This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Steve Blumenthal, chairman and chief executive officer of King of Prussia (greater Philadelphia area), Pennsylvania-based CMG Capital Management.
Most analysts missed the great bond rally of the last two years. The Zweig bond model, explained below, provides a disciplined, rules-based way that may help you better navigate and profit from the up and down trends in interest rates.
In December 2014, Wall Street analysts predicted a rise in interest rates. At that time, the 10-year Treasury was yielding 2.75%. Consensus was for a move to 3.25% by year-end 2015. They missed. The yield finished 2015 at 2.25%.
In December 2015, Wall Street analysts predicted a rise in interest rates. You may recall the Fed's December 2015 rate increase with expectations for three more rate hikes in 2016. Once again, few expected rates to decline. But, boy, have they. The 10-year Treasury note recently touched 1.37% and is now yielding above 1.5%.
What The Zweig Bond Model Signaled
The Zweig bond model kept investors invested in long-duration bond ETFs over that challenging period, when the majority of analysts were calling for higher rates. Gains in the bond market have outpaced gains in the S&P 500 Index over the past 12 months, with TLT gaining 20.05% and the SPDR S&P 500 ETF Trust (SPY | A-97) gaining just 4.16%:
Chart courtesy of StockCharts.com
Now, the "U.S. corporate pension industry is throwing its interest-rate assumptions out the window," says Shyam Rajan, head of U.S. interest rate strategy at Bank of America. BofA is forecasting the yield on the 10-year note will fall to 1.25% by September (source: Bloomberg). Lower for longer is the current mantra, but with rates so low, risk is high.
J.P. Morgan, for example, is calling for 1.40% by August, 1.65% by September and 1.70% by Dec. 31.
*Rounded to the nearest 5 bp
With the 10-year yielding above 1.5%, one has to question that yield return relative to the risk that investors will face when rates rise. A move to 1.70% by Dec. 31 will result in a loss in value of approximately 3% in the value of 10-year Treasury notes.
Further, you have to also wonder just how much help 1.5% will give your portfolio. In a traditional 60/40 mix, 40% of 1.5% over 10 years doesn't do much for you. And this is before inflation is factored in.