Long-term U.S. Treasury bonds were up 3% in the first week of January, following a blowout 2014 in which they rocketed up 30% — one of the five best years of all time. So are investors, wary of a meltdown in the stock market, missing a ‘melt-up’ in long bonds?
Noting that many bond investors have learned the hard way over the past few years that predicting the direction of interest rates can be extremely difficult, institutional investment manager Ben Carlson takes a look at how we can expect long-term treasuries to perform in the future. (Carlson’s blog is “A Wealth of Common Sense.”)
Crunching the numbers, Carlson shows why inflation is a bigger risk to long maturity bond holders than an increase in interest rates. Accounting for inflation, the average and median real returns for yields under 3% over 10 and 15 years were annual losses; even the best-performing periods were only slightly positive in the lowest yielding category. “At today’s yield levels, inflation and interest rate risk have to be accounted for. So while there could be one- or even five-year periods where longer maturity bonds perform fairly well from these yield levels, over the long term they’re likely to be a poor investment in terms of earning a decent return over the rate of inflation,” he writes.
Carlson’s bottom line? Determining your bond maturities by matching them with your future liabilities is a much more rational approach to portfolio construction than trying to guess when long or short yields are going to rise and fall.
