Watch Out for the Bond Market

by Amanda Vaught

2/6/2023

Most financial media keeps their focus on the stock market, but the bond market can be a significant portion of an investment portfolio and a major driver of returns. This often overlooked asset has the potential to be exciting this year.

 The bond market turned heads in 2022 by putting up its worst year for returns since1926. One might think that means that bonds can only move up from here. But will they?

To start, fixed income is paying income again! As the chart below illustrates, an increasing share of the bond market is paying north of 4% yields now. This is significantly more than we've seen over the past decade.

Image via The Financial Times [subscription required]

The Fed was the primary driver of returns in the bond market in 2022. As the Fed raised interest rates on the short end of the yield curve, the yields went up while the underlying price of the bonds went down. Most experts expect the Fed to slow the pace of its rate hikes this year and many expect them to conclude the hikes by June. This bodes well for the battered bond market.

Data via Blackrock. Past performance is no guarantee of future returns.

This is not an investment recommendation, and is for educational purposes only.

Typically, an investment portfolio is comprised of both stocks and bonds in order to add diversification and to serve different functions. (Diversification is important to reduce risk over time.) Stocks and bonds are good diversifiers of each other because they are typically uncorrelated, i.e, they move differently from one another. Over time, they seesaw their way to an overall positive return. 2022 was the anomalous case, where stocks and bonds became correlated and both asset classes fell significantly into October.

 What we'd like to stress, however, is a forward-looking approach. We expect stocks and bonds to get back to their typical behavior of being uncorrelated. This means, that going forward, we do not expect these asset classes to be recovering at the same time or at the same pace. And while the markets do their work to recover, bonds are paying you to wait.

Propel Financial Advisors may change their outlook at any time.