An ode to Bruce Lee and investors in a post-Covid, hawkish Fed, rising geopolitical tension era
Every few months, my fellow HBKS financial advisors and I are asked to write articles on financial planning or investment topics. I must admit feeling a bit of writer’s block recently given the variety of issues hitting our global economy seemingly all at once, a condition that has persisted since the onslaught of the COVID-19 pandemic in 2020. Driving home one night from the office, I remembered (who knows why this came to me) the famous quote from Bruce Lee to “be like water.” There are various interpretations of what Bruce meant, mine being that you should adapt to whatever it is you are confronting at the moment.
Coming off an extremely challenging year in 2022 for stocks and bonds, investors would be wise to adapt their financial portfolios to the state of a world facing higher than normal inflation as well as rising geopolitical tensions. The following chart illustrates the uniqueness of 2022 in that it was the first time in the last 45 years that stocks and bonds declined in tandem.
Annual returns for stocks and bonds since 1977 (%)
Sources: “Diversification isn’t dead: Bonds poised to offer balance,” by Capital Group, Bloomberg Index Services Ltd., Standard & Poor’s. Each dot represents an annual stock and bond market return from 1977 through 2022. Stock returns represented by the S&P 500 Index. Bond returns represented by the Bloomberg U.S. Aggregate Index. Past results are not predictive of results in future periods.
The U.S. economy and the broader global economy are no strangers to economic shocks and geopolitical instability. Under such circumstances in prior years, they have demonstrated their ability to adapt to their new environments over time and to survive and thrive. I see no reason the global economy cannot do the same this time around.
The primary headwind bonds had to grapple with in 2022 was the extremely rapid rise in interest rates by the Federal Reserve as evidenced by the chart below.
Rapid Pace of Fed Rate Hikes in This Cycle
Source: Bloomberg. Federal Funds Target Rate – Upper Bound (FDTR Index), using monthly data. Current cycle as of 10/31/2022. Note: Data is the short-term interest rate targeted by the Federal Reserve’s Federal Open Market Committee (FOMC) as part of its monetary policy. Lines represent the cumulative change in the fed funds target rate from the start of each rate hike cycle shown. Past performance is no guarantee of future results.
At the beginning of 2023, interest rates on average for bonds were higher than dividends on stocks for the first time in several years. Bond funds are also offering more income and higher return potential. The yield on the Bloomberg U.S. Aggregate Bond Index, a widely used benchmark for investment-grade (BBB/Baa and above) bond markets, ended 2022 at 4.68 percent, compared to a yield of 1.75 percent on December 31, 2021. The chart below illustrates that the vast majority of the total return on bonds in historical periods (during both high and low interest rate periods) comes from the interest coupon on the bonds.
Source: Bloomberg Index Services Ltd. As of 12/30/2022. Past results are not predictive of results in future periods.
In closing I am reminded of the famous picture of Bruce Lee from Enter the Dragon where Bruce is battered from whatever fight he just survived, but shows no sign of fear or backing down. Investors in 2023 might feel bruised in large part to a hawkish Federal Reserve raising interest rates, but they should not waiver from their long-term perspective. Still, whether retired or still working, investors should consider meeting with their financial advisor to see what changes they might make to their personal financial plan to ensure they are still on pace to reach their goals.
My final chart below illustrates that while periodic downturns in bonds are not uncommon, the good news is that the downturns on average historically have been short-lived compared to the expansionary, bull market side of the cycle.
Source: Northwestern Mutual Wealth Management Company. Bonds are represented by the IA SBBI U.S. Intermediate-Term Government Bond Index, which measures the performance of five-year maturity U.S. Treasury Bonds. 2022 data through the end of October. Areas of expansion are defined as bond market performance from the low of a bear market to the high of the market preceding the next bear market. Areas of contraction are market performance from the prior market high to the market low in a bear market. A bond bear market is defined as a loss of 5 percent or greater. All data from Morningstar Direct.
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