When we were in second grade at Indian Trail Elementary school, we couldn’t wait to get outside and play during lunch recess. Many of us packed our lunches so that we would not have to wait in the cafeteria line. That way, we could get outside as quickly as possible and maximize our time on the playground.
One of the first pieces of equipment that kids ran for was the teeter totter. And one of the promises you had to make when sharing a teeter totter with your friend was NO CHERRY BOMBS!! For those of you who may not remember, a cherry bomb is when the person on one end of the teeter totter waits until “their friend” is at the highest point and then jumps off. This causes you to suddenly fall back to earth, jarring your entire body. Cherry bombs caused many hurt feelings and hurt back sides. They also caused many fights and disagreements on the playground.
For those of you who are wondering why I am sharing this memory, the bond market could be poised to do the same thing to our investment portfolios that our friends did to us on the playground. As a reminder, there is an inverse relationship between interest rates and bonds. When interest rates go up, bond prices go down, as you can see in this graphic below.
In 2021, the aggregate bond market index dropped by more -1.5%. What is interesting about this is that last year the Federal Reserve did not raise interest rates. The bond market allowed interest rates on the 10-year Treasury bonds to rise in anticipation of the Fed needing to combat ever higher inflation.
As you can see from the chart below, negative years in the bond market are relatively rare. They also do not have the same variability of returns that the stock market can have. A really bad year in the bond market can produce a negative return in the low single digits, while a bad year in the stock market can produce a negative return of 30% or more.
What does this mean for the bond market going forward? As you can see in 1994, the Fed raised interest rates a half dozen times. This led to the worst year we have seen in the bond market in over 40 years. As of last summer, the Fed told us they were not planning to raise interest rates at all in calendar year 2022. At their meeting in late January, they told us they are planning to raise interest rates at least three times and possibly more. This is a massive shift on policy and could produce a second negative year in a row for the bond market.
How rare is that? As you can see in the chart below provided by our friends of Blackrock, the last time the bond market had back-to-back negative years was in the late 1950s. This is important for our retired and risk-averse clients who typically have more bonds in their portfolio to dampen stock market risk and volatility.
It looks like the bond market and the Fed may be getting ready to give investors a cherry bomb. There are a number of strategies that we can utilize to help minimize the damage to our clients’ portfolios as rates go up and bond prices go down. This includes shortening maturities on your bond portfolio, looking to alternative asset classes, and investing in inflation correlated assets.
Each of our client’s situation is unique. We will be discussing these issues with you in our review meetings over the next few months. As always, if you have questions in the meantime please do not hesitate to reach out to your advisor. We want to be proactive and keep you informed so that we can take the appropriate steps for you and your family. It is part of our mission as we continue “Moving Life Forward”.
The views stated are not necessarily the opinion of Cetera Advisors LLC 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.