Is This A Good Time To Invest In Bonds?
You’ve probably heard through the financial media that bonds are on a tear this year. The 10-year U.S. Treasury bond, one of the safest investments on the planet, has gained over 10% so far. That is its best performance in over a decade. Is this the right time to start selling those risky stocks and buy long-duration bonds?
Not so fast.
The main reason bonds in general have done so well is the Federal Reserve’s (Fed) decision to start cutting interest rates again in 2019. When rates drop, bond prices rise, causing a short-term gain. The longer the bond maturity the greater the increase, which is why the 10-year Treasury with its long duration is doing so well right now. Given the current strength of the economy, the Fed’s actions have been somewhat unexpected, but fears of a recession from Trump’s trade wars as well as political pressure from Trump to reduce rates to make it look like he’s been good for the economy have likely been factors.
Contrast 2019 with 2018, when the 10-year Treasury lost about 1%. That should give you some feeling about the volatility of long bonds, especially in today’s era of historically low rates. In 2018 the Fed increased interest rates three times, which was a major factor in the long Treasury’s poor performance. Although bond return volatility is generally much lower than that for stocks, longer duration bonds are much more volatile than shorter duration ones, and will struggle the most when rates rise.
In order for long bonds to continue to return even close to double digits, the Fed would need to reduce rates at least three times more. But with long-bond rates currently well below 2%, there isn’t much room for further rate reductions. Jeff Gundlach, founder and chairman of DoubleLine Capital, a bond investment company, stated that he would “absolutely not” buy 10-year treasuries at this point.
This doesn’t mean, of course, that you should avoid any bonds or bond funds in your investment portfolio. They are necessary and valuable as a source of stability as well as real growth (that is, above inflation). They are also useful to hold as potential capital for future stock investments after recessions. And short and intermediate duration bonds are often better than cash for generating positive real returns. Just don’t expect 10% bond returns to continue moving forward.