Bonds go up when stocks go down, right? Not anymore it seems. And what happens when stocks go down because interest rates go up (a situation that has become all too common in recent months)?
The historic relationship between bonds and stocks is that they generally have moved in opposite directions. This is how diversification in a portfolio works – when one asset class goes down, others may go up. For years, investors have used fixed income to provide what I’ll call “ballast” to a portfolio. Bonds were (sometime rightly, sometimes wrongly) considered the safer component that balanced out the more risky stocks in investors’ portfolios. However, what is rattling investors lately is that this traditional relationship disappeared following the Federal Reserve’s comments in June about an earlier-than-expected “taper” to their bond buying program when both stocks and bonds declined.
This shift has left bond investors wondering what the rest of the year looks like for bond returns. Can fixed income recover its losses this year and end in the black? It’s not likely for traditional core bond portfolios, by which we mean those strategies represented by the widely-referenced broad benchmark Barclays US Aggregate Bond Index (“Agg”) that invest heavily in interest rate-sensitive government-related bonds. With YTD returns through September 10th of -3.63% for core intermediate fixed income, avoiding an annual loss will require a major shift lower in interest rates, something we do not expect. Amazingly, an annual negative return in 2013 would represent just the third time traditional bonds lost money over the last 33 years.
So where do we think markets are headed? Our baseline view remains somewhat less pessimistic than the worst case scenario, in which stocks and bonds break from their traditional relationship in a rising rate environment. For the remainder of the year, US bond investors might expect to recoup some losses from coupon if rates pull back a bit. However, unless rates drop way down over the next few months, investors should expect negative returns from core fixed income in 2013.
Index returns are for illustrative purposes only and do not represent actual Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.