Beautiful Boredom in the Bond Market

There aren’t many occasions when “boring” is a compliment, but we swear this is a good and nice thing to say: This year, bonds are boring. After two rough years, they are back to doing what they do best—dampening a blended portfolio’s expected short-term volatility—disproving all those who argued bonds aren’t fit for purpose.

In our view, bonds have always been a bit misunderstood. Because of the US Treasury’s minimal default risk, Treasury bonds are widely regarded as “safe.” We get the reasoning, but it risks giving the false impression that bonds are “safe” in an absolute sense. People think they never fall, which isn’t true. Bonds, like all securities, are subject to volatility and the risk of decline.

In other camps, bonds have a reputation of offsetting stocks, a kind of insurance policy against a stock bear market. If your stocks aren’t doing well, the reasoning goes, at least your bonds will be. So when bonds fell alongside stocks in 2022, it ruffled many feathers. But it was hardly the first time bonds fell with stocks, and it won’t be the last. The correlation between US stocks and bonds is 0.006, which is about as close as you can get to the two having no directional relationship.^[i] (A correlation of 1.00 would mean they always move together and -1.00 would mean perpetual opposite movement.)

Bonds’ power lies in their long-term tendency to swing less than stocks. In our view, this makes them a helpful companion to stocks for investors whose goals, needs, time horizon and/or overall comfort with stocks’ fluctuations make it beneficial to have less expected volatility than an all-stock portfolio. This comes at the expense of lower long-term returns, but investing is always about the tradeoffs made to manage risk.

So yes, bonds fall. Sometimes the declines are mild, sometimes they are short, but sometimes they are longer. There isn’t really a set bear market definition in the bond world, as there is in stocks (a lasting decline of -20% or more, typically with a fundamental cause). But we think it is fair to apply that label to fixed income early this decade. After hitting a high in early August 2021, ICE BofA’s 7 – 10 Year US Corporate & Government Bond Index fell over -20% through mid-October 2022.^[ii] A comeback attempt ensued, but it was short-lived, and bonds retested their low in October 2023.

This year, however, the bond market is enjoying a nice recovery.

Exhibit 1: The Bond Market Recovers

Source: FactSet, as of 10/21/2024. ICE BofA US Corporate & Government (7 – 10 Y) Index total return, 3/30/2021 – 10/18/2024.

Volatility has also eased. Bonds’ median weekly movement in either direction over the last 20 years is 0.47%.^[iii] In 2022, the median weekly move up or down was 1.1%.^[iv] It isn’t all the way back to average this year, but at 0.71%, it is considerably closer.^[v]

These figures are all lower than stocks’ median weekly moves over the same periods, illustrating a crucial point: Even a bear market doesn’t prevent bonds from fulfilling their main portfolio role. We know this doesn’t ease the pain of experiencing a bond market decline, but looking facts in the face is key to making good portfolio decisions and not reacting to what just happened. No, bond returns aren’t all the way back to where they were in mid-2021, but they are on their way, and slow movement is to be expected.

To us, bonds now look pretty much back to their normal behavior. Long rates (which move inversely to bond prices) aren’t swinging much. There is movement, but we aren’t getting the big, sharp swings of 2022. Corporate and high-yield bonds’ spreads over US Treasurys have narrowed.

And, likely as a result, issuance has recovered. This has attracted a lot of attention, and some outlets call it “frothy.”^[vi] But this is just a return to normal issuance after the bond bear market and higher rates scared issuers away. While we do not have full data to know yet, much of this is likely refinancing activity as issuers dealt with the supposed “wall” of maturing debt. One of 2022’s biggest fears was that high long rates would render companies unable to refinance a flood of maturing high-yield debt. But this hasn’t panned out. Companies pushed out the wall with little trouble as rates eased: The amount of high-yield bonds and leveraged loans due to mature next year is down from late-2022’s estimate of $347 billion to $65 billion.^[vii] Lower rates, and especially for corporate borrowers versus Treasurys, enabled businesses to kick the can.

So welcome back to normal and boring, bonds. You may look a touch pale next to stocks, but that is how it should be.