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What’s Going On Mr. Bond Market?

Bond markets tend to behave much more rationally than the equity markets.  Therefore, we place more weight in interest rate and bond yield movements when developing the Pure Portfolios view of the world.  We have been very interested in the recent uptick in U.S. bond yields since the election.  Ben Carlson, CFA of Ritholtz Wealth Management does a great job in his latest Wealth of Common Sense Blog addressing the “doomsday” bond predictions with a rational look at past rising interest rate environments.

A few additional thoughts on the article and my observations on the recent uptick in U.S. bond yields:

  • Unexpected inflation is the biggest risk to bonds.  Currently, the U.S. economy is running at ~1.6% annual inflation.  There have been few (if any) upside surprises to inflation expectations.

  • Analysts have pointed to President-elect Trump’s economic policy as a reason for the increase in yields.  That’s assuming all of Trump’s initiatives get funded and pushed through Congress.  Nothing happens quickly in Washington.  Investors who are banking on shovels in the ground, simplified/lower taxes, and more favorable trade policies within the first year of the Trump presidency will likely be disappointed.

  • We understand the Republicans swept the House, Senate, and White House.  The historic “one party sweep” doesn’t hold the same legislative power due to fractured relationships within the Republican Party.

  • The same experts who have been wrong about interest rates for the past 5+ years are going to tell us what happens next?  The bottom line is that forecasting interest rate movements is very difficult.

  • The U.S. does not operate in a vacuum and capital flows freely.  It’s tough to imagine the U.S. decoupling from (negative) global interest rates.  Aprevious blog postabout the global interest rate environment speaks to this in greater detail.

  • The Fed is going to have a much tougher decision if the U.S. dollar keeps appreciating.  A rising U.S. dollar is similar to tightening.  For example, U.S. exports are more expensive to the rest of the world which could hamper domestic multi-national corporations. 

  • Dividend paying stocks are not a proxy for bonds.

  • In our opinion, fixed income is still the best risk buffer within a multi asset class portfolio. 

Kudos to Ben Carlson for a rational perspective on the bond market.

Find out how Pure Portfolios is structuring fixed income for our clients by contacting us.

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