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 Read More

A Strong Start to a New Year

by Jeremy Bryan

Stocks came out strong in January as attitudes regarding the economy and corporate earnings began to strike a more positive tone.  While it can be argued that not much has changed from a data perspective, investors clearly have reacted differently, and that sentiment change has driven markets higher.  

Based on recent economic data, the US economy is remaining resilient.  Gross Domestic Product (GDP) reflected continued growth in the US economy, unemployment rates remain near 50-year lows, and recent inflation trends have suggested the worst may be behind us. 

Typically, investors aren’t as concerned about what has already happened, but what is ahead.  It has largely been assumed that economic data on US growth and jobs would begin to slow.  The concern is whether the actions undertaken to slow inflation would lead us into slower growth but no recession (“soft landing”) or place us into recession (“hard landing”). 

Corporate earnings reports and the outlooks from companies for the year ahead will be closely monitored to give investors insight into the health of the economy and the possibility of a recession.  Clearly, there has been a slowing of activity in certain segments, with many companies in the technology space announcing layoffs after several years of aggressively hiring to support growth.  Other industries are expressing prudence and caution, but many have also suggested that the strength in the job market has kept the US consumer active and spending. 

From the stock side, the lack of significant deterioration and the higher potential of a “soft landing” has provided the backdrop for a January rally.  Further, many of the stocks and sectors hit hardest by the decline in 2022 have reversed trends in January and have been very positive.  The Nasdaq index, which is comprised of growth stocks, had a difficult 2022 but had the strongest rebound in January.  Small cap stocks were also significant performers during the month after a difficult time last year. 

Bond performance also rebounded in January after experiencing one of the worst years in history.  Long term interest rates declined, which provided the largest buoy to bond performance during the month.  Finally, alternative assets like gold and real estate also had strong months as investors began to re-engage across asset classes.  The question is, after a strong month, can we sustain this rally for the year?  Historically, a strong January tends to have a positive correlation with above average returns in markets.  Second, it is a rare event that stock markets experience back-to-back negative years, last happening in 2000-2002. 

Also, the current consensus expectation of a recession is not a great predictor of market performance going forward.  In our opinion, the logic follows that if something is widely expected, the realization of the event should not be a terrible surprise.  So, if we were to slip into a very short and shallow recession in 2023 with a period of slight decline and job loss that doesn’t exceed 6%, it is our opinion that the bottom of the market may already be in place, and we could have already started toward the next bull market. 

We would caution, however, that this doesn’t mean there aren’t concerns in the market, nor does it mean that volatility is a relic of the past.  Inflation trends are getting better, but that doesn’t mean they can’t revert.  Company outlooks have been prudent, but that doesn’t mean they can’t worsen.  Job loss, and consumer worries about their jobs, could have a negative effect on spending.

This is why we balance our optimism with prudence.  This is done by advocating for a blend of growth and safe assets, and having an investment plan that is oriented around your long term objectives and risk tolerance.  Markets are incredibly hard to predict from year to year but staying invested through the bad times to be rewarded by the good times remains the best way to achieve the goals for your money. 

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 February 2, 2023 Read More

July Brings Some Relief

Both stock and bond markets rallied in July despite economic data that reflects softening conditions and continued high inflation. Investors were encouraged by company earnings reports that showed a less bleak picture than feared. Overall, while we are certainly not out of the woods completely, the trend in July was better than the difficult markets experienced year to date through June.

Stock markets staged a rally in July with the S&P 500 and Nasdaq up more than 9% and 12% respectively. International stocks were mixed as developed markets were positive while emerging markets were slightly negative. Despite the significant rally during the month, both US and International markets have had negative performance over the past year.

Bond markets experienced a rally in July as well, with the Bloomberg Barclays Aggregate Index up over 2%. The performance was driven by a precipitous decline in the 10-year US Treasury Rate which fell from a recent high of 3.49% on June 14, 2022 to 2.67% by the end of July1. When interest rates are declining, bond prices typically rise. Similar to the stock market, the bond price rally in July was strong, but the yearly performance is still negative as interest rates remain significantly higher than this point last year.

With regard to the economy, the early data on inflation in July was not promising. The inflation rate came in at 9.1%, a new 40-year high2. Inflation remains the number one concern of investors, but the recent discussion points have shifted. The concern isn’t as much regarding demand and the elevated prices themselves, but rather how these price increases will slow demand while the methods used to control inflation (raising interest rates) will be so aggressive that it will send us into recession. This concern was further exacerbated by the most recent GDP report, which showed a second straight quarter of decline3. This is not the official determinant of a recession, but two quarters of GDP decline has been a rule of thumb to reflect past recessions.

Contrary to economic data, corporate earnings have been a little better than expected and certainly better than the sentiment of investors going into earnings season. As of 7/29/22, 56% of the S&P 500 companies have reported earnings for the second quarter. Of the companies that have reported, 73% have exceeded their estimates of earnings for the quarter. Currently, the expectations for earnings growth in 2022 and 2023 are 9% and 8% respectively4. If this growth rate proves accurate, this is a relatively healthy backdrop for stocks.

In short, there are currently conflicting signals between trends in the economy and the trends in corporate earnings. Also, after a period of significant decline and subsequent rally, there are always questions about whether this was the beginning of a new bull market or just a short pause in a prolonged bear market. While we never know with certainty ahead of time, there are early signs that give us some hope for the future. Price declines for things like gasoline, corn, and wheat – which have a direct influence on consumer pocketbooks – are a positive sign for consumer’s ability to continue to spend to support the economy. We continue to listen to company analysis on their current earnings but, even more importantly, what they are discussing with regard to outlooks for the remainder of the year. Lastly, we are watching for any changes to a strong job market and the effects of pricing on consumer behavior.

Even if this period is determined as a recession or not, stock market investors are always focused more toward the future than the past. While we never know the absolute bottom in advance, history would tell us that the companies in the US market are adaptable, efficient and have weathered storms in the past and come out stronger on the other side. Therefore, investors who are patient, prudent, and have a well-defined investment plan are rewarded over the long term.

https://fred.stlouisfed.org/series/DGS10
https://www.cnbc.com/2022/07/13/inflation-rose-9point1percent-in-june-even-more-than-expected-as-price-pressures-intensify.html
https://finance.yahoo.com/news/q-2-us-gdp-gross-domestic-product-economic-activity-123214911.html
https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/
Earnings%20Insight/EarningsInsight_072922.pdf

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 August 9, 2022 Read More
 
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