How Bad Could Bond Market Losses Get?

A few years ago Vanguard performed a study to see how the Barclays Aggregate Bond Index would be affected by an overnight 3% rise in interest rates (something that has never actually occurred). They calculated what would happen if rates suddenly rose from 2.1% to 5.1% and showed the impact going out 5 years:

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You can see the immediate loss would be around 13% (they also noted that the worst 12 month loss ever in bonds was -13.9% in 1974). But because the yield on bonds would now be much higher, the expected return going forward would now be around 5.1% annually, meaning the breakeven would be just over 3 years. So not exactly a crash of epic proportions.

Source: How Bad Could Bond Market Losses Get?

REITS Look Alarming

REITs have been the darling asset class for the last few years, they out performed all other asset classes in 2010, 2011, 2014, 2015 and the first half of 2016.  After being up 13.7% through June 30th of this year they have almost entirely wiped out that gain and are about to go negative for the year.

The Vanguard REIT ETF which tracks the MSCI US REIT index is currently yielding 3.92%, not much of a premium over the riskless US 10 year Treasury at 2.35%.

REITs have benefitted from investor’s search (reach) for yield and low borrowing rates on properties.  That could be coming to an end with the rise in the 10 year Treasury, a looming rate hike by the Federal Reserve in December, and rising defaults on commercial mortgages.

Buyer beware, we could be looking at a repeat of the Master Limited Partnership (MLP) debacle in the second half of 2015.

WSJ -Trouble Brewing in Commercial Real Estate

Global Inflation-Linked Bonds: A Primer

So what are inflation-linked bonds? They are most typically debts issued by sovereign nations whose nominal interest rate is adjusted, either up or down, by an inflation measure.Despite the obvious allure of this kind of debt — it eliminates a risk: inflation, duh! — there are not many issuers worldwide. Total global issuance is $3 trillion. The United States, with $1.2 trillion, and the United Kingdom, at about $800 billion, are the principal movers, though there is growing issuance in France, Italy, Spain, Germany, and Brazil, among other markets.

Source: Global Inflation-Linked Bonds: A Primer

How do the Mechanics of Negative Interest Rates Work?

Do bond holders that have a negative yield  pay the issuer?

chart-interest-option1

Now let’s look at an example with negative yields. If you buy the same bond at $101, and it matures a year later at $100, then your yield is -1%. You paid more for the bond than you received back when the bond matured, and you didn’t receive any coupon payments along the way. And this same mechanic can work for a bond that pays coupons. Say there is another bond that pays a $1 coupon in one year, along with the $100 you get back in maturity proceeds, in total you get $101. If you pay $102 for that bond today, then in a year you have again earned a yield of around -1%. You paid $102 in return for total cash flows of ($100+$1) = $101.

Source:  How do negative interest rates work?

On Inflation, Prepare for the Unexpected

Inflation levels are low and expected to remain low—but that’s no excuse for not protecting against unexpected moves, according to Meketa Investment Group.The Boston-based consultant advocated for allocations to inflation-protected bonds and real assets to safeguard portfolios against sudden inflation spikes.“Holding assets that do not decline in real value during unexpected inflationary periods enhances the ability of the total portfolio to make payouts while protecting its value on the downside,” the authors wrote. “This diversification reduces the volatility of the total portfolio’s value, even though the inflation-hedging assets may demonstrate considerable volatility when viewed in isolation.”

Source: On Inflation, Prepare for the Unexpected | Chief Investment Officer

Edward Altman: The Benign Credit Cycle Is in Extra Innings

Edward Altman says the benign credit cycle is in “extra innings,” but the metaphorical relief pitchers — central bankers — are running out of gas.

 

Source: Edward Altman: The Benign Credit Cycle Is in Extra Innings

Bonds yielding less than 0% now make up $6 trillion

The market for negative-yielding bonds is now worth around $6 trillion, and has doubled in just over a month, showing just how worried how investors across the globe are about the state of the world’s economy.

Source: Bonds yielding less than 0% now make up $6 trillion of the global debt markets – Business Insider

Chief Investment Officer – High Yield’s Liquidity Conundrum

Liquidity in the biggest individual high-yield fixed income funds varies significantly from one portfolio to the next, according to an analysis by Fitch Ratings.

Source: Chief Investment Officer – High Yield’s Liquidity Conundrum

Liquidity is a Coward

Liquidity is a coward – It’s never there when you want it.

Recently I was listening to an interview with Jeff Gundlach, the CEO and CIO of Doubleline Capital, where he was talking about the liquidity of commercial mortgage backed securities (a type of bond that is backed by mortgages on commercial buildings) and he used that phrase to describe the market in those securities.   Until you have actually been in a position that you can’t get out of at a reasonable price you would never understand how true that statement is.  Unfortunately in the last week, many high yield bond investors and managers at Third Avenue Focused Credit Fund are finding out how price and liquidity can disappear just when you need it most. (Third Avenue Blocks Redemptions From Credit Fund Amid Losses)

I love clichés.  The thing about clichés is that they wouldn’t be around and so heavily used if they weren’t true.  In this case, there is a hard lesson to learn.  One that can go without notice until you are right smack in the middle of it and wishing there was a way out.

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