Written by Erik Schuster, CFP® Financial Planner:
US Stocks and Bonds are moving in the same direction, down. Since 2000, it is rare to see stocks and bonds move in correlation. It happened briefly in 2008 and again in 2018. Both occurrences were short-lived. What we are seeing today is the perfect storm the Federal Reserve has been trying to avoid.
When inflation surged in 2021, the Fed kept using the word transitory. Transitory inflation is temporary if price levels subside while supply catches up with demand. In 2021 we saw inflation begin to increase with no action from the Fed. To put it simply, supply was not catching up to demand.
By December 2021, the Consumer Price Index was at 7% for the year, the highest since 1981. With no short-term end in sight, the Fed was forced to act. One of the few actions the Fed could take was to increase interest rates. It would begin to raise the Fed Funds rate starting in March 2022. The initial increase was .25%
The bond market will work in unison with rising and declining interest rates. When interest rates go up, bond values go down and vice versa.
As inflation continued to rise in 2022, the Fed had to become more aggressive with increasing interest rates. It was their only option to try and combat the inflation surge. In May 2022, the Fed decided to double the rate increase from March. They rose rates .5%.
The surge in inflation was fuel on the fire for the bond market. Under non-inflationary periods, rising interest rates would cause the bond market to lose value. What is occurring now is the worst-case scenario.
As of 6/13/2022, the Bloomberg U.S. Aggregate Bond Index, which is made up of U.S. Treasuries, high-rated corporate bonds, and mortgage-backed securities, has returned -12% this year. Its second-worst performance over the same period was -2.9% in 1984.
The question moving forward, is can bonds continue to be the “safe” money in your portfolio? What has occurred in the bond market was not unexpected. When interest rates went to near 0%, it was inevitable that they would have to rise at some point in the future. Most investors could have avoided this perfect storm of simultaneous stock and bond market declines. Again, the entire industry knew bond values would decline when the Fed inevitably decided to raise interest rates. Most of the industry did not want to break from the traditional asset allocation of stocks and bonds.
It may be time, if you already haven’t, to look at other asset classes for your “safe” money. Again, because this decline in the bond market was predictable, many products have been created to replicate bonds. Why do investors use bonds? Bonds are used for protection of principle, upside opportunity when stocks are down, and moderate growth. You cannot get one of those features today from a bond. Several insurance products have been created to replicate bonds. They offer principal protection, upside opportunity when stocks are down, and moderate long-term growth. Now might be the time to re-consider how bonds fit into your portfolio.