Do You Think Bonds Will Reduce Volatility? Think Again

By Mike Adams

From 1945 through 1980 bonds experienced a crushing bear market. From 1960 through 1980 many of the highest quality bonds sold at a loss of 50% or more. Shorter-term bonds could not keep up with inflation losing up to 70% of purchasing power.

The bear market in bonds lasted over 36 years!!

Most financial plans and financial advisors count on bond returns using data from the 1980s. That has been a long 40+ year bull market. I have not seen any plan that features devasting losses in fixed income. We believe the probability of another crushing bear market in bonds may be in the making.

At Adams Financial Concepts we are investing client funds in portfolios that will not experience what we expect will be a bond bear market.

At any given time bond prices are determined by three things:

(1) credit quality, (2) inflation, and (3) geopolitical situations.

We believe bonds could be on the verge of all three.

Credit Quality

The United States government debt stands at $36 trillion. That is a problem. Our President wants to remove the debt limit. He promised to extend the 2017 tax cuts and add to them by removing taxes on social security, tips, itemized deductions, and overtime. In theory he created the DOGE run by Elon Musk with the idea of trimming spending by $2 trillion. So far the savings achieved is a far cry from the $2 trillion.

Tariffs are likely to increase government revenue, but it is unlikely to offset the additional tax cuts.

Credit quality of debt in a country is not that different from the credit scores an individual gets from the credit agencies. It is a function of income and debt. For a country the income is GDP. United States debt for the last century and beginning of this century achieved the highest rating possible – AAA by all three rating agencies. As of August 2023 our debt is rated AA+ by both Fitch and Standard & Poor’s and AAA by Moody’s. Credit quality has begun to decline.

But the United States is not alone in that. The world is awash in debt.

Six of the G-7 nations now have government debt greater than 100% of GDP.

Those countries:

Japan (255%)
Italy (144%)
United States (123%)
France (110%)
Canada (106%)
UK (104%)

Worldwide debt is $307 trillion for a $100 trillion world GDP. Debt stands at 300% of GDP!!

There are 54 nations that are on the verge of a financial crisis. 22 of those nations have either already defaulted on their debt or are on the razor’s edge of default.

Credit quality is on the decline world wide and that includes the United States. Based on credit quality alone bonds will probably experience a bear market. Adams Financial Concepts clients’ portfolios are designed not to experience credit quality decline.

Inflation

Bond prices decline as interest rates increase. Bond buyers expect returns that will meet or slightly beat inflation over the longer-term. So as inflation picks up the coupon interest rates bonds pay increase and existing bond prices decline.

There are only five ways out of excessive debt and the world has excessive debt.

The world can grow their economies faster and pay down the debt.
The world nations can raise taxes holding spending constant and use the higher taxes to pay down debt.
Reduce spending on education, infrastructure and the social net and use the savings to pay down debt. That means cutting social security, healthcare, unemployment benefits, food stamps, agricultural subsidies and more.
Increase inflation so there is more currency to pay down the debt owed
Default on interest payments and reduce or delete principle payments.

The two highest probabilities are default and inflation. The chance of tripling GDP in the next few years is very unlikely. Some countries will try to raise some taxes and some will try to reduce spending. Countries with the highest level of debt will probably default in the same way Greece defaulted 10 years ago. Countries with “manageable debt” will probably try in inflate their way out by printing more money to cover debt refinances which will be required. In the United States the Fed pushed up Fed funds short term rates to deal with demand pull inflation and they were successful. However we now face a different kind of inflation. America is facing cost push inflation. Demand pull can be stifled by raising interest rates. Cost push inflation driven by wage increases and material costs is more difficult. The cure for cost push we experienced in the 1970s – stagflation. Stagflation is inflation with a recession at the same time.

That does not help bonds.

The impact on short-term bonds will probably be even more devastating. The dollar from 1960 to 1980 lost 70% of its purchasing power. What that meant was, on the average, what cost $1 to buy in 1960 cost $3 to buy in 1980. In 1960, a first-class stamp was 4 cents, a Coke was 10 cents, a dozen eggs 57 cents, and a gallon of milk was 49 cents.

By 1980 the first-class stamp was 15 cents, a Coke was 35 cents, a dozen eggs were 91 cents, and a gallon of milk was $2.16. Those portfolios sitting in cash had lost 70%.

Short-term bonds and notes track the value of the dollar. From 1960 to 1980 the dollar lost 70% of its purchasing power. Think eggs at $6.00 per dozen are expensive now? If we experience an inflation like the 1970s, eggs will be cheap at $28 per dozen. Milk could rise from $4.15 a gallon to over $15. A loaf of white sandwich bread could increase from $3.12 to over $14.

Those prices seem almost unimaginable. But if the stagflation of the 1966 to 1980 period is an indicator they are realistic. Think of how prices soared in 2021 and 2022 with a short bout of inflation. The inflation-stagflation time of the 1964 to 1980 was a period of 16 years.

Think of what that does for portfolios or investors who rely on fixed income or fixed annuities. For short-term bonds a similar situation will probably result in a devasting loss of purchasing power and quality of life.

Inflation even with the latest figures in the United States is on the increase. The impact of tariffs will probably increase inflation and reduce trade. Based on inflation alone bonds will probably experience a bear market. Adams Financial Concepts clients’ portfolios are designed with the intent to grow faster than the rate of inflation.

GeopoliticalIt seems like the United States is going to experience all three factors that are negative for bonds. President Trump has shifted from aligning with our traditional allies to connecting with Russia and Hungary. He has initiated tariffs and first implemented them on our two closest neighbors, Mexico and Canada. The impact of tariffs on both those countries will probably hammer their economies.

For the 500 companies in the S&P 500 fully 41% of their revenues are generated overseas. Those revenues are generated in countries on which our President intends to impose tariffs. Their response is probably to react by implementing tariffs on a good portion of the $7 trillion of revenues the largest American companies generated overseas.

Many of our former closest allies are negotiating free trade agreements with other allies and excluding the United States. That will place the United States at a significant disadvantage for those revenues that were generated overseas. Adams Financial Concepts client portfolios have little exposure to companies with high percentages of overseas sales. Our portfolios are domestic.

Bonds are presented to investors as stability and reduction of volatility in portfolios and financial plans. We feel that is very short sighted, ignores history, and sets the stage for significant losses. We know investors do not like volatility. At Adams Financial Concepts we are unwilling to sacrifice volatility for what is probable to be a destructive bond and fixed income bear market.

Article Written By:

Mike Adams, President & Principal

Adams Financial Concepts LTD

206-903-1019

https://adamsfinancialconcepts.com/

1001 Fourth Ave, Suite 4330, Seattle WA 98011