Monday, July 28
The U.S. bond market is flashing red. Using the Bloomberg U.S. aggregate bond index as a proxy, bonds are in their longest bear market in nearly 50 years.
Data shows the maximum decline in that period is only 17.2%, however. That’s because the index includes investment grade bonds, Treasurys, corporate bonds, and more.
The situation is even more dire for the “safest” bonds in the world, long-term U.S. Treasurys. The popular exchange-traded fund for long-term Treasurys, the iShares 20+ Year Treasury Bond ETF, peaked in August 2020, falling as much as 51.8% since.
Losing half your money in the world’s “safest” security seems impossible. But it happened and it’s still happening. Worse, no one knows how long it will continue.
And it’s weird that the stock market doesn’t seem to mind.
Bonds are supposed to be safer and less volatile than stocks. When the safer choices are in big trouble, shouldn’t we worry more about the riskier ones?
When you look at a company’s financials, equity takes the lowest priority in the capital structure. Most of the time, the hierarchy doesn’t matter much. But when a company goes bankrupt, the capital structure matters most.
If you’re a secured creditor, you’ll likely get your whole investment back. If you’re an equity holder, odds are you’ll get nothing.
This idea carries into the overall market. With bonds in a deep bear market, you’d think the stock market would be down 20%. Instead, it’s near a new all-time high.
Stock investors aren’t worried, they’re elated – as if the capital structure doesn’t exist.
While they aren’t bankruptcy risks, people think mega-cap technology companies’ shares can’t lose over time. That remains to be seen, though they’re certainly not cheap.
And with valuations so high, if the S&P 500 price-to-earnings ratio declines to its long-term mean, retirement fund values could be halved. That would hurt, much like a bankruptcy.
It reminds me of an exchange in Hemingway’s “The Sun Also Rises.” A character asked another how he went bankrupt. He said in two ways – gradually, then suddenly.
A bear market can play out gradually. Your account declines 5%, 10%, 15%, and then suddenly, your wealth has been cut in half. Don’t fall into the trap of believing the market can’t crash.