This much we all know: There’s money in the United States Treasury. But for a certain breed of investors fond of bonds, there’s money in U.S. Treasurys: government bonds sold in various yearly increments that can balance out a stock-happy portfolio, especially when the market enters the lair of the bear.
Yet Treasury bonds confuse many a market novice or intermediate investor. Perhaps it’s because of their name or the fact that they don’t operate via the same laws of marketplace fluctuation as various investment sectors. Energy stocks benefit from higher oil and natural gas prices, pharmaceuticals soar when new drugs gain FDA approval and technology companies take off when overseas markets for smartphones open up.
But no such product — or any commodity, really — drives Treasury bond prices, which lately have enjoyed quite the run-up.
[See: 7 of the Best Stocks to Buy for 2018.]
The most crucial difference between a Treasury buyer and a shareholder is this: When you buy stock, you essentially purchase a financial stake of a company — you own a piece of it. But with a bond, you loan money and collect interest, just as a bank would, to whichever party issues it. And in the case of Treasurys, the party has been pretty gung-ho.
“U.S. Treasurys are a highly liquid lending vehicle that make up approximately 40 percent of the U.S. core bond market,” says Todd Jablonski, chief investment officer of Principal Global Investors and based in Seattle. “The decline in interest rates in general over the last 30-plus years has provided a significant tailwind to the returns for bond investors.”
Less than three weeks ago, three strata of Treasury bonds broke a number of records. The 10-year Treasury hit a four-year high of 2.944 percent; the 5-year scratched 2.687 percent, its highest level since April 2010; and the two-year Treasury yield peaked at 2.213 percent, a level not seen since September 2008. And as trading began this week all three remained very close to those vigorous highs.
To put those yields in perspective, let’s look at where things sat roughly six months ago. On Sept. 8, the yields for 10-, five- and two-year Treasurys were 2.061, 1.641 and 1.274 percent respectively.
Since the fall, Treasurys have climbed without interruption. Even the 30-year bond — more volatile over the same period — enjoyed an auction in January that set a record for its traction with “indirect buyers.” These purchasers, usually seen as foreign investors, snapped up 72 percent of the offering: the highest share since at least May 2003, when such data was first shared with the public.
[See: Warren Buffett’s 8 Favorite Stocks.]
Just a year before in 2002, “The S&P 500 lost 22.1 percent,” says Gene Tannuzzo senior portfolio manager at Columbia Threadneedle Investments in Minneapolis. “Having exposure to 10-year Treasury bonds would have provided a nice offset, with positive double-digit returns of 11.8 percent.” Ditto in 2008, when the S&P (down 37 percent) couldn’t hold a candle to the 10-year Treasury yield (13.7 percent).
Yet anyone betting on good times to last in Treasuryland might what to think again, as new Federal Reserve Chairman Jerome Powell has made his interest rate agenda clear.
“The Fed has told us exactly what they are planning on doing this year and into the near future,” says Jeff Powell, managing partner of Polaris Greystone Financial Group and based in the San Francisco Bay Area. “They want to raise interest rates 75 basis points this year, and would like to have rates around 3 percent in the coming years. The Fed’s stance will most likely have a severe and negative impact for the bond market.”
And while U.S. Treasury securities are viewed as one of the safest investment options around, they’re vulnerable to interest rate risk. Think of a seesaw: In fact, that’s the exact image the Securities and Exchange Commission uses in an investor education document that explains the phenomenon. Rising market interest rates equal lower fixed-rate bond prices; falling rates equal higher prices.
Here’s a practical example: If a $1,000 Treasury bond has a coupon rate of 6 percent, that means it pays $60 per year in interest and you can buy it at $1,000 — that is, when interest rates are 6 percent as well. But if rates rise to 7 percent, the bond price must decline — in this case, to $857 — for that $60 annual payout to produce a 7 percent return to the investor.
Thus now may represent the quintessentially wrong time to overweight your nest egg with Treasurys.
“It appears the days of driving portfolio income by investing only in U.S. Treasurys and investment-grade corporate bonds are at an end, at least for now,” says Benjamin Halliburton, chief investment officer at Tradition Capital Management in Summit, New Jersey.
“We have recommended our clients lower their exposure to bonds, shorten their duration risk, and consider ‘floating rate’ bonds and convertible bonds as alternatives to their U.S. bond market exposure,” Jeff Powell says, adding that “the U.S. Treasury has fallen in yield as demand for safe, U.S. dollar-denominated investments went up.”
So what now, Treasury fans? No one owns the priceless crystal ball, not even the U.S. Treasury itself. But it’s likely a good idea to wait out the Fed’s expected interest rate hikes for 2018 and reassess where Treasurys might go from there or, hold on to the bonds you have and reap their benefits.
[Read: 5 of the Best Stocks to buy for March.]
“If investors can live with the volatility that can come from Treasury rates moving around, then investors can continue to receive the income stream that bonds provide,” Jablonski says. “Investing in bonds isn’t about growth, it’s about stability of an income stream.”
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Moment of Truth for Treasury Bonds originally appeared on usnews.com
