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Is the Bond Bull Dead?

Date: 2/1/2017

Author: Ted Black, CFP®

Dedicating an appropriate portion of one’s portfolio to high quality U.S. Bonds and/ or Bond Funds has long been an integral part of a successful long-term investment management strategy. However, it’s well understood that Bond performance can be directly affected by the level and direction of interest rates.

Although interest rates can be influenced by several items, the Fed Funds rate, which is set by the Federal Reserve’s monetary policy committee (FOMC), and is the rate at which banks and credit unions lend reserve balances to other depository institutions overnight, almost certainly exerts the most influence on the overall rate environment.

It’s common to see short to intermediate term trends in interest rates. However, if we look back from when the Fed Funds rate peaked at over 19% in the early Eighties through to the past several years of historically low rates, the long-term trend in rates has been down, down, down ... until there was almost no further to go. [For some perspective, after just witnessing the third interest rate hike by the Fed, the Fed Funds rate now stands at about 1%.]

Since falling rates create an attractive environment for Bonds, the last 30+ years have been very good to Bonds, and this period is often referred to as the Great Bond Bull. The flip-side of the equation is that rising rates can create a tougher environment for Bonds. And since we’re now seeing rate increases off the historic lows, it’s only natural to wonder how to address any Bond holdings.

In an effort to gain some insight on what to expect for Bonds moving forward, we studied how Bonds performed the last time the Fed increased the Fed Funds rate on a regular and extended basis. The most recent significant uptrend in rates started in the second quarter of 2004. At that time, the Fed Funds rate was at 1%. The Fed raised that rate steadily from that first move in early 2004 through the third quarter of 2006, when rates peaked at 5.25% … which is a pretty significant difference in rates over a roughly 1 ½ year period.

To see how Bonds performed during that period of rising rates, we looked to the performance of the Barclay’s U. S. Aggregate Bond Index®. This index is widely regarded as the benchmark against which Investment Grade Bond fund performance is measured, much like the S&P 500® is the benchmark for Blue Chip stocks. In 2004, the first year of that phase of rate hikes, this index produced a total return of 4.34%. In 2005, the total return was 2.43%. And in 2006, when rates peaked for that phase, the total return was 4.33%. [As an additional note, there are high quality, no-load Bond funds that outperformed this index during that 2004 – 2006 period.]

As we can see, the last round of rising rates wasn’t a disaster for Bonds. I’ve learned to not read too much into historic information, but still find the performance results during this rising rate period to be somewhat illuminating. It’s my opinion that dedicating an appropriate (for your situation) portion of your overall investment to high quality U.S. Bonds is still an advisable strategy, and that it would be premature to begin exiting any core Bond holdings.

If you questions about how your current situation might be affected by recent events, please feel free to call Ted Black, CFP® at 888-878-0001, extension 3.

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