The Hated. The Feared. The Amazing. The US Treasury Bond.

The Hated. The Feared. The Amazing. The US Treasury Bond.

January 2, 2015 Tactical Asset Allocation Research, Macroeconomics Research
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(Last Updated On: July 1, 2015)

As “everyone” seems to know, the US 10-year Treasury bond has a low relative yield and is “inevitably going to rise at some point in the future.”

We have no strong feelings one way or the other on the US Treasury. We simply aren’t smart (or perhaps arrogant) enough to make a strong call. We see compelling stories from smart folks saying it is a great investment and from smart folks saying it is a terrible investment.

But who really knows?

And while we don’t have a strong opinion on the future of bonds as a stand-alone asset class, we do have an ability to test how long-bonds can serve a portfolio.

The results below highlight the top 30 drawdowns in the S&P 500 Total Return Index from 1927 to 2013. Next to the S&P 500 return is the corresponding total return on the 10-Year (LTR) over the same drawdown period:

The Hated. The Feared. The Amazing. The US Treasury Bond.
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Long bonds are clearly interesting in a portfolio context. In addition to providing a real return, plus an expected inflation return, the asset serves as a quasi-insurance policy: When stock markets blow up, US long bonds do well, on average.

The resilience of this finding is remarkable. In the context of a traditional asset pricing model, such as the Capital Asset Pricing Model (CAPM), an asset that actually delivers returns when the rest of the world is blowing up (I.e., negative beta during treacherous times), should have a negative expected return because of the diversification benefits. But with US Treasury Bonds, we actually earn a positive expected return AND get the insurance benefit. One might even consider the US Treasury bond “anomalous.”

Of course, the hidden insurance benefit associated with US Treasury Bonds hinges on the assumption that the US will maintain its status as the king of the hill. When the world goes south, and everyone wants a stable asset, the US Treasury Bond is the only game in town.

There are many reasons why the US could lose its standing. But there are even more reasons why the US, while not perfect, is still light-years ahead of the competition. With 50+ year edges in education/research infrastructure, entrepreneurial culture, dominant military, endowed location, and so forth, we should continue to win the Tallest Man Award in the midget contest for the foreseeable future.

But things can–and do–change.

Happy New Year and Go America!


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • Darren

    The insurance benefit also hinges on the assumption that the US won’t experience a combination of 1) a meaningful rise in inflation, and 2) a falling stock market. Hasn’t happened in over 30 years, but just saying!

  • Darren, thanks for sharing your thoughts. Some devil’s advocate rebuttals:

    1) If you had a meaningful rise in inflation–relative to the rest of the jokers in the world–then yes, that might curb the flight to quality aspect.

    2) I’m not sure a falling stock market would prevent the long bond from performing. In fact, as the evidence suggests, the long bond shows its true colors when the US market is blowing up (along with the rest of the world).

    Nuanced arguments aside, you are making a broader point that is very astute: The insurance benefit of the long bond entirely hinges on the ‘confidence’ people have in the USA.

  • Darren

    I suppose I’m just zeroing in on the decade starting in 1968 when long term nominal rates started ramping up in response to rising and persistent inflation (coincident with a bear market). In nominal terms, owning treasuries would have detracted from returns and not served as portfolio insurance.

    Fair point, however, that treasuries still outperformed cash in that period, providing the boost to real returns that you’re talking about.

  • Mike Fellman

    Inflation expectations per se have nothing to do with long term Treasury yields. The expected RESPONSE of the monetary authorities to an uptick inflation expecations or a deterioration in the inflation outlook does.

    If the Fed announced tommorrow it was not raising rates unless inflation hit five percent, we would see a tremendous rally in Treasuries. Most investors in Treasuries, eg insurance companies, banks, foreign CBs ect, have NOMINAL liabilities, thus have no net exposure to inflaiton. (Inflation ought to decrease the real value of both their assets and liabilities by the same amount over time) They thus seek the highest possible nominal yield given their risk tolerance.

    Long term treasury bonds are nothing more than instruments of monetary policy. Nothing stops the US Treasury from funding itself exclusively with short term debt. (Less than 1 year in maturity) and essentially pay only the exogenously set risk free rate. (Ironically, an interest rate set by the US government itself via the Federal Reserve System!!!) Or alternatively, nothing stops the Fed from gobblingly up all the Treasuries it wants, thus reducing net issuance, cutting supply, and causing rates to fall.

  • True, very true.

    To the extent the govt gets more and more involved in long bond trading, there is less ability for actual market participants to price in expected inflation.

    But in theory, long bonds reflect real interest rates plus some element of expected inflation…

  • Mike Fellman

    The very act of issuance of long term debt implies government involvement in long term bond trading. When the government issues long term debt it is in effect shorting long term bonds. When the sovereign is the biggest issuer by far, government borrowing “distorts” the bond market. However in modern times, the government is always the biggest issuer. Thankfully, the government has discretion over both gross and net issuance. In the most extreme example, Treasury could fund itself exclusively with 28 day bills if it wanted to leave no impact on the capital markets. The point is that net issuance is an economic policy variable which until very recently has been ignored.

  • Jochen F

    Great article! In what way could you see a contribution to this result by the generel bull market in bonds? Also – how did bills or really long term bonds (TLT) work as diversifiers? Thank you and keep up the great work!