For those that have grown accustomed to stock prices going nowhere but basically up for the past five years, the sharp correction we’ve experienced over the near-term may be a bit unsettling. Even for those that had been sensing a sell off, it still stings when portfolio paper value drops sharply in a short matter of time. Such is the reality of stock market volatility. And since we don’t know what tomorrow may bring, it could get worse before it gets better.
As concern over stocks rises, investors tend to gravitate towards bonds. With renewed buying interest, the rate on the 10-Year Treasury is now pushing its way towards 2%, something precious few predicted at the beginning of the year. This attraction to bonds during stock sell offs and macroeconomic upheaval is typically known as a “flight to quality.”
To see a list of high yielding CDs go here.
Since bonds generally offer a contractually guaranteed return of principal with ongoing interest payments attached, they are viewed as a safer place to invest money. So when investors start to get skittish over stock declines, the bond market tends to be a place to park some dough until the coast is deemed clear.
Of course this is somewhat trader talk. Traders are always searching for the church of what’s working now. But what about buy and hold investors? Many long-term equity investors may view near-term volatility with apathy or potentially as a buying opportunity. Still, as stock prices drop and investors may attempt to step underneath the proverbial falling knife, there is absolutely no guarantee that there will be success in trying to catch it.
Indeed, although the long-term trend of equity markets has been higher, there may come a day when that trend ceases. It is hypothetically possible for stock prices to remain low for decades, and it has occurred through the annals of market history. We just exited a period, “The Lost Decade,” where it took 12 years for the market to sharply eclipse pre-attained highs, as measured by the S&P 500.
Back in 2000, bond investors could have locked into Treasuries with 6% yields – even higher if they had locked into corporates. While stock investors had to deal with ample volatility, the fear of the fiscal crisis, and probably tangled with selling out, bond investors – by and large – collected interest payments and achieved better return with less risk and no sleepless nights.
Of course today fixed-income yields are far less, so from a general rewards viewpoint, it’s tough to get excited about Treasuries. Still, and this is the important point, government paper and high-grade corporates provide portfolio stability. For the investor who all the sudden feels like further equity price dilution may be difficult to handle, having a portion of a portfolio in bonds may be a welcome thing to fall back on.
I would opine that the larger an investor’s bond allocation is, the more stock volatility they may be able to tolerate. If the market drops 25% and all of your investments are in equities, you may view the situation much differently than if you had a 50/50 stock/bond allocation.
Older investors tell me that they view pensions, Social Security, and other passive, guaranteed income sources as the bond component of their portfolio. If you are able to deem those sources as rock solid safe, then bonds may figure less predominantly into your investment program.
Low yields and the threat of Federal Reserve rate tightening action continue to provide a negative backdrop for bond investment. However, stock valuations and volatility as well as global hot spots and perceived instability are providing a near-term boon. While most investors may see little value in bonds, I continue to believe that if a sharper sell off than one might expect hits stocks, the value in having a portion of one’s portfolio allocated to bonds will become very apparent.
About the author: Adam Aloisi has over two decades of experience investing in equities, bonds, and real estate. He has worked as an analyst/journalist with SageOnline Inc., Multex.com, and Reuters and has been a contributor to SeekingAlpha for better than two years. He resides in Pennsylvania with his wife and two children. In his free time you may find him discussing politics, playing golf, browsing antique shops, or traveling.