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Mike Moreland

January 30 , 2017

An Underwhelming Response

An Underwhelming Response

The Dow Jones Industrial Average crossing the 20,000 mark was the event of the week.  Headlines, long histories in the financial press, and projections for the years to come were abundant.  What was missing?  The sense of euphoria that accompanied the Dow crossing 10,000 in the runup to the dot.com bubble seventeen years ago.  It was the early days of cable financial networks and all were cheerleaders first, reporters second.  This time around the coverage is more subdued.  Perhaps it’s the fact that memories are long; perhaps it’s a sense of perspective that taking nearly two decades to double an index return is no reason to pop open the bubbly. 

One market event receiving little attention is the end of the three-and-a-half decade bull market in bonds.  Ten year U.S. Treasury notes reached 15.8% in September 1981.  In the following years inflation was tamed and a series of monetary policy actions pushed yields down and prices up.  We believe the low was set in the post-Brexit period in midsummer, when the ten year yield touched 1.36%.  As that moment passed, and economic activity showed signs of accelerating, longer term rates rose, nearly doubling by late December following the Fed’s rate hike and indication of more to come in 2017.

From a broader perspective, the end of the bull market in bonds means investment management is entering an era most have not experienced.  Balanced portfolios have done well for decades with both stocks and bonds having the wind at their backs.  There was little opportunity cost for the risk control aspects of diversified portfolios.  Going forward, the benefits of diversification will come at a higher cost – bond returns will be less lucrative than in the past.

One outcome of this may be an assumption of higher risk to meet return goals – intentionally or not.  Investors will see calls to place greater emphasis on equities, the only marketable, growth-oriented asset class left standing. This is logical, at least most of the time.  What will be forgotten, however, is the importance of diversification in reducing risk.

The Case for Bonds: Principal Preservation

The chart on this page shows stock and bond histories from a different perspective – how bad can things get?  Over the past quarter-century the magnitude of periodic stock drawdowns dwarfs that of bonds.  Even if bond losses are more frequent going forward, they will not approach those of equity markets.  The principal preservation characteristics of bonds in a balanced portfolio remain intact.  The cost of carrying this insurance will rise, but the benefits are worth the expenditure.

How does this affect your portfolio? Contact your Security National Bank Wealth Management advisor for an update.

 

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