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.
