Valuation of Government Bonds

Podcast: Valuation of Government Bonds

Current valuation of government bonds became expensive. In this paper, I compare the total return on the iShares 20+ Year Treasury Bond ETF (ticker TLT) with the real yield on the 10-year US treasury bonds. By investing in the long-term US government bonds when the real rates are negative, makes such investment speculative and risky. 

The daily real yield on the 10-year US treasury bonds is at the historical lowest level. The real yield on the 10-year US Treasury bonds was -0.96% on December 10, 2020, according to the Federal Reserve Bank of St. Louis data. As investor in the long-term government bonds, you can expect to earn negative income after inflation for the next ten years. The downside risk of investing in the US government bonds is much greater than any short-term upside potential in my opinion. 

Why would you invest in securities that earn a negative return? The only reason is to believe that the interest rates can decline further. The price of bonds is negatively correlated with interest rates. As rates decline, the price of bonds increases. If you believe that the interest rate may decline further, then investing in the US government long-term bonds may provide price appreciation despite negative real income. 

By comparing the real yield on the 10-year US treasury with the performance of the investment in the long-term government bonds, you can visually see when the bond market becomes expensive (see chart 1). In this chart, I compare the return on $100,000 invested in the iShares 20+ Year Treasury Bond ETF (ticker TLT) vs. the real yield on the 10-year US treasury (data provided by Yahoo Finance! and Federal Reserve Bank of St. Louis). The bond portfolio invested in the TLT grew form $100,000 on January 2, 2003 to $337,790 as of December 10, 2020. It was amazing 17 years performance for the US treasuries. However, it was not all smooth on the upside. You may notice when the real rates stay positive, the US treasuries do relatively better than when real rates go negative. When real rates went negative from July 2012 until May 2013, the US treasury bonds performed poorly the following year, 2013-2014. Current real yield on the 10-year US treasury reached a new record low point of -0.96%. This is the reason to be cautious about investing in the long-term treasury bonds. 

When the real rates are positive and it least one percent, it provides additional reason to hold long-term US Government bonds. At least you are earning a positive income above inflation. Also, the performance of the TLT portfolio did relatively well when the real rates reach positive territory. When the real rates reached above one percent in 2014, the following year was very good for holding treasuries. Similarly, rates went above one percent in 2019, and treasuries performed amazingly well the following year. 

Real interest rates provide additional valuation tool to determine whether the bond market maybe expensive or not. When the real interest rates are positive, the investor is earning income above inflation. When the real interest rates are negative, the income from the bond portfolio will not compensate for inflation. It should also signal a warning sign that bonds maybe too expensive. 

Chart 1. Comparing the price performance of $100,000 invested in the TLT vs. the Real Yield on 10 Year Treasury

Data: 

Yahoo! Finance.  https://finance.yahoo.com/ data accessed on December 12, 2020

Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/series/DFII10 data accessed on December 12, 2020

Disclosures: 

The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information.

ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC.  Past performance doesn’t guarantee future results.

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Unit #2991
Denver, CO 80202



Categories: Economy, ETFs, Investing, Personal Finance, Podcast

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