Up, Down, or Sideways?
Read the weekly bond market commentary from Drew O’Neil.
Are yields headed higher or lower over the next few years? Given the recent market activity, there’s no shame in admitting that you aren’t sure. So what does this mean regarding your fixed income investment decisions? One could argue that “staying the course” is the best option, as a portfolio of high-quality bonds is likely perform well regardless of interest rate movement.
There is a reason that for many investors, an allocation to individual bonds with a buy-and-hold strategy is the cornerstone of their long-term strategy. Bonds provide stable cash flow and income, regardless of interest rate movement and other market influences. Sure, prices will react to general interest rate movement and other market events, but over time, these price changes become muted as a bond is going to be redeemed at par on its maturity date (barring a default).
Many of the headlines that are promoted by the financial media focus on short-term price movement and a total return strategy based on holding some packaged product or index-based investment. A general theme is that if rates go up, this is going to lead to negative returns in fixed income. There are two major flaws with these stories: 1) they are focused on short-term price movement, not the long-term strategy, and 2) they ignore the cash flow, which is the primary reason that many investors purchase fixed income as well as a large part of the total return generated when holding bonds.
To help point out the fallacy in these articles that bonds will perform poorly if/when interest rates rise, this chart highlights the projected performance over a five year period of an intermediate-term corporate bond ladder in three different interest rate scenarios: the yield curve falling by 1%, no change in the yield curve, and the yield curve rising by 1%. As you can see, regardless of the scenario, this portfolio is projected to perform quite well assuming a buy-and-hold strategy. Most of the commentary you read and headlines you skim are focused on the top line of this chart (Price Return), while with a closer look it is easy to see that price is only one piece of the puzzle. All three of these very different interest rate scenarios are likely to produce positive total returns over the next five years, ranging from 17.5% to 21.37%.
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.