Print Friendly, PDF & Email

Bond bears are right — and wrong

Reprinted courtesy of MarketWatch.com.

To read the original article click here

People learned a long time ago that it’s a lot easier to control a horse if the animal is wearing blinders. Think about it: The horse “knows” what he sees, and he sees only what’s right in front of him.

That horse’s visual universe has shrunk — conveniently for his handler, but sometimes at the expense of the animal.

I thought about this last weekend in connection with the many investors today whose vision is focused tightly on bonds — and on the notion that they’re going to lose money when interest rates go up.

I call these people the bond bears. They are right that interest rates are likely to go up. They have to. And they are right that this will depress the prices of existing bonds.

But the bond bears are wrong if they think this means they should sell their bonds or avoid the category. Collectively, investors who don’t get this figured out are likely to lose billions of dollars — losses that are totally unnecessary.

I can’t tell you when that will happen, but I’m sure it will, as I discussed in my previous MarketWatch.com column.

Bond bears have plenty of reason to believe they’re right. Who could be a better expert than Bill Gross, the man who for many years ran the world’s biggest bond fund?

I found a Fortune magazine headline that quotes Gross as saying “bonds could be in for a world of hurt …” because of the inevitable rise of yields and concomitant fall of prices.

There’s just one little problem: That dire warning of impending doom was made in the spring of 2011, and the big plunge has yet to happen.

Bill Gross put his money (actually his shareholders’ money) where his mouth was and reduced the Pimco Total Return Fund’s PTTAX, +0.09%  stake in U.S. government bonds to zero that year.

At the same time, he more than quadrupled the fund’s stake in cash. (If you have a bank account that pays 0.03% annual interest, you will understand the implications of that move.)

Bill Gross isn’t the only bond expert who has been flummoxed by interest rate predictions. The previous summer, in August 2010, Morgan Stanley issued a huge mea cupla for incorrectly forecasting that interest rates were about to rise.

“We got our rates call wrong and missed a great opportunity” to own bonds in 2010, the firm’s clients were told by James Caron, head of U.S. interest-rate strategy at Morgan Stanley in New York.

Someday these fears will come true, just as someday the stock market will take another serious dive, leaving millions of investors stunned and outraged to discover that such a shocking thing could happen.

Recently I received a message from a reader who believes the bond market is “in a weird short-term situation” in which it is failing to live up to his expectations.

This investor has liquidated his 40% stake in bonds (which, if chosen correctly, are paying a rate above inflation) and put that money in cash, which he admits pays him zero.

“I would normally hold bonds but feel they will be going down in the next couple of years,” he wrote. “I plan on staying in stocks no matter what.”

Those last three words — “no matter what” — send a chill up my spine.

It won’t surprise me a bit, sometime in the middle to late stages of a bear market, to get a message something like this from a reader: “I’m just too worried about further declines in stocks right now, and I’m going to cash. I plan on staying in bonds no matter what.”

The problem here isn’t bonds. It is not the bond market, or the Fed. It is not the stock market. All those entities are doing what they normally do.

No, the problem is individual investors who are trying to discern the short-term future of the markets and answer the question: What should I do about this?

People learned a long time ago that it’s a lot easier to control a horse if the animal is wearing blinders. Think about it: The horse “knows” what he sees, and he sees only what’s right in front of him.

That horse’s visual universe has shrunk — conveniently for his handler, but sometimes at the expense of the animal.

I thought about this last weekend in connection with the many investors today whose vision is focused tightly on bonds — and on the notion that they’re going to lose money when interest rates go up.

I call these people the bond bears. They are right that interest rates are likely to go up. They have to. And they are right that this will depress the prices of existing bonds.

But the bond bears are wrong if they think this means they should sell their bonds or avoid the category. Collectively, investors who don’t get this figured out are likely to lose billions of dollars — losses that are totally unnecessary.

I can’t tell you when that will happen, but I’m sure it will, as I discussed in my previous MarketWatch.com column.

Bond bears have plenty of reason to believe they’re right. Who could be a better expert than Bill Gross, the man who for many years ran the world’s biggest bond fund?

I found a Fortune magazine headline that quotes Gross as saying “bonds could be in for a world of hurt …” because of the inevitable rise of yields and concomitant fall of prices.

There’s just one little problem: That dire warning of impending doom was made in the spring of 2011, and the big plunge has yet to happen.

Bill Gross put his money (actually his shareholders’ money) where his mouth was and reduced the Pimco Total Return Fund’s PTTAX, +0.09%  stake in U.S. government bonds to zero that year.

At the same time, he more than quadrupled the fund’s stake in cash. (If you have a bank account that pays 0.03% annual interest, you will understand the implications of that move.)

Bill Gross isn’t the only bond expert who has been flummoxed by interest rate predictions. The previous summer, in August 2010, Morgan Stanley issued a huge mea cupla for incorrectly forecasting that interest rates were about to rise.

“We got our rates call wrong and missed a great opportunity” to own bonds in 2010, the firm’s clients were told by James Caron, head of U.S. interest-rate strategy at Morgan Stanley in New York.

Someday these fears will come true, just as someday the stock market will take another serious dive, leaving millions of investors stunned and outraged to discover that such a shocking thing could happen.

Recently I received a message from a reader who believes the bond market is “in a weird short-term situation” in which it is failing to live up to his expectations.

This investor has liquidated his 40% stake in bonds (which, if chosen correctly, are paying a rate above inflation) and put that money in cash, which he admits pays him zero.

“I would normally hold bonds but feel they will be going down in the next couple of years,” he wrote. “I plan on staying in stocks no matter what.”

Those last three words — “no matter what” — send a chill up my spine.

It won’t surprise me a bit, sometime in the middle to late stages of a bear market, to get a message something like this from a reader: “I’m just too worried about further declines in stocks right now, and I’m going to cash. I plan on staying in bonds no matter what.”

The problem here isn’t bonds. It is not the bond market, or the Fed. It is not the stock market. All those entities are doing what they normally do.

No, the problem is individual investors who are trying to discern the short-term future of the markets and answer the question: What should I do about this?