An Update on the Bond Bear Market

The prolonged bear market that started in late 2020 marches on. Stimulative measures, such as direct payments, tax credits, and government aid that aimed to bolster the economy during the COVID-19 pandemic, were expected to result in inflation. Bond investors anticipated that the Fed would need to raise rates to bring inflation under control. They sold their lower-yielding bonds that were likely to be replaced with higher-yielding ones as rates ticked higher, which led to the first leg down in the bond market – about 5% in late 2020 - before rebounding to finish the year.  

For most of 2021, the bond market was mostly choppy, moving sideways as investors tried to gauge how aggressive the Fed would need to be to get inflation under control. You might recall a lot of talk about “transitory inflation” that was likely to pass within a year or two. Bonds finished down about 2% (AGG).  

Then came 2022, the worst year for bonds in nearly a century. Inflation remained stubbornly high and in response, the Fed jacked rates up quickly. Bond investors were caught offside and were punished by losing nearly 15% over the course of the year.  

As 2023 got started, many (including myself) expected a rebound from the bond market as inflation started to cool off and a path to an end in Fed rate increases seemed clear. However, 2023 has looked very similar to 2021, choppy up and down, while investors try to figure out if rates will be higher for longer or if the Fed will stick to its plan to bring down rates over time.  

For now, bond investors are stuck in a historical downturn – about 16% off the highs from 2020.  

How bond investors were positioned has mattered a lot, with long-term bonds causing the majority of the pain – the 20+ year treasury ETF is down 45% from its highs! For reference, the S&P 500 was down 55% from peak to trough during the 2008 Financial Crisis.  

This makes sense - after all, if you owned a 2% bond in 2020 and now investors can earn 6%, you would hope that the bond is as short-term as possible so you could get your money back quickly and reinvest at higher rates. If you owned a 30-year bond at 2%, it’s going to be a long time before you are made whole.  

The saving grace for bond investors is that they are at least now locking in some yield for holding on. Take a look at how the yield on intermediate-term corporate bonds has increased over the length of this bond bear market.  

For bond investors, there are a number of things to consider in this environment:

(1) Pay close attention to how long-term your bonds are 

Just as we have seen big differences in the performance of short and long-term bonds in the past few years, we will likely continue to see that, either up or down, depending on yield. However, if you align when the bonds come due to when you need the money, short-term volatility won’t affect you as much.  

(2) Review the quality of the bonds you own 

When a stock falls 25% in value, there is uncertainty about its future. It could fall further and never rebound or it could recover quickly. The bond market is different. If the bond you bought is down 25% but you are confident that the bond issuer will repay its debt, patience is the only thing you need to be made whole. However, some companies and governments are much better positioned to pay their debt back than others.  

(3) Consider cash alternatives for short-term money   

Because of the increased yields across all bonds, there are short-term alternatives that yield 4-5%. However, many scared bond investors have poured out of bonds and into these cash alternatives without regard for their long-term financial plan. While this might make sense for money they need in a year or two, it might make less sense for long-term money that they can now lock in at higher rates for many years into the future.  

Lastly, this is likely the first time that your investing behavior has been tested in the bond market. The stocks in your portfolio have tested you many times in the past, but bonds, not so much. Just as you tried to make wise long-term decisions with your stock investments, it is critical to not make knee-jerk decisions with your bond investments this time around.  

Happy Planning, 

Alex

This blog post is not advice. Please read disclaimers.