When Rates Spiked Violently Did The Balanced Portfolio Get Whacked?

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Includes: DIA, IWM, QQQ, SPY
by: Dale Roberts

Summary

We know that longer dated bonds can get hit hard in price terms when rates spike.

Today's investor has largely known the good times for bonds with yields generally falling for the last 30 plus years.

Previous to this most glorious time for bond investors was the worst of times. From 1950 to 1981 the yield on a 10 year treasury went from 2% to 14%.

So what happened to a balanced portfolio in this period? What was the cost of holding bonds in the worst of bond bear markets.

We'll look at the Vanguard Wellington Fund and how it fared in the bond bear vs the bond bull.

Perhaps it's been easy to be a fan of the balanced portfolio over the last few decades. Heck, bond portfolios have been able to keep up with many equity portfolios at times. But what about that bond bear market? As we know bond prices can get hit hard when rates rise.

Here's the long term 10 year Treasury rate history from multpl.com

As we can see yields started to move up in the early 40's and then for the most part continued the assent towards 15%, with the greatest spike occurring in the late 1970's. We can call that a violent spike in rates as everything was being done to slay the inflation beast. As you may know the 1970's presents the period known as stagflation, when essentially nothing worked in a real return sense, when we factor in inflation.

So what were the chances of a balanced portfolio making it through the greatest bond bear in history with gains of any sort? For an answer, or idea of what happened, we turn to Vanguard's Managed fund, the Wellington Fund. It offers a very long history, it's one of the longest serving funds with a start date back to 1929. The Wellington Fund is a balanced fund that today sticks to the range of 2/3 equities and 1/3 bonds. See that link and read the prospectus for more details.

So what would an investor have given up, or left on the table, by adding bonds compared to an all equity portfolio?

Here's how that fund fared, compared to the S&P 500 (NYSEARCA:SPY). Wellington numbers are courtesy of yahoo finance, the S&P 500 returns are courtesy of moneychimp.com. The returns are nominal, not real returns. The third column represents the returns of Wellington compared to the S&P 500.

 

Wellington

S&P 500

Difference

1980

22.58

32.76

-10.18

1979

13.54

18.69

-5.15

1978

5.32

6.41

-1.09

1977

-4.38

-7.78

+3.4

1976

23.36

24.20

-.0.84

1975

25.18

38.46

-13.28

1974

-17.73

-26.95

+9.22

1973

-11.83

-15.03

+3.2

1972

10.99

19.15

-8.16

1971

8.88

14.54

-5.66

1970

6.40

3.60

+2.8

1969

-7.83

-8.63

+0.8

1968

7.91

11.03

-3.12

1967

8.16

24.45

-16.29

1966

-6.61

-10.36

-16.97

1965

5.44

12.45

-7.01

1964

10.85

16.59

-5.74

1963

11.92

23.04

-11.12

1962

-5.17

-9.20

-4.03

1961

18.97

28.51

-9.54

1960

5.17

-0.74

+4.43

1959

8.86

11.59

-2.73

1958

28.47

43.40

-14.93

1957

-4.30

-9.30

+5.0

1956

4.43

6.38

-1.95

1955

15.54

28.22

-12.68

1954

30.86

55.99

-25.13

1953

1.87

-.80

+2.67

1952

10.99

18.35

-7.36

1951

12.32

23.10

-10.78

1950

12.69

34.28

-19.79

1949

16.50

15.96

+.54

1948

3.85

9.51

-5.66

1947

-3.47

2.56

-6.03

1946

-2.41

-12.05

+9.64

1945

23.13

39.35

-16.22

1944

19.37

19.67

-.30

1943

24.88

23.60

+1.28

1942

16.62

21.74

-5.12

1941

-3.91

-9.09

+5.18

1940

0.16

-8.91

-8.75

And here's how the Wellington Fund compares to the S&P 500 by 10 year periods, by decade. For example the first 10 year period is January 1, 1940 to December 31, 1949.

1940-49 Wellington CAGR 8.92% S&P 500 CAGR 9.06%

1950-59 Wellington CAGR 11.69% S&P 500 CAGR 19.68%

1960-69 Wellington CAGR 4.55% S&P 500 CAGR 7.75%

1970 -79 Wellington CAGR 5.07% S&P 500 CAGR 5.8%

Average for periods was 7.5%. Average for periods 10.75%

Incredibly, the Wellington Fund did quite well compared to the S&P 500 in a period where we saw the greatest rise in yields, 1970-79. The early part of the 70's provided a few years when bond prices would have increased substantially, and as there are 2 sides to the bond coin, and when it comes to income, buying yields of 7-10% is nothing to sneeze at. That's a lot of income to reinvest, perhaps into stocks when they are going on sale and offering some long or near term value. That said, we can see that those were very modest returns for the Wellington Fund through the 10 year periods of 60-60 and 70-79.

And here's a look at the bond bull era, from 1981 until 2013. What's the total return cost of holding bonds in a period of one of the greatest bull market runs in history, 1980 to 1999.

 

Wellington

S&P 500

Difference

2013

19.66

32.42

-12.76

2012

12.57

15.88

-3.31

2011

3.85

2.07

+1.78

2010

10.93

14.87

-3.94

2009

22.20

27.11

-4.91

2008

-22.30

-37.22

+14.92

2007

8.34

5.46

+2.88

2006

14.97

15.74

-0.77

2005

6.82

4.79

+2.03

2004

11.17

10.82

-0.35

2003

20.75

28.72

-7.97

2002

-6.90

-22.27

+15.34

2001

4.19

-11.98

+16.17

2000

10.40

-9.11

+19.51

1999

4.41

21.11

-16.7

1998

12.06

28.73

-16.67

1997

23.23

33.67

10.44

1996

16.19

23.06

-6.87

1995

32.92

38.02

-5.1

1994

-0.49

1.19

-1.68

1993

13.52

10.17

3.35

1992

7.93

7.60

+.33

1991

23.65

30.95

-7.3

1990

-2.81

-3.42

-0.61

1989

21.60

32.0

-10.4

1988

16.11

16.64

-.53

1987

2.28

5.69

-3.41

1986

18.40

19.06

-0.66

1985

28.53

32.24

-3.71

1984

10.70

5.96

-4.47

1983

23.57

23.13

+0.44

1982

24.55

21.22

+3.33

1981

2.90

-5.33

+8.23

1980

22.58

32.76

-10.18

And here are the CAGR returns by decade.

1980 - 1989 Wellington 16.71% S&P 500 17.53%

1990 - 1999 Wellington 12.54% S&P 500 18.28%

2000 - 2009 Wellington 6.11% S&P 500 (-0.94%)

2000 - 2013 (to December 31, 2013)

Wellington 7.66% S&P 500 3.55%

Average for the 10 year periods was 11.79% for Wellington and 11.62% for the S&P 500. Please note returns would have changed from every start date, this is certainly a snap shot, by decade. Also returns would have changed for an investor who was dollar cost averaging, with returns affected by the timing of purchases.

This all looks very promising for those with a balanced portfolio and it may offer some comfort. But of course there is never a guarantee that history will repeat itself, there are simply too many moving parts and variables. The equity markets supported the Wellington Fund in many periods, with stretches of incredible (historic) gains. And that seems logical in hindsight as the S&P 500 could be purchased at very, very low price to earnings ratios in the early 50s and late 70s and early 1980s. Today, current PE ratios and especially the Shiller PE ratios are at very high levels. In fact, the Shiller PE ratio appears to be heading for 1929 levels. The stock markets may not be able to come to the defense of the balanced portfolio in any rising rate environment.

These are curious times. Warren Buffet will suggest that the stock markets are supported by those low yields, and when yields increase, many investors will move to the more attractive rates of higher fixed income. And perhaps over time, those rising rates can be somewhat attractive (and beneficial) to an investor who ladders their bonds, or makes bond fund purchases on a regular schedule. And perhaps rates will stay low pushing equities to higher prices and higher valuations. Who knows, but many investors will like to have their hands in both pots.

Money has to flow somewhere, and perhaps that is the main reason that a balanced portfolio might fare well in the future, and reason for that 'balanced' investor to be optimistic about the investment future. Along the investment path, both stocks and bonds will likely present opportunities.

Whatever your approach is, remember to stay the course and stick to the plan. If you don't have a plan, well, get one in a hurry.

Happy investing, be careful out there, and always know your risk tolerance level.

Dale

Disclosure: The author is long SPY, EFA, EWC, VIG, BRK.B, AAPL, ENB, TRP.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Dale Roberts is an investment funds associate at Tangerine Investment Funds Limited. The Tangerine Investment Portfolios offer complete, low-fee index-based portfolios to Canadians. Dale's commentary does not constitute investment advice. The opinions and information should only be factored into an investor's overall opinion forming process. The views expressed are personal and do not necessarily represent those of Scotiabank