Investment Insights: Into the Great Unknown with bonds?

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Open laptop displaying investment return graphs and reflecting the face of the Asian man looking at the screen.Stocks have been on the rise since the election as markets become more optimistic on the U.S. outlook. The drift upward seems to be based on the Trump administration’s potential tackling of tax cuts and deregulation along with better-than-expected economic releases domestically. While investors gawk at the all-time highs realized by the major four U.S. stock indices — the S&P 500 Index, Dow Jones Industrial Average, the NASDAQ Composite Index, and the Russell 2000 Index — headlines have not addressed the significant shift in the bond market.

While stock markets have strengthened after the election, bonds saw elevated volatility. Bond yields have drifted steadily lower over the past 35 years and had remained at relatively depressed levels for years. Markets may be bucking that trend after November 8 with the 10-year Treasury yield rocketing almost 27% higher, rising from 1.86% to 2.36% in just 10 days. Accordingly, the Bloomberg-Barclays U.S. Universal Bond Index, which represents the broad U.S. taxable bond market, has declined 2.18% so far in November through yesterday (Nov. 22).

The recent shifts in the bond market may reflect investors’ anticipation of increased fiscal spending in an effort to spark more robust growth. The new fiscal stimulus, a way for the government to more directly stimulate growth versus changing monetary policy, will likely shape economic growth going forward. The new tactic may start with infrastructure spending, which could turn into a key driver of the domestic economy as projects would create jobs and, in combination with lower taxes, theoretically could push consumers back to the spending levels we once saw. Growth is absolutely the focus of these potential policies; however, the bond market will likely react negatively to the deficits and increased debt these plans would likely create. Additionally, economic growth is typically coupled with inflation, which may also weigh on interest rate levels.

The outlook for bonds remains uncertain. Long-term trends point to bond yields remaining at dampened levels, or even drifting higher depending on the economy. Meanwhile, short-term trends are evidently themed towards volatility. New policies and regulations from the incoming administration will likely have a strong effect on our fixed-income positioning over the medium term. A December hike from the Fed is almost a certainty, but the “dot plot” will be more telling of rate guidance going forward – a key determinant for fixed-income portfolios. We remain underweight duration and allocated to high credit quality sectors as we navigate the current environment.

Chart showing market returns as of 11/22/16

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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

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