photo by bennylin0724
Written by Nathan White, Chief Investment Officer, Paragon Wealth Management
Backing into a dead end is the way I feel about much of the bond market right now. It might keep you off the risky streets, so to speak, but eventually gets you nowhere. Just when you think rates couldn’t go any lower bond yields continue to hit record lows. The 30-year Treasury hit a record low of 2.47% and the 10-year is around 1.42%. Yields are getting compressed across the board. Simply amazing to put it plainly.
Prudence would dictate to take profits on bonds but where would you put the money if you’re a conservative investor? In order to get a real yield on any bond investment it must either be in the high yield (junk) space or you must go to the long end of the curve. That means you’re taking on significant risk. The alternative is to put your money in cash and get nothing and hope that inflation stays low so your purchasing power doesn’t erode.
Bonds seem to be entering what could be their final blow-off phase. There is so much money that continues to flood into bonds due to many factors but there is not much road left at this point. We are starting to hedge our bond exposure (almost all corporate) from this point on as the reward is just not worth the risk. For example, as of 7/25 the iShares Barclays 7-10 year Treasury Bond ETF (IEF) has an average yield to maturity of 1.15% with an effective duration of 7.51. What this basically means is that the price appreciation potential from this point is barely over 7.5% and the 10-year would have to drop to zero for that to occur. Just a year ago the 10-year Treasury was in the high 2% range which was still amazingly low. If the yield returned to that level the holder of IEF would lose 7.5% and it would take 6 – 7 years with its measly interest rate to get back to even. That’s not the kind of trade-off I like but one that large numbers of investors are currently taking.