Flat yield curve and switching to intermediate Treasuries

Discussion of the Bond portion of the Permanent Portfolio

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sophie
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Flat yield curve and switching to intermediate Treasuries

Post by sophie » Mon Dec 18, 2017 7:31 am

We've had lots of threads on switching to intermediate Treasuries or cash based on an absolute interest rate for 30 year bonds and the idea that once you get down to 1-1.5% the downside greatly exceeds the upside, but I don't believe we've ever discussed this in the context of a flat or inverted yield curve. We are in that situation now!

While short term rates have been climbing due to Fed actions, market pressures have been pushing 30 year Treasury yields down. Here's the current yield curve:

Date 1 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr
12/15/17 1.24 1.31 1.48 1.71 1.84 1.95 2.16 2.28 2.35 2.52 2.68

My existing long term treasury assets have been doing very nicely, but I'm not crazy about the prospect of adding new assets in this situation. While it's possible for 30 year rates to drop lower than, say, the 10 year bond, that is historically an exceedingly rare event.

It may still be best just to keep going with the program, as it's still always possible for 30 year rates to decline further, and any losses will as always be mitigated by gains in the other assets (since bond yield increases do not occur in a vacuum). But, I'm seriously tempted not to put new money into bonds except to maintain a 15% allocation for safety.
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Re: Flat yield curve and switching to intermediate Treasuries

Post by whatchamacallit » Mon Dec 18, 2017 4:02 pm

The negative interest rates going on around the world are absolutely fascinating to me.

That being said, it seems like the 30 year treasury rate is a pretty good deal.

For a little more risk, i feel like the 10 year secondary market FDIC CDs ~2.90% and the EE bonds ~3.5% are a better deal for the retail investor. I know this could come back to bite me though.
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buddtholomew
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Re: Flat yield curve and switching to intermediate Treasuries

Post by buddtholomew » Mon Dec 18, 2017 4:22 pm

Sophie, although yields have flattened across the yield curve, duration has not (it has increased). TLT has a 17.79 duration that still makes the 30-year Treasury more volatile than shorter duration securities. Intermediate-term feels a lot more comfortable and easier to contribute, but having cash on the other end of the fixed income barbell does too. Convexity will dictate which performs better over time.
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Re: Flat yield curve and switching to intermediate Treasuries

Post by Mark Leavy » Mon Dec 18, 2017 6:40 pm

Great comment, Bud. It's easy to forget that the volatility of the assets (with respect to economic changes) are a big part of what makes the PP work.

Sometimes when I run investment models, I think that the first derivative of any one asset is much more relevant than that asset's CAGR - at least in a portfolio that is economically diversified.
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Re: Flat yield curve and switching to intermediate Treasuries

Post by buddtholomew » Tue Dec 19, 2017 3:31 pm

Thanks Mark!

Sophie, thought today was a good example to evaluate the bullet and barbell FI portfolio options.

100% GOVT ETF - AVG Duration 6.11, -.34%
50%/50% TLT + Cash - AVG Duration 5.62 years, -.40%

Not much here...
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Re: Flat yield curve and switching to intermediate Treasuries

Post by Cortopassi » Tue Dec 19, 2017 7:12 pm

Interesting that the day after you posted this, this happens:

https://www.themaven.net/mishtalk/econo ... _yFtyGlE4g
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sophie
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Re: Flat yield curve and switching to intermediate Treasuries

Post by sophie » Tue Dec 19, 2017 10:01 pm

Well, one day's price movements does not a trend make. I think that if the U.S. interest rates were the only thing affecting 30 year treasuries, the interest rates would be a lot higher by now. I figure the pressure from European bond buyers is what's keeping the yields down. To them, U.S. Treasuries look like a godsend, with German 30 year bonds still sitting around 1%. With market arbitrage I can't imagine the spread between U.S. & German bonds getting much larger than 2%.

I'm aware that bond price fluctuation is more important to the PP than yield. Just pointing out that our discussions previously was about absolute interest rates, i.e. how low can 30 year yields go before there's a natural point (e.g. 0 or 1%) that acts as a barrier to further yield drops. However, when the yield curve is flat like it is now, that barrier can effectively be a lot higher.
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Re: Flat yield curve and switching to intermediate Treasuries

Post by barrett » Wed Dec 20, 2017 6:17 am

buddtholomew wrote:
Sophie, thought today was a good example to evaluate the bullet and barbell FI portfolio options.

100% GOVT ETF - AVG Duration 6.11, -.34%
50%/50% TLT + Cash - AVG Duration 5.62 years, -.40%

Not much here...
Hey Budd,

I know this has come up before in these threads but I can't remember your answer...

How is it that you have an average duration of only 5.62 years on a TLT/Cash barbell? Seems like it should be closer to about 9, no? Wouldn't you need to be around 2:1 (Cash:LTTs) to get down to 5.62?

One thing I keep coming back to with the long bond portion of the PP is that in an ongoing low-rate environment like we've had since the end of 2008, it seems that the only way to really profit from LTT moves is to rebalance frequently. In general (the end of 2008 being the one exception) their price is not going to move up enough to force a rebalance even with 30/20 bands.

Have a look at these TLT numbers:

http://performance.morningstar.com/fund ... tion?t=TLT

I believe the trading range (yield) for long bonds during this period has fluctuated from about 2.2% to 3.75%. Both 2011 and 2014 delivered strong returns but, without rebalancing, those returns are largely offset by the poor performance in years like 2009 and 2013 (as well as the middling performance in most other years).

Or, looking at this from a slightly different angle, both stocks and gold can produce decade-long gains that are strong enough to carry the entire PP. LTTs can do that as well but not from current levels, unless we really do go pretty far into negative yield territory.
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buddtholomew
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Re: Flat yield curve and switching to intermediate Treasuries

Post by buddtholomew » Wed Dec 20, 2017 9:15 am

Barrett, good morning.
Correct, I hold enough cash, actually more than 2x the TLT total to achieve the 5.62 year duration.
I rarely purchase TLT (last purchase at 118) but rather contribute to other assets by reducing cash when yields rise or leave in cash when yields fall.
I agree with your concerns about LTT’s supporting the portfolio, but what else is available to potentially offset equity declines should they EVER materialize.
Hope this helps and as always appreciate your comments.
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Re: Flat yield curve and switching to intermediate Treasuries

Post by dualstow » Wed Dec 20, 2017 2:03 pm

Interesting, thread. Sophie, I guess I'm glad you're only talking about treasuries and not abandoning the pp. The stock market continues to provide temptation, and even with the pp performing fine, it's always a struggle. For me at least.

I'm also glad I don't have a lot of new money coming in, because I don't know what I'd do with it, but I don't care until cash exceeds 35%. When it does, I'll probably bite the bullet barbell and include long bonds in new purchases.

As for intermediate treasuries, I have some in my vp, and they're just sitting there with their pathetic 1.6 and 2% yields. Not tempted. O0
I'll take the barbell and hope that long bonds do their thing if called upon.
Barrick is acquiring Randgold.
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sophie
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Re: Flat yield curve and switching to intermediate Treasuries

Post by sophie » Wed Dec 20, 2017 3:31 pm

We all have our moments, dualstow!

Definitely sticking with the PP in general, it's just that I'm not quite sure what to do about bonds in the current flattened curve situation. I thought it was discussion-worthy. It's also potentially research-able since there was at least one inverted yield curve in the PP's past history.

It sounds like the answer is "nobody has a clue" - which I guess can be taken as "we can't even pretend to predict this particular future". So I guess I'll bite the "barbell" too. I've got my annual backdoor Roth & HSA contributions to deal with in January.
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Re: Flat yield curve and switching to intermediate Treasuries

Post by Cortopassi » Wed Dec 20, 2017 3:34 pm

TLT has gotten crushed the past few days. I know that doesn't add anything to the discussion...
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