Bonds Are Boring Again. But Political Turmoil Could Change That.

Bonds Are Boring Again. But Political Turmoil Could Change That.

Bonds have begun to recede into the background, where they belong. As steady earners, they don’t even try to compete with stocks, the prima donnas of the investing world.

The first half of the year was mediocre for bonds, but that counted as a colossal improvement. All too frequently in the last three years, bonds demanded attention for the worst of reasons.

Now, though, with the annual inflation rate falling, the fundamental outlook for the rest of 2024 and beyond is more positive for bonds than it has been in some time. If you’ve got cash sitting in a money market fund earning 5 percent a year in interest or more, you may want to start planning ahead because those lovely short-term interest rates could start to decline fairly soon — while bond returns would receive a hefty bonus.

But with mounting uncertainty about the country’s political future since the Trump-Biden debate, there are already signs that navigating the bond market will be tricky. Here are some important factors to consider, and some ways to handle them.

First, some investing essentials.

Stocks are risky. I’ve always known that, and I’m prepared to take periodic losses with them, in the expectation of receiving excellent long-term returns. But bonds? They’re supposed to be safe — a balm when the stock market inflicts pain.

They’ve been anything but soothing over the last several years. The market has been so bad that I’ve sometimes wondered whether it’s worth holding bonds at all. Just look at the numbers.

Since the start of 2022 through October of that year, as inflation soared and interest rates rose, core bond funds that mirror the main investment-grade benchmark — the Bloomberg Aggregate Bond Index — were pummeled. That index fell more than 15 percent in that period, including interest and dividends, and so did the funds that track it, like the Vanguard Total Bond Market Index Fund and the iShares Core US Aggregate Bond ETF.

At the same time, the S&P 500 lost almost 18 percent, including dividends. Bonds didn’t stabilize portfolio returns in the stock downturn. They made matters much worse.

Bond returns have improved since then, but not by much. In the first half of this year, that core bond index was still down slightly, and was 9 percent in the red from the start of 2022 through July 3.

To be fair, bonds have been fine investments, even in these rough years, in limited cases. Because you incur no losses if you hold a high-quality bond until it matures, individual bonds have worked well for limited periods and purposes: like parking money safely until you are ready to buy a house or put a child through college. Solid bonds — Treasuries, investment-grade corporate bonds or high-quality municipal bonds — have also been useful for people who need to generate safe income for retirement.

But bonds and bond funds have a broader purpose than that, as a permanent part of diversified portfolios, and in that respect, they have been disappointing.

History suggests that what we’ve just experienced is a rarity, however. This ordeal seems to be just about over, with one big exception:potential market turmoil stemming from the presidential race.

Let’s start with the core bond market issues

Consider how well bonds have performed over long periods. From Jan. 30, 1976, through June, the Bloomberg Aggregate Bond Index gained an annualized 6.5 percent. From 1984 until 2021, bond market returns were positive almost every year.

Interest rates and inflation are crucial for bonds, and for people buying bonds, they have improved a great deal.

This can be confusing. Higher yields give bondholders more income. The problem for investors comes when rates or yields are rising because bond prices then fall. That’s why bondholders, and bond funds, took losses in recent years.

During the financial crisis of 2008-9, short-term rates controlled by the Federal Reserve fell to nearly zero and rates for longer-term bonds, which are market-driven, fell, too. Those declining rates led to rich bond gains then — but also set up the debacle of the last few years, when inflation and interest rates soared.

We’re living in a more benign environment now, for both inflation and bond yields. While inflation hasn’t been vanquished, it has been tamed.

At the same time, interest yields are already fairly high. The 10-year Treasury note peaked at about 5 percent last October, and is unlikely to pierce that level again soon, in the consensus market view. At the current trading range, of 4 to about 4.5 percent, “10-year Treasuries are a good value,” said Jeff MacDonald, who heads fixed-income strategies at Fiduciary Trust International, a subsidiary of the asset management company Franklin-Templeton.

The odds are that yields for many taxable and tax-exempt bonds will be lower a year from now, he said, which would produce bond price gains on top of the income that bonds generate.

Furthermore, if you have kept your cash in money market funds, where yields above 5 percent are commonplace, you may want to think about shifting some money to bonds or bond funds. The Fed’s own projections suggest that it will start cutting short-term rates by the end of the year. Money-market fund yields would start to fall rapidly then, and it might be too late to lock in attractive bond yields.

If the economy begins to stall, interest rates could drop “faster and lower than the markets now expect,” said Gennadiy Goldberg, head of U.S. rates strategy for TD Securities. “It makes sense to get ahead of that.”

The stock market has barely reacted to the questions hanging over the presidential race. But the bond market has.

Longer-term bond rates leaped higher right after the debate, in response to an apparent rise in the electoral prospects of former President Donald J. Trump and Republican candidates for Congress and the worsening outlook for the Democrats.

Those steeper rates probably reflected concerns that Mr. Trump could control Congress as well as the presidency. He could then push ahead with policies like deeper and broader tariffs, along with tax cuts that could significantly widen the budget deficit. All that could contribute to higher inflation and interest rates.

Bond yields have since retrenched a bit and the political situation is fluid. It’s no longer even clear whether President Biden will be the Democratic nominee. At the moment, it would be wise to proceed cautiously.

Some bonds will be more vulnerable if rates suddenly shift. Remember that when rates rise, the prices of longer-term bonds drop more sharply than those for shorter-term securities. Right now, big bets on longer-term bonds would be risky. And high-yield bonds, also known as junk bonds, tend to be poor choices when the bond market runs into trouble.

The Bloomberg U.S. Aggregate Bond Index tracks a conservative section of the market. It has a duration — a sensitivity to interest rates — of about six years, and includes only government and high-quality investment-grade bonds. I’d think twice about buying bonds or bond funds riskier than that right now.

In fact, if the political situation becomes even dicier, simply holding cash — in money market funds or savings accounts or another safe place — may be a smart temporary move.

But bonds, especially Treasuries, can be a refuge in a real crisis. That’s an enduring reason to hold them. Yet bonds are at their best when they are quietly doing their main, unglamorous job: generating income and smoothing the bumpy ride of stock portfolios. I’m hoping the political world will permit bonds to be excruciatingly boring.

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