YTD Bond Returns Have Been Among the Worst Ever
Bonds of all types have had significant drawdowns this year as fears of inflation and Fed tightening are front and center in bond investors’ minds. Treasuries, Corporates, Securitized, Short, Intermediate, Long, Investment Grade, High Yield – it doesn’t matter – results have been among the worst periods we have ever seen. Even Short Treasuries, measured by the Bloomberg 1-3 Year Treasury Index, which have a pretty good track record of protecting capital over rolling 3-month periods, have experienced a 3.0% drawdown – their worst since the data started being tracked 30 years ago. The Bloomberg Aggregate Index (Agg) is down 9.5%, Long Corporates are down roughly 19.4%, and High Yield is down 7.4%. Surprisingly, equities have been relatively resilient, returning -10.4% YTD for the S&P 500.
The move has been both significant and swift, precipitated more by fear and uncertainty than fundamentals. Of course, the deplorable war in Ukraine continues, though normally this type of event precipitates a flight to quality, so perhaps it is keeping a ceiling on how high Treasury rates can go. Inflation is rampant, at a 40-year high, and the Fed is moving quickly. Despite these overhangs, the US economy is still expected to grow by 2-3% this year, and corporate earnings by about 10%. Sanctions on Russia will reduce world GDP, but clearly have pushed inflation well beyond transitory. The consumer is flush with post-pandemic cash, supporting consumption, and employment is strong, increasing wage pressures. There is significant pent-up demand for travel, concerts, sporting events, etc. Manufacturing PMI has rolled over, but is still strong. The brief 2-year/10-year Treasury yield curve inversion is an oft-cited indicator of recessions, but the timing typically varies. It remains to be seen if the Fed’s vigilance will go too far and move the economy in that direction, or perhaps negotiate a soft landing.
Is It Time Yet?
What is a bond investor to do? It may be time to nibble at the much higher rates available on short-term products – while 2-year Treasuries are up 194bps this year to 2.67%, 1-3 year Corporates are up 231bps to 3.43%. Other sectors of the market have seen similar increases in yields. The yield on the Agg is 172bps higher to 3.48%, while Long Corporates are 163bps higher to 4.73%. With the relatively limited recent drawdown in equities, the huge runup in recent years, and the rise in discount rates, we expect that improved funded status will cause many pension plans to rebalance in favor of bonds. Likewise, rates have moved higher in the US relative to many foreign markets, and though the move in the dollar has increased hedging costs, our bonds are still attractive to foreign buyers, supporting demand. Buyers will begin to emerge at more attractive rates.
This Too Shall Pass
Markets are resilient. Many periods of significant drawdown create attractive buying opportunities. There is often an overshoot, and prices can recover quickly. We are not predicting what rates will do, nor how Ukraine, inflation, or recession will play out, but it seems like the market has digested and discounted a fair amount of the potential economic fallout. For investors looking to add some yield to their portfolios at much better levels than anytime over the past 3+ years, it may make sense to begin to average in.
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Sources: Bloomberg as of 4/22/22 unless otherwise stated. Sectors listed are based on Bloomberg indices. Yields are represented as of the above date(s) and are subject to change. The views contained in this report are those of Income Research & Management (“IR+M”) and are based on information obtained by IR+M from sources that are believed to be reliable but IR+M makes no guarantee as to the accuracy or completeness of the underlying third-party data used to form IR+M’s views and opinions. This report is for informational purposes only and is not intended to provide specific advice, recommendations, or projected returns for any particular IR+M product. Investing in securities involves risk of loss that clients should be prepared to bear. More specifically, investing in the bond market is subject to certain risks including but not limited to market, interest rate, credit, call or prepayment, extension, issuer, and inflation risk. It should not be assumed that the yields or any other data presented exist today or will in the future. Past performance is not a guarantee of future results and current and future holdings are subject to risk. It should not be assumed that recommendations made will be profitable in the future. Actual results may vary. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Income Research & Management. “Bloomberg®” and Bloomberg Indices are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by IR+M. Bloomberg is not affiliated with IR+M, and Bloomberg does not approve, endorse, review, or recommend the products described herein. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to any IR+M product.