The “Near Perfect” Investing Environment May End Soon

For the past two decades, government bonds have moved in the opposite direction of equities in the short run but have produced similarly strong gains in the long run, representing a nearly “perfect” investment, according to a recent article in The Wall Street Journal.

From the beginning of 2000 to the end of 2017, the article says, “holding the latest 10-year Treasury and reinvesting coupons returned 155%, the S&P 500 with dividends 158%, while a 60-40 equity-bond portfolio beat both. But,” it adds, “the magic can’t continue forever.”

The danger, it points out, is that bond yields rise without a corresponding increase in real economic growth, as might be the case if inflation returns or the Fed changes its mild-mannered monetary policy. “Both of those possibilities,” according to the article, “are worth worrying about.” When investors believe that inflation is under control, the article argues, they focus on news related to real economic growth, which pushes bonds and equities in different directions. A strong economy boosts bond yields (and pushes prices down) as share prices rise in anticipation of higher profits.

A return of inflation concerns, however, could push up bond yields “with enough force to pummel share prices.” And, the Fed’s shrinking of its balance sheet and putting quantitative easing “into reverse,” could exacerbate the situation.

The article concludes with, “None of these dangers is sure to materialize in 2018,” asserting that inflation can stay low and economic conditions can continue to improve. However, it says, “high on the list of things to worry about is that higher bond yields will finally arrive in 2018 and bring with them not even more new stock-market highs but a correlation crisis.”