Bond Kings Fight Over a Dead Bull
When the Federal Reserve dropped interest rates to the floor after the 2008 financial crisis, everyone understood that the three-decade bull market in U.S. bonds was ending. The only question was when.
Two of the biggest names in bond investing -- Jeffrey Gundlach and Bill Gross -- recently squabbled over that question. Gross says the bond party will officially end when the 10-year Treasury yield tops 2.6 percent (it’s currently 2.4 percent). Gundlach insists that the end is 3 percent.
The disagreement has been amusing. It’s also moot because the bond bull market is already over.
Some historical perspective is illuminating. I looked at returns from long-term government bonds stretching back to 1926, the earliest year for which data are available. I found that rolling five-year returns from bonds averaged 3 percent annually from 1930 to 1981, when the fed funds rate peaked at 19 percent. Since then, rolling five-year returns from bonds have averaged 9.6 percent annually through 2016.
It’s no wonder investors are reluctant to say goodbye to the bond bull market.
But I also found that the bull market in bonds has been fading slowly since it began. Rolling five-year returns from bonds have gradually trended down since 1982. And in recent periods the returns from bonds have resembled the pre-bull market era. Long-term government bonds returned 3.3 percent annually during the five years that ended in November 2016, and just 2.6 percent annually through December 2016.
“Bye-bye bond bull market,” as Gundlach would say.
Nor does the Gundlach-Gross quarrel shed any light on what, if anything, investors should do about it. The traditional alternative to bonds is stocks, but U.S. stocks may not be any more appealing. First, U.S. stock valuations look frothy. Second, if interest rates continue to rise, the equity risk premium will shrink and stocks will seem increasingly less attractive.
Third, just because both U.S. stocks and bonds are expensive doesn’t mean they are equally risky. The rolling five-year standard deviation of long-term government bonds has averaged 7.6 percent from 1930 to 2016, whereas the comparable standard deviation for the S&P 500 has averaged 17.2 percent. (Standard deviation reflects the performance volatility of an investment; a lower standard deviation indicates a less bumpy ride.)
Even during the scariest episode for bonds on record -- when the Fed raised the fed funds rate by 14 percentage points in the late 1970s and early 1980s to battle stagflation -- the rolling five-year standard deviation of long-term government bonds never exceeded 16.6 percent. That’s still less than the average standard deviation for stocks. And no one anticipates a replay of the 1970s.
Gundlach and Gross surely know all this. So how to explain the fuss over a meaningless 10-year Treasury yield?
The answer became apparent when in the heat of battle Gundlach referred to Gross as a “second-tier” bond manager. Translation: This feud has little to do with bond yields and more to do with who’s crowned the bond king.
Gundlach and Gross are probably the only two bond managers who can stake a claim to that title. As manager of the TCW Total Return Bond Fund and now the DoubleLine Total Return Bond Fund, Gundlach has outpaced the Bloomberg Barclays U.S. Aggregate Bond Index by 1.5 percent annually from July 1993 through 2016.
Gross has been at it several years longer than Gundlach. But at the comparable point in his career, Gross’s Pimco Total Return Fund had beaten the Bond Index by 1.1 percent annually from June 1987 to November 2010. Gross joined Janus Capital Group Inc. in 2014.
Both are Hall of Fame-worthy feats. Whether they like it or not, Gundlach and Gross will have to get used to sharing the realm.
And investors will have to get used to more muted bond returns. No amount of bickering between bond kings is going to change that.
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