As bond yields increase, bond prices fall, 2021 has not begun well for fixed income investors. Currently, the 10-year Treasury bond is down by more than 4 per cent in 2021. The major holder, Warren Buffett, is hardly positive about the bonds. What could hold the future?
Less of uncertainty
First of all, we should consider that fixed income assets appear to be far more stable than stocks. The path is impossible. A very bad year for bonds will feel the same bad month for equities. Ten-year bonds that shift 10% up or down over the course of a whole year are very rare.
Price fluctuations are mostly restricted to single digits looking back over the last century. Yes, we saw a 32% rise over the 10-year period in 1982 as rampant inflation came under control. At the other side, we saw 11 per cent in the 10-year span of 2009 as the flight to safety began to unwind in the 2008-9 period. These are the drastic moves, however. In several years, we’ve seen much smaller price increases.
It is interesting that one of the worst bond years ever was in 2009. Just as the global economy recovered from the financial crisis, investors moved from the safe haven of bonds to riskier assets. We will see a similar dynamic in 2021. But, of course, much depends on how progress is re-opened and the policy response to it. To the degree that investors remain comfortable taking risks, bonds, especially government bonds, are likely to suffer.
The other problem for investors is inflation. Even the Fed has indicated that, for the time being, restoring growth is a priority over inflation. However, the huge stimulus used to counteract some of the worst effects of the pandemic was not inexpensive.
One indicator of money in the U.S. economy, named M2 by economists, has risen by about 20% over the past 12 months as a result of attempts to tackle the pandemic with stimulus controls, increased unemployment, PPP loans and other government spending. This kind of spike over a short period of time is uncommon. Some economists are worried that inflation will result. If it does, it’s rarely a successful bond result. Companies will also increase prices to offset the effects of inflation, but with bonds you usually get a fixed coupon, inflation can be eaten in exchange.
Is the Bull Run over here?
It is likely that a big bull running in bonds may be over. Since the early 1980s, yields on 10-year bonds have fallen from 15% to around 1%. There have been bumps along the way, such as 1999, 2009 and 2013, but the 10-year duration has mostly been very long-term. We always focus on a good long-term track record of U.S. equities, but bonds may offer stocks a run for their money, particularly on a risk-adjusted basis.
Of course, we do not accept zero as a lower yield bond, because the yields in France, Germany, Switzerland and the Netherlands are negative. This means that it’s likely that bond rates are still lower. Even, that’s not the direction they’ve been heading in since last summer.
Even, unlike in the past decade, less revenue is available from bond yields. Mathematically speaking, it is more difficult for a bond to have a negative year when it pays a 15% return than when the same bond provides just 1%.
However, even a bad year for bonds is likely to be very tame relative to what we’ve seen in a bad year for stocks. If the bond market is stuttering because investors are moving to riskier positions, this is less troubling for stocks, but if the inflation rate is increasing, stock investors will have reason to worry.