-Sir John Templeton, (11/29/1912-7/08/2008) Legendary Investor, businessman, and philanthropist
I just returned from a conference in San Diego, where during a roundtable discussion, attendees were encouraged to ask questions and share their views on the capital markets. Most of the dialogue was not relevant for this column, but the consensus there was the popular refrain that interest rates were going up and that we are in a bond bubble. As far as interest rates going up, I usually disagree. The ten year Treasury note’s yield is now about 2.80%. The ten year treasury is considered to be the bellwether bond, meaning it’s the instrument that would most clearly predict trends. It used to be the 30 year bond, but they’re less popular now, so even for people like me who believe that rates are not going up, I’m cautious enough not to invest in 30 year bonds. Borrowing and locking in a rate for 30 years is a whole different story. Think about it. There’s someone on the other end of that transaction investing in you with a low rate for 30 years.
I think using the term bubble to describe an investment high is a useless cliché, as it is being used to describe the bond market now. A real soap bubble is here now, and at some point is gone in a fraction of a second. That’s so unrealistic for what’s going on in bonds. It’s also scaremongering. I get this question a lot, because we’re always hearing about interest rates rising and the bond market bubble. The so called “hi-tech bubble” in the late nineties, represented by the NASDAQ index took 3 years to unravel, albeit with a decrease of 70%. For what it’s worth, the NASDAQ went up by 1300% in the 1990s. In the 1920s it wasn’t called a bubble, but was referred to as “The Roaring Twenties”, when the Dow Jones Industrial Average increased by 260% in that decade, only to drop 90% from 1929-1931, hardly the popping of a bubble, but real nasty nevertheless. These facts certainly do not predict the future, but their history offers an enlightening perspective. I’m sure Sir John Templeton above was a student of history.
As for the yield on the “bellwether” 10 year Treasury @ 2.80%, mentioned above, that’s up from 1.62% a year ago- a 75% increase in the rate. That begs the question; “Isn’t that a big increase in rates?” Well, 5 years ago the 10 year was yielding 3.50%, and 10 years ago it was yielding 4.00%. So that perspective could change any conclusions made.
Recently there was an article in Financial Planning Magazine by Craig Israelson entitled “Rate Rising – Dump Bonds? (Note the question mark, not exclamation point). Mr. Israelson showed in the rising interest rate environment of 1977-1981, when the FED raised the Discount Rate by 145%, the Barclays U.S. Aggregate Bond Total Return was +3.05% during that period. Likewise, when the FED raised the Discount Rate by 409% from 2002-2006, that same index increased by 5.05%. I’ve found similar data when doing my own research.
So where do the observations above fit in at the front line of asset allocation? Clients are less concerned about the stock market highs than they are about rising interest rates. That’s because the recent increase in stocks looked much better on statements than the recent pop in the 10 year Treasury yield, which had a negative effect.
One thing that always maintains my optimism for the future is the economic theory of “The Invisible Hand,” a term coined by economist Adam Smith in 1776. Investopedia paraphrases Smith’s definition thus:
“Smith assumed that individuals try to maximize their own good (and become wealthier), and by doing so, through trade and entrepreneurship, society as a whole is better off. Furthermore, any government intervention in the economy isn’t needed because the invisible hand is the best guide for the economy.”
Sal Petralia is a CERTIFIED FINANCIAL PLANNER™ Professional and a Registered Principal with LPL Financial, 5621 Strand Blvd. Unit 102, Naples, Fla, 34110; Tel 239-596-7822
Email: sal.petralia@lpl.com
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The opinions voiced in this material do not necessarily reflect the views of LPL Financial and are for general information only and are not intended to provide specific advice or recommendations for any individual.
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