The worst bond market in history

John Rekenthaler

Portfolio Matters

In the grand scheme of things, balanced portfolios have not performed terribly in recent months. The chart below shows the worst 12-month returns since 1926, adjusted for inflation, for a US-based portfolio consisting of 50% stocks, 40% medium-term government notes, and 10% of cash. (For the sake of simplicity, I have included only the steepest loss recorded during each bear market.)

A bar chart showing the largest 12-month losses for a portfolio consisting of 50% US stocks, 40% US government bonds, and 10% US cash, adjusted for inflation, during the 6 worst bear markets since 1926.

Although the results have not been pretty, overall rates of return are just that bad, not historically horrible. The largest loss of the Great Depression was not only nearly twice the size of the current decline, but three other periods also saw significantly larger declines: 1) the 2009 global financial crisis, 2) the 1973- 74, and 3) post-World War II funk. Somewhat worse than this year was also the headache that followed the years of “come and go” from the 1960s.

(The absence of a chronological pattern is worth noting. In order of magnitude, all six selloffs occurred during the 1930s, 2000s, 1970s, 1940s, 1960s, and 2020s. Perhaps we can regard the Great Depression as an anomaly that will not repeat itself. Since then, however, there is no indication that bear markets have become less frequent or less severe over time.)

Saved by

The relative blessing for the market this year has been equities. For the most part, balanced portfolios go where their stocks take them. (This idea informs the strategy for risk parity funds, which have sorely disappointed their investors in 2022. But that’s a story for another column). Growth stocks have struggled in recent months, but value stocks have held their own. As shown below, your support has made 2022 look pretty good from a capital perspective alone. (The exercise is carried out as before, looking for the lowest 12-month real returns, but this time it is calculated only from the performance of US stocks.)

A bar chart showing the largest 12-month losses for a portfolio consisting of 100% inflation-adjusted US stocks, during the 6 worst bear markets since 1926.

At negative 21.6%, the recent stock market crash fails to crack the bottom six.

bad news bonds

Same, unfortunately. Can’t tell about bonuses. Among fixed income securities there has been no safe haven. Interest rates have skyrocketed along the yield curve, thus sinking all investment grade debt. Lower quality notes have also had problems. Sometimes when interest rates rise, junk bonds work well because credit spreads tighten. Not this year. Instead, credit spreads have widened on fears of a recession. The result has been comprehensive losses in the bond market.

The following exhibit proves the point. It is calculated in the same way and over the same period as the two previous charts. In other words, it presents the worst results of the last 12 months since 1926, including the effects of inflation. In this case, however, the illustration shows medium-term US government notes, rather than balanced portfolios or the national stock market.

A bar chart showing the largest 12-month losses for a portfolio consisting of 100% medium-term US government notes, adjusted for inflation, during the 6 worst bear markets since 1926.

Two elements of this chart stand out.

First, the bars are much shorter here. It is true that bond market spreads can be volatile. For example, long-term Treasuries fell 34% in real terms from November 2021 to October 2022. That almost matches the lowest real return for a balanced fund during the Great Depression! But major fixed-income securities, the kind that are held within a medium-term government index or major taxable bond funds, tend to be fairly stable.

Second, current bond market rates as the worst in the last century. Barring further substantial losses, the stock market crash will soon be forgotten, buried in a database for future internet columnists to dig up. But the bond market recession will be remembered for a long time. The loss after inflation for medium-term government bonds has been even greater than during the second oil shock that ran from 1979 to 1981, when 10-year Treasury yields peaked at 15.8%.

an imperfect storm

This is because US bond yields were at their lowest point when this bear market began. Except for a brief stretch in 2013, and again when the coronavirus pandemic hit in the spring of 2020, Treasury payments have not been below summer 2021 levels for at least the last 150 years. Since bond yields are inversely related to price, Treasuries were at their most expensive when inflation began to pick up. A more dangerous combination for bond prices can hardly be imagined.

A line chart showing the monthly yield on medium-term Treasury notes, from 1926 to October 2022.

Fund investors, and perhaps pension fund managers as well, though the data to do that analysis is lacking, ended up buying high and selling low. In 2021, taxable bond funds posted their highest ever sales, receiving $340 billion of new net assets. This year, by a not-so-fun coincidence, they’ve suffered the same dollar amount of net redemptions. Investors walked in the door when Treasury payments were 1% and got out when they hit 4%. Buy high, sell low.

conclusion

In 2010, the financial press printed history after history about big bond bubble. Those predictions turned out to be, as Mark Twain said of the reports of his death, premature. Although bond yields rose shortly after those articles were published, they soon settled back down. Ten years later, the yield on medium-term Treasury notes had fallen below 2010 levels. The great bond bubble was no such thing.

However, if the timing of the warnings was misplaced, the sentiment was not. Buying stocks when their prices are unusually high, in the belief that they will grow even higher, can be a profitable strategy. It was for Japanese stock buyers in the mid-1980s, Internet stock enthusiasts in the late 1990s, and Treasury investors a decade ago. But, as recent events have shown, that strategy is nothing if not dangerous.

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