Bondholders are going to be in for some nasty surprises when they check their first-quarter statements in a couple of weeks. Because the losses are piling up.
In aggregate, bonds are down about 7% over the past three months--one of the worst quarters they've experienced since the 1980s, using the "AGG" bond ETF as a proxy. And yields are definitely not high enough to offset those losses, at less than half of one percent each quarter (AGG yields less than 2% per year).
The losses have become especially pronounced since the Fed meeting two weeks ago. Overnight, the yield on the 10-year U.S. Treasury jumped again, to almost 2.56%. "This month has now achieved accumulated Treasury losses to rank among the three worst in the last twenty years," wrote FHN Financial's Jim Vogel in a note to clients this morning. And according to Natalliance, "government bonds are on pace for their worst year since 1949."
It all reminds me of what famed investor Bill Miller warned us about several years ago--when people realize they can actually lose money in bonds, they panic. Going into the inflationary 1970s, he said, investors had done so well in bonds for so long they viewed them as essentially riskless, until it was too late. You could say we're living through a similar period right now.
The irony, of course, is that people were warned--last cycle, for years and years, about a bond crash that never panned out. It's exactly like the boy who cried wolf. Conceptually, the chorus that said the Fed's massive quantitative easing and the government's fiscal response to the financial crisis would ultimately cause inflation and crater bonds--well, it turns out they were right, but not then. It's only now, when those forces collided in a much larger way in response to the pandemic, that we're seeing it all play out.
And the public, like in the fairytale, learned to drown out those cries just at the very moment when the actual wolf showed up. Bill Smead, of Smead Capital Management, literally calls it "wolverine inflation." The market "has been in denial," he warned back in January; "inflation is not a friendly puppy dog."
So what should investors do? They're already piling out of bonds, which have seen outflows for ten straight weeks. Municipal bonds in particular--which have an especially risk-averse investor base--have seen historic outflows and are about to post their worst quarter since 1994, down more than 5%, according to Bloomberg. Investors have also been fleeing high-yield debt, especially as the Fed has turned increasingly hawkish this month.
You won't find many professionals (other than fixed-income specialists) recommending big exposure to bonds right now. The outlook is just too uncertain. Shouldn't bonds rally and perform better if growth slows, given how concerned people are about a recession right now? Not unless it puts a meaningful dent in the outlook for inflation, and it would take a very deep and lengthy downturn to do so, as Goldman and others have warned.
So where should people turn, when bonds are in the red, and cash is losing value because of inflation? You'll still find plenty of fans of the stock market, at least tactically, in this environment; and "real assets" like real estate often also get positive mention. Commodities have done extremely well, but are a tougher investment for the long run. (If you're inclined, gold, metals, energy, and foodgrains are the picks-- along with globally diversified real estate--from strategist Komal Sri-Kumar.)
As for stocks, Smead likes energy and housing market plays; MKM's Michael Darda recommends reopening plays and smaller-cap cyclical value; Bill Miller likes energy, financials, housing stocks, travel-related names, and even some Chinese stocks (he's also still bullish on mega-cap tech like Amazon and Meta). If you want to get really specific, Charles Bobrinskoy of Ariel, who has also correctly called this cycle, likes shares of Mosaic, BorgWarner, APA Corp, and MSG Entertainment right now.
And even the S&P 500 overall has been impressively resilient thus far, hanging in there with drop of less than 5% since the start of January--less than bonds, in other words. As bond losses deepen, don't be surprised to see the "TINA" dynamic continue to bolster stocks. TINA? "There Is No Alternative."
See you at 1 p.m!
Kelly
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