Was that the sound of a bond bubble bursting?
Understandably, given the amount of market chatter and headlines claiming that government bond yields are in a bubble, last month's 24 basis point sell off in 10-year US Treasuries triggered a few jangly nerves. And if watching the screens wasn't making you nervous, well then the following comments probably had you wondering if yields had turned a corner.
Bill Gross, of Pimco fame, said that faster inflation
"will create an upper drift in long-term yields".
Billionaire investor Jim Rogers chimed in saying that
"I'm short long-term government bonds … I plan to short more. That bull market, that's a bubble."
Putting aside the fact that Gross famously shorted US Treasuries about 2 years and 150 basis points ago, as well as the fact that Rogers has been predicting the end of the 'bubble' for a similar time period, if you're holding US Treasuries, like any holder of an asset that performs badly you may have been wondering what comes next.
There would have been a few investors asking themselves whether this is the beginning of the end, time to bail out of fixed income and say good bye to a thirty year bull market. Was January's spike upwards the sound of the initial pop as the bond bubble bursts?
Or, alternatively, was it appropriate to view the sell off as a 'healthy' correction - no bull market is consistent in its march upwards - and a great opportunity to start buying again, or at least no reason to bail out.
So, which one is it?
Well, let's have a look at some graphical evidence. The chart below is the long term chart of US Treasury ten-year yields, on a monthly basis, up to and including the end of January 2013.
So, do you see that bubble bursting? Well, it's tricky to see. In fact, last month's sell-off is barely discernible. Kind of disappears in the long term trend. Doesn't look like a popping bubble.
So, if not a pop, perhaps a slow hissing sound?
Okay, not fair you say. The graph gives too long a perspective. Let's zoom in a bit and see just the past decade to check if we can see any signs of a popping bubble. The following graph again shows 10-year yields, this time on a daily basis, just since the beginning of 2000.
Well, still no popping bubble.
Which shouldn't surprise us if we look at a couple of historical statistical facts about this fantastic bull market run.
If we take the bull market as beginning in September 1981, a little over 30 years ago, when yields on the 10-year Treasury peaked at just above 15%, then that gives us 376 monthly data points. Now, say you bought the ten year government bond, and held it constantly over the last 30 plus years, have a guess how many months you would have seen your government bond increase in yields.
Amazing statistical fact number one: the answer is a staggering 45% of the time - so in this multi-decade solid bull market, you would have seen the yields on your holding go up in almost as many months as the number of months yields went down.
So, the question to holders of US bonds is, why suddenly worry now? Unless you worry every month yields have gone up over the last 30 years, in which case you would have been almost a perpetual worrier and probably have very frayed nerves by now.
Just a good ol' correction
Amazing fact number two - over the same time period, the average monthly move in a month that the 10-year Treasury sold off has been a sell-off of 23 basis points. Therefore, last month's 24 basis points sell off is bang on average for what happened in every single other month that yields have risen over the last 30 years.
The diagram below shows the number of months that have seen different magnitudes of sell-offs.
So, anyone who rushed for the door and dumped their Treasuries hadn't checked what was a normal, regular feature of this multi-decade downward trend in yields.
I do want to point out that I am not oblivious to the other side of the argument, that a 25 basis point sell off when yields are 2% is entirely different from a 25 basis point sell-off when yields are 6%, in that the amount of carry yield you are receiving to protect your capital losses is very different.
But the point for investors to bear in mind is not to confuse a correction in a bull market with a popping bubble. Even the larger 60 basis points multi-month sell-off between the lows of July 2012 and current yields, pales into comparison with the last major correction of 135 basis points between October 2010 and February 2011.
At some point, ultimately this bull market will have to come to an end. Whether it transforms itself into a bear market or a persistently constant low level of yields, as in Japan, will have to be seen. But, just because yields rose 24 basis points in January is not a reason to start rushing for the exit.