You Don’t Own Enough Bonds

My friend JJ sent me this article on Friday: “You’re Probably Overinvested in Bonds” by Robert Pozen.

Kind of a funny time for that article. Here is a chart of TLT over SPY over the last several years:

You are here, down in the lower right-hand corner.

I hadn’t heard of Robert Pozen before I saw this article. Mr. Pozen is a distinguished senior lecturer at MIT Sloan School of Management and a former president of Fidelity Investments. Really. I hope someone forwards this to him because I’d love to debate him on this—anytime, anywhere, blindfolded, with one hand tied behind my back. Mr. Pozen instead recommends a 90/10 portfolio: 90% stocks and 10% money market funds. Why? Because stocks return more.

Boss, I’m tired. I’m tired of these simpletons running around telling people they should be in all stocks, all the time because they return more, with absolutely zero weight given to behavioral considerations. Lunacy. Anyway, I’m not here to talk about academics and their stupid opinions. I’m here to talk about bonds, which… are actually pretty attractive right now! The yield on the 30-year bond got out to about 5.18% last week. It’s a bit lower now. It is kind of hard to screw that up. And two-year yields were well above 4%. I see compelling value in bonds right about now.

It Might Be This Simple

Everyone, including me, is running around talking about how stocks are in a bubble right now. What if that were true? What if this turned out to be a repeat of 2000–2002 and stocks declined 50% over the next couple of years? Bonds would probably be up a lot—more than you think. I can envision a scenario where 10-year yields get to 2% or lower. 

Here’s another chart for your consideration:

This is a chart about gold, but you can see what stocks versus bonds did in the last two great bear markets. Is it as simple as selling stocks and buying bonds? It might just be that simple. If you are not in the mood to sell your stocks, at least buy some bonds.

Some bond math for you: Remember in 2022 when everyone got rinsed on long-term Treasuries? Well, the coupons on those bonds were exceptionally low, which means more duration, which means more sensitivity to interest rates. With a 5% coupon on the long bond, the duration is much shorter, and bonds are not as risky as they were four years ago. True story.

Now, my favorite portfolio is The Awesome Portfolio, which has 20% bonds, but the 60/40 portfolio is not so bad either. It’s definitely preferable to the 90/10 portfolio, which is brainless froggish leavings. The 60/40 portfolio… works pretty well! It has returned 9.34% over time (slightly more than The Awesome Portfolio, actually), and if you were unlucky enough to be investing in 1929–1933, when stocks went down 89%, bonds actually went up 11% over that time period, which would have significantly cushioned your losses. It would have saved your ass, actually. And the 60/40 portfolio would have saved you in the financial crisis, too, when bonds screamed at the outset of quantitative easing. The only time the 60/40 portfolio fails is during periods of rising inflation and monetary tightening, which is what we saw in 2022 and the late 1970s.

Sentiment Against Bonds

I’m not certain that bonds have bottomed yet, but I think we are in the ballpark. Sentiment against bonds is about as negative as you can get, as evidenced by this ridiculous article. Only at the bottom of the biggest divergence between stocks and bonds in history would somebody write something like that. I would call it recency bias. By the way, in the late ’70s, when bond yields were upward of 14%, people were calling them “certificates of confiscation.” Also a pretty great time to buy bonds! For the record, I don’t think bond yields are getting out to 14%.

What about supply? Everyone is always worried about debt and deficits. Well, right now, we are running a deficit-to-GDP of about 6%. Yes, the deficit is $2 trillion-ish, which seems large, but it’s not as large as it was post-financial crisis, when the deficit-to-GDP was 12%. Remember what happened then? Everyone was worried about the pile of debt turning into failed auctions and widespread panic. Not only did that not happen, but people showed up to the auctions in droves, the auctions were many times oversubscribed, and interest rates basically went to zero. Nobody wanted stocks, so they bought bonds! That happened in 2008, it happened in 2000, and it will happen again—perhaps soon.

I should differentiate between Treasury bonds and corporate bonds; I would not buy corporate bonds with your money. But government bonds… well, let me just say that if you held your nose and bought them here and didn’t look at them for three years, you’d probably be pretty happy.

A lot more to say here, but I think the best investment ideas can be expressed in 800 words. Good luck out there.

Jared Dillian, MFA