The Ticking Time Bomb in Your Portfolio
After eight years of short-term interest rates near zero, a lot was said about how the Fed’s easy money policy (aka ZIRP) benefited investors at the expense of savers.
However, it’s fixed-income investors who may get their heads handed to them in the months – and even years – ahead.*
Most have a ticking time bomb in their portfolio. And if you’re one of them, now is the time to defuse it…
There’s a common perception that the Fed’s ultra-low interest rate policy was an attempt to force investors out of cash and into stocks and bonds.
That’s not exactly true.
The central bank was trying to help Main Street. Low interest rates make it cheaper for businesses to expand (and hire) and for consumers to spend. But a byproduct of this monetary policy has been rocket fuel for equity and bond markets.
Super-low interest rates make holding cash unattractive. You are guaranteed a negative return after inflation.
So investors understandably gravitated to higher-yielding stocks and bonds, fueling a rally in both. The problem is that bonds don’t pay much anymore either.
Ten-year Treasurys today yield less at 2.05%. Sad as that is, these are some of the developed world’s highest-yielding government bonds. Many countries have seen government bond yields hit record lows.
Some are yielding less than nothing. German 10-year yields dropped below zero for the first time ever in 2016.
Yields are pathetic even at the long end of the spectrum.
Who in their right mind would lock up their capital for that long at such a paltry rate?
When it appears that investors have lost their senses, it generally means they have lost their perspective.
Remember the hyperinflationary early ‘80s? Consumers and investors were certain that double-digit inflation was here to stay. So they loaded up on inflation hedges galore: commodities, gold, silver and platinum.
Then they watched them wilt like last week’s roses for more than two decades.
Fixed-income investors are setting themselves up for a similar disappointment. Having seen rates so low for so long, some believe they will always be in the cellar.
History shows that is not the case. And bond prices move inversely to interest rate changes. In other words, when rates rise, bonds plunge.
Interest rates may stay down a while longer. (After all, no one – and I mean no one – was predicting eight years of ZIRP eight years ago.) But there will be a bloodbath when rates eventually move higher.
(Consider that if you are 35 or younger, your entire life has been one long bull market in bonds.)
Investors now think of fixed-income securities as safe, conservative investments that provide some income along with a bit of capital appreciation.
But capital depreciation could easily offset future income distributions. Not just for months – but for years.
This will come as a shock to many, as they are psychologically unprepared for it. (After all, this is their safe money.)
Don’t be one of them. Look at your total bond allocation. Make sure you have not overweighted fixed-income investments. Avoid long-term maturities. Pare back on medium-term maturities.
And sell ALL your leveraged closed-end bond funds. Yes, those safe-sounding ones that sport high yields. They are using leverage – margining the portfolio – and will take the biggest beating when rates rise again.
Wayne Gretzky famously said that he never skated to where the puck was. He skated to where it was going to be.
As an investor, you need to do the same. Reduce your bond market exposure now.
One day – and it may be sooner than you expect – you’ll be glad you did.
*The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of professional analysts.
About Alexander Green
An expert on momentum investing, value investing and investing based on insider activity, Alex worked as an investment advisor, research analyst and portfolio manager on Wall Street for 16 years. He now runs the wildly successful Oxford Communiqué, ranked as one of the top investment newsletters by Hulbert Digest for more than a decade. He is also the author of four national best-sellers: The Gone Fishin’ Portfolio, The Secret of Shelter Island, Beyond Wealth and An Embarrassment of Riches. He shares his wisdom in his free daily e-letter, Liberty Through Wealth.