- April 2, 2018
- Posted by: Terry Jack
- Category: Uncategorized
The bull market in stocks has driven the S&P 500 higher nine consecutive years. Investors both big and small can be thankful for this run especially after the lost decade ending in 2009. At some point there will be a significant market pullback that will reduce portfolio values and test your risk tolerance. Stock market pullbacks can be long depressing slides but also have the ability to move faster than teenage boys exiting my house when chores are about to be handed out. Do you remember it took just nine trading days in January and February of this year for the market to fall more than 10%?
Speaking of bull markets, the 10-year US Treasury Note was yielding 9.6% in September 1987 and trended down through 2017, fueling a 30 year rarely interrupted bull market for bond investors. Remember when interest rates go up, the price of already issued bonds move down and vice versa. Yes, the stock market is volatile, but don’t lose sight of the volatility and decline in price bonds can suffer in a rising interest rate environment which appears to be the situation we find ourselves in now.
Many governments and corporations have issued vast quantities of new bonds over the last five years to take advantage of low borrowing costs. In fact, more than a few corporations used the proceeds of bond sales to buy back their own shares thus pushing their stock price higher. Investors holding these lower yielding bonds will suffer as rates rise and higher yielding alternatives are available. Just two years ago a 10-year US Treasury would yield you 1.8% and now that same bond will pay you 2.8%. How much of a discount would you have to take to sell your bond paying 1.8% if investors can get the same type of bond with a higher yield? You certainly would not get full price from a buyer and therefore would potentially be selling the bond for a loss. Losing money on bonds is not something you want to make a habit of doing as bonds are supposed to be the low risk portion of your portfolio.
Fortunately, today there are viable options to help investors navigate rising interest rates and manage the fixed income portion of their portfolios without adding substantial risk. Floating rate bonds, both investment and non-investment grade, whose yields adjust to reflect increases in interest rates are one option. Another possible solution is shorter term Treasury Inflation Protected Securities (TIPS) which are bonds issued by governments, including the United States, whose face value actually rises with inflation. Finally, if interest rates are rising due to inflationary pressures even shifting a small portion of one’s fixed income allocation to commodities may offer some downside protection and added diversification over longer periods of time.
Today’s bull market for stocks deservedly gets most of the headlines but shrewd investors are now wary of the risks lurking in the bond market unlike teenage boys who don’t comprehend the jeopardy they face when not doing their chores.