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The Bond Crisis Part 2 - Challenging The Traditional Asset Allocation Model

In the first part of this article we looked at why the Bond market is in crisis. In this second part we will look at what happened in the bond marketi n 2020 and 2021 to date and what the elite investors are saying about it.

Challenges for the Bond Market in 2020 and 2021

The last year has been challenging. Bonds rallied as equities started to fall in February 2020, but when equity markets collapsed in March 2020 so did bonds.When equity markets bounced back, bonds did not. As a result, the long held assumption about the protection you get from holding bonds which is that bond prices rise when yields fall or the economy slumps has come into question. 

The crisis in the bond market accellerated after the democrats got into power in early January 2021 along with the promise of another gargantuan stimulus package to the tune of $1.9 trillion. This in addtion to the promise of getting the US population vaccinated by end of summer 2021 has raised hopes for a strong rebound in the economy starting in Q3 2020. The risk of inflation alongside a resurgent economy and possible end to continued QE has unnerved bond holders. The US has downplayed the possibility of negative interest rates happening in the US, as has been the case for some time now in Germany. However some analysts are not so sure this will not happen in the USA. And negative interest rates would be one play that would lead to an increase in bond prices while keeping interest rates at all time lows. The Fed may also decide to lower interest rates to stabilize bond prices. In any case, the rationale for holding bonds now is less compelling than ever before.

“We may finally once again be on the road to reflation,” said Ed Yardeni of Yardeni Research. “I’m seeing more and more signs of mounting inflationary pressures as a result of the unprecedented stimulus that fiscal and monetary policymakers are providing in response to the pandemic.” The Bloomberg Barclays Multiverse index which tracks $70tn worth of debt has lost about 1.9 per cent since the end of 2020, measured in total returns that account for price changes and interest payments. If this continues through March 2021, it would be the worst quarterly performance since mid-2018 and the sharpest first-quarter setback for the broad fixed income gauge in six years.

Warren Buffet's latest comments in his letter to Berkshire Hathaway shareholders

“Fixed-income investors worldwide — whether pension funds, insurance companies or retirees — face a bleak future,” he wrote. “Competitors, for both regulatory and credit-rating reasons, must focus on bonds. And bonds are not the place to be these days.”

Investors had moved to adjust their portfolios before the sell-off in Treasuries this week by buying lower-quality debt that offered higher returns.

Buffett warned on Saturday that the move by insurers and bond buyers to “juice the pathetic returns now available by shifting their purchases to obligations backed by shaky borrowers” was a concern.

“Risky loans, however, are not the answer to inadequate interest rates,” he said. “Three decades ago, the once-mighty savings and loan industry destroyed itself, partly by ignoring that maxim.”

The New Investor Crisis - Finding Yield at Low Risk

So where do Investors go to find yield at a lower risk? The Bond market environment is not favorable and equities are priced close to perfection or all time highs, some argue. Holding cash in an inflationary environment is not an attractive option either.

A market shift is occurring in these unique times. In a previous blog post we discussed the disruption to the financial industry being ushered in by DEFI (decentralized finance). Could the current bond and equity environment cause a shift in a percentage capital allocation to this new market place? It is hard to see where a better yield can be found and the evolution of the DEFI market with 40 billion of assets tied up the ecosystem (up from $1billion a year ago) may entice wealth management firms to allocate a small percentage of capital to this new asset class and build a new risk-adjusted balanced portfolio model for the current economic climate.



Bubbles, Bonds & The Allocation Dilemma - Part 1
The Bond Crisis - Challenging The Traditional Asse...

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