Business & Personal Checking Accounts – MutualBank

 

Bond Bubble?

Bond Bubble?

As interest rates have spiraled downward over the past decade, driving bond prices upward, many in the financial media have suggested that bonds and other fixed income instruments should be shunned and that bonds have entered “bubble territory.” With all of this discussion going around, it is important to understand what constitutes a bubble and what type of assets are affected by these events.

A bubble is typically defined as the aggressive appreciation of an asset far beyond a reasonable estimation of intrinsic value. One of the most memorable bubbles of the recent past was the so called “dot-com bubble.” During the late 1990s through early 2000, technology stocks appreciated to levels that could not be supported by fundamentals. The tech-heavy Nasdaq reached an all-time high of 5132 in March of 2000 before declining by almost 80% to 1108 in 2002.  Although there has been significant recovery in the Nasdaq, those who invested at the peak of the tech bubble over ten years ago, would still need to see the index appreciate by 90% just to get their original principal back! The problem as an investor is, if the decline is too great, the probability of timely recovery is remote and actual wealth destruction (as opposed to paper losses) takes place.

A bond is a much different type of asset than a stock or other capital asset as it is a contractual obligation to re-pay a loan at the end of a defined period of time. A stock by contrast involves no contractual obligation and the owner of such an asset is only entitled to the earnings after all other stakeholders have been paid. Therefore, the value of a stock at any time is subject to many more variables than a bond and is based on the perception of what those earnings will be at some point in the future. A bond by comparison, assuming the borrower/issuer is not bankrupt at the end of the contractual period, must return the principal amount owed in full. This fact makes the value of the bond much more ascertainable than that of a stock since at least as a bondholder/lender, I have a legal claim to an absolute value at a definitive point in the future. Therefore, since the ultimate value of a bond is known and there is no reasonable expectation of receiving more than the principal value at maturity, bonds can never really appreciate to levels that would constitute what we typically consider to be a bubble. 

The other argument often made today is that given low interest rates, investors should only buy very short-term bonds (if they buy bonds at all) as interest rates are sure to rise at some point in the future. The problem with this type of analysis is that it doesn’t take into consideration the opportunity cost of significantly less interest in the early years. Take for example, a U.S. Government bond issued at 3.4% (yield as of the date of this writing) with a ten-year maturity. One might argue that 3.4% annually is a paltry amount to accept over a ten year period and that one should shun this investment in favor of a very short-term instrument that would benefit from steadily rising rates.

Let’s examine this by contrasting the benefits of a 10-year U.S. Government bond paying a fixed 3.4% versus a two-year U.S. Government bond at the current .6%. Let’s assume that interest rates will rise 1.25% every two years such that the two-year bond in the example above would begin at .6% and would be renewed at 1.85%, 3.1%, 4.35%, and finally 5.6%. Many people would opt for the short-term bond in this example, but if the calculations are done, the better investment (assuming a ten-year holding period), would be the 10-year U.S. Government bond at a constant 3.4%. In this example, the 10-year U.S. Government bond held to maturity would generate $3,000 more in total income than the bond renewed every two years at subsequently higher rates.

What this example teaches us is that one should always run the numbers when making decisions as opposed to making assumptions or subscribing to conventional wisdom. The more important consideration is to make certain that the investment is made within the context of the proper time horizon and liquidity needs.

In summary, we are not of the belief that bonds as an asset class are in a classical “bubble,” nor do we believe that one should only opt for ultra short-term instruments. At MutualWealth, we continue to view bonds as an important asset class that has proven over time to diversify risk and generate a consistent stream of income. Although bonds may suffer through periods of rising interest rates, they will continue to serve a purpose in portfolio diversification and income production. With respect to strategy and individual security selection, we believe we serve our clients best by making investment decisions at the margin based upon actual analytical analysis as opposed to generic philosophical presumptions. As always, if you have concerns about the interest rate environment and the potential impact on your investments, please feel free to contact us at any time.               

Shayne Nagy, CTFA
Senior Vice President
Trust and Investments 


Contact a Representative Today

Back to Education Resources

Mutual News
  • Mutualfirst Financial, Inc. Announces Agreement With Major Stockholder 

    Muncie, Indiana - February 27, 2015 – MutualFirst...

    Monday, March 2, 2015

    READ ARTICLE

View Archived Releases
Mutual Blog

Proactive Steps to Take in Light of Anthem Data Breach

Chances are you are a person who has Anthem insurance coverage or you know someone who does. As a result, either you or your friend has a reason to be concerned.

A typical data breach includes a compromise of debit card numbers or partial personal identifying information. This kind of breach, though inconvenient, can typically be ‘fixed’. An initial investigation indicates that the Anthem breach includes a compromise of name, birthday and/or social security number. This kind of information is all one needs to steal someone’s identity.

According to Anthem this particular breach could affect up to 80 million people. Instead of trying to ignore this has happened or just being upset, it’s now time for you to be educated and try to protect yourself as best as you can. We have some tips that will help you accomplish that.


1. Review Your Statements


First, take a moment each month to view your eStatement or monthly statement. You can monitor your accounts throughout the month with Online Banking and the MutualBank App. Monitoring your accounts will give you the quickest opportunity to see if your accounts have been compromised. If you notice any transactions that are unfamiliar or questionable, please get in touch with your MutualBanker. Call us at 800-382-8031.


2. Be Cautious with Any Anthem Emails You Receive


Next, if you receive an email stating it is from Anthem, be cautious. Anthem’s website warns customers not to reply with information, click any links or open any attachments within the email. Anthem is not calling their customers and will not ask for information. Never give your credit card information, social security number, or other sensitive information to someone via email or over the phone.


3. Consider Freezing Your Credit


If you are a resident in Indiana, the Attorney General’s office website (http://www.in.gov/attorneygeneral/2853.htm) is offering and encouraging you to sign up for a free credit freeze with each of the three credit bureaus. A credit freeze places a hold on your credit where a new line of credit could not be obtained without you unfreezing your credit. This doesn’t affect already open credit lines like an existing credit card, yet helps to protect you against someone opening new lines of credit in your name.


4. Keep in the Know


Finally, try to keep in the loop on the Anthem Breach. The best source for current information about this breach can be found at Anthem’s Frequently Asked Questions. (http://www.anthemfacts.com/faq)

MutualBank is here to help inform you of ways to help protect against identity theft. Thank you for trusting us.

Sunday, February 15, 2015

READ BLOG ENTRY

View Archived Posts

Connect with us:

(800) 382-8031

  • Facebook
  • Youtube
  • twitter
  • RSS Feed
 
 
Bond Bubble?

Bond Bubble?

As interest rates have spiraled downward over the past decade, driving bond prices upward, many in the financial media have suggested that bonds and other fixed income instruments should be shunned and that bonds have entered “bubble territory.” With all of this discussion going around, it is important to understand what constitutes a bubble and what type of assets are affected by these events.

A bubble is typically defined as the aggressive appreciation of an asset far beyond a reasonable estimation of intrinsic value. One of the most memorable bubbles of the recent past was the so called “dot-com bubble.” During the late 1990s through early 2000, technology stocks appreciated to levels that could not be supported by fundamentals. The tech-heavy Nasdaq reached an all-time high of 5132 in March of 2000 before declining by almost 80% to 1108 in 2002.  Although there has been significant recovery in the Nasdaq, those who invested at the peak of the tech bubble over ten years ago, would still need to see the index appreciate by 90% just to get their original principal back! The problem as an investor is, if the decline is too great, the probability of timely recovery is remote and actual wealth destruction (as opposed to paper losses) takes place.

A bond is a much different type of asset than a stock or other capital asset as it is a contractual obligation to re-pay a loan at the end of a defined period of time. A stock by contrast involves no contractual obligation and the owner of such an asset is only entitled to the earnings after all other stakeholders have been paid. Therefore, the value of a stock at any time is subject to many more variables than a bond and is based on the perception of what those earnings will be at some point in the future. A bond by comparison, assuming the borrower/issuer is not bankrupt at the end of the contractual period, must return the principal amount owed in full. This fact makes the value of the bond much more ascertainable than that of a stock since at least as a bondholder/lender, I have a legal claim to an absolute value at a definitive point in the future. Therefore, since the ultimate value of a bond is known and there is no reasonable expectation of receiving more than the principal value at maturity, bonds can never really appreciate to levels that would constitute what we typically consider to be a bubble. 

The other argument often made today is that given low interest rates, investors should only buy very short-term bonds (if they buy bonds at all) as interest rates are sure to rise at some point in the future. The problem with this type of analysis is that it doesn’t take into consideration the opportunity cost of significantly less interest in the early years. Take for example, a U.S. Government bond issued at 3.4% (yield as of the date of this writing) with a ten-year maturity. One might argue that 3.4% annually is a paltry amount to accept over a ten year period and that one should shun this investment in favor of a very short-term instrument that would benefit from steadily rising rates.

Let’s examine this by contrasting the benefits of a 10-year U.S. Government bond paying a fixed 3.4% versus a two-year U.S. Government bond at the current .6%. Let’s assume that interest rates will rise 1.25% every two years such that the two-year bond in the example above would begin at .6% and would be renewed at 1.85%, 3.1%, 4.35%, and finally 5.6%. Many people would opt for the short-term bond in this example, but if the calculations are done, the better investment (assuming a ten-year holding period), would be the 10-year U.S. Government bond at a constant 3.4%. In this example, the 10-year U.S. Government bond held to maturity would generate $3,000 more in total income than the bond renewed every two years at subsequently higher rates.

What this example teaches us is that one should always run the numbers when making decisions as opposed to making assumptions or subscribing to conventional wisdom. The more important consideration is to make certain that the investment is made within the context of the proper time horizon and liquidity needs.

In summary, we are not of the belief that bonds as an asset class are in a classical “bubble,” nor do we believe that one should only opt for ultra short-term instruments. At MutualWealth, we continue to view bonds as an important asset class that has proven over time to diversify risk and generate a consistent stream of income. Although bonds may suffer through periods of rising interest rates, they will continue to serve a purpose in portfolio diversification and income production. With respect to strategy and individual security selection, we believe we serve our clients best by making investment decisions at the margin based upon actual analytical analysis as opposed to generic philosophical presumptions. As always, if you have concerns about the interest rate environment and the potential impact on your investments, please feel free to contact us at any time.               

Shayne Nagy, CTFA
Senior Vice President
Trust and Investments 


Contact a Representative Today

Back to Education Resources

Contact Us
Mobile Capture

24 Hour MutuaLine:

765-747-2931 or 800-289-4376

© MutualBank | Member FDIC | Privacy Policy