Bond vs. Equity Risk Perf During Rising Rates

[Closet_Gamer]

This is a thoughtful article on the relative risk/return of holding bonds vs. equities during periods of extended rate hikes.

Basic gist is that rates tend to depress the performance of other asset catgories and the risk/return of holding bonds is actually better than most alternatives during rate hiking cycles, perhaps even superior to equities.

AA devotees will recognise the implicit rebalancing opportunity this suggests.

Active investors will recognise the idea that perhaps its time to move to cash and await the crunch.

I'm not advocating for any of it, just wanted to pass along an interesting read.

https://mailchi.mp/verdadcap/risk-reward-in-a-hiking-cycle?e=6a3b6a5c9b

 

[corn18]

Good sentiment in that article. Not enough data to use it to draw a definitive conclusion, but I like the premise of don't just do something, stand there.

I don't know enough to know the mechanics, but as a bond fund's NAV drops due to rates rising, the yield goes up. At some point, the yield rising offsets the NAV dropping. It has something to do with the average duration of the bond fund. It does suck to see your total assets go down 13% just due to bonds when they should be acting as ballast for stocks.

 

[Ready-4-ER-at-14]

I'm kind of watching this thread to get a handle on what to convert to Roth next. We have some fixed income out beyond the date when the youngest of us need to do required minimum distributions and some higher dividend producing stock.(REITs) We have one more year where we can do a hefty conversion and possibly one after that if we defer SS even past full retirement age. Possibly we can convert all of this to Roth before RMDs hit.
Held bond values out like 20-30 years are really getting hammered and thus will be cheaper to convert if we wait a bit might pay like 70 cents on the dollar. However that dividend paying stuff has been appreciating still.
If the fed really keeps increasing interest rates till the economy flames out.. both will be hurt bad. We are talking 7 years before we would need any cash other than dividends or interest so it may not really matter.
Leaning towards stock first, then long term cds/ bonds last.

 

[Markola]

Good article. The doom and gloom herd is shouting “Sell your bonds now!!!!” Maybe not.

 

[Lsbcal]

I still think it is a decent strategy to stay short term *if* one is currently in short term bonds or Tbills.

At this point, switching strategies is unclear. It is always unclear for short term (maybe 6 months) timing.

The article in the OP was interesting. I'm just not sure if the current conditions allow one to take that data at face value. Is this anything like the 1970-82 period? It is unclear to me. While some inflationary pressures might be long term (trend to decrease globalization) the supply/demand issues might be somewhat short term. The Ukraine war is anybodies guess.

Personally I think equities will do all right as a recession appears to be quite a way off.

 

[corn18]

From the data, it looks like bonds take a hit on total real return initially when rates rise and then do well. This is 3 year rolling average total real return for total stock and total bond. I also added the Fed funds rate from what I could get from FRED.

1967-1973 sucked hard.

 

[Chuckanut]

The article in the OP was interesting. I'm just not sure if the current conditions allow one to take that data at face value. Is this anything like the 1970-82 period? It is unclear to me.

I would say the major difference between the mid '70s to the early '80s is the very low interest rates on savings compared to the inflation rate. As I have mentioned before, Treasury rates were very high (though never above the inflation rate), sometimes in the area of double digits for longer Treasury issues. Today, we have 2 year Treasuries around 2% with inflation currently running at over 8%. Not so good.

 

[Markola]

From the data, it looks like bonds take a hit on total real return initially when rates rise and then do well. This is 3 year rolling average total real return for total stock and total bond. I also added the Fed funds rate from what I could get from FRED.

1967-1973 sucked hard.

Very nice. Can you show the long term (150 year?) average return lines for each? (I know, give a guy an inch….)

 

[lawman]

Good article. The doom and gloom herd is shouting “Sell your bonds now!!!!” Maybe not.

This lessens my pain. I've watched VFIDX drop like a rock. It now has a yield of 3.61%. As much as I would like to stop the bleeding I suspect that now MIGHT not be the time to get out.Wish I'd done that a year ago but hindsight is 20-20.. I do not think the Fed will raise rates enough to seriously address inflation. I think the current share price already reflects as much as another 1% rise in rates. If that is true and the Fed stops there I should get about 3.61% gain in the next 6.5 years (duration). That is not a great return but that is an investment grade bond fund which is pretty safe..Where else can I get 3.61% almost guaranteed?

 

[Lsbcal]

I think this Paul McCulley interview is worth listening to regarding bonds and where we might be headed:
https://wealthtrack.com/a-noted-fed-watcher-says-this-fed-has-the-courage-to-defeat-inflation-despite-recession-risk/

 

[corn18]

Very nice. Can you show the long term (150 year?) average return lines for each? (I know, give a guy an inch….)

The chart shows average 3 year rolling average from 1871 on. Not sure what you are asking for, but I will gladly try to make it happen. I have all the data in my spreadsheet, so it's real easy to knock out charts.

 

[lawman]

I think this Paul McCulley interview is worth listening to regarding bonds and where we might be headed:
https://wealthtrack.com/a-noted-fed-watcher-says-this-fed-has-the-courage-to-defeat-inflation-despite-recession-risk/

Excellent commentary..Seems like he expects rates to continue to rise but perhaps slowly..I think everyone agrees that bond returns will be modest for the next decade but that begs the question if one liquidates his bonds where does one put that money?

 

[MichaelB]

I think this Paul McCulley interview is worth listening to regarding bonds and where we might be headed:
https://wealthtrack.com/a-noted-fed-watcher-says-this-fed-has-the-courage-to-defeat-inflation-despite-recession-risk/

Thanks for the link. Very good interview.

 

[Markola]

The chart shows average 3 year rolling average from 1871 on. Not sure what you are asking for, but I will gladly try to make it happen. I have all the data in my spreadsheet, so it's real easy to knock out charts.

I was just looking for horizontal colored lines for each asset class showing the averages over that long period. No big deal. The returns would probably resemble the numbers I circled.

 

[corn18]

I was just looking for horizontal colored lines for each asset class showing the averages over that long period. No big deal. The returns would probably resemble the numbers I circled.

 

[youbet]

This lessens my pain. I've watched VFIDX drop like a rock. It now has a yield of 3.61%. As much as I would like to stop the bleeding I suspect that now MIGHT not be the time to get out.

Yeah, I still own the vast majority of my fixed income positions too: preferreds, bonds, bond funds. Most have taken a significant hit. But I don't need to sell anything for several years and am optimistic that they'll be back before I need the money. The interest and divs continue and that's mostly what we need.

I agree, now will likely not turn out to be be the time to sell.

 

[RetiredHappy]

We had a phone meeting with Fidelity's FA (VP/CFP) last Thursday and based on our discussion, we finally bit the bullet and sold our long term bond funds today. We swapped most of that out for a value / dividend equity fund. The rest will go into a MYGA.

 

[Markola]

Average annual real return from 1871 to 2020

Total Stock = 8.55%
Total Bond = 2.90%
60/40 (no international) = 6.29%

And 50/50 real return was 5.73%. Beats a sharp stick. Thanks.

 

[Markola]

We had a phone meeting with Fidelity's FA (VP/CFP) last Thursday and based on our discussion, we finally bit the bullet and sold our long term bond funds today. We swapped most of that out for a value / dividend equity fund. The rest will go into a MYGA.

How did that conversation go? I thought FAs were there to talk you out of big AA changes.

 

[Lsbcal]

How did that conversation go? I thought FAs were there to talk you out of big AA changes.

One problem with an FA "might" be some feeling that "we" are making the decisions. But really it has to be you as you will be behind the wheel to take whatever consequences arise. I like the fact that I have nobody but myself to blame for decisions. But I totally get that some may need more information to make an informed decision then they currently have.

 

[RetiredHappy]

How did that conversation go? I thought FAs were there to talk you out of big AA changes.

We have a fantastic (free) FA at Fidelity and she reaches out to us every quarter, either FTF or on zoom meeting to check in with us to see if we need help with anything. She reminded us that we should reach out to her anytime instead of waiting for her to check in on us. I have been hating bond funds for the past year and my husband had 40% of his IRA in bond because he said he really wanted fixed income based on his age. I had 15% in bond funds. Anyway, in our Thursday meeting, she asked if we needed anything and I covered the topic of bond funds and that they were killing us. She did an analysis and she basically recommended anything that is long term, to get rid of them. She suggested alternatives etc, and she mentioned MYGA which I am already familiar with, and value/dividend stock funds. She also gave some sector re-balancing advice after reviewing our accounts.

We spent Good Friday holiday reviewing our portfolio and made some significant sell/buy this morning when the market opened.

 

[lawman]

We have a fantastic (free) FA at Fidelity and she reaches out to us every quarter, either FTF or on zoom meeting to check in with us to see if we need help with anything. She reminded us that we should reach out to her anytime instead of waiting for her to check in on us. I have been hating bond funds for the past year and my husband had 40% of his IRA in bond because he said he really wanted fixed income based on his age. I had 15% in bond funds. Anyway, in our Thursday meeting, she asked if we needed anything and I covered the topic of bond funds and that they were killing us. She did an analysis and she basically recommended anything that is long term, to get rid of them. She suggested alternatives etc, and she mentioned MYGA which I am already familiar with, and value/dividend stock funds. She also gave some sector re-balancing advice after reviewing our accounts.

We spent Good Friday holiday reviewing our portfolio and made some significant sell/buy this morning when the market opened.

Great example of why I have zero confidence in brokerage advisors..I too am bleeding to death with my investment grade bond funds. My so called "bond specialist" " suggested a bond fund for me just a few months ago..I feel stupid still being in bonds when Ray Charles could plainly see that interest rates would go up this year...

 

[RetiredHappy]

Great example of why I have zero confidence in brokerage advisors..I too am bleeding to death with my investment grade bond funds. My so called "bond specialist" " suggested a bond fund for me just a few months ago..I feel stupid still being in bonds when Ray Charles could plainly see that interest rates would go up this year...

Actually she is very good. She had been advising us to get rid of long term bonds since the day we met her. She costs us nothing and but has given only great advice.

 

[Markola]

Actually she is very good. She had been advising us to get rid of long term bonds since the day we met her. She costs us nothing and but has given only great advice.

We have an assigned advisor at Vanguard, so I get it. I hope your change works out and lets you sleep better.

 

[target2019]

Taking a look this morning at how well Wellesley Income performs in stressful times, I set a 100% VWIAX vs. 60/40 TSM/TBM comparison for the last 50 years. There are many possible comparisons possible of course. The two drawdown series are essentialy the inverse of each other.

In our portfolio over the past 10 years we added Wellesley as part of bond allocation. TBM was approximately 15% at one time, but now has dropped to 5% allocation, with Wellesley at 10%.

The bond fund threads here are very interesting, but at the end of the day I have more trust in Wellington Management than the sales/advisory pitches that obviously have maximum view at this time.

We didn't make the tactical switch to some VWIAX out of a deep understanding of bond markets. I came to the conclusion I should count on smarter people with a track record instead of agonizing over timing moves, plan adjustments, etc. YMMV.