Increasingly, investors are questioning whether the tried-and-true 60/40 paradigm is still relevant after a two decades-long reign. Those concerns may be justified. Take a look at this chart, and I'll explain. (THREAD)
Investors are reacting to the back-up in rates from their historically low levels amid persistent, high-inflation prints. The chart above shows that over the long term, forward bond returns have an inverse relationship to their current yield (or valuation). /2
The chart shows the long-term Government bond yield (using the Ibbotson SBBI series), which on average has a maturity of around 20 years (give or take). Overlaid is the 20-year forward return. /3
It’s not unlike the Shiller CAPE model for equities, which holds that the 10-year forward return is inversely proportional to the trailing 10-year P/E ratio. /4
We all know that bonds held to maturity will return the coupon but nothing else, more or less (at least in nominal terms). At a long-term yield of 2% and inflation north of 5%, bonds are not exactly a screaming bargain right now. /5
The last time that yields were this low (the 1940s and 50s), the volatility of bond returns was also extremely low. Those were the financial repression days. /6
We can run a simple regression of the yield and forward return to come up with a model for predicting future nominal returns. The result is shown below and reveals a very close fit between yields and forward returns (the R-squared is 0.94). /7
The unfortunate conclusion is that investors who buy long-dated government bonds today should expect to earn only 2% nominal if they hold these bonds to maturity. /8
Even if inflation reverts back to its 2% trend from the past decade, that means bond investors will earn a zero real return over the next 20 years or so. And if we have entered a structural inflation regime, it could be a lot less than zero. /END

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More from @TimmerFidelity

3 Nov
Until a few years ago, investors pursuing a diversified 60/40 portfolio got decent bond yields and downside protection when stocks slumped. But if that regime comes to an end (not a prediction, but certainly a possibility), how do we diversify from here? (THREAD)
The chart above shows that during the past two inflation super-cycles (the 1940s and 1965-80), bonds offered little protection. The scatter plot shows the nominal return index for the 60/40 model on the horizontal axis, and the real return index on the vertical. /2
Indexed to this series are the real returns for long-term government bonds, cash, high yield, TIPS (using a colleague’s synthetic series), gold, silver, the CRB, and the S&P 500. /3
Read 6 tweets
3 Nov
Following up on yesterday’s thread: Why would anyone bother buying bonds now? Traditionally, the 60/40 paradigm offered diversification and insurance, peace of mind. But what lies ahead? Take a look at this chart and we'll dive in. (THREAD)
As the chart shows, the only other time the 5-year inflation rate crossed above the nominal yield was 1942. That spurred a long period of very low nominal returns and negative real returns. The 20-year forward real return (yellow line) was negative for almost three decades. /2
The correlation between stocks and bonds back then was positive, from the 1930s all the way to the '50s. In other words, with perfect hindsight, there was absolutely no reason to follow any kind of 60/40 model back then. /3
Read 12 tweets
28 Oct
Bitcoin briefly beat its previous all-time-high, only to reverse lower. Short-term holders (less than 3 months) account for only 15% of all bitcoins, which remains below where it has been at most bottoms. So what's going on? (THREAD)
One thing: There’s now a retail vehicle for owning bitcoin, for those investors who don’t want to have to remember their keys. It may not be perfect but it might do for now. /2
In retrospect, some sort of buy-the-rumor, sell-the-news effect was to be expected, although the on-chain dynamics continue to show no signs of a speculative extreme. /3
Read 5 tweets
26 Oct
With the Fed's taper imminent, rates were on the move again last week, both in nominal and real terms. The TIPS break-even spread continues to test its upper bound of the past five years or so. Are inflation expectations ready to break out? (THREAD) Image
TIPS break-evens have rebounded from the depths of the pandemic. History shows a tendency to mean-revert around 2%, with the top of the range around 2.3% in recent years. But further back, break-evens spent a fair amount of time near 3%. /2 Image
Given that the CPI is north of 5%, a breakout to 3% would not surprise me. /3
Read 6 tweets
22 Oct
Bitcoin made a new all-time high of $66,000 on Wednesday. The chart below shows that both my supply and demand models continue to point to higher prices. (THREAD)
The gains have been pretty stealthy and without the help of momentum chasers. That may be ending now with the SEC approval of a futures-based ETF. /2
Whether such a development will prove to be a sell-the-news event remains to be seen, but I doubt it given the on-chain dynamics mentioned above. /3
Read 5 tweets
22 Oct
Is today's market an echo of the 1940s? The next few charts show the risk-reward tradeoff for the current cycle and for the WWII era. Look at this first one—a snapshot of the past 70 years—and I'll explain. (THREAD)
The chart above sets the stage with the baseline history. Cash at the lower left, stocks at the upper right, 60/40 in the sweet spot, and commodities in the worst place possible: earning only the inflation rate but with a massive vol. /2
Now let’s look at the past 18 months in the chart below. Commodities are up and to the right, along with equities, while bonds are well below the inflation rate. /3
Read 10 tweets

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