The Great Bond Bubble Bust

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On an April 12 podcast by Goldman Sachs called “Rising Stagflation Risks Are Changing the Investment Climate’’ their global head of asset solution stated, “I would say that the playbook for investments and portfolio construction, of the period since the financial crisis, may not be relevant anymore. We have entered a period of higher inflation, higher volatility, and more uncertainty.” To say that the first quarter of the year was challenging for investors would be a massive understatement! At the time of this writing, the NASDAQ Index is -14.66%* the S&P 500 is -7.84% and if you think that is bad, the Russian index is -36% followed by China’s Shanghai index slightly better at -11.77%.**

Those types of returns and that type of volatility can happen in equity markets and often does; but much more concerning to me was bond performance during that time period. Bonds, as measured by the ETF AGG – ishares Core U.S. Aggregate Index had a -8.89% principal rate of return since the beginning of the year. For almost the past 40 years, bonds have been a great way for investors to diversify their portfolios and avoid being completely exposed to the see-saw moves of the stock market. I have often heard people say, “when stocks go down, bonds go up – that’s why you need to have some bonds in your portfolio.”

There is a possibility that what investors thought of as a relatively safe investment class has just ended its 40-year historic run in valuation. This is very concerning to say the least! Many older investors have stuck to the old rule of thumb, “Whatever your age is, that’s how much of your portfolio you should allocate to bonds.” Well, I believe the problem with that is when you get up to age 75 and 80 years old, it could end up giving you massive exposure to bonds, and in so doing, you could expose yourself and your money to interest rate risk (the risk that rising interest rates may have on your current bonds). As interest rates rise, bond prices decrease in value. The opposite also holds true; if interest rates fall, bond prices go higher. This relationship between interest rates and bond prices is said to have an inverse correlation. Interest rates, although varying over time, have been falling ever since their peak in 1981.*

Essentially, bond prices have had a natural tailwind. As interest rates continued to fall, bond values naturally increased, as new investors were willing to pay a premium to own the high interest rate bonds. In fact, for the first time in U.S. history, the Federal Reserve instituted a Corporate Bond Purchasing Program to ensure that we didn’t have a “run on the bank” when it came to corporate bond prices. The Fed stopped its $6 trillion bond-buying program “Quantitative Easing” on March 9, 2022. A mixture of rising inflation and rising interest rates in an attempt to curb that inflation could have some bond investors selling their shares and heading for the hills.

I’m encouraging MCM readers who own investments to meet with their financial advisors to discuss the impact rising interest rates will have on their portfolios. There is a possibility that the longest bond market bull run we have seen in the modern era may have just ended. If that is true, conservative investors should consider restructuring their thought process regarding risk management. Another thing to consider is that as the Fed raises interest rates, the economy tends to slow down, and if they happen to raise rates too aggressively, I believe it could lead to a slowing economy and a decline in stock prices.

Bonds as well as stocks went down a considerable amount in the first quarter; I believe now is a great time to assess your risk exposure.


*marketwatch.com/investing/index/comp
**bloomberg.com/quote/SHCOMP:IND

 

 

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