Pimco High Income Fund (PHK), Annaly Capital Management, Inc. (NLY): Bonds – We’ve Seen This Movie Before. It Doesn’t End Well

Investors have short memories. Our recollections about five years ago are hazy. Ten years, and lessons are forgotten. Thirty years ago might as well have been the Big Bang.

Some New ETFs Could be Stars in 2013Bonds have been in a 30-year bull market, so even some of the most grizzled professionals haven’t experienced a prolonged period of pain. But history doesn’t forget. The bond market has been here before. And it didn’t end well.

Interest rates were kept incredibly low in the 1940s and 1950s to help manage the national debt after World 2. Ten-year Treasury bonds yield almost the exact same today as they did in 1950.

What happened to Treasuries after that? Those who held to maturity received their principal back. But inflation eroded all of the value of interest payments, and then some. And as interest rates rose in the 1970s, the value of existing bonds plunged. The result in real (inflation-adjusted) terms was three decades of sheer misery:

Average annual real returns

Period 10-Year Treasuries 30-Year Treasuries Corporate Bonds
1950-1959 (1.80%) (2.67%) (2.02%)
1960-1969 0.23% (1.96%) (1.90%)
1970-1979 (1.19%) (3.40%) (1.88%)

Source: Deutsche Bank Long-Term Asset Return Study.

These losses might seem small, but they add up fast. $100 invested in 10-year Treasury bonds lost 40% of its value in real terms by the early 1980s:

Source: NYU, Federal Reserve, author’s calculations.

Inflation was out of control in the 1970s and early 1980s — that wasn’t a normal period by any means. But even before the inflation spike, those who purchased Treasuries in 1950s went 20 years without earning a penny in real terms. That’s what you get for buying when rates are so low.

Short-term bonds might still make sense for those who need ready access to their money. For all else, the last century gives us a reasonable set of expectations going forward: Bonds are possibly a way to maintain the value of your assets, almost certainly not a way to grow them, and potentially a way to lose a lot of them.

Interest rates have risen over the last month, offering a taste. Pimco High Income Fund (NYSE:PHK) is down 10% in the last month. The Vanguard Long Term Corporate Bond Fund lost 4.6%. Mortgage REITS sensitive to the same interest rate risk have been pummeled; Annaly Capital Management, Inc. (NYSE:NLY) shares are off by one-fifth over the last year.

How bad can this get? It can’t be stressed enough that we have no idea. Many investors thought Japanese bonds were toast in the early 1990s. Twenty years and dozens of ruined careers later, we’re still waiting for the crash.

But when interest rates are this low, the best-case scenario becomes not getting hurt, and getting hurt becomes pretty likely.

The article Bonds: We’ve Seen This Movie Before. It Doesn’t End Well originally appeared on Fool.com.

Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

7 Most Expensive Cities in the World

5 Least Expensive Cities in the World

10 Celebrities Who Believe In Scientology

10 High Margin Food Products to Build a Business Around

The 10 Most Expensive Clothing Stores in the United States to Get Decked Out At

The 5 Biggest Kickstarter Scams That Swindled Backers’ Donations

The 10 Most Expensive Boarding Schools In the World

50 Crazy Facts About Japan You Won’t Believe

Top 10 Least Expensive Hybrid Cars to Save the Planet With

The 10 Biggest ‘Gate’ Controversies in History

The 10 States with the Highest Nursing Shortages Leaving Their Hospitals Depleted

The 10 Best Value Investment Blogs that Every Investor Must Read

The 6 Cheapest Boarding Schools in Europe 2015

The 5 Most Expensive Cars To Insure in the World

The 10 Most Common Genetically Modified Foods

10 Self-Made Billionaires Who Came From Nothing

The 10 Most Expensive Cities to Live in North America

The 13 Most Expensive Headphones in the World to Represent

The Top 20 Wealthiest Soccer Teams in 2014

4 BuzzWorthy Cannabis Stocks And Some Smoking Derivative Plays

The 10 Healthiest Fast Food Chains in America to Dine At

The 5 Most Expensive Cat Food Brands You Can Spoil Your Kitty With

The 6 Best eCommerce Platforms for Small Businesses

The 10 Worst Mistakes an Entrepreneur Can Make

The 5 Most OP Characters in League of Legends to Carry Games and Crush Foes With

The 5 Best Foods to Eat Before Running that Will Help You Pound the Pavement

10 Glaring Plot Holes in The Walking Dead that a Zombie-Filled Bus Could Drive Through

The 5 Biggest Celebrity Stoners Who Love Their Reefer

The 10 Most Overrated Movies Of All Time by Out-of-Touch Critics

Top 6 Least Expensive Cruise Destinations For 2015 that Will Take You to Paradise

10 States with Lowest Substance Abuse Rates in America

The 14 Most Watched TV Finales Ever

The 10 Best Selling Role Playing Games of All Time for PC

10 Most Influential Papers In Economics

Top 8 Biggest Charities in the US

10 Worst Celebrity Career Moves Ever

Top 10 Best Paid Tennis Stars in the World

Top 6 Cities For The Ultra Rich to Live in Comfort

10 Cities with High Demand for Nurses

6 of the Worst Greeting Card Messages Ever Crafted

How to Make Money in ArcheAge and Build Your Empire

10 Foods To Eat To Lower Cholesterol Levels

The 10 Most Hated Television Characters of All Time

The 30 Worst Halloween Costume Ideas Ever Brought to Horrible Life

10 Vocational Skills in Demand Today with Jobs Waiting to be Filled

10 Best Places to Visit in Central and South America

The 10 Greatest Empires in History Which Nearly Conquered the World

The 6 Cheapest Boarding Schools In America 2015

5 Clear Reasons LoL is Better than DotA, Continues to Rule MOBAs

The Only 9 Teams with a Chance to Win the Super Bowl

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!