In investing, even "the things we see coming"
are still able to surprise us.
The stock market rallied in a big way after the election much to the surprise of what almost all experts had expected. With Donald Trump as the President-elect and Republicans in control of both houses of Congress, US stocks have run on the prospect of faster economic growth resulting from tax cuts, infrastructure spending, and deregulation. The S&P 500 financials sector alone rose 13.55% in November.
While major US stock indices like the S&P 500, Dow Jones, NASDAQ, and Russell 2000 all made new all-time highs in November, many investors haven't seen their portfolios reach new highs and this has led to the obvious question, "Where are all my gains?"
The answer is that while US stocks rallied hard after the election, other asset classes were not treated as kindly. Specifically, bonds, international developed equities and emerging markets equities have taken a hit since November 8th as you can see in the table below.
|Large Cap Equities
|Small Cap Equities
|Int'l Developed Equities
|Emerging Market Equities
||MSCI Emerging Markets
||Barclays US Aggregate Bond
For more detail on asset class and sector returns read The Trump Trade – What Just Happened?
A typical globally-diversified portfolio with an allocation of 65% stocks and 35% Bonds likely broke even during this brief period as declines in bonds and international stocks offset gains in US stocks. Including market action back to the beginning of August, investors with larger allocations to bonds likely have net losses over the past four months. Financial headlines and news stories have largely not reported this.
Bond are the main culprit. Since hitting an all-time low in July of this year, yields on 10-year Treasury bonds have risen on positive economic reports and the prospects of coming rate hikes by the Federal Reserve. The rise in yields (fall in prices) accelerated in November; by the end of the month, the 10-year Treasury had notched a full one percent increase in yield to 2.37% from the all-time low of last July.
Historically, stocks and bonds have moved in opposite directions in times of extreme volatility but this inverse relationship has diminished over the "New Normal" period of ultra-low interest rates. During this eight-year period, stock and bond prices have often moved together. We may see a return to the inverse relationship of stock and bond performance if we do in fact see a period of rising interest rates.
How Risky are Bonds?
Bonds are far less risky than stocks. For historical context, the worst calendar year return for the Barclays Aggregate Bond Index since the inception of the index in 1976 was a loss of 2.92% in 1994, sometimes known as the Bond Market Massacre of 1994. Through the end of November of this year, including the recent post-election decline, the Barclays Bond index is still up 2.5%. Stocks are much more volatile than bonds. For example, the S&P 500 had a -18.2% return in only one week in 2008 and ended that year with a loss of 37%.
Just as important, the role of bonds in a portfolio has not changed. We own the bonds for liquidity, stability and staying power. They won't give us as much of a return but they'll hold up in a bear market. In our view, bonds are less risky now than they were before the election, primarily due to the price adjustment (loss) we've just endured.
In the weeks ahead the media will feature stories about the carnage in the bond market and these surely will include dire predictions that more pain is coming. For example, a December 2nd article in the Wall Street Journal by Richard Barley is titled, "Global Bond Markets: Into the Maelstrom. The storm that battered bonds in November doesn't seem likely to abate just yet." Headlines like these attract readers and sell ads but remind yourself that the authors can't see the future.
In our experience, widely-held expectations for markets such as the belief that "interest rates have to rise" often are wrong in the short term and only tend to be right…eventually. And in the case of bonds, "eventually" has been a long time in coming. People have predicted higher interest rates for more than a decade now. The recent jump in interest rates may mark the reversal of a long-term trend but on the other hand, it may not.
We've endured several bond market adjustments like this over the last five years—yields jump briefly, prompting shrill calls for "carnage ahead for bonds" only to reverse course and hit new record lows. This happened most dramatically in 2013 when the market had a "taper tantrum" when then Fed Chair Ben Bernanke announced that the Fed would gradually reduce its support of bond prices by tapering its bond purchases through the program known as Quantitative Easing. Bond values fell by 2%-3% in the course of three weeks before reversing and rising to record high levels in subsequent months. Reversals in market trends (stock market rallies or declines, periods of falling rates or rising rates) often take much longer to actually occur than predicted by investors and prognosticators. Sometimes when the reversal happens, the immediate short-term change is abrupt and sharp like that we witnessed in November. This is why even "the things we see coming" in investing are still able to surprise us.
Should the Trump presidency indeed usher in a new era of economic growth, we would anticipate that stock gains will outweigh any losses in bonds. If something else altogether happens—certainly a possibility now, as always—an allocation to bonds should provide a significant buffer against losses in stocks.
In closing, we note that a lot of really smart people were doubly wrong on both who would win the election and what the stock market would do if Trump were to win. Those same people are now projecting what the next four years will bring. We shouldn't make investment decisions based on their predictions. Instead we should maintain our discipline and continue to own a diversified portfolio that is appropriate for our own personal circumstances.