In this week’s Sector Watch, I took a look at how the next round of rate increases would affect equity prices. Investors appear to be fairly confident that equity prices will hold up during these increases, theorizing that an improving economy (the probable cause of higher rates) will likely lead to an increase in corporate profits, which should help support, if not boost, share prices. Though stock investors today feel fairly confident that things will continue to go their way, what about fixed-income investors. Is it truly time to bail out of bonds?
Maybe not, if history serves as a guide (for it’s never gospel). Surprisingly, the magnitude and frequency of substantial bond market declines has been relatively low, even when the Fed was actively reining-in short-term rates. Since the end of 1986 [the start of daily total return data for the Barclays Aggregate Bond Index (AGG)] there were only 16 times that the total return of the AGG declined by 5% or more, even though the S&P 500 saw 47 price declines in excess of 5%. However, these stock declines and recoveries were usually swifter and sharper than bond declines and recoveries, which took longer to materialize.
So there you have it. No one knows for sure what will happen to bonds in the year ahead. However, bonds just might confound the experts in the months ahead as they have for much of this year by appreciating further. One thing is for sure, however, is that total returns for the Barclays Aggregate. Bond Index, whether on an intra-year or annual basis, rarely stayed down for long, and never experienced the magnitude or frequency of declines as did the S&P 500 stock index. In conclusion, history shows, but obviously does not guarantee, that investors who prefer the steady income and relatively low volatility offered by bonds are also likely to better off buying, rather than bailing, by either adding to their holdings or rebalancing their diversified portfolios following declines of 5% or more.
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