“Bonds won’t be a good buy until around 2008 or 2009, when we will begin to enter another depression era.”

“At 3 to 5%, bond yields don’t sound impressive. But when equities drop precipitously in a deflationary economy, bonds are highly secure, offer a dependable income stream that buys more, and they actually appreciate in value.”

There are two seasons of the 80-year economic cycle that favor bonds, the first phase of the Growth Boom and the Deflationary Shakeout. In our current economic cycle, the first phase of the Growth Boom occurred between 1982 and early 1998. The next Deflationary Shakeout or depression era will begin between late 2008 and 2010 and last until around 2023. This means that the optimum portfolio right now and for most of this decade does not include bonds.

Bonds are a good investment when inflation rates are falling dramatically. For example, there was a drop in inflation from 14% to 1% between 1980 and 1998. Consequently, the average return, including capital gains, from 30-year U.S. Treasury bonds was 13.9%. That wasn’t quite as good a return as the S&P 500, but it came with virtually no risk on principle or interest. For the more conservative investor, bonds were a tremendous investment.

Bonds aren’t a good buy right now, and won’t be until around 2008 or 2009. That’s because inflation rates are forecast to be moderate and relatively stable, which in turn lowers the yield on bonds as well as eliminating their potential to appreciate.

The next season we will enter, which will be similar to the 1930’s depression era, will be another great opportunity to invest in bonds. The economy as a whole contracts, which means that both consumer prices and equities decline dramatically. And while falling prices also result in falling bond yields, long-term bonds will appreciate in value and offer a more secure investment than equities

For example, from 1930 to 1942, total returns on long-term government bonds averaged 3.5%, and on corporate bonds they averaged 6.2%. This doesn’t sound like much, especially by comparison with the returns we’ve seen during this economic boom. But consider this: The principle and interest on bonds were virtually guaranteed while in the same period blue chip stocks lost 80% of their value. Since the purchasing power of money was higher due to falling prices, a 3% to 6% bond yield was equivalent to about 6% to 9% in actual value to consumers.

We can expect the same general conditions to apply after 2009. By comparison with the kinds of returns we have been enjoying, bond yields will be low. However, bonds will be a secure form of wealth that will buy more when prices deflate. Therefore, a great strategy for coping with the upcoming Deflationary Shakeout is to buy long-term, high-quality corporate bonds. I prefer corporate to government bonds, since rising deficits in difficult times make government bonds a riskier investment.

I specifically recommend these portfolio moves for shifting your assets between equities and bonds:

• From late 2007 to mid-2009, begin to harvest the profits from your equity holdings and systematically shift your assets to very high quality corporate bonds.
• Maintain your bond portfolio intact until after the first serious domestic stock correction, which I predict will occur between late 2008 and 2011.
• After this stock correction, shift 20 to 40 per cent of your bond portfolio into Japanese, South Korean and Chinese equities and into other international markets that will remain buoyant after 2009.

By following this strategy you should be able to protect most of your wealth and earn a respectable return from your bond portfolio through the worst years in our economy since the Great Depression.