Why Won’t the Housing Market Crash?

Welcome to Ask the Compound, the show where you ask and we answer. I am Ben Carlson. Nationwide housing prices are up nearly 60% this decade alone. Mortgage rates have gone from sub 3% to 7 12% more recently. Yet prices refuse to fall. Why? Why won't housing prices crash or at least just fall a little, like, I don't know, 10%. What's holding up this housing market from crashing? I'm going to answer this question and more on today's show. Let's do it.

Welcome. Our email here is ask the compound [email protected]. We've got today we've got questions about bonds. A lot more questions about bonds. Paying out for mortgage early, a fan favorite as always. Why home prices aren't crashing, home country bias, and some advice for young investors. If you're in the live chat, shoot us a question. If you're on Twitter, shoot us a question. We love taking them live on the air. Someone asked, "Hey, how's Duncan doing today?" He looks good.

Okay. Uh, Philly Mike says, "Sounds like Ben is disappointed in the stock and the lack of a crash." I'm not disappointed. Duncan is disappointed.

The lack of a housing market crash. You wanted to crash.

Yeah, we'll see. All right. Today's show is brought to you by Exhibit A. Exhibit A for advice.com. That's the email address. Financial advisers, when you're presenting to a client, what they see matters more than what you say. Your words fade into the background. So, why settle for an outdated off-brand screenshotted chart when you only get one first impression? Exhibit A gives you 200 daily updated visuals, custom branded so you look like they were built in house. Change the colors, put your logo on there. Personally, me, I'm also ghostwriting eight monthly and four quarterly market updates for advisor clients. You put your brand on there, you send it to clients. I write about charts, economic data, market data, long-term evergreen stuff. So, it's presentation, newsletter, social post. Exhibit A takes complicated market topics, turns them into visuals so clients can actually understand them. 7-day free trial exhibit aforadvice.com. Try it out now.

Sure. I don't know. I mean, have you ever read a celebrity biography before? Like Andre Agassi, his biography is amazing. He didn't write that. The guy who wrote some bartender book wrote it. Like Ben Affleck was in the movie. Like, of course, all those books are ghostwritten. Let's be honest. I read the Bob Dylan one. That one's too weird for anyone else to have written. I'm pretty sure he wrote that.

All right. Um,

and people jack up the initial thing they listed at so they can bring it down, right?

On a recent episode of Animal Spirits, Ben mentioned he bought bonds for the first time in his career. Can we hear more about this? I'm 38 and 100% of my investments are in broad-based index funds. It has served me well up to this point, but lately I've been bond curious. Uh, how did you decide what type of bonds to buy?

Uh, I think a lot of investors have more or less given up on bonds as an asset class. First yields were ultra low for years coming out of the GFC. Then they went even lower in the pandemic. You know what happened next? Government spending 9% inflation. The Fed aggressively raising rates. Bonds got killed. Dan Chardon. By my calculation, this is the worst decade for bond market in modern finance history. So this just shows five-year treasuries, 10-year treasuries, long-term treasuries by decade. And these numbers, so this is by far the worst return we've seen for a decade for the five-year treasuries, for the 10-year treasuries, and long-term 20 and 30-year treasuries. And these numbers were even worse when you add inflation, even worse than the 1970s. Looking on a nominal basis, bonds did okay in the 70s. It was after inflation, but after inflation, it's even worse in the 2020s. Worst decade ever for bonds. Chart off. The question is, Dave says the decade isn't over yet. Yes, Dave. That's where I was going next. So now what? Right chart on. Bond yields have not been this high since 2007 before the great financial crisis. Bonds were a great hedge during the GFC when the stock market fell almost 60%. But we have not seen yields this high in bonds since then. It's been a long long time. Chart off. There are a lot of investors who have never invested in bond yields this high before. We've been talking internally. Ritholtz Wealth Management was founded in 2013. We've never had bond yields this high in the history of the firm. It's kind of crazy that there are a lot. I mean, I hate when people do the hey a whole generation of investors has never lived through a financial crisis or a bear market, but no, there's a lot of investors who have never had bond yields this high before. So I think that's why we are getting questions like this because people have never had to think about them like why would I when bond yields were one or two%? People thought like of course I'm not going to invest in them. No. And cash yields were higher. So why would anyone invest in bonds in that case anyway, right? That was the idea.

for people like me, they haven't even been on our radar, you know?

Right. Right. Yeah. But but yeah, not like a serious allocation ever.

So I did think this question was a good way to share some of my general thoughts about investing in bonds. Now, I think investing in bonds, keep them short to intermediate term in nature. I don't think long-term bonds make sense because there's just way too much volatility. 20 and 30 years is way too long. So even though you get whatever the yield is a little higher, the volatility because inflation can change, interest rates can change, economic growth can change. So now if interest rates fall, will long-term bonds give you the biggest bang for your buck to the upside? Sure. But Daniel, give me a chart on this. Is TLT just back to inception in the last 25 years or so? Multiple even before the current one. Currently, bonds are down, long-term bonds are down 40 some percent with income reinvested. But even before then, you had multiple 20, 10, 15% corrections in long-term bonds. I think that's way too much risk for the quote unquote safe part of your portfolio. Take your volatility where you're being paid for it. Now, could you say, "Hey, Ben, what if long-term bond yields get up to 8, nine, 10%." Maybe we can have a different discussion, but even at like five or six percent, I'm not backing up the truck on long-term bonds. I still think intermediate term and for me that's four to six years in duration maybe shorter right because you can still get 4% on your cash right now that's a fixed income. Um in his book with Tony Robbins in 2014 I can't remember what it was called mastering something Ray Dalio gave one of his all-weather portfolios and he said 40% in long-term bonds and to me that's just that's way too much risk for people and of course it didn't work out very well. So I've written some stuff on long-term bonds over the years. Um I wrote a piece in 2021 called a bleak future for long-term government bonds. I just said people have had it way too easy from the current level of rates. It's going to be way harder going forward. Not trying to toot my own horn, that's just math. In 2015, I wrote, "Are long-term bonds worth the risk?" Here's what I wrote, Duncan. If you're a trader, it's possible long maturity bonds can make sense if you can ride the trend and get out before a large loss. But if you're a long-term investor, I think you really have to consider the risk-reward relationship in long-term bonds. And that's the thing with bonds. It's risk-reward. I prefer bonds for stability, income, dry powder, and volatility reduction. Some people also need them for an emotional hedge. So, that's why I like to keep duration shorter. Um, bonds are about balance. They can help like how you handle emotional volatility. So, why am I personally buying bonds at the moment? A few reasons. One, yields. Daniel chart on. Uh, this is a chart from Exhibit A. Starting yields are a great predictor of forward bond returns. This is the starting yield for the 10-year bond versus actual forward 10-year returns. It's not a perfect model because rates can change in the short term, but over the long term, yields do a very good job of telling you where returns are going to be in the future. Chart off. Bonds are also a great hedge against deflation, disinflation, and financial crisis. Three things we haven't had in a very long time. People are really worried about inflation right now. If inflation stays high and rates keep going up, bonds are not going to do very well. But I don't try to build portfolios based on where I think the market and economic environment is going to go. No one could possibly

So, here's the thing. I have a ton of equity risk in my portfolio. I'm not doing this in my retirement accounts. I am doing this in my brokerage accounts using tax efficient bond ETFs. My brokerage account has both long-term and intermediate term goals. So, I could use bonds in the future for a remodeling project on the house, maybe a vacation, maybe I use them for dry powder the next time the stock market falls, or maybe I just hold them and clip my 5.5% for the foreseeable future. So, I say that bonds are providing both a level of income and a margin of safety for the first time since before the great financial crisis. And I'm middle-aged guy now. Like when in 2007 there's no reason for me to buy bonds because I was so young and just starting out in the investing world. Now 20 years later I have other goals, other responsibilities and so I'm looking to hedge different risks. So I think the timing is right for bonds even if they get hurt a little bit more if rates keep rising from here.

Yes.

safe is in a Yes. And John Carlo asked a question. He says, "Dumb question." No dumb questions here. Just dumb people. I'm kidding. If you buy a bond ETF, can you lose capital if it goes down, right? But if you own the bonds, you get the capital and the coupon, right? Um I've gotten a lot of fights about this over the years. People say, "Hey, why don't I just own the individual bonds? Then I'm safe." I think that's more of a behavioral thing. If you own the bond and take it to maturity, right, it doesn't necessarily mean you can ignore interest rates because rates can still change. If you buy a bond today and it's 5% and yields go up to 6%. Then you still own the 5% bond, you've lost a little bit of money. Yes, you get it back at at par, but you still get that money back in nominal terms. A bond fund is just a fund of individual securities that can change and be bought and sold individually. So, it's more of a behavioral component. But with an ETF product, there is always the risk that people just don't want to buy the ETF, right? And then the price could potentially

trade at a discount to NAV, right? I mean,

Dave wants me to explain for you what a duration of 15 years of risk means. Okay? So, a duration will tell you more or less what a 1% change in bonds will give you. So, if rates rise 1% and your duration's 15%, you can expect to lose around 15% of your price value today. If yields fall 1%, you can expect to gain 15%. It's not perfect 1:1, but that's pretty close. So, with a 5-year duration, yields fall 1%, you gain 5%. If yields go up 1%, you're down 5%. Right. So, it just means that the higher the duration, the more volatility. And I think there's no reason to take excess volatility in the quote unquote safer part of your portfolio.

well, that's the thing. If you're taking long bonds, like, why are you that's the point. Why are you taking more volatility in your bonds? You should be trying to cut the volatility out.

That's my point. All right. Next question.

All right. I think people just want me to say it's okay to pay off your mortgage early. They just want to get me on record for saying it. I

This is a great question. I say you never pay off your 3% mortgage early. Never. No ifs, ands, or buts about it. Don't do it. It's a terrible idea. 6% mortgage, 7% mortgage, that's a very different hurdle rate. From a math perspective, if you're looking at bonds versus paying down a mortgage rate, the mortgage makes way more sense when it's 6 to 7% versus bonds, even of similar yield levels. There's no market risk involved paying off your mortgage. No prepayment penalties, no credit risk, no interest rate risk, right? None of that. Sure, minor tax breaks on your mortgage interest deduction, but you'll pay higher taxes on your bonds anyway. So, there still are though a few reasons why it might not make sense, and they more or less boil down to like liquidity and flexibility. Like, you can't I talked about bonds being a good source of dry powder. You can't rebalance with your house. If you pay off your mortgage early, you can't then use those funds to rebalance into stocks when they fall, right? So I think if you own bonds to hedge your portfolio, you can't do that with principal repayments. Obviously, house is liquid, right? So if this decision is based purely on hurdle rates and you're a numbers person, then the mortgage prepayment makes more sense. If it's an investment decision, it's not so clear-cut. Also, I think paying off your mortgage early is not an investment decision. I think it's a personal finance decision. It's about where you want to allocate your dollars. That's the way that I would look at it. So I don't necessarily look at it as like bonds versus mortgage. That's for like very number-coded people, which maybe there are a lot of those people watching and listening.

Oh, you can.

no, you can you can deduct the interest if you use it for upkeep of your house or remodeling or something. You can deduct the interest in the HELOC. But hey, you know, that's what got people in trouble in the 2000s. They were taking out HELOC loans and they were going on vacations or buying other houses.

No, the bank is not going to check you on that. So, it's a line of credit because guess what? The house secures it. So, you can do whatever you want with it, right?

I see.

Okay. Good.

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