Bonds have fallen out of favor among some investors who fear rising interest rates and inflation — but are all the long-term concerns justified?
For many investors, the highly publicized risks of rising interest rates and inflation and the hype surrounding high-growth company stocks are lessening the appeal of bonds. While these vehicles are still considered an essential part of a well-diversified portfolio, bonds and other fixed-income investments are often overshadowed by flashier equities.
Excitement over stocks of “FAANG” companies (Facebook, Amazon, Apple, Netflix, and Google) and others has led to a frenzy of investing, with investors borrowing large sums of money against their portfolios to buy equities. The Financial Industry Regulatory Authority (FINRA) reports that investors have driven margin debt up 71% year-over-year.
On June 16, Federal Reserve officials announced two probable interest rate hikes by the end of 2023. This is a sign that inflation is “rattling” markets, with economists and investors fearing high debt levels and a rapid increase in consumer demand may cause significant price increases.
Many are questioning if bonds are still a good bet based on whether bond rates will keep pace in a potentially inflationary environment. And with so many bright, shiny investment options, numerous individuals are climbing on the high-growth-stock bandwagon.
But some experts believe inflation and interest rate worries are overblown, and there is a greater risk in buying too many “trendy,” over-valued stocks.
An often-misunderstood market
Because a bond is, simply put, a loan to a government or a corporation, high-quality bonds have long been viewed as a “safer bet.” But some investors and advisors also cling to some costly misconceptions about this investment vehicle.
It’s a myth that any rising interest rates will cause all bond prices to fall. And even the worst-case scenario might not be as bad as conventional wisdom would have investors believe. Higher-yield bonds can hold their value if rates increase gradually, with their higher yields making up for the loss in bond price. Furthermore: “The Bloomberg Barclays Aggregate Bond Index has been up in almost every calendar year back to 1976, a period which includes many periods of rising interest rates. It had losses in just three of the last 42 years.”
During the global financial crisis, investment-grade bonds returned more than 8%, while stocks worldwide sank an average of roughly 34%. When markets were at peak volatility because of the COVID-19 pandemic, bonds worldwide returned just over 1%, whereas equities fell by almost 16%.
When data crunchers go back even further — from January 1988 through November 2020 — they find that bond returns remained positive about 71% of the time the equities markets were down.
The fallibility of market predictions
Economists and market watchers are just not that good at forecasting rates. Since the mid-1990s, government forecasters have “consistently overestimated” the 10-year Treasury bond rate, indicating “systemic errors” — namely, that forecasters are “missing a change in the structure of the economy.”
According to Deutsche Bank’s chief international economist Torsten Slok, “The whole economics profession has just not been very good at predicting what interest rates will do.” Market watchers also have a “dismal track record” when predicting interest rates, currency, and inflation.
As for the threat of inflation, the Federal Reserve is being pressured to “pump the brakes” on what is perceived as a “runaway” economy. After consistently arguing that recent price increases are a “temporary response,” Federal Reserve Chair Jerome Powell indicated in June that the Fed would be taking it more seriously.
“Inflation could turn out to be higher and more persistent than we expect,” said Powell.
The benefits of creating a comprehensive, customized strategy — and staying the course
Bonds have traditionally represented a no-nonsense option to even out a well-managed and diversified portfolio. And even threats of higher interest rates should not completely change that assumption.
Many experts believe that fixed-income vehicles like bonds will likely remain an essential component of any long-term investment strategy, reinforcing the idea that “the purpose of fixed income has never been income.”
The track record of bonds is undeniable: In the last 42 years, The Bloomberg Barclays Aggregate Bond Index showed losses in only three. High-quality bonds can offer stability when the stock market plummets.
Every well-considered investment and wealth management strategy should be regularly reviewed and adjusted to reflect an individual’s goals, lifestyle, and aspects of changing regulatory, tax, and economic environments. But jumping on bandwagons or chasing trends isn’t usually the best choice — and a wise investment portfolio remains an adequately diversified one.
Lindberg & Ripple features a team of experienced advisors who can assist with managing the complexities of wealth management. We’ll help you develop and maintain a customized plan designed to grow and preserve wealth for future generations. Contact us to learn more.