Regardless of your geographic location, you’re aware that our world continues to face a myriad of uncertainties. Geopolitical and armed conflict, market volatility, inflation, and a host of economic data points dominate the 24/7 news cycles. What are we to make of it?
I won’t patronize you with clichés or platitudes. The market has been difficult, and we have seen negative performance across the spectrum of strategies we manage. Virtually no asset class has been spared the effects of supply chain disruptions and resulting inflation. I’ll further spare you an economics lecture except to briefly explain the negative impacts of inflation on bond holdings, and how we address it inside of managed portfolios.
Simply stated: bondholders experience decreased valuations when interest rates increase or are expected to increase. Consider that if you are holding a $1,000 face value bond with a stated “coupon” rate of 10%, you are being paid $50 every six months as a “yield” on that bond – the interest rate you receive as the creditor to the institution to whom you loaned money. Now consider if market interest rates increase to 11%. The value of your 10% coupon bond is no longer $1,000, because a potential buyer of bonds in the open market can pay the same $1,000 that you paid for your bond but receive a higher interest rate (11% in this case). To sell your bond in the open market, you must discount the price you paid…your bond is no longer worth $1,000. This scenario is playing out in the nearly $100 Trillion (yes, with a “T”) bond market worldwide.
You would be right to ask why would we continue to hold bonds and how do we combat the effects of increasing interest rates on bond values? To answer that adequately, we need to consider a facet of the bond market referred to as “duration” which can be summarily defined as a bond’s sensitivity to interest rate movements. The technical definition involves the discounted value of future payments, but if I wrote any more, I would lose you as reader if I haven’t already done so! Suffice to say, shorter-term bond maturities of higher quality are more resilient to rate increases. Furthermore, bonds mature over time – we should expect new bonds to be issued at higher market rates which will ostensibly reward investors with higher yields. We have consciously selected shorter-duration, higher quality bond funds in our strategies and firmly believe they remain a relevant component for clients who near or at retirement. There is certainly more to be discussed on the topic, but I will leave it here in the interest of brevity.
Are we in a recession or is one coming? Technically speaking we have not yet met the criteria of a recession as we have not experienced two consecutive quarters of negative GDP growth. Q1 of 2022 saw a contraction of 1.5%, and the forecast for Q2 is positive. Markets are almost certainly reacting negatively to the simple fact that in a credit-dependent economy, the cost of borrowing is increasing, and it is undetermined to what extent companies can pass higher costs on to consumers and maintain profitability.
We’ve officially entered a bear market defined by a 20% decline in a respective index (S&P 500 for example). The average bear market lasts less than a year and experiences a decline of 36%. It is anyone’s guess if this will be a “run of the mill” bear market and if recession will ensue. If it is, we’re over the halfway point. Further prognostications are simply unhelpful as the temptation is to slip into market timing. We maintain that now is the time to be reminded of the long-term disciplines that have rewarded investors, and market timing rarely works and is almost never repeatable. Your portfolio is informed by your financial plan, which is informed by your goals, time horizon, assets, risk tolerance, etc. Allowing emotions to inform actions has proven time and again to be detrimental to long-term investment performance as our decisions tend to lag the market.
Hang in there. This might get worse. If you’re concerned about your accounts, please reach out and let’s discuss it as soon as possible.
Disclaimer: All information is for informational purposes. No information detailed here constitutes an offer to sell or buy a security. This summary does not constitute advice. Investors should always seek investment advice specific to their unique financial situation and objectives.
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