Amidst the “panic”, “fear” and “tumult” in government bond markets, it can be difficult to keep a cool head. Short-term trading is easily conflated with longer-term considerations, and the prevailing narratives can quickly become hyperbolic and often apocalyptic. This is deeply unhelpful for most investors – what’s the best way to navigate such situations?

In spells of real or manufactured market stress, it is far too easy to lose sight of our own investment approach and the things that we consider important. Most typically this means long-term, fundamentally-minded investors being dragged into short-term thinking. 

I have found one of the easiest ways to uncover what an investor thinks is actually important (or to get them to focus on it) is to give use the crystal ball test. Ask: if you had to predict the performance of an asset class over a period of time and could see one market or economic variable in the future to assist you, what would it be?

We can use this approach to cut through a lot of the noise engulfing government bonds at the moment by asking something like:

• If you had to predict where 10 year US Treasury yields would be in five years’ time and could use a crystal ball to see one metric in the future, what would it be?

Would it be growth, inflation, the deficit, debt to GDP, the Fed balance sheet – or something else?

This obviously has nothing to do with actually forecasting the future, but is rather a way to focus on the things that should matter to us about the asset class under scrutiny.

It can also prove insightful to invert the question and ask: if you knew X in advance, would it help you predict the performance of the asset class? This is particularly helpful during times of market stress, where investors can veer dramatically from whatever their process should be and instead become wrapped up in whatever the market is obsessing over. (The next Treasury auction is probably not as critical as we think). 

It is amazing how much time market participants spend talking about issues that probably don’t matter to them given their approach and goals, and, even if they did, they couldn’t predict how they would unfold. This problem becomes particularly acute in stressed environments. 

Fundamentally-focused investors who care about quaint things like cash flow and coupons are incredibly vulnerable to getting caught up in the activity of short-term traders, because this is what drives markets in the moment. Finding ways to draw ourselves back to our own process and principles is vital.

The other piece of information that the crystal ball test can elicit is an investor’s real time horizon. If I were asked to predict Treasury yields over one month and over five years, the variables I would want to see in advance would be very different. Factors that might matter over five years, probably won’t tell us much over the next few weeks. (I am not actually sure what I would want to see in my crystal ball if I had to make weekly predictions).

One of the best way to understand an investor’s genuine time horizon is to ask them what they would most like to know in advance, and work back from there. If they want to see the next inflation print, they are probably not a long-term investor.

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While we cannot predict the future or forecast asset class behaviour accurately, asking ourselves or someone else what we would do if we could peek into the future can help to get the focus back to what’s important to us and away from lure of market noise.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

At any given point in time, there is a risk in financial markets that is the focus of everyone’s attention. Recently this has been US Treasuries with talk of a ‘fiscal crisis’ and ‘debt sustainability’ increasingly common. This, of course, is not a new issue. In fact, it seems to rise to prominence whenever there is a gap in the schedule of ‘things to worry about’. Rather than go too far into the weeds on this topic, I would rather focus on the dangers of the language that is often used when this subject is discussed, which is often hyperbolic, ambiguous and difficult to verify.

US Treasuries are one of the largest and most important asset classes in the world. Not only are they a critical holding in most portfolios, but they are also fundamental to the functioning of financial markets and the global economy. Their fortunes matter to investors in a profound way; that means that using words like ‘crisis’ or suggesting debt is ‘unsustainable’ has consequences.

While you may truly believe that there is an impending crisis or that US debt is unsustainable, you cannot stop there. The issue is far too significant to make vague, headline-worthy statements with little substance behind them. You need to give more – such as answering these questions:

– What do you mean by a crisis – specifically – what would it look like?

– Crisis suggests something sudden – is it likely to happen soon?

– What would the implications be across financial markets?

– At what point does debt become unsustainable? Is there a threshold?

– The US cannot run out of money to pay its debt, so do you really mean an inflation problem? If so, what are you forecasting will happen to inflation?

– It sounds pretty bad if US debt is unsustainable. What should I do? Not hold bonds? Not hold equities?

– How can we test whether your views are valid?

There are some effective tactics at play when people talk about US Treasuries in a dramatic and imprecise way. Key is exploiting the fact that people’s standard mental model is to think of US government debt in the same way as a household or company – as if at some point they simply won’t have enough money to pay the next coupon.

For the avoidance of doubt, the US cannot run out of money to service its debt like a corporate (because it issues debt in its own currency) and neither will it suffer a mirror of the Eurozone debt crisis (for the same reason).

None of this means that there are not risks here. There clearly are. But if you are going to talk about fiscal sustainability, it is very important to be clear about exactly what you mean. If the issue is that sustained deficits on top of already high levels of debt, and a lack of willingness to address them, will lead to future inflationary or currency problems, then say so and invest accordingly.

In addition to the often incorrect framing of the ‘credit’ risk faced by the US, there is also a remarkable lack of verifiability to the prognostications offered. When someone talks of fiscal sustainability in the US, it is often not clear whether they think that this means that 10-year yields will move 30bps higher, or the entire market will implode. That ambiguity makes accountability difficult.

It is so easy as an investor to talk in bold terms about the fiscal risk in the US. You can take the occasional victory lap when yields rise a little, but then claim the big risk is still to come; it just hasn’t happened yet.

This is incredibly unhelpful for other investors. Not only is it likely to cause a great deal of worry, but there is no way for them to know what to do about it. They are left with the notion that there is a major risk overhanging markets with hugely uncertain impact and timing.

If your view is that deficit and debt levels mean that the term premium should increase because of greater levels of inflation uncertainty, that is a reasonable, implementable and testable investment thesis. It doesn’t need the language of crisis.

If you genuinely believe that US government debt levels are a far more serious problem, then show your working. How does this play out? And what should investors do about it and when?

Espousing views about market risks that are exaggerated, light on detail and difficult to validate is fantastic for attracting attention, but it doesn’t necessarily make for great investment insight. We should think about how we use our language, because it matters for how investors feel and act. 

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).