Skip to main content

Sound Advice: April 13, 2022

Tough Time For Bonds

Over the years, difficult periods for the stock market have invariably prompted “flights to quality” on the part of investors.  In most cases, these shifts meant that funds were being moved from higher risk holdings to those appearing to offer increased safety.  That usually led to a redeployment from stocks to bonds, typically those of the U.S. Treasury or high-grade corporate borrowings. 

With interest rates now rising, however, that approach is no longer working.  Indeed, in recent months it has backfired.  In the latest calendar quarter, the Treasury market posted its worst performance in more than 40 years.  For the period, the ICE 15+Year U.S. Treasury Index sustained a loss of 13%.  The iShares 20+ Year Treasury Bond Index dropped 14%.

This is typical of what takes place when interest rates are rising.  The rule of thumb for bonds is that when rates rise, bond prices fall.  In most cases, the longer the maturity of the bonds, the greater the interim loss.

Why does this happen?  Interest rates on bonds are set near prevailing rates when they are first issued.  If, for example, a new bond carries an interest rate of 4% and a year later interest rates for a bond of similar maturity have climbed to 5%, the market price of the 4% bond will drop to a level at which a buyer will receive a 5% return.  In this case, let’s assume that the original value of the bond was $1,000.  To provide a 5% return, the value of that bond would have to drop to $800.

That’s what happens when rates are rising. During these times, bonds can be problematic investments.  Of course, as bonds get close to their maturity dates their prices will move up to the face value, but there could be a very long wait and an extended span when market prices are well under purchase prices.

The sensitivity to interest rate changes is reduced as the time to maturity is shortened, but short maturities have very low returns.  Current rates for U.S. Treasury securities range from only 0.7% for three-month bills to 2.8% for 10-year bonds.  Higher rates are available from lower-quality issues, but the exposure to price erosion increases as the quality drops.

By comparison, the dividend yield from the Standard & Poor’s 500 Stock Index is 1.4%, not much different from that of shorter-term treasuries, but in view of the likelihood of a rebound following this year’s pullback in the stock market, flights to quality in response to current market stress would be ill-advised. 

N. Russell Wayne, CFP®

Sound Asset Management Inc.

Weston, CT  06883

203-222-9370

www.soundasset.com

www.soundasset.blogspot.com

Any questions?  Please contact me at nrwayne@soundasset.com

                                                                                                                   

Comments

Popular posts from this blog

Sound Advice: January 3, 2025

2025 Market Forecasts: Stupidity Taken To An Extreme   If you know anything about stock market performance, you can only gag at the nonsense “esteemed forecasters” are now putting forth about the prospective path of stocks in the year ahead.   Our cousins in the UK would call this rubbish.   I would not be as kind. Leading the Ship of Fools is the forecast from the Chief Investment Strategist at Oppenheimer who is looking for a year-end 2025 level for the Standard & Poor’s Index of 7,100, a whopping 21% increase from the most recent standing.   Indeed, most of these folks are looking for double-digit gains.   Only two expect stocks to weaken. In the last 30 years, the market has risen by more than 20% only 15 times.   The exceptional span during that time was 1996-1999, which accounted for four of those jumps.   What followed in 2000 through 2002 was the polar opposite: 2000:      -9.1% 2001:     -11.9% ...

Sound Advice: March 10, 2021

The ABCs of Stock Picking After decades of analyzing stocks (and funds) and investing for clients, I'm happy to share in plain English what's involved, what works, and what doesn't.  Keep in mind the reality that successful stock picking is an effort to maintain a good batting average. In baseball, a batting average of .300 or better is considered quite good.  With stock picking, you need to do better than .600, which means you have many more winners than losers. No one gets it right all of the time.  It's not even close.  Wall Street shops all have their recommended lists and the financial media regularly hawk 10 stocks to buy now. Following that road usually is a direct route to disaster.  Don't be tempted. Let's begin with the big picture: The stock market goes up and down over time, but the long-term trend is up.  When there's a rally under way, everyone feels like a genius.  When the market hits an air pocket, though, with few exception...

Sound Advice: June 17, 2020

Rock and a Hard Place Regardless of your age, impressions from childhood linger.  As the first days of summer approach, we all remember the feeling that accompanied the end of a school year.  Yet as much as many of us would like to believe we again have the summertime freedom to do as we wish, the reality is quite the opposite. Although months of confinement and limitations on social interaction have increased our personal discomfort and severely impacted the business community, our current situation is not analogous to the end of any school year.  It’s quite the opposite. There is every reason to continue wearing face masks, social distancing, and avoiding close contact with others.  Nothing suggests that we can modify our behavior significantly or resume patterns of daily living we enjoyed only a few months ago. There are no meaningful advances in medical treatments.  At best, there are attempts to combine different approaches...