Before this decline, most investors knew the level of income offered by bonds was far too paltry. To be fair, that was the case for about a decade. Like a frog adjusting to increasing levels of discomfort, the era of super-low rates and declining inflation led to a secondary focus on yield. The primary focus was not on bonds’ return on investment, but rather on their return of investment.
You have to travel back to the early ‘80s to see anything quite like the last six months, inflation-adjusted. Since the start of 2022, the general bond market has plunged about 11%. With stocks in a bear market, there have been no traditional places for investors to hide. Year-to-date, overall portfolio declines in the mid-teens are the norm, even for conservative investors. Once again, truly ugly.
How we got here is now a well-known story; a witch’s brew of a pandemic plus massive government stimulus plus supply-chain breakdowns plus war-induced shocks to both energy prices and food inputs. In a flash, it’s added up to a worldwide surge in inflation and, importantly, rising inflation expectations.
Late last year, the Federal Reserve abruptly pivoted from its overly-sanguine view on inflation. I mistakenly shared that sanguine view, to be honest. Ultimately, I do still believe our recent spike in inflation will subside. But, as far as clawing back the recent carnage, a bond market recovery will undoubtedly require more patience.
However, there is some good news. The worst of the pain in bonds is likely over and yields are significantly more attractive today.
It’s important to recognize that now, more than ever, financial markets act like betting venues. Investors don’t just wait around for outcomes to be revealed. Instead, markets lurch from one set of expected outcomes to another set, based on shifting sentiment and probabilities about an uncertain future.
The Fed is the bond market’s focus and their power largely resides in their “forward guidance” about the path of their interest rate hikes. With the power of their words alone – how far and how fast they’ll raise interest rates – they largely control the direction of the bond market.
Once the Fed’s policy path is fully believed – and the Fed’s credibility is restored – their entire rate hiking campaign will be fully absorbed by the bond market. At that point, the lurching will stop and the ballast of bonds will return. I feel that time is very near and – I think I speak for many out there – it won’t be a moment too soon!
Jason P. Tank, CFA, CFP® is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a non-profit program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at [email protected] and at www.FrontStreet.com