How safe is the “safe” portion of your portfolio? How thirsty were you about piling into safe assets at any price?
Unfortunately, a lot of people may soon find out the harsh truth about overpaying for the perceived safety of US Treasurys and German Bunds. I’ll leave out JGBs from this discussion because those are in God’s hands and can only ascend to the heavens.
Jeff Gundlach and Bill Gross have both been quoted as saying bunds could be one of the greatest shorts of all time. They briefly sold at a yield of approximately zero before a vicious reversal in the last two weeks. At the Ira Sohn Conference this week, Lee Cooperman described buying long-dated bonds here as picking up a dime in front of a steamroller. “You may get away with it a few times, but…”
Hans Mikkelsen, a credit market strategist from Merrill Lynch, noted a shocking fact about the reversal that ought to serve as a reminder about how duration can affect a portfolio if and when the perception of rising rates gets into the marketplace:
Ugly bond math
One key reason for the recent increase in US long term interest rates has been surging German rates – basically unwinding a big source of downward pressure on US yields. With today’s further increase in yields (+13bps to 0.99%) 30-year bund yields have now increased 53bps over the past two weeks. For the typical high yield bond with a duration of 4.4, a 53bps increase in yield would imply roughly a 2.3% decline in bond price – or the equivalent of about a third of a year’s worth of yield. However, at their peak two weeks ago 30-year bunds had duration of 23.7. Hence 30-year bund prices have declined approximately 12% over the last two weeks, or roughly 25 years worth of yield!
Josh here – maybe this was merely a dead cat bounce, or, in German, und tote katze sprungkraft. There’s going to be a lot of government bond buying in the Euro Zone for the foreseeable future (or forever), after all. Or maybe the safety chasers get punished even further,
Either way, they got their head’s up. The investment markets are a jungle. And like any jungle, virtually everything around us – from snakes to bugs to plants to beasts, even the soil – can f*ck you up.
Bank of America Merrill Lynch – May 4th 2015