MAKE BONDS GREAT AGAIN
In search of a deflationary impulse
Since 1990, the 7–10 year bond total return (blue) and spot gold (gray) have about the same performance, 483% versus 474%, respectively.
There are some notable differences in performance that we need to keep in mind. First, shorter-duration bonds (green and orange) have underperformed, while longer-duration bonds (not shown) have outperformed. But we are concerned with the 7–10-year bonds in the article.
The total return trend is another important consideration. Bonds were on a relatively smooth uptrend due to falling yields until 2018 but then diverged significantly after the pandemic stock market crash. Then, due to rising inflation and rates, one of the worst bear markets for bonds began.
On the other hand, gold did not rise in an orderly fashion. From 1990 to 2003, the performance was negative, but due to a strong uptrend, by October 2011, the performance had matched that of the 7–10 year bond total return. Gold fell until 2015, but as bond yields crashed, it became an attractive investment again. Bond yields rose due to inflation, and gold broke to new all-time highs after a two-year consolidation. We are now back to a similar performance since 1990 for the 7–10 year bond total return and gold.
This is problematic for the bond market and strategic allocations. If people perceive gold (and managed futures) as a viable alternative to bonds for the popular 60/40 allocations, it could pose a significant threat to the financial conditions in the USA. Higher yields would make the cost of financing an exploding debt prohibitive. Investors will demand even higher yields to invest in bonds. Even higher yields could serve as a trigger for an equity bear market. Artificial intelligence may not provide the urgently needed deflationary impulse in the short term.
Compounding the problem is the fact that China is no longer exporting deflation at the same rate as it did in the previous decade. Prices for Chinese goods have been rising around the world. What could be the trigger for the next deflationary impulse to lower yields and make bonds great again?
It appears that a short-term solution would be a housing market carnage, like in 2008, to trigger deflation. A stock market decline will be inevitable, but by how much? It is hard to say, but it may get ugly for equities. Making bonds great again will require sacrifices by non-diversified equity investors. How this will affect the 60/40 stock and bond allocations is unpredictable.
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