Let's face it, for the past decade bonds have been seen as boring. They have continued to rise in value, slowly, until the air was let out of their balloon in 2022. Add in some meme stock rallies (think Game Stop) and the emergence of fee-free trading to the masses, and these sleepers became a product of complacency. It is kind of like comparing penny slots (bonds) to the craps table (stocks) in Vegas. Not as exciting, but there for a reason. Just ask how many penny-slotters lost their behinds vs. someone at a table watching their kids' education funds get whisked away. If you have seen the movie 'Vegas Vacation,' this will resonate with you.
Why Things Change:
As we step into 2024, the spotlight is on bonds and fixed income as a compelling asset class, largely due to the prevailing interest rate environment. Remember, bonds have an inverse relationship to interest rates. When rates rise, a bond's value decreases. When rates decline, a bond's value increases. An easy way to think of this is:
Imagine owning a bond that is worth $1,050 and paying 4% in yield/interest. If rates rise 1%, and new bonds being issued are paying 5%, who wants your old bond paying less?
The answer is 'many.' But they will simply pay you less for it. It is no longer worth $1,050. Like a car without the newest technology, it's just not as attractive.
We see the potential change in a bond's value in the chart below. Given that rates are expected to eventually fall, returns look attractive (far right).
Portfolio Feng Shui:
It is always good to revisit the effect that your fixed income/bond allocation has on your long-term portfolio. Yes, in the short term, bonds can be uneventful. Watching paint dry comes to mind. But, like painting a room, it sets the tone and foundation for all of the other abstract art and furniture to be added, thereby creating that perfect feng shui. Ultimately, your portfolio can have feng shui, too.
The chart below is an example of how bonds maintain prices that typically have minimal fluctuation. As discussed earlier, bonds create opportunities when interest rates change (among others). But investors shouldn't necessarily buy bonds if they are looking for growth. Bonds are held for 1. Income 2. Stability/Risk Management. As a prior colleague of mine, Jeff Mortimer - Founder of Dragonfly Asset Management, used to say, 'we own bonds so that we can own stocks.' Total return (principal growth + accumulated income) should be the focus, and they are a life raft in turbulent times... the times that most investors don't have the stomach for.
Why Bonds Are Now In Focus:
Central to the appeal of bonds and fixed income in 2024 is the prevailing interest rate landscape. Central banks often adjust interest rates to either stimulate or cool down the economy. For the past couple of years, the Federal Reserve has increased interest rates to battle inflation in an attempt to slow the economy. This pushed bond values down (see the whole year of 2022). Given the current environment, most analysts and economists see the Federal Reserve (The Fed) decreasing rates in the next 12-18 months. What happens to your bonds then? Correct, their values are likely to rise. One could say that given today's market, bonds are a bit 'on sale' and opportunities are plentiful.
It wasn't so long ago that investors were bellyaching about not getting yield. Their savings accounts, CD's, bonds, etc. were a little light on total return. Then 2022 hit, the Fed pulled out the proverbial cannon and launched rates higher. Although painful at the time, it has opened a possible window of opportunity to rebalance your fixed income allocation while the getting is good.
Will a bit of greediness get in the way by holding onto equities a bit too long, missing the window to take some gains and rebalance portfolio allocations? Maybe. Timing markets is 99% of the time a losing strategy. But, having stocks at all-time highs and bonds being on sale, it seems foolish not to brush up your long-term allocation, if necessary for your goals.
We spent the better part of a decade in a 'monkey could have made money' market. Those days are now gone. Gaining good, long-term performance is still not rocket science. However, understanding the ebbs and flows of factors such as interest rates and their effect on your portfolio is a vital tool in your toolbox in order to reach your destination even-keeled.