“Investors who fled the perceived risk of equities into the ‘safe,’ low volatility arms of bonds during the Great Depression. . .experienced a peak-to-trough real drawdown. . .exceeding 67%”
Bonds are exposed to interest rate risk and the greater a bond’s duration, the greater the sensitivity to that risk. Perhaps more importantly given the current interest rate environment, the more rates fall, the more that risk rises exponentially. In other words, last year’s explosive treasury performance on the back of a relatively small drop in rates (just 1%) reflects the high-octane nature of this relationship and just how dangerously ‘wound’ bonds are right now (see figure 3). Investors who fled the perceived risk of equities into the ‘safe,’ low volatility arms of bonds during the Great Depression know this all too well. From December 1940 through August 1981, they experienced a peak-to-trough real drawdown on US bonds exceeding 67%.[i]
So much for safety, stability and defense.
This is an excerpt from our article “What color is your parachute?” published January 31, 2012