Sexy Bonds & Bond Girls

The stock market did something last week it has not done since 1987 – over 10 consecutive days ending Feb. 23, 2017, the DOW closed at a record high every day, 10 days in a row!

Stock market euphoria is manic right now, driven by investor hopes of lowered personal and corporate taxes, hopes of corporate regulatory reform, and hopes of some type of waiver, credit, or tax cut so corporations can return money they hold offshore into their US bank accounts. It is no secret that the Trump administration is a very business-friendly cast of players, just ask Meryl Streep! Hollywood 1%’ers get angry when they see people making money the old-fashioned way.

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Not a Bond Girl – and not amused…

One of my favorite Warren Buffet quotes is, “be greedy when others are fearful and be fearful when others are greedy”. Right now, folks are getting greedy. While I am not necessarily fearful, I am at least cautious and looking at the market with a wary eye. I’m making sure my investments are ready for the consequences of a market that is probably “overbought”.

Simply put, the market is expensive right now – especially for a bargain guy like me. I like to buy my summer clothes in the winter and my winter clothes in the summer. Right now we’re buying parkas in the middle of a blizzard and sunscreen on the morning of the 4th of July. The Schiller PE (chart below) is a metric by which we can rate the relative expense of the market in terms of its price versus its earnings (PE ratio). Right now the Schiller PE is just below 30 and well above its historical average of 16. How that compares:

schiller-pe

chart @ www.multpl.com

So what does this mean? It means the market will soon take a short term dip and pause from its long term upward trajectory. There’s no need to panic but we do need to check to make sure our investments have a seatbelt and that we are driving responsibly while being mentally prepared for the the ride.

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Bond Girl #1 – Seatbelt on…

Mention safety in terms of investing and you’ll immediately hear two words – bonds and gold, along with “huh”? Let’s take a look at these two assets in terms of safety and their overall place in your investment portfolio. We’ll start with long term allocation models from 1926-2015 to see how bonds affect a long-term portfolio:

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I’ve highlighted the “sweet spot” in these returns where a 70/30 or 80/20 mix will limit your downside risk with minimal effect on your long term gain. This is called Portfolio Efficiency. Going from 100% stocks to 70% stocks and 30% bonds (a conservative portfolio in my opinion) shaves 1% off your total return while cutting 13% off your maximum downside risk. Giving up a yearly 1% gain is nothing to sneeze at long term, but a 13% difference in a downturn is the investing effect of an airbag cushioning a severe blow to your nest egg.

Of interesting note, look at the swing between 1931 (horrible) and 1933 (amazing).  This is why we have a LONG TERM outlook and we invest monthly, every month, no matter what!

Bond Girl
Bond Girl #2 – In most cases, bonds are not sexy…

So where do we go for sexy bonds? Like stock market index funds, you can buy bond index funds as well. AGG covers the spectrum of the bond market much like SPY acts as a low cost index fund of the S&P500. Another option is TLT, the 20+ year (long term) Treasury Bond or LQD which is a fund made up of large corporate bonds. How do they perform? Let’s take a look at bonds versus our other safety net – Gold.

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sexy chart from schwab.com

Of interesting note, see the relative stability ride of AGG and LQD versus a rocky ride in TLT and a rollercoaster ride in GLD.  I’ve added SPY (the S&P500, green line) in this chart for reference to the stock market as a whole, and you’ll see a massive dip in stocks during ’08 – ’09, and you’ll see how bonds would smooth that out and even spike a bit in reaction as investors looked for safety in both bonds and gold. Hence our seatbelt…

A Look At Gold:

A recent Gallup Poll asked Americans what they thought was the safest longterm investment. 28% said gold, followed by 20% saying real estate and 19% saying stocks. Over the past 30 years, gold has retuned a respectable 8% per year on average and since 2000, gold has outperformed the S&P500 and offered a fantastic hedge against the market.

Mention gold at certain times in history and people will go absolutely batshit crazy – from the gold rush in the American West to the gold rush in Brentwood, TN during 2011 when “We Buy Gold” stores were popping up on every corner.

Bond Girl
Bond Girl #3 – Taking gold a little too far…

Here’s the problem with gold – it’s a difficult to value since its price is fueled by speculative actions on supply & demand. It is a non-producing asset, meaning unlike stocks or bonds, it will pay no dividend. Gold’s use as a currency is historically obvious but if you own gold in a gold fund, you don’t really own any physical gold. And even if you do own physical gold, do you feel confident in taking some gold down to Kroger to pay for some groceries? I would limit gold exposure to no more than 5% of your portfolio.

A Simple and Real World Look:

So what do we do? Unlike the S&P500 where I have given the middle finger to mutual funds and professional money managers, there is actually some benefit to actively managed bond funds. Bonds are so static (and so not sexy) that timing their maturity dates and yield curves in an active fashion is key to maximizing your return in the bond market.

I invest in 2 bond funds, TOTL (corporate, government, and mortgage bonds – a sexy bond fund) and PONDX (corporate bonds, credit swaps, derivatives, and collateralized debt – downright kinky). Both are run by managers with long term performance records that are quite impressive and their expense ratios are under .75%. I also own the TLT fund, made up of 20+ year T-Bills, and I am currently considering TIPs which are inflation-protected bonds. I think their time will come soon. One thing to remember is bonds have a “yield” where they pay you to hold them. We’ll go deeper into yield in a later blog.

For gold I own CEF which is a Canadian gold + silver fund (61% gold, 31% silver).  I like this fund because I can use my strong US dollars to buy the fund against the weaker Canadian dollar and the fund was trading at a 15% discount to its Net Asset Value when I purchased, meaning its assets were on sale. I’d also recommend GLD or IAU – both pure gold funds.

Bond girls Together
Bond Allocation (sorry, had to do it…)

Allocation? I admit I don’t practice what I preach here. My total bond exposure is about 12% of my current portfolio, though I am taking steps to move that to a 20% goal. My total gold exposure is 5% and my total cash exposure is under 2%. Again I’m not saying I’m right, it’s just a real world look at where I am and where I want to be. I’d be interested in knowing what others think – both in terms of bonds and your favorite Bond Girl…

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Bond Girl #4 – mic drop…

Be well, and thanks for reading!

Todd

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