The Rise and Fall of US Bonds

The performance of government bonds is obviously related to the movement in interest rates. However, the movement in interest rates can be very long term in duration and distort asset allocation models indefinitely. Over the past 65 years since the last time we were at 2% US government bond rates in 1948, or 6 o’clock on our inflation/deflation clock, interest rates have had a general rise then a decline. Therefore forward looking 10 year future return forecasts vs long term averages can be very inappropriate.

Thanks to Paul Gambles of MBMG in Asia for this research piece by Craig L Israelsen on the topic:-

“From 1948 through 1981, the federal discount rate increased – not every year but as a general trend. In 1948, the federal discount rate was 1.34%, and by 1981 it reached 13.42%. During this time of rising interest rates, the average annualized return for U.S. bonds was 3.83%. In the Rise & Fall chart below, the year-to-year performance of U.S. bonds is represented by the vertical bars. The U.S. bond performance was measured using intermediate-term U.S. government bond returns from 1948 to 1975 and the Barclays Capital Aggregate Bond Index returns from 1976 to 2012.”

Notably, U.S. stocks (as measured by the S&P 500) showed essentially the same performance during both periods. From 1948 to 1981, when interest rates were rising, the S&P 500 had an annualized return of 11%. During the recent 31-year period of declining interest rates, the S&P 500 generated an 11.14% annualized return. So, while interest rate movement has a marked impact on bond returns, stocks have been largely immune – they tend to march to a variety of drummers.

Furthermore, cash (as represented by the three-month Treasury bill) also seemed relatively unaffected. Cash averaged 4.49% during the 34-year period of rising interest rates and 4.72% during the 31-year period of declining rates.”

Firstly, it is interesting that this research fits in exactly with our Kondratieff inflation / deflation analysis. Secondly, that if you optimize the first thirty year cycle into a multi asset portfolio you would get a very different answer to that of the second 30 year period. 3.8% vs 8.8% is a very large variance and also as catastrophic as getting the shorter but equally difficult equity 15 year periods right and wrong.