In our recent commentary, “Avoid Headline Hysteria“, we discussed the financial “gurus” who gaze into their consistently cloudy crystal balls and continue to make authoritative sounding forecasts about future events.
We would avoid this subject if it weren’t for our concerns about the damage done to individual investors heeding the advice of these pundits who, unfortunately, are granted credibility by the public because they are seen on TV or their columns appear in renowned financial publications. In our view, these prognosticators should be lauded only for their persistence, since no matter how often they are wrong, they shamelessly make their next prediction.
The truth about interest rates
In our 40 years of experience as municipal bond specialists, we have observed one overriding truth that has proven to be invariable: No one has ever consistently predicted the direction of interest rates for any extended period of time. Any successful strategy for building a quality municipal bond portfolio that maximizes an investor’s income and after-tax return, must have this axiom as its foundation: Attempting to time municipal bond interest rates is a futile pursuit.
An excellent example of this was an article in Barron’s by Randall Forsyth on March 10, 2010, which focused on the unanimity of interest rate forecasts.
In the piece, “The Case for Bonds,” he wrote: “You can’t pick up a financial publication these days that doesn’t ominously warn of rising interest rates and how they will decimate fixed income investments.”
He quoted Smart Money magazine as saying bonds “could turn ugly fast,” and said Smart Money columnist James B. Stewart similarly warned investors to “prepare your portfolio for higher rates,” which “typically ravage the value of fixed income assets like bonds.”
Don’t be confused. This is James B. Stewart the author, not the legendary actor of “It’s a Wonderful Life.”
This James Stewart is the talented journalist who has authored a number of best-selling non-fiction books, including “Disney War” and “Den of Thieves.” He is a respected professor of journalism at Columbia University and may also have some expertise in the area of equity investing.
However, when it comes to advice on the fixed-income markets, Mr. Stewart has never missed an opportunity to miss an opportunity.
We first took him to task in June 2005, when in his earlier columns he suggested that long-term interest rates were poised to go substantially higher and fixed income investors should buy short-term CDs rather than locking in higher long-term rates (long-term, high quality, tax-free bonds at that time were yielding over 6.00%).
His call turned out to be less than prescient, as long-term interest rates plummeted.
He explained it by saying it was a “puzzling development” that long-term interest rates were one full percentage point lower, even though the Fed had raised the Fed Funds rate eight times. Although he confessed to getting it wrong, he suggested it was excusable since “everyone else” was also wrong. Incredibly, after admitting his previous error, in the same column, he once again recommended two-year CDs.
We need not report Mr. Stewart’s results in the CD markets over the ensuing years. As all investors and savers know, short-term CD returns were — and continue to be — microscopic, and that’s before factoring in federal and state taxes.
Their aim may be true, but their predictions aren’t
We don’t doubt that Mr. Stewart and other interest rate seers, for the most part, are sincere in their efforts to protect their followers from the market risk that can occur if rates rise.
What they fail to realize, however, is that for long-term bond investors, market values will fluctuate over the years and fixed-income investors traditionally employ a “buy and hold” strategy, making temporary market fluctuations irrelevant, as investors learned during the recent financial crisis.
Ironically, what these equity-oriented, uninformed gurus ignore is “income risk,” and income, after all, is the reason investors buy bonds in the first place.