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Last year, the unexpected bear market in bonds threw markets into turmoil and raised questions about fixed income's role as a bulwark against volatile stock prices.
After 40 years of falling inflation leading to lower interest rates and ever-growing bond values, it can be difficult for investors to reconcile this new reality with their long term investment strategies.
The outlook for bonds in 2023 is on top of many investor's minds. Should you keep bonds and fixed income in your portfolio? Are bonds still a good way to diversify?
While temporary downturns may cause uncertainty around your bond strategy today, maintaining a patient outlook is paramount - especially when managing portfolios over multiple cycles.
It is too early to make any definitive predictions, however this year the trend in bond interest rates has been significantly different from last. Rather than continuing an upwards trajectory like in past year, after reaching its peak of 4.2% at the end of October 2022, 10-year Treasury yields have begun to fall - something economists and investors had not anticipated.
Last week's Consumer Price Index data indicated that overall inflation had decreased in December for the first time since June, with core inflation still rising but at a slower rate than before.
Prices of new and used vehicles have dropped significantly, providing some relief to consumers; additionally landlords may be offering more favorable rates on leases as they roll over which could further reduce shelter costs.
Bond Returns are Positive Year-to-Date
The rising cost of living is often an intimidating force for consumers, but recent news about inflation should bring a glimmer of hope.
After reaching 6.5% higher compared to the year prior, Treasury Inflation-Protected Securities (TIPS) are now priced with expectations that annual inflation will be only 2.2%.
With easing interest rates and the hopes of Fed rate hikes being paused this year, it appears there may soon be some relief from climbing prices - creating optimism in economic outlooks across the nation!
Last year's decline in bond prices has presented the perfect opportunity for long-term investors to maximize their expected returns going forward - with bond yields now significantly more appealing. This phenomenon can be attributed to the relationship between interest rates and bond prices: when one rises, the other one falls. In 2022, bond prices declined thus leading to increased interest rates.
Bonds Are Yielding More Than They Have in 14 Years
Bond yields are now at their highest levels in more than a decade, presenting investors with the unique opportunity to purchase fixed income securities that offer higher returns and increased diversification within their portfolios.
With an average yield of 3.9%, investment grade Treasuries have yielded significantly above its 1.7% since 2009 while corporate bonds generate 5% and high-yield bonds 8%.
These substantial gains stand as a stark contrast compared to just 14 years ago when investors had little other option but take on more risk for comparable rates of return.
Corporate bond yields and credit spreads Are Improving
Despite the possibility of an economic slowdown, credit outlook remains optimistic - with market expectations pointing towards a mild recession and companies well-positioned to repay debts. Recent months have seen improved spreads on credits as positive figures for the job market continue, along with signs that Federal Reserve tightening could be slowing down.
Despite positive momentum early this year, investors must be aware of potential surprises on the horizon. A standoff in Washington could have negative repercussions for bond markets. Surprises often occur as you may recall when Standard & Poor's downgraded U.S debt back in 2011. That hurt bond markets in the short-term. Additionally, commodity prices and supply chains may suffer if geopolitical tensions worsen or credit default rates rise with a worse-than-anticipated slowdown domestically or abroad respectively.
Investing in bonds now can be intimidating based on recent events over the past 18 months. But, it also presents an opportunity now that bond yields are higher. With the right approach and steady commitment to long-term planning, investors have an opportunity to position their portfolios for success over years and decades!
So, what's the bottom line?
Despite potential bumpy roads ahead, keeping a balanced portfolio with bonds can help offset the risk of stocks. Interest rates may be rocky at times but if investors stay consistent and stick it out long-term, maintaining the right allocation to bonds in your portfolio is still a prudent approach to investing.
Schedule a free retirement consultation with Covenant Wealth Advisors today!
Mark Fonville, CFP®
Mark is a fiduciary, fee-only financial advisor at Covenant Wealth Advisors specializing in helping individuals aged 50 plus plan, invest, and enjoy retirement without the stress of money.
Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Disclosures:
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place.
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