Bond Market Commentary
Stuck on “the Soap Box”
By Douglas Drabik
February 20, 2018
We’ve heard this message before but it simply cannot be emphasized enough, especially given 2018’s early addition of market volatility. For years we have seen the advent of terms such as “the new norm”. 2017 serves as a prime example of a sustained period of nearly motionless interest rates. Bond market movement was so sluggish that it was easy to be lulled into believing this was standard. Now in 2018, the financial markets are exhibiting some rise and fall. When the 10 year Treasury hits 3.00%, it is easy to imagine the critical captions slandering the use of bonds, mainly because they are doomed to fall in price. Never mind that that means they are moving up in yield.
The start of 2018 can arguably be reasoned more “normal” than the muted 2017 markets. Here starts the soap box. This is in no way suggesting that runaway interest rates are upon us (so many headwinds to refute that) but as interest rates rise, whether that is now or down the road, it is imperative that a distinction be made between individual bonds and packaged products containing bonds. Simply it is like comparing apples and oranges. To learn more about this difference, ask your advisor for a copy of the ‘True Fixed Income – A Favored Class for a Rising Interest Rate Environment.’
Individual bonds protect investors with 3 defined characteristics, one which sets them apart from nearly all other asset classes. This one bond characteristic is particularly important if interest rates begin to rise: it is the redemption date which typically is a stated maturity or a call date. The understanding is that there is a finite date designated (a promise) to return the face value of an investment. Without a redemption date, there is automatically heightened risk associated with principal retention. When you buy real estate, there is no forward promise that it will be worth more or even as much down the road. When you buy a stock, there is no forward promise on price or return of principal. Although the heightened risk often comes with higher return, no promise whatsoever is made on that future price. Even though bond funds hold individual bonds, because they don’t have stated maturities, principal is at risk in a dissimilar way between individual bonds and many packaged products containing bonds. In an upward moving rate environment, there is an increasing uncertainty as to the return of principal when comparing that to an individual bond held to maturity.
An individual bond held to maturity negates all the market price fluctuations (up or down) during the holding period. An individual bond delivers, as promised, regardless of interest rate movements. Despite any market moves, an individual bond provides and investor the exact cash flow and income it decreed on the purchase date as well as the face value at redemption. The Fixed Income Quarterly (FIQ) contains an advisor’s testimonial regarding action taken to solidify her client’s positions moving forward. Although it is not a new message, it is one well worth repeating.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.