Admittedly, the bond market is far less exciting than the stock market. Yet, we believe it is imperative for investors to understand basic fundamentals of fixed income investing and align their portfolios not only according to the current yield curve but given an expectation of where future rates may be headed.
For perspective, the 10-year Treasury bond posted its highest yield in October of 1981, registering 15.8%. While this peak was very short-lived, yields did remain above 10% between 1980 and 1984.
Over the next 30 years, albeit in a very erratic fashion, interest rates have fallen by a considerable margin, bottoming at 1.4% in July of 2012. From this market low, we watched the 10-year Treasury move up to 3.0% by year-end 2013, only to retreat somewhat during the first five months of this year. At the present time, the yield appears to be fluctuating between 2.5% and 2.6%.
While we do not profess to be in the interest rate predicting business, it is our contention that the current level of interest rates remain below average and is likely to trend higher as the Federal Reserve continues to taper and as our economy grinds forward. All else remaining equal, as rates rise, bond prices tends to fall. While we are not predicting a radical increase in rates, we do believe interest rates will rise to more normalized levels over the long-term horizon.
During this transitional period, we believe maintaining a short to intermediate duration bond portfolio of high quality securities with a modest exposure to Treasury Inflation Protected Securities (TIPS) and high yield bonds is the appropriate strategy for most investors. This is also consistent with our belief that fixed income securities are held in one’s portfolio to provide current income, asset protection, and to provide stability during uncertain times.
All comments and suggestions are welcomed.