Last week in the corporate bond portfolio I manage for the Oxford Bond Advantage, out of more than 60 bonds we hold, we didn’t have a single one fluctuate on the downside by even 1%.
But we did have 10 bonds increase in price by as much as 2%. And two bonds were up 3.5%.
That’s a record on both the upside and downside.
Bonds fluctuate in value – not as much as stocks do, but moving up or down 1% is not out of the question.
But never have I seen a portfolio where not a single bond moved down 1% or more. And more amazing was that the 10 out of 60 that moved up climbed as much as they did.
This doesn’t happen! There is always some selling that will drive down two or three bonds.
Am I bragging a little? Yes! But I have concerns about the rate at which the markets are moving up.
Before I get into the meat of this piece, let me be very clear about who I am…
I am a market coward, and anyone over the age of 55 with any amount of market experience should be too.
A market coward gets a sick feeling in their stomach when they see the kind of week we just had in our bonds. They get a little queasy because they’ve been around the block often enough to know that bonds don’t act this way.
When they do, a market coward’s guard goes up.
This is because they know they’re approaching the age when they can’t replace losses as easily as they could in the past. And if the market coward knows one thing, they know that record highs are an indication of only one thing on the horizon – and it isn’t good.
The point here isn’t that new highs in the market are a bad thing. They aren’t! But getting sucked into the idea that this is the new normal or it can go on forever is a formula for disaster.
Maybe “delusional” is a better description.
For this reason, experienced bond and stock investors should both have their guards up.
Dealing with the inevitable sell-off in stocks is simple: Stop losses work and protect you on the downside.
On the bond side, though, it’s a two-step process.
The first step to reduce risk is to hold short maturities.
Any experienced bond investor has accepted that they’re human, and when the winds shift and it looks like the world is going to end – which is how all market corrections appear – they know how difficult it is to control their emotion-driven decision making.
And it is emotion-driven decision making – better known as panic-selling – driven by market volatility that accounts for almost all of the average investor’s losses.
In bonds, the way to deal with this is to hold only bonds with short maturities of eight years or less. These types of bonds have lower yields, but they also fluctuate in market value a fraction of the amount longer-maturity bonds do.
And less fluctuation and volatility mean there’s less of a chance your emotions will take over.
The second bond component is holding staggered maturities. This means that you schedule at least one bond to mature per year over the course of eight years.
This will provide fresh money coming from maturing bonds each year, which allows you to buy into rising yields in a sell-off.
And buying into a sell-off in bonds (yields move higher when market values drop) will actually increase the overall yield of a bond portfolio.
That’s the exact opposite of what the talking heads on TV say will happen, but if you do the math, you’ll see this works.
So the experienced, market coward bond investor, as crazy as it may sound, actually hopes for a market sell-off. Their experience has taught them to always expect one, and if they have their ducks in a row, the short and staggered portfolio will lead to lower volatility and higher returns, not losses.
We are at year 35 of the bull market in bonds and year 10 of the bull market in stocks. Where do you think this is going?
If that doesn’t make a market coward of you, you have my condolences.
Get your guard up now!
Good investing,
Steve