Review: Bond surprise: Yields dip despite Trump, Fed

It’s become an article of faith lately that bond yields have to go up – just like they were supposed to last year. Well, the market continues to confound the market timers. Bond yields are actually down.

This is a good reminder that the market doesn’t actually care what you think. It’s going to do what it’s going to do.

The market can stay irrational a lot longer than you can stay solvent. Even if you were able to come up with the platonic ideal of the yield curve, the market is under no obligation to actually get there.

There are all sorts of reasons for this, but let’s look at a few:

Any analysis is for a point in time. Unless you’re able to predict the future, you can only work with the information that is currently available. Meaning that you don’t have the information that will come out in the future. And the future is pretty immediate – stuff (that’s the technical term) is constantly happening. We’re always getting new information that will impact the economy and the financial markets. Which your analysis didn’t account for. The more precise your analysis, the quicker it becomes stale.

Financial markets are really people betting on what they think will happen in the future. They’re saying that I’m willing to give you this amount of money now for those cash flows in the future. This can get pretty abstracted with some instruments, so it’s easy to forget, but when you boil everything down far enough, that’s all finance is. There are all sorts of things that go into figuring out how much someone will give you today for those future cash flows, but they are all estimates (guesses). And no matter what amazing quantitative analysis you have done, no one has to agree with you. And what’s worse, a lot of the time the variables with the biggest impact are the ones that are the least certain.

And to top all of this off, the market has already incorporated all of the information that is out there in the market. By bringing together all of these people who are doing their own analysis and disagreeing with each other, the market is essentially coming to a consensus estimate of a security’s price. But the new information that is constantly coming out means that the consensus is ever changing. And without being able to predict the future, we just have no way of knowing whether that information will be better or worse than the market expected. That last part, how the information compares to the market’s expectation, is wildly important. Because that’s what actually drives prices – the market is always trying to guess what is going to happen next, and prices move on how reality compares to those guesses.

This doesn’t mean that you should be fatalistic about your investments though – the financial markets can be incredibly powerful tools to help you reach the retirement that you want – you just need to use them correctly. For more on how to do that, read our ebook Making the Markets Work for You




 

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