Bonds are historically mediocre at returning positive real yields, which is why I've avoided them. But it seems to me that using bonds to bet on an interest rate reversion seems promising.
Here are the premises, as I see them:
Personally, I think that it is far more likely for rates to hold steady or fall back to 2%, because the 2009 to 2020 2% inflation era seemed to work OK economically.
So under this reasoning, the sensible strategy might be to bail out of stocks, pile into long-term T-bonds, and get back into stocks if and when stock prices (P/E) readjust to more closely reflect the traditional 4% equity risk premium, roughly P/E=1/(2% real bond yield + 4% equity risk premium )=17. Or even if P/E doesn't fall, holding bonds through an interest rate decline would give one a lot more money to put into modestly historically overpriced stocks.
edit: obviously, title is wrong - "2010 to 2019 interest rate regime"
Here are the premises, as I see them:
- 30 year T-bonds are paying 4.45%
- The Fed is seeking to return to 2% inflation. During the 2010-2019 pre-covid era, at this inflation level, 30 year bond yields were about 1.5-2%
- There are good reasons to believe that the current episode of inflation is an economic readjustment from covid era shifts in demand, not a consequence of pre-covid low rates.
- If I use the zero-coupon bond equation value for interest rate r, par value V, years Y: Price=P=V/(1+r)[sup]Y[/sup] I get the following 30 year 3-year-holding period nominal-dollar profits for holding bonds through an interest rate shift from rate r1 to r2, as Profit = [(1+r2)[sup]Y-3[/sup]/(1+r1)[sup]Y[/sup]]-1
- +116% profit if 30 year bond rates drop to 'normal' level of 2% after 3 years
- +66% profit if 30 year bond rates drop to 3% after 3 years
- 1.2% loss if 30 year bond rates rise to 5% after 3 years
- 23.5% loss if 30 year bond rates rise to 6% after 3 years
- 40% loss if 30 year bond rates rise to 7% after 3 years
Personally, I think that it is far more likely for rates to hold steady or fall back to 2%, because the 2009 to 2020 2% inflation era seemed to work OK economically.
So under this reasoning, the sensible strategy might be to bail out of stocks, pile into long-term T-bonds, and get back into stocks if and when stock prices (P/E) readjust to more closely reflect the traditional 4% equity risk premium, roughly P/E=1/(2% real bond yield + 4% equity risk premium )=17. Or even if P/E doesn't fall, holding bonds through an interest rate decline would give one a lot more money to put into modestly historically overpriced stocks.
edit: obviously, title is wrong - "2010 to 2019 interest rate regime"