5 Things You Must Know Before Investing in US Bonds
With the equities prices rising for the 8-9 year consecutive years, most people are flocking to the stock market for riches and ignoring the past-favourite – Bonds. So today let’s take a look and see if bonds are really a thing of the past. To make things simple, I will focus on US Bonds.
1. What are US Bonds?
In simple terms, US bonds are similar to fixed deposit. When you invest your money in US Bonds, you are effectively lending your money to the US government and for that loan, they will pay you a fixed interest each year. In bonds, that interest is also known as bond yield. However, unlike fixed deposit, the US bonds are also tradable in the market. So as you can imagine, the US bond prices do fluctuate. Lastly, US bonds also come is different durations, ranging from 1 month to 30 years.
2. How Are the US Bonds doing now?
To answer that question, let’s use the US 30-Year Bond Yield. As you can see below, the US 30-Year Bond Yield has been dropping since the 1980s. For the sharper reader, you may ask, “How can the yield go up and down when the interest is fixed?” Indeed, the actual interest doesn’t change, it is the bond price that changes.
source: tradingeconomics.com
Bond Yield = Fixed Interest/ Bond Price
When the bond yield drops, it means the bond price goes up. Hence, the US bond prices have been trending upwards in the past, as you can see from the chart below.
3. So What’s Next?
Bond prices generally move inverse to the Interest Rate. With the Fed raising rates, the general consensus is that the bond prices will begin to fall. However, I am holding a slightly different view. If you look at the 30-Year US Bond Yield from a grander scale, you will notice that the yield has been on a downtrend. Most importantly, it has not broken the previous highs throughout the trend.
4. Will the Bond Yield Go Higher or Lower?
The answer is I don’t know for certain but we can look for signs. While this is not an exact science, bond yield is generally a sum of GDP growth + inflation. If you look at the chart below, the US GDP growth rate is about 1%. As for inflation, with the latest rate hike, we are at 1.25%. So overall, the bond yield should be about 2.25%. That sounds like a good resistance level because for the GDP growth rate to go higher, the US economy must do something really amazing in the next few years. With their political uncertainty and the world still reeling from the past crisis, the chances of the GDP growth shooting higher is less likely in my opinion.
Therefore, I believe there is a higher chance for the bond yield to stay low or trend even lower. This means the bond prices may go higher.
source: tradingeconomics.com
5. How to Invest in Bond?
With the above information, you can either buy some US bonds or using exchange-traded funds like TLT. Of course, you need to put a stop loss should the bond yield really go up (never assume you are always right). But I like what I’m seeing here – if I’m wrong, I lose a bit but if I’m right, I win a lot. And finally, please don’t buy anything based on what I say here. Do your own due diligence too!
See you soon!
Investing Always,
Pete
