Gentlemen Prefer Bonds
“If you're not confused about the stock market...you're not paying attention."
The Portfolio Performance
The portfolio is UP +15.78% YTD
The S&P 500 is UP +11.69% YTD
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I’ve updated the dividends for September from all dividend-paying positions. Year to date, the portfolio has generated $10,692.43. Remember, this portfolio is not reinvesting dividends so that everyone can see the actual cash generated. I highly recommend reinvesting dividends in your own portfolios. This is especially important for younger investors who don’t need the extra income. The compounding of dividend reinvestment can be extraordinary over 10, 20, or even 50 years. If subscribers are interested in the subject, please comment below. If there’s enough interest, I’ll write an article on dividend reinvestment.
A Little History
August 4, 2017
On August 4, 2017, I posted an article, “Day 220: Bond Bubble?” In that post, I discussed why I thought the yield on US Treasuries was going to go higher. On January 13, 2018, I posted that I was shorting US Treasuries in order to capture the gains from rising rates.
January 13, 2018
On January 13th, 2018, I wrote the post “Shorting US Bonds”. https://www.claybaker.com/single-post/2018/01/13/Shorting-US-Bonds. No ‘click-bate’ question mark after the title, no discussion with my readers; I simply did it. Why? Because I felt the bubble was about to burst and that soon, we would see a dramatic shift in the bond market. My action at the time was to buy shares in the TBT (ProShares UltraShort 20+ Year Treasury); as bond prices come down, the TBT goes up; it’s a hedge against falling bond prices or rising yields. However, you like to view it.
I know that 99.99% of my readers come here for stocks. While stocks get most of the media attention, the bond markets move everything. The reason I care about the bond market is because the bond market is larger than the stock market. The U.S. bond market is valued at $51.3 Trillion, while the stock market comes in at about $46.2 trillion. Often, we hear stories online about how China and Japan own most of the U.S. debt. Those stories make great clickbait, but it’s simply not true. China and Japan are the largest ‘foreign’ holders of U.S. debt. The largest holder of U.S. bonds is the Social Security Trust Fund.
Intragovernmental holdings totaled more than $6.89 trillion in January 2023. Why would the government owe money to itself? Because some agencies, like the Social Security Trust Fund, take in more revenue from taxes than they need. These agencies then invest in U.S. Treasuries rather than stick this cash under a giant mattress,
This transfers the agencies' excess revenue to the general fund, where it's spent. They redeem their Treasury notes for funds as needed. The federal government then either raises taxes or issues more debt to raise the required cash.
The TBT investment has generated a return of more than +68%, plus over $1,000/year in dividends. Year-to-date dividends are $1,021.22. The initial investment of $24,994 now has a market value of $42,098. I think this will continue to increase in value until the market is convinced that the Fed is going to start cutting rates. When market sentiment shifts and the Fed does start cutting rates, we need an investment that can perform in the opposite environment. I was warned several times against holding the TBT long-term because the fund rebalances daily. Due to the compounding of daily returns, holding periods longer than one day can result in significantly different returns than the target return. The fund manager and those giving me the warnings didn’t expect the Fed to raise rates by 525 basis points in 15 months. I think I got a little lucky because the historically high rate of increases benefitted the investment.
What I’m doing next
Making an investment in a declining rate environment will require a different fund; I’m looking at the iShares 20+ Year Treasury Bond ETF (TLT) and the ProShares Ultra 20+ Year Treasury (UBT). The TLT is a long bond ETF whose price will rise when interest rates come down. Remember, bond prices and yields move in opposite directions. The TLT tracks an underlying index that measures the performance of U.S. Treasuries that have a remaining maturity greater than or equal to twenty years. The UBT seeks daily investment results that correspond to two times (2x) the daily performance of the ICE U.S. Treasury 20+ Year Bond Index. The UBT comes with the same warning as the TBT because the fund rebalances daily. Due to the compounding of daily returns, holding periods longer than one day can result in significantly different returns than the target return. If you’re considering the UBT, keep this in mind: the fund can go up 2X the index daily or down 2X the index daily. Whatever the underlying bond index does, the UBT will do it two times greater.
I selected the TBT when I expected rates were going to go up because inflation looked sticky, and I was betting on the Fed raising rates aggressively. I had no idea they would raise as aggressively as they did. The Fed’s interest rate hikes have slowed the economy, and over the next few quarters, we’ll learn by how much. The lag effects of each rate hike take about 12-15 months to work through the economy. We’ve already seen some cracks appear in the form of bank failures and credit card and auto loan default rates inching up. Corporate credit for high-growth companies is almost non-existent, and when companies can find loans, the interest rate is exorbitant. If the Federal Reserve raises rates again in November, we’ll likely see more aggressive positioning for a recession, and that sentiment may trigger a recession. The Fed will respond by cutting rates slowly at first, and as lag effects keep showing up, they will cut more aggressively. Unless we have a major event like COVID or a financial crisis, I don’t see rates going back to zero percent. I think 3.50% - 4.0% is a likely range. This all makes me more inclined to start investing in the TLT and be prepared to shift to the UBT if a black swan event appears.
The TLT launched in August 2002 at around $84/share and reached an all-time high of $171 in July 2020 (+103.6% in 18 years). The TLT is currently trading around $87, a near round trip to its IPO price. I suspect it will get closer to $80-$84 by the time I make an investment. Below $80 I would go all in and hold tight.
My action for now is to prepare a spot in the portfolio. If the Fed holds rates in November, I think I’ll trim the TBT position to raise some cash and reduce our exposure.
Place the TLT in a placeholder within the portfolio.
"Markets don't go to zero, Portfolio's do.
Buy quality, be patient...and look twice for motorcycles."
- Clay Baker
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Rule #1: Don't lose money
Rule #2: See Rule #1
Rule #3: Portfolios go to zero, markets don't, Stay Invested
Rule #4: When good stocks you own drop 10% below your cost basis, add shares
Rule #5: Bull markets aren't sustained without the Transports
Rule #6: When Forward P/E is lower than TTM P/E, expect earnings to increase
Rule #7: When an investment bank sells below book value, buy it
Rule #8: Tips are for waiters. Do your own homework.
Rule #9: Don't sell a stock because you're bored with it. Do your own homework.
RULE #10: Being early and being late is the same as being wrong...move on.
Rule #11: Investing is easy. Waiting is hard; waiting is the hardest part.
Disclosure: I am personally invested long in some or all of these stocks or funds that appear in the Stay Invested portfolio and may purchase or sell shares within the next 72 hours. I am also invested in other stocks and funds that do not appear in the Stay Invested portfolio but may be mentioned or related to this article. It is not my intention to advise or encourage the purchase or sale of any security. I am invested long in these securities mentioned in this post:
AMD, AMZN, AAPL, ARKK, ARKG, CNRG, ENPH, FB, GNRC, GBTC, GLD, HRTX, HD, MSFT, NVDA
I am invested short in these securities mentioned in this post:
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is not intended to offer investing advice, guarantee 100% accurate predictions, or to be interpreted as providing a personal recommendation.