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How Far Can You Push a Beachball Under Water?

How Far Can You Push a Beachball Under Water?

January 02, 2024

When we were kids, we often looked for relief from the summer heat by finding a pool or a pond to jump into and cool off. Most homes in my neighborhood did not have central air conditioning back then. Eventually, my parents put a window A/C unit in their bedroom, but we were rarely allowed in that room, and certainly not on days when you had a little league baseball game.

For most of us, getting into a pool meant that you had to put one together. They had a flimsy metal side and a vinyl liner that you clipped to the outside with pieces of plastic. Nobody I knew had a permanent above-ground pool, and the idea of putting an in-ground pool into a home in Northeast Ohio, where you could only use it a few months a year seemed ludicrous at the time. For those of you who have no idea what I am talking about, I found a picture of one of these ancient relics online.



To amuse ourselves, we would sometimes see how far you could push a beachball under the water. As the air-filled ball was pushed further and further under the water, we knew that it would go higher and higher when it was eventually released.

For those of you who have a portion of your portfolio invested in bonds, the last couple of years may have felt like somebody was using this portion of your portfolio as a beachball and was shoving it further and further underwater.

Historically, bonds, have been used to reduce the volatility in portfolios that is typically caused by gyrations in the stock market. As you can see from our first graph today, the bond market only experienced four negative years in the last five decades before 2022. Until recently, 1994 was the worst year in the bond market in the last hundred years producing a negative return of -2.9%. I remember this being considered a horrible return at the time.

In February 2022, as the Fed decided that inflation was no longer transitory and that they would have to begin raising interest rates to combat the massive amounts of fiscal and monetary stimulus that had been dished out since the onset of the COVID-19 pandemic, I wrote a blog post, entitled, “Will the Bond Market Give us a Cherry Bomb?” In this blog post, I suggested that if the Fed raised interest rates aggressively, the bond market, which moves in the opposite direction of interest rates, could potentially give us a major cherry bomb like we used to get on the playground when somebody jumped off the teeter-totter when they were at the bottom. A link to that blog post is included below if you would like a reminder.

Well, the ensuing two years in the bond market turned out to be worse than even I imagined. As you can see in our second chart below, as the Fed raised rates at its fastest pace in forty years, the AGG, which is the bond market equivalent of the S&P 500, put in its worst two-year performance in over 100 years, falling from 114 to 92 (-19%). This was akin to pushing the bond beachball further and further underwater.


We knew that eventually, the Fed would stop raising rates as inflation fell from a peak of 9.1% in June 2022 to 3.1% today. As a matter of fact, the core PCE, the Fed’s preferred measure of inflation has advanced at an annual rate of less than its 2% target over the last three months. The narrative from the early November Federal Reserve Bank meeting, along with the unemployment report and CPI report released that month indicated that they may be done raising interest rates. 

As a result, the bond market has come shooting back up like a beachball that had been held underwater. As you can see in our final chart today, the bonds had gone through six consecutive negative months from May through October, something that had not happened since this metric began being tracked in 1926.

November turned out to be the bond market's 8th best monthly return in the last 100 years. For those of you who have been concerned or frustrated that bonds have not been performing their historical role as a counterbalance to stock market volatility, the coming years may look very different from what we have experienced the last two years as the Fed is now indicating that it will reverse course.

It is important to remember that the teeter-totter works both ways. At the press conference following the December meeting, Fed chairman Jay Powell said that the Fed was not only done raising interest rates, but they would also likely cut interest rates at least three times in 2024.

As painful as the downturn has been over the last two years, the reverse could be true going forward. This is a perspective we wanted to make sure that our trusted friends and clients were aware of as we head into the new year, and we seek to continue “Moving Life Forward”.

© 2024 Jesse Hurst

The views stated are not necessarily the opinion of Cetera and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.

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