Adaptation is tantamount to survival in the physical world. So argued Darwin, at least, and I am not one to argue with most science and its interpretation of natural laws. Adaptation has been critical as well for the survival of countries during wartime, incidents of which I am drawn to like a bear to honey, especially when they concern WWI. Stick with me for a few paragraphs on this – the following is not likely to be boring and almost certainly should be instructive.
In the first decade of the 20th century, British war colleges and their generals were philosophically trapped by the successful strategies of a prior era – an era before the invention of a functional machine gun. They felt that machine guns might dampen the spirit of their fighting forces. What counted was the horse and the sword. Britain’s cavalry training manual of 1907 in fact stated that “the rifle or machine gun, effective as it is, cannot replace the devastation produced by the speed of the horse, the magnetism of the charge, and the terror of cold steel.”
The British were to experience the horror of their inability to adapt at the Battle of the Somme in 1916. German and British lines were separated by only 300–400 yards and millions of pounds of barbed wire. After several weeks of intense mortar barrage, which the British felt would leave German trenches in shambles, the Brits were ordered to advance on the German lines – each three feet apart, at a deliberate pace, wearing 65 pounds of gear. The soldiers heard their generals’ whistle at the break of an early July dawn, climbed over the top and advanced slowly. They were accompanied by officers on horseback flashing steel sabers, confident that the charge would psychologically and then physically overwhelm the mortar-battered Germans in a matter of minutes.
Instead, they were met by 1,000 German machine guns. The Germans, it seems, had burrowed themselves for weeks, 50–100 feet underground, surviving the mortars relatively intact. And their generals were well-versed in British tactics – always charging at the break of dawn, always blowing loud shrieking whistles, always advancing three feet apart with horses and bayonets of a bygone era. But the Germans believed in machine guns, not horses. Within the first few minutes there were 30,000 dead and wounded. By the end of the day there was not a single British soldier alive that had penetrated German barbed wire. Machine guns cut them down like scythes harvesting wheat. The few that reached German trenches were incinerated by German flamethrowers, another 20th century technological invention. The Somme was the biggest disaster in the history of British arms, and perhaps history’s bloodiest single slaughter. During the extended battle, one million British and German soldiers were killed or wounded, yet it was Britain’s not Germany’s temporary Waterloo, based on their failure to adapt to a new age.
Now that bonds have suffered a near Somme-like defeat in the past few months, fixed income investors are concerned about their prior conceptions of bonds as an asset class – an asset that has historically provided reliable income and stable to higher prices. This concept has been more than validated over the past 30 years as the total return of long-term bonds equaled and even exceeded the performance of stocks for much of the time period. But now – with yields so low, and with a negative 3%–4% two-month return for bond indices – investors wonder if the bond “horse and saber” has given way to the alternative asset “machine gun” of a new era.
Well, future performance on the battlefield is one thing – and I will attempt to analyze that in the next few pages. But there will always be a place for the bond market “army.” A significant portion of an institutional or individual’s portfolio will always require bonds.