Bond Market Factors

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onthecusp
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Bond Market Factors

Post by onthecusp » Fri Oct 12, 2018 11:41 am

Recently rising rates gets more people talking about bonds as investments. Talking heads (or disembodied voices on the radio) make various statements that purportedly explain what is going on. One comment that I heard on the radio was an economist using a bunch of words to basically say that with higher rates, people will buy more US denominated bonds, preferentially to stocks or overseas bonds. That seems an overly simplistic view of things, rates could be rising because people are inclined to sell bonds, or at least pay less. I realize that is simplistic as well.

Since I am in a period of increasing bond allocation before retirement, I would like to understand what I'm buying a little better. I don't really have to know, but it is one way I manage my investing emotions. Here is a list of things I see affecting rates. Is there any consensus on the relative strength of each effect?

1. Fed rate hikes. These don't directly set rates of other instruments but do provide a floor risk free rate. So every thing else should settle somewhere higher.

2. Active investors buying / selling treasuries as alternatives to corporate bonds based on varying risk assessment of the corporate markets.

2a, b, c ... add Municipal bonds, REITs, MLPs, high dividend stocks .... that are evaluated versus interest rates.

3. General market expectations. I would have thought that treasuries would get more expensive when all the "fear factors" (Schiller P/E10, P/E, trade wars, etc.) are active. From some of the posts here lately I would have thought fear is increasing, yet treasuries fall and rates rise. I guess fear is always there and it is relative to other factors?

4. Demographic effects. Are baby boomers in later retirement selling their bonds?

I've probably missed only a dozen or so factors. In the end I guess I should simply be thankful that in my case, the bond purchases will pay a little better than older purchases.

In edit I wanted to add that I appreciate the boglehead focus on similar issues with respect to a balanced low cost portfolio.

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galeno
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Re: Bond Market Factors

Post by galeno » Fri Oct 12, 2018 1:24 pm

KISS.

A Boglehead takes risk and reward on the equity side and dampens both on the bond side according to risk tolerance / acceptance.

The best bonds to do this are intermediate term INVESTMENT GRADE bonds. US treasuries or a total bond market (TBM) fund or ETF will do the job.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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patrick013
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Re: Bond Market Factors

Post by patrick013 » Fri Oct 12, 2018 1:35 pm

I think the Fed policy to normalize rates is most important.
As Bill Gross once said, the economy cannot function like
this. Looking to the horizon I think the 2020's will be a buyer's
market. FFR around 3.5%, Agency bonds, LT bond funds,
dividend funds, and REIT's all looking at very good yields.
Stable rates will lead to better premiums. Plan ahead.

Still wary about MLP's. They want to spend 500 billion on
added pipes. How can they pay dividends at the same time ?
Might be a lower dividend period.
age in bonds, buy-and-hold, 10 year business cycle

robertmcd
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Re: Bond Market Factors

Post by robertmcd » Fri Oct 12, 2018 2:51 pm

I would focus on holding the correct duration bonds based on your equity percentage and age. And like others said stick to investment grade. I prefer treasuries because historical data shows that they create a more efficient portfolio than corporate bonds but total bond market is still a fine choice. But there are times when I wouldn't want to own any short term treasuries. For example, in recent history there were savings accounts that yielded more than short term treasury bonds with zero interest rate risk. A free lunch so to speak. So i made sure to avoid owning any bonds with risk that I wasn't being compensated for.

Intermediate term treasuries, vanguard intermediate term bond index, vanguard intermediate term investment grade, or TBM if you only get to own 1 bond fund for a lifetime.

A strategy I prefer that is advocated by Larry Swedroe:
80% equities or greater - long term treasury VGLT
40% to 80% equities - intermediate term treasury VGIT
0 to 40% equities - short term treasury VGSH

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nisiprius
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Re: Bond Market Factors

Post by nisiprius » Fri Oct 12, 2018 3:34 pm

Between the people urging shrilly that everyone should reduce duration and go to short-term because of rising rates, and the people urging shrilly that everyone should go long-term for higher yields and stronger MPT diversification of stocks...

Between the people urging shrilly that nobody should hold anything but Treasuries, and the people urging shrilly that the US Aggregate Index has too much in Treasuries and government issues and everyone should hold more corporates...

I feel very comfortable just staying vaguely in the middle of the mainstream with the Vanguard Total Bond Market index fund.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

bhsince87
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Re: Bond Market Factors

Post by bhsince87 » Fri Oct 12, 2018 3:55 pm

I've heard a few thousand ideas as to what causes bond yields to rise and fall. I've come to the conclusion that nobody really knows.

There does seem to be a consensus that as an economy improves, rates/yields tend to go up. And vice versa when an economy is in decline.

There are probably dozens of mechanisms at work which cause this.
Retirement: When you reach a point where you have enough. Or when you've had enough.

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onthecusp
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Re: Bond Market Factors

Post by onthecusp » Fri Oct 12, 2018 8:45 pm

Thanks for the comments regarding bond strategies.

I guess I could have said that I have all my bond investments in a couple of Fidelity treasury funds.
FIBAX - Fidelity® Intermediate Treasury Bond Index Fund Premium Class (0.03% ER)
FSBAX - Fidelity® Short-Term Treasury Bond Index Fund Premium Class (0.03% ER)

I'm happy with that decision considering a short time to retirement and a few years until claiming social security.

Still, bonds are a new thing for me. Since first buying them just about 2 years ago I have clearly experienced the fact that bonds are not super safe, only relatively safe. Really the total loss, due to falling bond prices on quite a large chunk of my investments, is a drop in the bucket compared to daily fluctuations in the stock side of the portfolio. So I believe in the utility of bonds, I'm just exploring how they work.

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onthecusp
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Re: Bond Market Factors

Post by onthecusp » Fri Oct 12, 2018 9:06 pm

patrick013 wrote:
Fri Oct 12, 2018 1:35 pm
I think the Fed policy to normalize rates is most important.
As Bill Gross once said, the economy cannot function like
this. Looking to the horizon I think the 2020's will be a buyer's
market. FFR around 3.5%, Agency bonds, LT bond funds,
dividend funds, and REIT's all looking at very good yields.
Stable rates will lead to better premiums. Plan ahead.

Still wary about MLP's. They want to spend 500 billion on
added pipes. How can they pay dividends at the same time ?
Might be a lower dividend period.
Fed policy is certainly a consensus among the talking heads. Seems reasonable to me that low fed rates would drag down all rates, so hikes would reverse that. In a healthy economy the yield curve rises with duration so the recent rise in long term rates may be an indication of a still reasonably healthy economy.

Maybe a different discussion, but MLP yields are pretty high, many between 4 and 7%. The unit prices seem held back by the concerns you express, but that keeps the yield higher; higher than bonds are paying, compensating for the additional risk. Many of these borrow so much that arguments about how much they will have to pay to service that debt also figure into the risk/price calculus.

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watchnerd
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Re: Bond Market Factors

Post by watchnerd » Fri Oct 12, 2018 10:42 pm

patrick013 wrote:
Fri Oct 12, 2018 1:35 pm
I think the Fed policy to normalize rates is most important.
As Bill Gross once said, the economy cannot function like
this. Looking to the horizon I think the 2020's will be a buyer's
market. FFR around 3.5%, Agency bonds, LT bond funds,
dividend funds, and REIT's all looking at very good yields.
Stable rates will lead to better premiums. Plan ahead.

Still wary about MLP's. They want to spend 500 billion on
added pipes. How can they pay dividends at the same time ?
Might be a lower dividend period.
For a period in the early 00's, when normal equity indexes flat lined for years and commodities were booming, I owned a basket of MLPs, and then eventually an MLP ETF.

The returns were pretty solid, but man were the taxes a PITA.
Tax Sheltered: 35% US Stock | 35% ex-US Stock | 30% TTM || Taxable: 35% US Stock | 35% ex-US Stock | 15% TTM | 15% Munis

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patrick013
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Re: Bond Market Factors

Post by patrick013 » Sat Oct 13, 2018 12:06 pm

onthecusp wrote:
Fri Oct 12, 2018 9:06 pm
patrick013 wrote:
Fri Oct 12, 2018 1:35 pm
I think the Fed policy to normalize rates is most important.
As Bill Gross once said, the economy cannot function like
this. Looking to the horizon I think the 2020's will be a buyer's
market. FFR around 3.5%, Agency bonds, LT bond funds,
dividend funds, and REIT's all looking at very good yields.
Stable rates will lead to better premiums. Plan ahead.

Still wary about MLP's. They want to spend 500 billion on
added pipes. How can they pay dividends at the same time ?
Might be a lower dividend period.
Fed policy is certainly a consensus among the talking heads. Seems reasonable to me that low fed rates would drag down all rates, so hikes would reverse that. In a healthy economy the yield curve rises with duration so the recent rise in long term rates may be an indication of a still reasonably healthy economy.
I think the 500 was helped out by tax reductions, but forward looking
EPS might only increase $5 a year.
onthecusp wrote:
Fri Oct 12, 2018 9:06 pm
Maybe a different discussion, but MLP yields are pretty high, many between 4 and 7%. The unit prices seem held back by the concerns you express, but that keeps the yield higher; higher than bonds are paying, compensating for the additional risk. Many of these borrow so much that arguments about how much they will have to pay to service that debt also figure into the risk/price calculus.
I might consider a MLP fund but the taxes are high. At least the
better performers would have the asset weight. The bigger ones
are probably the best.
age in bonds, buy-and-hold, 10 year business cycle

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patrick013
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Re: Bond Market Factors

Post by patrick013 » Sat Oct 13, 2018 12:16 pm

watchnerd wrote:
Fri Oct 12, 2018 10:42 pm
patrick013 wrote:
Fri Oct 12, 2018 1:35 pm

Still wary about MLP's. They want to spend 500 billion on
added pipes. How can they pay dividends at the same time ?
Might be a lower dividend period.
For a period in the early 00's, when normal equity indexes flat lined for years and commodities were booming, I owned a basket of MLPs, and then eventually an MLP ETF.

The returns were pretty solid, but man were the taxes a PITA.
Which MLP ETF ? MLP's are hard to predict, haven't secured all
their pipelines yet it seems. For some funny money only for me.
Some profitable years and some cash investment years only, so it
would not be unexpected if dividends were cut to do that pipeline
expansion eventually. Have to ride that out then. Like real estate
the one's with the highest occupancy win, and also with the most
pipes to lease. Routes can change leaving many pipes unleased.
age in bonds, buy-and-hold, 10 year business cycle

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watchnerd
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Re: Bond Market Factors

Post by watchnerd » Sat Oct 13, 2018 12:33 pm

patrick013 wrote:
Sat Oct 13, 2018 12:16 pm
watchnerd wrote:
Fri Oct 12, 2018 10:42 pm
patrick013 wrote:
Fri Oct 12, 2018 1:35 pm

Still wary about MLP's. They want to spend 500 billion on
added pipes. How can they pay dividends at the same time ?
Might be a lower dividend period.
For a period in the early 00's, when normal equity indexes flat lined for years and commodities were booming, I owned a basket of MLPs, and then eventually an MLP ETF.

The returns were pretty solid, but man were the taxes a PITA.
Which MLP ETF ?
AMJ
Tax Sheltered: 35% US Stock | 35% ex-US Stock | 30% TTM || Taxable: 35% US Stock | 35% ex-US Stock | 15% TTM | 15% Munis

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