Pants on the Ground

You probably heard about the Warsh FOMC meeting, where he was hawkish. Actually, the meeting was a lot more nuanced than that—Warsh is making some big changes to how the Fed conducts its business, the biggest of which is that it has eliminated forward guidance. The Fed will no longer project what it’s going to do. This is going to create some volatility in rate expectations. But it is a good thing.

Anyway, if weren’t following the bond market all that closely, the long bond actually rallied after the FOMC meeting, while short-term yields went up significantly. A big curve flattening. The thinking is that the Warsh Fed has credibility and, by threatening to raise short-term rates, will reduce inflation in the long term—hence, the rally in 30-year bonds.

Now, I have been making a lot of noise about investing in the bond market recently, especially in The Daily Dirtnap (subscribe here). Up until this point, I had no exposure to bonds whatsoever, but in the last few weeks, I have moved about 20% of my portfolio into Treasury bonds across a range of maturities (but most of all, 30 years). I have a big bet on that interest rates are going to decline, and perhaps by a lot. 

Bonds Are Incredibly Underowned

Be truthful: Do you have the “40” in the 60/40? Probably not—nobody does. There are 80-year-olds rolling around with a portfolio of 100% stocks. Do you have any exposure to bonds at all? My guess is that two-thirds of people, and perhaps more, do not. Individuals are the most underweight bonds than they have been since… forever?

The 2022 bond bear market disabused them of ever investing in bonds again. Treasury bonds were down 20% (which blew up a bank, if you recall) and provided no diversification to stocks whatsoever. So why invest in bonds? What is the point, especially when stocks go up almost 20% in a couple of months? 5% on bonds does not sound very appealing. 

Well, there are a lot of reasons you invest in bonds. First, bonds do provide diversification—maybe not now, but they will again. Second, in the bear markets of 2000–2002 and 2007–2009, bonds were not only a place to hide out, but they also provided handsome returns and a cushion against volatility in your portfolio. I can’t believe I’m trying to convince people to invest in bonds. You didn’t used to have to convince people to invest in bonds. They just did! It was the right thing to do.

It’s Time to De-Risk

A lot of this has to do with mitigating risk. We now have the most expensive stock market in history. Apple has doubled in four years even though revenues are flat. Semiconductors are pretty far above the 200-day moving average. Use any metric you want—this market is stupid, and now is a good time to de-risk. You may think you can hide out in certain stocks, like staples, and that may be true, but in a bear market, all stocks tend to go down.

Maybe you are concerned about the national debt. Well, we do have a lot of debt, but the truth is that it is not as out of control as it has been in the past! The deficit-to-GDP ratio is at 6%. In 2010, it was at 12%. I have gotten many things wrong in my newsletters, but one big thing I got wrong in 2010 was predicting that the bond market would collapse and that we would have failed auctions. Not only did we not have failed auctions, but they were many times oversubscribed, which easily absorbed the massive issuance. 

Yes, we have $2 trillion deficits, but relative to the size of the economy, they are half the size that they were 16 years ago. I am not as worried about the deficit as most people are, which I guess makes me a contrarian? Maybe we will grow our way out of it; maybe there will be political change; maybe we will eventually decide to do something about it. Maybe Marco Rubio gets elected and does another round of DOGE, for real this time. You never know, as Joaquin Andujar once said.

If you have bond-phobia, I encourage you to get over it. If you had a 60/40 portfolio in the Crash of 1929, you would have been much better off—bonds went up! At least have the 20% that is required in The Awesome Portfolio, but you might want to go further than that. And I encourage you to get as much duration as possible. The iShares 20+ Year Treasury Bond ETF (TLT) is good, but I prefer the F/m US Treasury 30 Year Bond ETF (UTHY).

And lay off the options. People tie themselves in knots trying to trade options on TLT. If there is an open-end long-term government bond mutual fund that you like, you can do that too. You never know—the bond market may surprise you.

Jared Dillian, MFA