Your SlideShare is downloading. ×
Bond Market Town Hall Meeting
Upcoming SlideShare
Loading in...5
×

Thanks for flagging this SlideShare!

Oops! An error has occurred.

×

Saving this for later?

Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime - even offline.

Text the download link to your phone

Standard text messaging rates apply

Bond Market Town Hall Meeting

420
views

Published on

An open forum to answer advisor's questions about the impact of recent events on the bond market

An open forum to answer advisor's questions about the impact of recent events on the bond market

Published in: Economy & Finance, Business

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
420
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
0
Comments
0
Likes
0
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. Bond Market Town Hall Meeting
    August 12, 2011
  • 2. What is the impact of the S&P downgrade?
  • 3. Vs.
    The downgrade was more a political statement than an economic analysis
    The US economy still looks very strong relative to many AAA rated countries
    The sheer size of the US economy dwarfs most of the remaining AAA countries like Liechtenstein
  • 4. Do Nothing or Do Something?
    Take little action as they have in Greece…Or
    Enact austerity measures in the face of a downgrade like they have in England
  • 5. Neither approach has received a warm reception from the public
  • 6. Two Major Events
    Actually, there were two major events over the week of August 5-12, 2011:
    S&P Downgrade of US Treasuries
    http://www.standardandpoors.com/home/en/us
    2. Fed policy statement that it intends to keep interest rates low until mid-2013
    http://www.federalreserve.gov/newsevents/press/monetary/20110809a.htm
  • 7. What S&P Did
    Long-term US notes and bonds downgraded to AA+ for the first time in history
    Short-term bills maintained top A-1 rating
    Moody’s and Fitch maintained the AAA rating but kept the US on negative watch
  • 8. What S&P Said
    “The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics.”
  • 9. “More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges”
  • 10. “…we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon.”
  • 11. The S&P Downgrade
    S&P is saying that they believe what is going on in Washington is not business as usual – There is a greater degree of partisanship
    Two views of how America ought to be governed are in direct conflict to a greater degree than normal with no clear path to resolution – Infighting between Republicans and Democrats poses a greater barrier to solving the debt problem
  • 12. Where does that put the US?
    The sovereign debt of 126 countries are rated by S&P
    18 have AAA rating (was 19)
    3 have AA+ rating (was 2):
    Belgium
    New Zealand
    USA
  • 13. First and Second Tier Countries
  • 14. Comparing the AA+ Countries
    Belgium
    Tied the record for a democratic country without a government in place in 2010
    Economy is ranked 20th or would be 8th as a State behind Ohio
    New Zealand
    Recovering from one of the largest natural disasters in history
    Economy is ranked 52nd or would be 31st as a State behind Kansas
  • 15. Third Tier Countries
  • 16. Junk Bond Countries
  • 17. 126 Country Ratings 8/11/11
  • 18. Are Government bonds still safe?  What about municipal and corporate bonds?
  • 19. US Government Historical Defaults
    Has never happened, so no data available
    Yields on Treasuries went down after S&P announcement,
    • Suggests market still believes US sovereign debt remains the best available.
    • 20. S&P credibility may be hurt; several corporate bonds remain AAA rated in spite of S&P’s policy of not rating companies above their country’s rating
  • Asset Dedication Security Selection
    Asset Dedication regards bonds issued by the federal government or government sponsored agencies as the safest investments:
    • Treasuries, TIPS
    • 21. Certificates of Deposit
    • 22. Agencies
    We select whichever asset class offers the highest yield for any particular year, which creates opportunities to swap when conditions change
  • 23. Municipal Debt Defaults
    Municipal debt defaults are very rare for investment grade bonds.
    Investment grade mean AAA, AA, A, BBB rating
    Asset Dedication uses only AAA or AA bonds for retirement portfolios
    “A” rated bonds occasionally used if nothing higher is available for a particular year when the portfolio is implemented
    BBB or lower are never used
  • 24. [1] Moody’s U.S. Municipal Bond Defaults and Recoveries, 1970-2009
    [2] Moody’s Corporate Default and Recovery Rates, 1920-2009
    [1]Standard and Poors U.S. Municipal Rating Transitions and Defaults, 1986-2009
    [1] Moody’s U.S. Municipal Bond Defaults and Recoveries, 1970-2009
    Data source: Standard and Poor’s
  • 25. Corporate Debt Defaults
    Corporate debt defaults are also rare for investment grade bonds but more frequent than municipal bonds (see next slide)
    As before, Asset Dedication uses only AAA or AA bonds for retirement portfolios
    “A” rated bonds occasionally used if nothing higher is available for a particular year when the portfolio is implemented; BBB or lower are never used
    Only four corporations currently rated AAA: Microsoft, Exxon, Johnson & Johnson, Automatic Data Processing
  • 26. [1] Moody’s U.S. Municipal Bond Defaults and Recoveries, 1970-2009
    [2] Moody’s Corporate Default and Recovery Rates, 1920-2009
    [1]Standard and Poors U.S. Municipal Rating Transitions and Defaults, 1986-2009
    [1]Moody’s Investor Services, Corporate Bond Defaults and Recoveries, 1920-2009
    Data source: Moody’s
  • 27. [1] Moody’s U.S. Municipal Bond Defaults and Recoveries, 1970-2009
    [2] Moody’s Corporate Default and Recovery Rates, 1920-2009
    Data source: Moody’s
  • 28. [1] Moody’s U.S. Municipal Bond Defaults and Recoveries, 1970-2009
    [2] Moody’s Corporate Default and Recovery Rates, 1920-2009
    [1]Standard and Poors U.S. Municipal Rating Transitions and Defaults, 1986-2009
    Data source: Hempel
  • 29. Are individual bonds better than bond funds?What will happen when rates rise?
  • 30. Flat Rates or Rising Rates
    Given that there is little room for rates to move down farther, we would expect rates to either stay low or rise
    There is historical precedent for rates staying low and flat as we have seen in the US following severe economic crises and as Japan has experienced since 1985
    In prior periods of rising rates, bond funds have lagged individual bonds, particularly when clients take withdrawals
  • 31. Historical Interest Rates Average Yield 1800-2010
    Long Depression
    Great Depression
    Source: United States Treasury 10-year constant maturity yield 1962-2009, Global Financial Data 1800-1962.
  • 32. Japanese Interest Rates Since 1985
  • 33. Impact of Interest Rates on Total Return
  • 34. Impact of Interest Rates on Total Return
  • 35. Bond Funds and Rising Rates
    When bond yields rise, prices fall
    The period from 1950 to the peak in 1981 saw bond fund total return lag individual bonds by more that 3% compounded*
    Turnover forces bond funds to recognize losses, which cannot be overcome, especially when the investor is taking withdrawals
    *The 10-year Treasury index (2.2%) is used as a proxy for bond funds compared to the 10-year Treasury bond (5.6%)
  • 36. Rising Rates 1950-1981
    Source: United States Treasury 10-year constant maturity yield 1962-2009, Global Financial Data 1800-1962. 5-year rolling average
  • 37. Rising Rates 1950-1981Individual Bond Average Yield = 5.6%
  • 38. Rising Rates 1950-1981Volatility of Bond Fund Returns and Unexpected Losses
  • 39. Rising Rates 1950-1981Volatility of Bond Fund Returns Leads to Total Return of 2.2%
  • 40. Bond Funds Funding Shortfall
    Volatility of bond fund returns and lower total return when rates rise cause funding shortfalls for investors taking withdrawals
    When compared to an income-matching portfolio of individual bonds, a bond fund will generally experience shortfall when rates rise*
    Essentially, rising rates for a bond fund that needs to generate income creates the worst case reverse dollar-cost-averaging scenario
    *The 10-year Treasury index (bond fund proxy) compared to a series of 8-year income-matching portfolios. Income-matching portfolios are built using bond prices for the starting year and are spend down. The funding target was $100,000 per year increasing at 3% inflation. An equivalent amount is set aside in a bond fund for each starting year and systematic withdrawals are taken out to cover the target.
  • 41. Bond Fund Shortfall with Withdrawals Worst Case Reverse Dollar-Cost-Averaging Caused by Volatility
    Source: United States Treasury 10-year constant maturity yield 1962-2009, Global Financial Data 1800-1962. CRSP 10-year Treasury Index total return
  • 42. Is now a good time to buy bonds with rates so low?
  • 43. Evaluating the Tradeoff of Waiting
    Although rates are low, there is an opportunity cost of waiting for rates to rise
    Waiting is cash is the best place to wait even though money market rates extremely low (less than 10 bps)
    Bond funds will likely lose money if rates rise, erasing any advantage of waiting
    At current rates, for an investor with a 10 year horizon, rates would have to rise 75 bps just to break even
    The probability of breaking even is less than 10%
  • 44. 10-Year Treasury Yield 12 Month Rate Change Distribution 1881-2011
    Rate Change > 0.75%
    9.1% of the time
    Data source US Treasury, and Robert Shiller
  • 45. The Living Yield Curve Show Clients How Rates Have Changed
    http://www.smartmoney.com/investing/bonds/the-living-yield-curve-7923/
  • 46. Treasury Yields
    Yields do not seem to reflect concern about the safety of Treasuries, even in light of the downgrade
    Over the last year, rates have come down slightly
    YTD, rates have seen a greater change because rates rose through the early part of 2011
    The last month has seen a steady decline
  • 47. Yield Curve Comparison8/11/10 – 8/11/2011
    Data source: US Treasury
  • 48. Yield Curve Comparison8/11/10 – 8/11/2011
    Data source: US Treasury
  • 49. 10-Yr. US Treasury – Past 12 Mos.
    Data source: BondDesk Group
  • 50. 10-Yr. US Treasury – Past Month
    Data source: BondDesk Group
  • 51. Daily and Historical Data on Yields
    Daily data on yields is available from a variety of sources.
    www.bonddesk.com provides comprehensive data on the retail bond market
  • 52. What has been the impact on investment grade municipal and corporate bonds?
  • 53. Evaluating the Yield Matrix
    CDs are delivering relative value out further than we have seen in the last 12 months
    Municipal bonds seem to be tracking treasury yields closely
    For taxable accounts, municipal bonds still deliver superior after-tax yields relative to other asset classes (and are safer than similarly rated corporate bonds)
    Corporate bonds are starting to see spreads increase
  • 54. Yesterday’s Yields(8/10/11)
  • 55. Yesterday’s Yields on Munis
    (For more details on municipal bonds, click here)
  • 56. Yesterday’s Yields on Corporates
    (For more details on corporate bonds, click here)
  • 57. More details on Corporates
    The spread between corporate bonds and Treasuries has increased slightly
    Corporate bonds have not seen yields slip as much as Treasuries
    Unfortunately for investors, there is little diversification among industries in investment grade bonds
    Not only do financial firms dominate the volume of issues, but they also deliver higher yield at similar credit ratings
  • 58. Corporate Spreads
    Data source: BondDesk Group
  • 59. Corporate Spreads
    Data source: BondDesk Group
  • 60. Corporate Bond Sector Concentration
    Data source: BondDesk Group
  • 61. Corporate Bond Yield Matrix
    Data source: BondDesk Group
  • 62. When will Rates Rise?
  • 63. The Fed’s Guidance Indicates That Rates Will Stay Low for the Foreseeable Future
    “The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”
    FMOC press release 8/9/2011
  • 64. Forecasters are notoriously bad at guessing the direction of interest rates, let alone the actual value
  • 65. “Indeed, the trend towards far higher rates is already beginning”
    “Here Come Higher Interest Rates” by Shawn Tully, editor-at-large of Fortune Magazine, on 6/19/2009.
  • 66. The Federal Funds Target Rate has remained unchanged since…
    December 16th, 2008
    Board of Governors of the Federal Reserve System, 2010
  • 67. Yield Curve Comparison6/19/09 – 8/11/2011
    Data source: US Treasury
  • 68. 3 Types of Interest Rate Forecasters
    Those that don’t know where rates are going
    Those that don’t know they don’t know
    Those that know they don’t know but get paid lots of money to pretend they do.
    Larry Swedroe: The Value of Interest Rate Forecasts, moneywatch.com
  • 69. Thank You for Attending
    Contact us with your questions:
    Brent Burns (burnsb@assetdedication.com)
    Steve Huxley (huxleys@assetdedication.com)
    Jeremy Fletcher (fletcherj@assetdedication.com )
    Please click here for our Disclosure statement
  • 70. Disclosures
    Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended or undertaken by Asset Dedication) made reference to directly or indirectly by Asset Dedication in their literature or otherwise will be profitable or equal the corresponding indicated performance level(s). Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results.
    Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Asset Dedication), will be profitable or equal any historical performance level(s).