Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

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MathIsMyWayr
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by MathIsMyWayr »

fatcoffeedrinker wrote: Thu Aug 13, 2020 10:59 pm I usually avoid direct bank CDs because I have a 54% marginal tax bracket, so the after tax rate is fairly low.
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coingaroo
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by coingaroo »

mbizzle wrote: Fri Aug 14, 2020 8:53 pm The first is up until recently we have not had a near zero interest rate AND a flat term structure. The upward sloping yield curve is what has allowed bonds to provide a strong total return in response to the latest round of Fed balance sheet expansion. Given the flat yield curve investors can no longer bank on this providing any more juice.
How are we in a flat term structure?

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jeffyscott
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by jeffyscott »

fatcoffeedrinker wrote: Fri Aug 14, 2020 12:46 pm
jeffyscott wrote: Fri Aug 14, 2020 11:49 am
fatcoffeedrinker wrote: Fri Aug 14, 2020 10:44 amTo be sure, there is a pretty stiff surrender charge structure of 9/8/7/6/5.
Is that the percent by year, e.g if you pull the money out in year one (or the company fails in that year), you lose 9% and in year 5 it would be 5%?
Yes, by year, for voluntary withdrawals. But I don't think it applies if the company fails. If that happened, you would have to rely on the state guaranty. That all said, I'm basing this solely off of the blueprintincome website. If I were to buy, I'd read the entire annuity contract to make sure I understood all of the nuances.
The guarantee seems to typically say something like: "Two hundred fifty thousand dollars ($250,000) in the present value of annuity benefits including net cash surrender and net cash withdrawal values."

So, I think the guaranteed amount is the surrender/withdrawal value.
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rockstar
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by rockstar »

Check this out. Starting at the 34 minute mark.

https://www.youtube.com/watch?v=elgz5bzwfpQ
mbizzle
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by mbizzle »

coingaroo wrote: Fri Aug 14, 2020 9:35 pm
mbizzle wrote: Fri Aug 14, 2020 8:53 pm The first is up until recently we have not had a near zero interest rate AND a flat term structure. The upward sloping yield curve is what has allowed bonds to provide a strong total return in response to the latest round of Fed balance sheet expansion. Given the flat yield curve investors can no longer bank on this providing any more juice.
How are we in a flat term structure?

Image
Apologies for my misstatement, you are correct there is structure. I was rushing to completing my thoughts, and I incorrectly used the term flat as a shorthand for tying the back end of the curve to a fairly low rate.

Their point is that with essentially 0 at the front end an 1.4% at the 30 year, the amount rates can continue to move lower is limited (again referencing their upper bound of -1% due to cash arbitrage). If we take their -1% as the upper bound then with the current yield curve the amount of total return possible is fairly limited. In their piece they estimated it at 17% and that's if yields reached -1% down the curve I believe.

Their overall point is that there is a significantly higher chance of inflation now than previously given MP1 and MP2 have largely run their course with rates where they are, and the government will need to rely on fiscal expansion in order to further stimulate the economy. The combination of lower total return expectations for nominal bonds given the starting point of yields today and the potential for higher inflation doesn't bode well for nominal bonds.

From my perspective I do see merit in their arguments, and plan on diversifying some of my 20% nominal bond exposure. While we can't predict the future, we can scenario plan much like they have in their research piece and structure a well diversified portfolio to account for all risks.
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whodidntante
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by whodidntante »

Nate79 wrote: Thu Aug 13, 2020 9:38 pm
gasman wrote: Thu Aug 13, 2020 9:33 pm
Nate79 wrote: Thu Aug 13, 2020 9:31 pm YTD total bond market return is about 7% and 1 year return about 10.5%.
Future expected returns are somewhat lower.
How many years in a row do people need to repeat this before it comes true? In the mean time TBM keeps churning out great returns year after year.

People can not predict the future no matter their confidence in their ability.
Yep. TBM will definitely churn out great returns, year after year, because yields have no impact on bond returns. :twisted:
BogleFan510
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by BogleFan510 »

People have a hard time unpacking nominal from real returns.

The market is pricing in expected deflation and 0% is fine if you get more valuable dollars in the future, relatively speaking, risk adjusted.

Rememeber that bond holders also have a superior claim to assets when stocks fail.

The 0% average yield has a ton of micro stuff built in under the covers, and expected yield is just a book number.

In a BQ situation, bonds might get 100% recovery and shareholders nothing. The micro economy impacts these instruments we call funds, and I think bogleheads sometimes dont pay much attention to the actual companies borrowing, trying to make money, and fighting to survive inside their legal instruments we call investments. That said the market is pretty good at pricing risk, so I am comfortable with 0% nominal.

PS. Fiscal expansion only stimulates the economy to the extent borrowers are willing to accept risk and invest with leverage. In Japan this proved to be a problem as despite govt efforts, companies moved to a cash flow financing model and avoided debt despite 0% rates for many many years. UK and other economies have similar experiences with 'money supply don't work to grow' results. In Japan the reaction was to excessive debt in the early 90s based on cheap capital and the bad investment decisions that resulted. Something to ponder.
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jeffyscott
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by jeffyscott »

BogleFan510 wrote: Fri Aug 14, 2020 11:13 pmThe market is pricing in expected deflation and 0% is fine if you get more valuable dollars in the future, relatively speaking, risk adjusted.
The 5 year nominal rate is at 0.29%, the 5 year TIPS real rate is at -1.24%. That does not indicate an expectation of deflation, since about 1.5% inflation is needed to break-even. Where do you see deflation expectations?
PS. Fiscal expansion only stimulates the economy to the extent borrowers are willing to accept risk and invest with leverage. In Japan this proved to be a problem as despite govt efforts, companies moved to a cash flow financing model and avoided debt despite 0% rates for many many years.
I don't think leveraged investing is the only way that borrowed money can be used to stimulate the economy, people can borrow cheap money just to spend it. Americans are probably much more likely to do that (in normal times) than Japanese.
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fatcoffeedrinker
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by fatcoffeedrinker »

MathIsMyWayr wrote: Fri Aug 14, 2020 9:27 pm
fatcoffeedrinker wrote: Thu Aug 13, 2020 10:59 pm I usually avoid direct bank CDs because I have a 54% marginal tax bracket, so the after tax rate is fairly low.
California loves you. Don't forget the additional 0.1%.
It's actually a little under 54% because I can deduct above the line the self-employed half of the Medicare tax. But yes, CA loves me until I retire in 3 years. Then the gravy train will stop abruptly.
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by ScubaHogg »

I’d be curious to see a case study of historical hyperinflation and high inflation (the kind that people seem to worry is going to happen in the US). In any of those cases, did the very high inflation immediately follow very low inflation / negative real yields? My guess Is no.

I’d like to exclude cases where a conquering power invaded took over and imposed a new regime (ie, Hungary post WW2). I doubt even the biggest US pessimist thinks that’s going to happen here.
“Unexpected Returns dominate the Expected Returns” - Ken French
JackoC
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by JackoC »

jeffyscott wrote: Sat Aug 15, 2020 6:58 am
BogleFan510 wrote: Fri Aug 14, 2020 11:13 pmThe market is pricing in expected deflation and 0% is fine if you get more valuable dollars in the future, relatively speaking, risk adjusted.
The 5 year nominal rate is at 0.29%, the 5 year TIPS real rate is at -1.24%. That does not indicate an expectation of deflation, since about 1.5% inflation is needed to break-even. Where do you see deflation expectations?
Yeah that post and the one about 'TBM will keep churning out good returns, it always has' show there is an issue with at least some retail investors in fully realizing how low expected real returns on low risk assets now are (usually negative pre tax, predominantly negative after tax in taxable for people in at least middling brackets). It's hard to say though how many people don't fully realize it and what they'll do differently when they eventually do realize it.
rockstar
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by rockstar »

JackoC wrote: Sat Aug 15, 2020 11:01 am
jeffyscott wrote: Sat Aug 15, 2020 6:58 am
BogleFan510 wrote: Fri Aug 14, 2020 11:13 pmThe market is pricing in expected deflation and 0% is fine if you get more valuable dollars in the future, relatively speaking, risk adjusted.
The 5 year nominal rate is at 0.29%, the 5 year TIPS real rate is at -1.24%. That does not indicate an expectation of deflation, since about 1.5% inflation is needed to break-even. Where do you see deflation expectations?
Yeah that post and the one about 'TBM will keep churning out good returns, it always has' show there is an issue with at least some retail investors in fully realizing how low expected real returns on low risk assets now are (usually negative pre tax, predominantly negative after tax in taxable for people in at least middling brackets). It's hard to say though how many people don't fully realize it and what they'll do differently when they eventually do realize it.
How does this work for the folks buying target dated funds? I know a lot of people that buy these. Basically, a chunk of their portfolio will return close to zero for the foreseeable future.
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by abuss368 »

It is a challenge and reminds one of a decade ago. Just when rates rose a little over the years they are right back.
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by abuss368 »

irrationalexuberance wrote: Thu Aug 13, 2020 7:37 pm I'm curious what you guys make of this:

https://www.bridgewater.com/grappling-w ... everywhere

In particular, this passage jumped out at me:

"Every portfolio is unique, but most have equities and bonds, and the traditional 60/40 mix is a reasonable starting point for considering the impact of zero bond yields. Taking this as a prototype, there is the bond portion and there is the equity portion, and both are impacted by zero bond yields. Obviously, at near-zero yields, the bond portion has a near-zero expected return. And because there is a limit to how much yields can fall and no limit to how much they can rise, the bond portion has a limited upside return and an unlimited downside return. A zero bond yield also raises the risk related to the equity portion. In economic downturns, the bond portion can no longer provide capital gains to offset losses in the equity portion. And lacking the ability for interest rates to fall, there is less ability for an interest rate cut to stabilize a decline in economic growth and earnings, as well as less ability for a decline in the discount rate to cushion a decline in prices due to a decline in earnings. The net of it is that zero bond yields reduce the return of the traditional 60/40 portfolio while raising its downside risk relative to its upside potential."
The problem is higher yield almost always means higher risk.

One can only go so far out on the branch before it snaps.
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columbia
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by columbia »

JackoC wrote: Sat Aug 15, 2020 11:01 am
jeffyscott wrote: Sat Aug 15, 2020 6:58 am
BogleFan510 wrote: Fri Aug 14, 2020 11:13 pmThe market is pricing in expected deflation and 0% is fine if you get more valuable dollars in the future, relatively speaking, risk adjusted.
The 5 year nominal rate is at 0.29%, the 5 year TIPS real rate is at -1.24%. That does not indicate an expectation of deflation, since about 1.5% inflation is needed to break-even. Where do you see deflation expectations?
Yeah that post and the one about 'TBM will keep churning out good returns, it always has' show there is an issue with at least some retail investors in fully realizing how low expected real returns on low risk assets now are (usually negative pre tax, predominantly negative after tax in taxable for people in at least middling brackets). It's hard to say though how many people don't fully realize it and what they'll do differently when they eventually do realize it.
For those familiar with the person and/or the meme, it feels a bit like Baghdad Bob.
MathIsMyWayr
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by MathIsMyWayr »

fatcoffeedrinker wrote: Sat Aug 15, 2020 9:30 am
MathIsMyWayr wrote: Fri Aug 14, 2020 9:27 pm
fatcoffeedrinker wrote: Thu Aug 13, 2020 10:59 pm I usually avoid direct bank CDs because I have a 54% marginal tax bracket, so the after tax rate is fairly low.
California loves you. Don't forget the additional 0.1%.
It's actually a little under 54% because I can deduct above the line the self-employed half of the Medicare tax. But yes, CA loves me until I retire in 3 years. Then the gravy train will stop abruptly.
Good for you. I bet you cannot go below the 9.3% bracket. It covers such a wide range of taxable income.
justsomeguy2018
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by justsomeguy2018 »

So where the heck do you park your incoming new excess capital if in the accumulation phase when equites are approaching bubble status and bond yields are near zero with massive downside potential?

I keep coming back to some kind of mixture of cash (deflation hedge) + inflation hedges (TIPS).

Other options?:

EE bonds
Mortgage principal pay down
Gold/silver
Last edited by justsomeguy2018 on Sun Aug 16, 2020 10:32 am, edited 1 time in total.
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coingaroo
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by coingaroo »

mbizzle wrote: Fri Aug 14, 2020 10:38 pm Their overall point is that there is a significantly higher chance of inflation now than previously given MP1 and MP2 have largely run their course with rates where they are, and the government will need to rely on fiscal expansion in order to further stimulate the economy. The combination of lower total return expectations for nominal bonds given the starting point of yields today and the potential for higher inflation doesn't bode well for nominal bonds.

From my perspective I do see merit in their arguments, and plan on diversifying some of my 20% nominal bond exposure. While we can't predict the future, we can scenario plan much like they have in their research piece and structure a well diversified portfolio to account for all risks.
I have just read the research (I apologise for committing the sin of commenting before reading) and I have to say, I see a lot of merit in their arguments too.

This chart calls out to me, especially as I have been reading heaps of Daniel Amerman's 'Fed policy determines market returns' commentary. It's clear that MP1 and MP2 (as referred to in the research note) have 1% to go, and then no more. MP3 is the next outcome.

Image

I do have some arguments against the core tenants though. The authors believe money printing will create inflation; however over the past decade, we've seen QE and other Fed interventions have little effect on moving inflation. We also know the traditional drivers of inflation, which is economic slack, has not had a strong influence since the 1990s.

Image

We know that money velocity has been declining since the 1990s, but what makes us think it will be reserved now? Given the increasingly higher personal savings rate since the pandemic, the fact that everyone know someone who is unemployed or laid off, and general restraints on borrowing and spending (see: people paying down credit card debt), suggests to me that money velocity can continue to go lower. And unlike Fed interest rates (which I do agree has a -1% floor in practice), M2V can continue to go down forever.

Arguing that M2V will suddenly revert and go higher (beyond a V-shaped normalization to ~1.4 pre-COVID and then continuing its decline), is saying this time it's different. May I also suggest that if the new M2V does normalize around the current rates of ~1.1, we should see rampantly slashed inflationary expectations and hence a significant and fundamentals-driven decline in assets sought after for inflation-hedging abilities (i.e. TIPS, gold).

This is not enough to discredit the argument that bonds have been destroyed as a return-generating asset. It is a portfolio shock absorber, and much less shock absorbent than in the past. It is extraordinary difficult for me to see a situation where bonds provide real returns over the next 10 years.

But I question whether a switch to inflation-linked assets is how you should re-structure a portfolio, because such an assumption assumes we will see high consumer price inflation. Which we have not seen at all, not since the GFC, not since the 1990s.
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coingaroo
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by coingaroo »

May I also point out that:

* even with Fed intervention, the market should equivalently balance assets based on risk/reward; which in this case suggests that stocks should be trading at unattractive and low-forward-return prices as it is doing today; and stocks may lose 30% or 50% of its value again while bonds even at near-zero rates keep and make you money.

* TIPs are much much less anticorrelated to stocks (according to PortfolioVisualizer, 2009 to now); likely due to the fact that recessions lead to lower inflation and hence LOWER tips yields...

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anoop
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Re: Grappling with the New Reality of Zero Bond Yields Virtually Everywhere

Post by anoop »

irrationalexuberance wrote: Thu Aug 13, 2020 7:37 pm I'm curious what you guys make of this:

https://www.bridgewater.com/grappling-w ... everywhere

In particular, this passage jumped out at me:

"Every portfolio is unique, but most have equities and bonds, and the traditional 60/40 mix is a reasonable starting point for considering the impact of zero bond yields. Taking this as a prototype, there is the bond portion and there is the equity portion, and both are impacted by zero bond yields. Obviously, at near-zero yields, the bond portion has a near-zero expected return. And because there is a limit to how much yields can fall and no limit to how much they can rise, the bond portion has a limited upside return and an unlimited downside return. A zero bond yield also raises the risk related to the equity portion. In economic downturns, the bond portion can no longer provide capital gains to offset losses in the equity portion. And lacking the ability for interest rates to fall, there is less ability for an interest rate cut to stabilize a decline in economic growth and earnings, as well as less ability for a decline in the discount rate to cushion a decline in prices due to a decline in earnings. The net of it is that zero bond yields reduce the return of the traditional 60/40 portfolio while raising its downside risk relative to its upside potential."
This doesn't make any sense at all. It completely ignores the very probable descent into NIRP and the complete backstopping by the fed.
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