Could 2021 Be One Of The Worst Years On Record For The Bond Market?
Last August yields on the U.S. 10-year Treasury bottomed out around 0.5%. Last month they hit triple that, at 1.5%. When bond yields rise, bond prices fall, so 2021 has not started well for fixed income investors. Currently, the 10-year Treasury bond is down over 4% for 2021. Great investor Warren Buffett is hardly optimistic about bonds. What might the future hold?
First off we should consider that fixed income assets tend to be a lot more stable than stocks. A rout is unlikely. A really bad year for bonds, can feel about the same a bad month for equities. 10-year bonds moving 10% up or down over the course of an entire year is fairly unusual.
Often price moves are confined to single digits looking back over the past century. Yes, we did see a 32% increase in the 10-year in 1982 as rampant inflation came under control. At the other extreme we saw an 11% in the 10-year in 2009 as the flight to safety during the 2008-9 started to unwind. Yet these are the extreme moves. In many years we see far smaller price changes.
It is notable that one of the all-time worst years for bonds was 2009. Right as the global economy was emerging from the financial crisis, so investors moved from the safe haven of bonds to riskier assets. We may be seeing a similar dynamic in 2021. Though of course, much depends on how reopening progresses and the policy response to it. To the extent investors remain comfortable taking risk, bonds, especially government bonds will likely suffer.
The other question on the minds of investors is inflation. Even the Fed has stated that getting growth back is the priority over inflation, for now. However, the massive stimulus used to fight some of the worst effects of the pandemic has not been cheap.
One measure of money in the U.S. economy called M2 by economists, spiked around 20% over the past 12 months as a result of efforts to fight the pandemic with stimulus checks, enhanced unemployment payments, PPP loans and other government spending. That sort of spike over a short period is unprecedented. Some economists worry inflation will result. If it does that it seldom a good outcome for bonds. Companies can often raise prices to mitigate the impact of inflation, but with bonds you generally receive a fixed coupon, so inflation can eat into your return.
Is The Bull Run Over?
It is possible that a massive bull run in bonds may be over. Since the early 1980s yields on 10-year bonds have tumbled from 15% all the way down to around 1%. There have been bumps along the way such as 1999, 2009 and 2013 but generally the 10-year has put in a great long-term performance. We often focus on the strong long-term track-record of U.S. equities, but bonds can give stocks a run for their money especially on a risk-adjusted basis.
Of course, perhaps we should not view zero as the lower bond for yields, since in France, Germany, Switzerland and the Netherlands yields are negative. That implies it’s possible that bond yields still go lower from here. Still, that’s not the direction they are trending in since last summer.
Also, unlike in decade past, less income is available from bond yields. It’s harder, mathematically speaking, for a bond to have a negative year, when it’s paying a 15% yield, than when that same bond offers just 1%.
However, even a bad year for bonds is likely to be pretty tame compared to what we could see in a bad year for stocks. If the bond market is stuttering because of investors shifting to riskier positions, that’s less worrying for stocks, but if an inflation spike is coming, stock investors may have cause to worry.
Published at Tue, 02 Mar 2021 22:03:02 +0000