Bonds are Interesting Again

We’ve been experiencing a stock market with higher-than-average volatility since January of 2022.  While this has garnered a lot of deserved attention, something else has happened along the way.  For those looking to earn a recurring level of income, bonds (and even relatively safe bonds) are now providing a worthwhile yield which provide a level of income not seen in many years.

When we talk about investing, we don’t often start with bonds and that has been for good reasons up until recently. Most bonds weren’t providing a level of income sufficient to take either interest rate risk (as interest rates rise, bond prices fall) or default risk (companies failing to return the principal on their bonds).  This was the main reason for our stance that bonds were unattractive for most of 2021 and into 2022. 

Fast forward to now:  2-year treasuries, which are considered relatively safe investment assets, now have yields approaching 5%.  This level hasn’t been seen 2007, or stated another way, it has been 16 years since we had shorter term treasuries paying these levels of interest. 

Now, investors certainly had to experience a lot of pain to get to this level of yield.  In 2022, aggregate bonds experienced their worst year since at least the 1970s.  The US Federal Reserve, and other monetary policy makers across the globe, have had to increase their respective interest rates significantly to battle the global high level of inflation experienced in the post-COVID world.  These actions created difficult returns for existing holders of bonds.  New savers and purchasers of bonds, however, are now benefiting from much higher returns for similar risk levels.  As a result, the biggest adjustment we have made to our asset allocation outlook is that bonds represent a more attractive alternative now compared to the last few years. 

This doesn’t mean that bond investors are not facing risks.  Bonds are still susceptible to interest rates rising, and until we get better data reflecting inflation is under control, interest rates may continue to rise.  It is our expectation, however, that inflation will continue to decline even though we don’t expect “normal” inflation of 2% to happen this year.  If we see continual improvement, we could see interest rate stabilization or potential declines, which would be tailwinds for current bond buyers. 

From a stock perspective, higher interest rates tend to be a general headwind, but the degree of influence can be dependent on the sector as a whole and the financial health of the company.  A viable bond yield, however, can act as a negative influence on the market as investors rotate toward bonds for a less risky way to earn their returns.  While higher bond yields, and relative bond attractiveness, can be headwinds, there are simply too many variables to actual stock market performance to say with certainty since bonds are attractive, stocks are not.

The stock market declined in February after a very strong January.  Stocks were digesting higher interest rates, inflation data that was a bit higher than hoped or expected, as well as earnings results and future outlooks that reflected some level of caution among US companies.  It is our opinion that over longer periods of time corporate earnings growth drives stock market returns.  This is difficult to time with precision, but until investors are more comfortable that future earnings growth is stabilizing or increasing, it will be difficult for markets to rally significantly. 

With all this in mind, what are investors to do?  In our opinion, understand your return needs and objectives.  For some investors, incorporating a higher portion to bonds now could make more sense as the income level is higher now with a lower level of risk compared to stocks.  For other investors, with longer timelines and higher tolerance for risk, stocks still represent the best investment for long term growth.  That is why the blend of assets, and our recommendations, are more personalized and tailored to the specifics of our clients.

There is no blanket answer on stock or bond allocation and certainly no timing strategy that can perfectly adjust to maximize returns with minimal risk.  Usually, the best answer is to own a portion of both that is suitable for your ability and tolerance for risk that meets the needs in the short term combined with your objectives for the long term. 

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on March 1, 2023
Call Us: (775) 674-2222