Should You Own Bonds? (Part 1)

Depends. How is that for an answer? It is important to understand the big picture and to not get caught up in recent returns or recency bias. Bonds have performed horrible so far in 2022. The Aggregate Bond Index is down 6.19% as of April 4^th. U.S. Corporates are down 7.79%. The worst first quarter since 1980 (will come back to that year later).

Many people are asking how diversification is helping them if the bond market is down approximately the same as the stock market?

Well, did you know that in 1980, U.S. Corporate Bond index actually rose from that first quarter to finish down less than 3%?  In fact, the worst calendar return for the period of 1970-1982 was less than 5%. I picked this period because this was during a decade when inflation was rising significantly, and U.S. 10-yeartreasury rates hit 15% in September of 1981.

Let us look at this from an annual return perspective versus a short-term quarterly perspective. The worst year for the S&P 500 was 36.5% loss in 2008. There were also a 22% loss in 2002, 26% in 1974, and even 44% in 1931. The worst years for 10-year treasuries since 1928 include 2009 at -11%, 2013 at -9% and -8% in 1999 and 1994, respectfully. I do not think it will happen, but a 30% drop in the S&P 500 could happen over the next 12 months. It has never happened, nor do I think it is even remotely reasonable to suggest that bonds, regardless of inflationary pressure we see not already expected, will be down 30% over the next 12 months.

Bonds are down significantly due to the uncertainty of what the Fed is going to do, or how far/how fast they plan to raise rates. There is also a short-term supply issue hanging over the market considering at some point the Fed will need to sell those bonds that they have been buying. Recall though, if it is public information, then it is highly likely it is built into the prices of any investment. Once the bond market has a better grasp of the Fed’s intentions, the bond market will stabilize. It is a myth that bond values always drop during rising rate environments. If that is the case, why did bond values increase the last 9 months of 1980 even though interest rates were still increasing?

Hopefully, this has helped you gain a better perspective of the risk here with bonds. Again, I think it would be a huge mistake to think since bonds are down 7% in the first quarter, they will be down 28% for the year. The point is don’t panic and make a rash decision based on one quarter of returns (for any investment). You also can go without bonds if one can accept the downside risk of the market.

If you would like more information, please contact Brian Tillotson at Virtus Wealth Management, and stay tuned for my next, follow-up article describing how we address this overall concern as part of our strategy to mitigate risk for our clients. It’s not just bonds! Always remember, your portfolio should be customized for your goals and objectives.