Interest Rates on the Move! (Finally)

[njhowie]

Now if I have an intermediate grade bond fund (similar duration), I could use a switch strategy between that and Treasuries. It actually works out to be an improved performance over the last 20 years. Very few switches involved. No guarantees going forward though but not really a major risk (bonds not like stocks) and not a strong function of the timing. Also it is easier for me to do rebalancing and also shift to shorter durations should I choose that. I am probably making this more complicated but it is not too hard to do.

Using the past 20 years as your reference point might not be the thing you want to be doing when discussing interest rate sensitive instruments. The past 20 years has been extremely uncharacteristic in the continual down trend in rates. We are now set on a course for rising rates, at least for the remainder of this year.

When you purchase the CD, you know your exact return and the date you will get your principal back at the time of purchase. It is a guarantee for the duration of the CD. With any fund, you have no guarantees of the returns in annual yield, or the price you could sell for at any point in time.

It's also worth noting, new issue brokered CD rates pay more than equivalent maturity treasury securities. I do not buy the new issue CDs any longer as I can find much better in the secondary market CD offerings, getting as much as 0.25% higher (after commission) than the equivalent maturity new issue CD.

Considering your switch strategy - seems like another name for market timing.

 

[njhowie]

Seems to me that as long as you stay within the FDIC limits that CDs and Treasuries are substantively the same.... is there something that I'm missing?

You aren't missing anything, you are spot on.

CDs, via FDIC are backed by the "full faith and credit" of the United States - exactly the same backing treasuries.

https://www.fdic.gov/consumers/assistance/protection/depaccounts/confidence/symbol.html#Full

FDIC deposit insurance is backed by the full faith and credit of the United States government. This means that the resources of the United States government stand behind FDIC-insured depositors.

 

[Lsbcal]

I'm very aware that the since 1982 we've been on a downward yield rate trend. That is just history. As long as rates rise gently then returns should be OK. That would be the market consensus I think and if it were not considered viable then we should expect a jarring upward lurch to get the market consensus back on track.

I'm not at all against CD's. I don't really know how to compare a rolling CD strategy to a bond fund. We should remember that bond funds get some extra returns from secondary mechanisms like yield curve roll. To compare a rolling CD strategy to a bond fund we would have to pick a calendar period. But that has it's own flaws.

I think one could do well with either strategy over a long period of years. Longer then the duration of the fund or CD considered.

As to market timing, I only mentioned it in passing. I am not proposing it be used by anyone else but we are all adults and can make our own decisions.

 

[njhowie]

I think one could do well with either strategy over a long period of years. Longer then the duration of the fund or CD considered.

As to market timing, I only mentioned it in passing. I am not proposing it be used by anyone else but we are all adults and can make our own decisions.

Agreed on both points.

 

[audreyh1]

This thread made me ask myself what the recent rate rise scenario looks like compared to past rises. I tend to look at the 5 year Treasury as being closest to intermediate bonds. Some rate rise periods for the 5 year Treasury were (bp/mo means basis points per month, VBMFX is total stock market) :

Really bad period: Feb 1994 - Dec 1994, 5.0% up to 7.8%, 26 bp/mo, VBMFX return = -3.9%
Reduced return period: Apr 2004 - June 2006, 2.8% up to 5.1%, 9 bp/mo, VBMFX return = +1.2%

For the last 3 months as of Jan 19, 2018 we've had rises of 8bp, 17bp, 22bp.

I wouldn't expect a 1994 sized rate rise slope over many months but I'm just echoing the market expectations. If so the returns would be worse then 1994 because we are at such low rates. Also in 1994 the rate rise was jagged with some months having higher rate rises and some even rate declines. So it was hard to see the trend.

It also helps to look at the return over the next year. Usually after a tough year, there is a big rebound year. It reinforces rebalancing when bonds get clobbered.

 

[jim584672]

Bank CDs are better in that they don't have interest rate risk. The short term bond funds have been clobbered lately with the rates going up.

 

[audreyh1]

I have definitely bought FDIC insured CDs instead of bond funds when the yield was close to what bond funds of similar duration were offering.

Generally I don't sweat bond funds I've already owned for a long time being clobbered. They recover. We see it again and again. In the meantime you take advantage of the lowered price and buy more when you rebalance. And then just when stocks reach a breather and go negative, your high quality bond funds magically perk up, giving you an opportunity to rebalance in the other direction.

 

[Lsbcal]

It also helps to look at the return over the next year. Usually after a tough year, there is a big rebound year. It reinforces rebalancing when bonds get clobbered.

That's for sure. For instance, in 1994 Total Bond Market went down -2.6% but the next year it returned +18.2%.

 

[Lsbcal]

I read this Bloomberg article about Ray Dalio's thoughts on bonds:
https://www.bloomberg.com/news/arti...io-says-bond-market-has-moved-into-bear-phase

Dalio predicted that the Federal Reserve will tighten monetary policy faster than they have signaled, and said that economic growth is in the late stage of the cycle but could continue to improve for another two years. The current economic environment is good for stocks but bad for bond investors, said Dalio, who’s chairman of Bridgewater, the world’s biggest hedge fund.

“It feels stupid to own cash in this kind of environment. It’s going to be great for earnings and great for stimulation of growth,” he said.

Got me to thinking more about a radical step of moving my intermediate bond fund money to short bonds or even money market for a year or so. VMMXX (money mkt) is at 1.45%. Somewhat below expected inflation.

 

[REWahoo]

Another prediction of the future, with the likely accuracy of a monkey throwing darts...

 

[Lsbcal]

Another prediction of the future, with the likely accuracy of a monkey throwing darts...

Well some monkeys are smarter then others.

But it's not just the prediction that has me concerned. It's the recent past performance (I know, not the future ...) and the feeling that I'm not being paid to take the rate risk at this point in time.

I could settle right now for 1.45% in a money market account with zero rate risk. Or I could roll the dice with an intermediate term investment grade fund at a SEC yield of 2.94%. Or something in between. Conundrum.

 

[MichaelB]

Well some monkeys are smarter then others.

.
.

 

[REWahoo]

I could settle right now for 1.45% in a money market account with zero rate risk. Or I could roll the dice with an intermediate term investment grade fund at a SEC yield of 2.94%. Or something in between. Conundrum.

Back to basics: When do you need the money? If over the next couple of years, maybe the MMKt is the way to go. If your investment horizon is longer term, might be best to stand pat.

 

[redduck]

Another prediction of the future, with the likely accuracy of a monkey throwing darts...

Well some monkeys are smarter then others.

OK, so where can we find a monkey that is smart and can throw accurately?

 

[REWahoo]

OK, so where can we find a monkey that is smart and can throw accurately?

Aren't the best darts played in bars? Maybe start with monkey bars...

 

[MuirWannabe]

I continue to invest periodically in munis. Specifically VWIUX. Honestly, I’m not sure how wise or stupid this is. Seems nobody likes bonds and within the bond category folks really don’t like munis. I do like the tax free dividends they provide. But I realize they are a drag on my overall portfolio at least until the SHTF. Which hopefully doesn’t happen. But even in a fantastic up market like we are experiencing, I’ve come to appreciate the role of bonds.

Still, if anyone wants to comment on how dumb investing in munis is, I’m just dumb enough to want to hear it. [emoji4]

Muir

 

[audreyh1]

I continue to invest periodically in munis. Specifically VWIUX. Honestly, I’m not sure how wise or stupid this is. Seems nobody likes bonds and within the bond category folks really don’t like munis. I do like the tax free dividends they provide. But I realize they are a drag on my overall portfolio at least until the SHTF. Which hopefully doesn’t happen. But even in a fantastic up market like we are experiencing, I’ve come to appreciate the role of bonds.

Still, if anyone wants to comment on how dumb investing in munis is, I’m just dumb enough to want to hear it. [emoji4]

Muir

I hold some as part of my bond allocation as a diversifier. They tend to behave somewhat independently from other bond classes, but usually do well when there is a rush to quality in spite of their often being dissed.

 

[audreyh1]

Well, I expected the sudden and accelerating jump in intermediate and long interest rates to upset the equity markets, but it was still really something to witness!

When the Fed starts a series of interest rate hikes, one of the concerns is that the bond market will anticipate where they are headed, and jump there fast in anticipation, which is very disruptive to all the markets. So the Fed tries to keep things calm and orderly by talking about gradual, paying attention to data, blah, blah, blah. Well, the markets pretty much ignored the Fed late 2016 and throughout 2017 continuing to party. Now that has turned around. All of a sudden there are a millions reason for interest rates to move quickly as scared investors are seeing lurking inflation everywhere.

 

[audreyh1]

I know folks expected rising interest rates to hurt bonds. But did they expect them to ALSO hurt stocks to this degree?

One month returns as of 2/8/18:

AGG (a good proxy for higher quality intermediate bonds) -1.72% ouch!

VTSAX Vanguard Total stock market adm. -5.94% bigger ouch! 3.5X

Stocks are interest rate sensitive too.

 

[Lsbcal]

How do we know that the rates rising is what caused equities to decline? I am not saying that this is a wrong conclusion, just that because it is coincident to some degree is it the cause?

My own guess is that this equity decline is just brought about by a degree of herd behavior and fear of volatility. Volatility going in only one direction (up) has never occurred for very long. And I could easily be making a simple minded model in my head that is wrong.

 

[Montecfo]

How do we know that the rates rising is what caused equities to decline? I am not saying that this is a wrong conclusion, just that because it is coincident to some degree is it the cause?

My own guess is that this equity decline is just brought about by a degree of herd behavior and fear of volatility. Volatility going in only one direction (up) has never occurred for very long. And I could easily be making a simple minded model in my head that is wrong.

We dont. That was just a part of the excuse for selling. If it was higher rates financials would have rallied.

It was a vix rise then automated selling which became panic selling by some.

 

[audreyh1]

Wow big moves today! After the Fed minutes came out there was quite a jump in interest rates with the 10yr moving above 2.95%.

I think we’ll see a 3% 10 yr very soon.

 

[GrayHare]

I stocked up on DTYS and TBT last year, so bring it on!

 

[audreyh1]

How do we know that the rates rising is what caused equities to decline? I am not saying that this is a wrong conclusion, just that because it is coincident to some degree is it the cause?

My own guess is that this equity decline is just brought about by a degree of herd behavior and fear of volatility. Volatility going in only one direction (up) has never occurred for very long. And I could easily be making a simple minded model in my head that is wrong.

Stocks are interest rate sensitive. I think interest rates are going to be a headwind for stocks in the near future. That’s just my opinion, of course.

 

[audreyh1]

I stocked up on DTYS and TBT last year, so bring it on!

You’re a brave man! No shorts for me!