23/12/2010 – Long-Term Bonds: The Best Possible Investment? Think Again

And, finally, there’s the mainstream economic experts who have
it on good authority that long-term bonds increase in value during
financial instability and uncertainty.

On this, the following news items from November-December 2010
reflect the enduring faith in fixed-income assets as the ultimate
safe-havens:

• “Bonds Tumble On Signs of Economic Recovery” (Reuters)
• “US Treasury Prices Rise as traders positioned for
  negative headlines….” (Associated Press)
• “Treasury’s rise as investors sought shelter in
  safe haven assets amid rising fears about sovereign debt
  woes in the eurozone. The slow motion train wreck is likely
  to play out over year end as each country plays musical chairs
  with solvency. The market’s concern here is ‘What is next?’
  The 10-year Treasury yield will fall if the problems get
  worse from here.” (Wall Street Journal)

There’s just one problem with this notion: namely, bonds (of
any denomination) do NOT have a built-in disaster premium. This
is the myth-busting revelation of the latest, free report from Elliott
Wave International. The resource titled “The
Next Major Disaster Developing For Bond Holders” includes
a thoughtful selection of various EWI publications that expose
the very real vulnerability of bond markets to economic downturns.

The premier study on the subject comes from Chapter 15 of EWI
President Robert Prechter’s book Conquer The Crash by
way of this memorable excerpt:

“If there is one bit of conventional wisdom that we hear
repeatedly with respect to investing, it is that long-term
bonds are the best possible investment [in downturns]. This
assertion is wrong. Any bond issued b a borrower who can’t
pay goes to zero in a depression. Understand that in a [major
contraction], no one knows its depth and almost everyone becomes
afraid. That makes investors sell bonds of any issuers that
they fear could default. Even when people trust the bonds they
own, they are sometimes forced to sell them to raise cash to
live on. For this reason, even the safest bonds can go down,
at least temporarily, as AAA bonds did in 1931 and 1932.

The first chart (see below) shows what
happened to bonds of various grades in the deflationary crash.
And the second chart (see below) shows
what happened to the Dow Jones 40-bond average, which lost
30% of its value in four years. Observe that the collapse of
the early 1930s brought these bonds’ prices below — and their
interest rates above — where they were in 1920 near the peak
in the intense inflation of the ‘Teens.”

That’s just the tip of this myth-busting report. “The
Next Major Disaster” uncovers flaws in other widely-accepted
bond lore, including these two assumptions:
 

• High -yield bonds rise during economic expansions
• AND — municipal bonds provide a steady refuge in times of
  economic stress.

Read more about Robert Prechter’s warnings for holders of municipals
and other bonds in his free report: The Next Major Disaster Developing
for Bond Holders. Access
your free 10-page report now.