This past Thursday we saw a huge melt-up in the market on the news that Europe will try to solve their debt problems with more debt. To make matters worse, the headlines all declared that European banks were agreeing to a 50% haircut on their Greek bond holdings. A haircut is where the bond holders (who are lenders to Greece) are agreeing to get 50% of their money back. Of the 350 billion Euros in debt that Greece has on the books, nearly 140 billion Euros are held by the European Union, European Central Bank and the IMF (these three entities are referred to as the troika). Guess who is not going to have to take the 50% haircut? That’s right, the troika. That means it is not really a 50% haircut. Greece would be getting a haircut of much less than 50%. Isn’t it nice of the really big bankers to protect themselves? This kind of deal just goes to show how little has changed in three years. It is all about no one taking losses on bad investments…no one except taxpayers of western economies and average investors.
The reality is the European deal that the market rose in the face of, is far from a done deal. But, it does go to show just how desperate investors are to have Europe cleaned up nice and tidy. Europe is doing their best to kick the can down the road. Stay tuned – there will be plenty more to come in the European drama…
In the last few weeks, I have had a number of conversations with folks about the risks that lurk beneath the surface in many types of bonds. First, let me be clear there are many types of risks facing bond investors. The big risk that all US dollar based bonds face is rising interest rates. Rising rates puts downward pressure on the price of bonds. The longer the term of the bond, the more sensitive to interest rate movements. This means that a 1% rise in interest rates will have a bigger downward impact on a 30-year US treasury bond than a 10-year, and so on. The chart below shows the US Fed Funds rate versus the Fidelity Bond fund (ticker FTHRX). I am using this fund as it is the only general bond fund that I could retrieve the 20-year price history for. The reality is that the last 20 years of declining interest rates has been like the never ending summer for bonds. Really, rates have been falling since 1980. You can see on the chart that the blue line has made its way lower over time. All the while, bonds have enjoyed a massive 30 year bull market. So, with the Fed Funds Rate at near zero, there is nowhere for the blue line to go but up. What do you think will happen to the red line (a general bond fund) when the blue line starts to climb? The issue for investors is that no one knows when the blue line will start to climb. It could be that one day we wake up to a political, economic, or other event that will change the direction of interest rates in the US. When that time comes, investors will have to be prepared for the end of the perpetual bond summer, and usher in a new mindset for a very long bond winter. The bond winter that will come will impact all types of bonds. Unless an investor is temporarily using bonds to hedge a stock portfolio (like I am), my advice is to have a plan to sell those bonds that did well for three decades. The weather will be changing.
Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions? Call me to schedule a free review of your current investment portfolio – 913.693.7918.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.
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