Bonds: The Underestimated Market – The NEST Edge

The NEST Edge

The NEST Edge is a monthly webinar hosted by NEST Financial Founder, Dan Dillard, with CIO and Partner, Sean McDougle. Together they discuss what the markets and economy are currently doing and add their outlook on portfolio management. You can watch this month’s NEST Edge on our YouTube channel.

March 2021

In this NEST Edge segment, Senior Partner Dan Dillard and Chief Portfolio Manager Sean McDougle discuss the big narrative right now: how the equities world finally awoke and decided it was the time to start worrying and discussing rising Treasury yields.

Highlights include:

  • What have yield been doing and why it matters
  • How markets are doing compared to the market dip in March 2020
  • How treasuries effect the equity markets
  • Money flow and why it matters
  • Clouds in the summer of 2021
  • What NEST portfolio are doing and what we are looking towards

A Letter from Sean

You will hear dozens of theories about why the equities world finally awoke and decided it was the time to start worrying and discussing rising Treasury yields, but since we at NEST have had this expectation since summer 2020, I’m going to cut right to the meat and then unpack why this matters. Growth and inflation are ripping to the upside (increasing) and US Treasury yields go up in those environments. It’s that simple. The hard part is identifying the direction of growth and inflation. With the data we follow, this has been a pretty easy call to make.

Now, why this matters and what it means. The “yield” is the percentage of the price paid back in a dividend. If an investment costs $10 and the dividend is $1 per share, then the “yield” is 10%. A Treasury is a bond issued by the US government. It’s very common for interest rates to be based off the 10-year US Treasury yield such as mortgages. If yields are rising, so are interest rates which is not exactly what you want in a fragile economy. So why are yields rising seemingly out of nowhere? Well, they’re not. The yield on the 10-year US Treasury bottomed in July 2020 and has been steadily rising since. If this snuck up on anyone they need to get their vision checked and I’m half blind.

Source: Trading Economics 

Yields are rising because the expectation is that the economy is going to start picking back up. Whether you agree or disagree with that is another discussion but you cannot, I repeat cannot, ignore the bond market. In regards to where the economy is, it’s a way more informative market than equities. Even before COVID-19 introduced the influence of retail (average Joe) investors to markets, the equities markets have always been the least useful gauge on economic health compared to the bond and currency markets because the volume in both are pretty much 100% institutional and professional. We are about to walk into the largest year-over-year economic expansion in recorded history and the bond market is pricing that in.

To boil it down even further, US Treasuries are a safe haven and people rush to them when things are scary and they run from them when things appear to be getting better. The problem is that the herd is generally one to two quarters behind the bond market, which is why the average investor does not make any money. To make things even more interesting, it is probable that clouds are on the horizon in the summer of 2021 which will cause a rush back to Treasuries.

The longer I’m managing our NEST portfolios I’ve realized that the biggest reason it is getting easier is not because I have more experience (it doesn’t hurt), it’s because I’m further from the stuff academia fills your head with. I won’t sit here and discount an education because that’s where it all starts, but too many of my peers burn in the rules they are taught in books and never think for themselves or look for more current methods.

Let’s not forget, for the goofballs who are still unsure if inflation is coming, go look at the CRB index which tracks commodities. The debate is over and has been for a while. If you’re waiting for Goldman Sachs or the Fed to tell you that inflation is here, good luck. Speaking of that, I didn’t luck my way into the best start of a year in my career. I was positioned for rising growth and inflation. Year-to-date, our most aggressive portfolio is up roughly 15 times the S&P 500 as of 3/1/21.

Sean McDougle, CFP®
Chief Investment Officer & Partner, NEST Financial


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One Comment

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