Is the 40-year bond bull market over?

Since “Good Riddance” was released in 1997, this Green Day hit has been played as the background song to video montages commemorating the end of an era, especially graduation videos. In fact, we bet it was a background song of you (or your kid’s) graduation video. As another example, the tune was played as background music to a video montage in the second-to-last episode of “Seinfeld.”

It's something unpredictable

But in the end, it's right

I hope you had the time of your life

Today, we listen to this song in the background while viewing the chart below displaying a possible end to the forty-year fixed income bull market. As equity investors at heart, we bid “good riddance” to the easy money in fixed income.  

The blue line displays the yield of the 10-year U.S. Treasury bond with a red line to display the trend.  Lower yields (vertical access) indicate the price of the bond rising—this is indicated by the downward sloping line. Thus, as yields now begin to rise, the price of the bonds will decline. The break above the red line suggests the trend could be over and it is the end of an era.

Another turning point, a fork stuck in the road

Time grabs you by the wrist, directs you where to go

So make the best of this test, and don't ask why

It's not a question, but a lesson learned in time

In 2022, the yield on the 10-year Treasury moved from 1.7% to 2.8%. This means that investors looking for safety in their fixed income experienced significant declines in 2022.  The total return of the Bloomberg Aggregate Bond Index was -10% as of April 28, 2022.

The declines in “conservate” portfolios left many investors scratching their heads and looking for answers. The main reasons for the current bond bear market:

1)      Fed raising interest rates = bond prices decline

2)      Current inflation

3)      Bond holders selling bonds (less demand)

We took the following action in our investors’ portfolios last year in anticipation of the conditions above. First, we lowered exposure to fixed income. Second, we looked to short-term bonds as protection and a way to participate in the higher interest rates. This includes floating rate bank loans, which have a low duration. Finally, and maybe most importantly, we used select commodities as a hedge to the decline in bond prices. This is because inflation often causes commodities (like gold) to increase in price.

So take the photographs and still frames in your mind Hang it on a shelf in good health and good time Tattoos of memories, and dead skin on trial For what it's worth, it was worth all the while

In past recessions, bonds have been a nice place to hide out. So, with the economy in the late stages of the cycle and a recession a higher possibility in the next 12 months, we arrive at the question of the year—should investors sell bonds or is the worst over?

So far, fixed income has not provided protection at the latter stage of the market cycle. We believe this is still the case even after the increase in rates. Interest rates during previous late-cycle periods were attractive and gave stocks some competition for assets. Consider the chart below displaying the yields in the past late-stage year of cycle:

Today, with the 10-year yield at 3.0%, we believe stocks are still attractive when compared to bonds and commodities continue look poised to increase in price due to factors causing inflation like supply chain disruptions, lack of investment over the past couple years in finding more fossil fuels, and the Russia-Ukraine conflict. 

It is possible rates have peaked and bond prices stabilize. Right now, we continue with our current strategy highlighted above and watch carefully to see if bond rout continues. At some point, the yields will be attractive and bonds investable again.

Like all other periods of life, the era of low interest rates could be behind us.  It was a good run and we will remember fondly, but it is now time to prepare for the present.

Disclosures

INFORMATION PRESENTED IS FOR EDUCATIONAL PURPOSES ONLY AND DOES NOT INTEND TO MAKE AN OFFER OR SOLICITATION FOR THE SALE OR PURCHASE OF ANY SPECIFIC SECURITIES, INVESTMENTS OR INVESTMENT STRATEGIES. BLOOMBERG IS THE SOURCE OF MARKET DATA. INVESTMENTS INVOLVE RISK AND ARE NOT GUARANTEED. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RETURNS. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY DISCUSSED HEREIN.