Financial Professionals

September 19th, 2022

The Bear Market in Bonds

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All readers are well aware of turbulence in the stock market, which would normally mean stability and perhaps even rallying in the bond market. When stocks zig, bonds are supposed to zag.

Not in 2022.

Investors have been shedding government and corporate bonds at a rapid clip this year, with the Bloomberg Global Aggregate Total Return Index for bonds sinking into bear market territory last week. This drawdown marks the first bear market for this index since its inception over 30 years ago.1

Corporate bonds have not fared much better. Spreads – which in this case is the difference in yield between corporate bonds and government bonds (Treasurys) – have risen alongside Treasury bond yields. Investors are demanding higher yields from corporations perhaps in response to more challenging economic conditions ahead, and those rising yields are denting returns on existing bonds. Spreads have risen in roughly half of all the weeks in 2022, which is already more than we’ve seen in any year this century.

A key reason it is so rare for spreads and Treasury bond yields to rise at the same time is that normally the Federal Reserve would be cutting rates when the economy was showing signs of weakening. The opposite is happening today, of course, as the Federal Reserve has made clear that getting inflation under control is a higher priority than economic growth and full employment. When interest rates rise, Treasury bonds decline in price.

Zacks Investment Management has maintained a relatively cautious stance on fixed income over the past couple of years, maintaining a short duration in the portfolio in order to reduce volatility and interest rate risk as much as possible. We also continue to diversify across different income-producing asset classes, pursuant to each client’s objectives.

Preferred stocks, for instance, offer an income-generating alternative to the traditional fixed-income asset class. Preferred stocks are still stocks, so generally speaking, we would expect higher volatility and more frequent drawdowns than we would in bonds. But 2022 has been somewhat of an outlier year, with the Zacks Preferred Strategy down just -6.02% through the first half of the year compared to its benchmark, the ICE E-L F&A Preferred, which is down

-14.40%. Our strategy also yields about 3% more than the 10-year U.S. Treasury, which in short has meant higher income with less volatility.2

One of the key reasons the Zacks Preferred Strategy has fared so well is the defensive posture in the portfolio, specifically with an overweight to well-capitalized banks. Banks’ strong financial position makes their ability to pay dividends more secure, providing support to their market values. In a rising interest rate environment – which we’re currently in – the potential for a fixed rate coupon to turn into a floating rate coupon on more than half of the positions in the Zacks Preferred Strategy is also providing support to the portfolio.

Municipal bonds are another possible avenue for diversification, though they do not work for every type of investor (based on tax-equivalent yield). In cases where municipal bonds make sense, shorter duration municipal bonds have held up much better than similar duration U.S. Treasuries and corporate bonds throughout 2022, and we have not seen a rise in municipal bond yields like we’ve seen in the taxable arena. The intermediate portion of the curve appears more attractive than the shorter end of the curve, which is where we’ve kept focus. Unlike the Treasury yield curve, the municipal bond yield curve remains positively sloped, and balance sheets for local and state municipalities continue to improve. 

The unpredictable nature of inflation, interest rates, Fed policy (to an extent), and reactions in the stock and bond markets has created an environment in 2022 where investors need to be flexible and active, in my view, which is what we’ve been doing this year in our fixed income management and also in alternatives to fixed income.

Bottom Line for Investors

The positive correlation we have seen between bonds and stocks in 2022 has created challenges for many investors, particularly since it is so rare for stocks and bonds to enter a bear market around the same time. I do not believe this is part of a longer-term trend, however, and/or that traditional methods of stock-bond diversification have broken down. Asset allocations are designed based on the risk-return profiles they generate over 5, 10, or 20+ years – not a single year.

For 2022, however, I think investors should approach the fixed income markets with an active and flexible approach. Certain municipals look good on a relative basis, and at current levels, investment-grade corporate bonds are now paying meaningful yields. Preferreds offer a strong alternative to fixed income as well, in my view, and they also have the added benefit of having more than 90% of dividends treated as qualified for tax purposes. For investors willing to take on duration and credit risk, a preferred stock allocation is a viable option.    

Disclosure

1 Wall Street Journal. September 8, 2022. https://www.wsj.com/articles/broad-declines-drag-bonds-into-rare-bare-market-11662602793?mod=djemMoneyBeat_us

2 Strategy Report 2022.


DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Past performance is no guarantee of future results. Performance is presented net of fees. Except as otherwise noted below, net of fees performance is based on the maximum annual fee of 1.75%. Lower fees may apply for larger accounts. Higher fees may apply to smaller accounts. Separately managed account minimums apply. Inherent in any investment is the potential for loss. Standard management fees are available on request and are described in Part 2A of Form ADV.

Results for Zacks Preferred Strategy (the “Strategy”) are shown net of fees. Results for the Strategy reflect the reinvestment of dividends and other earnings. The results portrayed is the performance history of a composite of all discretionary accounts with no material investment restrictions, which are not restrained by investment style, type of security, industry/sector, location, size or market cap; it invests primarily in U.S. common stocks.

Prospective clients and clients should not assume identical performance results to those shown would have been achieved for their account if it was invested in the Strategies during the period. Clients of the firm may receive different performance than the composite. Client performance may differ due to factors such as timing of investment(s), timing of withdrawal(s), and client[1]mandated investment restrictions. Wholesale, retail and institutional clients of the firm may have differing performance due to timing of trades.

Investments in the Strategies are not deposits of any bank, are not guaranteed by any bank, are not insured by FDIC or any other agency, and involve investment risks, including possible loss of the principal amount invested.

Clients of the firm who invest in multiple Strategies, including Strategies whose results are presented, may receive different performance than the composite due to differences between the investments of the Strategies and differences in each client’s asset allocation between the Strategies. Clients of the firm may also experience differing results from the composite due to differences in contributions to and withdrawals from the client’s account compared to the composite account.


Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.

The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks, as well as limited partnership interests. The index includes all Nasdaq-listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debenture securities. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Dow Jones Industrial Average measures the daily stock market movements of 30 U.S. publicly-traded companies listed on the NASDAQ or the New York Stock Exchange (NYSE). The 30 publicly-owned companies are considered leaders in the United States economy. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Bloomberg Global Aggregate Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index is a modified market capitalization weighted index composed of preferred stock and securities that are functionally equivalent to preferred stock including, but not limited to, depositary preferred securities, perpetual subordinated debt and certain securities issued by banks and other financial institutions that are eligible for capital treatment with respect to such instruments akin to that received for issuance of straight preferred stock. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.
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