The bond market turned in its worst performance ever this year, a unique time when it provided little shelter from the storm in financial markets. That was particularly painful for investors watching their stock portfolios sink into the red as well, with the S & P 500 down 19.3% for the year. Bonds have provided solace in the past, acting as ballast, cushioning portfolios from the worst stock market losses. “Let’s start by saying, nobody’s ever seen anything like this,” said Jim Caron, head of macro strategies for global income at Morgan Stanley Investment Management. The Bloomberg US Aggregate Bond Index was down 12.4% for the year, as of Friday’s close. Caron said its prior worst year was 1994, when it declined 2.9%. According to Bloomberg data, the index has only been negative five times since 1976. “As far as returns go in simple measures, that’s as bad as it gets. Equities are down about 19%. There was no safe place to hide,” he said. “There was no place to go… inflation was 7% and that’s what you lost in cash.” When bonds lose value, the price declines and the yield goes up. The Federal Reserve’s rapid lift off from its zero interest rate in March to a range of 4.25% to 4.5% now sent bond yields screaming higher. With global central banks all on the same trajectory, the bond market was under extreme pressure. The benchmark 10-year Treasury yield, for instance, was at 1.51% at the start of the year, before spiking as high as about 4.30%. It was at 3.75% Friday. Besides bond investments, that particular yield influences mortgage rates and all kinds of consumer and business loans. For investors, the tried-and-true 60/40 investment strategy failed, since both stocks and bonds fell. Portfolios modeled that way are typically spared the crushing blow from a down stock market because bonds are often viewed as a safety play in a market rout. That lifts the 40% bond side of the portfolio. But that didn’t happen this year. “Unless rates go up as much as they did this year, which I hope they don’t, it’s going to be hard for it to be worse,” said Morgan Stanley’s Caron. “It doesn’t mean it won’t be negative, just mathematically, it won’t be worse.” Rick Rieder, BlackRock’s chief investment officer of global fixed income, said yields could still go higher but the bond market has gotten to a place where investors can find a good return. He expects the 10-year Treasury will edge back above 4%, but yields could move lower in the second half of the year, rates will come down as inflation cools. Rieder said the 20-year average for the 10-year yield was 2.90%. “I think 2023 is going to be a banner year for fixed income and not so much because it’s going to be rates rallying, just because the carry is so darn attractive,” said Rieder. “I think the returns on fixed income next year could be quite good.” The carry is the difference between the yield on a bond and the cost of holding that instrument. Rieder currently favors bonds with durations of five years or less. He expects interest rate volatility will come down, and that will be positive for assets including corporate bonds and mortgages. Stocks are still likely to be volatile and risky and could continue to decline, he said. “I could buy general quality fixed income at 5.5% to 6% and put it in,” Rieder said. “Are we going to get an 8% return in equities next year? Maybe.” Rieder said he is more positive on the economy than many. “I don’t think the economy is going into a deep recession, but I don’t think the odds are zero either. Equities priced at an 18 multiple are not giving you a lot of room,” he said.
