Portfolio Lagging? Blame Your Bonds
- Dec 7, 2016
- 3 min read
After an impressive start to the year, bonds have hit the brakes. In July, long term Treasuries had returned 18% for the year. However, the bond market didn't react to the election like everyone thought it would. Starting Wednesday November 23rd, long term treasuries experienced an accelerated selloff which brought the normally stable asset class just about back to break even for the year. Intermediate term bonds suffered a similar, yet less severe fate, and all while U.S. stocks rallied sharply.
Total Return Including Dividends, December 31st 2015 - December 6th 2016
Long Term Treasuries (1.0%), Barclays Aggregate Bond (2.2%), S&P 500 (10.4%)
So What Happened?
Bonds are typically solid in times of uncertainty, and we can all agree about the uncertainty of a Trump administration. So, normally we'd expect investors to favor bonds in times like the present. The reason is that investors usually load up on bonds, especially Treasuries, when they get scared. However, investors have been buying massive amounts of stocks instead.
The reason why may be subtle.
The Inflation Factor
Traders are betting on increased economic growth under a Trump presidency. Lower taxes, infrastructure rebuilding, and deregulation are all tactics to boost short term growth. This is good for stocks and their focus on "short termism". With higher expected growth rates for stocks, the tendency is for inflation to follow.
If you own a bond though, inflation is one of your main enemies. If inflation plays out, the value of your future dollar will be worth less than it is today. If you have fewer future dollars to buy the things you like, you need more income to buy the same amount of stuff. If you need more income because you favor more stuff over less stuff, you demand higher bond yields to generate more of the $$$ you need.
When demand for higher bond yields climbs, bond prices fall as they are inversely related. This is especially noticeable in long term bonds, which can be a lot more sensitive to changes in yield.
Whala! There goes what was a great year-to-date bond return.
Did You Even Notice?
Chances are when you opened your November statement, you didn't bat an eyelash. You saw about the same balance as the previous month, muttered something disparaging about the stock market, and then went on about your day.
I do the same thing.
Despite U.S. stocks cresting double digit returns year to date, International Stocks are clunking along at a 1.7% year-to-date return, about the same as most bonds. If you own a 60% stock / 40% bond portfolio, only the U.S. portion of your stocks (maybe 30-40%) is driving any real growth in your portfolio. When weighed against all the other "stuff" in your globally diversified portfolio, you haven't seen much positive action so far this year.
I hate the be the bearer of bad news, but that's the way it is with investing. Very rarely does everything move in the "right" direction at the same time. If that's the way it worked we'd all just buy the thing that always does best. If only...
The last few weeks have reminded me of an important diversification expectation; we must remember that diversification smooths out not only the bad times, but the good times as well.
Blame your bonds this round.
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