What Buffett’s “Bleak Future” for Bonds Means for Fixed Income Investors

Warren Buffett’s Berkshire Hathaway has a cult following among investors thanks to its robust track record of market-beating returns. Since 1965, the company has realized a compounded annual gain of 20%, which is nearly double the 10.2% return for the S&P 500, although the S&P 500 significantly outperformed Berkshire Hathaway in 2019 and 2020.

The Oracle of Omaha has always been a fan of equities and did not mince words about fixed income in Berkshire Hathaway’s annual letter.

In the letter, Buffett notes that the 10-year Treasury bond has fallen 94% to yield just 0.93% at year end, which is a sharp decline from the 15.8% in September 1981. He also notes that investors in German, Japanese, and other bonds earn a negative return on trillions of dollars worth of sovereign debt, pointing to a “bleak future” for bond fixed income investors.

When looking at pockets of higher income opportunities, Buffett warns that shifting purchases to obligations backed by shaky borrows is reminiscent of the savings and loan crisis three decades ago and isn’t the answer to inadequate interest rates.

The recent increase in both nominal and inflation-adjusted rates hasn’t caused a crisis in the financial markets thus far. On March 4, 2021, Federal Reserve Chairman Jerome Powell noted the rise in rates but said that it wasn’t a major concern unless it prompted a “persistent tightening in financial conditions” that has yet to materialize.

The Central Bank is likely to hold off on any action until there is an established economic recovery. Right now, Treasury bonds are trading at their lowest yields since 2013 and well below 0.3% yields at the beginning of 2010. The correction in bond and equity markets in the meantime will likely be just that—a correction.

Treasury Secretary Janet Yellen, a former Federal Reserve Chairwoman, also noted that inflation fears from President Biden’s $1.9 trillion stimulus bill were unwarranted. In particular, she noted that there was 3.5% unemployment prior to the pandemic and no sign of inflation increasing while adding that the administration has tools to reduce inflation if it arises.

“Right now, with interest rates at historic lows, the smartest thing we can do is act big,” Yellen said in January. “In the long run, I believe the benefits will far outweigh the costs, especially if we care about helping people who have been struggling for a very long time.”

Check out this article to see if you even need bonds these days.

Warren Buffett may be known for his stock picking but, when speaking for others, he seems to favor holding a portion of a portfolio in short-term government bonds. In Berkshire Hathaway’s 2013 annual letter, Buffett said that he instructed the trustee of his wife’s inheritance to put 90% of her money into a stock index fund and 10% into short-term government bonds.

Aside from Buffett’s preference for equities, investors may also want to consider blue-chip, high dividend paying stocks as an alternative way to generate income from a portfolio. These companies typically include utilities, pipeline operators, financial institutions, REITs or others that have a strong balance sheet and robust free cash flow generation.

International bonds may be another area to consider. In particular, investors may want to look at countries that don’t have the same inflationary concerns as the United States and Europe, where low interest rates persist. A diversified basket of emerging market bonds, for example, may be a way to increase yield and diversify risk.

Warren Buffett warned that bonds face a “bleak future” in Berkshire Hathaway’s 2020 annual letter. While the timing of a decline remains up in the air, there’s little doubt that bonds will face a tough five to ten years given interest rates are at near-record lows. The good news is that dividend stocks and foreign bonds provide alternative ways to generate income.

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