Trees Do Not Grow To The Sky

By David Snowball

You thought the fallout from 2000-01 was bad?  You thought the 2008 market seizure provoked anguish?  That’s nothing, compared to what will happen when every grandparent in America cries out, as one, “we’ve been ruined.”

In the past five years, investors have purchased one trillion dollars’ worth of bond mutual fund shares ($1.069 trillion, as of 11/20/12, if you want to be picky) while selling a half trillion in stock funds ($503 billion).

Money has flowed into bond mutual funds in 53 of the past 60 weeks (and out of stock funds in 46 of 60 weeks).

Investors have relentlessly bid up the price of bonds for 30 years so they’ve reached the point where they’re priced to return less than nothing for the next decade.  Here’s a quick snapshot: the blue line is the yield on a 10-year Treasury bond (yields fall when bond prices are being bid up, so that peak in 1981 is the beginning of The Great Bond Bull).  The red line is the consumer price index and the gap between the two is your “profit” from holding a bond.


If interest rates and inflation stay low, your bond investment will return nothing.  If interest rates and inflation move quickly up, the market value of the bonds that you (or your bond fund manager) hold can drop like a rock: Fidelity’s research suggests that a 1% interest rate rise would cause a 10-year bond portfolio to drop 8%.  A 3% rise would cause a nearly 30% decline.

And still the money rushes in, $28 billion more last month.  Clearly, most folks are betting that this tree will reach the sky.

And some are not.

Jeffrey Gundlach, founder of DoubleLine funds and a star fixed-income manager, believes “[d]eeply indebted countries and companies … will default sometime after 2013.” “I don’t believe you’re going to get some sort of an early warning. You should be moving now.”  (Bond Investor Gundlach Buys Stocks, Sees ‘Kaboom’ Ahead, 11/30/2012).

GMO, which is almost always right but often early, has sold off all its bond holdings (GMO abandons bond market, 11/26/2012). “We’ve largely given up on traditional fixed income,” both government and corporate.  Their GMO Benchmark-Free Allocation (GBMFX) is just 2.8% in bonds and 21% in cash.

Rob Arnott, manager of PIMCO All Asset and leveraged All Asset, All Authority funds says “less than 10% of the strategies are invested in core bonds and TIPs” (thanks to claimui for highlighting Arnott's essay on the Observer’s discussion board).

The Great Gross, manager of over a quarter trillion dollars in bond investments, was modestly misquoted in August as saying “stocks are dead.”  By December, he was more-correctly attributed with, “and bonds are deader, at least through 2022” (Time magazine, 11/26/2012).

Mark Egan, the best bond fund manager that you’ve never heard of, has not a penny in government bonds but 55% in cash (thanks to PatShuff, also on the board, for alerting us to the new Scout Unconstrained Bond Fund portfolio).

Steve Romick and his team at the highly-flexible, consistently stellar, adamantly contrary FPA Crescent Fund (FPACX) hold only 3.6% in bonds (as of 10/31/12) and 34% in cash.

Michael Hasenstab and his team at Templeton Global Bond (TPINX), whose “five- and 10-year trailing returns are the category's best by a wide margin,” Morningstar reports, has 3.5% in US bonds - about a third of what they stash in Poland.

That’s what they’re doing.  What might you do?

  1. Start saving more.   Serious investors foresee 4% returns, not 8 or 10%, and they’re adjusting their savings levels.
  2. Act now, not later. “Act” is not investment advice, it’s communication advice.  Start talking with your spouse, financial adviser, fund manager, and other investors online, about how they’ve thought about the sorts of information I’ve shared and how they’ve reacted to it.  Learn, reflect, then act.
  3. Look for other sources of income.  Consider emerging markets bonds, dividends from blue chip stocks, called bonds, real estate ownership or premiums from covered calls as a way of adding income and diversifying risk.
  4. Look for other tools to control volatility.  The Observer has been spending time looking at covered call strategies, long-short equity strategies, at unconstrained or benchmark-free fixed income funds and at equity managers with a commitment to an “absolute returns” strategy. 
  5. Give your managers some breathing room.  The best managers are apt to act too soon.  They’ll become conservative when it would feel better to you to be aggressive.  If you’ve chosen well, you need to let them do their jobs.

David Snowball is publisher of the Mutual Fund Observer.  He serves Augustana College (Rock Island, Illinois) as a Professor of Communication Studies.  David grew up in Pittsburgh, earned his bachelor’s degree at the University of Pittsburgh and doctorate at the University of Massachusetts.  His teaching and research revolves around rhetoric, propaganda and persuasion. 




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