Bonds!

[TwoCitiesCapital]

6 hours ago, mattee2264 said:

I'm inclined to stay in short term bonds. While inflation will probably continue to come down I would expect the yield curve to steepen especially as concerns over US government debt begin to build. 

 

 

 

 

I tend to agree it will steepen, but think it'll be the more traditional type with short term rates falling. 

 

The US fiscal position is totally untenable, and yet still better than much of the developed world who are NOT the reserve currency with forced buyers of USD and treasuries. 

 

It'd be hard for me to imagine a spiral of long term treasuries without first seeing spirals in Europe, Japan, China, etc. 

[james22]

5 minutes ago, TwoCitiesCapital said:

I tend to agree it will steepen, but think it'll be the more traditional type with short term rates falling.

 

My vote.

 

[thepupil]

On 10/19/2023 at 2:14 PM, thepupil said:

I sold almost all my individual 20 ish year individual corporate bonds today, having lost 5-10% in a relatively short time frame seemed like a liquid day with very tight bid/ask. 

 

I plowed all proceeds and more into VCLT w/ some $55 tail hedge puts. this move generated some tax losses, freed up lots of margin, and replaced that which i sold w/ diversified equivalent.

 

eventually, I'll migrate these to tax free accounts but in the accumulation phase it's just easier to buy in taxable, short term returns dominated by price change whcih thus far is negative/loss generative.

 

Long term Corporate Index:

$76, 4.45% coupon, 22 yr wgt avg maturity, duration of 12, yield of 6.5%. 

 

I'm happy to be early to taking duration risk and am happy to lose money all the way down. Let's go!

 

this was a good trade. late October really sized into VCLT. 

 

now we're seeing bloomberg articles on pensions not being able to get enough long duration corporate paper.

 

spreads have actually tightened to < the prior "free money" decade. been lightening up on spread risk and bonds generally, but still probably have more than 99% of people my age lol. 

 

 

 

 

Quote

(Bloomberg) -- 

A quirk in retirement fund accounting is making corporate pensions look particularly flush now, giving them more incentive to cut risk by dumping equities and buying bonds.

Corporate bond yields, used to value companies’ pension payouts, have jumped since early last year, effectively allowing fewer dollars now to fund future obligations. That oddity in pension accounting has helped leave retirement plans with 104.2% of the funding they need as of the end of October, data from the Milliman 100 Pension Funding Index shows.

That’s the greatest level of overfunding since October 2022 according to the index, which looks at aggregate funding ratios for the 100 biggest corporate pensions. Funding levels have been climbing for more than a decade, helped by a surging stock market. 

 

The surplus could further boost bond buying, according to JPMorgan Chase & Co. Fully funded pensions often sell equities and buy bonds, particularly corporate notes, to lock in higher yields that can cover future obligations. 

“Pension plans are taking advantage of the highest yields in many, many years, which is logical and what they should do and they’re doing it,” said Eric Beinstein, JPMorgan’s head of US high grade credit research and strategy, in an interview. “Not only does the fixed-income yield look attractive, but equity volatility is also a lot higher now. So, you’re not incentivized to hang on another year, thinking maybe stocks will be up 

 

Since March 2022, the 100 US public companies sponsoring the largest plans have enjoyed surplus or near-surplus funding levels overall, Milliman’s analysis through October 31 shows. Retirement plans were underfunded for much of the decade or so following the 2008 financial crisis, but that trend reversed after the central bank started raising rates. 

 

“By and large, it is an industry that moves slowly,” said Matt McDaniel, who leads US pension strategy and solutions at consulting firm Mercer. “There probably should be a little bit more urgency. There is one of the ironies of pension risk, is that the better funded you get, the higher your risk is because you have more to lose.”

Traditional yield buyers, namely pension funds and insurance companies, were net buyers of corporate debt through the first half of the year and make up about 30% of total US corporate bond ownership, according to Morgan Stanley. 

 

“While we don’t have real-time data to track these flows, anecdotally demand has accelerated further in 3Q so far, especially in September,” strategists including Vishwas Patkar wrote in an October note. “There is significant room to grow, especially if complete duration hedging is the ultimate goal.”

The strategists expect yield buyer demand to stay robust, though they say “some normalizing of rates volatility is needed.   

The demand comes as US investment-grade debt issuance has shrunk — helping tighten spreads on corporate debt. 

 

“We are under-supplied in the product that liability-driven investors want to own the most and that is long duration,” said Maureen O’Connor, global head of high-grade debt syndicate at Wells Fargo & Co. “A lot of that has to do with pensions rotating from equities to fixed-income.”

Insurers and pensions are known as liability-driven investors as their strategies involve funding future liabilities. Their investments, such as equity or debt, are determined by their obligations.

The average spread on US corporate bonds stood at 113 basis points on Tuesday — 11 basis points tighter than the average of 124 basis points seen over the last decade, even after more than a year-and-a-half of monetary tightening, which has raised recessionary risks.  

Long-Duration Bet

Across most multi-tranche high-grade deals this year, the longer-dated tranches have been the most oversubscribed, and new issue concessions are now tightest at the long-end of the curve, according to O’Connor. That shows liability-driven investors are willing to buy at very close to fair value, she said.

“The liability-driven investors’ bid for duration and the absence of supply has been topical almost all year,” she said. “And it’s definitely going to continue to be, going forward.”

Still, that doesn’t mean the tightening is “logical,” JPMorgan strategists led by Beinstein pointed out in a September report. There’s a lot of time between 10 and 30 years for credit risk to deteriorate, which risk premiums ought to provide compensation for, but instead they’ve fallen to the low end of the historical range, they noted.  

Bingeing on Bonds

Pensions usually see the present value of their liabilities drop as rates climb. By the end of October, pension liabilities had fallen to about $1.179 trillion, from $1.685 trillion at the end of February 2022, just before the Fed started hiking, Milliman’s data shows. 

“I’m not an economist, and I don’t think anybody can forecast interest rates, but it’s hard to believe that interest rates would be significantly higher than they are right now,” said Zorast Wadia, principal and consulting actuary at Milliman. When rates eventually come down, “pensions are going to see a rise in their liabilities unless they’re locked in.”

Last month, 10- and 30-year Treasury yields started crossing above 5% before retreating, further incentivizing pension plans to double down on fixed-income investments. Higher bond yields have also boosted the percentage that retirees can withdraw annually from personal savings over 30 years, with a strong chance of not running out of money, according to Morningstar’s annual retirement income report out last week. 

“We are seeing plan sponsors — a lot of plan sponsors actually — set explicit investment strategies that say, ‘When I hit a trigger point of 95% funded or 100% funded, I’m going to take X number of assets from the equity portfolio and move it to the fixed-income portfolio’,” said Mercer’s McDanie 

“Those that don’t have those formal-type strategies are still having the same conversations and saying, ‘Hey, if I took 60% equity risk when I was 80% funded and now I’m 105% funded, it probably makes sense to be taking a little bit less today’,” he added. “So, we’re definitely seeing plan sponsors making those moves.” 

Meanwhile, US equity markets have been rattled this year by war in the Middle East and concerns around the strength of US consumers, giving pension fund managers another reason to move into safer assets like bonds.

“We’re always out talking to our clients and those that we work with saying, ‘Look, we’ve seen this story before where funded status looks great and it falls down’,” said McDaniel. “‘Let’s make sure once you get to those periods where funded status is in a good spot, you’re doing something to protect yourself’.”

 

Quote

 

 

[james22]

In general, bonds add little or no value to the portfolio of ordinary long-term investors

 

https://www.morningstar.com/news/marketwatch/20231122350/dump-your-bonds-this-new-research-says

[gfp]

On 10/11/2023 at 9:14 AM, gfp said:

I think there is a lot of demand across the curve for treasury securities with a 5 handle.  This year's bond market (and maybe the stock market as well) is shaping up to rhyme with 2018.

 

On 10/26/2023 at 1:11 PM, gfp said:

 

It will be interesting to see if anything on the UST curve from 2's out to 30's can close today with a 5 handle...  As I posted above, the seasonal pattern is playing out just like 2018.  Big September-effect yield fake out.  There is a lot of demand for US government securities at 5%.

 

 

So now that the September-effect seasonal fake out in bond yields has ended, with absolutely no change to the outlook for issuance / supply, can we all admit that it is the long term outlook for the economic growth and inflation that matters for long term interest rates and not issuance?  The long term damage from the COVID-era fiscal deluge might even have decreased long-term economic growth potential - in a way, that wasteful inflationary period may end up contributing to lower long term rates over time if it contributes to another step down in long term economic growth.

 

Lower interest rates = worse economy

Higher interest rates = better economy

 

Stock market bulls should be hoping for higher interest rates, not the other way around.

 

 

[james22]

If you look back at the annual returns you’ll notice that consumer staples/defensive has only lost money 6 times over the last 40 years; and its worst year was a loss of 14%. It has a comparable risk level to long term treasuries yet an outperformance of 6% per year.

 

https://engineeredportfolio.com/2016/12/17/historical-performance-of-us-equity-sectors/

[frommi]

Its a little bit funny, the article is from 2016 and since then the staples sector has underperformed by a lot. Maybe past performance is a poor indicator?

[Fitz]

@frommi I was thinking the same thing. 

 

I think it is a little dangerous to think that way, when you look at past prices and try to make a statement about owning certain stocks over bonds due to their 'price' volatility it's missing the point. 

 

Owning a bond, or lending money to a company is a completely different animal as the cash flows and return aren't determined by the sentiment of the market at any point. They are only determined by the company or country's ability to pay. When the yields on bonds, especially treasuries are higher than the earnings yield for the market, it may be a nice time to move some of your money into bonds. Especially if you have an opinion about the growth in earnings going forward. 

[Gregmal]

There has been a lot of fanfare around bonds but really most of it is just "please spare me the volatility" masquerading around as financial savviness. 

[james22]

2 hours ago, frommi said:

Its a little bit funny, the article is from 2016 and since then the staples sector has underperformed by a lot. Maybe past performance is a poor indicator?

 

Yeah, jinxed it.

 

But look at what bonds have done since then.

[tede02]

Man, what a ride with rates this year (and equities I suppose)! Right now I'm feeling pretty good about shifiting a lot of cash to term debt over the last 4 months. I just missed the coveted 5% treasury note the day Ackman publicly said he was taking his rate bet off and long rates dropped back in the 4s. I bought a nice chunk of TIPS. Wish I had some more medium term nominals but you can't have it all I guess. 

 

I follow the main inflation reports, (CPI, PCE, PPI, etc.) and the downward trend is quite strong. All that said, if I were the Fed, I personally would have preferred to maintain more hawkish rhetoric at least for a while. They pencil in 3 rate cuts for 2024 and now you have equities back to their highs and long rates plunging. This fights against what they're trying to do unless they do really want market expectations to start easing conditions. 

 

 

[mattee2264]

Wouldn't be so sure.

Usually there is a term premium of around 100bps. So with the Fed funds rate still at 5% and the 10 year bond dipping below 4% even if the market is correct and there will be six rate cuts in 2024 that isn't going to produce much of a yield curve. And the US government has a lot of debt that needs to be refinanced as well as the likelihood of another multitrillion dollar deficit. 

[CorpRaider]

2 hours ago, tede02 said:

Man, what a ride with rates this year (and equities I suppose)! Right now I'm feeling pretty good about shifiting a lot of cash to term debt over the last 4 months. I just missed the coveted 5% treasury note the day Ackman publicly said he was taking his rate bet off and long rates dropped back in the 4s. I bought a nice chunk of TIPS. Wish I had some more medium term nominals but you can't have it all I guess. 

 

I follow the main inflation reports, (CPI, PCE, PPI, etc.) and the downward trend is quite strong. All that said, if I were the Fed, I personally would have preferred to maintain more hawkish rhetoric at least for a while. They pencil in 3 rate cuts for 2024 and now you have equities back to their highs and long rates plunging. This fights against what they're trying to do unless they do really want market expectations to start easing conditions. 

 

 

I am beginning to understand why the psychology/ institutional incentives have historically (ok N = like 5) led to premature cutting and declarations of victory.  Not drawing a conclusion that will happen this time, just that I think I see why that would be the most likely path.  Seems you kind of need that real crisis/boogie man to get the rope to do the thing properly.  I suppose it all kinds of feed back into the anchoring of the crowd which is imop best explanation for time series momentum/trends.

Edited December 14, 2023 by CorpRaider

[gfp]

Would you look at that...  

[TwoCitiesCapital]

38 minutes ago, gfp said:

Would you look at that...  

 

[Gmthebeau]

Everyone and their dog saying lock in long term rates here at 4%, but virtually nobody saying it at 5%.  Rest assured the crowd always wrong, and we will likely see persistent inflation and despite Jerome salivating to cut rates, the 30 year will likely re-approach 5% sometime in 2024.

[gfp]

17 minutes ago, Gmthebeau said:

Everyone and their dog saying lock in long term rates here at 4%, but virtually nobody saying it at 5%.  Rest assured the crowd always wrong, and we will likely see persistent inflation and despite Jerome salivating to cut rates, the 30 year will likely re-approach 5% sometime in 2024.

 

On 10/11/2023 at 10:14 AM, gfp said:

I think there is a lot of demand across the curve for treasury securities with a 5 handle.  This year's bond market (and maybe the stock market as well) is shaping up to rhyme with 2018.

 

[Gmthebeau]

5 minutes ago, gfp said:

 

 

 

I would agree there is pretty good demand around 5%, but I think we will see it again probably in late 2024 but as fast as markets move (or get manipulated) who knows maybe by mid-year.  Nobody is going to buy 30 year bonds at 4%, despite all the TV pundits trying to get you to buy the ones they would like to sell.   Core inflation is still around 4%, so rates are again to low on the 10-30 year part of the curve.   The only way it makes sense is if inflation totally collapses (very unlikely) soon.

[lnofeisone]

On 12/20/2023 at 11:12 AM, Gmthebeau said:

Everyone and their dog saying lock in long term rates here at 4%, but virtually nobody saying it at 5%.  Rest assured the crowd always wrong, and we will likely see persistent inflation and despite Jerome salivating to cut rates, the 30 year will likely re-approach 5% sometime in 2024.

To me the question is really, will Jerome have to raise the rates? 

[TwoCitiesCapital]

On 12/20/2023 at 10:41 AM, Gmthebeau said:

 

I would agree there is pretty good demand around 5%, but I think we will see it again probably in late 2024 but as fast as markets move (or get manipulated) who knows maybe by mid-year.  Nobody is going to buy 30 year bonds at 4%, despite all the TV pundits trying to get you to buy the ones they would like to sell.   Core inflation is still around 4%, so rates are again to low on the 10-30 year part of the curve.   The only way it makes sense is if inflation totally collapses (very unlikely) soon.

 

I mean, I'm not saying it's a good bet for a buy/hold for the next 30-years, but TLT has had very strong inflows this year (~20 billion as of early November).

 

Plenty of people were clamoring for 20-30 year type bonds @ 4-5%.  

[mattee2264]

On 12/20/2023 at 4:12 PM, Gmthebeau said:

Everyone and their dog saying lock in long term rates here at 4%, but virtually nobody saying it at 5%.  Rest assured the crowd always wrong, and we will likely see persistent inflation and despite Jerome salivating to cut rates, the 30 year will likely re-approach 5% sometime in 2024.

 

I think a lot of bond "investors" are just speculating on rate cuts rather than investing for income. There seems to be a presumption that we are heading back to zero interest rates. But the Fed only aggressively cuts when something breaks or the economy is heading south. 

 

If you read the Fed comments it has basically said that it feels that current rates are restrictive and they don't want to overshoot so there is a little room to cut rates next year. But if you assume that a normal term premium is around 150 basis points then for 4% long bond rates to make sense you need the Fed to slash rates by at least 200-250bp and absent a recession or something majorly going wrong in the financial system that is difficult to imagine. 

And locking in 1-2% real returns does not feel enticing from an income perspective. 

 

I prefer short term bonds. History shows that cash is not always trash and there are periods when Treasuries can outperform stocks. And with the CAPE at 30x a 100% equity allocation seems unnecessarily risky. 

 

 

[lnofeisone]

I'm posting this to see if I'm missing something. Specifically, I'm curious if I'm way off on taxes and stumbled into "IRS hates this one trick," and then they call me. Please poke holes here. 

 

Opportunity: Buy municipal zeros 

There is a minor quirk in the way bond pricing works called de minimis rule. It says that if you were to buy a bond and there is a discount, there is a magic delineation line at par value - 0.25%*years left to maturity. So if you have 10 years left on a 100 par bond, you have 100-0.0025*10 = $97.5

 

a) If the bond price is above this magic line ($97.5 in the above example), any gains you were to have on the bond will be capital gains (interest is taxed as ordinary income) in the eyes of the IRS. 

b) If the bond price is below this magic line ($97.5), any gains you were to have on the sale of the bond will be ordinary income. 

 

Why this opportunity exists: Feds raised interest rates, and bonds got beat up. If you apply the 0.25*years to maturity, a lot of the recent zeros will be well below this magic line. So let's play this out:

1) Buy zero that's below the de minimis magic line

2) There is no interest and because it's a tax-free muni, you don't have to worry about accounting for accumulations

3) Because the bond was below the de minimis line, all gains count as ordinary income

3) Ordinary income on tax-free municipal bonds is tax-free -> the gain on the bond is tax-free

 

The other way to look at it is

1) Buy zero that's below its original issue discount (OID) or below the adjusted issue price

2) Hold to maturity at which point you'd collect the gain + all the interest credit and it's all tax free

 

What am I missing?

 

[Dinar]

@lnofeisone, check with your accountant.  From what I remember, you have to declare the accretion above the 0.25% every year, and you WILL get taxed on it.  

[lnofeisone]

10 minutes ago, Dinar said:

@lnofeisone, check with your accountant.  From what I remember, you have to declare the accretion above the 0.25% every year, and you WILL get taxed on it.  

That's 100% fair but it is a muni so no taxes, if muni states matches residence? I'll see if I can TurboTax it.

[Dinar]

1 hour ago, lnofeisone said:

That's 100% fair but it is a muni so no taxes, if muni states matches residence? I'll see if I can TurboTax it.

I would bet a nice bottle of champagne that you are NOT correct.  Call the IRS or your accountant or tax lawyer or find a relevant passage of the tax code.