Bonds and Rebalancing Bitcoin

Trades in Whisky and Soda;

On Monday, 20^th January, Donald Trump will be sworn in as the 47^th President. They say a week is a long time in politics; well, that’s nearly two. Before we even consider what happens in the first 100 days, he will probably be sentenced for the hush money trial this week, although the Judge has offered an unconditional discharge. This is the sort of thing markets will face in the run-up to the inauguration. It will be a choppy fortnight.

Although US equities had a good year, most of it was banked by July, with notable falling breadth later in the year. That means fewer stocks are driving the market, which increases risk.

S&P 500 – Past Six Months

We also saw two spikes in market volatility in August and December. These were not on par with the financial crisis or the pandemic crash, but shots across the bow, nevertheless. Note how the S&P500 has not yet made a new high since December’s VIX spike. The vast majority expect the S&P to spring to new highs when Trump returns to office.

VIX - S&P 500 Implied Volatility Index – Past Six Months

In less than two weeks, Trump’s administration will hit the ground running, and it will surely be good for the US economy, and hopefully good for the world economy, albeit with caveats. There will be winners, and we are already seeing a move in oil and gas. There has also been strength in crypto, although I have my doubts about how far they will go on the idea of a US Bitcoin strategic reserve. There will also be losers relating to tariffs and other unknowns, and that may even impact the UK.

Whatever policies he enacts, there is no escaping the fact that the US stockmarket and the dollar are richly priced, and the value has shifted to bonds. I have seldom been bullish on the long bond in recent years, having been firmly in the bond bear camp. However, the primary reason for being cautious on bonds was the ultra-low yields, and that is now firmly behind us. Bond yields are now high and moving higher.

UK 20-Year Gilt Yields (black) and Prices (blue)

Prices and yields look at each other in the mirror. To simulate what would happen to bond prices with changes in yield, I have produced this table. Start on the left vertical and choose your yield. Move along to the right to see your end yield. The number on display in the table is your approximate capital profit or loss, excluding income.

Impact on 20-Year Gilt Price by Change in 20-Year Yield

Complex bond maths simplified, but that covers 90% of it. The table helps us to understand what is at stake. If the gilts purchased in Soda in November, at a yield of 4.9%, were to see a deflationary crash back to the gilt yield seen in March 2020 (0.4% - an unlikely event), the capital gain would be around 150%. Similarly, a melt-up in yields would cause losses.