The global rally in bonds has extended to new records this month as trade and recession fears have moved to the fore. The mid- and even long-term bonds of many developed countries are now trading at negative nominal yields, a phenomenon never before seen. However, inflation remains muted, so in real terms these yields are not as absurd as they appear at first glance. There have been times of financial stress such as 1920, the 1940s, 1970s, and 1980 when US Treasuries have had worse real yields. The net effect on purchasing power is all that matters, whether headline yields are negative or positive.
Now, buying and holding such bonds to maturity is a very different proposition from holding them only during slowdowns in the economy. In the portfolios we run, our current bond positions have appreciated strongly over the last few months, on the order of 5-15%, and should US Treasuries follow European bonds into negative territory, their prices would rally by as much again.
It is precisely this tendency for quality bonds to rally during slowdowns that makes them so useful in a portfolio, as their gains may offset losses elsewhere. Furthermore, in a tactical all-weather portfolio such as those we maintain at our firm, declining assets tend to be trimmed early, so the portfolio as a whole may continue to appreciate. This is indeed what we have been seeing in recent weeks, thanks to light equity allocations and healthy portions of bonds and gold. Nobody can know for sure whether equities will enter a bear market, or if this volatility will pass, as in so many other episodes in the last decade, but for now we are content with our tilt towards a defensive stance.