This could be the end of the longest-running trend in your financial lifetime
The decades-long bond bull market could well be over. But it won’t end quietly. Investment strategies that have worked for years, no longer will. John Stepek explains what happens next.
Whatever happens, the bond bull market won't just end quietly
What I find most fascinating about the gradual rise in US interest rates is how keen everyone is to pretend that it doesn't matter.
This, I believe, is known as "whistling past the graveyard".
The long-term decline in interest rates, along with the corresponding demise of inflation and the long-term epic bull market in bonds, began in the early 1980s.
Here's what that means: if you are under 60, then you have not known any time in your investment lifetime during which interest rates have been heading higher rather than lower.
(Although yes, anyone who had a UK mortgage in the early 1990s, or ran a business bank then, could be forgiven for exclaiming "you think I don't know about rising interest rates?!?!" I'm talking long-term trends, rather than short-term panics that were the result of failed monetary experiments.)
And because many of us don't really start paying proper attention to our portfolios or building proper wealth until we're into our 40s, the reality is that if you are under 80, then falling long-term interest rates are probably all you've really been aware of during your main wealth-building years.
In other words, if you're alive and you're reading this, chances are that falling interest rates have been the biggest factor influencing your finances during your lifetime.
And that now looks like it's over. The ten-year US Treasury yield has gone above 3.1%. That's the highest level in seven years, and if you give any credence to charting (I take it with a pinch of salt, but no more than a pinch), then the long-term trend lower is well and truly broken.
Gosh. I feel like we should be throwing some sort of commemoration party.
What happens now?
To be clear, I'm not convinced that there will be an epic crash as a result of all this. If the economy is back to health, then really, interest rates should be a good bit higher. And we may find that a lot of the economic problems and "conundrums" we have been agonising over in recent years are effectively the product of a distortionary low-rate environment.
There is a lot to be excited about out there. Amid all the chatter and gossip about our politics, and the worries about productivity, there are some extraordinary technological advances.
Renewable energy still has plenty of hurdles to clear, but (not unlike US shale, in fact) it's advancing at a far more rapid rate than anyone believed possible. Automation and AI will turn out to be tools that help us to develop exciting new possibilities for improving our standard of living, rather than job-stealing pitiless androids that will crush us underfoot.
However, the economy is one thing; financial markets are another. And there's no doubt that markets have been pulled and stretched and squeezed by extraordinary levels of official intervention and manipulation over the last few decades.
When investors (and people in general) get used to things being one way for a long time, then they bet ever more heavily on things staying that way in the future. And then they get a nasty shock when that turns out to be a mistaken assumption.
Ben Inker of US asset manager GMO one of my favourite sources of commentary has just issued his latest quarterly report, in which he points out that low volatility has made it very profitable and very tempting to load up on specific strategies that only work if that low volatility continues.
In other words (and we're back to Hyman Minsky's point on stability again), "the calm itself encourages behaviours that eventually lead to highly volatile outcomes".
That's now changing. So all the increasingly big bets that people have made on things staying the same will cease to pay off. And the problem is that the demise of those bets will have ripple effects to other parts of the market.
As Inker puts it: "The very existence of risk parity and volatility targeting strategies creates fragility in the markets in the form of feedback loops. At first, a period of calm will lead to increased leverage, which creates net buying to support markets. But a rise in volatility or a shift in correlations can lead to deleveraging and selling pressure just when markets are already shaky."
The precise consequences of that unwind remain to be seen. But it does suggest that what has worked since the financial crisis will cease to work, and something else will take its place.
In the latest issue of MoneyWeek out tomorrow a number of our regular contributors take a look at what that "something else" might be. You should subscribe now if you haven't already done so.
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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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