Yield Curve trends

[disk-golfer]

I am trying to study up on bonds to better understand them. Next I will tackle “the meaning of life” and then “quantum physics”. I quickly discovered how bonds, interest rates and the economy are intermixed. I am not trying to be a market timer, but I do want to keep an eye on these key barometers.

Now for my question. I found this really cool site that shows the yield curve compared to the S&P 500 over the last few years. The top line on the graph shows the yield curve in late 2000 and the bottom line is the current curve. Doesn’t the yield curve look ominously like it did just before the last big bear market?

Any thoughts?

 

[cute fuzzy bunny]

This sort of yield curve has predicted 9 of the last 3 recessions.

A few years back I was sternly warned about my bond holdings imminent smack-down due to rising interest rates. They not only didnt lose ground, we had a bit of a bull run in them and I made a bunch of money.

The meaning of life and quantum physics might be better starting points.

Then you'd get to dig into this http://en.wikipedia.org/wiki/Uncertainty_principle

And realize that while there are lots of particle positions we can measure, the momentum is unclear and velocity and direction changes are equally unpredictable. Which makes the whole exercise of limited value.

Oh yeah, I forgot. The particles are also emotional and do completely unexpected and self destructive things on occasion, just to screw with you a little more.

 

[Gone4Good]

Doesn’t the yield curve look ominously like it did just before the last big bear market?

Yes. The yield curve has been signaling recession for a year or so now. The yield curve has had some historic success in predicting recessions on account of two things 1) the long interest rate is set by a market which is generally smarter than a couple of guys at the Fed and 2) banks make money by borrowing short and lending long. It's tough to make money doing that when short rates are higher than long rates. If lending banks can't make money lending - guess what? - they don't. Credit crunches are typically what ends economic expansions.

At the risk of saying "this time, its different" - this time looks to be different. Technical factors, and not fear, are driving $ into treasuries (and pressuring long interest rates as a result). And despite the term-structure inversion, credit is abundant. The fact is, the US economy does not rely on banks for credit they way it once did. So if banks lend a little less, it probably won't make that much difference in the availability of credit and the economy can keep partying on.

 

[clifp]

So if banks lend a little less, it probably won't make that much difference in the availability of credit and the economy can keep partying on.


I think you are right in addition to all those nice Japanese business man trading us cars, for little piece of paper saying we will give you money in 10 to 30s year, we now have the Chinese goverment/business trading us Jeans, DVD players, and tacky tourist stuff, for the same pieces of paper.

I am looking forward to the day the US goverment tells the foreign investors, you want our money, you and what army our going to collect.

 

[dex]

If you want to scare yourself; look at the S&P chart.
If it gets to 1547 and then retreats it could be considered a double top - not good.

http://stockcharts.com/charts/historical/spx1960.html

http://www.incademy.com/courses/Technical-analysis-II/Double-top/12/1032/10002

 

[disk-golfer]

Thanks for the great responses. They are helping me wrap my head around “why would anyone buy a long term bond at a lower interest rate?”. And yes the historical trends are scary. I guess we have to have the testicular fortitude to ride out the valleys or risk missing the bull runs.

One thing I forgot to mention in my original post is why I started researching bonds. Simple girl (the wife) and I decided to re-categorize CDs as bonds or at least “bondish”. We did and all the sudden we were not so cash heavy. We will adjust this strategy as soon as we better understand what we are doing in the bond arena.

BTW here's the link to the dynamic yield curve:
http://stockcharts.com/charts/YieldCurve.html

Thanks again!

 

[bosco]

They are helping me wrap my head around “why would anyone buy a long term bond at a lower interest rate?”.

I know not everyone agrees with this, but personally I avoid long bonds, whether the interest rate is lower or higher than shorter ones. The added risk, IMO, doesn't justify a little more return (even when it's there).

IIRC, Bernstein also makes this point in 4 Pillars and recommends shorts and intermediates.

That being said, there is money to be made on long bonds in a falling rate environment. Not by me, though.

 

[audreyh1]

Same here. I hold mostly short and intermediate high quality bonds. I avoid long. For asset allocation purposes, short/intermediate high quality seems to provide a better diversifier to equities.

Right now we aren't really being rewarded much for holding other than cash, are we?

Audrey

 

[Robert the Red]

The meaning of life and quantum physics might be better starting points.

Then you'd get to dig into this http://en.wikipedia.org/wiki/Uncertainty_principle

Don't forget this:

http://cosmicvariance.com/2006/02/27/quantum-interrogation/

which explains how you can beat the uncertainty principle most of the time, if you are very very clever. After you understand this stuff, then get back to the yield curve.

 

[bssc]

I am looking forward to the day the US goverment tells the foreign investors, you want our money, you and what army our going to collect.

Yes, and that governments will get voted out of office by all the taxpayers who will be disappointed that they cannot buy cheap DVD players and Britney Spears dolls at Walmart.

 

[ziggy29]

I know not everyone agrees with this, but personally I avoid long bonds, whether the interest rate is lower or higher than shorter ones. The added risk, IMO, doesn't justify a little more return (even when it's there).

IIRC, Bernstein also makes this point in 4 Pillars and recommends shorts and intermediates.

Yep. The risk/reward profile just doesn't justify long bonds in most cases. Historically they only return something like 0.5% more than shorter bonds and have much more volatility. Relative to the added historical return, the sharp increase in risk isn't worth it.

 

[Gone4Good]

Yep. The risk/reward profile just doesn't justify long bonds in most cases. Historically they only return something like 0.5% more than shorter bonds and have much more volatility. Relative to the added historical return, the sharp increase in risk isn't worth it.

But if bonds zig when stocks zag that added volatility actually reduces portfolio risk and makes rebalancing more effective.

 

[ronin]

Part of the answer seems to be a glut of global liquidity looking for a safe parking place.