Most of our content tends to be geared to the stock market, but bonds are becoming cool again. Today, we will focus our attention on bonds, the traditionally safe & boring portion of investment portfolios. A quick peak at stocks before we dive into bonds: The Debt Ceiling issue came and went per usual, and stocks rallied Friday as a deal appears to have been reached (as we predicted in out last blog: Debt Ceiling Drama). Since the S&P 500 bottomed in October of 2022, it's managed to rebound by about 20%! Still some recovery work to do, but the data confirms that stocks are doing far better than the headlines indicate.
Here's what you need to know about the Bond Market in 5 minutes or less:
Bonds are debt instruments offered by companies or the government when they want to raise money. They are typically used to balance risk in an investment portfolio, as they are less risky than owning stocks. The value of bonds is greatly impacted by the movement in interest rates:
I've spent a lot of time discussing this topic in client meetings; we witnessed the bond market’s version of a “crash” as the aggregate bond indexed lost 13% for the year. This truly was an unprecedented move for bonds, as the worst annual loss prior to 2022 was a mere 2.9% (1994). The losses last year were induced by the Fed's aggressive push to move rates higher. The Federal funds rate has gone from 0% to 5% (if interest rates rise, bonds lose value).
Yes! All investments carry some form of risk, and bonds still fall on the safer side of the spectrum. I believe 2022 was an anomaly created by the pandemic. Consider this: since the Aggregate Bond Index (AGG) was created in 1977, it has only lost money during 5 calendar years! From 1977 until now, bonds have generated a positive annual return 89% of the time:
We've already established the role of interest rates & bonds. The graphic below will show longer term trends of bonds based upon interest rates. As you will see, today's interest rates (~5%) are quite favorable for bond investors. During the 1990's & 2000's we saw similar rates, and bonds performed well. Furthermore, bonds are finally generating some powerful yield, which serves as a form of protection. For example, if a bond is yielding 5% per year, and the price of the bond stays flat, the investor will receive 5% in the form of income. Conversely, during most of the 2010's when interest rates were near 0%, bond holders didn't have the luxury of income.
I believe bonds are poised to do well no matter how stocks move. Let's start with scenario #1: Stock Crash, and we potentially enter into recession. History shows that stock market crashes are followed by drastic interest rate cuts. Remember what happens if interest rates drop? Bonds gain value. So the bond portion of your portfolio should perform well if stocks falter.
What if stocks soar? It's likely that interest rates will flutter a little higher, which should reduce the principle value of your bonds. But remember- the starting yield is already 5%, so the total return will likely be positive even if stocks climb higher. In closing, the pain experienced to reach today's interest rates was brutal. However, I think the bond market will be an amazing bright spot for client portfolios as we move forward.
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