Oh Yeah, THAT’S Why I Wanted Bonds in the Portfolio
It is so easy for investors to get caught up in the popular Wall Street chatter. Interest rates have nowhere to go but up. Bonds are doomed to ever increasing losses. Everyone had pretty much accepted these ideas as gospel. Only a fool would invest in bonds under such circumstances, right?
Yet over the last week bonds have quietly staged a strong rally, and interest rates have tumbled back down. The Federal Reserve hasn’t changed its policy – they are still expected to raise rates a couple more times this year. But the Fed does not control bond prices. That is the markets job. If investors prefer the safety of bonds to the risk of stocks – bond prices will rise to meet that demand (and interest rates will fall) – regardless of what the Fed does.
Yesterday was a case in point. US stocks tumbled, with the Dow and S&P both down well over 1%. The fear du jour is political uncertainty in Italy and Europe throwing doubt on prospects for future global growth. With investors having a minor panic attack, US Treasury bonds at near 3% suddenly started to look pretty attractive. Bond prices reacted to the increased demand and rallied strongly. The broad market US bond index rose more than 0.7%, enough to almost eliminate any losses from a balanced portfolio, even as most investors had a pretty bad day!
Bond investors still need to keep expectations in check. We are not out of the woods as far as inflation, and the economy is still growing strongly. Higher rates have made some fixed income alternatives such as CD's and fixed income annuities attractive once again. If the stock market returns to rally mode, rates will likely rise again. (In fact, just 12 hours latter, it seems as if Treasuries will be giving back some of yesterday's gains as investor fears over Europe are already subsiding.) But this is another good example of the prevailing wisdom being incomplete (if not wrong). At least for more conservative investors, bonds still have a place in a diversified portfolio, and yesterday’s market action clearly demonstrated one of the reasons.
Past performance is no guarantee of future results. Investments (both stocks and bonds) can lose money.