June 18, 2018
 
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John R. Deitrick, CFP®

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Can bonds still save the day?

A look back in history

For much of the past 30 years, investors have enjoyed a bond bull market. The yield on the 10-year U.S. Treasury bond rose to over 15% in 1980, which means investors could have earned 15% a year just by clipping U.S. Treasury coupons back in the '80s. That same 10-year Treasury yield is now around 3%. Bond prices have an inverse relationship with yields: As yields drop, their prices rise. In this case, the drop in the 10-year yield from 15% in 1980 to 3% today caused the price of the generic 10-year bond to more than double over that time.


How can behavior bias affect us?

Simply put, behavioral biases can lead us to make poor decisions about our investments. For example, emotional reactions to market volatility could cause an investor to assume too much or too little risk to meet their investment objectives. Being overly sensitive to market movements can also lead to erratic trading activity, such as buying and selling too frequently. Regardless of the form these biases take, they all have the potential to put investors in a position where they end up farther away from achieving their goals.

How did bonds perform during other rising rate environments?

Looking back through history, the overall trend in interest rates has been declining. However, there have been several periods during which the Fed raised the fed funds target rate more than once. Recently, the Fed first raised rates in December 2015, and Treasury yields have been rising since the Brexit referendum in July 2016. History shows us that when the Fed has taken a slow and steady approach to raising rates, as was the case from 2004-2006, bonds fared well. However, when the Fed has raised rates at a more rapid pace, such as from 1999-2000 and 1994-1995, bond returns were weaker. Notably, the Fed often raises rates to combat inflation. As such, even during periods when interest rates rose quickly, Treasury Inflation-Protected Securities (TIPS) performed well.


                                  Source: Explara.com

Understanding what protection really means going forward

As interest rates rise, bonds may be less effective as portfolio shock absorbers. It's also worth taking a step back and asking what protection really means. It is never fun to lose money. Nonetheless, when the stock market fell 10% during the first quarter of this year, bonds declined only 2%. It's tempting to focus on direction and say they both fell together, but nonetheless, bonds fell materially less than stocks did. This smaller loss is perhaps not what everyone would like in terms of protection, but it is still a far better outcome than holding stocks alone. John Lynch, Chief Investment Strategist at LPL, noted: "Since 1980, the average annual peak-to-trough decline in the S&P 500 has been 14%, and pullbacks generally arrive without warning. Investors need to be prepared for such events and high-quality bonds may help provide protection for diversified long-term portfolios." The table below highlights the pattern of this relationship through several pullbacks over the last decade.
 
 
Bottom Line

Navigating the complexities of the bond market can be tricky, particularly in a rising rate environment. With yields at historic lows, and the U.S. potentially entering a new regime of rising rates, it's probable that bond returns will be less attractive, especially since the current yield is a good indication of bond returns. However, that doesn't mean bonds' role as shock absorbers has ended. For most investors, the decision is not whether to go all in with bonds or fold completely. Rather, it's a matter of selecting what types of bonds - as well as considering their maturity and credit quality - to include in a well-diversified portfolio. Investors can also select certain alternative investments that are less interest-rate dependent for additional sources of returns. Remember, bonds are in your portfolio to help provide diversification and potential income, and can also still offer some level of protection against stock market volatility.*

*D iversification does not ensure a profit or guarantee against loss.

This material is for informational purposes only and sets forth the views and opinions of our investment managers as of this date. The comments, opinions and estimates are based on or derived from publicly available information from sources that we believe to be reliable. This commentary is not intended as investment advice or an investment recommendation nor should it be construed as a solicitation to buy or sell securities. All indexes are unmanaged and an individual cannot invest directly in an index. Index returns do not include fees or expenses. Past performance is no indication of future performance. The Standard & Poor's 500, often abbreviated as the S&P 500, or just the S&P, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). The Bloomberg Barclays Investment Grade US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers. The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. The Bloomberg Barclays US Treasury Inflation-Linked Bond Index (Series-L) measures the performance of the US Treasury Inflation Protected Securities (TIPS) market. 


This Thought of The Week has been prepared by and for Global Financial Private Capital, LLC ("GFPC"). GFPC owns all copyright rights in and to this and each of its Thought For The Week articles. It is impermissible to copy or redistribute GFPC's Thought For The Week articles without our prior approval.

Investment advisory services offered through Global Financial Private Capital, LLC. Securities offered through GF Investment Services, LLC. Member FINRA/SIPC. 501 North Cattlemen Road, Ste. 106, Sarasota, FL 34232

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Investment advisory services offered through Global Financial Private Capital, LLC, an SEC Registered Investment Adviser. SEC registration does not imply any level of skill or training. Past performance is not indicative of future results. This commentary is not intended as investment advice or an investment recommendation it is solely the opinion of our investment managers at the time of writing. Nothing in this commentary should be considered as a solicitation to buy or sell securities. Insurance and Annuity product guarantees are subject to the claims-paying ability of the issuing company, and are not offered through Global Financial Private Capital. 
 
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AssetLock® is tracking software used to monitor the performance of a client's portfolio, and to predetermine the amount of downside the client is willing to tolerate.  It is NOT an actual stop order and will NOT automatically sell the individual securities in the portfolio.  Therefore, the AssetLock® value is a reference point to encourage a conversation between the advisor/firm and the client to determine if the client's portfolio should remain unchanged, reset the AssetLock® percentage by reallocating to a different risk profile, liquidate part or all of their portfolio or opt out of AssetLock®.
John R. Deitrick  CFP®
Advanced Retirement Design LLC.
7263 Sawmill Rd.
Suite 150
Dublin, OH 43016
Office: 614.602.6506
Fax: 614.259.6094
Email: jdeitrick@advancedretirementdesign.com
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