The financial media headlines have been dominated over the past week by the latest bold declarations. Treasury yields are on the rise, and “the bond bull market is over!” Except that it’s not over. Not even close to starting to be over as a matter of fact. At least not yet. For despite its extraordinarily advanced age and recent fall coupled with the bold proclamations from some notable bond gurus, the 37-year old bond bull market still remains very much alive today.
Bonds Under Fire
Now it should be noted that the bond market has been very much under pressure as of late. Consider the following chart of the 10-Year U.S. Treasury yield (IEF). At the start of September, 10-Year U.S. Treasury yields have risen from a low of 2.05% to as high as 2.55% on Friday.
Knowing that as bond prices fall, bond yields rise, this chart looks bad, right?
Let’s continue by taking this recent rise in yields and put it in the context of the bond bull market. With the latest pullback in bond prices, 10-Year U.S. Treasury yields have inched above their long-term downward sloping trendline.
It’s official. The bond bull market is over, right!?! This sentiment was confirmed by none other than the Bond King himself just this past week.
“Gross: Bond bear market confirmed today. 25 year long-term trendlines broken in 5yr and 10yr maturity Treasuries.”
–Janus Henderson Advisors, Bill Gross, January 9, 2018
Sure, bonds have had a tough stretch as of late. But the bond bull market is not over. It’s going to take a whole lot more than the recent rise in yields to kill off today’s bond bull market.
Not So Fast
Let’s begin by pulling back and taking a look at the bond bull market through a much wider lense. The bond bull market first began in late 1981. This was the first year of the Reagan administration at a time not long after the first flight of the space shuttle Columbia. It was also a time when the then Cinderella story San Francisco 49ers were gearing up for their first Super Bowl run under then third year coach Bill Walsh and the Motor Trend Car of the Year was the Chrysler K Car (love those white wall tires!).
In short, the bond bull market has been going on for a long time now. So what about this upside break in Treasury yields in this longer term context? Pull out your microscopes and look at the following chart. See it? Right there in the bottom right corner? See it? Yeah, neither can I.
But what I can see is a number of other instances over the past 37 years where 10-Year U.S. Treasury yields moved more measurably above this downward sloping trendline in yields including late 1999 into early 2000 as well as all of 2006 into most of 2007. Yet despite these supposed trendline breaks, the bond bull market remains still alive today.
So what is the first key takeaway? That breaking a downward sloping trend line for a few minutes one trading day or for several months for that matter is simply not enough to declare a bull market in anything dead, particularly when it has lasted as long as the bond bull market. It takes a whole lot more.
But what about the proclamations of the Bond King? Shouldn’t he know what he is talking about? Don’t get me wrong. I have a ton of respect for Bill Gross and has listened to what he has to say for decades now. But as demonstrated by the tweet below from a few years back now, even the best of ‘em can miss the mark with their bold proclamations.
“Gross: The secular 30-yr bull market in bonds likely ended 4/29/2013.”
–PIMCO, Bill Gross, May 10, 2013
The same can be said of similar proclamations from other respected bond gurus, some of which were out in force in late 2016 declaring that 10-Year Treasury yields could top 6% in the next few years. Indeed, this outcome may very well come to pass, but A LOT of things need to happen between now and then to lead to this end result. And to date, many of these things remain decidedly elusive. Moreover, it is important to note that many of these very same bond gurus making bold calls such as declaring the bond bull market being over in 2012 also understandably maintain openness in their predictions. This includes suggesting that bond yields could fast track their way lower to 1% back at the start of 2015, only to see them turn and steadily rise throughout the rest of the calendar year.
As a result, while they remain worth respecting and listening to closely, remember that the bold prognostications by market gurus of any ilk are nothing more than pieces of worthwhile information that should be considered in a broader context when continuing to map out one’s own investment journey that takes place step-by-step over long-term periods of time.
Bond Bull Market – Alive And Well
When it comes to today’s bond bull market, sure it has struggled recently, but it remains very much alive and well today.
Bull markets do not die all of the sudden. Instead, they die a slow death over time. And the longer they have been in place, the longer it takes to kill them off. When it comes to bull market durations, 37-years is definitely on the very long side of the historical spectrum. As a result, the bond bull market is not going to simply end overnight. Instead, it is going to be a process that will take months if not years to fully play itself out.
In order to officially declare the bond bull market dead and the arrival of a new bond bear market to take its place, we are going to need to see A LOT of accompanying events take place along with it. And virtually none of these things exist today.
Let’s begin with the trendline break itself. Yes, we inched across the downward sloping trendline for the 10-Year U.S. Treasury yield. But we are not even close to seeing a confirmation in this trendline break for the 30-Year U.S. Treasury yield. In fact, this remains locked in the very middle of its long-term range. Bond bull market very much alive and well here.
With this point in mind, it is worthwhile to compare the path of the 10-Year and 30-Year bond yields (TLT) since early September. While the 10-Year yield has steadily risen, the 30-Year yields remains well below its highs from late October. This implies not that something is going on with the bond market more broadly, but instead that something may be taking place more specifically with 10-Year Treasury bonds.
Now consider the same 10-Year Treasury yields against their shorter dated brethren in 2-Year Treasury yields. Here we see 2-Year yields are rising even faster than 10-Year yields.
This, my friends, is further evidence of the yield curve flattening that we have been hearing so much about. This is shown differently in the chart below as the spread between the 10-Year U.S. Treasury yield and the 2-Year U.S. Treasury yield (the 2/10 spread), which has been falling like a rock since late October to new post crisis lows.
While the 2/10 spread increased marginally in recent days, the trend remains definitively lower. And most other spread readings across the yield curve including the 5/30 spread have not even moved marginally higher but instead have fallen to fresh new lows in recent days.
Why do these spreads matter? Because in order for the bond (AGG) bull market to end, we almost certainly need to see steadily rising inflation along with sustained economic growth. And the leading signal from the bond (BND) market that inflation is steadily on the rise and stronger economic growth is on its way is a steepening yield curve. Put more simply, we would expect to see 30-year yields rising faster than 10-year yields and 10-year yields rising faster than 2-year yields. But instead, we are continuing to see the exact opposite. The yield curve is flattening. And 2-year yields (SHY) are rising faster than 10-year yields, which are rising faster than 30-year yields. If anything this suggests signals of disinflation and a weaker economy, which is supportive of a bond bull market picking up steam in the next few years instead of coming to its demise today.
OK. So the trends in the bond market itself do not suggest the bull market is actually ending. But let’s take this a few steps further.
Let’s suppose the bond bull market was indeed ending and 10-Year U.S. Treasury yields were set to fast track their way to 6% in the next two years as some experts are suggesting. Now before going any further it should be noted that a move in 10-Year U.S. Treasury yields from today’s levels at 2.55% to 6% in two years means that we are going from current levels that are still roughly -1 standard deviations below the long-term historical average to +1 standard deviations above the long-term historical average. In other words, this suggests that something radical is about to happen in the U.S. economy in order to realize this outcome – either that economic growth is going to run so hot that it’s going to bring rapidly escalating inflation along with it, which is likely to cause the U.S. Federal Reserve to start slamming on the monetary policy breaks, or that we have a bond market riot that comes without U.S. economic growth. Either way, the outcome would be decidedly negative for capital markets in general across the board. So if this was indeed the case that such an outcome was nigh, we would expect to see commensurate ripple effects across the capital market landscape.
With this in mind, let’s consider high yield bonds (JNK). This is an asset class that has seen its absolute yields under 6% fall to their lowest levels on record and its yield spreads relative to comparably dated U.S. Treasuries at just over 3% also approaching their tightest levels in history last seen in 2007. Put more simply, high yield bonds are priced at a considerable premium today. Now recognizing the fact that investors are not likely to wish to receive a negative premium for the considerably greater default and liquidity risks that come with owning high yield bonds versus a comparably dated U.S. Treasuries (put more simply, investors are not going to own a high yield bond yielding 5.7% if they can get U.S. Treasuries with the same time to maturity yielding 6%), we should expect high yield bond prices to also be moving sharply lower in anticipation of this bond bull market coming to an end. But how have high yield bonds been doing lately amid these calls that the bond bull market is now over? Just fine as a matter of fact.
Either high yield bond (HYG) investors are absolutely oblivious, or something else is going on in the bond market other than a bull meeting its imminent demise. Even during the immediate aftermath of the U.S. Election, which was the last time that the bond gurus were out on the streets in force declaring the end of the bond bull market, we saw a reflexive action in high yield bonds to the downside that ultimately proved to be unfounded. And this same lack of response same thing can be said today for investment grade corporate bonds (LQD), emerging market debt (EMB), senior loans (BKLN), convertible bonds (CWB), or any other spread product whose valuation is directly or primarily reliant on U.S. Treasury yields including – wait for it – U.S. stocks (SPY). If the bond bull market has officially come to an end, apparently the rest of capital markets has not gotten the memo as of yet.
Now have we seen a rise in inflation expectations as of late? Sure, as the 5-year breakeven rate, which is a measure of expected inflation over the next five years derive by 5-year Treasuries (IEI) versus 5-year inflation indexed Treasuries (NYSEARCA:TIP), has risen from around 1.56% at the start of September to 1.89% as of Friday. This is notable and is a development worth monitoring in the days, weeks, and months ahead. But this same reading remains below the late January 2017 highs of 1.96% and is still well below the expectations toward 2.4% throughout much of the post crisis period up until a few years ago when the realization started to set in that the sustainably higher inflation anticipated from extraordinarily aggressive monetary policy might never actually materialize.
So while we do have some evidence of increased inflation expectations lately, they should still be considered marginal at best to date.
Let us take another step and consider U.S. Treasury (TLH) yields relative to their global counterparts. Much has been made about the corresponding rise in government bond yields from comparable global safe havens such as Japan (NYSEARCA:EWJ) and Germany (EWG) and how they are also supporting this end of bond bull market days theme. Yes, 10-Year government bond yields in Japan recently to as high as 0.09%, but this is still notably low and we have seen this script a few times before over the past year.
Same with German Bunds. We have seen 10-Year yields rise to 0.58% on Friday at a time when the European (VGK) economy is supposedly continuing to improve and the ECB is taking their foot away from the monetary policy accelerator. Yet we even higher yields touched back in July 2017 only to see them fall back again in the second half of last year.
And even with the recent rise in yields across the safe haven bond world, it is still important to note that the premium that global bond investors are getting paid to put their money in U.S. Treasuries remains about as attractive as it has been in recent history.
This relatively attractive valuation for U.S. Treasuries relative to their global safe haven counterparts suggests that a source of demand should remain to stem the onset of any bear market tide and hold the bull market in place at least for the time being.
But what about the blow out in the deficit and the increased U.S. Treasury issuance expected to result from recently passed tax legislation? The world has shown repeatedly in recent years including Japan over longer-term periods of time that governments can borrow like drunken sailors and still maintain historically low interest rates. This is an important issue worth monitoring, but we need to see evidence of such pressures actually showing up in bond prices and yields first before actually taking action on such expectations.
What about the fact that the Fed is set to increasingly shrink their balance sheet going forward as part of quantitative tightening, or QT? It is important to remember two things. First, the Fed to this point is shrinking its balance sheet by allowing some of its existing maturities to roll off without reinvesting the proceeds. Put simply, they are not selling, instead they are no longer repurchasing as much as they were before. This is an important difference. Moreover, even when they finally do start selling outright at some point in the future, it is critical to remember that they are only one participant in a large and vast global marketplace for U.S. Treasuries. And they will be one seller in a market that could be filled with many buyers along the way, particularly if the global economy is not doing so hot in the future. This helps explain why U.S. Treasury yields consistently rose throughout much of QE1, QE2 and QE3 despite the fact the Fed was buying massive sums of U.S. Treasuries all along the way.
Lastly, let’s come full circle and consider the technical aspect once again. In order for a bull market in anything to be over, we need to see a successive series of lower lows and lower highs. In the case of U.S. Treasury yields, this would be higher highs and higher lows. But when looking at 10-Year U.S. Treasury yields, we don’t even have the first higher high as of yet, as the 10-Year Treasury yield at 2.55% remains below the high of 2.62% from early 2017. We would need to see multiple higher highs and higher lows over the course of a year or more before we can even begin to conclude anything about a 37-year bull market in bonds being over.
And when considering the same chart for 30-Year U.S. Treasury yields, we don’t even have any signs of a reversal in trend, much less anything even resembling a higher high of which to speak.
I’m Still Alive
Putting all of this together, the recent talk of the bond bull market being over is grossly overblown. Could this be the very beginning of the end for the bond bull market? Sure, anything is possible. But we are going to need to see A LOT, and I mean A LOT, of confirmation not only from 10-Year U.S. Treasuries, not only from the U.S. Treasury market in general, not only from the broader bond market, but also from the capital markets and economic data spectrum as a whole before we can even begin to consider that the bond bull market that is running at 37-years and counting is even close to being over. If anything, it is the latest attractive buying opportunity in a long series of buying opportunities that have presented itself in the bond market over the past four decades.
What then explains the recent selling in the belly of the U.S. Treasury curve and the corresponding rise in yields? I will be interested as I have been in past years to take a look at the Treasury data on major foreign holders of Treasury securities when it is officially released in a few months, as I suspect we will be able to find our answers in this data has we have so many times in the past when the mainstream financial media is still talking about things like “taper tantrums”.
Of Stocks And Bonds And Bulls
Before closing, I am compelled to raise a related point. Just as I am writing in defense of the bond bull market still being alive today, I would almost certainly be writing something very similar about the U.S. stock market that closed on Friday at yet another new all-time high at 2786 on the S&P 500 Index (SPY) if it ended up falling sharply below 2200 in the coming months. And this comes from someone in myself that has been a proclaimed long-term stock market bear for many years now (just because I think something will ultimately end badly does not mean that this bad ending will arrive tomorrow and be fully felt overnight).
Some would be out proclaiming the start of a new bear market in stocks as supported by the fact that the S&P 500 Index (IVV) had fallen by more than -20% from its peaks. But just as long lived bond bull markets do not suddenly die with a simple short-term break in trend, long lived stock (NYSEARCA:VOO) bull markets such as our second longest in history today to date will not simply die with one sharp pullback to the downside even if it ends up being a fleeting drop of more than -20% from its all-time highs.
The bull market topping process in any asset class, whether it is stocks (DIA), bonds, or anything else, is something that takes place over extended periods of time and is filled with various escape routes along the way for those that need them. The key in navigating any such transitions is to be prepared and stand at the ready to take not only gradually evasive but potentially even countercyclical action when the time comes. And while their time will eventually come, when considering both the 37-year bond bull market and the 9-year stock bull market, we have yet to arrive today at such a junction for either asset class. At least not yet.
Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.
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Disclosure: I am/we are long RSP,TLT,TIP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.