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Interest Rate Head Fakes

Sigma Investment Counselors

May 15, 2015

We have seen significant sell-off in the bond market over the past few weeks as the markets try to get their arms around future Fed actions.  These sharp moves in yields can cause one to be uneasy about what could happen.  The fear is that interest rates project upward causing large losses in bond portfolios.  That fear is real and could potentially happen.  However, do not let the volatility of the bond market create fear and cause you to act unnecessarily.  We have seen many head fakes in the bond market over the past few years.  Therefore, bond markets need to be viewed from a similar long term lens as stocks.

Bonds held in an investment portfolio have a significant role.  A high quality bond portfolio provides the safety, security, and downside protection necessary to achieve specific goals.  Historically, bonds have paid a nice fixed income along with the preservation of capital component.  In the current interest rate environment, income is minimal as investors demand for safety continues to hold yields at historic lows. 

The bond market has been very volatile since the recession.  Over the past 5 years, we have seen large shifts in the 10-yr US Treasury yield.  Looking at the graph below provides some perspective to the large swings in the 10-yr Treasury yield in very short timeframes.

 

 10 Year Treasury

 

From 4.0% in early 2010 to less than 2.5% a few months later, and back up and down again over the last five years.  This graph tells me that the recent selloff was real, but insignificant in the grand scheme of things.  We have seen this before and it is likely we will see it again as the economy continues the slow recovery and markets overshoot expectations on both the upside and downside.

We are all risk takers when markets are moving higher and therefore little value can be seen in bonds currently.  Yet, that unpredictable equity downturn that occurs in the stock market every year is when the value is added.  According to JP Morgan, 19 of the last 35 years have had intra-year stock market (S&P 500) downturns of 10% or greater and the average intra-year drop was 14.2% yet the annual return of the stock market (S&P 500) has been positive in 27 of the 35 years.

When, how low, and for how long is what everyone wants to know about the future of markets.  Nobody knows, and the individual or computer that gets it right will have a difficult time replicating their value of timing the market.  Investment portfolios, similar to interest rates, have many moving parts and stocks and bonds play a significant role in achieving financial goals.  Long-term strategies and discipline allow investors to be successful.

All suggestions and comments are welcome.

Tony Basalla

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