Mar 14, 2012
Let's take a look at some bond market action. The bond market it far larger than the stock market so this should not be a topic you should just skip -- this is what 'the world' actually owns with majority of its money -- the bond market. Even if you are primarily an equity person -- understanding some bond market basics will help you to understand what is going on overall in the markets.
While bonds mature at par and always pay a positive (nominal) return to maturity, intermediate and long-term bonds are very much subject to material drawdowns.
If we define the bond market to be the Barclays Aggregate index, let's take a logical look at what has happened when this key index drops. That is, let's calculate how each segment does on both a relative and absolute basis when bonds get nailed.
As you can see in the table below, through last nights close, the bond market has lost at least -0.23% in daily total return change 101 times over the past 3 years (we effectively solved for the last 100 here). Obviously, longer-maturities do worse and investment grade bond ETFs are not immune to this -- LQD has dropped on 89 of those 101 days and show a slightly larger loss than the overall Barclays Aggregate ETF return.
We prefer to show many of our big picture themes in our Allocation Board portfolios -- as talk is ultimately cheap. On Feb 16, we lowered duration further than we were and mentioned in the dated comment the overvaluation of intermediate and long-duration bonds. We moved incrementally towards a very defensive bond position. In both E-ETFRE and E-ETFRS, allocations that both hit new all-time highs yesterday -- we are essentially all junk-bonds with a mix of very low duration fixed-income ETFs. Junk bonds are down slightly today -- but that shouldn't be a big shock as the correlation of junk bonds to the overall bond market is not strongly negative on big down days. Indeed, while junk bonds tend to rise on big bond market loss days -- as seen below, it's not a vastly dominant percentage of the time --- and that is certainly reasonable and very much consistent with very low correlated assets.
The screenshot above is from the tools page app called Down Day Stats. It is on the Tools page with a number of other useful apps (some of which are free). Try it for other key markets --- like treasury bonds (TLT) vs Gold (GLD) vs Silver (SLV). Or see how emerging markets act on days the dollar rallies (UDN goes down). What is 'normal' behavior? You need to have facts to understand what is 'not normal' as this can be very helpful in understanding what is actually going on. If it all seems complex, that is because it is kind of complex. The Euro, junk bonds, bank stocks, tech stocks -- how do they all interact?? Basing your investing on these key ideas is what money management is about, in our opinion --- not gambling on the next Netflix (NFLX) or Green Mountain Coffee (GMCR) earnings report.
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