In the wake of the 2007-2009 bear market, investors have poured hundreds of billions of dollars into fixed income in an effort to reduce the risk of their portfolios while seeking to earn a more stable if more modest return on their money (see www.ici.org). So far, it seems to have worked out okay. For example, since the bear market low of March 9, 2009 through the market’s most recent close of May 6, 2011 the Barclays Aggregate Bond Total Return Index is up 16.82%. Sure, it’s not the 107.02% earned in the S&P 500 Total Return Index over the same time, but it hasn’t lost money in nominal terms.
However, as pointed out by Greg Mankiw, professor of economics at Harvard University, fixed income is not without serious risks in the coming years.
A remarkable feature of current financial markets is their willingness to lend to the federal government on favorable terms, despite a huge budget deficit, a fiscal trajectory that everyone knows is unsustainable and the failure of our political leaders to reach a consensus on how to change course. This can’t go on forever — that much is clear.
Less obvious, however, is how far we are from the day of reckoning.
Winston Churchill famously remarked that “Americans can always be counted on to do the right thing, after they have exhausted all other possibilities.” That seems to capture the attitude of the bond market today. It trusts our leaders to get the government’s fiscal house in order, eventually, and is waiting patiently while they exhaust the alternatives.
But such confidence in American rectitude will not last forever. The more we delay, the bigger the risk that we follow the path of Greece, Ireland and Portugal. I don’t know how long we have before the bond market turns on the United States, but I would prefer not to run the experiment to find out.
Furthermore, I suspect that many fixed income investors would be shocked to learn that historic drawdowns in fixed income-in real terms-have been larger and longer than the drawdowns in equities.
As a rule you promote a ‘prediction free’ system of trading via a strategy-driven process (e.g. ‘relative strength’) on this site, and that’s what you sell.
On the other hand, your posts on fixed income over the last couple of years have been consistently biased towards making bearish predictions (or publishing others’ bearish predictions) about, or issuing bearish warnings (or publishing others’ bearish warnings) for, bonds.
Even the title of this post is somewhat counter to your stated philosophy. I can see how making a ‘where does x go?’ post can be a good straw man entry point into a ‘we don’t predict but we react’ conclusion, but the bonds posts tend to end with the predictions and/or warnings.
I find this interesting. Do you?
Like we say, we don’t know how bonds will perform—anything is possible. However, a couple of things stand out. 1) Bonds have poor relative strength in our Global Macro universe at the present time, and have been poorly ranked for quite some time. This is, of course, subject to change, but right now suggests weakness in bonds. 2) Retail investors flow of funds has been overwhelmingly toward bonds. Morningstar and DALBAR both show rather conclusively that you can actually make money-good money-betting against retail investors. Although there is certainly no guarantee you will be right, history suggests that bonds will perform poorly going forward. That may account for what you currently perceive as an anti-bond bias. That being said, if their relative strength improves, we will happily own bonds again. And we’ll probably be discussing some other asset class negatively at that point!
1) Your blog has discussed bonds poorly at times when bonds actually did have good relative strength! (I commented about it on the blog at the time)
2) At such times (see above), the emphasis again was on funds flows.
Do you have a SYSTEMATIC APPROACH to trading bond funds based on funds flows?
… because without a systematic, backtested, rigorous approach to trading based on funds flows, aren’t you better off ignoring funds flows?
… RS trading is generally forward holding for 1/6th to 1/12th the time period of the lookback RS measurement period. “Funds Flow” trading is generally based on holding periods much, much longer than RS holding periods. So it literally is apples Vs. oranges. Perhaps “funds flow” is good for a diversifying strategy or as a strategy on its own, but since your firm doesn’t use it as such, why discuss it?
… Agreed poor RS in bonds at present. Why not make that the focus of the bonds posts, rather than funds flow?
That said - I love your blog and visit it several times a week.
I’m glad to hear that you are enjoying the blog. Most of our comments on specific asset classes are driven by RS, but fund flows have also been shown to be valuable. By the way, many RS methods have average holding periods of a year or so-still not as long as is typical for funds flow trading-but much longer than people often think.
I agree with Bill. This is obviously a sales blog as you tout your bias often. You want individual investors to think you are better at it than them, so you make fun of their moves. You do so when ideed your own products have really underperformed bond indices and well known bond funds. If you believe in relative strengh, then they have been the leader on a longer term basis. And, you commonly show the good parts of your return, leaving out the bad parts, so I expect you’ll do the same in reply. Or, you will not show this at all ie. post any disagreement.
Individual investors, on their own, do not do very well as a group. That’s just what the research shows. (In fact, Morningstar is launching ETFs that buy what retail investors are selling because their research indicates that it may outperform.) If you disagree with this, I would like to see your evidence.
Evidence also suggests that investors do better if they get assistance. For example, we wrote up a recent study of 401k investors that made this conclusion. If you decide to work with us, great. If you decide to work with someone else, great. But your odds of doing well on your own are not good.
Confirmation bias and self-serving bias make individual investors think they are doing much better than they are. We get calls routinely from people who claim to be doing much better than we are. However, we have yet to see any personal account statements documenting such a fact. (One person had good performance by counting their 401k contributions as part of their performance!) Very few individual investors have ever calculated a time-weighted rate of return for their portfolio. Many of them do not even know what that means or how to calculate it. Of course we would love new business, but we also hope that the blog can serve an educational purpose.
Like any manager, we have good periods and bad periods, depending on the state of relative strength. Performance for every quarter, good and bad, is on our website. However, most of our portfolios have outperformed their benchmarks from the time they were opened. (We don’t run any bond products so I don’t know about relative performance there.) You are free to examine our performance on all of our products-it’s all out in the open-and free to ignore them if you like.
Bias, to me, connotes some kind of unwarranted or unearned favoritism. We champion relative strength, but because it is a well-known and powerful return factor, I’m not sure if it qualifies as a bias. Thanks for your comment and thanks for reading.