Why are bonds performing so poorly over the last two weeks?
I noticed that the ETF and TLT has dropped rather drastically. Is this an overreaction?
I don't think it is an overreaction. Bond prices run inversely to interest rates. As interest rates go up, bond prices are going to go down. When you look at a bond or a bond fund, you should always keep an eye on the duration. TLT is a fund that owns 20+ year Treasury bonds. The average maturity is 26.41 years. The duration is 17.9 years. That means for a 1% increase in long interest rates, the fund will drop in value by approximately 17.9%.
Since the election, long interest rates have been rising. If interest rates keep going up, TLT will continue going down in price.
Hope this helps.
The prices of bonds move in the opposite direction of interest rates. When interest rates are moving higher, the prices of bonds move lower. Last December, when the Fed raised rates by 0.25%, that was the beginning of the current interest rate upcycle. Next month, we will most likely see another hike of a similar amount. When rates generally move up, prices of other fixed income securities will also change to keep their yields in line with the prevailing interest rate yield.
From 1980 until quite recently, interest rates slid from the mid-teens to just a notch above zero. The slide led to a three-decade bond rally. As rates went down, bond prices rose. But when rates are at rock bottom, as they have been since the Great Recession of 2008-9, there's only one direction for them to go: up.
The incoming administration is hoping for an acceleration of business activity. This will almost certainly be accompanied by rising interest rates. That will be a headwind for bonds, utilities, and other interest-rate sensitive issues.
Yes, the recent price changes may be an overreaction, but there will probably be exposure to further weakness as rates move higher.
Bonds are in the very early stages of a long-term bear market. The 10-year topped in 1982 at 15% and has been in a 34-year bull market ever since. President-elect Trump's agenda of lower taxes, less regulation, and infrastructure spending will be pro-growth, which will generate an uptick in inflation.
This has been a concern for advisors and money managers for some time. If rates rise, as they have done recently, the value of the bonds held by ETFs and Mutual Funds go down in value. That is what happened to TLT. It is usually worse for longer-dated and zero-coupon bonds.
You can think of it like a teeter-totter. As interest rates, and maybe inflation, rise on one end, the value of bonds already issued on the other end drop in market value.
Bonds have a role to play in a portfolio. Advisors and investors just need to be aware of the risks and investment behavior. With regards to it being an overreaction, only time will tell. If your investment strategy is sound, it should not make a huge difference to your portfolio. I take possible moves like this in consideration when I put together client portfolios; because you don’t know when it is a trend, or a temporary overreaction.
Mark Struthers CFA, CFP®
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This is for informational purposes only. Your specific situation would need to be taken into account. All information is subject to change. Not to be considered investment, tax, or legal advice.