Warren Buffett recently appeared on CNBC to announced the elevation of Ajit Jain and Greg Abel, both to vice chairmen of Berkshire Hathaway, setting them up as potential successors in the event of his eventual retirement. His appearance was interesting as always (with the exception of the awkward responses to the ideologically laced banter from Kernen). But the most interesting point to me, was his discussion of bonds.
I probably should have taken the opportunity to ask myself again, why I didn’t purchase any BRK after I read any of the first half dozen Buffett focused books in my library, but I (painfully) digress. Buffett mentioned essentially that he thought stocks have proven fairly attractive relative to bonds, which were yielding around 2% while the federal reserve has been telling us they are going to take inflation to 2%. Now I suppose one could question whether they can achieve that goal (they haven’t yet), but when you are dealing with fiat money, I don’t think betting against the printer is a bet with a high probability of success over the long term. It sounds like Buffett would agree with that.
So this inspired me to look at real rates now and into the history of real rates of interest in U.S. Treasuries. Where are we on that curve? The first place I went to look for the data was Multpl.com. This site is a really good resource for economic and valuation data. I go here often to look at the CAPE and other valuation ratios for the S&P 500. It also has real yield history for U.S. Treasuries (and a bunch of other stuff under “more”).
So I found what I was looking for but, the great data on real yields doesn’t go back so far, as U.S. TIPS were only introduced in like the mid 90’s. Multpl only goes back to like 2004. Lots of economists have put together historical charts using nominal yields minus trailing 1 year inflation, but that has some duration matching and other potential drawbacks. The Multpl chart uses nominals minus the TIPS yield reflecting inflation expectations over the relevant term. Anyhow, it is a great site and I encourage you to check it out if you are not already familiar. A quick look at the real yields on the site indicates that real yields were in the 2%-3% range just prior to the Great Recession.
Turning back to Buffett, the comment he made got me thinking, should I really have any allocation to bonds (beyond I Bonds of course)? The real yield is ~ .50%. I also could see inflation getting a little hot (I actually have this theory that we could sort of echo the 60s -70s as a backlash to trump, labor’s loss of the share of economic output versus capital, etc….here comes Bernie). I don’t really find the prospect of locking money up for a decade at a .50% real return to be very appetizing. I do, however, acknowledge the potential for unforeseen deflation, or who knows what, and the real psychological benefit to having that “ballast” to dampen the volatility of the price quotations in my portfolio.
Yet, I am considering replacing my bonds with an allocation to trend following (see Alpha Architect or Meb Faber for more information). Historically, equity allocations with a trend overlay have yielded bond-like volatility with better returns. Of course, that is history. Perhaps a topic for a future post?
Thanks for reading.