By: Dave Chenet, CFA, CAIA
| Close | Weekly return | YTD return | |
| S&P 500 | 4,369 | -2.11% | 13.81% |
| Nasdaq Composite | 13,290 | -2.59% | 26.98% |
| Russell 2,000 | 1,859 | -3.84% | 5.92% |
| Crude Oil | 81.28 | -0.88% | 1.27% |
| US Treasury 10yr Yield | 4.25% |
Source: YCharts, Yahoo! Finance, WSJ
Stocks And Bonds Have Both Been Falling. Is This a Repeat of 2022?
Investors will not soon forget 2022 – a Federal Reserve frantically tightening monetary policy to curb inflation led to pain for both the stock and bond markets, with a diversified portfolio of 60% stocks & 40% bonds suffering its worst calendar year loss since the great depression. After a torrid start to 2023, stocks have cooled of late as stronger-than-expected economic data has sent bond yields higher and challenged the rosy hopes of a Federal Reserve that has reached the conclusion of its rate-hiking cycle. Bonds, in turn, have also turned lower as the yield on the US 10-year treasury bond has risen to its highest level in 15 years. While challenging in the short-term, we do not believe that bond investors should abandon bonds in favor of (now higher yielding) money market funds for a few key reasons:
- The Fed now has some “ammo”: High quality bonds typically do well when economic growth slows. This wasn’t the case in 2022 despite consecutive quarters of negative GDP growth because interest rates were too low and inflation was still accelerating. Inflation has now moderated and the Fed has increased fed funds rates to 5.25-5.5%. Slowing growth can now be helped by the Fed cutting rates, a net positive for bonds.
- Real interest rates are now positive: “real”, or inflation-adjusted interest rates have turned positive and have reached a level that has historically slowed economic growth and inflation. Higher real rates may counteract the still-stimulative fiscal policy stance and reduce the risk of additional Fed hikes into 2024 and beyond.
- Bond math may now benefit investors: while “cash-like investments” i.e. money market funds offer investors a yield advantage over longer-term treasuries, the duration (or interest-rate sensitivity) of longer-term bonds offers investors the opportunity to see the price of their bonds go up and interest rates go down.
So, at a point where the market cycle is considered by many to be “late cycle”, high quality bonds appear to offer an opportunity for investors to diversify some of the stock risk that they hold in their portfolios.
What We’re Reading:
FT: Bond fund giant Pimco prepares for ‘harder landing’ for global economy
Marcus: What if Generative AI turned out to be a Dud?
WSJ: Mortgage Rates Hit 7.09%, Highest in More Than 20 Years
Chart of the Week:
Source Charles Schwab This chart published by Charles Schwab, shows the total return of short-term bonds vs intermediate-term bonds in the 12 months following the Fed’s last rate hike. In each of the last seven instances, investors would have been rewarded by both coupon and price gains in their intermediate-term bond positions.
