Bonds are Still Protecting Your Portfolio
Contributed by Doug Walters, David Lemire, Max Berkovich
We like to classify assets within a portfolio as being either “Growth” or “Protection.” For us, Growth is comprised of stocks and other risk-on assets, while Protection includes assets like cash, bonds, and gold. With bond yields rising and, therefore, bond prices falling, we face the uncomfortable question: what happens if Protection is not protecting?
Since the depth of the pandemic, when bond yields were historically low, we have witnessed a steady rise in yields. The 2yr US benchmark treasury yield was nearly zero, the 10yr hit 0.5%, and even the 30yr fell as low as 1.2%. The low rates were great for those seeking car loans and house mortgages but not so great for investors earning little on their fixed-income investments.
Since then, we have faced inflation and a Fed that is beginning to address it with a higher Fed Funds rate. This week, Fed Chairman Powell said that a 50 bps hike is on the table for May and that he envisions front-end loading rate increases. As a result, we have seen yields rise, and the curve flatten, with the 2, 10, and 30 hitting 2.5%, 2.8%, and 2.9%, respectively. As yields increase, the bad news for investors is bond prices are falling (yield up, prices down). The good news is that as bonds mature, investors will be able to invest in higher-yielding securities.
So with the value of bonds in a portfolio falling, is Protection not protecting? In the short-term, it may feel like they are not, but investing is a long-term endeavor. Bonds are not risk-free. Their value can fall. But when intelligently employed in a diversified portfolio, they can be a powerful weapon for risk control. Bonds provided critical stability in the pandemic as equities fells, and in the next crisis will be there again to provide ballast.
The past two years have been one of the worst periods for bonds in the past century. Historically, difficult stretches for bonds are often followed by above-average returns. Bond investors have reason to be optimistic.
Stocks were down on the week, but bonds provided the notable move, with yields rising across the curve. The Fed continues to have an outsized impact on sentiment, with comments from the Chairman about a potential 50 bps hike in May sending stocks lower and bond yields higher. But earnings season provides our headline of the week with Netflix (NFLX) and Tesla (TSLA) of particular note.
Netflix and Frills
It has been a tough year for growth stocks, with one market darling, Netflix, particularly hard hit.
- The company reported this week its first decline in subscribers in a decade. The shares fell 35% on the day and are down nearly 70% over the past 5 months.
- The decline is emblematic of growth stocks. The Russell 1000 Growth index is down about 15% this year, while Value is down less than 2%.
- Tesla also reported this week. The company which was once known for persistent negative earnings produced net income of over $3bn for the quarter. That is twice as much as Ford is expected to generate this quarter.
- There are two lessons from Netflix and Tesla. One is diversification. It is critical in markets like these to protect against concentration risk. The second is to be selective with Growth. Evidence shows Growth does not outperform, but Growth that also displays good Quality and/or Momentum does.
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