Tag Archives: Bonds

Where Can We Hide in a Financial Crisis?

Markets are booming today, but just 18 months ago, things looked like this:

Ouch.

I lost about 22% of my portfolio in less than five weeks. It certainly made life interesting.

Today, markets sit near all time highs and jobs go begging. It’s a far cry from the darkest days of the COVID disaster.

But the next financial crisis is coming. It could be in a month, a year, or ten years. But as investors, we need to be prepared.

One of the best ways to protect ourselves is to own assets that are not correlated with stocks. That way, when the market is falling off a cliff, a part of our portfolio is preserved.

People often look to overseas stocks or real estate to diversify. I own those myself. But although they can deliver nice returns, they are highly correlated with US stocks.

Global stocks have a 0.97 correlation with the S&P 500, a near perfect match. Even Real Estate Investment Trusts (REITs) show a very strong correlation (0.70).

Investment grade bonds (-0.06) and cash (-0.17) show low correlations with stocks. But the yield to maturity on that Bloomberg investment grade bond index is just 1.42%, way below inflation. And cash in a bank account returns about enough to buy a candy bar at the end of the year.

So where do we go? Here are some options:

Litigation Finance

This arcane corner of the financial world gives plaintiffs and lawyers money to sue people. The lawsuits usually involve a small company suing a larger one.

Returns can be eye popping. But it’s difficult for those of us who aren’t lawyers to understand what we’re investing in. Are these good cases likely to win? Or suckers’ bets?

It probably only makes sense as a small portion of a portfolio, at most. And minimum investments can be high, making it less attractive to many.

Farmland

Ya gotta eat, right?

New platforms have sprung up to help people invest directly in farmland. Returns can exceed those of stocks, and correlation with US stocks is almost nonexistent (-0.05).

This could be an attractive area, but it’s quite unfamiliar to me, and probably to most other investors. I’d have to research it a lot more before jumping in.

Dividend Aristocrats

Dividend Aristocrats are blue chip stocks that have increased their dividends every year for at least 25 years. They’re household names like Coca-Cola, Exxon, and IBM.

They generally have higher returns than the S&P 500 with lower volatility. That’s a win-win.

But they’re highly correlated with the rest of the index (0.9). That said, they’re still better than overseas stocks in this respect, and not dissimilar to real estate.

Wrap Up

We have some interesting options for keeping our portfolios safer in the next bear market while preserving yields today. I encourage you to dig deeper into your favorite categories.

What asset classes do you favor in a crisis? Let me know in the comments at the very bottom.

More on markets:

Will Evergrande Spark a Global Financial Crisis?

Should Anyone Own Bonds?

How Solana Could Wipe Out Visa and MasterCard

Photo: “Tomb of Lehman Brothers” by futureatlas.com is licensed under CC BY 2.0

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Amazon Business American Express Card

You already shop on Amazon. Why not save $100?

If you’re approved for this card, you get a $100 Amazon gift card. You also get up to 5% back on Amazon and Whole Foods purchases, 2% on restaurants/gas stations/cell phone bills, and 1% everywhere else.

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Fundrise

This platform lets me diversify my real estate investments so I’m not too exposed to any one market. I’ve invested since 2018 and returns have been good so far. More on Fundrise in this post.

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The only place I buy vitamins and supplements. I recently placed an order and received it in less than 48 hours with free shipping! I compared the prices and they were lower than Amazon. I also love how they test a lot of the vitamins so that you know you’re getting what the label says. This isn’t always the case with supplements.

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Should Anyone Own Bonds?

I used to love bonds. Especially government bonds. Guaranteed income, easy liquidity, and stability in a crisis.

What’s not to like?

But my old flame hasn’t done much for me lately. And I’m not the only one.

The Problem

Bonds have hovered at or below the rate of inflation since 2009:

Just barely keeping up with inflation might be enough, given that I have much riskier positions in stocks, real estate, and tech startups.

But if an investment pays a yield below the rate of inflation, you’re essentially paying someone to hold onto your money. Instead of getting even a modest return, you lose a little of your cash every year, like clockwork.

Today, I own long term treasury bonds and medium term treasury and mortgage bonds. The long term bonds pay 1.73%, and come with a big risk of decline when interest rates increase. Which they’re just about bound to do, given that that they’re are sitting near 0.

The shorter duration bonds pay even less: 1.28%.

What Kind of Return Do We Need to Keep Up With Inflation?

Recent inflation numbers have been scary: over 5% a year. But, if we look at the longer run averages, the picture brightens a little.

Over the last 20 years, inflation has averaged 2.16%. Over the last 10 years, the figure is 1.89%.

I don’t know how long the sudden higher inflation of the last couple of months will last. But it appears that a floor for a return that will keep up for inflation is no less than 2%.

Where Can We Get Our 2%?

The attractive features of government bonds are liquidity, stability, and a modest income. Let’s review a few alternatives, with that in mind:

1) Corporate bonds. Returns aren’t much better than government bonds, at around 1.7%.

2) Fundrise. Love it, but not a good substitute for bonds. Real estate development just isn’t as stable. It’s not very liquid either. However, returns are good. I’ve notched around 7% since I started investing.

3) Single Premium Immediate Annuities. A rather exotic choice. Rates can be good at around 3.5% in some cases. And the income is guaranteed. But they’re not very liquid: there’s a 10% IRS penalty for withdrawal before age 59.5. But if you’re older, they could work well.

4) Dividend Aristocrats. These aren’t just any high dividend stocks. These have a history of paying higher dividends every year for at least 25 years. That’s a surer bet than many stocks with even higher dividends, because those huge payouts may not last.

The yield on some of these large, stable companies is impressive:

ExxonMobil: 6.5%

Chevron: 5.5%

IBM: 4.8%

Consolidated Edison: 4.2%

Of course, the stock prices could go down.

But if you’re buying for income, and the company is large and stable and has increased its dividend of decades on end, you don’t care. You just collect your check and head to the golf course.

What’s more, you can buy a basket of these stocks, rather than just one, insulating yourself from the chance that one of them cuts its dividend.

Wrap Up

Dividend Aristocrats seem like one of the best options to replace the income bonds no longer offer. They are also less likely to fall with higher interest rates.

What do you think the best option is? Leave a comment at the very bottom of the page and let me know! I just might use your idea. 🙂

More on investing:

What Does the Pandemic Mean for Real Estate Investments?

Why I Just Invested in EyeRate, the Best Online Review Tool

What I Learned From an Investor Who Turned $100,000 into $100,000,000

Photo: “Governor Jerome Powell speaks at Brookings panel, ‘Are there structural issues in U.S. bond markets?'” by BrookingsInst is licensed under CC BY-NC-ND 2.0

If you found this post interesting, please share it on Twitter/Reddit/etc. using the buttons at the bottom of the page. This helps more people find the blog! 

Save Money on Stuff I Use:

Amazon Business American Express Card

You already shop on Amazon. Why not save $100?

If you’re approved for this card, you get a $100 Amazon gift card. You also get up to 5% back on Amazon and Whole Foods purchases, 2% on restaurants/gas stations/cell phone bills, and 1% everywhere else.

Best of all: No fee!

Fundrise

This platform lets me diversify my real estate investments so I’m not too exposed to any one market. I’ve invested since 2018 and returns have been good so far. More on Fundrise in this post.

If you decide to invest in Fundrise, you can use this link to get your management fees waived for 90 days. With their 1% management fee, this could save you $250 on a $100,000 account.

iHerb

The only place I buy vitamins and supplements. I recently placed an order and received it in less than 48 hours with free shipping! I compared the prices and they were lower than Amazon. I also love how they test a lot of the vitamins so that you know you’re getting what the label says. This isn’t always the case with supplements.

Use this link to save 5%! 

Misfits Market

My wife and I have gotten organic produce shipped to our house by Misfits for over a year. It’s never once disappointed me. Every fruit and vegetable is super fresh and packed with flavor. I thought radishes were cold, tasteless little lumps at salad bars until I tried theirs! They’re peppery, colorful and crunchy! I wrote a detailed review of Misfits here.

Use this link to sign up and you’ll save $10 on your first order. 

The Tiny Village That Beat the Great Depression

Nestled in the Austrian Alps is the tiny village of Worgl. In 1932, as the world economy was in the depths of the Great Depression, Worgl too had fallen on hard times:

The Great Depression was in full swing and of its population of nearly 5000, a third were jobless, and about 200 families were bankrupt. The situation was desperate. The town would try anything.

What followed was one of the most radical economic experiments in history. The town created a new form of money. It was a lot like the standard Austrian schilling it replaced, except its value dropped by 1% every month. In a year, you’d have just 88.64 left of every 100 schillings.

This gave residents a strong incentive to stop hoarding currency, a natural reaction to a scary economic climate:

The speed that money changed hands (14 times higher than the national schilling) helped keep local businesses afloat and, in time, brought back the town’s lost jobs.

Soon, the town went from 1/3 jobless to full employment. Tax revenues boomed as people paid their bills in the new currency before it lost its value.

Worgl’s success attracted attention from its neighbors:

Things looked up for Worgl and [Mayor] Unterguggenberger. The town did so well that six neighbouring villages successfully copied the system and over 200 grew an interest in following suit.

Ultimately, the central bank shut down this experiment in a local currency. Shortly thereafter, unemployment shot right back up to where it was before Worgl’s mayor made this bold move to save his town.

It makes sense that Worgl would’ve rocketed ahead of nearby villages. Worgl essentially had (very) negative interest rates and a far more accomodative monetary policy than its neighbors.

Today too, lowering interest rates, even below zero, is a commonly used tactic to stimulate economic activity. The US Federal Reserve lowered interest rates substantially at the beginning of the COVID crisis, and Japan and much of Europe has had negative rates for years.

But despite the success of Worgl, the results of negative rates today are mixed. Negative rates might encourage consumers to spend, but they could also discourage banks from lending. After all, who wants to lend when you might have to pay for the privilege!

Worgl remains an interesting footnote to monetary policy. Whatever the applications to today may be, I applaud the bravery of those villagers who took a radical step to try to save their home.

For more on markets and the economy, check out these posts:

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Photo: “File:Pfarrkirche Woergl Osten.jpg” by Thom16 is licensed under CC BY-SA 3.0

Australia Takes the Lead As Governments Move to Reign in Interest Rates

Government bond yields are increasing in many countries, including the US. Australia is already taking action. Europe and Japan also appear to be close:

This morning, Australian three-year government bond yields reached as high as 0.15% at the market open, far above the 0.1% ceiling established by the Reserve Bank of Australia last November under its yield curve control policy.  The RBA accordingly pledged to buy up to A$3 billion ($2.3 billion) in three-year paper in an unscheduled operation just one day after undertaking the largest purchases since March, successfully pushing yields back down towards that 0.1% bogey by day’s end.  

In a report predicting that the RBA will wait until July before deciding whether to tweak its existing policies, Andrew Boak, Goldman Sachs chief economist for Australia and New Zealand, noted yesterday that “there are no modern day precedents for a central bank exiting yield curve control.” 

A similar struggle is underway in the Land of the Rising Sun.  Japan, which instituted yield curve control back in 2016 with a targeted 0% yield on the 10-year government bond, is now facing a test of its resolve:  The yield on 10-year government debt reached 0.175% this morning, the highest since the debut of that program.  “I want you to understand that we aren’t aiming to raise our target from around 0%,” BOJ governor Haruhiko Kuroda declared in an address to parliament this morning, a message surely intended for Mr. Market as well. 

Meanwhile, a scaled-down bond selloff on the Old Continent looks to spur the powers that be to further impose their will on the market. Yesterday, German 10-year yields reached minus 0.23%, near a one-year high and up from minus 0.53% one month earlier, three days after ECB president Christine Lagarde declared she is “closely monitoring the evolution of longer-term nominal bond yields.”  

In light of that dizzying ascent to minus 0.23%, one of her colleagues appears ready for action. “In my view, there is an unwarranted tightening of bond yields, so it would perhaps be desirable for the ECB to accelerate the pace of [asset] purchases to ensure favorable financing conditions during the pandemic,” Greek central bank governor Yannis Stournaras told Reuters this afternoon.

More here (see the Feb 26 post).

Higher interest rates on government bonds tend to lead to higher interest rates throughout the economy. This can be a problem for stocks, since it can make it more expensive for companies to borrow to fund expansion, etc. It can also make bonds more attractive compared to stocks, which hurts the stock market.

If we see sustained upward pressure on US rates, I expect to see the US follow Australia and try to get the rates back down.

For more on interest rates on markets, check out these posts:

If you found this post interesting, please share it on Twitter/LinkedIn/email using the buttons below. This helps more people find the blog! And please leave a comment at the bottom of the page letting me know what you think and what other information you’re interested in!

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Photo: “Pebbly Beach Kangaroos Australia – 095” by Kyle Taylor, Dream It. Do It. is licensed under CC BY 2.0

Forget GameStop, Treasury Yields Are The Thing to Watch

Treasury bonds have been falling hard lately. Their interest rates are up significantly as a result:

The yield on the 10-year note, a bellwether for borrowing costs on everything from mortgages to corporate loans, has jumped to near 1.5% from around 1% in a matter of weeks, lifted by increased expectations that vaccines and government stimulus efforts will accelerate growth and inflation.

And the sell-off is making its way into the stock market today:

The sell-off in the bond market ricocheted into equities, pushing the broad S&P 500 down 2.3 per cent and the tech-heavy Nasdaq Composite down 3.3 per cent by afternoon on Wall Street.

A lot of this is the side effect of something good: people are getting vaccinated, new vaccines are coming, and economic stimulus could boost the economy further. That picture is leading investors to expect greater economic growth in the future, along with greater inflation (see the Feb 22 post):

Signs of a renewed economic boom, in tandem with pockets of price pressure, color that move in rates. Bianco Research notes today that Wall Street economists now expect U.S. real GDP growth of nearly 5% this year

But higher rates on Treasury bonds could affect other markets negatively in several ways:

  • Higher Treasury yields tend to mean higher rates in other areas. This could make it more expensive for companies to borrow to fund expansion, etc. That would hurt their shares.
  • If Treasuries offer more interest, that makes stocks less attractive by comparison.
  • Treasury yields, especially the 10 year note, tend to drive mortgage rates. Higher mortgage rates mean a weaker real estate market.

Nonetheless, the Fed remains committed to low interest rates and a loose monetary policy:

In his remarks to the House Financial Services Committee, [Federal Reserve Chairman Jerome] Powell said it could take more than three years before inflation reached the Fed’s target of 2%. That helped to reiterate the message that the central bank was in no rush to pare back on stimulus anytime soon, Deutsche’s Reid said.

I think that if rates spike too high, Powell will probably get the Fed in there buying lots of bonds (with printed money, if necessary) to get the rates back down. He doesn’t want to see higher rates derailing the economic recovery.

A slower rate rise may be less problematic:

“If it is stable and steady, it is easier for equities to digest,” O’Rourke said in an interview. “A quick spike has the potential to create a shock.”

Overall, this situation concerns me and it’s one I’m going to watch. But I am pretty confident that Powell will put a stop to extreme increases in Treasury yields.

For more on recent developments in financial markets, check out these posts:

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Photo: “Jerome H. Powell, governor of the Federal Reserve Board, discusses how markets currently function” by BrookingsInst is licensed under CC BY-NC-ND 2.0

This One Trend is Driving Every Financial Market

Regardless of which market we look at, we see a similar trend: skyrocketing prices since the beginning of the pandemic. You can see this in the S&P 500, a broad measure of stocks:

In commodities:

In the increase in real estate prices and the corresponding decrease in capitalization rates (this chart is from Dallas…see similar trends in other cities in the research papers linked in this post):

And even in Treasury bonds (recall that the yield moves in the opposite direction from the price, so a lower yield means a higher price):

Why are all these markets looking the same? The likeliest cause is a huge jump in the money supply. The Federal Reserve has aggressively printed money since the beginning of the pandemic, looking to counter the seismic economic shock. I think this is probably appropriate. In any case, the effect is unmistakable, however you measure money supply.

Here’s how the “monetary base,” or “the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve),” has expanded:

If you look at another definition of the money supply, M1 (“the sum of currency held by the public and transaction deposits at depository institutions”), it looks like this:

And if you broaden your definition of money supply to M2 (“M1 plus savings deposits, small-denomination time deposits (those issued in amounts of less than $100,000), and retail money market mutual fund shares”), you see the same familiar pattern:

Whichever way you slice it, there’s a lot more money out there than there used to be. That money can be used to bid up stocks, bonds, real estate, commodities, bitcoin, Gamestop, or whatever you like.

There is some debate in the literature about whether you can draw a correlation between the money supply and increasing stock prices. This study sounds a cautionary note:

future profits may not change, if interest rates decline at the same time that demand for firms’ products, and thus their sales, decline.

This could be relevant for companies that can’t deliver their products in a contactless manner. But companies that can have been thriving.

In all, it appears that the massive increase in the money supply is driving financial markets of every stripe in one direction: up. Until the Fed changes policy, I suspect the bias is likely to be toward buoyant markets, especially with vaccines coming on line and the pandemic’s end in sight.

Have a great weekend, everyone!

If you found this post interesting, please share it on Twitter/LinkedIn/email using the buttons below. This helps more people find the blog! And please leave a comment at the bottom of the page letting me know what you think and what other information you’re interested in!

Photo: “Governor Jerome Powell speaks at Brookings panel, ‘Are there structural issues in U.S. bond markets?'” by BrookingsInst is licensed under CC BY-NC-ND 2.0

My View on Markets in 2021

My main business is investment, and some recent developments have gotten me thinking about where markets are headed this year. An end to the pandemic by Q2 2021 is predicted by multiple models (here and here). We’ve seen a substantial increase in personal income in 2020, largely due to the CARES Act. Much of that was saved and might fund consumption in 2021. More stimulus is likely forthcoming from the new administration and a Democratic Congress.

The combination of an end to the pandemic, increased personal income/saving/pent up demand, and further stimulus seems to set up a great scenario for stocks this year.

Meanwhile, Treasury yields dropped substantially in 2020 despite massive stimulus (and thus borrowing). The same may not occur this year, but suffice it to say the Treasury market seems to be able to absorb quite a lot of new issuance (see page 3 of this document).

My investments are heavily weighted toward equities, and I am expecting a good year. Perhaps we’ll revisit this in a year and see if I was right!