Should We Be Worried About a Bond Bear Market?

The Dreaded 3% is getting dangerously close! Of course, we are referring to the yield on the 10-year Treasury note which closed Friday (2/23/2018) at 2.87%. The last time it traded above 3% was in January 2014. CNBC pundit Art Cashin, the Director of Floor Operations for UBS Financial Services at the New York Stock Exchange, warned us that once the 10-year yield hits 3%, “All hell will break loose.” Mr. Cashin appears to have been referring to both the bond and the equity markets. Not to be outdone, CNNMoney chimed in with “Why 3% Is the Scariest Number for Stocks.”

The recently crowned “Bond King” Jeffrey Gundlach at DoubleLine Capital has also highlighted 3% as critical to determining whether the three-decade bull market in bonds is at an end. The prior bond king Bill Gross went a step further last month when he declared that the bond bear market is finally upon us. On that day (1/9/2018), the 10-year yield closed at 2.55%. A few weeks later (1/31/2018 in a CNBC appearance), Gross tempered his forecast as a “mild bear market” with the 10-year Treasury note breaking even for the year. Either way, everyone can agree that a bear market for bonds (especially among the highest quality issues) looks nothing like a bear market for stocks.

Even with the recent increases, interest rates remain well below their historical averages. If, indeed, we are experiencing a reversion to the mean, there is no reason to believe that the reversion would be sudden rather than gradual. It is essential to understand that there are three sources of returns for bond investors—interest rate movements, coupon payments, and price changes resulting from rolling down the yield curve.

Bottom line: Even if we are at the cusp of further increases in interest rates due to higher inflation, it is not a reason to abandon the bond positions in a balanced, diversified portfolio. Bonds still perform the critical task of lowering portfolio volatility while delivering a positive real expected return and providing a reliable stream of income. It is important to have diversification among both maturities and issuers, with a substantial percentage allocated to the highest quality sectors. Furthermore, as with equities, there is no magic number like 3% where once it’s breached, blood will start flowing in the streets. If you would like to learn more about Clarity’s approach to bond investing, please call us at 800-345-4635 or email us at info@clarityca.com.