As investors are currently experiencing yet another episode of rising bond yields — one that has led to a fall in prices for long-term treasury bonds and has prompted a certain degree of “panic” from investors and financial professionals alike — it may be worth placing the persistent bond-market concern within the context of history.
The first point to be made is the important distinction between secular and cyclical trends.
Secular vs. Cyclical
While a secular trend is a long term trend — one that may be in place for many years, potentially only seen once in a lifetime — a cyclical trend occurs over a shorter period of time and can occur in the context of a secular trend. For example…
In the chart above one can see an example of cyclical trends existing within a secular trend. The long-term, secular trend is down (the line moves lower over longer periods of time), but there are short-term cyclical trends as well — both up and down. This chart is similar to what has been seen in long-term treasury bond yields since the 1980s — i.e. a secular trend down, with short cyclical periods where the yield has moved up. (NOTE: falling bonds yields mean that bond prices are rising… i.e. since the 1980s, the secular move for bond prices has been up, with short cyclical periods where bond prices have moved down.)
Long-Term Treasury Bond Yields
In the chart above one can see the extent of the latest “bond market panic” with respect to previous “panics”. When placed in a historical context one can see that short-term (cyclical) rises in yields have occurred regularly within the long-term (secular) trend of falling yields.
Secular Decline in Bond Yields (Secular Rise in Bond Prices)
To understand the secular fall in long-term treasury bond yields (i.e. the secular rise in long-term treasury bond prices) one needs to understand the economic environment and the significance of the Fisher equation. Irving Fisher’s eponymous equation has been addressed in Alternative Investments: Part 4 — Duration-Oriented Unconstrained Bond Strategy and the current economic environment has been discussed in Economic Constraints and Policy Options (among other articles under the Economic Environment tab). The main point to understand here is that, in an over-indebted economic environment (i.e. one with high levels of unproductive debt — debt that does not create an income stream to repay the principal amount borrowed and the interest on that debt) economic growth is constrained by debt and long-term treasury yields fall over time, but this over-indebted environment can see temporary rises in yields and inflation on the way to lower yields and disinflation/deflation. Based on Irving Fisher’s equation, a fall in inflation expectations leads to a fall in the risk-free rate (i.e. the yield on long-term treasury bonds), and a rise in the price of long-term treasury bonds.
It’s important to note that the secular decline in bond yields hinges on the existing unproductive debt in the economy; until that debt is significantly reduced, yields are likely to work lower over time as growth will continue to be constrained.
The Persistent Fallacy of Rising Rates
So often does recent history obscure decision-making and mask history’s full story; the same misguided oversight can be seen over and over in decisions relating to finance, economics, and investments. The anomaly of the Restricted Market Era described below is still the expectation for the vast majority in the industry — even after years of evidence to the contrary, the shadow of rising inflation and bond yields haunts those that began their careers during the Restricted Market Era (1948-1989). One can see the persistent misinterpretation — the expectation that the Fed will raise interest rates, growth will resume, inflation will take off, bond prices will fall, and bond yields will rise “because they’re so low there’s only one direction in which they can move” — in this link to forward rate expectations.
Distinguishing Characteristics of the Global Market Eras(1871-1948 & 1989-Present) and the Restricted Market Era(1948-1989)
Chart Source: End of the Bond Bull — Better Hope Not by Lance Roberts
To distinguish between the Global Market Eras and the Restricted Market Era one needs to address debt, demographics, and the accessibility of the labor force and raw materials.
The uniqueness of the Restricted Market Era begins with the rise of Russia’s Iron Curtain and China’s Bamboo Curtain; during this period about 50% of the world’s population was not included in global trade — a vast portion of labor/working-individuals, that at one time interacted with the world, were now no longer doing so. The non-curtained economies could not benefit from what was invented, created, manufactured, and traded (both goods and natural resources) in the curtained economies, and the curtained economies couldn’t benefit from the advancement in the non-curtained economies — leading to less competition, more constraints and inefficiencies (less people available to help with transportation, manufacture, etc.), and ultimately leading to higher costs and prices (an inflationary environment).
The uniqueness of the 1948-1989 era can also be seen in debt levels and demographics: the personal saving rate reversed course from negative territory to 28% during the years 1933 through 1948, and the U.S. ratio of public and private debt to GDP fell from 295% to 139% — this provided an environment free from the disinflationary constraints of unproductive debt, launching the U.S. into the post-war boom (rising prosperity, wealth, and birth rates).
In stark contrast the Global Market Eras — although allowing for cheaper goods and technological advancement via an interconnected labor force — are characterized by high unproductive debt levels that constrain growth, low levels of saving, and falling birth rates.
The Restricted Market Era is then the anomaly — an era of uniquely high inflation and bond yields due to low debt-constraints, high costs/prices from restricted trade, and positive demographics (a baby-boom generation hitting their peak spending years). With a grasp on historical-context one can see that the yields on bonds are more in line with a larger portion of history than one might initially believe — they’re in line with the range encountered in the Global Market Eras, rather than the Restricted Market Era; high inflation and high bond yields may only be seen when unproductive-debt levels are much lower. For an even longer history see: 300-Years of Long-Term Government Bond Yields
When one thinks of “investing” today there is generally an immediate tendency toward stocks — ticker symbols running across the screen of an investment news program; this is our current culture: get rich quick or invest for the long-run, but invest nonetheless — plan for your retirement, save for college. The exposure to this culture (albeit rather passive, at first) provides a degree of socialization occurring at an early age — TV, radio, social media, news, movies, etc. — and ultimately culminates in adulthood when the chorus of chants to, “start investing for your future and your family’s future” become much more immediate and relevant. The important point to make here is that investments are cultural — ours seems to focus on stocks — other cultures prefer property to stocks, still others have preferred gold/precious metals/jewelry, and one was even preoccupied with rare flowers. But the preoccupation, the popularity, the desire, the tradition, can lead to a temporarily-higher price for an investment — one that ensures a lower future price.
There have been episodes in not-so-distant history where returns for other investments have eclipsed stocks; the amount of time you have to invest is of extreme importance. Refrain from looking at the entire history of the stock market, saying “it’s grown a lot in 100 years, so I should invest in stocks”; instead decide on a realistic time horizon (how long you will actually be investing) — for many, this may be less than 30 years — and look at the many slices of the stock market with that same time horizon… the view may be a bit surprising. As the economist Lacy Hunt has written, “From 1971 to 1948, there were two twenty-year periods when the total return on long-term Treasury bonds exceeded the total return on the S&P 500: one from the 1870s to the 1890s and another from 1928 to 1948″ — and in the future there will likely be more long-stretches-of-history where unassuming investments eclipse the returns of the stock market.