C’mon Bonds, Get Real!

December 1, 2010

Investors are buying bonds by the truckload, presumably to make money. When you buy a bond, you are really purchasing two things: an expected return and an adjustment for inflation. In other words, in order to earn a real return-that is a return after inflation-the bond you buy has to preserve your purchasing power, at a minimum. What are the odds of that happening?

It turns out that the odds of a decent real return get higher as your bond yield gets higher. The table below is taken from an article by Michael Nairne of Tacita Capital that appeared in Advisor Perspectives. He took Ibbotson data on long-term government bond yields from 1926-1990 and examined what the real return was over the following 20 years.

Source: Tacita Capital, Advisor Perspectives (click on chart to enlarge)

As you can see, with a 10% yield, you’ve got a good historical probability of earning about a 6% real return, which is pretty nice. Your real returns tend to drop as your initial yield drops. If you were to buy a long-term government bond right now, the Barclays Capital LT Government Index yield is 3.75%. If you draw a line through the central tendency of the distribution (regression eyeballing!), you can see that real returns are typically negative when yields are below 4%. Your odds of even maintaining your purchasing power are low, and are basically dependent on seeing a deflationary scenario unfold.

Will we see deflation? I don’t have any way to put odds on that, but it seems unlikely to me, especially since repeated revisions in the CPI index have already driven reported inflation far below where it would be otherwise. (According to Shadow Stats, estimated inflation using the 1980 basket of goods is already running about 8.5%.)

Source: Shadow Stats (click on chart to enlarge)

Getting real returns is likely to require a more flexible investment strategy than loading the boat with bonds and praying for deflation. Our Global Macro strategy, for example, might fit the bill. It will own bonds when they are a strong asset class, but will rotate to entirely different asset classes in different market environments. If inflation picks up—or if you think Shadow Stat is right and it already has—a global, tactical strategy might be much more likely to preserve your purchasing power over the long run.

Leave a Comment » | Markets, Tactical Asset Alloc, Thought Process | Permalink
Posted by Mike Moody

How to Turbocharge Client Anxiety

December 1, 2010

If you are an investment advisor, you actually want to do the opposite of this. But according to a recent article by Bob Veres in Advisor Perspectives, client anxiety is being turbocharged for you:

…the primary challenge for investment advisors, financial planners and money managers today, which is different from the challenges you faced in the past, is the sheer amount of attention that investors are now able to pay to the ups and downs in their portfolios…

Put in its simplest terms, your clients are being driven to an unbalanced mental state by the sheer amount of information and opinions that are piling into their awareness at increasing speed, and nobody has a vested interest in telling them that paying attention is highly unlikely to improve their investing lives, and may well be sabotaging their returns.

In point of fact, what clients see and hear in the mainstream financial media is noise, not trend. Trend is only apparent when you step back and examine markets from a distance. Noise tends to reinforce their worst tendencies toward emotional asset allocation, especially when one of the articulate doom-and-gloomers shows up on CNBC. By the time they are finished talking, your clients are ready to buy canned goods and ammunition and lock themselves into a bunker.

This is not very helpful. The more clients pay attention to the ups and downs of the market, the more their emotions are engaged. The more their emotions are engaged, the worse their returns are likely to be. In large part, your job as an advisor is to protect them from the noise. You have a couple of options in this regard.

1) You can try to get them to ignore the noise by telling them how useless it is. This is not likely to be successful.

2) You can try to get them to ignore the noise by distracting them. If you can convince your client to read only the sport pages (one of my common suggestions) or to take up trekking in Nepal, they might not pay enough attention to become anxious. Clients who are busy with work or families often do a good job of this on their own. In many cases, even a suggestion made jokingly to take up birdwatching or to start building model ships helps clients understand that their emotional engagement is more likely a hindrance than a help.

3) You can try to replace the noise with more productive content, like Systematic Relative Strength, for example. There are no doubt other news outlets and financial sites that might help to keep a client focused on the longer-term trend and on methods that might actually help their performance rather than hurt it.

Anything that you can do to defuse their anxiety and to reduce the behavior penalty on their returns is likely to be as profitable as any investments you can make in their account.

Leave a Comment » | Investor Behavior, Markets, Thought Process | Permalink
Posted by Mike Moody

High RS Diffusion Index

December 1, 2010

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.) As of 11/30/10.

This index has pulled back from above 90% in recent weeks, but remains above 80% indicating the continuing rising trends of high relative strength securities.

 

Leave a Comment » | Markets | Permalink
Posted by Andy Hyer