January 17th, 2012
Econintersect: In 2011 investors had a rather wild ride with stocks. Many markets saw double digit losses (see Macrotides’ analysis) and the U.S. ended the year nearly flat after coming within a hair of marking an official primary bear market on a closing price basis and clearly did on an intraday basis. Between April 29 and October 4, intraday prices dropped 20.0% for the Nasdaq Composite and 21.2% for the S&P 500. See GEI News.
For bonds it was a much different story, although there was an early fall scare for bond investors as well. From September 22 to October 27 the 10-year treasury bond yield shot up from 1.72% to 2.42% and those holding long-term treasuries suffered a serious setback. The ETF iShares Barclays 20+ Year Treasury Bond Fund (NYSE:TLT) declined by 10.4% in a month, a monstrous loss for a bond holding. Shorter maturity ETFs also had big losses: iShares Barclays 10-20 Year Treasury Bond Fund (NYSE:TLH) lost 6.1% and iShares Barclays 7-10 Year Treasury Bond Fund (NYSE:IEF) lost 4.6%. Yet, for the entire year the total returns were huge: IEF 15.4%, TLH 20.4% and TLT 33.1%.
Those who were agressively bearish on bonds for 2011 could have seen a loss of with the double short ETF ProShares UltraShort Lehman 20+ Fund (NYSE:TBT) that totaled 52% for the year. This might have been the fate for those who followed the advice of Bill Gross (PIMCO Total Return Fund) who was bearish on Treasuries and was underweight for much of the year. Gross, perenially one of the top fixed income fund managers, ended the year in an unaccustomed low performance position for 2011 (4.16% total return), ran underweighted in Treasuries throughout the year.
Others, such as Jeffrey Gundlach argued for a bond market rally from early in the year and were rewarded with oursized returns. One such money manager was Hoisington Investment Management. The firm wrote is their final quarterly report for 2011:
2011 was unusual as the 40% total return in a long dated risk free portfolio of treasuries was one of the best in history. The long end of the treasury market far surpassed the Barclays Aggregate Bond Index which recorded 7.8% rate of return. The S&P 500 Index lagged bond returns by being up only 2.1% for the year. For only the third time since 1870 the long term treasury bond market outperform the S&P 500 Index over a twenty year period with the unmanaged 30yr bellwether up 8% versus 7.8% for the S&P 500 Index. HIMCO accounts realized returns of 9.7% over that same twenty year period.
Macroeconomic Fixed Income Composite Performance
CALENDAR YEAR ENDING DECEMBER 2011
Investors seem to be convinced that the bond rally will continue. Reuters reports that the week ended January 11, 2012 saw the fifth highest ever one week total for net investment in bond funds. Some money managers are also making the bond rally bet for 2012, as well.
An article by Joe Light and Ben Levison in the Wall Street Journal (January 14, 2012) expresses doubts that bonds will rally further in 2012. But they go on to say that isn’t the most significant thought. They claim there are simply better places to put money than in government bonds. However, there have been similar statements for much of the past ten years and bonds have just kept on grinding higher.
Remember the great bull markets for stocks in the 1980s and 1990s? Many have called that the greatest bull market in history. Well, someone who invested in 1981 would be further ahead had they held long-term treasury bonds for the 30 years than if the bought the S&P 500 stock index. Light and Levison say the long bond has returned 11.03% annually since 1981, compared to 10.98% average per year for stocks. Just to give a numerical example, $1,000 invested in the long-term Treasury at the end of 1981 would be $23,078.64 at the end of 2011. The same invested in the S&P 500 would have reached $22,768.88. Taxes and transaction costs have been ignored.
Bonds haven’t been better than stocks by much over the 30 years, but boring old bonds beating stocks for 30 years? You have to be impressed. And bonds haven’t gone through seven primary bear markets (declines of 20% or more) during the 30 years either as stocks have.
The following graph from the WSJ article does have an alarming characteristic: it shows exponential growth and is "going parabolic." Be reminded that "if something is too good to be true it probably isn't."
The current long-bond is yielding 2.90% and that is not the historic low; almost the entire decade of the 1940s was spent below that yield. In fact, there were several occasions when the yield was in the 2.0% region. See the graph below. If that decade were to be repeated there are still some significant gains to be garnered from the long-term Treasury.
Disclosure: William H. Gross of PIMCO as well as Lacy H. Hunt and Van R. Hoisington of Hoisington Investment Management are guest contributors to GEI Blogs.