In our Weekly Market Update we have made an effort to track the deflationary story being told in the global fixed income markets, specifically sovereign yields have continued to trade lower defying what most investors thought was possible; Swiss 10 year debt recently yielded 25 basis points. A while back I quoted a Seth Klarman Tweet about German debt trading at multi-century low yields.
Many thought that the 30-plus year bull market ended in June of 2013 when the Fed first talked about tapering its asset purchases (the Fed never actually used the word tapering in its statements) which caused a pretty violent, albeit short-lived, panic in the bond market. Arguably the bull market has continued through today with no idea of how long it can last.
Although there is folly in trying to predict when rates across the bond market will actually rise (the Fed only controls a couple overnight rates; the Fed Funds Rate and the Discount Rate), with the Fed’s telegraphed intention to start raising rates by the middle of next year it becomes prudent for market participants (both advisors and do-it-yourselfers) to game plan a rising rate environment. The sense of panic that occurred in June 2013 should make the need for this clear. Emotions can trigger from both equity and fixed income market volatility and of course periods of heightened emotions are when investors are more likely to make poor decisions.
As a reminder there is a general rule of thumb that a ten year bond will drop 8% in price for every 1% increase in interest rates. Yes, an investor will likely get their principal back at maturity but if they wait until maturity they are collecting a below market yield until the issue finally does mature.
Certainly shortening maturities will avoid most of the brunt of a big lift in rates but an entire fixed income portfolio that only yields 80 basis points will be difficult for clients both in terms of their patience and keeping their financial plans on track.
In terms of solutions there are of course several different paths to take. Coincidentally, the Barron’s cover story this week looks at Best Income Ideas For 2015. While it is a good article it is kind of a strategy free list of various income segments some of which can be very volatile including dividend stocks which as we’ve said before; dividend stocks are stocks not bonds and their volatility characteristics are not like bonds. They may be low vol for equities but that is not the same as fixed income.