Something Almost Nobody Saw Coming

Bonds are a slowly sinking ship,” a very successful financial professional said to me in the beginning of October 2018. Let’s see how bonds have done since then, as represented by the Barclays US Aggregate Bond Index.

It’s clear that the Barclays US Aggregate has gone up in value. Although, I can understand why it wouldn’t be expected to. 

The Federal Reserve began raising rates on December 17, 2015 and was expected to slowly increase the fed funds rate over time until rates were “normalized.” The common consensus was that existing bonds would lose value as the Federal reserve increased rates… “a sinking ship” as the above-mentioned financial professional called it.

Despite this expectation, bonds should have remained an important element of portfolio construction. Bonds with good credit ratings are less volatile than stocks and can help lower the overall risk of a portfolio. However, it is difficult to defend a position in bonds if they are viewed as “a sinking ship.” Some investors abandoned prudent diversification because of this expectation.

What no one expected, however, was for the Federal Reserve to put a pause on raising rates, and even hint at the possibility of cutting rates. Without the expectation of rates continuing to rise, bonds prices were pushed up, resulting in the performance shown in the chart above. 

On June 20th, the Wall Street Journal ran the headline, “A 10-Year Treasury Yield Below 2% Is Something Almost Nobody Saw Coming.”

“Something Almost Nobody Saw Coming” seems to be a familiar phrase in investing, and the reason why we build diversified portfolios. No one knows what is going to happen in the future, and whoever claims to know is foolish. So, it is often best to build a portfolio that could weather a range of possibilities.

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