Marc Cuniberti: Bonds go through a sea of changes
November 25, 2018
For the second time in as many years, conservative investors holding bonds were sweating bullets and seeing red in balances as bonds tanked a few weeks back. This also means interest rates conversely rose with some reasonable velocity as the two move opposite of each other. The last time this happened was right after Trump was elected in the fall of 2016.
The speed at which fixed income (investments with a fixed return as a prerequisite) fell in late 2016 caused news headlines to shout things like "carnage" in an otherwise mundane area of investing, the bond market.
Now, once again the rout made headlines.
In an Oct. 8, 2018 article entitled "Bonds in $916 Billion Wipeout Spark Fear of Worst Run Since 1976," the author goes on to highlight the eye-popping amount trimmed off aggregate bond prices which is the 916 billion mentioned in the title.
No doubt some conservative investors, thinking their portfolios held investments that were safe and therefore shouldn't move much, likely put calls into their advisors or twisted up their brokerage statements as the bond rout became reality in the form of declining portfolio balances.
The strong U.S. economy, rising inflationary pressure and the Federal Reserve's statements on continuing expected increases in a key rate called the "Fed Funds Rate" may be some of the reasons for the bond sell off.
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Bond prices generally move opposite of interest rates, whereas if rates rise, bonds will tend to fall. The duration of the bond (maturity) determines how much the bond will react to interest rates moves.
Generally speaking, markets hate surprises and fast jerking prices in either direction in bonds or stocks can disrupt an otherwise calm market, which some may argue was the climate in stocks and bonds prior to the beginning of the bond sell off.
Bonds are IOU's from whoever, meaning there exists corporate, state or federal bonds as well as a plethora of others. They offer different yields and maturities and even have a few different ways that they can pay you.
They are also rated from investment grade to junk and all levels in between and the description is self-explanatory. What investors may not know is the "junk" is sometimes added to the cream (the better bonds) to boost returns on funds that might have names like "income fund" or "high yield funds."
These funds won't use the name junk of course, but do have to reveal the rating on everything they hold in their financials. Usually bonds hanging around the "junk" moniker have a tendency to move more violently then the higher graded stuff and all of them move in opposite of maturity. This means the longer the maturity date (expiration date) the more susceptible they are to rate movements and therefore are usually more volatile.
Investors can lessen the volatility of their bond portfolio by choosing shorter duration and higher graded holdings but with this adjustment also comes lower yields. There are no free lunches it is said.
Patience is key
For now at least, the bond market could be said to be in turmoil, at least for those investors holding the longer term ones.
Of course with pain for some also comes pleasure for others. As is usually the case in markets, when somebody loses money, others are happily picking it up on the other side of the trade.
Sound advice for all investors is to remain calm, be patient and if necessary or nervous, review your holdings to make sure you are not over exposed in any one area. Market upsets don't last forever and running with a stampeding panicked herd can be hazardous to one's portfolio health.
A variety of protection strategies may be available to avoid such need to act rashly in the face of rapid sell off's.
This article expresses the opinions of Marc Cuniberti and are opinions only and should not be construed or acted upon as individual investment advice. He is an Investment Advisor Representative through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Marc can be contacted at SMC Wealth Management, 164 Maple St #1, Auburn, CA 95603 530-559-1214. SMC and Cambridge are not affiliated. His website is http://www.moneymanagementradio.com.
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