Stocks are at record highs and your bond funds are in the red. Here’s why that is less alarming than it looks.
William F. Davis, CFP® | Vericrest Private Wealth
If you opened your third-quarter statement and went looking for the weak link, you probably found it in about four seconds. Stocks are up double digits. Bonds are down.
The natural question is why we own them at all. The answer is that bonds just got a raise, and most people missed the announcement.
What Happened
The 10-year Treasury yield climbed above 5.3% this fall, a level last seen in 2002. In a recent piece for Kitces.com, James Liu, CFA, founder of Clearnomics, put the damage in one number: the broad U.S. bond market was down 2.9% through September, while the S&P 500 was up more than 12%.
Bond prices and yields sit on opposite ends of a seesaw. When yields go up, the price of the bonds you already own goes down. That’s the whole mechanism, and it’s why this year’s statement looks the way it does.
The Raise Nobody Noticed
Now the other side of the seesaw. Liu’s data shows the Bloomberg U.S. Aggregate Bond Index yielding 5.6%, compared with an average of 3.0% since 2009. Investment-grade corporate bonds yield 6.0%, against a long-term average of 3.9%. The chart below shows the gap.
For more than a decade after the financial crisis, bonds asked you to accept very little income in exchange for stability. Today they pay nearly double that. A price decline is a one-time event. The higher income shows up every month after it.
This Is Not 2022
I know what some of you are thinking, because I remember 2022 too. That year the bond index lost 13%, its first double-digit loss on record, according to Ben Carlson at A Wealth of Common Sense.
Two things are different now.
First, the reason. In 2022, rates rose because inflation was out of control, which hurt stocks and bonds at the same time. This year, Liu points out, inflation-adjusted yields are rising too, which reflects economic growth and heavy investment as much as inflation. That’s why stocks have kept climbing while rates rise.
Second, the cushion. In 2022, bonds started the year paying next to nothing, so there was no income to absorb the price drop. With a yield around 5.5% and a duration under six years, rates would have to rise roughly another full point in a year before price declines wiped out that year’s income. That is rough arithmetic and not a forecast, but it’s a very different starting line.
Nobody Buys the Left Guard’s Jersey
Bonds are the offensive line of a portfolio. Nobody wears their jersey, nobody drafts them in fantasy, and the only time they get mentioned is when something goes wrong. Eagles fans know better than most what happens to the quarterback when the line isn’t there.
Bonds are in our portfolios to do three jobs: pay income, steady the ride when stocks stumble, and give us something to rebalance from when they do. A down 2.9% year, in a year when stocks are at record highs, is that position being played roughly as designed. Thrilling, I know.
What About the Cash on the Sidelines?
Plenty of investors have been parked in cash, waiting for clarity on rates. Cash still pays about 4%, and there is nothing wrong with holding what you need for the next year or two.
But cash yields move with the Fed, and they can fall as fast as they rose. Bond yields can be held for years. For money you won’t need for a while, sitting out now means passing on some of the best income bonds have offered in two decades.
What This Means for You
A bond allocation that is slightly down in a year like this one isn’t broken. For our portfolios, bonds are there for income and ballast, and the income half of that job just got considerably easier.
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William F. Davis is a CERTIFIED FINANCIAL PLANNER™ and Managing Partner with Vericrest Private Wealth LLC, a financial advisory firm in Newtown, Pennsylvania.
Vericrest Private Wealth LLC (“Vericrest”) is an SEC registered investment advisory firm. The information provided herein should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security or investment advisory service. Past performance is no guarantee of future results, and there is no guarantee that future investments will be profitable. While we believe that third party information provided is accurate, Vericrest does not guarantee or otherwise warrant such information. For more information please contact Vericrest or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov) to review important disclosures about our firm.
