Short-term rates went up, and long-term rates went down. That's not how it's supposed to work, right? One would think they would move in tandem up together. Short-term interest rates are now 0.25 basis points higher since the Federal Reserve raised them in December of 2015. Of interesting note though, Treasuries have actually rallied to start the year and have not increased like they should have, according to common thought. Because of the sell-off in oil and the world economy slowing, Treasuries and quality bonds have been rallying like none other and the yields on them are lower than they were just a few months ago.
YTD, iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) is up about 9%, not including dividends. Needless to say, investors who own bonds are partying well into the new year, even though it was a month ago, as bonds have handily outperformed stocks.
10-Year Government Bond Comparison
A year ago, I wrote an article looking at the spread between U.S. Treasuries and other world government bonds. The difference between the spread was quite interesting. A year later, not much has changed. Below are the stats from one year ago and today:
|10-Year Government Bond Yields||10-Year Government Bond Yields|
|Hong Kong||1.41%||Hong Kong||1.53%|
|Great Britain||1.48%||Great Britain||1.41%|
As you can see, a few have gone up, and a few have gone down. Of interesting note though, U.S. 10-year Treasuries are actually lower than they were a year ago. I don't think anyone would have predicted this, especially with all of the chatter about rates rising back to their "normal" yields. I am starting to think that low is the new normal. In fact, I wouldn't recommend fighting the downward trend in bonds, as it has been going down for a few decades now, and governments around the world are still lowering interest rates, with Japan the most recent government to try negative interest rates.
Personally, I think negative interest rates are scary. They take money from savers, mostly retirees, and when retirees have less money to spend, I don't think economies do as well. Along with that, who really wants to pay a bank to put money into a CD or pay a company for the privilege of holding its bonds? But that's what people are doing in countries like Switzerland. They don't get any money and have to pay to just hold the bonds. But world governments are determined to print money and lower rates, so this seems to be the new normal. And as deflation keeps on rearing its ugly head, bonds are a great place to be and should increase in value if we enter a period of deflation, as the interest on them is fixed.
One nagging question I still have though, is will U.S. Treasuries keep going down to be on par with their European counterparts? Obviously no one knows, and only time will tell. But U.S. Treasuries are the safest debt in the world and yet they still yield quite a bit more than their European counterparts. If one thinks they will keep going lower to be on par with their counterparts, Treasuries and bonds are the place to be. So far this year, anyway, that has been true.
My two favorite bond holdings, which are Build America Bond funds, Guggenheim (NYSE:GBAB) and Black Rock (NYSE:BBN), have done great so far this year. GBAB is up 5.4% YTD (even after a nasty sell-off today) and BBN is up 10.3% YTD. I am glad I had these two positions, as my stock portfolio isn't showing the same enthusiasm to start the year off. For those looking to start a position in them though, they are nearing their highs, so unless you can live with the ups and downs of the bond market, it might be better to hold off for a while to see what the FED does, as bonds might have gotten a little ahead of themselves if the FED does raise rates later on this year.
A Way To Hedge Your Portfolio
If you're looking to hedge your portfolio if rates do rise, I heartily recommend New Residential Investment Corporation (NYSE:NRZ). Its portfolio of Excess Mortgage Servicing Rights will actually increase as rates go up, so this is a nice way to hedge potential losses in bonds if rates ever do go up. You can read more about NRZ here and why it will do well in a rising rate environment. I believe it offers a great entry point, especially in light of the recent sell-off that is unwarranted in my opinion.
If you would like to read more about my recommendation for bonds in the coming year, you can read my 2016 recommendations here. Overall, I think bonds will do well in 2016, especially compared to the stock market. The world economy is slowing, and there is uncertainty in the air. Revenue and earnings are actually decreasing at many companies, or at least slowing quite a bit, and stocks generally will not perform well in that type of environment. While I do own stocks, I definitely have my portfolio tilted towards fixed income, and have left it that way for the past few years, in spite of continuous bond sell-offs and rallies, and it has done quite well. I still recommend holding a nice oversized portfolio of quality bonds in one's portfolio. Good luck as we continue into a rocky start to the new year.
Disclosure: I am/we are long BBN, GBAB, NRZ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.