3 Things 3-20
Thing One Are US Bonds Safe Or Not? It’s been a rough week or so for banks and bank stocks. News about the impending failure of Silicon Valley Bank (SVB) dominated the headlines starting last weekend. And when some of the details became known, the question that got asked repeatedly by pundits, reporters, and everyday people was: are bonds safe? The answer is it depends on what you mean by safe. Before we elaborate, let’s review, at a 50,000-foot level, what happened. On March 8th, Silvergate Bank, a California based bank which began operating in 1988 as a savings and loan association, announced it would be winding down operations due to losses suffered in its loan portfolio. That same day, SVB announced their intent to raise capital through a $1.75 billion stock offering. Their announcement led to a collapse in their stock price (from $267 at the beginning of the day to $106 at the end of the next day). It also led to mass attempts at withdrawing deposits by SVB customers, a so-called “run on the bank”, which then led to the bank being taken over by regulators. In announcing their capital raise on March 8th, SVB explained that the money was needed to plug a $1.8 billion hole caused by the sale of a $21 billion loss-making bond portfolio consisting mostly of U.S. Treasuries. That’s when the question about the safety of US bonds began to get kicked around. The answer depends on whether you hold them (bills, notes, or bonds actually) to maturity (1yr, 2yrs, 10 yrs, etc.) or not. Assuming you hold it to maturity, and the US government doesn’t default on its debts (a subject for another day), yes, the bond is safe. Even in a rising interest rate environment, you will get all your money back, albeit with less purchasing power, but that’s beyond the scope of this discussion. If, on the other hand, you would like to get your money back by selling the bond before it matures, in the same rising interest rate environment, no, the bond is not safe. It will lose value as interest rates rise and you will not get all the money you put in if you sell it. This what is known as interest rate or duration risk and it led to the undoing of SVB, Silvergate, and perhaps more banks in the days and weeks to come. Keep this n mind if you’re ever in the market for “safe” government bonds.
Thing Two A Couple Of Yield Question For Your Consideration Since interest rates and bond yields are all over the news, we thought we’d share two particularly relevant questions along with their answers on the topic: Q: Why is the 10-year yield significant? A: Per Investopedia.com: “The 10-year is used as a proxy for many other important financial matters, such as mortgage rates, and auto loans. This bond also tends to signal investor confidence. When confidence is high, prices for the 10-year drop and yields rise. This is because investors feel they can find higher returning investments elsewhere and do not feel they need to play it safe. When confidence is low, bond prices rise and yields fall, as there is more demand for this safe investment.” Q: What do rising yields mean for the stock market? A: Per USA Today(from a few years ago): “In the past three months, the 10-year Treasury yield has risen by over half a percentage point, a rapid move that is larger than 90% of all the three-month periods since 1990, according to UBS Financial Services. Still, stocks typically perform quite well during these periods. On average, the S&P 500 registers a 3.9% gain (16.5% annualized) when interest rates rise by more than half a percentage point, data from UBS Financial Services shows. While returns tend to be a bit lower in the three months after a big move in rates – 2.5% on average – they are no worse than a typical three-month period. The rise in yields does have implications for the stock market and could make shares of companies with high valuations less attractive. Those types of stocks tend to be technology companies, who are priced typically for growth and not for a steady return of dividends like consumer staples, utilities, and real estate companies. Rising rates tend to be favorable for more cyclical sectors, or companies whose businesses and stock prices tend to follow the business cycle. Those include sectors like consumer discretionary, energy, financials, industrials, and health care."
Thing Three Just A Thought "This time, like all times, is a very good one, if we but know what to do with it." - Ralph Waldo Emerson