June 11, 2013
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Interest rates will eventually go up. The 50-basis-point spike in May on the 10-year Treasury bond may have been the beginning. But despite industry and media assertions, history shows that there is nothing to fear from rising rates.
The fund industry is creating untested and potentially hazardous investments to deal with the perceived threat. My research shows that in rising-rate environments, total returns are generally positive, not negative. Investors should shorten duration and diversify into multi-asset fixed-income portfolios, which are safe, proven, cost-effective and easy to implement. These portfolios have historically outperformed during rising rates.
What if rates go up?
Bill Gross, manager of the PIMCO Total Return Fund, said May 10 that the secular 30-year bull market in bonds likely ended April 29. David Rosenberg, chief economist and strategist for Gluskin Sheff + Associates, said in early May that his “love affair with the bond market has come to an end.” The Wall Street Journal reported in May that 98% of economists believe that the yield on the 10-year Treasury will be higher in December.
Are Gross, Rosenberg and the economists surveyed correct? Probably.
How rising rates will affect bond returns, however, is debatable. The problem is that there is no debate. The industry has an unchallenged conviction that interest rates will rocket up, bond prices will collapse and bond investors will be ruined. Forbes compared the coming bond rout with the great tulip mania of 1637. The Wall Street Journal warned investors to “watch out” and that the “sword of Damocles” hangs perilously over their heads. A panel of experts told Barron’s to “skip bonds” altogether.
Those warnings have been made with such abject certainty that one would guess that this collapse has happened before. It has not, at least in any of the most notable periods of rising rates:
- The worst bear market in modern history, which ended 30 years ago.
- June 1980 to June 1982, when 10-year Treasury bonds rose 4.5%.
- May 1983 to June 1984, when bonds rose 3.2%.
- August 1986 to August 1988, when bonds rose 2.1%.
- October 1993 to November 1994, when bonds rose 2.6%.
- November 1998 to December 1999, when bonds rose 2.1%.
- December 2003 to August 2006, when the Federal Funds rate rose 4.3%.
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