The best time to buy bonds
Is now a good time to buy bonds? Yields are higher, prices are lower.
With my portfolio invested in 10 different index funds, there's always at least one fund that's lagging behind the rest at any given time. As the Fed has begun to raise interest rates -and the economy improves across the globe- yields have been rising, dropping prices for bonds across the board. Above you can see the Vanguard Long Term Corporate fund I am invested in - it hasn't been doing well recently. The Long Term Treasuries fund (TLT) I have hasn't been doing any better.
As an investor, whenever I see the price of something I am invested in drop, my immediate reaction is to evaluate whether this is a good opportunity to add to my investment. So, is now a good time to add to my bond investments?
When IS a good time to buy bonds?
The best way to know when to buy anything is to look to the past. Historical returns don't guarantee performance in the future, but they certainly give us a clue to HOW assets will behave in certain situations. Looking the chart above, the boxes you see are different asset classes stacked according to their relative performance in each year: the higher the better. The lime green box is the aggregate corporate bond index, which is a fairly good stand in for my corporate bond ETF.
From this view it's clear that the boom years of 2004 and 2005 were AWFUL times to own bonds, and a great time to own stocks. Eerily similar to the market today, in fact, with the past two years showing the green tile close to the bottom of the pile. On the other hand, the bond index was THE top performer in 2008 during the financial crises, when it returned around 6%. That's not amazing, but it's much better than the -37% that the stock market returned. This isn't too surprising since high quality corporate debt is usually a more secure asset than stocks.
The last economic cycle clearly shows us that the best time to buy bonds is when the economy is charging at full tilt, and has been for some time.
When to buy bonds: is now a good time?
If I am looking for when to buy bonds, it’s clear that there is an advantage to buying when the economy has been doing well. Although the economy has been going at full tilt for a while now, I am not completely convinced that it's a great time to buy because interest rates seem set to continue rising, and the economy doesn't show signs of stopping either.
First of all, it's clear that interest rates are going to continue to rise at a slow but certain pace for the next year or two. The Fed has committed to raising the Fed Funds Rate, and inflation seems to be rising as well. Both of those factors would certainly have a negative affect on bond prices, unless the Fed raises rates too quickly and tightens lending to the point where we go into a recession. Given the slow pace of rate rises, I don't think that will happen soon... but it could. I will also be on the lookout for a yield curve inversion (when longer maturity bonds pay less than short maturity bonds), but that hasn't happened yet.
The economy as a whole seems to be in nearly perfect health, with few signs of overheating. The stock market is highly valued, and a little expensive for my taste, but holding steady. The housing market is looking fairly good, with a wobble here and there. Although the unemployment rate is quite low, the workforce participation rate is still below its long term average leading me to think that continued job growth is possible without too much inflation. What's more, the debt fueled asset binge that led us into the last recession doesn't seem to be repeating itself. Since uncontrolled debt is usually (but not always) a key factor in sending the economy into a recession, I would definitely be looking to see some sort of stress in loan defaults or credit delinquencies before worrying about a fresh recession.
My conclusion? Not now, but soon...
It's been frustrating to watch my bond funds drop this year, but my portfolio as a whole is doing fine thanks to the magic of diversification. As you can see from my portfolio tracker I created for free in Personal Capital, I am about even for the year when accounting for all of the assets in my 10 fund portfolio. Even though bonds are the best buying opportunity I see in my current portfolio, I don't think that now is the time I want to buy. The stress factors that I would look for just aren't as prominent as I would want them to be before buying bonds, and I definitely don't want to be buying bonds into a rising interest rate environment. As the economy heats up, and interest rates rise some more, I might add to my position in the next year.
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