A lot of smart people are betting on rising interest rates and a coming bear market in bonds. Yet, people have been calling for an end to the decline in interest rates for years, said Dennis Gartman, editor and publisher of The Gartman Letter.
“They were convinced five months ago and five weeks ago; they were convinced five hours ago, and they will be convinced next week and the week after and five years from now,” Gartman said during a panel at ETF.com’s Global Macro ETF Strategist Conference in New York this week.
Gartman said the bet on rising rates has been “a terrible, terrible, terrible, terrible bet.”
“I think you’re going to be surprised how much farther rates can, in fact, go down. You have to be prepared for that fact.”
To get bond exposure, Gartman recommends the Aberdeen Asia-Pacific Income Common fund, which owns Australian and New Zealand short-term government securities.
“Should you own traditional 10-year Treasuries as your bond buffer in an equity portfolio? Probably not,” said Jim Lowell, chief investment officer at Adviser Investments. “Should you only own shorter duration, government-backs or corporates, or intermediate short term? Probably not.”
Lowell likes junk bonds, some areas of sovereign debt, some emerging market debt and investments that are either reasonably correlated or low correlated to the income universe, such as currencies and commodities.
Bonds are not dead, argued Anthony Parish, vice president of research and portfolio strategy at Sage Advisory Services. If you look at the last four interest rate cycles (1988, 1994, 1999 and 2004), economic conditions are nowhere near where they need to be for the Fed to raise rates. ISM Manufacturing is currently at 55.4 percent, versus an average of 57.2 percent at the start of prior tightening cycles. Core CPI is at 2.1 versus the average 2.3; unemployment is 6.3 percent, versus the average 5.5 percent; consumer confidence is 81.2, compared to 103.6 on average; housing starts are currently 1,001 compared to an average 1,621; and GDP growth is 2 percent, versus 4.3 percent on average.
There’s always a bull market somewhere in bonds, Parish argued. If you look at the best performing asset classes within the bond market when the 10-year Treasury yields are below 2 percent, that includes preferred stocks (average monthly return of 1.17 percent), U.S. corporate high yield (average monthly return of 1.12 percent), and U.S. convertibles (average monthly return of 0.96 percent).
Rising rates don’t necessarily lead to negative returns in the bond market, Parish added. What happens when rates do rise? From 1977 to 1982, rates rose from 8 percent to 14 percent. Yet, there have only been three years of negative returns in bonds since ’77—1994, 1999 and 2013.
Another reason bonds aren’t dead? Stock returns are a function of price movement; bond returns are not. Bond returns, instead, are a function of time because of income accrual. Even if the price drops 5 percent, you still have a positive return because of that accrual of income.
But beware the panic sell-off after rates rise, he warned. “This is the fatal flaw for bond investors. This is the doctor killing the patient after saving the patient.”
