Pain in the Bond Market

The first quarter 2022 market downturn squeezed equity and fixed-income asset classes alike. As investors, we’ve all grown accustomed to pull-backs in stocks, but not like the simultaneous stock and bond drawdowns of the magnitude we just witnessed.

This less common market event of both negative stock and bond returns likely affected all of us, but its impact may have gained special notice from conservative, bond-centric investors because they also have the highest loss aversion.

If this first quarter drawdown were relegated to the equity markets, it surely wouldn’t be fun, but it also wouldn’t have garnered near the attention if it hadn’t been for the hit to bonds. We expect equities to go down from time-to-time, but not so much bonds.

That’s because generally speaking, bonds have experienced a 40-year bull market—there’s seldom been bad news to communicate; but the first quarter of 2022 delivered some of history’s worst bond returns, in addition to negative stock returns. This year’s first-quarter drawdown of -6.7% ranks as the third-worst quarter for bonds in the last 50 years.

Typically, the greatest short-term pain in a portfolio comes to those investors more heavily weighted towards equities and other more volatile assets. However, in the first quarter of 2022 both stocks and bonds had negative returns—so, conservative investors have experienced a drawdown that is much less common for them. In fact, bond returns for the quarter were worse than stocks.

In the past 50 years, an investor with a 30/70 stock/bond mix has only experienced three worse quarters.

This differs markedly from the experience of a more aggressive 70/30 investor. They’ve experienced similar or worse quarterly performance 26 times, or on average, every two to three years. Said a different way, the conservative 30/70 investor just experienced a return of -6.0% that would rank near the bottom percentile over the last 50 years.

To put that in context, the same percentile loss for a more aggressive 70/30 investor would be a much larger -14.1%; instead, the first quarter of 2022 saw the 70/30 investor “only” experience a -5.2% drawdown (see chart below).

Historically speaking—yes, bonds saw one of their worst quarters. But comparatively speaking, equities tend to fare much worse, and far more often. This type of performance from bonds has, so far, proven exceedingly rare.

So, where does this leave us?

I know I can sound like a broken record sometimes, but staying the course with your portfolio is the most prudent way forward – even in the throes of unusual pain in fixed income.

We’ve made adjustments to our bond portfolios in the form of more active management, shorter durations, multi-sector rotation, and private credit exposure. But these things take time to play out, and there is no silver bullet against rising rates.

Including the March rate hike, the bond and stock markets seem to be pricing in more than eight interest rate hikes. This is the reason for the volatility and nosedive in returns. It’s the initial shock of things to come that always hits hardest, but it will not remain this elevated forever.

Bonds remain a crucial component to conservative-moderate portfolios in the form of diversification and risk mitigation. This will not change because of short-term market headwinds.

Usually around the time that an overwhelming number of investors and the financial media are ready to capitulate and bail on an asset class, they’ll wish they hadn’t.