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2012: Is This Time Different?

By: Jeff Goble

A new year begins! For the past three years now, we have been debating whether the historic Fed action that has driven short-term bond yields to 50-year lows is only temporary … or somehow more permanent.

As the chart below of two-year Treasury note yields illustrates, since 1979 bond yields have basically been falling due to decreasing inflation expectations and the record amounts of cash flowing to the United States for safety and because of globalization. Does this mean the 30-year secular bull market in bonds is ending?

For perspective, if you look back to the 1930s and 1940s, bond yields actually look normal today and perhaps even a little high. Is it somehow possible that the double-digit yields in the 1980s seen in the chart were a Volcker-initiated, inflation breaking, one-time event and now we are simply reverting back to the 100-year mean? I would love to know.

It has been very tempting to change the way you invest money for the bank during this longer-than-normal low-rate trough as there are so few reasonable investment options now with any yield. I like following a counter-cyclical formula for bank investing as it helps remove the emotion of the market and also helps you resist the temptation to invest outside of your policy or try new things when you have too much cash and need yield. Hopefully, following this proven formula will help you create more consistent, long-term performance for your bond portfolio:

When market yields exceed your portfolio’s overall yield, take losses in stages on your shorter-term issues and extend your maturity/duration with non-callable issues, generally longer than your portfolio’s overall average maturity. When market yields are less than your portfolio’s average (like now), consider gains if appropriate, improve quality and patiently reinvest generally shorter than your portfolio’s average maturity as you wait out the low rate cycle.

This formula is really just a mechanical dollar cost averaging plan and I think it will serve you well over time. Keep in mind that it will always be tempting to do just the opposite of these moves, so remember the counter-cyclical theory. Generally speaking, the highest bond yields in your portfolio will be those purchased after taking losses, as they create incredibly valuable cash to invest when bond yields are peaking (please reference the chart: 2006, 2000,1994,1989,1984 and 1981).

This time is different. Eventually, though … I think it will turn out to be the same.

* * * * *

Best wishes for a prosperous 2012 and a special thank you to BankNews for the privilege of writing this column again this year and over the past 23 years. Thank you for your email and comments throughout the year and I hope I have helped you sleep a little better at night.

Jeff Goble is executive vice president and managing director, investment banking, at UMB Bank, n.a., Kansas City. His email address is Jeffrey.Goble(at)umb.com.

Copyright (c) January 2012 by BankNews Media



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