Long-Term Bonds
Q: I sold long-term bonds a few years ago, worried that rising interest rates would cause losses. Since then, the higher yields of long-term bonds have offset declines in value and gains have been decent, while short-term bond funds have had paltry returns. Now that interest rates have gone up substantially, when do you think SMI will recommend long bonds again?
A: There are a couple important points to make here. First, while the Fed has raised short-term interest rates multiple times over the past year, the effect on long-term interest rates has been negligible. In fact, the yield on a 10-year Treasury bond is lower now than it was a year ago when the interest rate hikes started. That's possible because the market, not the Fed, determines the interest rates of longer-term bonds. This occurs through the normal buying and selling process. When demand is high, prices go up and yields go down. This can happen even when the Fed is raising short-term rates, and is the story of the last year in the bond market.
The second important point is that while we've been as surprised as anyone that long-term bond yields have fallen instead of rising, now does not seem like the time to start buying longer maturities. In evaluating whether long-term bonds look like a good buy, the expectation of what interest rates will do in the future is an important factor. It's been that expectation of higher yields that's caused us to recommend short-term bonds over long-term the past few years. But that's not the only consideration. The other key criteria is this: are long-term bonds compensating you for the additional risk you're taking? At this point, that answer is an emphatic "no." As I write this, the yield on a two-year Treasury is 3.68%. The yield on a ten-year is 4.07%. So your reward for taking on an extra eight years of risk is less than 40 basis points (0.39%). Until the risk/reward equation shifts to reward investors for locking up their money for the long-term, short-term bonds seem the place to be, despite their still relatively-low yields. 
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