Bonds are off to a weak start so far in 2018, in part due to wage growth fueling fears of higher inflation, and the possibility of that translating to a more aggressive pace of Federal Reserve rate hikes. As corporate earnings move higher and fiscal stimulus provides a further tailwind, the case for stock investing remains compelling, in our view. Still, pullbacks can occur without warning, and as mentioned in our Outlook 2018: Return of the Business Cycle, we expect more volatility, as is typical with an economy in the latter half of the business cycle. Pullbacks of 10% or more have been infrequent over recent years, but such calm is rare, as investors were recently (and unpleasantly) reminded. John Lynch, Chief Investment Strategist, noted, “Since 1980, the average annual peak-to-trough decline in the S&P 500 Index has been 14%, and pullbacks generally arrive without warning. Investors need to be prepared for such events, and high-quality bonds may help provide protection for diversified long-term portfolios.”
It is true that bond market performance during stock market pullbacks, as shown in the chart above, has historically been helped by a 35-year trend of falling interest rates, and that returns may have more of a headwind moving forward if rates continue to rise. However, it is also important to point out that even though bonds lost ground in the most recent pullback, they did manage to outperform stocks by a sizable margin, providing a significant diversification benefit for investors relative to owning only stocks. We discuss the potential benefits of bond diversification in more detail in this week’s Bond Market Perspectives, due out later today.
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The economic forecasts set forth in the presentation may not develop as predicted.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
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