Today, I sold the remainder of my TIPS position.  Real yields for the 30 yr have dipped below 0.5% which I find to be expensive.  That said, clearly we are in an environment where return expectations have to be ratcheted DOWN.  While US 10yr rates have dipped below 1.6%, it is not the lowest in the world as Japan has been at 1% for a long time and Germany is at 1.2%.  I can certainly see a scenario where US rates go lower.  As I mentioned a few days ago I was going to touch on scenario analysis and what it looks like.  This is an example where it can be helpful.

In the investment world (well, in everything, really) events are probabilistic.  What I mean by that is that to any activity, there is a probability that it happens or not.  The method consists of coming up with all the POSSIBLE outcomes and weighting these outcomes by the probability they occur.  So in this case, I try to come up with possibilities for interest rates and the results.

Scenario                                                Probability             10yr Rate outcome
Global growth increases                             10%                           +1%
Global growth resumes at lower rate          60%                            -0.10%
Global growth declines                               30%                            -0.50%

Expected outcome                                     100%                           -0.11%

Admittedly, the probabilities and outcomes are subjective and flawed but they provide a framework of thinking about the markets.

I look at these results and think, where are the risks to my predictions?  Maybe rates don't go too much lower even in a decline growth market.  Maybe rates go up further if we start getting some growth at some point?  I think this is a possibility and 10year rates can go up 2% or more and that would impact the overall outcome.  Given that I feel this is the case, I am looking to bail on my long term bonds temporarily and see how the balance of risks plays out in the near future.

My big concern right now (and the flip side opportunity)  is about the exodus from equity.  Allocations to equity by large institutions is going down and the public is disenchanted by equities.  The problem is that the more bonds we put in our allocations, then the higher the savings rate must go up and therefore consumption goes down.

So there is a negative feedback loop that impacts equities.  As much as I like them here, it will be important not to fall so much in love that you lose flexibility.  Keep some powder dry for opportunities.