Treasury Bonds - What's Not to Like?

[karluk]

I think there are quite a few issues raised in this thread that merit discussion, but one salient point that everybody seems to have tacitly decided not to discuss is that it's not currently possible to invest in long term treasury bonds with a 4 or 5% yield. 30 year treasuries closed today with a yield of only 3.783%. That's under 4% and SIGNIFICANTLY under 5%. According to my calculations, a rise in long term t-bond rates to 5% would reduce the market value of 30 year treasuries by about 22%, which is about 5.8 years of interest at the current yield.

So, my personal opinion is that OP has a valid point that in the future long term treasuries may be so beaten down by rising interest rates that they will be attractive to income seeking retirees. Until then there seems to be a touch of fantasy to this thread - OP seems to be thinking, "Long term rates aren't that much under 4%, so let's round up and pretend they've already gotten there. But somebody may object that 4% is too low a yield to make it worthwhile to tie up one's assets for three decades, so let's say that once they get to 4% they will then be in the 4-5% range. That will make everyone feel far better about making a 30 year commitment."

The Bond Market: Ryan Indexes - Markets Data Center - WSJ.com

 

[haha]

I think there are quite a few issues raised in this thread that merit discussion, but one salient point that everybody seems to have tacitly decided not to discuss is that it's not currently possible to invest in long term treasury bonds with a 4 or 5% yield. 30 year treasuries closed today with a yield of only 3.783%. That's under 4% and SIGNIFICANTLY under 5%. According to my calculations, a rise in long term t-bond rates to 5% would reduce the market value of 30 year treasuries by about 22%, which is about 5.8 years of interest at the current yield.

Maybe on the theory of first things first, since the whole idea of tying up money at a fixed rate for 30 years when interest rates are near generational lows seems kind of counterproductive, what difference does it make if OP has also burnished the expected rate beyond anything that has been available lately? Few would do this in any event.

None of this means that long term bonds might not be a reasonable short term gamble. If rates go to where they were just a month ago, the gains would be considerable. Not for me though, too afraid of what must inevitably happen over the longer term. As we have seen, things can change very quickly.

Ha

 

[clifp]

I asked the "What am I missing" question because I was truly wondering if there was something I hadn't considered. I realize this forum may be more stock-oriented, but I haven't been able to find a straight forward discussion about having 30-year Treasury bonds as a portion of ones fixed income portfolio anywhere. Not even a mention of it, which seems curious, because at certain interest rates, it appears (to me) to be a viable fixed income investment.

I'll admit that I missed your emphasis on a portion. FIRECalc which is heavily used on the forum, by default allocated 25% of your assets to long term bonds. You can easily change it to 30 year Treasury bonds and from what I've observed it makes very little different in a portfolio.

You aren't missing anything. If 30 year treasury yields move up to 4-5% than it absolutely makes sense to put a portion into long Treasuries. They will in all likelyhood provide a modest return after inflation at the rate. At 4.5% interest rate a portion as large as 60% makes sense.

I am by nature a stock guy but in 1999-2001 when I could buy Muni bonds that yielded 5-6% and TIPs bonds that were pay 3.5%-4.0% real yield I sold tons of stocks to buy bonds. If bonds went back to 4.5% I'd even invest 25% in bonds some of which would be 30 year treasuries.

But the rub is I can't buy 30 year Treasuries that yield 4-5%. The best I can get is 3.5%. A year ago when they were 2.5% I was telling anybody who would listen and plenty who didn't don't buy Treasuries. (I was hardly alone in my advice) After being wrong for 4 years it was nice to be right this year.

At the current level, I still think the yield is a little too low, but I don't think you'd be dumb to have a portion of your money in them. If and when yields rise, the more attractive bonds become.

 

[CaptainO]

I'll admit that I missed your emphasis on a portion. FIRECalc which is heavily used on the forum, by default allocated 25% of your assets to long term bonds. You can easily change it to 30 year Treasury bonds and from what I've observed it makes very little different in a portfolio.

You aren't missing anything. If 30 year treasury yields move up to 4-5% than it absolutely makes sense to put a portion into long Treasuries. They will in all likelyhood provide a modest return after inflation at the rate. At 4.5% interest rate a portion as large as 60% makes sense.

I am by nature a stock guy but in 1999-2001 when I could buy Muni bonds that yielded 5-6% and TIPs bonds that were pay 3.5%-4.0% real yield I sold tons of stocks to buy bonds. If bonds went back to 4.5% I'd even invest 25% in bonds some of which would be 30 year treasuries.

But the rub is I can't buy 30 year Treasuries that yield 4-5%. The best I can get is 3.5%. A year ago when they were 2.5% I was telling anybody who would listen and plenty who didn't don't buy Treasuries. (I was hardly alone in my advice) After being wrong for 4 years it was nice to be right this year.

At the current level, I still think the yield is a little too low, but I don't think you'd be dumb to have a portion of your money in them. If and when yields rise, the more attractive bonds become.

Whew, thanks clifp. Based on one poster’s comments, I was beginning to think I needed to see a psychiatrist for even asking the question. And thanks for the insight regarding FIRECalc. That was the kind of information I was hoping to get. I agree that rates are too low now. When they started climbing so fast and a lot of news articles implied they would be increasing a lot more soon, I started to pay attention and wonder about the possibilities. I may be in for a long wait, though. The rates have been headed down again recently.

 

[HFWR]

Of course, Harry Browne's permanent portfolio includes 25% long bonds.

 

[Gearhead Jim]

Of course, Harry Browne's permanent portfolio includes 25% long bonds.

How permanent is permanent?

If he was 100% equity or 100% cash right now, would he still put 25% of his money into long bonds, under the current conditions?

That seems like a poor bet to me, but I'm just an amateur.

 

[clifp]

How permanent is permanent?

If he was 100% equity or 100% cash right now, would he still put 25% of his money into long bonds, under the current conditions?

That seems like a poor bet to me, but I'm just an amateur.

I think Harry would have been disciplined enough to stick to his AA. I don't think most of his disciples are. I mean holding 25% gold and 25% 30 year and 25% equities and 25% cash pretty much guarantee that a least 1/4 and often 1/2 your portfolio is losing money every year. You should have been selling gold and buying bonds at the beginning of the year.

Also the PP is a wealth preservation portfolio not particular good way to accumulate wealth.

 

[Running_Man]

While it is true that the Permanent Portfolio was designed to preserve wealth, the permanent portfolio as offered in mutual fund form has equaled the S&P500 with far less volatility since 1996. Since 1972 it has a CAGR of 9.5%. It lost 1.5% in 2008, the worst year ever was 1981 and it lost 5.1%. Also Harry Browne did not advocate keeping the investments at 25% only rebalancing to 25% when an investment fell to less than 15% of the portfolio or exceeds 35% of the portfolio, then rebalance the entire portfolio back to 25/25/25/25.

I myself think the portfolio is brilliant in that few portfolios are arranged in a manner to state what they hope to accomplish then actually do that. One can argue that gold or bonds are overvalued but my take is we will learn this in the future but there will always be someone who hates one of these 4 investments, which makes them very much worth having. Craig Rowlands book describes the methodology quite well and William Bernsteins review of it on amazon is worth the read.


Amazon.com: The Permanent Portfolio: Harry Browne's Long-Term Investment Strategy (9781118288252): Craig Rowland, J. M. Lawson: Books

 

[Gearhead Jim]

Thanks for the comments!

 

[AndrewJackson]

I will really never understand government bond "math". How is it that long term rates went to 15-20 percent in the early 80's when our debt to gdp bottomed near 30%-40%? Yes, inflation concerns were quite different back then, but still, it really makes me wonder sometimes? Are there fundamental levels of debt to gdp where these bonds are ever a horrible bet? From Japan's experience, it seems like the answer is no.

 

[clifp]

I will really never understand government bond "math". How is it that long term rates went to 15-20 percent in the early 80's when our debt to gdp bottomed near 30%-40%? Yes, inflation concerns were quite different back then, but still, it really makes me wonder sometimes? Are there fundamental levels of debt to gdp where these bonds are ever a horrible bet? From Japan's experience, it seems like the answer is no.

Well anything over 80% seems to be risky (Ireland hit that level before the crisis hit) and I think over 120% is generally the real danger level.


Historically countries like US, Canada, Australia, NZ that have not defaulted on their debt are a much smaller number than countries that have. Even if we restrict defaults to say since 1900, we have defaults by Russia (3 times), Germany, Italy, Japan, and near default by England, China. There is probably some country in Latin America that didn't default in that time frame but I am not sure who. Plenty in Africa, and Asia and more than a few in Europe. I read a paper by a couple of Harvard economist chronically the nasty habits that sovereign countries have on welching on the debt.

Sadly (for bond holders) the days of the debt collector arriving at the capital escorted by fleet of warships from the British or American navy are behind us. I suspect that an army of lawyers lacks the same intimidation factor.

Then recently, Greece, Cyprus, Iceland, Ireland... and possibly more to come from the Eurozone.

When they do default, the collection is worse than getting money from bankrupt companies. The court case take decades to resolve the Argentinian default of 2001 just had a major court victory in the US, but of course not in Argentinian courts.

But as general rules when countries default on their debt bond holder get between $.25 to $.50 on the dollar and any amounts above $.25 seem to require a decade or two of court battles and lawsuits.

Anyway while I don't always see eye to eye with the credit ratings companies. I think S&P is right to give a higher credit rating to Johnson & Johnson, Microsoft, ADP, and Exxon than Uncle Sam. I'd much rather have a JNJ 30 year bond yielding 4.7% than a 30 year treasury at 4.7% much less at 3.7% today.

 

[Khufu]

The CPI is so far away from real inflation because of the sneaky things the government has used to "adjust" the number.

Complete nonsense, of course. Here's a comparison of the CPI from the Bureau of Labor Statistics against the Billion Price Index maintained by MIT:

Looks like they line up pretty well to me:

Taken from Krugman:

http://krugman.blogs.nytimes.com/2013/04/30/still-coring-after-all-these-years/

 

[emi guy]

I believe Zvi Bodie, a widely published BU professor of economics, has a similar investment strategy suggestion (to invest in treasuries) for what he calls " a worry free retirement".

 

[haha]

Are there fundamental levels of debt to gdp where these bonds are ever a horrible bet? From Japan's experience, it seems like the answer is no.

I am not sure you would universal agreement with your conclusion.

Ha

 

[Mulligan]

I am not sure you would universal agreement with your conclusion.

Ha

I have always just been a simplistic government debt alarmist type person. But the someone recently I read pooh poohed the concern in a way I really hadn't thought about. He said the debt is slightly higher than GDP. That is equivalent to a persons mortgage debt slightly exceeding their annual income. In other words, no big deal. That made me think in terms of my mortgage as it is about 150% to current income and I live just fine under that parameter. There, of course, was no counter point to his own argument. What would it be? Does this mean economically speaking we could carry 200% plus, since I know in my budget I could? I was always curious about that line of thinking as I really hadn't been exposed to it before. Aside from interest rate spike exposure and foreigners not buying the debt, what else would be the risk in this thinking?

 

[sailor]

He said the debt is slightly higher than GDP. That is equivalent to a persons mortgage debt slightly exceeding their annual income. In other words, no big deal. That made me think in terms of my mortgage as it is about 150% to current income and I live just fine under that parameter. There, of course, was no counter point to his own argument. What would it be? Does this mean economically speaking we could carry 200% plus, since I know in my budget I could? I was always curious about that line of thinking as I really hadn't been exposed to it before. Aside from interest rate spike exposure and foreigners not buying the debt, what else would be the risk in this thinking?

I think better analogy would be a ratio of debt to US tax revenue.
That does not look as rosy: let's say 16 trillion over 2.5 trillion, about 640%

 

[Mulligan]

I think better analogy would be a ratio of debt to US tax revenue.
That does not look as rosy: let's say 16 trillion over 2.5 trillion, about 640%

Now to a lay person like me, your analogy makes more sense. I wonder why it is always spoken in terms of debt to GDP, instead of tax revenue? I don't think I have ever even seen it reported or discussed in that manner though.

 

[imoldernu]

Complete nonsense, of course. Here's a comparison of the CPI from the Bureau of Labor Statistics against the Billion Price Index maintained by MIT:

Looks like they line up pretty well to me:

Taken from Krugman:

http://krugman.blogs.nytimes.com/2013/04/30/still-coring-after-all-these-years/

Well, there are charts, and there are charts.

Shadow Government Statistics - Home Page
Some of the "sneaky things " are Hedonic and quality adjustments, geometric weighting, and methodology changes in the years 1980 and 1990.

 

[clifp]

I have always just been a simplistic government debt alarmist type person. But the someone recently I read pooh poohed the concern in a way I really hadn't thought about. He said the debt is slightly higher than GDP. That is equivalent to a persons mortgage debt slightly exceeding their annual income. In other words, no big deal. That made me think in terms of my mortgage as it is about 150% to current income and I live just fine under that parameter. There, of course, was no counter point to his own argument. What would it be? Does this mean economically speaking we could carry 200% plus, since I know in my budget I could? I was always curious about that line of thinking as I really hadn't been exposed to it before. Aside from interest rate spike exposure and foreigners not buying the debt, what else would be the risk in this thinking?

Well that is very flawed analogy. Is that 150% ratio your net or gross income? Lets assume this is net and between payroll, state, and federal taxes you pay 1/3 of your income on taxes. So the actual ratio of debt to after tax income is 225%.

The government has similar problem it is net income that counts not gross revenue. The debt to GDP ratio is a bit over 100%. The Federal government generously allows its citizen to keep 80+% of the revenue we generate to pay our mortgage, put food on the table and also lets state and local governments collect another 15% of so. So the ratio of debt to net income is actually over 500%. For FY 2013 it looks like the final number will 17.2 trillion in debt and 2.71 trillion in revenue or a ratio of 634%. Now at an average interest rate of say 3% that is sill less than 20% of our revenue goes to pay interest. But if interest rates go up another 2 or 3% pretty soon 40% of the government revenue go to interest and that does seem to be a tipping point.

 

[HFWR]

Well, there are charts, and there are charts.

Shadow Government Statistics - Home Page
Some of the "sneaky things " are Hedonic and quality adjustments, geometric weighting, methodology changes in the years 1980 and 1990, and ignoring food and energy prices in calculations of Social Security adjustments.

Well, one can (and we have) argue that, but there's nothing particularly "sneaky" about it. It's not a secret.

 

[Mulligan]

Well that is very flawed analogy. Is that 150% ratio your net or gross income? Lets assume this is net and between payroll, state, and federal taxes you pay 1/3 of your income on taxes. So the actual ratio of debt to after tax income is 225%.

The government has similar problem it is net income that counts not gross revenue. The debt to GDP ratio is a bit over 100%. The Federal government generously allows its citizen to keep 80+% of the revenue we generate to pay our mortgage, put food on the table and also lets state and local governments collect another 15% of so. So the ratio of debt to net income is actually over 500%. For FY 2013 it looks like the final number will 17.2 trillion in debt and 2.71 trillion in revenue or a ratio of 634%. Now at an average interest rate of say 3% that is sill less than 20% of our revenue goes to pay interest. But if interest rates go up another 2 or 3% pretty soon 40% of the government revenue go to interest and that does seem to be a tipping point.

I was using gross, but I get to keep about 80% of mine, unlike the government. You bring up a very worrisome point though to me. People keep referring to "when interest rates go back to historical normal levels I will purchase some bonds". Well that 2-3% increase you referred to is still within range of "normal rates". I do not see how the government could function properly paying out 40% of budget on interest. Makes you wonder if rates will really go much higher, but if they did maybe it will not be a very pleasant experience for all down the road.

 

[Katsmeow]

Now to a lay person like me, your analogy makes more sense. I wonder why it is always spoken in terms of debt to GDP, instead of tax revenue? I don't think I have ever even seen it reported or discussed in that manner though.

The thing is that as tempting as it is to compare the federal budget to a household budget, they aren't the same. So, those comparisons actually aren't all that useful and break down.

Let me google that for you

 

[haha]

I have always just been a simplistic government debt alarmist type person. But the someone recently I read pooh poohed the concern in a way I really hadn't thought about. He said the debt is slightly higher than GDP. That is equivalent to a persons mortgage debt slightly exceeding their annual income. In other words, no big deal.

Interesting POV, and this area gets too murky for me very quickly-BUT- GDP is not available to pay government expenses, and thus IMO not comparable to a person's mortgage and his income.

Government has only it's revenues, in fact only the portion of those revenues that is not very tightly committed to other purposes, to pay debt service. How much luck would the government have if it suspended welfare, military pay and pensions, federal health and retirement benefits, federal worker pay, NSA, FBI etc etc etc?

The analogy you read I cannot quite see as being accurate.

My cautious attitude toward securities of all types at this time is mostly due to a different scent on the wind. The 10 year government bond does not essentially fly from about 1.7% to 2.7%+ without something having changed. That is a massive change in a rate that has been quite steady in the prior recent past. The move may be over, or may not be and I have no way to know.

People may say, so what? To me there is big so what. Last April or may $100,000 invested in 10 years treasuries would have earned about $1700/year. Now $100,000 would earn $2700. Only difference is 3 0r 4 months between the two commitments.

Eso no me gustaria.

Ha

 

[clifp]

I was using gross, but I get to keep about 80% of mine, unlike the government. You bring up a very worrisome point though to me. People keep referring to "when interest rates go back to historical normal levels I will purchase some bonds". Well that 2-3% increase you referred to is still within range of "normal rates". I do not see how the government could function properly paying out 40% of budget on interest. Makes you wonder if rates will really go much higher, but if they did maybe it will not be a very pleasant experience for all down the road.

Yup that is the $64 trillion question. I really do think the 40% is near the tipping point. I bought my first house in 1983 a couple of year out of school, with one of my college roommates. Both of our net income was a bit over 25K at the time and the house cost 153K so our debt to income ratio was 300%. Now today that would manageable. However back than with 10% down (borrowed from parents) the only way we could swing it was with Graduate Payments loan. (The predecessor to the option ARM and other creative mortgages.) The assumption was that as young engineers in a time of high inflation our incomes would rise rapidly. So each year for the first 5 years our payments would increase. But for 4 years our payments did not even cover the interest on the loan but rather went further in debt.

The kicker was the interest rate 13.75%! I just calculated that our interest coverage to income was 40% (300%*13.75%). As it turns everything worked out as planned. We took in a couple of roommates and had a tame frat house, inflation cause our salaries to rise and the value of the house to rise. With 3 years we had enough equity to qualify for a conventional ARM and rode the lower interest rates down throughout the 80s and early 90s. But looking back there were so many things that could have gone wrong leaving us and the bank with an underwater mortgage.

So it is possible that Uncle Sam could get bailed out by higher inflation driving up higher tax revenue. Obviously they could raise taxes but realistically 20% is tough sell to the American people I think 25% of GDP is the actual upper limit.

 

[Animorph]

Japan is way into this heavy debt, can't afford it if interest rates rise, but let's create inflation anyway thing. Keep an eye on them and we might have some ideas about what to do/not to do/try to avoid altogether.