The S&P 500 is up over 3% since the election. I hesitate to call this a “Trump Rally”, especially as the election looms so large in recent memory. For now, it seems prudent to recognize that the election has brought with it a reduction in uncertainty and a sigh of relief that the contentious campaign season has come to an end. While the media is distracted by every shiny object the President-elect waves in front of them, they are missing a bigger story. The Federal Reserve is expected to raise rates in December which would send ripples through multiple markets. What would a rate spike look like? We don’t have to go very far to find out. We just had one.
The 10-year US Treasury yield was 2.23% to begin 2016. It dropped down to 1.35% in July then bounced hard to 2.39% at the end of November. These are huge moves in today’s low rate environment. JP Morgan estimates that a 1% spike in yields should drive the Bloomberg Barclays Aggregate Bond Index, the standard fixed income benchmark, down 5.5%, but it only lost 3.31% during this year’s jump in rates. It is up 2.50% this year through 11/30 after rising 6.16% through 7/8. Most fixed income assets followed this roller coaster pattern for the year.
Investors who held longer duration bonds felt the pain more acutely than those holding bonds of shorter duration. Most active managers have been taking that duration risk off the table in anticipation of rising rates so it makes sense that for the most part active managers avoided the brunt of the pain. Money managers that were scared out of the longer end of the yield curve often tried to make up the lower yield by taking on more credit risk. This is where it’s important for investors to know why they hold fixed income securities. Is it for income? Does it provide diversification against equity downturns? Too often I am being pitched fixed income products that are chasing returns. An investor who is looking to their fixed income portfolio for high-octane performance is sure to experience several different flavors of disappointment.
If you didn’t notice the wild ride, congratulations. A traditional 60% equity / 40% fixed income portfolio would have gained 5.74% through 7/8 then gained 0.96% as rates rebounded. Not exactly an exciting return stream, but that’s one of the strengths of a balanced portfolio. The easier it is for an investor to stick with their financial plan, the more likely their success.