How bad of an investment are bonds?

I’m not making an especially profound observation when I say the answer depends on your macro view. Bonds are more or less attractive depending on macro outcomes, including and especially inflation.

If you think inflation’s likely to take off, you don’t want bonds. Just ask anyone who bought TLT at the highs five years ago and now sits with a near 50% loss.

The problem is that macro outcomes, inflation included, are hard to predict. Just ask… well, anyone who bought TLT at the highs five years ago and now sits with a 50% loss.

The 40-year bond bull ended with a 40% drawdown. And, as the figure below reminds you, the drawdown’s still with us.

Hide the children. That’s a bloodbath.

It’s fair to say sentiment around the US long end — and really around DM duration in general — remains poor. Public sector leverage across advanced economies is quite high and rising. Inflation, while obviously lower versus 2022, remains uncomfortable in some locales. Many argue annual consumer price growth’s unlikely to settle sustainably at or near 2% given socioeconomic and geopolitical shifts seen as conducive to rolling bouts of macro volatility. And on and on.

I buy the new macro epoch narrative, which is to say I think “The Great Moderation” is indeed over. If your pitch is “We’re not in Kansas anymore,” I’m with you. But I do wonder if DM government bonds are a knife worth catching in the near-term given the distinct possibility that a US recession’s imminent.

Have a look at the charts below. They’re from Jim Reid’s latest slide deck which clocks in at an impressive 75 pages (encompassing hundreds of visuals).

These are the worst rolling five-year returns for the US long bond ever, both in nominal and real terms.

It’s thus tempting to say things can’t get a lot worse. That even if the macro and fiscal fundamentals continue to argue against duration, bonds are due for a bounce.

The figure on the left, below, from the same Deutsche Bank slide deck, appears to suggest there’s some value in the long bond. Or at least that real yields aren’t so paltry as to be a laughable proposition for a 30-year loan.

And yet, the figure on the right speaks to the importance of context and perspective. “30-year US yields look high in the 20 years of the TIPS market, but are only just above average when we create a proxy over the last 70 years,” Reid wrote.

With that in mind, he went on to caution that investors might be putting too much faith in long-term inflation trends which aren’t justified.

That brings us full circle and speaks to my long running contention that far from constituting a “new normal,” the so-called “Great Moderation” was in fact an anomalous period of relative macro calm — an aberration that was destined to “mean revert.” We are, after all, talking about a world that runs on fiat.

Apropos, when Reid looked at average annual inflation for more than 150 global economies since 1971, he found that not a single one of them averaged less than 2%. Switzerland, at 2.2%, came closest.