An Inconvenient Truth: 
Bonds Have Vicious Bear Markets Too (Updated April 2014)

Over the years, most of us have grown accustomed to the tried and true method of permanently holding bond funds.  These investment vehicles have come through for us time and time again, providing a cushion to those nasty stock market drops that happen every several years.  After all, if we could get high single-digit returns from an asset class that never dropped more than high single-digits, why not buy and hold?  As a local mortgage company's commercial says, "It's the biggest no-brainer in the history of mankind." 

Better think again

Unfortunately, bond funds aren't the cute, cuddly pets we've been conditioned to hold forever.  They do have their own bear markets, which can be vicious in their own right.  Sure, your average intermediate-term bond fund will probably never drop as much as your average stock fund has, but you'll be surprised to learn just how far they can and do drop.

Bond Bear Markets:  An Inconvenient Truth

This first chart shows how much the average intermediate-term bond fund fell during each bond bear market since the 1950's.



That 1968-1970 bar looks sickening, with a -26% drop using month-end data.  It's safe to say it probably hit -30% intra-month.  Notice that the much talked about big, bad bond bear market in 1994 is laughably small.  We only included it here because it is talked about so much in the media.  Otherwise, it would only warrant a footnote.

Additionally, the recent "scary" bond market drop in 2013 didn't even register on the bond bear market Richter scale.  We try to keep our chart for month-end data drops that register a minimum of -5.0%.  The May-August 2013 drop was a mild -3.92%.  It really does just warrant a footnote. 

But stocks will bail me out, right?

This chart shows how stocks and a typical 60/40 stocks/bonds split did during these bond bear markets. 
60 40 Bond Bears
During the past 57 years, stocks only bailed you out once!  During the other bond bear markets, stocks dropped as well, sometimes by more than the bonds!

The sad reality of the bond market is it has a physical "ceiling and floor."  Unlike stocks, bond prices (and inversely, their yields) have limits.  In the grand scheme of things, we've reached the limits.  In over 220 years of history (see chart below), the 1.6% 10-year U.S. Treasury yield reached in 2012 was a record low!  It doesn't mean we can't go below 1.6% (think Japan for the last 5 years!), but we're basically bouncing along the physical floor. 



Notice that we've also endured two 20+ year stretches of long-term rates below 4%.  With the Fed tapering off their bond purchases, rates may rise to levels we haven't seen in decades.  On the other hand, if the inflation rate keeps falling and stays below 2% (see chart below), long-term interest rates may stay low for years!  No one knows for sure.



Investors rode the 30+ year bull market all the way to the end.  Long-term bonds have only two possible routes to take from this juncture:  Either interest rates stay low for many years to come or rates rise.  These two scenarios give you either a return of yield only (with no capital appreciation) or flat-to-negative returns as yields rise.

Since most of us aren't going to sell all of our intermediate-term bond funds and load up on floating rate funds or whatever we're being told will hold up well in a bond bear market (don't look at 2008's numbers), we're suggesting a better alternative.  Tactical bond fund strategies offer the opportunity for potential gains in a low or rising rate environment and the ability to move to cash for safety to avoid large drawdowns.  If we just entered a bond bear market that could possibly unwind some or most of the last bond bull market's gains, it might be worth taking a new look at tactical bond strategies. 

We offer several tactical bond strategies that can be viewed on our investment strategies webpage, along with a soon-to-be-released tactical rotation bond strategy.  Over a full market cycle, these strategies are designed to provide superior risk-adjusted returns with a focus on minimizing drawdowns.  Strategies include:  
  • Tactical High Yield Strategies
    • High Yield Bull/Bear (#1 one-year return by Morningstar)
    • Tactical High Yield (long-only version of High Yield Bull/Bear)
  • Bond Allocation Bull/Bear (just celebrated nine consecutive positive quarters) 
Please contact us for more information.
 

(877) 885-7468

www.optimusadvisory.com 

info@optimusadvisory.com 

 

 

Optimus Advisory Group's Mission
At Optimus Advisory Group, we're meeting the need for liquid tactical & alternative investment strategies.  
 

For more information about any of our programs, please contact us.  You may also download the fact sheets for any of our investment strategies by visiting our website and clicking the Investment Strategies tab.  Each fact sheet contains strategy descriptions, research, performance numbers, statistics and disclosures for each model.

 

Thank you for your interest in our investment strategies.  We'll continue to keep you informed.

 

Sincerely,

 


Steve Rumsey

Chief Investment Officer
Optimus Advisory Group

6 Venture, Suite 200

Irvine, CA 92618 

(949) 727-4734

 

Advisory services offered through Optimus Advisory Group,
a registered investment advisor.

 

Disclosures

The performance results shown include the reinvestment of dividends and other earnings. Comparison of the Optimus Advisory Group Programs to any other indices is for illustrative purposes only and the volatility of the indices used for comparison may be materially different from the volatility of the Optimus Advisory Group Programs due to varying degrees of diversification and/or other factors. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will be profitable. Optimus Advisory Group does not make any representation that the Optimus Advisory Group Programs will or are likely to achieve returns similar to those shown in the performance results in this presentation. Optimus Advisory Group reserves the right to trade different funds within their models.
 

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. The S&P 500 Composite Index (the "S&P") is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Standard & Poor's chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of all indices) do not reflect the deduction of transaction and custodial charges, nor the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices and index funds used as proxies for indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual client or prospective client in determining whether the performance of the Optimus' portfolio meets, or continues to meet, his/her investment objective(s). It should not be assumed that any Optimus portfolio holdings will correspond directly to any such comparative index.
 

Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy (including the investment strategies devised or undertaken by Optimus Advisory Group) will be profitable for a client's or prospective client's portfolio. All performance results have been compiled solely by Optimus Advisory Group and have not been independently verified.
 

The Optimus performance results do not reflect the impact of taxes.