Bonds

The “Simple Asset Class ETF Value Strategy” (SACEVS) seeks diversification across a small set of asset class exchanged-traded funds (ETF), plus a monthly tactical edge from potential undervaluation of three risk premiums:

1. Term – monthly difference between the 10-year Constant Maturity U.S. Treasury note (T-note) yield and the 3-month Constant Maturity U.S. Treasury bill (T-bill) yield.
2. Credit – monthly difference between the Moody’s Seasoned Baa Corporate Bonds yield and the T-note yield.
3. Equity – monthly difference between S&P 500 operating earnings yield and the T-note yield.

Premium valuations are relative to historical averages. How might this strategy react to changes in the Effective Federal Funds Rate (EFFR)? Using end-of-month values of the three risk premiums, EFFR, total 12-month U.S. inflation and core 12-month U.S. inflation during March 1989 (limited by availability of operating earnings data) through February 2025, we find that: Keep Reading

What is the best type of account to use for a Treasury Inflation Protected Securities (TIPS) ladder, constructed with incremental maturities to generate a constant risk-free stream of real future withdrawals via compounded inflation adjustments? In his February 2025 paper entitled “Best Asset Location for a TIPS Ladder”, Edward McQuarrie models TIPS behaviors and tax rules to determine whether investors should hold TIPS ladders in: a taxable brokerage account; a tax-deferred account such as a 401(k) or traditional IRA; or, a tax-free account such as a Roth IRA. Potential tax treatments of TIPS ladder account withdrawals include:

1. Maturing principal (initial capital), which is not taxed.
2. Ordinary income (coupon).
3. Tax-favored income, such as qualified dividends or long-term capital gains, with a rate as low as half that for ordinary income.

Only taxable brokerage accounts encounter all three treatments. All withdrawals from tax-deferred accounts are treated as ordinary income. Roth withdrawals are always tax-free. His baseline case is a 20-year TIPS ladder with $1 million initial funding, assuming a 2% real coupon at purchase with all maturities and coupon payments occurring at year-end. He initially assumes a 3% annual inflation rate but considers rates varying from 1% to 9%. He focuses on a 24% income tax rate. He discusses Original Issue Discount (OID), unrealized inflation adjustments, which is crucial to differences in tax rates across account types. Based on this modeling, he concludes that:

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How do returns of different asset classes recently interact with inflation as measured by monthly change in the not seasonally adjusted, all-items consumer price index (CPI) from the U.S. Bureau of Labor Statistics? To investigate, we look at lead-lag relationships between change in CPI and returns for each of the following 10 exchange-traded fund (ETF) asset class proxies:

• Equities:
  • SPDR S&P 500 (SPY)
  • iShares Russell 2000 Index (IWM)
  • iShares MSCI EAFE Index (EFA)
  • iShares MSCI Emerging Markets Index (EEM)
• Bonds:
  • iShares Barclays 20+ Year Treasury Bond (TLT)
  • iShares iBoxx $ Investment Grade Corporate Bond (LQD)
  • iShares JPMorgan Emerging Markets Bond Fund (EMB)
• Real assets:
  • Vanguard REIT ETF (VNQ)
  • SPDR Gold Shares (GLD)
  • Invesco DB Commodity Index Tracking (DBC)

Using monthly total CPI values and monthly dividend-adjusted prices for the 10 specified ETFs during December 2007 (limited by EMB) through January 2025, we find that: Keep Reading

Can investors get a trading edge from CME FedWatch, which tracks probabilities of changes to the Federal Funds Rate (FFR) at future FOMC meetings based on the prices of 30-day Fed Funds futures contracts? In their January 2025 paper entitled “Watching the FedWatch”, flagged by a subscriber, Stefano Bonini, Shengyu Huang and Majeed Simaan compare FFR forecasts from a simple model based on CME FedWatch to conventional model forecasts based on Fed Funds futures. They conduct statistical backtests of forecast accuracies during May 1994 through March 2024 (232 scheduled FOMC meetings). They then compare economic values of the two forecasts via two trading strategies that, 30 days before each scheduled FOMC meeting from the end of 2009 through 2023:

1. If the forecast is for a rate cut or no change (a rate increase), takes a long (short) position in Fed Funds futures contracts set to expire in the month of the next FOMC meeting.
2. If the forecast is for a rate cut or no change (a rate increase), takes a long (short) position in iShares Core U.S. Aggregate Bond ETF, AGG. After release of the actual rate decision, if the forecast is wrong, they close the AGG position.

Using daily values of specified variables over the ranges stated above, they find that: Keep Reading

“Exploiting the Presidential Cycle and Party in Power” summarizes strategies that hold small stocks (large stock or bonds) when Democrats (Republicans) hold the U.S. presidency. How has this strategy performed in recent years? To investigate, we consider three strategy alternatives using exchange-traded funds (ETF):

1. D-IWM:R-SPY: hold iShares Russell 2000 (IWM) when Democrats hold the presidency and SPDR S&P 500 (SPY) when Republicans hold it.
2. D-IWM:R-LQD: hold IWM when Democrats hold the presidency and iShares iBoxx Investment Grade Corporate Bond (LQD) when Republicans hold it.
3. D-IWM:R-IEF: hold IWM when Democrats hold the presidency and iShares 7-10 Year Treasury Bond (IEF) when Republicans hold it.

We use calendar years to determine party holding the presidency. As benchmarks, we consider buying and holding each of SPY, IWM, LQD or IEF and annually rebalanced portfolios of 60% SPY and 40% LQD (60 SPY-40 LQD) or 60% SPY and 40% IEF (60 SPY-40 IEF). We consider as performance metrics: average annual excess return (relative to the yield on 1-year U.S. Treasury notes at the beginning of each year); standard deviation of annual excess returns; annual Sharpe ratio; compound annual growth rate (CAGR); and, maximum annual drawdown (annual MaxDD). We assume portfolio switching/rebalancing frictions are negligible. Except for CAGR, computations are for full calendar years only. Using monthly dividend-adjusted closing prices for the specified ETFs during July 2002 (limited by LQD and IEF) through December 2024, we find that:

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How should investors think about research using long-run financial data? In their October 2024 paper entitled “Long-Run Asset Returns”, David Chambers, Elroy Dimson, Antti Ilmanen and Paul Rintamäki survey the body of evidence on historical return premiums for stocks, bonds, real estate and commodities over the current and previous two centuries. They discuss benefits and pitfalls of long-run datasets and make suggestions on best practices. They also compare premium estimates from alternative data compilers. Based on the body of long-run asset class return research, they conclude that:

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Given anxiety among investors about the rapid rise of U.S. public debt, are U.S. Treasuries fairly valued? In his July 2024 paper entitled “A Historical Perspective on US Treasuries Risk Premia”, Olivier Davanne describes factors driving the U.S. Treasuries yield curve and explains how to gauge beliefs of market participants. He extracts investor rate expectations for various horizons from the monthly Consensus Economics surveys and the quarterly Surveys of Professional Forecasters to support a model of U.S. Treasury premiums based on eight variables, four related to monetary policy (current and expected) and four related to risk pricing (current and expected), as follows:

1. Current short-term yield.
2. Expected equilibrium short-term yield.
3. Short-term yield expected in one year.
4. Short-term yield expected in three years.
5. Current short-term risk premium for 10-year U.S. Treasury notes (T-note).
6. Expected long-term equilibrium for the T-note risk premium.
7. As an indication on the expected speed of convergence between them, expected T-note risk premium in three years.
8. As a measure of monetary policy risk premium, current risk premium on 1-year U.S. Treasury notes.

Applying a standard statistical procedure to the current Federal Funds Rate, yields for 3-month, 6-month, 1-year, 2-year, 5-year and 10-year U.S. Treasury instruments and responses to the above-cited surveys during 1994 through early 2024, he finds that:

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How do exchange-traded-funds (ETF) focused on Treasury Inflation-Protected Securities (TIPS) perform? To investigate, we consider ten of the largest TIP ETFs, all currently available, as follows:

• • iShares TIPS (TIP)
  • Schwab U.S. TIPS (SCHP)
  • Vanguard Short-Term Inflation-Protected Securities (VTIP)
  • iShares 0-5 Year TIPS (STIP)
  • SPDR Portfolio TIPS (SPIP)
  • FlexShares iBoxx 3-Year Target Duration TIPS Index (TDTT)
  • PIMCO 1-5 Year US TIPS Index (STPZ)
  • SPDR Bloomberg Barclays 1-10 Year TIPS (TIPX)
  • PIMCO 15+ Year US TIPS Index (LTPZ)
  • FlexShares iBoxx 5-Year Target Duration TIPS Index (TDTF)

As benchmarks, we consider iShares 1-3 Year Treasury Bond (SHY), iShares 3-7 Year Treasury Bond (IEI), iShares 7-10 Year Treasury Bond (IEF) and iShares 20+ Year Treasury Bond (TLT). To match duration of each TIPS ETF, we assign the one of these four benchmarks with the highest correlation of monthly returns. We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using monthly returns for the 10 TIPS ETFs and the four benchmark ETFs as available, and concurrent monthly changes in the U.S. Consumer Price Index (CPI), through October 2024, we find that: Keep Reading

Do target retirement date funds, offering glidepaths that shift asset allocations away from equities and toward bonds as target dates approach, safely generate attractive returns? To investigate, we consider seven such mutual funds offered by Vanguard, as follows:

• • Vanguard Target Retirement 2020 Fund (VTWNX)
  • Vanguard Target Retirement 2025 Fund (VTTVX)
  • Vanguard Target Retirement 2030 Fund (VTHRX)
  • Vanguard Target Retirement 2035 Fund (VTTHX)
  • Vanguard Target Retirement 2040 Fund (VFORX)
  • Vanguard Target Retirement 2045 Fund (VTIVX)
  • Vanguard Target Retirement 2050 Fund (VFIFX)

We consider as benchmarks SPDR S&P 500 ETF Trust (SPY), iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and both 80-20 and 60-40 monthly rebalanced SPY-LQD combinations. We look at monthly and annual return statistics, including compound annual growth rate (CAGR) and maximum drawdown (MaxDD). Using monthly total returns for SPY, LQD, three target retirement date funds since October 2003 and four target retirement date funds since June 2006 (limited by Vanguard inception dates), all through September 2024, we find that:

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Does investor fear level predict U.S. Treasury instrument returns? In their September 2024 paper entitled “Fear in the ‘Fearless’ Treasury Market”, Tianyang Wang, Yuanzhi Wang, Qunzi Zhang and Guofu Zhou examine how investor fear relates to future returns on U.S. Treasuries. They define bond risk premiums by duration as annual returns in excess of the 1-year interest rate. To measure investor fear level, they employ Thomson Reuters MarketPsych Indices (TRMI), which apply natural language processing to assess investor fear, positivity, negativity, optimism, pessimism, trust, stress, surprise, credit risk and volatility from 42,000 news and 800 social media inputs. They construct a bond market Fear Index by combining these assessments and suppressing noise via a 12-month moving average. They decompose the Fear Index by duration (short-term vs. long-term), depth (intense vs. mild) and source (news vs. social media). They compare their bond Fear Index with other sentiment metrics and examine its import globally. Using end-of-month prices for 1-year to 5-year zero-coupon U.S. Treasury notes, contemporaneous TRMI outputs and data for other potential bond return predictors during January 1998 through December 2022, they find that:

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