Why I cut loss on Treasuries ETF?
In my earlier post, I shared that I cut losses on all my LEAP calls on IEF ETF and TLT ETF. I have read previously on the perfect (all weather) 60-40 equity bond portfolio which beat both holding 10 year Treasury and reinvesting coupons returned 155% and S&P 500 with dividends 158%. The theory is when stocks are up, you need to rebalance and shift to bonds, vice versa. The crux lies in the link between equity and bond, when there is a crisis, investors will flee to Treasury which is considered as a safe haven.
The risk is that bond yields rise without any corresponding strength in economy to protect the profits and stock prices. This may be caused by Inflation and Interest Rates hike. Allow me to side track my previous train of thought on this, if the corporate taxes are reduced, the deficit in the long run will increase, the Interest Rate will not increase as fast as Federal Reserve will like to.
Behavior of Shares and Bonds
Prices of Shares and Bonds have moved in opposite direction since the 1990s with a strong negative correlation. Since the start of 19th century, there has been only one other significant period where stocks and bonds behaved this way according to Ian Harnett of Absolute Strategy Approach. The late 1950 and 1960s had a similar stock bond relationship to the past few years. The behavior of share and bond prices moving inversely may change, but question is when will this shift materialize?
The extra yield on Treasury investors are looking for to compensate for inflation uncertainty is extremely low. The other risk is Fed, quantitative easing has only just been put into reverse mode, the 4 trillion is only 3 billion smaller. As the balance sheet shrinks, the pressure is put on bond yields and downward pressure on stock prices. I believe inflation will be low for 2018, economy will improve further but higher bond yield will definitely happen.
Bond Bear Market
Legendary value investor Bill Miller has an optimistic view on equity market. He strongly believes that bond bull market has come to an end and investors are cashing out from bond market, shifting to equity market. He said,”I believe that if rates rise in 2018, taking the 10 year treasury above 3 percent, that will propel stocks significantly higher, as money exits bond funds for only the second year in the past ten. Bonds, in my opinion, have entered a bear market, but one that is likely to be benign for the next year or so.”
The market had already showed a strong rally in 2017 and a strong start in 2018. The improvement in corporate earnings, global recovery, tax reform, improvement in fundamental factors and further stimulus to economy drove the market prices up. According to Bill Miller, investors are shifting from bond market to stocks which will further reinforce the stock price’s movement. My guess is rising bond yield condition will further depress bond prices (TLT and IEF). The thesis is the bull run for bond market may come to an end.
Warren Buffet felt that stocks have gotten less attractive but they are still very highly attractive compared to bonds because interest rates are very low. With rising valuations, it is not like buying shares after the 2008 financial crisis which is like shooting fish in a barrel. Nonetheless, I felt that rather than seating and waiting for the Treasury ETFs to appreciate, it will be better to switch out to stocks and ride this last wave.