Below is my “go to” inflation chart. The Ned Davis Research Inflation Timing Model consists of 22 indicators that primarily measure the various rates of change of such indicators as commodity prices, consumer prices, producer prices, and industrial production. The model totals all the indicator readings and provides a score ranging from +22 (strong inflationary pressures) to -22 (strong disinflationary pressures). High inflationary pressures are signaled when the model rises to +6 or above. Low inflationary pressures are indicated when the model falls to zero or less.
Source: Ned Davis Research
Bonds, bond funds and bond ETFs lose money when rates rise. I posted this next chart just a few days before Treasury yields hit a 35-year yield low of 1.37%. What it shows is how much money is lost when rates rise.
If your starting point was a yield of 1.40% (top half of chart), as it was on 7/11/2016, and rates rose to 2.40% (which they did) your loss would be -8.84% if you were invested in 10-year Treasury Notes and -19.07% (bottom section of chart) if yields on the 30-year Treasury Bond rose to 3.25% (which it nearly did). Further, note the risk of loss if the 10-year rises to 5.40%. Note the -53.90% loss on the 30-year if yields rise to 6.25%.
A number of pundits are calling for a 5% yield in the 10-year within a few short years. I’m not in that camp but really… I don’t know. I’m more in the “one more big recession” camp that will properly reset equity valuations and if so then rates should gap lower.
What I do believe is most important, is that investors should see this chart and size up the potential risk-reward for themselves. With rates just coming off 5,000-year lows, my best advice is to think about your bond exposure as if your retirement wealth is dependent on it… and it is.
2.45% Treasury yields suck (as a good friend reminds me is a technical term) and rising inflation will eat into the net real yield and further cause interest rates to spike higher. Treasury yields were north of 5% in 2007.
Be tactical with your bond exposure. Don’t look at the last 35 years, as many people do, and project it forward. The great bond bull market yield low is likely in. Think differently about how you position that 40% of the traditional 60% equity / 40% bond portfolio.
