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Good one, Hank. When interest rates rise, and they will, the principle on the 1.9% could lose 10% or more. Just figure how much longer it will take...to REGAIN your principle, forget about doubling it. The sad thing is that it will be the "little investors" who will get creamed on this. They get suckered into buying these longer-term Treasuries at stupid prices, and they are left holding the bag when the pros have already turned out the lights. There are a lot of other options for investors than dumping money into long-term Treasuries, but unfortunately many folks do not remember, or choose to forget, the last time we had real inflation and significantly higher interest rates.
Now, hank; you know that example may confuse some folks wandering into MFO for a read. While the calculation provides data for a buy and hold of a 10 yr note; this is not a likely scenario for the individual investor. This would be the equivalent to an individual investor buying an equity share with a dividend of the same amount and presuming there would be no growth in the underlying value of the purchased share.......the price for 10 years.
Sample: Jan 1, 2010 through Jan 10, 2012. Numbers rounded and the bond fund is represented by IEF; although not the total optimal expression of the 10 year note, but an easy to review ticker for the 7-10 year range.
Let us presume one buys equity fund "x" and also buys bond fund "x" on Jan. 1, 2010. The equity fund is purchased with the hope of an increase in value(price) of the fund holdings and during the wait, it is nice to obtain the 4% dividend being paid by the fund. A divident play too, eh?
Another investor buys a bond fund consisting of only 10 year T-notes. This investor is also playing the yield(dividend) side; but also expects price appreciation too; not unlike the equity purchaser above.
The scenario is that the equity fund investor expects this area to grow in value/price; and the bond fund investor expects the opposite, and that equities are not the place to be with the current market conditions, and that bonds should benefit.
Next, based on the above....the equity and bond investors both purchase their choices on Jan 1, 2010 with values as of yesterday, Jan 10, 2012. The basis of these numbers are from the IEF etf. I will presume an equity fund could be found that closely matched the below, as of Jan 1, 2010.
---equity fund is at $89 with a dividend of 4% ---bond fund is at $89 with a yield of 4%
Scenario 1: Equities do indeed advance in this time period, and the equity fund holder finds current pricing at $105, although this has caused the dividend to move down to 1.9%. But, the equity investor is now not focused on the smaller yield, although it is extra gravey money on the side; because the primary value of the holding is the advance in the price, which roughly translates into a 10% average return for the two years holding period. This investor is pleased.
Scenario 2: The same event takes place for the bond fund holder, and this investor is also pleased.
Neither investor in their winnng scenarios gives regard as much to the dividend or yield; because the value of the growth of their money is really in the price advance; with the dividend/yield being a little extra boost in their return.
Yes, indeed; it does matter for the price point of purchase for anything, yes? Not unlike Bob C. mentioned regarding bonds. Some folks may get the big head slap. Has the end game arrived for low bond yields? I surely can not answer that, but Mr. Bernanke is still not convinced about the strength of economy. While I don't agree with the policies and methods in total; I am but a passenger within the boat, of which; he is the captain and decides the course of travel.
Addendum: The low interest rate environment; if it continues for a much longer time period may place a strain on the abilities of portions of pension funds and insurance companies to balance their outflows of monies on pensions and policy plans (annuities, etc.). Also involved are those who need or choose to maintain bank.CU accts. with interest bearing features, including CD's. These folks will continue to fall behind in the cost of goods and services going forward; unless there is a full blown deflation in our future. This is a concern I have, related to susstained low interest rates.
Hopefully, my show and tell is of some value.
Ok, I either have to stop the coffee for today; or get another cup.
Well, Catch. for starters my example was somewhat hypothetical as one can't earn interest on a 10-year treasury bond for longer than 10 years. But I think the point about the folly of holding treasuries at these rates still stands. Alibet, a fund manager may effectively use long treasuries as leverage to dampen volitility or for other strategic reasons. (I'm glad the manager of my high yield fund holds a few.) However, for most of us non-professionals, I view these things with a great deal of skepticism.
Now, if I understand your argument, you believe the low coupon rate (1.9% on 10-year treasury) does not represent the real return potential because one should also consider "capital appreciation" of the bond's market value. You compare this to the capital appreciation in equity holdings.
That's not a fair comparison. Appreciation of a treasury bond is tied to falling interest rates - clear and simple. For example, when than-current T-bonds yield only 1.5%, than folk will eagerly pay a premium to buy the older one yielding 1.9%. That's well and good far as it goes. Obviously, the party can't continue indefinitely. As Bob C pointed out, when rates reverse, there will be hell to pay.
Equities on the other hand increase in value as the underlying businesses grow and prosper. Product development, increased customer base, more efficient operations, all play a part in this type of constructive appreciation. In addition there's often inflation protection from things like real estate and infrastructure owned by the company.
Where's the constructive appreciation In a treasury bond? Appreciation yes. Only because newer issues continue to DECLINE in real value as measured by rate of return. That's akin to enjoying free home heating during winter by burning the walls and furniture. A good example how detatched from reality the bond market has now become is that, even in the face of a "downgrade" by S&P, government bonds have continued to rise in price.
I assume you recognize rates will reverse someday - likely in our lifetime. When that happens the touted "capital appreciation" of government securities will begin to resemble Titanic's vaunted voyage. I further assume you and many others intend to "bail" at just the right time. (like we all did when NASDAQ was around 5,000?) In that I wish you well and believe you will have a better chance of success than the average investor. Keep in mind, however, nobody's gonna ring a bell when it's time to jump ship. There will be false spikes in rates followed by false declines, likely lasting many years before a clear trend is apparent. During the process it's likely investors more savvy than you or I will have picked the low hanging equity fruits and successfully transitioned to the rising rate environment. The johnny-come-latelys (Bob calls them little guys) will only than sell their debased bond holdings and climb aboard the equity boat at greatly inflated prices.
Really, a +1 for hank? I do believe he and I are noting the same pricing actions; just in different and generally opposing investment sectors. One may receive a profit with either.
Perhaps another bond investor will offer some support for poor old Catch.
Reply to @hank: "I assume you recognize rates will reverse someday - likely in our lifetime. When that happens the touted "capital appreciation" of government securities will begin to resemble Titanic's vaunted voyage. I further assume you and many others intend to "bail" at just the right time. (like we all did when NASDAQ was around 5,000?) In that I wish you well and believe you will have a better chance of success than the average investor. Keep in mind, however, nobody's gonna ring a bell when it's time to jump ship. There will be false spikes in rates followed by false declines, likely lasting many years before a clear trend is apparent. During the process it's likely investors more savvy than you or I will have picked the low hanging equity fruits and successfully transitioned to the rising rate environment. The johnny-come-latelys (Bob calls them little guys) will only than sell their debased bond holdings and climb aboard the equity boat at greatly inflated prices. As Bob C pointed out, when rates reverse, there will be hell to pay."
Seconded. I'm not as positive on equities, but I'm certainly negative on treasuries.
Reply to @scott: You have been negative for about 4 years now. All the houses are bad on the block--the US just happens to be the best of the worst because it did what safe havens do--it bailed out the world in 2008. I see Gross is now about 30 percent tresuries--maybe it is about time to dump them.
Comments
Link to compound interest calculator
http://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php#results
Now, hank; you know that example may confuse some folks wandering into MFO for a read. While the calculation provides data for a buy and hold of a 10 yr note; this is not a likely scenario for the individual investor. This would be the equivalent to an individual investor buying an equity share with a dividend of the same amount and presuming there would be no growth in the underlying value of the purchased share.......the price for 10 years.
Sample: Jan 1, 2010 through Jan 10, 2012. Numbers rounded and the bond fund is represented by IEF; although not the total optimal expression of the 10 year note, but an easy to review ticker for the 7-10 year range.
Let us presume one buys equity fund "x" and also buys bond fund "x" on Jan. 1, 2010. The equity fund is purchased with the hope of an increase in value(price) of the fund holdings and during the wait, it is nice to obtain the 4% dividend being paid by the fund. A divident play too, eh?
Another investor buys a bond fund consisting of only 10 year T-notes. This investor is also playing the yield(dividend) side; but also expects price appreciation too; not unlike the equity purchaser above.
The scenario is that the equity fund investor expects this area to grow in value/price; and the bond fund investor expects the opposite, and that equities are not the place to be with the current market conditions, and that bonds should benefit.
Next, based on the above....the equity and bond investors both purchase their choices on Jan 1, 2010 with values as of yesterday, Jan 10, 2012. The basis of these numbers are from the IEF etf. I will presume an equity fund could be found that closely matched the below, as of Jan 1, 2010.
---equity fund is at $89 with a dividend of 4%
---bond fund is at $89 with a yield of 4%
Scenario 1: Equities do indeed advance in this time period, and the equity fund holder finds current pricing at $105, although this has caused the dividend to move down to 1.9%. But, the equity investor is now not focused on the smaller yield, although it is extra gravey money on the side; because the primary value of the holding is the advance in the price, which roughly translates into a 10% average return for the two years holding period. This investor is pleased.
Scenario 2: The same event takes place for the bond fund holder, and this investor is also pleased.
Neither investor in their winnng scenarios gives regard as much to the dividend or yield; because the value of the growth of their money is really in the price advance; with the dividend/yield being a little extra boost in their return.
Yes, indeed; it does matter for the price point of purchase for anything, yes? Not unlike Bob C. mentioned regarding bonds. Some folks may get the big head slap. Has the end game arrived for low bond yields? I surely can not answer that, but Mr. Bernanke is still not convinced about the strength of economy. While I don't agree with the policies and methods in total; I am but a passenger within the boat, of which; he is the captain and decides the course of travel.
Addendum: The low interest rate environment; if it continues for a much longer time period may place a strain on the abilities of portions of pension funds and insurance companies to balance their outflows of monies on pensions and policy plans (annuities, etc.). Also involved are those who need or choose to maintain bank.CU accts. with interest bearing features, including CD's. These folks will continue to fall behind in the cost of goods and services going forward; unless there is a full blown deflation in our future. This is a concern I have, related to susstained low interest rates.
Hopefully, my show and tell is of some value.
Ok, I either have to stop the coffee for today; or get another cup.
Take care, and get the blower ready, eh?
Catch
Now, if I understand your argument, you believe the low coupon rate (1.9% on 10-year treasury) does not represent the real return potential because one should also consider "capital appreciation" of the bond's market value. You compare this to the capital appreciation in equity holdings.
That's not a fair comparison. Appreciation of a treasury bond is tied to falling interest rates - clear and simple. For example, when than-current T-bonds yield only 1.5%, than folk will eagerly pay a premium to buy the older one yielding 1.9%. That's well and good far as it goes. Obviously, the party can't continue indefinitely. As Bob C pointed out, when rates reverse, there will be hell to pay.
Equities on the other hand increase in value as the underlying businesses grow and prosper. Product development, increased customer base, more efficient operations, all play a part in this type of constructive appreciation. In addition there's often inflation protection from things like real estate and infrastructure owned by the company.
Where's the constructive appreciation In a treasury bond? Appreciation yes. Only because newer issues continue to DECLINE in real value as measured by rate of return. That's akin to enjoying free home heating during winter by burning the walls and furniture. A good example how detatched from reality the bond market has now become is that, even in the face of a "downgrade" by S&P, government bonds have continued to rise in price.
I assume you recognize rates will reverse someday - likely in our lifetime. When that happens the touted "capital appreciation" of government securities will begin to resemble Titanic's vaunted voyage. I further assume you and many others intend to "bail" at just the right time. (like we all did when NASDAQ was around 5,000?) In that I wish you well and believe you will have a better chance of success than the average investor. Keep in mind, however, nobody's gonna ring a bell when it's time to jump ship. There will be false spikes in rates followed by false declines, likely lasting many years before a clear trend is apparent. During the process it's likely investors more savvy than you or I will have picked the low hanging equity fruits and successfully transitioned to the rising rate environment. The johnny-come-latelys (Bob calls them little guys) will only than sell their debased bond holdings and climb aboard the equity boat at greatly inflated prices.
That's how hank sees it anyway.
Really, a +1 for hank? I do believe he and I are noting the same pricing actions; just in different and generally opposing investment sectors. One may receive a profit with either.
Perhaps another bond investor will offer some support for poor old Catch.
Take care of you and yours,
Catch/Mark
Seconded. I'm not as positive on equities, but I'm certainly negative on treasuries.
Perhaps 1.12.12 will be the date to remember.
http://www.businessweek.com/news/2012-01-12/treasury-30-year-falls-as-sale-draws-lower-than-average-demand.html
Take care,
Catch