I much rather contend with only equity market risk over the long haul .
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Re: Might rising rates hit LTTs more softly than we fear?

Post by D1984 » Thu Jul 09, 2015 3:14 pm

mathjak107 wrote: todays self off in TLT and treasury's are an example of what you could face if rates continue upward. TLT  was down  the equal to a 300 point drop in the dow .

there is a reason many knowledgeable investors are switching to bond funds  with short durations.

I have about 10% in vanguard total bond but all the rest is in vanguard short term bond , fidelity floating rate  and vanguard  inflation proof short term bond.

I am insulating myself as much as feasible from big rate risk .

I much rather contend with only equity market risk over the long haul .
There will likely be some losses in LTTs when/if rates rise (and I don't doubt they will rise at some point...the question is by how much, and how much rates will rise from current levels). I gather (as per one of your other posts on this board in the "Nowhere to hide" thread IIRC) that you believe that yields (interest rates) on LTTs will rise back to 6% or 7%; as per your post in that thread you stated "if rates head back to their norm over many many years in the 6-7% range".

My question is why do you think rates on LTTs will go up to 6% or 7%? Are you expecting average inflation of 4% or 5% per year over the next decade or two? The reason I ask that is that LTT rates have historically averaged about 1.75% to 2.25% over inflation. The current yield (interest rate paid) as of today on a 30-year TIPS is around 1.08%...so the markets are expecting a bit over 1% inflation or so over the long term. Perhaps they are right; perhaps they are wrong, but that is what they are expecting. The yield on a 30-year nominal (non-TIPS) LTT as of today is (per the Federal Reserve's website) 3.10%. Given that in both the case of the TIPS and the nominal LTT the markets seem to be pricing them both to yield around 2% real, what makes you think the markets are dead wrong? I'm guessing you either expect:

A: Inflation high enough to drive long-term bond yields to 6% or 7% (in other words, inflation at 4% or 5% or a little higher) so that they still yield around 2% real.

B. That inflation will stay muted (say maybe 1% or 1.5% or perhaps 2% at worst) per year on average over the coming decade or two but somehow bond yields will still spike to 6% or 7% which would give real yields of 4% to 5% on bonds.

If the former, please explain why you have anything in bonds at all (and/or why you aren't arbitraging the hell out of the presumed mispricing between expected inflation vis-a-vis TIPS and nominal bonds by investing in 30 year nominal vs 30 year TIPS swaps in order to make a killing if your prediction comes to pass).

If the latter, I'm curious as to why you think Treasury securities should have a "real" yield that is almost equal to what was and is historically expected on equities (around 5% to 7% real) when the long term average on said securities is around 2% real or maybe a little more.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Thu Jul 09, 2015 3:24 pm

rates on long term treasuries only have to go up 1 or 2 points to do severe damage and set them so far back that if equity returns are weak you will have very little in the way of gains at this stage.

my intention is not to talk anyone out of the pp , but my intention is to make sure everyone understands when you are this close to the end of a rate cycle this isn't your father's investing environment anymore.

we are so far from hyper inflation , gold has not reacted well to world events or general inflation and rates are poised to rise while stock valuations are high.

talk about the perfect storm for a portfolio
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Re: Might rising rates hit LTTs more softly than we fear?

Post by Pointedstick » Thu Jul 09, 2015 3:38 pm

If we are "so far from hyperinflation" we are also so far from the kind of situation that would make bond yields spike. You can't have it both ways: either inflation is so low that gold sucks, or it's so high that bonds get crushed. How can it be both?
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Re: Might rising rates hit LTTs more softly than we fear?

Post by Reub » Thu Jul 09, 2015 3:50 pm

Why is it impossible to have rising rates, falling equities, and lower gold prices? Where does it say that it  can't happen?
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Re: Might rising rates hit LTTs more softly than we fear?

Post by Pointedstick » Thu Jul 09, 2015 4:05 pm

Reub wrote: Why is it impossible to have rising rates, falling equities, and lower gold prices? Where does it say that it  can't happen?
Anything is possible, of course. But for this to happen all at once implies low inflation, economic turmoil, and positive real interest rates that are rising. Pretty much the definition of a tight money recession. In this environment, everything will explode for a year or two and cash will be king. But we already have 25% cash. Pretty much the only thing that should beat the PP is a 100% cash or very short-term bond portfolio.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Thu Jul 09, 2015 5:13 pm

again , are you trying to grow money or protect money  ?  the pp failed to keep pace with even a 40/60 mix over long accumulation periods and we are taking about  huge amounts of difference. compared to a typical growth model over the same time frames the differences can be  a million or more just starting with 100k.

the fact is you have to really stop looking at 10 or 15 year periods and look over an investing lifetime leading up to retirement .

the cost of that protection is enormous if you are looking to  grow your savings.  long term looking at 30-40 year accumulation periods the last 146 years ,you never needed that protection . 

long term money needs to be long term money and invested like long term money.

most retirements today are underfunded and more seniors than ever before are ending up having to find work later in life.

if you think it is tough finding a job at 60 you don't want to try it at 80 .

folks need to give themselves the best chance of  growing that money .

you would be hard pressed to find any 30 year time frames that money did not grow in a diversified fund nicely.

on the other hand comparing results over almost any 30 year period has left the pp way behind and all money was exposed to the same events the pp is protecting against.  think about that fact .
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Re: Might rising rates hit LTTs more softly than we fear?

Post by screwtape » Thu Jul 09, 2015 5:53 pm

mathjak107 wrote: long term money needs to be long term money and invested like long term money.

most retirements today are underfunded and more seniors than ever before are ending up having to find work later in life.
Sounds like what I was hearing when I rolled my closed-out pension plan into a T. Rowe Price target date fund. That was their stated philosophy and they were about 80/20 stocks at the time (I was 58). That was in 2007. You can probably imagine the horror story that soon followed. Like the Jews after the holocaust I vowed never again and that's basically why I'm in the PP right now a couple of years before retirement.

But I've since given up all forms of religious fanaticism and I'm not a PP zealot. If I become convinced there is a better way I will adopt it, but I do intend to keep all my physical gold no matter what as I've grown kind of fond of the shiny metal.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by mathjak107 » Thu Jul 09, 2015 6:10 pm

of course what is that target fund worth today  had you just left it  ?  and what will it be worth in 20 years ?  i would bet a whole lot more .

the truth is folks  hurt themselves , not markets .  it is always bad planning , bad moves or lack of a plan that gets the small investor.

time makes everything all right especially the normal 30-40 years we do our accumulating for retirement in.

the huge price you pay for protection time just  gives you for free anyway.


there is no 30 year or longer period the pp can compare to the balance of even a 60/40 mix , forgt about comparing it to a target fund or growth model.

yet both money was exposed to the same disasters , black swan events and financial melt downs , yet over and over conventional investing grew that money by leaps and bounds over the pp.

you really have to think about the  fact both saw the same events.

as always my intention is not to have anyone change. but my intention is for you to sleep with the enemy .


when you compare how wonderful the pp does using 10 or 15 year time frames you are not looking at a real accumulation stage which spans many decades and gives you big potential for growing money compared to the pp and it has done so over every accumulation period spanning those years.


i want you to realize times are very different at the bottom on an interest rate cycle and you have a leveraged bet on lower rates still which may be betting against the house.

all i want you to do is see if everything still makes sense to you .

if your answer is yes than by all means follow your brain.
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Re: Might rising rates hit LTTs more softly than we fear?

Post by screwtape » Thu Jul 09, 2015 6:17 pm

mathjak107 wrote: of course what is that target fund worth today  had you just left it  ?  and what will it be worth in 20 years ?  i would bet a whole lot more .
It did recover nicely and I didn't leave it until it did, having learned at least enough about investing to know selling low was a bad idea.

As to how well it has done since I don't generally like to engage in that kind of masochistic exercise. Probably pretty well if it was 80/20.

What will it be worth in 20 years? You tell me.
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