As a general rule, if you aren’t prone to thrill seeking, you tend to stay on the ground while others bungee jump. In a similar vein, investors who want to avoid the ups and downs of financial markets tend to favor bonds over equities.
Unfortunately, in recent weeks, many bond investors have suffered a nasty surprise.
The prospect of less monetary accommodation from the Federal Reserve (Fed) has sent bond market volatility to its highest level since late 2011, as the chart below shows.
But while the recent volatility spike has been a shock to many, it’s important to put it into context.
To start with, bond market volatility is rising from an unusually low level. Over the last couple of years, bond markets were unusually calm. In fact, as the chart above shows, the doubling of volatility since the spring represents a return to long-term average volatility rather than a bond market crisis. (The same is true of recent equity market volatility, which has also now reverted back to its long-term average.)
In addition, bonds aren’t the only more volatile asset class. Every asset class, from stocks to gold, has experienced a pronounced spike in volatility as investors digest the possible impact of the Fed tapering its bond buying program. And though tapering isn’t likely to derail the recovery, I expect that volatility is likely to continue in coming months as investors accustomed to ever looser monetary conditions adapt to tighter money.
So where does this leave bond investors worried about more of the same rocky road ahead? Here are three portfolio positioning suggestions:
1. As I’ve been recommending all year, be mindful of your bonds’ duration. While I believe rates may pull back in the near term and I expect the 10-year Treasury note to finish the year around 2.5%, the long-term direction of interest rates is higher. This suggests investors may want to consider owning bonds with shorter maturities, which should be less sensitive to rising rates.