The first quarter of 2021 was positive for U.S. stocks, but bonds declined amid the rise in interest rates.
With the dramatic spike in interest rates discussed here, bonds performed poorly in the first quarter of the year. The Barclay’s Aggregate Bond index was down more than 3% in the first quarter, a large loss for bonds in a short timeframe. We regularly remind clients, however, that a “bad” result for bonds is a lot better than a “bad” result for stocks. While bonds incurring an interim fall of 3% during the course of a year is fairly extreme, stocks having an interim fall of 14% at some point during the course of a year is the historical average. The good news for prudent bond investors is that performance pressure on bonds is likely to recede no matter which way interest rates go from here:
- If interest rates decrease a bit, bond prices would gain support from the decline in rates (as bond prices go up when rates go down, and vice versa).
- If interest rates stabilize at/near current levels, most of the negative price impact of rising rates is already past and short/intermediate term bonds will be resetting to the higher rates fairly quickly, thus providing more income going forward.
- If interest rates continue to rise, we could see a further decline in bond prices (although, we believe that this pressure will be somewhat muted as discussed above). However, if rates were to rise further, because of the relatively short-term nature of our managed bond portfolios, the incremental downside should be limited, as the benefit of higher rates should happen fairly quickly as the underlying bond holdings turnover.
In addition to providing stability, we often view bonds through the lens of “dry powder” that can be used to take advantage of stock market corrections when they occur. Again, the stock market experiences, on average, a 14% correction in a given year. Since bonds tend to hold their value when stocks sell off, the proceeds from bond sales can be used to buy stocks in such circumstances.
As noted in previous commentaries, we believe that bonds will continue to be a challenging asset class in the coming years, but we believe that challenge stems more from a continuation of low interest rates than from the threat of inflation and rising rates. These concerns are why, for most of our portfolios, we have generally (a) avoided long-term bonds in our managed strategies and (b) employed active managers that are not benchmark constrained and can take advantage of interest rate volatility.
As we move through 2021, there are a number of lingering issues that will garner headlines and inevitably lead to volatility in the markets. Ultimately, we believe that the markets are reasonably positioned, and our overall market outlook leans optimistic.
Eric Toole, MBA, CFP(R), is a Principal at Antares Wealth Management. He can be reached at firstname.lastname@example.org.