Showing posts with label bond yield. Show all posts
Showing posts with label bond yield. Show all posts

Tuesday 14 March 2023

What does the bond market turmoil mean for investors?

 

What does the bond market turmoil mean for investors?

US Treasuries have suffered the worst start since 1788 after falling by 9.8 per cent this year, triggering experts to question the 60/40 portfolio strategy


The bond market has suffered a record $10 trillion sell-off this year. AP

Investors fretting over this year’s $13 trillion global stock market crash may have overlooked similar carnage in a market that is actually more important for the global economy.

The bond market has also suffered a record $10tn sell-off and this could hit investors just as hard because a strange thing is happening.

Both shares and bonds are crashing at the same time. That is something financial experts say isn’t supposed to happen.

But in 2022, it is. Which means there is no hiding place for investors in this troubled year. There may also be an opportunity, if you are sharp.

Retail investors may pay little attention to the bond market but institutions and governments have been known to obsess over it.

For them, the bond market is the big one. It is about triple the size of the global stock market and plays an essential role in keeping economic activity ticking. At the end of last year, the bond market was worth about $120tn, against $41.8tn for global shares.

If the bond market gets bumpy, everybody is in for a rough ride.

Governments issue bonds to raise money for their spending while companies use them to generate the funds they need to grow. Both promise to pay investors a fixed rate of interest over a preset term, with a guarantee to return their original capital afterwards.

At maturity, the issuing government or company must repay the debt. If it cannot, there is trouble.

Bonds are traded by investors, which means their value can constantly change, depending on factors such as inflation, interest rates and demand. As is the case with shares, bond prices can rise and fall. Just not as much. Usually.

Ordinary investors rarely buy individual bonds but invest through a fund holding a spread of government or corporate bonds.

Bonds offer them a fixed rate of interest plus capital growth if prices rise, with fewer of the ups and downs you find with shares.

The two are supposed to be non-correlating assets. So, when shares fall, bonds are supposed to mitigate losses by standing firm.

The one thing they are not supposed to do is crash simultaneously. Yet, that is what is happening right now.

In doing so, they have destroyed a golden rule of portfolio planning.

For decades, financial planners said the safest way to generate steady, strong long-term returns is to invest 60 per cent of your money in shares and 40 per cent in bonds.

The classic 60/40 portfolio strategy has generated an impressive average return of 11.1 per cent a year over the past decade.

You can even buy exchange-traded funds (ETFs) that automatically deliver this, such as the BlackRock 60/40 Target Allocation Fund or the Vanguard 60% Stock/40% Bond Portfolio.

The writing was on the wall for the 60/40 strategy last year, as US large-cap stocks hit record-high valuations, while US Treasury government bond yields neared record lows.

“For all intents and purposes, we think investors have many reasons to be concerned that the 60/40 might be dead,” Nick Cunningham, vice president of strategic advisory solutions at Goldman Sachs Asset Management, said last October.

This will hit investors who had even never heard of the 60/40 rule because “we see shades of the classic 60/40 present in many portfolios due to an over-concentration in the most familiar asset classes", Mr Cunningham added.

As this warning proves prescient, it may be worth looking at your portfolio to see how exposed you are to this double jeopardy.

This has been a challenging year across the board, says Jason Hollands, managing director of investment platform Bestinvest.

“2022 has seen one of the worst starts to a calendar year for core US assets on record,” he says.

US Treasuries have suffered the worst start since 1788, according to Deutsche Bank, falling by 9.8 per cent. That isn’t supposed to happen to the bond market.

“At the same time, the S&P 500 Index of US shares has fallen 20.38 per cent, the worst first half for US equities since the Great Depression in 1932,” Mr Hollands says.

This is happening because central banks, led by the US Federal Reserve, are throwing monetary policy into a sharp reverse.

After decades of slashing interest rates and pumping out stimulus, they are tightening as fast as they dare to curb inflation.

“Central bankers have now yanked away the key supports for equity and bond markets that turbocharged them in 2020 and 2021,” Mr Hollands says.

Rising interest rates are bad news for shares because higher borrowing costs squeeze both businesses and consumers, hitting profits.

Bonds suffer because they pay a fixed rate of interest, which looks a lot less attractive when rates are rising and investors can earn higher yields elsewhere.

The stock and bond sell-off isn’t over yet despite signs of a recovery in recent days, says Fawad Razaqzada, market analyst at City Index and Forex.com.

Optimists convinced themselves that the Fed would curb rate increases for fear of tipping the US into recession, but this is a misreading.

The Fed is in a hawkish mood. I think the start of another equity and bond market sell-off is nigh,” Mr Razaqzada says.

It is not all bad news, though.

Bonds do this odd thing that sometimes confuses private investors. When bond prices fall, yields rise.

While the bond price crash is bad news for existing holders, new bond investors are earning a higher rate of income. Yields on 10-year Treasuries have almost doubled from 1.63 per cent to 3.06 per cent this year.

Stock and bond market crashes have one thing in common. Both can throw up opportunities for forward-looking investors.

The Fed will continue to raise rates this year but it also wants room to cut when the US economy slips into recession as a result, probably in 2023, says Lisa Emsbo-Mattingly, managing director of asset allocation research at Fidelity Investments.

“If inflation comes down, real rates, which are yields minus the rate of inflation, could rise further into positive territory after being below zero for the past two years,” she says.

This would allow government bonds to carry out their old job of providing a steady level of income for lower-risk savers and pensioners. Bonds could then start making a meaningful contribution to that balanced 60/40 portfolio split again.

Bonds are cheaper than they were after this year’s dip and are starting to look better value for money.

It could soon be time to start buying bonds again, ideally before the Fed starts cutting rates next year to reverse the recession, at which point bond yields will fall again, Ms Emsbo-Mattingly says.

“But the window of opportunity for yield-seekers may be brief,” she says.

There are hundreds of bond ETFs to choose from, including iShares Core 1-5 Year USD Bond ETF, iShares Global Government Bond UCITS ETF (IGLO) or db x-trackers II Global Government Bond UCITS ETF.

Accurately timing bond fund purchases is no easier than timing the stock market, yet recent volatility is throwing up an opportunity.

It may even make bonds exciting.

Updated: July 05, 2022, 1:00 PM


https://www.thenationalnews.com/business/money/2022/07/05/what-does-the-bond-market-turmoil-mean-for-investors/?utm_source=paid+google&utm_medium=paidsearch&utm_campaign=us+uk+always+on&utm_term=&gclid=Cj0KCQjwtsCgBhDEARIsAE7RYh1ru7FE_OrhxgydUWGygjSPzvR2gW8TwdoBc7cuP1pnWRt4dXjGcFYaAslIEALw_wcB

Tuesday 2 May 2017

Relationship between Price and Maturity of Bonds

If the yield remains constant:

  • A premium bond's value decreases towards par as it nears maturity.
  • A discount bond's value increases towards par as it nears maturity.
  • A par bond's value remain unchanged as it nears maturity.

Monday 1 May 2017

Important Relationships of Fixed Income Securities (Bonds)


Defining the Elements of a Bond

Coupon rates and bond prices

The higher the coupon rate on a bond, the higher its price.

The lower the coupon rate on a bond, the lower its price.


Interest rates and bond prices

An increase in interest rates or the required yield on a bond, will lead to a decrease in price.

A decrease in interest rates or the required yield on a bond will lead to an increase in price.

That is, bond prices and yields are inversely related.


Bonds risks and bond yields 

The more risky the bond, the higher the yield required by investors to purchase the bond, and the lower the bond's price.