Bond market is speaking; who is listening?
June 12, 2015
The Federal Reserve remains vague regarding the timing of interest rate hikes, however the bond market is already taking action. On Thursday the yield on the 10 year US Treasury bond closed at 2.38% up from a piddling 1.68% as recently as February 2nd.
Bond yields move inversely to bond prices. Therefore, rising bond yields result in falling bond prices. While a 70 basis point change in interest rates may not be alarming to many investors, the resulting decline in the price of bonds and bond proxies (defined as slow or low growth equities that pay out almost all of their earnings in the form of dividends) should be. Since February 2, 2015, the S&P 500 Utilities Index Total Return (including dividends) has fallen nearly 11% through June 11, 2015, while the price of the 10 year US Treasury bond has fallen by about 6%. Meanwhile, the broad equity index (as measured by the total return of the S&P 500 Index) is up over 5% during this time. The losses resulting from seemingly meager interest rate increases should serve as a warning to investors. The magnitude of losses in these bond and bond proxies could be significant if rates merely approach their modern-day historical levels.
Bond and bond proxy investments have been a favored investment for risk-averse investors in the wake of the 2008 financial crisis. Sadly, these perceived safe-haven investments are now exceptionally risky and susceptible to significant losses. We at MPMG have been outspoken in the past about the high-risk nature of these investments, and will be providing a more detailed and timely update on navigating this risk in our upcoming quarter-end newsletter. If you would like to receive our quarterly newsletter, please sign up by following the link below.