Bond Market Commentary
Don’t Let 30 or 60 Days of Data Eradicate Long Term Planning
September 20, 2021
There are many nuances we have to deal with regardless of how much we implore, aspire or wish them to disappear: mask or no mask, transitory or permanent, Republican or Democrat, accommodative or declining support, bull run or pullback, higher rates or flat, participation or sidelined, etc. It may be observed that the media exasperates listeners on either side of these controversies… to sell tickets to their show?
Unfortunately, misinformation or lacking perspectives may prompt unintended long term misjudgment. Let’s examine one of the latest mantras, “don’t invest in fixed income because the real yield (interest rate adjusted for inflation) is minimal or negative.” The fear of inflation is changing investor’s long term planning and investing. Let’s examine.
If a bond’s yield is 1.80% and inflation is 2.00%, it is sometimes printed that you are “losing” money. There are two ways you can actually “lose” principal when purchasing an individual bond: 1) if the bond defaults (fails to make interest payments or return face value at maturity) or, 2) if you sell the bond before its maturity when the current market price is lower than the bond’s adjusted cost basis. Therefore, if you buy high quality (investment-grade) individual bonds, default is a greatly mitigated risk and if you hold the bond to its maturity, interim market prices won’t reduce the return of full face value at maturity. This is the reason why individual bonds can be effective securities when desiring to protect your wealth. They may not make you wealthy but they can prevent you from losing your wealth.
What inflation does is reduces your purchasing power. In the scenario above, you don’t “lose” principal, it slightly affects what you can buy in the future. Investors allocate portfolio holdings to different asset classes because each allocation plays a different role. The example portfolio allocation chart indicates that 30% of the assets are likely intended to preserve wealth, not grow it. You wouldn’t want to discard all of your stocks if you want your money to grow. You also shouldn’t discard your individual bonds that serve primarily to protect principal long term.
Think about the irony, due to inflation, of being told to shift your fixed income allocation which serves to protect principal into additional stocks because they may provide higher current yields. In other words, shift from inflation risk into market risk? What is the buying power of principal shifted to a stock if the market encounters a 10% pullback? How about a 55% pullback similar to what was experienced during the Great Recession? Stocks provide an opportunity to grow but run the risk of higher highs and lower lows. Individual bonds provide the defensive position to preserve wealth. Each component plays an important role.
In addition, keep inflation talk in perspective. Looking back since just before the Great Recession, many data points have outpaced inflation which averaged 1.67% (January 2007 through September 2021). Wage growth, home prices, stocks and bonds have all done better. This means on average, purchasing power has grown since 2007.
According to Bloomberg, longer term forecasts by economists anticipate 2.5% PCE (inflation) for 2022 and 2.1% for 2023. The Fed’s forecast is for 2.1% in both 2022 and 2023. In other words, no experts are anticipating runaway inflation and for temporary escalated data to drop.
The push and pull media as well as 30 or 60 days of economics should not dictate a change to long term fixed income planning. Individual bonds serve and will continue to serve their primary role of principal protection. Stay disciplined to your portfolio allocations.