Update: bonds, earnings and positioning
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This week the bond market was relentless. The 10Y yield touched 5% for the first time since 2007. An all US Treasury bond portfolio is now down 40% since COVID (see below). Just pause for a minute and think of the implications of that. Who are the biggest holders of US Treasury bonds? Well, almost every single pension fund in the world, almost every big bank in the world, University endowments, family offices, hedge funds, you name it. And yes, a lot of retail investors too.
Holding bonds during the inflationary early 2020s has been one of the worst possible trades. Obviously if you just keep holding to maturity, these losses don’t affect you, you get the full principal plus interest, but sitting on huge piles of unrealized losses was exactly what hurt banks in this week’s earnings sessions (BofA, Goldman, Morgan Stanley, to name just a few). Or if you need liquidity and need to sell these bonds before maturity (for example if you’re a pension fund or Silicon Valley Bank), you’re in trouble.
That’s what usually happens during inflationary periods. High, sticky inflation implies higher interest rates from the Fed, which drives bond yields up, and their prices down. When they have to sell, bondholders become bagholders.
However, during this cycle, bonds start to become more and more attractive at one point. US Treasuries, which are considered to be a zero-risk asset with so much liquidity that it tends to be considered a substitute for cash, are offering a 5.2% return on the 2-year bond and 4.9% on the 10-year. That’s a really really good return for a risk-free asset (nothing is risk free ofc, but the probability of US defaulting on its debt is negligible).
So investors start piling their stimulus-induced excess savings into T-bonds, pulling out from the equity market. What’s been going on since the summer is still very much the main trend on the market. And this week, it brought the market down quite a bit. Even decent earnings beats couldn’t prevent the slump. A sign of things to come?
