After Their Worst Stretches Ever, Bonds Are On The Mend This Year

After one of their worst years ever, bonds are recovering in 2023 as the investment vehicle reclaims its role as a successful stock hedge. As an illustration, during the most recent bank crisis, investors looked to Treasurys for protection.

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That wasn't the case the previous year when an increase in interest rates reduced the value of Treasury bonds and caused a decline in the value of stocks. The two declines caused investors to lose faith in the 60/40 portfolio approach, which refers to keeping 60% in stocks and bonds and has long been regarded as the cornerstone of wise investing. Given that bond and stock markets frequently move in opposite directions, it called into question the long-held notion that diversification among assets boosts returns and prompted some in the investment community to pronounce the strategy "dead."

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According to Gina Bolvin, head of Bolvin Asset Management Group, "Bonds are acting like bonds again." "Despite continuing high inflation rates and the Fed raising interest rates, high-quality bonds are surging and acting as a buffer against equity risks as the equity market declines. It's encouraging to see bonds resume their function as diversifiers in a diverse asset allocation after the challenging year of last year.

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The iShares 20+ Year Treasury Bond ETF (TLT), which is up 7.3% in 2023 after falling 32.8% in the previous year, is a good example of this recovery. Additionally, after falling 17.9% last year, the BlackRock 60/40 Target Allocate Fund Institutional Shares (BIGPX), an ETF that tracks returns on a 60/40 portfolio, is up 3.4% so far in 2023.

Both asset classes are making a comeback as a result of those gains. After losing 19.4% in 2022, the S&P 500 has gained 3.4% so far this year, trying to make up ground after suffering its largest annual loss since the Great Recession. After losing over 13% and having its worst year ever in 2022, the Morningstar U.S. Core Bond Index increased 3.4% this year.

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U.S. 2-year and 10-year Treasury rates remain very close to their top levels in more than a century after last week's downward movement.

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According to Ross Mayfield, an investment strategy analyst at Baird, "it appears that the cycle high for yields is certainly in, but there's still value and return in bonds that investors have rarely seen since the financial crisis."

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"An appropriate time"

Following the bank closures, investors have been moving to areas of the fixed-income market perceived to be of the greatest quality, which has resulted in robust flows into money-market funds in recent weeks. Treasury bills and other short-term liquid securities are held by money market funds.

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Sara Devereux, head of global fixed income at Vanguard, said: "For investors who might have backed away from notes because of their failure in 2022 or because of the years of low rates before that, it may be an ideal opportunity to explore adding bonds to portfolios."

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Furthermore, Devereux advised concentrating on a high-quality fixed income, such as U.S. bonds, because bonds often rise during a downturn as benchmark rates fall. Municipal bonds, Treasury bonds, and agency mortgage-backed securities. Investors should look for credit risk and a probable recession as well as the opportunity to increase the yield on corporate bonds.

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Chris Fasciano, a financial planner at Commonwealth Financial Network, emphasized quality fixed income as a way for investors to further diversify their credit quality on the relationship side of a 60/40 portfolio while also locking in attractive income. Quality fixed income can help reduce price volatility while also helping investors lock in attractive income.

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Bond yields are still attractive as the first quarter of 2023 winds down, according to Sam Millette, a fixed-income analyst with Commonwealth. He mentioned the 10-year U.S. 3.9% in Treasury

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Also, he advised investors to avoid over-allocating to lower-quality bonds, which have a larger risk of default, due to the current high yields.

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According to Millette, fixed-income investors may experience further gains through the end of 2023. Over the rest of 2023, he said, "the mix of still high yields, as well as the potential for price increase in times of market instability, make for a relatively appealing case for fixed income."

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The outlook for high-quality bonds after last year's performance, according to Bolvin, is the best she's seen in ten years. Starting yields could indeed help predict future rates of return on an investment, and current performance shows "the runway for solid returns within limited income is just getting started," she said.

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Adding or not adding?

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Should investors increase their exposure given the bond market's bullishness?

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From the beginning of the year, Commonwealth Financial has not adjusted its allocations.

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Bolvin reduced her stock overweight in her tactical model, though, noting improved bond return possibilities. She reduced equity exposure to 63% by reallocating 2% to bonds.

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She also advised sticking with bonds with AAA or AA ratings in the fixed-income market, arguing that investors should look to equities instead of lower-rated bonds for risk. Due to the preferred stock being dumped during the financial meltdown, Bolvin has also upgraded them. In a typical balanced portfolio, Bolvin said she would take into account a preferred stock allocation of 2% to 5%.

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She also advised investors to increase their holdings of high-quality bonds when the market declines if they don't believe interest rates will be reduced soon or significantly.

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In 2023, diversified portfolios will perform a better job of assisting investors in reducing volatility, according to Bolvin, who forecast earlier that the 60/40 portfolio will be revived. This is in part due to bonds.

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The fact that stocks and bonds are generally performing well at various times has made the trip easier for investors, according to Bolvin, even though returns for both have been good so far this year. The goal of a 60/40 portfolio is to achieve that. We believe the chances of a diversified portfolio are at their greatest after all the calls for the death of the 60/40 last year.