An Interesting Fact
September 22nd, 2009By any conventional measure, bonds are a lower risk investment than equities (stocks), particularly government bonds. However, although I continue to design portfolios using bonds as an instrument to dampen volatility, I continue to wonder, “are government bonds really safer than stocks”?
You may remember a post a while back about a recommendation to a client to make an investment in the S&P 100 not long after the market bottomed out and began to rise. Although the move was particularly well timed and the money had come from bonds that had been called, I’m not about to say I saw the rapid rise in stocks coming. Yes, it has been a rapid rise, as I just read, a day or two ago, that the last six months have represented one of the six strongest six month periods for stocks in the history of the market.
What was I thinking when I made the S&P 100 recommendation? First and foremost was the discipline of sticking to rebalancing a portfolio. One needs to pay attention to the basics. It doesn’t mean you have to follow them 100 percent, but like blocking and tackling, you have to pay attention to the basics.
The second thing that was running through my mind was the rising risk of loaning money to the U.S. government, which, traditionally, is a big part of nearly any bond portfolio.
Yes, everyone in the world who can understand a standard news source knows about the rising U.S. government debt. But today, in a Washington Times article by Richard Rahn, a senior fellow at the Cato Institute and the Chairman of the Institute for Global Economic Growth, I read the following super-interesting fact:
“The U.S. entitlement programs (Social Security, Medicare, Medicaid, etc.)…will take more than 100 percent of all federal tax revenue this year, requiring that virtually all of the other government programs, including defense and interest payments on the debt, be funded by more borrowing.”
That’s staggering, truly staggering. Would you consider a loan to such an entity to be a low-risk investment?
I can explain and lecture on bell curves and standard deviations all day long, but everyone, including myself, has to be concerned about loaning money to such an entity, no matter what the historical profile looks like.
What to do? I’m glad, really, really glad, that none of my clients have an excessively large exposure to U.S. government bonds. Yes, many, especially my older clients, have a significant bond position, but they’re all in highly diversified bond positions.
Also, ironically, stocks may be lower risk than loans to the U.S. government. Will they be completely immune from U.S. government and currency issues? No. But even if the U.S. government can’t meet debt payments or inflates its way down the road by simply printing more dollars, millions of people around the world will continue to drink Coke, fill their cars with ExxonMobil gasoline and use a computer powered by Windows (although I’m an Apple guy). Capitalism will march onward.
What about gold? It’s still just an inanimate commodity.
What else to do? If you’re depending much on an entitlement program, you may wish to give your dependency some serious thought. Do I really think the U.S. would eliminate or seriously scale back its entitlement programs? In all honesty, none of our politicians on either side of the isle have the political backbone to take on the issue. However, time and again over the centuries, markets and balance sheets have proven to be stronger than political will or desire. Ironically, the 60s generation that wanted peace and sex with everyone may run begging to the churches they have despised all their lives for handouts of basic life sustaining elements like bread and water.
Do I think the day of reckoning will happen within the next one to three years, as Mr. Rahn does? You probably know by now that I’m not about to make a specific time dependent prediction like Mr. Rahn.
However, I do think it’s safe to say that it’s highly risky to loan money to an entity going the direction of the U.S. government or to depend on such an entity for an “entitled” payment. Thus, informed investors may want to consider making their decisions accordingly.
Have a super day.
Thanks,
Rod
26 Responses to “An Interesting Fact”
Leave a Reply
Would you like to raise your return, reduce your risk and cut your costs? Sign up for our newsletter and check out our blog, or better yet, consider adding Schulz Financial to your investment team.
Rod,
I too am very concerned about the solvency of the US. I think it would take only one big move by China to push the dollar over the cliff. I think that the current stock market is another bubble as well.
Everyone needs to prepare to survive any short-term financial crisis without needing external resupply in my opinion for at least a month.
Seize the Day,
Rob
Emergency Preparedness For the 21st Century Family
Rob,
It’s good to hear from you. I have faith in the stock market because it’s only trading at ~16 times earnings. That’s reasonable and investors, along with the companies they’re buying into, have some degree of discipline.
Politicians, on the other hand, well, I won’t even go there. It will be interesting to see if anything significant happens with the U.S. solvency in the next 1-3 years. Although social security is projected to go negative in 2010, I think it will be quite some time before the house of cards comes tumbling down.
As far as China, I’m with you; they’re doing a good job of concentrating their power over the U.S. It’ll be interesting to see if they make the U.S. and its politicians dance like a puppet on strings.
Again, it’s good to hear from you. Stay tuned!
Thanks,
Rod
Good to see you again Rod.
I have a reasonably large exposure to U.S. Government Bonds at the moment. I need to rebalance…
Rod,
Wow! I didn’t know the US government was THAT bad off financially! Amazing! Well, presently, I don’t have any bonds. I do have stocks, but I’m unsure what else to invest in.
Health, Fitness for Working People — Darryl Pace
Rod,
I enjoyed this post. Very informative and I like the way you ease the reader into the subject. ( I need that at times.)
“Ironically, the 60s generation that wanted peace and sex with everyone may run begging to the churches they have despised all their lives for handouts of basic life sustaining elements like bread and water.”
I agree. You have some great points in this post that I will take with me.
Thanks,
Lynn Lane
Success Strategies For Life
Hi Rod,
great reminder and interesting fact. I like how at the same time you are humble about that you aren’t saying you foresaw the stock rise.
Happy Dating and Relationships,
April Braswell
Single Baby Boomer Dating Success Expert
Finding the right balance between stocks, bonds and other assets is a fine art. The road ahead is still a rough one.
And the S&P 500’s P/E ratio was at 144 as of July 31, when you use as-reported earnings to calculate it. Still waiting for corporate profits to come back before jumping back in.
Steve Chambers
Business to Business Sales Trainer
Hi Rod,
great to see you blogging again actively. I always learn so much at your financial website. Indeed, my second cousin is a Wall Street Bondsman with the (largest I think?) minority owned financial firm. He’s strong on bonds and their stability as well. The rest I do not yet have a fully formed opinion upon.
Happy Dating and Relationships,
April Braswell
Single Baby Boomer Dating Success Expert
Rod,
Government bonds are only as safe as the issuing government itself.
It’s hard to decipher offical data and official information from China. They are masters of deception.
John Ho
Numerology Expert Helps Understanding Personality for Better Influence & Persuasion
This is such a brilliant post and Ive learnt so much!!!
Cheers
I still don’t know anything about this stuff and you still sound like you are an expert in the industry. I will keep reading and try to “get it.”
Lisa McLellan
Child Care Expert,
Babysitting Services, Babysitting Tips, Babysitters, Nannies
I agree with Rob’s point on China. It is a very delicate dance indeed.
Anthony
http://www.anthonylemme.com
Funny thing Rod. i didn’t even go to highschool and i can balance my checkbook and run a profitable business….whats up with the ivy league in D.C.?
If i ran my business like the politicians run the government i would be bankrupt many times over.
Don Shepherd
Central Oregon Expert
In my opinion, bonds are currently ok in the short-term, but we will see a significant decline in the medium term as the redemption dates get nearer for the massive volume of recent issues.
How to manage that…over to you!
Martin Wright
Impact, Poise, Presenting
Just checking in to see if you have any updates on the best place to invest our clost to worthless money! LOL Hope you are well!
Lisa McLellan
Babysitting Services – Babysitter in your area
Lisa,
I can’t put something specific in writing, but think back to our discussion about efficient markets.
Thanks,
Rod
Martin,
Thank you for your comments. Bonds are something to dampen the volatility of the equity side of one’s portfolio. Although one can increase his bond return by extending the duration or by lowering the quality, research shows that the incremental return does not justify taking on the risk of either longer duration or lower quality. Hence, stay with the short duration bonds (or preferably, bond funds unless you have tens of millions of dollars to diversify the bond side of your portfolio) and high quality. The equity side of your portfolio is where you’ll make the money, if you stay long term and play it scientifically.
Thanks,
Rod
Don,
You bring up a good point and you’re RIGHT! It’s really not that complicated. One either has the money or he doesn’t. And in the case of DC and the Ivy League, they’ve lost all common sense.
Thanks,
Rod
Lisa,
Hang in and it will continue to soak in. All this DOES ultimately have an impact on your life style.
Thanks,
Rod
John,
You bring up a good point, which is why I wouldn’t loan the U.S. government a dime.
Thanks,
Rod
April,
Thank you for your comments. Please accept my apology for being so long to get back with you.
Have a super day!
Thanks,
Rod
Steve,
Based on pragmatic research and the tools that are available, the appropriate portfolio balance is far more science and skill than art. It’s a matter of whether or not one chooses to believe the facts and analysis.
Thanks,
Rod
April,
Thank you for your kind words. I frequently tell my clients that I’m not clairvoyant. No one is, but the human ego continues to drive each individual to believe that they’re smarter than everyone else combined. You live in Vegas. Do you believe the majority of the gamblers leave significantly ahead while the casinos frequently come out significantly behind?
Thanks,
Rod
Lynn,
Thank you for your kind words. Please forgive me for taking so long to get back to you and everyone else.
Things are moving forward again.
Thanks,
Rod
JJ,
I can’t give you personal advice on line, but I wouldn’t loan the U.S. government a dime.
Thanks,
Rod
Just checking in. Hope you are all doing well!
Lisa McLellan, Child Care Expert
Babysitting Services – Babysitter in your area