After a strong July rally, in fact the 17th best month for US stocks ever since 19501, stocks have since given back all their gains.2 What has been exceptionally unique this year has been the high correlation between bonds and stocks.3 A challenge that most investors have been experiencing this year has been the price movement of stocks and bonds which have tracked closely to one another. Typically, the correlation between these two assets is elevated during rate hiking cycles. Generally, bonds have been viewed as the “safe” part of an investor’s portfolio. However, as of the end of September bonds have returned -14% year-to-date. With US stocks down in 2022 some -23% at the end of September, rebalancing has been less impactfully as both asset classes are down to a similar degree. We have also seen a historically tight labor market which has helped the US economy dodge a recession thus far. Remember, the National Bureau of Economic Research (NBER) is the official arbiter of determining the start of a US recession.
The Opportunity in Fixed Income
Though bonds have seen historic negative returns, the yield today compared to just the beginning of this year is a dramatic improvement. The US 2-year treasury was yielding a mere 0.73% at the start of 2022; now it is yielding 4.22% at the end of September. It is important to note with the FED expected to raise rates even further, that sticking with bonds with shorter durations is prudent. However, if the US economy does fall into a recession, longer duration bonds will likely gain favor as investors seek safety.
Though difficult to grasp, an important topic is the duration of bonds today. Most people think of duration simply as the maturity of the bond. In the world of fixed income, it also describes the sensitivity of bonds to fluctuations in interest rates. Though maturity is a large factor to duration, the coupon rate or starting yields of newly issued bonds also plays a significant role. With interest rates rising, bonds issued today with a higher starting yield will fluctuate less to interest rate moves compared bonds issued with lower interest rates.
At the moment, the labor market remains a bright spot for the economy. According to the Bureau of Labor Statistics (BLS), the US unemployment rate fell back to 3.5% in September, which is in line with pre-pandemic levels and near all-time lows. Additionally, a September jobs report from the BLS indicated that voluntary job leavers or “Quitters” comprise 15.9% of those who are unemployed, the highest since 1990. Workers only quit when they feel comfortable they can find another job, a strong indication of a tight labor market. Although job openings seemed to have peaked in March of this year, with approximately 10.1 million job openings reported in October, there are still plenty of jobs available. A tight labor market forces employers to raise wages which adds to inflationary pressures in the economy. Keep in mind, the FED is trying to ease labor market conditions by reducing job openings.
So far 2022 has been a roller coaster ride, and volatility is likely to persist through the end of the year. Remember, bear markets tend to be points in time while bull markets tend to occur over time. Investors have already experienced one of the worst first 9 months for both bonds and US stocks ever. In volatile periods, like 2022, the likelihood of making an emotional and potentially detrimental decision rises. Please do not hesitate to give us a call, we are to help and support you.
*Hedge fund returns are lagged 1 month. Sources: Factset, J.P. Morgan, Russell, MSCI, FTSE Russell, Alerian.
- BlackRock; Student of the Market, September 2022
- “US stocks” or “stocks” represents the S&P 500
- “bonds” represents the Bloomberg US Agg Bond Index