For those seeking shelter from this year's stock market storm, a rather unsexy yet still dependable asset class beckons – bonds.
Dull old bonds are at their most attractive in years, as they flaunt exceptionally high yields investors may find hard to resist. Last Friday, yields for 2-year Treasury bonds hit a new 15-year high of 4.266%, while 10-year Treasury bonds reached an 11-year high of 3.829%.
Bonds typically serve as a safe haven for capital during times of uncertainty. This is because they are considered lower-risk assets and are notably less volatile than stocks. Bonds also offer a safeguard against inflation, especially Treasury inflation-protected securities (TIPS), designed for that specific purpose.
Yet even the bond market has not been immune from the headwinds in recent weeks. Investor sentiment has turned gloomy after Fed Governor Jerome Powell signaled his resolve to stick the course with ongoing monetary tightening, despite that causing serious “pain” for businesses and households.
The Fed hikes have triggered worrying reactions in international financial markets, including a record sell-off of gilts (British bonds) and intervention in currency markets by the Bank of Japan. These events have coalesced into what Gennadiy Goldberg, a strategist at T.D. Securities, has called a “volatility vortex” for bonds.
Yet bonds remain less volatile than stocks. By the end of September, the S&P 500 index has fallen roughly 23% since the start of 2022, while bond market indexes have dipped about 15% over the past 12 months.
Under these conditions, bonds may offer a middle-ground solution to weary investors who don't have the stomach for the stock market but are still reluctant to liquidate their holdings into cash.
The Interest in Bonds
Multiple factors are feeding into the bond market, chief among them being interest rate hikes.
Bond prices usually sink as interest rates rise. This occurs since the original fixed rate offered by the bond (when rates were lower) becomes less competitive as interest rates move upward, causing investors to sell them off, lowering their market price.
Another factor is the yield (the return on the bond). Typically, long-term bonds offer higher yields than short-term bonds. Investors want better compensation for keeping their capital tied up for more extended periods and remaining exposed to interest rate risk.
Yet, short-term rates are currently substantially higher than long-term rates, which many market analysts interpret as signs of an incoming recession. This “inverted yield curve” happens because investors seek greater yields to cover their losses during a downturn in equities over the short term.
“The bond market anticipates a recession in the first half of 2023 and is already looking forward to the eventual recovery,” Komal Sri-Kumar, president of Sri-Kumar Global Strategies, told CNBC. “That's what happened in 2006, 2007 — we are following the same pattern.”
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Bonds are growing in popularity among a wide range of investors. A July survey from Bankrate.com showed a growing cross-generational appetite for bonds compared with last year.
Asked about investment assets for time periods over ten years, 9% of those surveyed indicated a preference for bonds, up 5% from last year. While that jump came largely from Gen Xers and Boomers, Millennials' appetite for bonds increased to 7% from 5% in 2021.
Several famous faces in finance have been openly fond of bonds in recent weeks. CNBC's Jim Cramer, the host of Mad Money, told viewers on September 22 that he skipped his usual investment in an S&P 500 index and instead “bought tranche of two-year paper” for the first time in over two decades. Billionaire investor Jeff Gundlach also Tweeted on September 27 that he has been buying up throughout the recent slump.
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How To Buy Bonds
There are several ways investors can purchase Treasury bonds.
One option is to buy them directly from the government itself. For this, there is TreasuryDirect, a government website that issues Treasury securities in paperless electronic form.
First-time bond buyers will need to open a new account, which takes roughly 10 minutes. This requires a valid Social Security number (SSN) or Taxpayer Identification Number (TIN), a U.S. address, an email address, a web browser that supports 128-bit encryption, and a bank account.
U.S. government bonds can also be bought on the secondary market, typically via a brokerage or a bank. Big brokerages like Schwab, Fidelity, Vanguard, Interactive Brokers, and several major U.S. banks offer Treasury Bonds. This option may better suit those who already invest through these platforms and would rather keep their bonds there alongside the rest of their portfolio.
During times of volatility, bonds can add safety and stability to a portfolio. For some investors, this may be a prime time to consider bonds. However, bonds may not be ideal over the long term. Historical data shows that the stock market has continually outperformed the return on bonds over many decades.
While the nominal guide of a 60/40 split between stocks and bonds is often cited as a safely-balanced allocation, every investor must come to their own conclusions as to how much of role bonds should play in their portfolios.
This article was produced and syndicated by Wealth of Geeks.