Is Now the Time to Go Long?

Posted by Jacob Radke
October 17, 2023

Bonds between 2020 and today have proven to be challenging. Three out of those four years saw losses. In 2020, the Bloomberg Aggregate returned approximately 7.5%. In 2021, it declined by 1.77%. In 2022, it dropped by 13.02%, and as of 2023, it's down by 1.18%.

Of those 4 years stocks were still up 75% of the time. Meaning they were up in 2020, 2021, and to date 2023.

Cumulatively over this period bonds are down and stocks are up.

So why should bonds be attractive today?

I think the JPMorgan Guide to the Markets has a great insight and that is, global bond valuations are at the bottom of their 10 year ranges, which opens the door to valuation and price increases, but also newly issued bonds are yielding >5%.

Those >5% bond yields are attracting the masses to longer dated bonds.

But if you look at those long bonds, investors would not have been served well.

There are two main reasons for attraction to long bonds. One is they allow someone to lock in high rates for the longest period of time.

Would you rather have 5% for 1, 2, 5, 10, or 30 years?

And the second is if rates fall they experience the greatest benefit.

Given that we are nearing the bottom of the valuation range over the last 10 years it seems likely that rates will fall more than they’d rise over the next 10 years.

The risk you run in doing so, however, is that rates rise above 5% and you experience a drawdown in price.

In early 2023 the consensus was that rates would fall into the end of the year on a Fed cut and a recession.

Neither of those things happened, or are forecasted to happen.

So rates rose and anyone who picked up positions in long bonds suffered.

The biggest question now is, is it worth the risk to go to the long end of the curve with so much uncertainty?

A quick return model shows:

If rates rise 1% 1-3 years notes would still return almost 4%.

If rates fall 1% 1-3 year notes would return over 8%.

If rates rise 1% 30 year bonds would fall over 11%.

If rates fall 1% 30 year bonds would return over 20%.

The why behind investing in either of these depends on the person.

However, from a risk-reward perspective, it makes more sense to favor 1-3-year notes.

But the flows tell a different story.

A steady $40 billion has gone into long term bonds.

A bumpy $13.7 billion has gone into short term bonds.

This raises the question: why should we follow the money into long-term bonds?

And the answer is hedging.

While if rates fall only 1% it may make sense to not shift over, if they fall by 2 or 3% in a short period of time you make out very well.

By holding the 1-3 year notes, you miss out on all the potential gains and forfeit the yield.

How that happens is we plunge into a recession, which the market has at a 0% chance.

This is, of course, something we are watching very closely ready to make changes on.

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