THE HARDEST THING ABOUT having money is knowing what to do with it. But in my experience, the best trades feel mandatory, like an act of self-preservation. There’s no time for thinking, considering, waffling. There’s no decision to be made.
That’s why, while bonds might seem risky given their strong run during the last few years, I’m compelled to be a bull right now, no matter what happens in Iraq.
First, and most important, the trend in bond prices is still up (with bond yields heading down). Regardless of the news cycle, the market moves in trends, which tend to persist longer than most people tend to believe. Indeed, more than any other reason, the best argument to be a bond bull is that the bond market itself is strong.
Second, as we pointed out last week, the prevailing attitude toward bonds these days is doubt. Talk to most pundits, and it’s just a matter of time before cash “on the sidelines” goes rushing back into stocks. Recent rallies have been just “safe haven” buying — nothing substantial, just a temporary “flight to quality.” Given the long bull market in bonds, buying them these days (and thus betting on lower interest rates) seems, well, a bit stupid. From a contrarian’s perspective, this is bullish for bonds.
Perhaps the most convincing argument for bonds, however, is that they’re just plain cheap. You see, in trading, like most things in life, our perspective is shaped by experience. With bond yields as multidecade lows, most people’s experience has been that of generally higher interest rates than the market is now offering.
The problem with most people’s history, however, is that it starts right around the introduction of color TV. Truth be told, from wars to global depression (and a major stock-market crash), there’s a heck of lot of important history that occurred in the first half of the 20th century.
And while bond yields might feel unbearably low compared with earlier periods in our lifetimes, longer-term data suggest that yields aren’t low at all. For example, high-quality corporate bonds, now yielding more than five, sported yields well below three for much of the early 1900s. A similar example can be found in long-term government bonds, up strongly in price and still yielding more than 4.5 today. From 1925 to 1959, yields topped four only twice.
The funny thing about history is that it has a tendency to repeat itself. So despite their huge drop, it’s important to know that interest rates have traded much lower in the past.
As we often like to point out, it’s strong technique, not security selection that ultimately determines success. But because the future is always uncertain, the best results come by following the market and not your gut. And although real moves take time, I still believe that fixed income is a smarter risk than equities right now. From even a cursory glance at the long-term data, it would appear that history is on my side.
– Originally on Mar 17, 2003 by Jonathan Hoenig
