What does a bond bear market look like?

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lgs88
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Re: What does a bond bear market look like?

Post by lgs88 » Mon Nov 21, 2016 4:16 am

nisiprius wrote:...I didn't talk about it, but I posted a picture of it. This is the one chart I showed that's a price chart rather than a growth chart...-


Nisiprius,

Will you help me understand how continuous regular investment affects these charts? e.g. rather than just reinvesting the interest from my bond fund, I continue making monthly investments.

If I understand correctly, this should cushion the impact of rising rates, since I am buying more of the higher-yielding bonds than what just my reinvested dividends would yield. Is this so?

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Re: What does a bond bear market look like?

Post by Call_Me_Op » Mon Nov 21, 2016 6:47 am

lgs88 wrote:
nisiprius wrote:...I didn't talk about it, but I posted a picture of it. This is the one chart I showed that's a price chart rather than a growth chart...-


Nisiprius,

Will you help me understand how continuous regular investment affects these charts? e.g. rather than just reinvesting the interest from my bond fund, I continue making monthly investments.

If I understand correctly, this should cushion the impact of rising rates, since I am buying more of the higher-yielding bonds than what just my reinvested dividends would yield. Is this so?


It's really no different from a rolling bond ladder. If there is a sharp rate increase, all of the bonds in the portfolio will experience an immediate reduction in value (reduction in NAV if we are talking about a fund). But a given bond will mature at par, so in effect, all of the bonds in the ladder (or fund) have a higher yield to maturity (YTM) after the rate increase, and you are buying the higher YTM bonds with your new money. That is definitely a good thing.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: What does a bond bear market look like?

Post by carolinaman » Mon Nov 21, 2016 8:29 am

dodecahedron wrote:
carolinaman wrote:I can see interest rates rising to some extent. But to get into a bond bear market I would think rates would have to rise a lot, perhaps increase by 5% or more. In order for that to happen, it would seem there would have to be a very dramatic increase in demand for goods and services and some scarcity. The world is awash in cash and demand is very low right now. I do not see that situation changing dramatically. My understanding is the Fed has only so much influence on interest rates, and those mostly on the short term. I am not an economist, so what am I missing?


Economist to the rescue here! What you are missing is that if government spending ramps up its spending (e.g., either because we get the political will to do the long overdue infrastructure spending all sides agree we need, i.e., roads, bridges, etc. AND/OR if the country gets into another war), then thanks to the fiscal multiplier effect, we could get precisely that "very dramatic increase in demand for goods and services and some scarcity" that you describe as needed for that to happen.

Will these happen? Who knows? But they are certainly possibilities that can't be ruled out.


Thanks dodecahedron for your good explanation. I worked in local govt for 27 years and have a basic understanding of how infrastructure projects are planned, designed and funded. In Obama's first term, he talked about funding "shovel ready" projects. The reality is it takes a lot of time and money to plan and design a project. Any project that is already "shovel ready" is already funded, and not much happened with his "shovel ready" projects. I believe that it will take a couple of years to ramp up for starting new infrastructure projects. There should be some leading indicators of this happening, but it seems to me that the economic impact will not be felt until the projects start.

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Re: What does a bond bear market look like?

Post by ChosenGSR » Mon Nov 21, 2016 9:17 am

vitaflo wrote:
tbradnc wrote:This thread is a good segue to a question i've wanted to ask for a while.

I've owned an intermediate bond fund for many years. Interest is always reinvested into the fund. The cost basis for the fund is showing a hefty unrealized long term loss (as well as short term loss, reflecting interest reinvested over the previous year).

Yet I keep hearing that this bond fund is up YTD. How can that be?


It's possible the NAV price has gone down, but the dividends have made up for it. If NAV goes down 1% you will have an unrealized loss. If you yield 2% in dividends on the fund, overall you will be up. Because 2-1=1% overall gain.

This is a common problem when people discuss returns, they just look at the price chart and don't take reinvested dividends into account most times. This goes double for bond funds who's entire overall return comes from the yield. NAV changes should theoretically even out over time.


When one looks up a bond fund on say Yahoo and looks at the chart, I take it the graph does not take into account dividends. Where does one look up a chart that does?

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Re: What does a bond bear market look like?

Post by Spewin » Mon Nov 21, 2016 9:44 am

ChosenGSR wrote:
When one looks up a bond fund on say Yahoo and looks at the chart, I take it the graph does not take into account dividends. Where does one look up a chart that does?


Look for "Growth of $10,000" type charts. Those usually take dividend reinvestment into account, so I also assume bond coupon reinvestment.

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Re: What does a bond bear market look like?

Post by dbr » Mon Nov 21, 2016 9:45 am

ChosenGSR wrote:
When one looks up a bond fund on say Yahoo and looks at the chart, I take it the graph does not take into account dividends. Where does one look up a chart that does?


Growth of 10K chart. It shows the accumulated wealth with dividends reinvested: http://beta.morningstar.com/funds/XNAS/VBMFX/quote.html

Also, return data for a fund is always total return including dividends and is reported as compound average annualized growth rate for periods of more than one year.

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Re: What does a bond bear market look like?

Post by Johnnie » Mon Nov 21, 2016 9:48 am

dodecahedron wrote:
carolinaman wrote:
Economist to the rescue here! What you are missing is that if government spending ramps up its spending (e.g., either because we get the political will to do the long overdue infrastructure spending all sides agree we need, i.e., roads, bridges, etc. AND/OR if the country gets into another war), then thanks to the fiscal multiplier effect, we could get precisely that "very dramatic increase in demand for goods and services and some scarcity" that you describe as needed for that to happen. Will these happen? Who knows? But they are certainly possibilities that can't be ruled out.


Careful - to my eyes that statement looks more like "Keynesian politician to the rescue here." Our own Lady GaGa is always lurking... :wink:
"I know nothing."

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Re: What does a bond bear market look like?

Post by HomerJ » Mon Nov 21, 2016 10:45 am

ChosenGSR wrote:When one looks up a bond fund on say Yahoo and looks at the chart, I take it the graph does not take into account dividends. Where does one look up a chart that does?


Never use Yahoo for any graphs. Completely worthless to ignore dividends. Morningstar.com has graphs that includes dividends for both stock and bond funds.

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Re: What does a bond bear market look like?

Post by btenny » Mon Nov 21, 2016 11:44 am

Go to Yahoo Finance (Linked below) and look at Vanguard Intermediate Term Muni fund (VWITX) returns for the period 1978 to 1981. Look at the bottom of the page. During this time period interest rates were going up dramatically due to inflation. This is the most recent period when interest rate went up a lot for several consecutive years. The fund had negative returns for four years. But then in 1982 the fund returned 31% so it recovered it losses. But with the inflation that occurred in that period I am sure the fund lost money on net basis.

http://finance.yahoo.com/quote/VWITX/pe ... ce?p=VWITX

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Re: What does a bond bear market look like?

Post by Call_Me_Op » Mon Nov 21, 2016 11:58 am

btenny wrote:Go to Yahoo Finance (Linked below) and look at Vanguard Intermediate Term Muni fund (VWITX) returns for the period 1978 to 1981. Look at the bottom of the page. During this time period interest rates were going up dramatically due to inflation. This is the most recent period when interest rate went up a lot for several consecutive years. The fund had negative returns for four years. But then in 1982 the fund returned 31% so it recovered it losses. But with the inflation that occurred in that period I am sure the fund lost money on net basis.


Not a great example because rates were much higher at the start of that period compared to today.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: What does a bond bear market look like?

Post by longinvest » Mon Nov 21, 2016 12:06 pm

btenny wrote:Go to Yahoo Finance (Linked below) and look at Vanguard Intermediate Term Muni fund (VWITX) returns for the period 1978 to 1981. Look at the bottom of the page. During this time period interest rates were going up dramatically due to inflation. This is the most recent period when interest rate went up a lot for several consecutive years. The fund had negative returns for four years. But then in 1982 the fund returned 31% so it recovered it losses. But with the inflation that occurred in that period I am sure the fund lost money on net basis.

Btenny,

I would look at a larger picture than just three years. Here's part of a post I made earlier in this thread about 1966 to 1981 (inclusively), comparing stocks, bonds, and inflation during the period:

viewtopic.php?f=10&t=203552#p3121204
longinvest wrote:[...] While stocks (blue) had higher returns from 1966-1981 (or, more precisely, from December 31, 1965 to December 31, 1981), they experienced a far worse bear market than bonds (red) during that period. Look at the 1973-1975 period! Inflation is represented by the yellow line in the chart:

Image

ADDED: Bonds returns are those of Bond Fund 10-2 from 1966 to 1971, and TBM from 1972 to 1981.
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Re: What does a bond bear market look like?

Post by Kevin M » Mon Nov 21, 2016 12:09 pm

Referring to a quick 7% drop in the share price of OP's bond fund, OP asked, "Is this what a bear market looks like in bonds?" It was correctly pointed out that you are pretty much guaranteed to recover from this loss over time in a high quality bond fund, and end up better in the long run. I simply pointed out that while this nice result may be what a bond bear market looks like in nominal terms, things can look much worse in real (inflation-adjusted) terms over quite long periods--16 years in the case I mentioned.

My point was no, a quick 7% drop is not what a bond bear market looks over a holding period equal to or longer than the duration of the bond fund--if you are thinking in nominal terms. After a period equal to the duration of the fund you will be in the same place you would have been with no rate increase, and after that you will be better off (in nominal terms). But you probably should be thinking in real terms, in which case a bond bear market looks like 1966-1981. That is a lot longer than the 5-6 year duration of a typical intermediate-term bond fund.

It also has been correctly pointed out that the main reason you will recover from a loss in bond price is that bonds mature at par (100, or 100% of face value). This is especially true at low yields, since the reinvestment component is a much smaller piece. The reinvestment component does come into play though, which is why duration is less than term to maturity.

Between Nov 1 and Nov 17 the price of a 7-year Treasury dropped about 3% (any fund that dropped 7% had either significant credit risk or much more term risk). I shared the chart below in another current bond thread, which shows the price trajectories of a 7-year bond held to maturity before and after the 16-day yield increase (and corresponding price drop), assuming no further changes in the yield curve. I've also included some of my comments from that thread, since they are relevant here too.

Kevin M wrote:Image

The blue line shows the theoretical price history of the bond if the yield curve had not changed. We're assuming the bond was purchased at par (100), so the coupon rate equals the yield on Nov 1. We see that the price of the bond increases for about three years as it approaches maturity, then it flattens out for about a year, then it declines for about the final three years, and of course hits 100 again at maturity.

(Fans of VG intermediate-term Treasury fund will note that the fund holds bonds in the 3-10 year range, so would sell this bond before it starts its price decline).

The red line shows the theoretical price history of the bond if the yield curve had changed as it did between Nov 1 and 17, but then remained static until the 7-year bond matures. First note that the bond dropped in price by about 3% over those 16 days. We can explain this roughly in duration terms without even using a calculator, since the duration of the bond is between 6 and 7 years, so a yield increase of about 0.5% should result in a price decrease of somewhere between 3-3.5% (0.5 x 6-7).

Next note that bond price then increases more rapidly than in the first scenario, which makes sense because the yield curve is steeper. Now note that the bond returns to par in about 2.5 years (so all price loss is recovered, and that the price continues to increase for a total of about five years (compared to about three years in scenario 1). Price decreases back to par during the last two years.


Since a bond fund is a collection of bonds, the fund share price will reflect the price trajectories of the bonds held by the fund, so we'll see some of the effects shown in the chart above. Of course a bond fund does not mature--new bonds are purchased as old bonds mature or are sold--and the yield curve is not static, so the bond fund price trajectory will be messier than what is shown in the chart.

Kevin
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Re: What does a bond bear market look like?

Post by btenny » Mon Nov 21, 2016 2:09 pm

Long. Do you have a chart that shows bond returns over the 1961-1981 period with inflation taken out so it shows the real negative returns over that period and the loss by year? Same for stocks? I don't have things like that book marked so I can present them here. I was pointing out to the OP and others that bonds can lose significant value over medium periods before they recover. Plus if you include inflation bonds can lose a ton over relatively short periods. That is why lots of people misunderstand bond duration and related issues. That is why I think it is so important to point out the effects of inflation to all the young people that have not experienced how fast high inflation can destroy wealth and kill a good retirement plan.

But I get your point about looking at longer periods than 4 years.

Good Luck.

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Re: What does a bond bear market look like?

Post by Kevin M » Mon Nov 21, 2016 3:07 pm

btenny wrote:Do you have a chart that shows bond returns over the 1961-1981 period with inflation taken out so it shows the real negative returns over that period and the loss by year? Same for stocks?

Using data from our Simba backtest spreadsheet, here is real growth of $1 table for 15 years 1967-1981 (inclusive). ITTRG = Intermediate Term Treasury Real Growth, USStocksRG = US Stocks Real Growth. Scroll down in the code window to see the later years in the table.

Code: Select all

Year  ITTRG  USStocksRG
----  ------ ----------
1967  0.9637  1.1174
1968  0.9429  1.1818
1969  0.8653  1.0179
1970  0.9622  1.0328
1971  1.0037  1.1361
1972  1.0000  1.2823
1973  0.9528  0.9645
1974  0.8854  0.6241
1975  0.8836  0.8081
1976  0.9384  0.9748
1977  0.9021  0.8738
1978  0.8413  0.8603
1979  0.7553  0.9325
1980  0.6874  1.0980
1981  0.6586  0.9692


Note that ITT had recovered in real terms by 1972, so really 1973-1981 was really the bad spell. Looking at the longer time period simply emphasizes that a bond bear market (and stock bear market) in real terms can last longer.

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Re: What does a bond bear market look like?

Post by dbr » Mon Nov 21, 2016 3:13 pm

Kevin M wrote:
btenny wrote:Do you have a chart that shows bond returns over the 1961-1981 period with inflation taken out so it shows the real negative returns over that period and the loss by year? Same for stocks?

Using data from our Simba backtest spreadsheet, here is real growth of $1 table for 15 years 1967-1981 (inclusive). ITTRG = Intermediate Term Treasury Real Growth, USStocksRG = US Stocks Real Growth. Scroll down in the code window to see the later years in the table.

Code: Select all

Year  ITTRG  USStocksRG
----  ------ ----------
1967  0.9637  1.1174
1968  0.9429  1.1818
1969  0.8653  1.0179
1970  0.9622  1.0328
1971  1.0037  1.1361
1972  1.0000  1.2823
1973  0.9528  0.9645
1974  0.8854  0.6241
1975  0.8836  0.8081
1976  0.9384  0.9748
1977  0.9021  0.8738
1978  0.8413  0.8603
1979  0.7553  0.9325
1980  0.6874  1.0980
1981  0.6586  0.9692


Note that ITT had recovered in real terms by 1972, so really 1973-1981 was really the bad spell. Looking at the longer time period simply emphasizes that a bond bear market (and stock bear market) in real terms can last longer.

Kevin


There is a reason the period right around 1966 was the worst time time to retire in the 20th century, give or take a couple of others right at the beginning. The same data shows why 1982 is the best or nearly the best year in which to retire in over a hundred years. The domination of this problem by the luck of timing is amazing. And I don't think anyone would have known those outcomes ex ante.

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Re: What does a bond bear market look like?

Post by nisiprius » Mon Nov 21, 2016 4:34 pm

dbr wrote:...There is a reason the period right around 1966 was the worst time time to retire in the 20th century, give or take a couple of others right at the beginning. The same data shows why 1982 is the best or nearly the best year in which to retire in over a hundred years. The domination of this problem by the luck of timing is amazing. And I don't think anyone would have known those outcomes ex ante...
Yes. People look at long-term data and run withdrawal simulations in the hope and expectation that they will see a great decrease in uncertainty, but it doesn't happen.
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Re: What does a bond bear market look like?

Post by itstoomuch » Mon Nov 21, 2016 5:05 pm

OP. Not pretty. But pretty in that it happens real quick like.

look at GNMA bonds, bonds of GM, C, JPM, GE, AIG, etc, from 2007-2019.
If you can get a hold of Vanguard semi-annual holdings report from 2007 -2009, of shortterm, medium, longterm bond indexes, It was for me a real eye opener.

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Re: What does a bond bear market look like?

Post by ogd » Mon Nov 21, 2016 6:29 pm

Good Listener wrote: Anna, I know that higher rates actually lead to higher returns eventually, but doesn't that assume that rates down keep rising for let's say 30 years (mirror image of the bull market. )

No, there are no other assumptions, other than bonds being safe and not defaulting. The recent interest rate increase will, seen by itself, lead to higher returns than if this particular increase hadn't happened, 7 years from now in the case of your fund. There may be other increases along the way, but each with its own "better than not" timeline and each pushing the yield higher.

Also, wrt to the general spirit of the thread, I strongly object to the applicability of the terms "bull market" and "bear market" to bonds, particularly over longer timeframes. The "30 year bull market" cut the returns of the intermediate bond investor by some 3-4 times -- they would have been far better had the rates stayed put where they were. Some bull market that is. Similarly, a long so-called "bear market" will greatly boost your returns after a first few years of pain. A picture ("designation") that might make some sense in the short timeframe completely breaks down over timeframes longer than duration. You want rates to go up if you are heavily in fixed income (ignoring possibly negative effects on the economy in this discussion), despite the initial pain.

Good Listener wrote:I have gone from a several hundred K gain in these funds to a few hundred K down in the last month or so. And it is like a gnawing daily event. I would defy all my investing principles to take a loss now, which would be permanent.

Maybe it helps to think of it in terms of yield. Like so "I was okay holding this fund at 1.5% yield (or whatever), why wouldn't I be okay holding it at 2.5%?". The decline, for this particular duration fund, should translate into about a 1% bump in yield. SEC yield (a counterpart of YtM for individual bonds) is the number to watch, and it should go up fairly quickly though not immediately -- it's a 30 day average.

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Re: What does a bond bear market look like?

Post by young-ish » Mon Nov 21, 2016 7:05 pm

Good Listener wrote:
Is this what a bear market looks like in bonds?


No. Check out Wade Pfau's research on bond market declines... https://retirementresearcher.com/greate ... nd-market/

U.K. and U.S. investors lost over 60% of their money in the four decades beginning during WWII.

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Re: What does a bond bear market look like?

Post by jalbert » Mon Nov 21, 2016 9:24 pm

I don't know what bonds Mr Pfau was referring to for 1929-1932 US data for instance, but it certainly wasn't treasuries:

http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html

And it was a time of deflation (CPI down 20%) so real returns were much larger. Presumably he is referring to all US bonds, which had a large fraction of corporate bonds, which saw high defaults.

In 1972-73, inflation was +17% in total, so a 10-yr treasury would have lost 12% in real terms, not in excess of 50%.

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Re: What does a bond bear market look like?

Post by garlandwhizzer » Mon Nov 21, 2016 9:52 pm

Wade Pfau's table of the worst bond markets gives us caution. It is important to remember that the results are listed in the kind of dollars that count, real inflation adjusted returns. When you go into a period of ever increasing inflation over multiple decades, bond yields tend to lag increases in inflation by the time the bonds mature at par. In nominal dollars bonds do well during bond bear markets but inflation eats up returns faster than they accumulate. Once inflation gets sound footing and becomes progressive you move from demand pull inflation which tends to correct itself over time to cost push inflation which does not correct itself and tends to beget ever higher prices on goods and services. The Germans of the 1920s and those of us who were around in the 1960s and 1970s know what that's like as workers and companies demanded ever higher profits to compensate for expected inflation in the future. But to many investors today, lulled by 35 years of decreasing inflation, it is only theoretical, not something to be feared. Once the increasing inflation trend gets going it's very hard to protect yourself in any asset class. TIPS would provide some protection but their yields which are negative now for short and intermediate terms would be expected to be significantly more negative due to increased demand as bond assets rush from nominal bonds to TIPS. Everything suffers in this environment with TIPS, commodities, and real assets doing perhaps better (or less badly) than other assets. Equities also suffer but less so than nominal bonds. One bright spot: severe inflation does not tend to be a global phenomenon. More often it is localized to a country or region. International diversification may help considerably.

Hopefully such a scenario does not recur in our lifetimes. I remember what it was like and experiencing it once is quite enough.

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Re: What does a bond bear market look like?

Post by longinvest » Mon Nov 21, 2016 10:11 pm

btenny wrote:Long. Do you have a chart that shows bond returns over the 1961-1981 period with inflation taken out so it shows the real negative returns over that period and the loss by year? Same for stocks? I don't have things like that book marked so I can present them here. I was pointing out to the OP and others that bonds can lose significant value over medium periods before they recover. Plus if you include inflation bonds can lose a ton over relatively short periods. That is why lots of people misunderstand bond duration and related issues. That is why I think it is so important to point out the effects of inflation to all the young people that have not experienced how fast high inflation can destroy wealth and kill a good retirement plan.

But I get your point about looking at longer periods than 4 years.

Good Luck.

Btenny,

Here's the same chart, but inflation-adjusted.

Image

ADDED: Bonds returns are those of Bond Fund 10-2 from 1966 to 1971, and TBM from 1972 to 1981.

The chart was built using hisorical data in the VPW backetsting spreadsheet, which is based on a combination of Simba's spreadsheet data (1972 and later), FRED, and Prof. Shiller data (before 1972).

What's most important, with bond funds, is duration. The 10 to 2-year fund has a duration of approximately 5 years. As such it has limited nominal volatility, and it adjusts to an increase in yields (due to higher inflation) within a relatively short time frame. In 1982, bonds were back in the black, above $10,000 adjusted to inflation (one year beyond the end of the chart); so they were back within 5 years (that was lucky; math tells us that it could have taken up to two times duration in a continuously increasing yield environment).

Most of the scary historical charts of bonds are made with a constant-maturity single 20-year Treasury bond fund. Yes, a bond fund containing a single bond maturing in 20-year which is sold and replaced by another 20-year bond every year. This is not the kind of bond fund Bogleheads normally use. This is because, in the literature, there are "bonds" (maturity > 10 years), "notes" (maturity up to 10 years), and "bills" (maturity up to 1 year). 20 years is in the center of the maturity age of Treasury Bonds (10 to 30 years). What we call a "bond fund" (such as an intermediate bond fund) should probably be named a "notes fund" in the context of such literature.

I am not trying to dismiss the inflation risk of nominal bonds; I am just saying that this risk did not really show up* in the 1970s-1980s, because nominal yields adjusted to inflation during this challenging period.

* The lag to inflation in the 1970s-1980s was simply the normal lag we expect from a rise in yields according to the duration of a bond fund.

In the 1940s-1950s, inflation was volatile and had spikes up to near 20%, yet nominal yields remained low, below 3% even for long-term Treasuries. This resulted in a significant loss of purchase power for bonds that was never recovered from. (I do not associate the gains in the 1980s to a recovery from the 1940s). Short-term debt instruments were hit the hardest, because their yields remained even lower, below 2%.
Last edited by longinvest on Tue Nov 22, 2016 3:16 pm, edited 2 times in total.
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Re: What does a bond bear market look like?

Post by jalbert » Mon Nov 21, 2016 11:05 pm

Institutional investors who invest in long-term nominal bonds match the duration of the asset to the duration of their liabilities. This means they at not taking term risk with the bonds, nor are they taking inflation risk if their liabilities are nominal liabilities. As a result, investors are not compensated for taking term risk or inflation risk with long-term (nominal) bonds: institutional investors establish the market price.

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Re: What does a bond bear market look like?

Post by livesoft » Tue Nov 22, 2016 8:36 am

More "research" on bond market declines from Ben Carlson:
How Bad Could Bond Market Losses Get?

Short answer: Not that bad.
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Re: What does a bond bear market look like?

Post by garlandwhizzer » Tue Nov 22, 2016 12:07 pm

The chart in longinvest's post shows real inflation adjusted returns on a 5 year duration bond portfolio and stock portfolio over the 16 years from 1966 - 1981. Both were negative in real returns over the 16 year time span. Frankly I don't find it very reassuring that in a moderate/severe inflationary environment you lose purchasing power from investing in both stocks and bonds for more than a decade and a half. While not a total disaster, it certainly doesn't do much for reaching future retirement goals.

In most of the world today deflation seems to pose a greater risk than inflation. Hopefully in our lifetime inflation/stagflation will not emerge from this current low growth, low inflation environment throughout the developed world. I believe that a severe inflationary outcome is a low (but not zero) probability event over the next few decades. It is more likely in my view that US inflation will very slowly increase and plateau at some level at which both stocks and bonds will produce positive but less than long term historical returns. I believe a well diversified asset allocation portfolio provides good defense against the uncertainty of the future as challenges may come from any direction including unexpected ones.

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Re: What does a bond bear market look like?

Post by btenny » Tue Nov 22, 2016 12:30 pm

Long. That is an excellent chart. You did good work. Your chart shows a LOSS of 20% or so in the capital of a bond fund over 4 years from 1978 to 1981. If I had just retired and lost that much in my "stable bond funds" I would go crazy. This is what a real bond bear market looks like. Can you continue your fund chart to say 1985 to show how fast these funds recovered? I bet they did OK if you just stayed the course.

The real problem I see now is how are our various Vanguard stock and bond funds doing right now versus inflation for say the last 18 years. How fast are things really growing when you subtract out inflation. Plus it would show the real effects of the recent recessions of 2000 and 2008.

Then add in a 3% or 4% draw down due to retirement on a second set of charts. How are those folks doing? This would show us how they are really doing.

Good Luck.

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Re: What does a bond bear market look like?

Post by Kevin M » Tue Nov 22, 2016 1:04 pm

Earlier I posted the tabular results for real returns of intermediate-term Treasuries (ITT) and US Stocks for 1967-1981 (inclusive). longinvest's chart shows results that don't look quite as bad for bonds. Here's the chart based on the data I shared earlier.

Image

As mentioned earlier, the data is from the Simba backest spreadsheet. I believe that the ITT data prior to availability of the Vanguard ITT fund is based on longinvest's 10-4 year rolling bond ladder simulation, so perhaps longinvest can weigh in and say if the extra two years of shorter-maturity bonds in the 10-2 year ladder is enough to explain the difference in performance. Another factor is that the Simba spreadsheet applies an expense ratio to better simulate a fund, but I wouldn't think this is enough to explain the difference. At any rate, this is most definitely not data for a 20-year Treasury rolled annually, but for a bond ladder that is intended to be representative of the Vanguard ITT fund.

Minor technical note: The values on the horizontal axis are year-end, which is consistent with the convention used in the Simba spreadsheet and PortfolioVisualizer. So if you specify start year as 1967 and end year as 1981, you will get returns for 12/31/1966-12/31/1981. I believe longinvest's chart is showing year-start on the horizontal axis.

It's true that bonds recovered quickly after 1981; the backtest spreadsheet data shows full recovery (in real terms) during 1985.

People can draw their own conclusions as to whether or not this was a period during which inflation risk showed up for bonds. I would think that a retiree drawing down a bond-heavy portfolio would have thought so.

I can't think of any reason that a bond fund's duration has anything to do with nominal bond yields lagging inflation. I think it has more to do with inflation expectations, which it seems reasonable would lag actual inflation due to recency bias and hindsight bias (people tend to project what has happened recently into the future). EDIT: However, it is true that returns lag changes in yield proportionate to duration, since the longer the duration the longer it takes for higher/lower yields to compensate for decrease/increase in bond price.

Agreed that the worst long period for US bonds started in 1940 or 1941. Backtest spreadsheet data for ITT shows cumulative real return of -46% for the 40-year period 1941-1980 (inclusive). The Wade Pfau article quoted earlier shows cumulative real bond return of -63% for the 41-year period 1940-1981, while the backtest spreadsheet data indicates -47% for ITT during this period. Pfau cites the "Dimson, Marsh, Staunton Global Returns Dataset" as his data source, and DMS uses "long-term government bonds" for bond data. The backtest spreadsheet data only goes back to 1954 for long-term Treasuries, so we can't use it for this older time period. At any rate, definitely a very bad 40-year period for US bonds.

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Re: What does a bond bear market look like?

Post by HomerJ » Tue Nov 22, 2016 1:23 pm

btenny wrote:Long. That is an excellent chart. You did good work. Your chart shows a LOSS of 20% or so in the capital of a bond fund over 4 years from 1978 to 1981. If I had just retired and lost that much in my "stable bond funds" I would go crazy. This is what a real bond bear market looks like.


But rates were rising the entire time. And Bonds were doing okay. It was the double-digit INFLATION that killed bonds at the end of that period.

People are quoting that period as a reason to be worried about rising rates, and a bond bear market. But we've had rising rates before without bond destruction. Unexpected inflation is the real killer.

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Re: What does a bond bear market look like?

Post by HomerJ » Tue Nov 22, 2016 1:33 pm

Kevin M wrote:Agreed that the worst long period for US bonds started in 1940 or 1941. Backtest spreadsheet data for ITT shows cumulative real return of -46% for the 40-year period 1941-1980 (inclusive). The Wade Pfau article quoted earlier shows cumulative real bond return of -63% for the 41-year period 1940-1981, while the backtest spreadsheet data indicates -47% for ITT during this period. Pfau cites the "Dimson, Marsh, Staunton Global Returns Dataset" as his data source, and DMS uses "long-term government bonds" for bond data. The backtest spreadsheet data only goes back to 1954 for long-term Treasuries, so we can't use it for this older time period. At any rate, definitely a very bad 40-year period for US bonds.


What was the real returns for the 20-year period 1951 through 1971?

You know, instead of ending in 1981 where the last couple of years experienced double-digit high inflation?

Rates were rising the entire period from 1951 to 1971. What's the damage to bonds if you take out super high inflation? (And even during that period, inflation was still in the 3%-5% range - what do the numbers look like with 1%-2% inflation?)

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Re: What does a bond bear market look like?

Post by Kevin M » Tue Nov 22, 2016 1:47 pm

HomerJ wrote:People are quoting that period as a reason to be worried about rising rates, and a bond bear market.

Really? I don't see that. We are simply saying that inflation can be the main culprit in a bond bear market in real terms. So when we talk about bond bear markets, we should talk in real terms, and factor in inflation.

HomerJ wrote:What was the real returns for the 20-year period 1951 through 1971?
You know, instead of ending in 1981 where the last couple of years experienced double-digit high inflation?

Rates were rising the entire period from 1951 to 1971. What's the damage to bonds if you take out super high inflation? (And even during that period, inflation was still in the 3%-5% range - what do the numbers look like with 1%-2% inflation?)

Backtest spreadsheet numbers show cumulative real growth of 1.2030 (so $10K grew to $12,030K) for the 21-year period 1951-1971 (inclusive). Again, no one's arguing that nominal returns weren't positive during these periods. Do you live on nominal dollars or real dollars?

It's easy to undersand that once yields are high enough, you will recover quickly from a rate increase in nominal terms. For a bond fund with duration of 5 years, if yield increases from 4% to 5% you will recover the nominal price loss in about one year. If yield increases from 9% to 10% you will recover the loss in nominal terms in about six months. It takes longer to recover in nominal terms at lower yields, but the duration principle still works the same; i.e., the point of indifference (in years) to a single yield change is equal to the duration.

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Re: What does a bond bear market look like?

Post by longinvest » Tue Nov 22, 2016 2:58 pm

Kevin M wrote:As mentioned earlier, the data is from the Simba backest spreadsheet. I believe that the ITT data prior to availability of the Vanguard ITT fund is based on longinvest's 10-4 year rolling bond ladder simulation, so perhaps longinvest can weigh in and say if the extra two years of shorter-maturity bonds in the 10-2 year ladder is enough to explain the difference in performance. Another factor is that the Simba spreadsheet applies an expense ratio to better simulate a fund, but I wouldn't think this is enough to explain the difference. At any rate, this is most definitely not data for a 20-year Treasury rolled annually, but for a bond ladder that is intended to be representative of the Vanguard ITT fund.


Here's the reason for the difference.

My chart's legend was incorrect, for bond returns. I edited my posts to clarify it. The VPW spreadsheet (the source of my data) always uses the most reliable source of returns to approximate TBM and TSM, for each historical period. In pre-1972 years it uses FRED and Shiller derived returns, and starting in 1972 it uses Simba's TBM and TSM returns.

Specifically, the VPW spreadsheet uses Bond Fund 10-2 from 1966 to 1971 (inclusively), then uses Simba's TBM returns from 1972 to 1981 (incusively), which happen to be significantly higher than the returns of Bond Fund 10-2 and 10-4, possibly (?) because its inclusion of corprorate bonds, I don't know; this continues to intrigue me. It does not subtract an expense ratio from Bond Fund 10-2, but an expense ratio is taken out (in Simba's) from TBM's returns. It also uses Shiller's S&P500 returns from 1966 to 1971, then Simba's TSM returns from 1972 to 1981. It does not subtract an expense ratio from Shiller's S&P500, but an expense ratio is taken out (in Simba's) from TSM's returns.

Kevin M wrote:Minor technical note: The values on the horizontal axis are year-end, which is consistent with the convention used in the Simba spreadsheet and PortfolioVisualizer. So if you specify start year as 1967 and end year as 1981, you will get returns for 12/31/1966-12/31/1981. I believe longinvest's chart is showing year-start on the horizontal axis.


Yes, in my charts, years indicate the start of year (or end of day on the preceding December 31st). This way the line between 1966 and 1967 represents the unrolling of year 1966, which seems pretty intuitive to me. This would allow me to hypothetically add monthly returns without having to slide anything. Marking the last day of the year on the chart seems wrong, to me. Maybe that's an improvement suggestion I should make to Simba's maintainers.

Kevin M wrote:EDIT: However, it is true that returns lag changes in yield proportionate to duration, since the longer the duration the longer it takes for higher/lower yields to compensate for decrease/increase in bond price.


Here's my intuition. Over the long term, the total return of a ladder is the average yield of its bonds at the time they were bought. If I invest into a ladder of bonds bought, respectively, with yields of 3%, 4%, 3%, 5%, and 5%, holding them to maturity, my return should be near the 4% average. Of course, there will be a lag, because new bonds continue to be acquired at different yields. But, it cannot be otherwise, mathematically. If, at the same time, inflation was running 3%, 4%, 3%, 5%, and 5%, then the bond fund will necessarily keep pace with inflation, even though it will lag behind. A full recovery will eventually happen as long as yields (on the long end of the ladder) reflect a small bonus on top of inflation, which has been the case pretty much all the time, except in the 1940s-1950s period. With yields, on the long side of the ladder, reflecting a small bonus above inflation*, the ladder is likely to recover from a one-time increase in inflation (with an accompanying increase in yields) within a time more or less equal to its duration, the point of indifference (adjusted based on the size of the bonus).

* This is like having yields of 3.5%, 4.5%, 3.5%, 5.5%, and 5.5% at the time of purchase, in my example.

Nominal bonds are very vulnerable to inflation risk, as we learned in the 1940s-1950s. There exist TIPS which are not vulnerable to inflation.
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Re: What does a bond bear market look like?

Post by jalbert » Tue Nov 22, 2016 4:07 pm

The chart in longinvest's post shows real inflation adjusted returns on a 5 year duration bond portfolio and stock portfolio over the 16 years from 1966 - 1981. Both were negative in real returns over the 16 year time span. Frankly I don't find it very reassuring that in a moderate/severe inflationary environment you lose purchasing power from investing in both stocks and bonds for more than a decade and a half. While not a total disaster, it certainly doesn't do much for reaching future retirement goals.

I consider that chart to be a reason to allocate to real estate. I guess others would use it to justify a small-cap value tilt or int'l equity position.

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Re: What does a bond bear market look like?

Post by Kevin M » Tue Nov 22, 2016 5:38 pm

jalbert wrote:
The chart in longinvest's post shows real inflation adjusted returns on a 5 year duration bond portfolio and stock portfolio over the 16 years from 1966 - 1981. Both were negative in real returns over the 16 year time span. Frankly I don't find it very reassuring that in a moderate/severe inflationary environment you lose purchasing power from investing in both stocks and bonds for more than a decade and a half. While not a total disaster, it certainly doesn't do much for reaching future retirement goals.

I consider that chart to be a reason to allocate to real estate. I guess others would use it to justify a small-cap value tilt or int'l equity position.

Really? A much safer, more reliable way to hedge increasing inflation is with TIPS.

Of course you can invest in a risky asset that has a decent, historical correlation with inflation, but with TIPS you know you're going to keep up with inflation going forward, so you don't have to bet that future returns will resemble historical returns for protection.

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Re: What does a bond bear market look like?

Post by Explorer » Tue Nov 22, 2016 5:41 pm

Given the unprecedented size of our national sovereign debt (and global sovereign debt), how many of the bond experts really believe the world can afford really high interest rates at any part of the bond maturity spectrum?

My naive view is the rates will rise but nothing like they did in the 1980s.

Your thoughts appreciated - particularly nisiprius's.

Thanks.

P.S: I am beginning to nibble at long term bond funds both corporate and treasuries because I believe they got punished quite a lot during the last 3 months.

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Re: What does a bond bear market look like?

Post by Kevin M » Tue Nov 22, 2016 6:01 pm

longinvest wrote:Yes, in my charts, years indicate the start of year (or end of day on the preceding December 31st). This way the line between 1966 and 1967 represents the unrolling of year 1966, which seems pretty intuitive to me.

Neither way seems more intuitive to me than the other. Note that Portfolio Visualizer (PV) and Morningstar use year-end (M* puts it a little to the left, so it's more clear), Yahoo Finance does year-start (they put it a little to the right and label it with the first trading day of year, so it's more clear), and Google finance puts year right in the middle of the lines dividing the years, so pretty clear.

longinvest wrote:This would allow me to hypothetically add monthly returns without having to slide anything.

Don't have to slide anything with either convention, as long as you include the end of year 0 with the year-end convention and include the start of year N with the year-start convention. All that changes is whether the months are tied to the year label on the left (year-start) or right (year-end).

longinvest wrote:Marking the last day of the year on the chart seems wrong, to me. Maybe that's an improvement suggestion I should make to Simba's maintainers.

Seems fine to me, and changing it would throw it out of sync with PV, which is basically an online version of Simba.

longinvest wrote:
Kevin M wrote:EDIT: However, it is true that returns lag changes in yield proportionate to duration, since the longer the duration the longer it takes for higher/lower yields to compensate for decrease/increase in bond price.


Here's my intuition. Over the long term, the total return of a ladder is the average yield of its bonds at the time they were bought. If I invest into a ladder of bonds bought, respectively, with yields of 3%, 4%, 3%, 5%, and 5%, holding them to maturity, my return should be near the 4% average. Of course, there will be a lag, because new bonds continue to be acquired at different yields. But, it cannot be otherwise, mathematically. If, at the same time, inflation was running 3%, 4%, 3%, 5%, and 5%, then the bond fund will necessarily keep pace with inflation, even though it will lag behind. A full recovery will eventually happen as long as yields (on the long end of the ladder) reflect a small bonus on top of inflation, which has been the case pretty much all the time, except in the 1940s-1950s period. With yields, on the long side of the ladder, reflecting a small bonus above inflation*, the ladder is likely to recover from a one-time increase in inflation (with an accompanying increase in yields) within a time more or less equal to its duration, the point of indifference (adjusted based on the size of the bonus).

I think it's even simpler to conceptualize. Assume yields track inflation with no lag. A longer duration bond fund or ladder is going to lose more with a given increase in yield/inflation, and will take longer to recover (duration as point of indifference). Or, short term bonds roll over more quickly, so will track inflation more closely--you're stuck with the lower yield for less time, and get to more quickly roll into the higher yield/inflation.

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Re: What does a bond bear market look like?

Post by rgs92 » Tue Nov 22, 2016 6:12 pm

Isn't it best to look at a big chunk of your bond holdings as an annuity churning out income at the rate from the time you bought it and not worry about the principal value?

For that matter, I look at my holdings in PFF (the big preferred stock ETF) as a static thing providing a 5.5% yield over the long term, sort of like a fixed annuity but with the advantage that I could liquidate it down the line if I wanted to at some price, but it's not my intention so I ignore the principal value.

I also have some fixed annuities, and each year I get a statement of a theoretical market value for each one (they say it's for IRS purposes), but it's not really relevant.

So I look at my bonds the same way. They were purchased over a long time period, and the purpose was income, and that stays the same pretty much.

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Re: What does a bond bear market look like?

Post by longinvest » Tue Nov 22, 2016 6:30 pm

Kevin,

Kevin M wrote:
longinvest wrote:Marking the last day of the year on the chart seems wrong, to me. Maybe that's an improvement suggestion I should make to Simba's maintainers.

Seems fine to me, and changing it would throw it out of sync with PV, which is basically an online version of Simba.


OK, that's a good point. We wouldn't want that.
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Re: What does a bond bear market look like?

Post by tibbitts » Tue Nov 22, 2016 6:36 pm

Kevin M wrote:
jalbert wrote:
The chart in longinvest's post shows real inflation adjusted returns on a 5 year duration bond portfolio and stock portfolio over the 16 years from 1966 - 1981. Both were negative in real returns over the 16 year time span. Frankly I don't find it very reassuring that in a moderate/severe inflationary environment you lose purchasing power from investing in both stocks and bonds for more than a decade and a half. While not a total disaster, it certainly doesn't do much for reaching future retirement goals.

I consider that chart to be a reason to allocate to real estate. I guess others would use it to justify a small-cap value tilt or int'l equity position.

Really? A much safer, more reliable way to hedge increasing inflation is with TIPS.

Of course you can invest in a risky asset that has a decent, historical correlation with inflation, but with TIPS you know you're going to keep up with inflation going forward, so you don't have to bet that future returns will resemble historical returns for protection.

Kevin

A risk with TIPS is that the index they use won't have much relationship with your personal inflation rate. But it is a different risk than the other asset classes have.

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Re: What does a bond bear market look like?

Post by Kevin M » Tue Nov 22, 2016 7:22 pm

tibbitts wrote:A risk with TIPS is that the index they use won't have much relationship with your personal inflation rate. But it is a different risk than the other asset classes have.

Yes, a good point. But unless you can buy an asset that matches a particular real liability you have, for example a prepaid college tuition plan, you're going to have that problem with any asset.

Owning your home (a subset of "real estate") is another good personal-inflation hedge, since housing cost is a big chunk of most people's expenses. You still are exposed to rising property taxes, insurance and maintenance costs, but at least a large percentage of the fair market rental value is hedged.

Perhaps a healthcare stock fund to hedge rising medical costs? But there's still a lot of risk due to changing valuations, possible changes in government regulations, etc.

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Re: What does a bond bear market look like?

Post by nisiprius » Tue Nov 22, 2016 7:40 pm

rgs92 wrote:...Isn't it best to look at a big chunk of your bond holdings as an annuity churning out income at the rate from the time you bought it and not worry about the principal value?...
Quite possibly. One of the things I always find curious is that this viewpoint is often expressed by dividend stock enthusiasts, even though dividends fluctuate, aren't guaranteed, and were cut and cancelled by many companies during the Great Depression.

And yet it is rarely expressed for bonds, even though it has more merit for bonds than it does for dividend stocks.

(And a problem with TIPS is that currently, the actual coupon rate is so low that they are not, in fact, good income sources. Although the trickle they generate is inflation-indexed).
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Re: What does a bond bear market look like?

Post by nedsaid » Tue Nov 22, 2016 9:40 pm

Valuethinker wrote:
nedsaid wrote:
My thesis is that increased infrastructure spending would not cause little if any inflation in the economy because there is still slack or unused capacity. For example, the labor participation rate is still relatively low as discouraged workers have given up on looking for work. Economic growth is only about 1% to 2% which implies there is a lot of unused capacity.


I believe a number of contractors are already reporting skilled labour shortages in the US. Calculated Risk is your go to for this sort of information (anything to do with the micro of the US macroeconomy). Also the regional Feds will have stuff.

With the industry in a slump for so many years, a lot of people will have left the industry. Skilled construction workers don't grow on trees. The low US labour force participation rate is also about a high disability rate amongst workers without college education, and not unrelated there is the whole opiates issue (in that most get on to opiates, originally, for pain relief i.e. disproportionately manual workers).

Also in any country, a big proportion of construction workers are immigrants, legal or illegal. As with Brexit that could become a factor.

The US economy may or may not be close to full employment. Another unknown would be restrictions on imports, as the US is a very big importer of consumer goods. Prices of such might rise.

Conversely higher interest rates are likely to lead to a stronger dollar and that would be deflationary.


Valuethinker, you talk like a trained economist. You raise excellent points. As a whole, the US economy is certainly not near full employment. But yes, there are shortages of skilled workers in certain industries. You could say that segments of the US economy are at full employment.

Your point about higher disability rates for workers without college is well taken. But it seems like when the economy is bad that more people seem to be disabled. There must be a bit of gaming the system though it is impossible to say how large the effect is. But I am suspicious, a bad economy does not cause physical disabilities. I suspect what happens is that those who are able to work but are working through genuine physical problems get discouraged, throw in the towel, and obtain a disability status.

Another factor in the low participation rate are the people who get discouraged at poor job prospects and elect to retire early.
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Re: What does a bond bear market look like?

Post by jalbert » Wed Nov 23, 2016 12:04 am

Really? A much safer, more reliable way to hedge increasing inflation is with TIPS.

TIPs are useful, but at current real yields, they mostly just hedge themselves against inflation and avoid detracting from the real returns of other assets.

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