Bonds have been behaving badly. But the fixed-income market’s comeuppance is a good thing for investors looking for better value and more income from their bond funds.
Historically, bonds have offered shelter for portfolios when financial storms touch down on Wall Street. But bonds have not been a haven this year in the grip of surging inflation and fast-rising interest rates. Instead, fixed-income assets ranging from U.S. Treasuries to higher-yielding “junk bonds” have logged double-digit-percentage losses resembling declines suffered by more-volatile stocks.
“A 10% drawdown in the stock market is common, but it is unprecedented for the bond market,” says Lawrence Gillum, a fixed-income strategist at LPL Financial.
The bond market pain meter highlights this year’s outsize declines and pokes a hole in the myth that bonds never lose money. The Bloomberg U.S. Aggregate Bond index, which tracks the investment-grade bond market and serves as the benchmark for most bond funds, has fallen 10.6% so far this year through July 8 – putting it on track for its worst annual return ever. (Its worst year up to now was 1994, when it fell 2.92%.)
U.S. Treasuries with maturities of 10 years or more have taken an even bigger hit, tumbling 22.5%, according to the Bloomberg U.S. Long Treasury Total Return index. And high-yield junk bonds – those rated BB or lower, with a higher risk of default – have fallen 12.9%.
Bond experts have been surprised by the swift and steep drop in bond prices, causing yields, which move in the opposite direction, to spike sharply higher. “No, it’s not normal at all,” says Andy McCormick, head of global fixed income at fund company T. Rowe Price.
The Fed Gets Tough With Aggressive Rate Hikes
As inflation surged to 40-year highs, it forced the Federal Reserve to try to tame skyrocketing prices with aggressive interest rate increases, reversing the cheap-money policy in place since March 2020, when the Fed cut its key short-term interest rate nearly to zero to boost the economy at the start of the COVID-19 pandemic. The central bank began raising rates in March of this year, and it surprised markets in June with a three-quarter of a percentage point hike, the biggest since 1994. And rates may be heading even higher.
But amid all the gloom in bond-land, there are rays of sunshine peeking through the clouds, says LPL’s Gillum. “We think the worst is behind us,” he says. The valuation and yield on all types of bonds, he says, look much better today than at the start of the year.
Just as stocks go on sale in a bear market, bonds have moved from the full-price aisle to the discount bin. That doesn’t mean rates can’t move even higher …….