Barron's has a couple of different articles about trouble ahead in the bond market (longer duration) and what to do about it. This is right in the strike zone of what we talk about all the time here. At the start of the year, there were a lot of calls to buy further out the curve because with all of these Fed cuts coming, rates were going down they said. There turned out to not be that many Fed cuts and bond yields have churned around quite a bit with the 10 year treasury peaking at 4.9% in October 2023, bottoming out at 3.6% in September of this year and currently sits at 4.61%.
Unlike iShares bond ETFs which target ranges of maturities, the US Treasury ETF suite target just a single year, including the US Treasury 10 Year Treasury ETF (UTEN). The chart compares to iShares 10-20 Year Treasury ETF (TLH).
The chart tracks from when the yield on the ten year bottomed out in September. A one percent increase in the yield with this sort of maturity is going to result in a large price decline. My assertion has been that retail investors want bonds to kick off an income stream without moving in price and that is not what you get with this sort of ETF.
From its all time high in July 2020, TLH is down 41%. The price might literally never recover. I don't see how it can get back to that level unless the ten year's yield goes back to 58 basis points. I don't know what interest rates will do but going below 2% ever again seems like an incredible long shot. If rates go up then the current 41% decline from the peak will get worse. Even if you forget about the past, I'm saying that from here, if rates go up then funds like UTEN, TLH and the others will go down a lot more. Taking on that risk to get a yield in the mid-fours makes no sense to me.
If Torsten Slok from Apollo is right, it might get worse causing a 2022 repeat for 60/40 portfolios. In what amounts to a long Tweet, here's what Slok said.
As opposed to trying to support or refute Slok's argument, I think it is more productive to make sure the portfolio is resilient in case things shake out exactly like he says or if he's right for the wrong reason. He thinks rates across the curve are going up. Who knows if that will be right but avoiding bonds with duration mitigates this threat.
If 2022 actually repeats (it won't be exact even if 2025 is a lousy year), swapping out the AGG-like exposure for T-bills back then and doing nothing else would have reduce the decline by 652 basis points.
There are plenty of fixed income segments that trade very similarly to T-bills as well as alternatives that are fixed income proxies. If you use alternatives though, diversify your diversifiers in case something goes wrong with one of them. From there, adding just one reliable first responder defensive can help. Think of the equity portion of your portfolio as 100% (not of your dollars, just whatever dollars are in equities). If you took 5% of the equity allocation and put it into an inverse index fund, it would actually lower the net long exposure to 90%. There would be 95% in equities with the inverse index fund directly offsetting 5%.
This second step gave a 181 basis points improvement over S&P 500 plus T-bills and the decline is about half the decline of VBAIX which is a proxy for a more traditional 60/40 portfolio. The odds of your portfolio not going down at all in a down 20% world are not very good. The way we used to frame this for blogging purposes was that we're trying to avoid the full brunt of large declines.
What we've described is reasonably simple in terms of portfolio holdings. When to implement these tweaks is more difficult. Assuming you're not buried in longer term bond funds or individual bonds, the decision to shorten duration is less difficult. Just do it. If you are buried, well thankfully I'm not in that position. If it's individual bonds, time will bail you out eventually. If bond funds, like we mentioned above, they might never come back. For the stock component, there are many valid ways to tell you when to reduce exposure using moving average studies, again our example was swapping just 5% out in favor of an inverse fund. Don't emotionally bank on your indicator being the single best one that takes you out at the very top. That might be the case but probably not.
Just a little more context here is that yes, many indicators can convey greater risk in equities, equities might keep going up anyway. As noted above, small tweaks can go a long way to improving performance without causing the portfolio to completely sit out a large rally.
Yes, an inverse index fund could have a tracking problem but -1x S&P 500 has a decent track record for staying close, you could use client personal holding BTAL instead.
If you go narrower than broad based index funds and you can find a stock that you think functions as a reliable first responder the way I do with client/personal holding CBOE, then that would hopefully help too. We haven't even talked about 2nd responders like managed futures but as a follow up to the other day, this is much closer to simplicity hedged with just a little complexity.
There was an ETF filing for the Strive Bitcoin Bond ETF. The short version is that it will buy Microstrategy convertible bonds. A little more detail is that the fund can use swaps and options to create the exposure in addition to the actual convertibles. The fund will also be able to hold convertibles from other companies who do the same strategy of issuing convertibles to buy Bitcoin.
I don't believe Microstrategy has any connection to Strive but the fund would seem to be creating an outlet to place more bonds. Who knows where a saturation point of demand might be for these converts but a fund that allows access for retail investors to something where there previously was no access will probably attract assets.
That doesn't mean anyone should buy this fund if it ever lists however. The bonds have no yield. The strategy of issuing converts with no yield to buy Bitcoin has been "working" because Bitcoin has been going up leading to Microstrategy going up even more in percentage terms, because it is a leveraged Bitcoin play, which draws in more buyers as the price goes up. If it's not a pyramid, I don't know how it's not a pyramid. Anytime Saylor describes it, he is always fast talking and very jargon heavy with at least one term he made up; Bitcoin Yield. There's no scenario where I want any part of the Microstrategy ecosystem.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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