The April Issue of the ETF Investor Guide is AVAILABLE NOW! Links to the April Data Files have been posted below. Market Perspective: Rate Hikes Loom even as Inflation Slows The […]

The April Issue of the ETF Investor Guide is AVAILABLE NOW! Links to the April Data Files have been posted below. Market Perspective: Rate Hikes Loom even as Inflation Slows The […]
Click Here to view today’s Global Momentum Guide The Russell 2000 Index gained 0.58 percent last week and the MSCI EAFE 0.03 percent. The S&P 500 Index fell 0.10 […]
The same cannot be said for bonds. They entered a major bear market in 2020, and it accelerated in 2022. If one investment bank is correct, the 10-year U.S. Treasury bond suffered its worst performance since 1788, a year when much of the world assumed the fledgling United States could fail. Last year, the 30-year Treasury bond suffered larger losses than the Nasdaq 100 Index.
Those losses stopped in October 2022 as investors digested the turn in inflation. Monthly inflation numbers peaked in June 2022 and slumped quickly before accelerating slightly in 2023. If the recent slide in crude oil holds, monthly numbers will turn down again. Crude oil is a very reliable indicator of future inflation, and the current slump could help drag CPI numbers below 4 percent. At that point, the Federal Reserve would very likely hold interest rates steady because the current level of interest rates is a historically normal level for a CPI of between 3 and 4 percent.
Higher interest rates are good news for savers and investors looking to buy bonds. After years of offering zero percent returns, many short-term bond and money market funds offer yields of 4 percent or more. For the bond sleeve of a portfolio, there are a great many potential investments after the rise in rates, with even short- and intermediate-term government bonds offering decent income.
One corner of the bond market that remains volatile is long-term government bonds. These bonds have the longest duration in the market, meaning they have the greatest amount of interest rate risk. The 30-year, zero-coupon bonds are the highest risk. They’ve tumbled more than 50 percent since peaking during the pandemic. At that time, those bonds were “return-free risk,” as some banks are learning these days. It made no sense to have these bonds even as a trade because the upside was highly limited and the downside was not. Pimco 25+ Year Zero Coupon U.S. Treasury (ZROZ) and Vanguard Extended Duration (EDV) have these types of bonds in their portfolios, while iShares 20+ Year Treasury (TLT) has interest-bearing bonds that have somewhat lower duration.
These bonds remain highly aggressive for an investor’s bond sleeve because of their volatility. However, given the decline in the bonds and the relative valuation of equities, there is a case for holding them in place of some growth stock exposure.
There are four ways two assets can behave in relation to each other. Both increase; both decrease; one rises, and the other falls; one falls, and the other rises. In 2022, Invesco QQQ (QQQ) and the three aforementioned long-term bond funds — TLT, EDV and ZROZ — all lost more than 30 percent. Due to inflation and rising rate concerns last year, both bonds and stocks traded similarly.
One possibility is that these bond funds and QQQ will continue sliding together. They stayed largely correlated until the bank failures in March. If they remain correlated moving forward, then we expect the risk for stocks will exceed that of bonds. As the interest rate rises, bonds lose money in a fairly linear manner. However, as we saw with banks in March, at certain levels of interest rates, companies can start going bankrupt. If inflation and interest rates are headed for new highs, bonds will do poorly, but stocks probably will fare worse.
If this scenario plays out, cash or short-term bonds would be a better alternative to either stocks or long-term bonds.
The next possibility is that both stocks and long-term government bonds rally. Both tumbled in 2022, and both have done well in 2023. The Nasdaq pulled ahead as of March 16, with a 15.22 percent return in 2023, while TLT had a gain of 6.27 percent, the lowest of the three bond funds. Investors may not have as much upside with bonds as stocks, but stocks cannot rally much if bonds sell off again.
The next possibility is that bonds fall and stocks rise. We see this as highly unlikely right now. A significant move lower in bonds will pull stocks lower as well though. Investors have already started increasing bond and cash allocations because they offer good income.
The final possibility is that bonds rise and stocks fall. A recession and/or a bear market in stocks could be one way this happens. We have seen this scenario play out multiple times during previous corrections and bear markets. If a recession lowers inflation, it will likely play out again because the Federal Reserve will have some room to cut rates.
In theory, anything is possible, but inflation has peaked for now. The oil price drop in March will help put a lid on inflation in the near term. The past 50 years of economic history show rapid increases in inflation and interest rates, along with a deeply inverted yield curve as we have now, have almost always been followed by a recession within about two years at the latest. However, the last time similar conditions existed was in the early 1980s, and at that time, a recession was almost immediate once the yield curve started steepening. The banking troubles hint at the stress in the financial system. Finally, the Federal Reserve hasn’t thrown in the towel yet. While they did start a bailout for some banks, they aren’t bailing out the whole financial system. That day may come, but it will take greater losses in the financial markets, losses that will likely trigger a rally in government bonds.
Duration
Duration is a measure of interest rate risk. Measured in years, it gives a rough estimate of how much a bond fund or an individual bond will move for a 1 percent move in interest rates. A bond with a duration of 10 would be expected to rise or fall 10 percent for a 1 percent drop or rise in the relevant interest rate.
TLT has a duration of 17.64, EDV 24.23 and ZROZ 26.18.
Volatility
TLT has a standard deviation of 14.82, EDV 19.32 and ZROZ 20.75. TLT has a beta of 2.04 versus the average bond fund, EDV 2.61 and ZROZ 2.73.
ZROZ is riskier than EDV, and both are riskier than TLT.
Performance
Over the past year, TLT declined 16.64 percent, EDV 21.97 percent and ZROZ 23.84 percent. QQQ fell 10.84 percent.
Year to date, TLT, EDV and ZROZ have increased 8.22 percent, 10.84 percent and 11.49 percent. QQQ gained 14.89 percent.
From their peak in 2020, TLT lost more than 40 percent, while EDV and ZROZ slid 55 percent.
Income
TLT has a 30-day SEC yield of 3.79 percent and pays monthly dividends.
EDV has a 30-day SEC yield of 3.82 percent and pays quarterly.
ZROZ has a 30-day SEC yield of 3.30 percent and pays quarterly.
Outlook
The Federal Reserve launched a depositor bailout program in March. Traders immediately bid up Nasdaq stocks, cryptocurrency and some of the riskiest stocks in the market on the expectation of further stimulus. They also pushed the 30-year Treasury bond back near its 2023 high, along with many short-term bonds.
Aggressive investors might be tempted to buy growth stocks or ETFs such as Invesco QQQ (QQQ) for exposure. Long-dated government bonds offer solid upside though, while also offering some opportunity if a recession or financial crisis develops. For this reason, investors who want added equity exposure in areas such as growth and technology may be better served by allocating part of that equity slice to longer-term government bonds.
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The Investor Guide to Vanguard Funds for April is AVAILABLE NOW! Links to the April data files are posted below. Market Perspective: Stocks Rally as Banking Fear Subside Equities rallied sharply […]
The week after the Good Friday and Easter holidays provided traders with several clues about the state of the market. Perhaps the most important clue came on Wednesday when Consumer Price Index (CPI) data was released. It showed that inflation had slowed to 5 percent on an annual basis, which is down from an annual rate of 6 percent in March. In addition, the monthly CPI figure was down1 percent, which was lower than the expected increase of .2 percent.
However, core CPI increased by .4 percent, which means that inflationary pressures may remain even as prices continue to stabilize. The Core CPI figure is generally given more weight by investors and policymakers alike. This is because it ignores food and energy prices that tend to be extremely volatile and may create a distorted picture of current economic conditions.
On Thursday, the Bureau of Labor Statistics (BLS) released its Producer Price Index (PPI). It showed a drop of .5 percent in prices for finished goods and services during the month of March after prices were unchanged in February. Furthermore, unemployment claims rose from 228,000 in the final week of March to 239,000 in the first week of April.
On Friday, monthly core retail sales and overall retail sales figures were released at 8:30 a.m. In March, overall retail sales dropped by 1 percent, which was steeper than the .4 percent drop expected by analysts prior to the report’s release. Core retail sales dropped .8 percent during that same time period compared to an estimated contraction of .4 percent.
Consumer sentiment and inflation expectation reports were released Friday morning. The University of Michigan sentiment index came in at 63.5, which means that consumers are generally upbeat about the state of the economy. This figure beat a consensus estimate of 62 and was slightly higher than figures released in the second half of March.
It was also revealed that consumers expect the inflation rate to be about 4.6 percent over the next 12 months. This is a .8 percent increase since the previous month and is the highest figure since December 2022 when consumers also expected inflation to be at 4.6 percent throughout 2023.
The data points will likely have a significant impact on the Federal Reserve’s policy regarding interest rates. On Wednesday, notes from the Federal Open Market Committee (FOMC) March meeting were made available to the public. During that meeting, the federal funds rate was raised by 25 basis points to roughly 5 percent.
However, according to the FOMC minutes release, there were discussions about a potential rate hike of 50 basis points. These talks were ultimately shelved because of issues with Silicon Valley Bank (SVB) and Credit Suisse. According to the FOMC minutes, it is believed that issues within the banking sector will result in increased lending standards that will likely have disinflationary consequences.
By Friday, the S&P 500 reached a high of 4,161, which represented a gain of about 1 percent for the week. The Dow reached a high of 34,023 on Thursday and finished the week up roughly 1.2 percent. Finally, the NASDAQ was up about .9 percent for the week after hitting a high of 12,191 on Friday morning. This year the NASDAQ has now gained 16.72 percent, the Dow is up 2.26 percent and the S&P 500 has increased 8.2 percent.
Those who own shares in bank stocks were among the biggest winners this week as JPMorgan Chase saw its share price rise by almost 7 percent on Friday to $138.03 a share. In addition, Citigroup shares experienced a rise of more than 4 percent Friday to $49.49. World Wrestling Entertainment (WWE) saw its share price go up by 2.3 percent to over $103 this week and has risen by more than 20 percent since April 2. That was the day that the company announced that it would be acquired by Endeavor, which is the parent company of the Ultimate Fighting Championship (UFC).