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Bond Stagnation: Time For Long-Term Exposure?

Carla Fried

Whoever said every ending is a new beginning obviously isn’t following the bond market. Last week, Pimco’s Bill Gross clearly enunciated that the decades long bond rally is over. But then this week he provided some important nuance with a tweet: “30-yr bond bull mkt over but bear mkt begins only with consistent 2-3% real & 4-5% nominal GDP growth. Not there yet. Maybe never.”

Never seems a little bit over-the-top, but the important take-away is that the bond world’s wisest sage just made a case that we could be stuck at the bottom of a U for a very long time. Rates have fallen from their early 1980s highs (the left side of the U) but we’re now at the bottom of the U with no imminent danger of the right side of the U (rising rates) forming any time soon.

The Federal Reserve has made it clear that until the unemployment rate gets to 6.5% and/or inflation trends above its 2% target, it’s not going to budge on its key Federal Funds rate.

US Unemployment Rate Chart

That’s not expected to happen anytime through late 2015.

Prudent investors who high-tailed it into short term bonds in anticipation of the great bond bubble bust are now in year three or four of waiting, and year three or four of earning less than 2% on their short-term holdings.

This could be just the right market to go with a barbell strategy. Sure, it remains prudent to keep a big chunk of your bonds good and short. But if you buy into the expectation that rates aren’t going to rise sharply any time soon, keeping some of your bond money in longer-term securities can add some incremental yield. Thus the barbell: you’re long and short, but not in the middle of the yield curve.

The Vanguard Extended Duration Treasury ETF (EDV) has an effective duration of 25 years right now; it also yields 3.1%. That yield is more than double the payout for the Vanguard Short-Term Bond ETF (BSV) which has a current effective duration of 2.8 years. (Duration measures a bond portfolio’s sensitivity to interest rates. A portfolio with a duration of 5 years will see its price decline 5% if interest rates were to rise 1 percentage point.) If you’re tempted to add a little bit more yield, just think sip not gulp. As this five-year chart of the total return for both ETFs show, the longer duration makes for a far more volatile ride.

EDV Total Return Price Chart

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

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