To the clients and friends of ProfitScore:

The Bond Bear Market

Stocks can trend for years, but interest rates trend for decades.  We are four years deep into a bond bear market, and this has caused many advisors to rethink their asset allocation strategy.  For the prior 40 years, bonds offered a buffer against equity volatility and steady income, but now their correlation is positive with risk assets and offers no risk offset to 60/40 portfolios. A recent Bank of America report highlights the severity of the current situation, noting that the losses in 30-year bonds from their peak in July 2020 to the present far surpass those of any previous bear market, earning the moniker “the greatest of all time” and the “humiliation trade.”  To illustrate this, the iShares 20+ Year Treasury Bond ETF (TLT) has plummeted over 45% since July 2020, while the Barclay’s U.S. Aggregate Bond Index has declined by more than 18%. When adjusted for inflation, these declines are even more pronounced.

The year 2022 was particularly catastrophic, often cited as the worst year for bonds since 1976. During this period, the TLT dropped by over 31%, and the Barclay’s Index fell by 13%, severely shaking investor confidence in the stability of fixed-income securities.  Net of inflation, the decline of a 60/40 portfolio was worse in 2022 than in 2008.

Bonds are under pressure on many fronts. Rising interest rates, driven by central bank policies to combat inflation, affect bond prices inversely. Concerns over government debt sustainability and potential sovereign credit downgrades have further undermined confidence.

To add insult to injury, the indexation of the market, driven by passive ETFs, has increased overall asset correlation, making it difficult to find and allocate to noncorrelated assets. Where investors could once rely on a simple 60/40 allocation, they now need to consider other asset allocation alternatives. Investors increasingly diversify into alternative asset classes to achieve greater stability and improved risk-adjusted performance. A popular method is the core-satellite strategy, where alternatives can provide higher returns and enhanced diversification benefits.

Navigating the bond bear market will require caution, agility, and a focus on a more active investment thesis. Diversification, active risk management, and vigilance in adjusting portfolios will be key strategies for investors to weather the storm and seize emerging opportunities.