The media is hyper-focused on the rout in Treasury bonds, touting the rise in the 10-year yield to 1.7%; what’s left unsaid is that yield was first hit nearly a decade ago in the autumn of 2011.
Nearly every day the financial news headlines trumpet the selloff in bonds and the rising yields that go along with it. Some market pundits are convinced a bear market in bonds is underway. It’s easy to get caught up in the hype, but we believe whether or not it’s a bear market is the wrong thing to focus on from a goals-based perspective.
With most planning horizons stretching out 20 or 30 years, Horizon Investments believes the focus should be on whether bond yields and interest rates will ever again be high enough to provide substantial income and capital gains to meet someone’s financial goals.
The recent rout has done little to improve the long-term return picture for bonds. The selloff has pushed up the yield on the 10-year Treasury note to about 1.7%, a level it first reached nearly 10 years ago in the autumn of 2011.
Rallies and routs have come and gone, but low yields remain. Over the last nine and a half years, the 10-year Treasury yield has averaged just 2.1%. Berkshire Hathaway’s Warren Buffett put it starkly in his recent shareholder letter, writing that bonds investors “face a bleak future” with yields at current levels1. We would encourage investors to consider that possibility, even though there could be some eye-catching headlines in the news.
For example, if the month of March ended today, the pullback in Treasury bonds from their peak last year would make history. The drawdown, or peak-to-trough decline, from 2020’s pandemic-fueled high for the Bloomberg Barclays Treasury Total Return Index totals 6.1%; the biggest retreat in U.S. government debt since the bull market in bonds began in September 1981. (Note: Horizon Investments is using monthly data as daily prices are not available for the entire period; Source: Bloomberg.)
The reasons for the drop are well-known: the global economy is reopening, a fresh $1.9 trillion in U.S. stimulus spending has just begun and much-faster U.S. GDP growth being predicted for this year is spurring fears of inflation.
But to change the nearly decade-long, low-rate environment would require a permanent shift to a faster pace of inflation. Horizon doesn’t see that happening, and we take issue with the financial markets pricing in Federal Reserve rate hikes within the next two years.
We believe historically low interest rates are here to stay for the foreseeable future (see our Q1 Focus on the Death of the Business Cycle for a deeper dive). We see the combination of disinflationary forces from technological innovations, the rising dominance of the services sector in the American economy’s make-up and the Fed’s promise to keep rates lower-for-longer all working together to prevent a return to decades past when bonds provided substantial interest income.
The financial planning challenge is to find the right mix of bonds and fixed-income alternatives to keep a client on track to meet their goals while remaining within their risk comfort zone. While this may look different over the next 20 years compared to what we’ve seen over the past two decades, we believe the use of innovative solutions around accumulation, preservation and distribution can help reduce the reliance on traditional fixed income in a time when the market is changing.
1 Letter to Berkshire Hathaway shareholders February 27, 2021, https://www.berkshirehathaway.com/letters/2020ltr.pdf
Further reading:
Essentially Nothing. That’s How Much Bonds May Return Over Next Five Years
It’s Getting Harder to Fund Retirement Using Bonds
If Inflation Returns, Bond’s Diversification Power May Disappear
Disappearing Junk Bond Yields
Soaring Innovation Companies Go Cold as Interest Rates Rise: Big Number
Inflation Could Be Coming, Are You Ready?
Small-Cap EPS Growth Expected to Be 4x Faster Than S&P 500
Biden, Trump Agree: Make America’s Growth Great Again
Is Now the Time for ESG?
This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, please reach out to Chief Investment Officer Scott Ladner at 704-919-3602 or sladner@horizoninvestments.com.
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