My partner John Washington has been investing for a very long time -- he can tell us about his experience during the unfortunate stock market decline of 1929. John's career is approaching its 50th year, and he has lots of sayings, investing rules and advice. He frequently reminds us that stocks fluctuate, that short-term results are meaningless, that consistent earnings growth is vital and that trends always last longer than anyone ever thinks they will.
John's last observation about trends enduring is among his most sagacious. Remember the bull market of the late 1990s and the "bubble"? Remember how many times you heard that the market was too high and was certainly at a top? I remember eight well-known strategists call eight separate and wrong bottoms to the bear market. The point is that trends last beyond intuition. In the equity markets the trend is positive. Be careful about thinking it will end too soon. In the economy the trend is positive. Be careful.
The bond market is a great example of a trend that outlasted rational expectation. Interest rates that have trended lower and lower for several years simply cannot remain at 60-year lows, or can they. In fact, they have. The 30-year US Treasury Bond was yielding 4.77 percent at the quarter's close, and the yield on the 10-year note was 3.84 percent. Remarkable, isn't it? At a time when our deficit is at record highs, our country is at war, and for the first time in history, we are facing the ongoing threat of terrorist attacks on US soil -- individuals, institutions, and foreign governments are willing to lend the United States money for 30 years for an annual, taxable return of 4.77 percent.
John has another saying: No trend lasts forever. When interest rates move higher, bond prices will fall. The longer the term of the bond, the greater the price swings.
Please know that you can lose money investing in bonds. While principal is guaranteed if held to maturity, the day to day price of bonds can vary a lot. The current 10-year Treasury note has a 4 percent rate, a 3.88 percent yield to maturity, matures on Feb. 15, 2014, and is priced at $1012.50. Volatility in bond prices is measured by something called "duration". The duration of the current 10-year note is around eight. If interest rates rise by 1 percent, the price of the 10-year note will drop about $80 per bond, so if rates go to 4.88 percent, the price drops to $931.67. If rates climb by 2 percent, the price will drop to $860.66. Sure enough, if you hold your bonds until 2014, you will receive your $1,000 per bond. The duration of the 30-year Treasury is 15, so a bond purchase for $1,000 would drop to $850 if rates rose by 1 percent. We know better than to call the end of this interest rate trend, but we feel that as we near the end of the pendulum's swing, it is more comfortable to borrow than to lend. We encourage a very defensive posture if investing in fixed income.
Othello's advice to Iago was patience. Neither we nor the Moor would suggest that patience is easy, but we would certainly agree it is essential. It is essential for success in Shakespearean drama and in investing. Hang in there, you're doing fine.
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