Chart of the week
The Illusion of Safety
What does this chart show?
The real drawdowns for 5-year Treasuries from 1926 - 2018. From 1940 to nearly the end of 1981, 5-year Treasuries suffered a real loss of 44% of their value. They broke even in 1985, 45 years after their drawdown began.
Why does it matter?
Bonds are the go-to diversifier for most investment portfolios and are often positioned as the ‘safe’ complement to be paired with stocks. U.S. Treasury bonds offer a portfolio guaranteed yield, diversification, and are routinely a safe haven asset during negative growth shocks.
Treasury bonds, being backed by the full faith of the U.S. government, are generally thought of as bland and unexciting. As such, their risks and weaknesses are often overlooked, especially in the aftermath of the best 40 year period for them in U.S history1.
The time period in this chart where treasury bonds suffered most, 1940 - 1981, was a period of major macroeconomic and geopolitical volatility that spanned WWII, the Korean War, the Vietnam War, an oil embargo, and our departure from the gold standard2. Massive government spending to support wars and social policies was inflationary, directly eroding the real purchasing power of the bonds. In response to inflation, interest rates were taken from near zero in 1940 to a high of ~20% by the early 1980s.
While history doesn’t usually repeat, it often rhymes. Analyzing prolonged periods of inflation volatility demonstrates the real vulnerabilities inherent in treasury bonds that are often touted as the most safe investment money can buy.
The Bottom Line
Despite their reputation, bonds have historically not been a reliable safety net during bad periods for stocks and also have a serious vulnerability - inflation. Worse, this vulnerability is the same as stocks, their primary companion in most investment portfolios. Allocating to assets that are biased to perform well during inflationary periods (gold, commodities, trend, crypto?) brings diversification and balance to a portfolio while helping to maintain real purchasing power.
Chart & Data Sources - Ben Carlson’s great blog, A Wealth of Common Sense
Yield on 5-year Treasuries
Through History
