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Bond Market Commentary

In Spite of this… Bonds Will Be Bonds

By Doug Drabik
July 23, 2018
  • Many economists and financial experts have been predicting higher interest rates year-after-year. “This was the year”. In spite of this, the 10 year Treasury is up only 45bp year-to-date and down 122bp over the last decade.
  • The Fed implemented a zero interest rate policy (ZIRP) for over seven In spite of this, inflation has remained low.
  • The world’s primary central banks (including the Fed) have raised the money supply largely through open market security purchases. The desirability is to make more money available for businesses and people to spend. In spite of this, the money in general did not go to purchase more products and/or services but instead into investments.
  • Following the Great Recession of 2008, the U.S. economy has shown healthy growth, favorable by comparison to most European and Asian nations. In spite of this, U.S. interest rates have remained considerably higher than a majority of these nation’s rates.
  • The Fed, since December 2015, has raised Fed Funds 7 times (175bp). In spite of this, the rest of the yield curve has not followed suit. One year Treasury rates are up 170bp, five year rates are up 110bp, ten year rates are up 64bp and thirty year rates are up 3bp.
  • The U.S. is a consumer driven economy. Consumer spending determines roughly 69% of the U.S. GDP. In spite of this, an aging population which controls a disproportionate amount of the wealth has less need for goods and services and is more likely to allocate money into investments.
  • The Baby Boomer generation (26% of U.S. population according to the Pew Research Center) is reaching the retirement age of 65 at a pace of 10,000 per day. The retirement age is when fixed income may be a more crucial wealth protecting asset. Boomers control approximately 50% of the nation’s wealth according to Deloitte Consulting. In spite of this, many retirees remain “over-allocated” to growth assets, thus more vulnerable to potential return fluctuations (risks).
  • The financial world is full of uncertainty (just read the previous bullet points). In spite of this, bonds (individual bonds) will be bonds. What does this mean? A buy-and-hold individual bond purchase, barring default or early redemption, will provide its stated income stream, cash flow and the return of its face value in spite of (these): expert rate predictions, Fed policy, recessions, interest rate fluctuations, yield curve fluctuations, consumer spending or any other uncertain future events.

With so much uncertainty, attention to asset allocation is at a premium. If you think we are headed to an inverted curve and eventually a recession, it may bear reminding that the equity markets haven’t fared well during negative growth periods (July 9th commentary). The strategic mindset behind bonds is very different than that of equities or other growth assets (July 2nd commentary). The foundation of the portfolio is built around its asset allocation. The base of the foundation should be built around the “Knowns”, that is, assets with the protective qualities to weather the “Unknowns” (July 16th commentary).

This series of commentaries began on June 27, Unravelling the Changing Yield Curve. The takeaway week-to-week is simply this:

  • Maintain discipline with asset allocation.
  • There are no direct substitutes for individual bonds.
  • Bonds are defensive because in a buy-and-hold scenario, they perform as expected from day one throughout maturity.

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

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