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Traditionally, many people view bonds from a largely “sanctified” and secured perspective. In fact, several risk-averse investors have jumped ship from stocks to bonds, many of them retirees and aged investors who need fixed and secured long term investments to secure their financial futures.
But analysts have revealed that this orientation might not be entirely reliable after all. Investors in the U.S have invested over $900 billion in US bonds since January of 2008; most of the funds used have been pulled out from stocks and equities with the hope of landing a more secured and more valuable investment.
While investors who put money in bonds and hold until maturity may not lose money unless the issuer defaults (a very unlikely scenario), mutual funds and investors who trade to maximize yield can however suffer losses if the interest rate rises.
Interestingly, long term treasuries have a track record of losing years as the stocks, at least for the past 80 years, and have even fared worse than equities in the markets over the years. This raises the question – where is the general sense of security coming from? According to Mitchell Stapley, the chief fixed income officer at Cincinnati-based Fifth Third Asset Management. “The greatest irony here is the perception of safety in a fixed-income security…..As the head fixed-income guy here, when I look at bonds today, they scare the hell out of me.”
In the last 75 years, US treasury bonds (long term) have recorded considerable losses in 22 of those years; not much different from stocks which recorded losses for 24 years. This clearlyshows that losses on long term treasuries are nearly as much as those incurred on stocks.
Mercer Bullard, an associate professor of law at the University of Mississippi, and founder of investor advocacy group Fund Democracy,pointed out that “if interest rates were to rise rapidly there would be significant losses in bond funds…. that can catch a lot of people and hit them with losses they weren’t expecting.”
The confidence borne by most bond holders stems from the fact that they are all staunch believers in the “theory” that interest rates will never go higher. Wherever they got their beliefs from, the truth is history has consistently taught us that change is the only thing that is constant.
In fact, managers of some of these bond funds have issued warnings that interest rates will remain low indefinitely, and that investors in bonds will be affected when interest rates ultimately rise.
But for how long will interest rate remain perpetually low, with prolonged economic decline in major economies of Europe and the U.S, over-flowing debts, and un-curtailed spending, the days of inflation may not be long gone for economies like that of the USA; and with inflation comes higher interest rates.
But only if…….
This is a story of crazy overvaluation. When people start hoarding assets, and stop asking “at what price”, citing things like “safe haven”, “recent past performance” and “foolproof”, you know a valuation is out of touch with reality. No matter how safe an investment may seem, guaranteeing yourself negative real returns over 10 years is crazier than the tech bubble of the late 1990s – people know beforehand how limited the upside will be, while capital losses are guaranteed with inflation. And at what risk to the buyer of say 10-yr US debt? A nation incentivised to weaken the dollar, and inflate its way out of debt in the long run. Would you lend money at -1% to someone you know will do anything to short-change you, or pay you back in magic beans? Would you buy the right to hold that debt off an existing bond holder, when the price is already extortionate and other investors are clamouring for a piece of the action, no matter the cost? Article is exactly right, it ends in tears, in my opinion.