11/18/15   Where Is The Safe Haven During A Treasury Bear Market?

Editor’s Corner

Ron Rowland

Historically, U.S. Treasury bonds have been one of the best portfolio diversifiers. During the 2008 financial crisis, they were one of the few asset classes to move higher as nearly all stocks, commodities, and non-government issued bonds moved lower. When other asset classes sell off, capital tends to flow into U.S. Treasury bonds. This is the “flight to quality” you often hear about.

Over the years, I have had conversations with many retail investors that have a firm grasp of how the stock market works, but they will readily admit to being perplexed about bonds. I think the root of the confusion is the inverse relationship between yields and prices. With stocks, supply and demand determines the price. Any stock dividend yield is a function of its price, and therefore often considered a secondary factor.

With bonds, yield is usually viewed as the primary factor, and price becomes secondary. Perhaps an easier way to think about it is that a bond’s price is a derivative of its yield. Because of the inverse relationship, that means if the yield goes up, then the price goes down. Adding to the confusion, financial commentators often flip between talking about yield movements and price movements for bonds. The emphasis is always on the interest rate being paid (yield), yet when they say that bonds are in a bull market, it means bond prices are going up and the yields are going down.

The last few years, all of the talk has been about rising interest rates for the simple reason that yields are near historic all-time lows. The thinking goes, interest rates (yields) can only go one direction from here, and that direction is up. Of course, that means bond prices will go down and implies a bear market for bonds is coming.

Many investors try to jump to a conclusion that higher yields are good for bonds. After all, wouldn’t you want to own a 30-year Treasury bond paying 3.04% today than one paying 2.25% back in January? Additionally, that 3% yield now provides competition for stocks because that is higher than the average stock dividend.

However, this thinking can prove to be short-sighted. What many novice investors forget is that to achieve that 3.04% yield on a 30-year Treasury bond bought today, one must hold that bond until it matures in 2045. In the meantime, any increase in yield can wreak havoc on its price.

Let’s take the iShares 20+ Year Treasury Bond ETF (TLT) as an example. As its name implies, it invests in long-term U.S. Treasury bonds. From January 30 through yesterday, when the 30-year Treasury yield rose from 2.25% to 3.04%, the total return of an investment in TLT was -11.5%. That small 0.79% increase in yield cost more than 11% of the initial investment. To add insult to injury, it is still only paying 2.25% on that initial investment. The new higher yield is only available to someone buying today at the lower price.

An investment in TLT has essentially cost five years of interest payments as the 30-year Treasury yield moved from 2.25% to 3.04%. If you think the new 3.04% yield is attractive, think what will happen to the price of TLT when yields move up to 4%, 5%, and higher. And that brings up another point—if rising interest rates bring on the next bear market for stocks, then what will be the “flight to safety” asset class?

Investor Heat Map:11/18/15


All sectors lost momentum over the past week, with the most of the damage occurring on Thursday and Friday. Technology kept its top ranking for a fourth week, while Utilities was on the bottom for a second week. Since the last update, a lot of shifting occurred between the two extremes. Industrials climbed two spots to second, as defense contractors received a boost from global terrorist activities. Telecom and Materials both improved enough to move into the upper half. Four sectors slipped into the red, bringing the count of negatively trending groups to six. Consumer Discretionary dropped from second to sixth as many retailing stocks took a hit. Energy fell from fifth to tenth as crude oil prices remain stubbornly low. The Utilities sector encountered short-term weakness, keeping it in last place.


The top-five style categories are in the same rank order as a week ago, although only four remain in the green. Mega-Cap heads up the list and is followed by the three Large-Cap categories. The market’s preference for these larger capitalization stocks represents a defensive posture. A week ago, all eleven categories were green. The seven Mid-Cap and Small-Cap categories have since flipped over to red. This is both a big change and further evidence of a defensive market. Within the lower ranks, the move of the Small-Caps above the Mid-Caps noted in the previous update was mostly undone this past week. Mid-Cap Value jumped from last to sixth, while Small-Cap Growth and Micro-Cap each slid three places lower to land on the bottom.


Global markets continued to weaken as two more categories moved into the red. Only Japan and the U.S. are posting positive momentum scores, and both are in danger of flipping to red. Japan took the top spot away from the U.S. despite moving into a recession this past week. Stocks there actually moved higher, suggesting the latest news was already baked into stock valuations. China and World Equity are the two global categories that went from green to red, although both maintained their ranks. Minor shuffling occurred among the lower categories as most weakened in the face of a strengthening U.S. dollar and global economic growth concerns. Pacific ex-Japan was the only category posting an improved momentum score, and it was only a single point better. However, it was enough to move it ahead of Emerging Markets. After nine weeks on the bottom, Latin America has now moved up a notch. Canada is the new basement dweller, revisiting its August and September lows this past week.

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“Various concepts of r* were discussed. The staff presented several briefings regarding the concept of an equilibrium real interest rate—sometimes labeled the ‘neutral’ or ‘natural’ real interest rate, or ‘r*’—that can serve as a benchmark to help gauge the stance of monetary policy.”

–From the minutes of the October FOMC meeting (released 11/18/15)


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