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Optimus Advisory Group: An Inconvenient Truth: Bonds Have Vicious Bear Markets Too

Comparison of the Optimus Advisory Group Programs to any other indices is for illustrative purposes only and the volatility of the indices used for comparison may be materially different from the volatility of the Optimus Advisory Group Programs due to varying degrees of diversification and/or ...

07/23/2013

Over the years, most of us have grown accustomed to the tried and true method of permanently holding bond funds within client accounts.  These investment vehicles have come through for us time and time again, providing a cushion to those nasty stock market drops that happen every several years.  After all, if we could get high single-digit returns from an asset class that never dropped more than high single-digits, why not buy and hold?  As a local mortgage company’s commercial says, “It’s the biggest no-brainer in the history of mankind.”

Better think again
Unfortunately, bond funds aren’t the cute, cuddly pets we’ve been conditioned to hold forever.  They do have their own bear markets, which can be vicious in their own right.  Sure, your average intermediate-term bond fund will probably never drop as much as your average stock fund has, but you’ll be surprised to learn just how far they can and do drop.

Bond Bear Markets:  An Inconvenient Truth
This first chart shows how much the average intermediate-term bond fund fell during each bond bear market since the 1950′s.


That 1968-1970 bar looks sickening, with a -26% drop using month-end data.  It’s safe to say they probably hit -30% intra-month.  Imagine talking to your clients after that Armageddon-esque plunge.  Keep in mind, the bond market “panic” we just went through would barely show up on the chart, with maybe a -5% hit.  The median drop on this chart is -12.5%, so -5% is nothing.  Also notice that the much talked about big, bad bond bear market in 1994 is laughably small.  We only included it here because it is talked about so much in the media.  Otherwise, it would only warrant a footnote.

Trying to come to terms with reality
What caused these bond bear markets?  Was it inflation?  Was it the Fed?  How about the economy?

The short answer is it depends.

Obviously, rising rates negatively impact bond prices, but why do rates rise?  Here are some charts for helping to sort it all out.

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