{"id":91659,"date":"2016-06-21T09:12:38","date_gmt":"2016-06-21T13:12:38","guid":{"rendered":"http:\/\/countingpips.com\/?p=91659"},"modified":"2016-06-21T09:12:38","modified_gmt":"2016-06-21T13:12:38","slug":"long-term-bonds-are-a-huge-value-trap","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2016\/06\/long-term-bonds-are-a-huge-value-trap\/","title":{"rendered":"Long-Term Bonds Are a Huge Value Trap"},"content":{"rendered":"
June 21, 2016<\/div>
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By WallStreetDaily.com<\/u><\/a> \"Long-Term<\/p>\n

As income-oriented investors continue to scramble to find decent yields, many are being enticed towards long-term bonds.<\/p>\n

Don\u2019t be one of them.<\/p>\n

While the yields are tempting enough, they\u2019re still not very attractive \u2013 and in the current market conditions, it\u2019s a value trap that\u2019s bound to bring losses in the long run.<\/p>\n

As a source of income<\/a>, they\u2019re all risk and very little reward.<\/p>\n

You see, bonds denominated in a fiat currency are a massive one-way bet against the investor.<\/p>

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No Gold Standard Hits Bonds<\/h2>\n

When the monetary system was tied to gold, long-term bonds were a good option. Investors knew exactly what they were getting \u2013 a fixed stream of returns over a long period of time and a return of principal at the end.<\/p>\n

Of course, prices could move up or down during the term of the bond, but since money was tied to gold, investors had no reason to expect severe movement in either direction.<\/p>\n

In this environment, bonds were a good deal, and income investors could rely on them to fund their retirements.<\/p>\n

But all that changed when the U.S. went off the Gold Standard in 1933\u2026<\/p>\n

The True Value of Money<\/h2>\n

Once bonds were linked to paper currency, governments were tempted to inflate their currencies, thereby reducing their debts.<\/p>\n

For example, Franklin D. Roosevelt invalidated gold clauses in 1933 at the same time he raised the price of gold from $20.71 to $35. Bondholders with provisions that said they were to be paid in gold were instead repaid in devalued dollars.<\/p>\n

So with the value of money being controlled by the government, long-term bondholders have a one-way bet against them.<\/p>\n

The government can increase its deficits, providing goods and services without paying for them, and finance the increase by allowing inflation.<\/p>\n

And over a 30-year bond term, you have no way of knowing how far the government will take this.<\/p>\n

For example, investors who bought 30-year bonds at 5% in the 1960s, believing there was some allowance for inflation built in, saw the value of their principal decline by 75% over the life of the bond, wiping out the real value of their interest income.<\/p>\n

Of course, at some point, people will grow tired of seeing their savings decimated and will speak out. As this becomes an important issue politically, the government will act to reverse the inflation.<\/p>\n

That\u2019s what happened under Paul Volcker\u2019s Fed in the 1980s, when inflation was lowered from 14% to 4% within a few years. So if you bought 12% long-term bonds when inflation was peaking, you made out like a bandit.<\/p>\n

Buyer Beware<\/h2>\n

By and large, bondholders, which include savers and pension funds, have less political power than borrowers, and are on the opposite side of the table from the government.<\/p>\n

Economically, double-digit inflation can cause a lot of damage. So there\u2019s no doubt that if inflation gets into the double digits, the government will move to rein it in, just as it did in the 1980s.<\/p>\n

That means there\u2019s a level of interest payment at which you should buy long-term bonds.<\/p>\n

Today, with inflation around 2% (and the Fed target also at 2%), you might feel that a real interest rate of 3%, plus 2% inflation, plus a modest cushion for the risk that inflation zooms to 10% would be an appropriate risk-free yield for a long-term U.S. dollar bond.<\/p>\n

That would give you an appropriate yield of about 6%.<\/p>\n

Currently, the 30-year bond yields 2.39% per annum.<\/p>\n

That 3.61% difference between what you should<\/em> accept and what you actually<\/em> get is a measure of how big a rip-off long-term bonds are.<\/p>\n

The value of a 2.39% 30-year bond in a 6% interest rate environment is 49.8% of par. In other words, the government is giving you less than half of what you should receive.<\/p>\n

While riskier long-term bonds pay higher interest rates, they\u2019re an even worse deal than long-term Treasuries<\/a>.<\/p>\n

In practice, you\u2019re unlikely to hold a 2.39% 30-year Treasury until 2046. With yields so low, barely above the level of inflation, if you sell before 2046, you\u2019ll receive only a fraction of its nominal value. For example, if Treasury yields rise to 4% two years from now, you\u2019d receive 72% of what you paid.<\/p>\n

Conversely, with yields dropping further, there\u2019s a very small chance for profit over any but the shortest run. That\u2019s because the Fed would have to put short-term rates into negative territory. And as the Fed is discovering in Japan and Switzerland, that\u2019s difficult to do when banks and investors start hoarding cash.<\/p>\n

The bottom line is that in these markets, it\u2019s hard to get a decent yield from an investment without taking on excessive risk.<\/p>\n

But a five-year bond yielding 1.09% is a much better deal than a 30-year bond yielding 2.39%. For one, it carries much less principal risk and by 2021, maybe sanity will have returned to the money markets and you\u2019ll be able to reinvest at a proper rate.<\/p>\n

Good investing,<\/p>\n

Martin Hutchinson<\/p>\n

The post Long-Term Bonds Are a Huge Value Trap<\/a> appeared first on Wall Street Daily<\/a>.<\/p>\n

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 <\/p>\n","protected":false},"excerpt":{"rendered":"

By WallStreetDaily.com As income-oriented investors continue to scramble to find decent yields, many are being enticed towards long-term bonds. Don\u2019t be one of them. While the yields are tempting enough, they\u2019re still not very attractive \u2013 and in the current market conditions, it\u2019s a value trap that\u2019s bound to bring losses in the long run. […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-91659","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/91659","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=91659"}],"version-history":[{"count":2,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/91659\/revisions"}],"predecessor-version":[{"id":91700,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/91659\/revisions\/91700"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=91659"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=91659"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=91659"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}