Bonds: Born to Be Mild
A 30-year bull market for bonds has come to an end, but this does not make a bear market inevitable, in our view.
We’ve reached the end of a golden age for bond investing, during which the benchmark 10- year US Treasury note provided an annualized total return of 8.6%, as the Display below shows. Along the way, there were extended periods—including the past decade—when bonds outperformed equities by a sizable margin.
Over the five years since the credit crisis began, the bull market in bonds continued—in large part because the Federal Reserve flooded the fixed-income market with liquidity by repurchasing longer-duration government bonds and other debt instruments. Coupled with bond buying by individual investors, the Fed’s purchases drove bond prices up and bond yields down. The 10-year Treasury yield hit a historic low of 1.4% in July 2012.
Some observers think a bear market for bonds is inevitable; they are warning investors to get out of bonds while they can. We have a different view. We expect bond yields to rise and bond prices to fall to some degree, but we believe a number of factors will moderate the impact.
Bond prices may be disrupted when the Fed reduces its buying program, and if and when the Fed begins to sell its holdings to shrink its balance sheet. But continued purchases of Treasuries by central banks around the world could well reduce the impact of a change in the Fed’s current policy.
Increased bond buying by insurance companies and private-sector defined-benefit plans could also temper the pace at which bond yields rise. For these huge investors, higher bond yields would likely spur significant buying that might, in whole or in part, offset the impact of the Fed’s selling.
We think 10-year rates are presently about 1% lower than they would be if the Fed hadn’t embarked on its monetary easing policy. When the Fed tightens, we expect interest rates to rise at least 1% in the medium term, and then, possibly, to go on rising after that. Looking out as far as 2030, our quantitative tools forecast that 10-year Treasuries will deliver annualized returns on the order of 2%–4%, as shown in the display.
But we also see plentiful evidence that active bond managers can continue to deliver positive returns even if Treasury prices fall. From August 2012 to January 2013, rising yields caused the 10-year T-note index to fall 2.9%, but the majority of fixed-income funds still produced positive returns. That’s because active fund managers used their insights into valuation and the supply-and-demand balance to choose bonds that withstood the sell-off in Treasuries. These included bonds with shorter durations and lower credit quality, which tend to hold more of their value when rates rise. We believe active managers will likely outperform once again if Treasury yields rise further.
Even with diminished yields, high-grade bonds should continue to have a place in investor portfolios—not least as a counterweight to equity-market volatility.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Douglas J. Peebles is Chief Investment Officer and Head of Fixed Income at AllianceBernstein.