What about Bonds?

by | Mar 2, 2021 | Investing, Smart Financial Tips

Remember our old friend, the Tapir?

A few years ago, in a desperate attempt to make Fed policy even mildly interesting, we introduced our little friend[i] to you.  At the time, after massive intervention into the fixed income markets in response to the 2008 financial crisis, the Fed hinted that it might start “tapering back” on its support.  The market did not like that news and quickly responded with what came to be called the “Taper Tantrum.”  Thus the Tapir made his entrance for several letters.  We grew kind of fond of him.

I thought of this last week, wondering if we were potentially looking at Taper Tantrum 2.0.  Not that we didn’t miss our buddy, but with bond yields moving sharply higher and equities having their worst week in a while, maybe there was cause for concern.  The 10-year Treasury note’s yield broke above 1.6%, if only briefly, and some started to wonder if the very dovish (so far) Fed might be losing control of the bond market and be forced to tighten sooner than planned.[ii]

OK, so what about my bonds? Should we be worried?

The short answer is no.  Our COO (and former CIO), Martha Post, was quoted on this topic in a US News & World Report and spoke about it in our second Investment Committee video last year.  Bonds play an important stabilizing role in the portfolio, and that does not change simply because interest rates are lower and might rise at some point.

Bonds are a lot less risky than stocks–to avoid bond risk by taking more stock risk does not make any sense when you think about it.  The magnitude of bond declines is much less than that of stocks. Over the past 20 years, the biggest calendar year decline in US bonds was 2% (US Aggregate), compared to 37% for US stocks (S&P 500). Making a market timing decision to lower your bond allocation would have the result of increasing the risk of your portfolio.[iii]

Through the end of February, the Barclays Aggregate Bond index was slightly down, about -2.2%, while equities rose, especially small cap and value equities instead of the big tech names.  For example, year-to-date index returns through February 28[iv]:

S&P 500                                  1.7%            large cap stocks

Russell 2000 Value                 15.2%          small value stocks

But will the Terrible Tapir roil the markets if rates rise?

That is always a risk, but we have been facing it and discussing it for over a decade now, and any actions taken along the way to try to “hedge” this risk would probably have reduced your long-term return.  For example, a shorter duration bond portfolio would have earned substantially less every year, and that really adds up over time.  And we all know how much can be lost trying to time the equity markets.

Meantime, before we could even write for month end, we had a huge first day of March, with equities up across the globe.  The S&P 500 rose about 2.4%, as the yield of the 10-year Treasury fell to 1.4%.[v]  Suddenly the sun is shining, and the Tapir is enjoying a quiet afternoon.

With the J&J vaccines approved and launching into rapid distribution[vi], the markets now clearly see an end to our ordeal in sight, getting closer every week.  And this is the best news of all.

[i] well, OK, at 600 lbs., maybe not so little

[ii] Verlaine, Julia-Ambra, and Sam Goldfarb. “Bond-Market Tumult Puts ‘Lower For Longer’ In The Crosshairs”. WSJ, 2021, <https://www.wsj.com/articles/bond-market-tumult-puts-lower-for-longer-in-the-crosshairs-11614517200?mod=hp_lead_pos5> [Accessed 2 Mar 2021].

[iii] Source: Morningstar Direct, data as of 12/31/2020

[iv] Source: Morningstar Direct, data as of 2/28/2021

[v] Osipovich, A. and Wallace, J., 2021. Stocks Surge, With S&P 500 Logging Best Day Since June. [online] Wall Street Journal. Available at: <https://www.wsj.com/articles/global-stock-markets-dow-update-03-01-2021-11614588580?mod=hp_lead_pos2> [Accessed 1 March 2021].

[vi] Lovelace Jr., B., 2021. FDA approves Johnson & Johnson’s single-shot Covid vaccine for emergency use. [online] CNBC. Available at: <https://www.cnbc.com/2021/02/27/fda-approves-jjs-single-shot-covid-vaccine-for-emergency-use.html> [Accessed 1 March 2021].

Team Hewins, LLC (“Team Hewins”) is an SEC-registered investment adviser; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. The information contained within this letter is for informational purposes only and should not be considered investment advice or a recommendation to buy or sell any types of securities. Past performance is not a guarantee of future returns. It should not be assumed that diversification protects a portfolio from loss or that the diversification in a portfolio will produce profitable results. The opinions stated herein are as of the date of this letter and are subject to change. The information contained within this letter is compiled from sources Team Hewins believes to be reliable, but we cannot guarantee accuracy. We provide this information with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in any of the aforementioned areas.

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