Investors who shied away from bonds during the last few years of near-zero yields might be reconsidering, especially after the rollercoaster ride equity markets have had.
After a bear-market rally in July and starting August relatively strong, the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite all ended the month with losses. These continued into September, despite a temporary boost from the release of "just-right" August jobs data. Then, the Federal Reserve's reaffirmation that it would fight inflation boosted the Dow on Sept. 8.
That day, CNN's Fear & Greed Index, which gauges the mood of the stock market based on market movement, still indicated that fear was driving the market. By contrast, a week earlier the index was neutral. This fear comes as 69% of respondents to a Bankrate poll said that they're worried about a recession before the end of next year, and 41% said they're unprepared to handle a downturn if one were to occur during that time.
And these concerns may not be overblown.
"There may be more difficult times in the economy and the markets as we move through the next three to six months," said Steve Wyett, chief investment strategist for BOK Financial®. To prepare for these difficult times, BOK Financial has been cutting risk in client portfolios over the past six months by reducing allocations to equities, particularly during July's bear-market rally, he explained. He serves on the Asset Allocation Committee, which sets broad asset allocation guidelines for both retail and institutional client portfolios.
Bond market may be better prepared for turbulence ahead
The year has been a mixed bag for bonds, but some experts believe that might be changing.
On one hand, year-to-date through Aug. 31, 90-day US Treasurys outperformed 23 of the 24 (95%) major asset classes across stocks, bonds and alternatives. On the other hand, during that same time period, the 10-plus year Treasury index was down 22.5%.
Over short time periods, if stocks are down, then typically high-grade bonds are up in value, but that has not been the case recently, experts said. The Bloomberg US Aggregate Bond Index, for instance, was down 10.75% through Aug. 31.
However now, as equity markets continue to have their ups and downs, "bonds might actually pay enough interest to provide attractive returns not tied to capital gains. That would be a welcome change," Wyett said.
For instance, on Sept. 1, the 2-year Treasury yield hit a 15-year high of 3.51% after ADP jobs data showed a slowdown in private payroll growth. Ten-year and 20-year Treasury yields also rose—though the yield curve remains inverted, which is often viewed as a sign of economic trouble and even recession.
"When the interest rates were so low, there virtually was no cash flow on fixed income," Wyett continued. "Now we probably should see bond yields stay relatively stable. As an investor, that means my prices don't go down. My risk mitigation improves and my cash flow improves in my portfolio. And from an overall investment standpoint, that's just a better environment."
Risk mitigation may be key looking forward
Bonds' ability to provide some risk mitigation should hold even as the Federal Reserve works to quell inflation in the months ahead, experts said. "The Fed has already told us they're targeting a Federal funds rate of close to 4%. If they're able to hold to that, then bond prices shouldn't fall much further from here," Wyett explained.
That said, within the bond market, some types of bonds may fare better than others. For instance, if we have a recession or an unforeseen market crisis event, US Treasurys are typically the best performing investment during those periods, experts said. But whatever the future holds as the year continues, it's important to remain focused on your longer-term path, they noted.
In Wyett's words: "We don't want to become overly exuberant when times are good or, as is true now, overly pessimistic when markets and the economy struggle. We do make smaller changes to our asset allocation to better manage risk or pursue returns, but these changes are always within the defined ranges of our investment objectives."