50%+ returns on government treasury bonds? Is it possible?
Let’s face it, most investors only care about stocks. They want a great story and the ability to dream about great potential returns. Congruently, when someone brings up government bonds, more often than not investors generalize them as a boring safe asset which is owned in a diversified portfolio to reduce risk and generate conservative income.
Let me offer you an alternative perspective. When investors allocate a proper portion of their asset mix to treasury bonds during the right stages of a monetary easing cycle, they can perform extraordinarily well. As an example of the type of returns an investor could make, an investor that bought 20+ year duration U.S. treasury bonds in the spring of 2011, would have found themselves up close to 50% by the summer of 2012. Those are returns without using leverage.
Does that sound like a boring conservative investment return to you?
You might be asking the question – why or how can bonds make that kind of return?
That is because longer duration bonds are very sensitive to changes in interest rates and when an investor owns these bonds during a period of declining interest rates, there is an opportunity to make great returns as the bonds price in those lower yields. I will elaborate on this further in a moment.
Now many investors may be skeptical because of the fearmongering preached from market strategists.
Have you heard pundits and strategists argue that with the rising U.S. deficits, that the bankruptcy of the U.S. government is imminent? Or heard that China and Saudi Arabia are dumping all their bonds and will rocket interest rates higher forcing a huge funding crisis?
Often these doomsday sermons are given by strategist advocating the purchase of gold, crypto currencies and other alternative assets. Or alternatively they simply are underestimating the ability of governments and central banks to manage these flows.
The bullish case for U.S. Treasury and Government of Canada bonds for the remainder of 2019
In order to make a bullish argument on bonds is about building the narrative for lower interest rates to come. Let me ask you a series of questions for you to draw some conclusions.
- The Federal Reserve and the Bank of Canada are done raising interest rates. These monetary cycles of raising and lowering interest rates are multi-year cycles and only very rarely is there a flip-flop in policy. Do you believe the Fed and Bank of Canada are done raising rates?
- Through history, central banks raise interest rates and tighten credit conditions until the economy stalls, often falling into a recession. Do you believe that we have entered an economic slowdown?
If you answered yes to the above questions, then positioning in treasury bonds is a no brainer.
It is our thesis that the business cycle has peaked, inflation will remain subdued and consequently interest rates have also peaked. As the economy slows, the central banks will ease to stimulate the economy and bonds will have the opportunity to be one of the strongest performing assets in your portfolio.
Best part, it will be a good diversifier for your portfolio as these are periods where volatility in stock portfolios increases.
How do you participate?
There are a number of long duration government bond ETFs available to be owned both in and out of your RRSPs.
Just to name a few:
- BMO Federal Bond Index (ZFL) – Canadian government bonds in Canadian dollars
- iShares 7-10 Year Treasury Bond ETF (IEF) – US government bonds in U.S. dollars
- iShares 20+ Year Treasury Bond ETF (TLT) – US government bonds in U.S. dollars
During the business cycle, there is a right time and a place for each style of investment. It certainly is a interesting time to consider government bonds anticipating a new rate cutting cycle.
Thanks for reading,
Patrick Ceresna, CMT CIM DMS
Big Picture Trading