“Analysts predict bond market ‘hell’ next year.” That was the headline for a MoneyNews article from Dec. 2. Unfortunately for those investors who heeded the warning, it was Dec. 2, 2013.
Regular readers of my articles know that one of my favorite hobbies is collecting forecasts and then holding the forecasters accountable — something Wall Street and the financial media rarely, if ever, do. The reason they fail in this pursuit is that they know accountability ruins the game. Even though the evidence clearly shows there are no good forecasters, Wall Street and the financial media need you to believe there are so you’ll feel compelled to “tune in.”
I had filed the MoneyNews piece in my “investment porn” collection, along with a reminder to check back in a year to see how the forecast turned out. On Dec. 2, 2013, Bill Blain, a senior fixed income broker at Mint Partners, told CNBC, “I reckon we’re going to have hell in the bond markets next year.” He added: “I think there is potential for a massive sell-off in the U.S. once we see the taper finally start, and that’s not because people are not prepared, it’s because that is what happens when you stop distorting markets.”
One Year Later
How did Blain’s forecast turn out? On Dec. 2, 2013, the 10-year Treasury yielded 2.81 percent. One year later, it was yielding just 2.28 percent. That made it a hell of a year for investors who ignored Blain’s forecast and hell for those who heeded it.
Unfortunately for investors, Blain was far from alone in his forecast of rising interest rates. Investment “guru” Jeremy Grantham was among the many who forecasted a bear market in bonds. For example, in a quarterly client letter released in February 2014, Grantham warned that “because of the U.S. Federal Reserve’s expansive monetary policy… all global assets are once again becoming overpriced,” When asked about fixed income as an investment, he wrote: “fugetaboutit.”
Through Dec. 2, 2014, Vanguard’s Short-Term Treasury Fund (VFISX) returned 0.9 percent, their Intermediate-Term Treasury Fund (VFITX) had returned 4.2 percent, and their Long-Term Treasury Fund (VUSTX) had returned 20.0 percent.
Ignore the Forecasters
In my own view, the most “impressive” piece in my collection is this one. On April 22, 2014, a Bloomberg survey of 67 economists found that 100 percent of them expected the 10-year Treasury note yield, which closed at 2.73 percent that day, to rise over the following half a year. Six months later, the 10-year Treasury note yielded just 2.25 percent. Yes, 100 percent of those economists were wrong.
The really sad news is that—despite the overwhelming body of evidence demonstrating the active management of bond portfolios is at least as much a loser’s game as it is in equities, if not more so—many individuals allow such forecasts to influence their investment decisions.
The Fortune Sellers
Whenever I’m asked about whether or not one should pay attention to such a forecast, I relate a story from William Sherden, the author of the wonderful book, “The Fortune Sellers.” Sherden was inspired by an exceptional incident to write his book. In 1985, when preparing testimony as an expert witness, he analyzed the track record of inflation projections by different forecasting methods. He then compared those forecasts to what is called the “naive” forecast — a simple projection of inflation rate into the future. He was surprised to learn that the simple, naive forecast proved to be the most accurate, beating forecasts from prestigious economic forecasting firms equipped with minds holding Ph.D.s from leading universities and thousand-equation computer models.
Sherden then reviewed the leading research on forecasting accuracy from 1979 to 1995, and covered forecasts made from 1970 to 1995. He concluded:
Economists cannot predict the turning points in the economy. Of the 48 predictions made by economists in his sample, 46 missed the turning points.
Economists’ forecasting skill is about as good as guessing. For example, even the economists who directly or indirectly run the economy — the Federal Reserve, the Council of Economic Advisors and the Congressional Budget Office — had forecasting records that were worse than pure chance.
There are no economic forecasters who consistently lead the pack in forecasting accuracy.
There are no economic ideologies whose adherents produce consistently superior economic forecasts.
Increased sophistication provides no improvement in economic forecasting accuracy.
Consensus forecasts offer little improvement.
Forecasts may be affected by psychological bias. Some economists are perpetually optimistic and others perpetually pessimistic.
For the last several years, investors have persistently heard warnings about how rising interest rates were going to doom their bond portfolios unless they dramatically shortened maturities. Investors who heeded those warnings missed out on earning the term premium, which not only has existed, but for most of the past six years, the curve has been fairly steep. It’s also worth noting that the research demonstrates term risk has been best rewarded exactly then, when the curve is steep. Thus, investors who heeded the gurus were acting contrary to (likely without knowing) the historical evidence. Consider the following: The mid-year 2014 S&P SPIVA report card on active versus passive bond funds shows that more than 96 percent of actively managed long-term government bond funds had underperformed their benchmark over the prior five years.
The Bottom Line
Finally, what’s most important for people to understand is that it really doesn’t matter to bond investors if yields rise, as long as the rise in yields was anticipated (built into the yield curve). In other words, for you to be better off staying on the short end of the curve, rates not only have to rise, but they also have to rise by more than was already expected. Hopefully, you’ll remember these stories and the historical evidence the next time you’re tempted to act based on the forecast of some “guru.”
Larry Swedroe is director of research for The BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country. He has authored or co-authored 14 books, including his most recent, The Incredible Shrinking Alpha: And What You Can Do to Escape Its Clutches. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.
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