As a reward for not panicking during the Great Recession in 2008 and 2009, investors have been blessed by one of the longest market rallies in history. It began in March of 2009 and has continued until now.
It was not a steady climb upward. The market was much more volatile than many people were used to, with lots of dips along the way. However, those investors who followed a strategy of broad, global diversification benefited from reduced volatility and enhanced downside protection. This is because their portfolio was balanced, and spread the risk as broadly as possible, just the opposite of putting all your eggs in one basket. A properly-diversified portfolio tends to include U.S. large, medium and small companies, international small, medium and large companies, companies from emerging markets, real estate, commodities and bonds.
Bonds have an important place in the strategy because they provide stability. Stocks may jump up and down and all over the place, and over several years they might even jump 100% in value. Meanwhile, the bonds in the portfolio crank out predictable coupon yields quarter after quarter after quarter. It’s as exciting as watching grass grow.
For some of our clients, the relatively sluggish performance of their bond allocation was frustrating. “Why do we even have bonds in the portfolio at all?” was a common refrain.
How things have changed. In the blink of an eye, the bond market has taken off. Year to date, while stocks were bouncing around at prices roughly where they were in early 2018, bond investors have reaped some significant capital gains.
How significant? Since the beginning of 2019, investors in the 30-year Treasury bond have seen gains (interest plus price appreciation) of 26.4%—which would be a great full year’s return for stocks. Long-term bonds overall have generated a 23.5% return, as represented by the Bloomberg Barclay’s U.S. Aggregate Bond Index. Investment grade corporates have returned a not-too-shabby 14.1%, while the 10-year Treasury note has gained 12.6%.1 Those investors who were griping earlier now understand that there are times when bonds can add more kick to their returns than they expected. Every asset class has its day in the sun — you just don’t know when.
The yield drop that caused these returns was a surprise for many market analysts. They had been predicting over roughly a decade that bond yields had nowhere to go but up. The market tends to teach gurus humiliation. The yield on the 10-year Treasury note is now just under 1.47%; it was more than 3% at the end of 2018.
As you may know, bond values are bond yields move in opposite directions — if the value of a bond falls, the dividend (or yield) that it pays out increases in percentage. So if yields are dropping, it indicates that investors are snapping up bonds and driving up prices.
How long will this continue? It’s very hard to imagine that 10-year Treasuries would fall another 1.5%—to zero yield. The smart money says that most of the gains have already been taken, and anybody looking for 20+ percent returns in long-term bonds going forward is just diving into the water after the tide has gone out.
There’s an important lesson here. We know the market is unpredictable and confounds prognosticators. It doesn’t usually pay to time the market, or tweak your asset allocation in anticipation of what you think the market is going to do.
If you want to benefit from a globally-diversified investment strategy, it takes some discipline, and sometimes gritting your teeth a little. But the satisfaction is great when a humble asset class that nobody paid attention to suddenly blossoms, and you already had it in your portfolio.