In the grand scheme of things, balanced portfolios haven’t performed exceptionally well in recent months. The chart below shows the worst 12-month returns since 1926, after adjusting for the effects of inflation, for a US-based portfolio of 50% equities, 40% medium-term government bonds, and 10% from cash. (For simplicity, I’ve only included the largest loss during each bear market.)
While the returns have not been all that pleasant, the overall performance is just as bad, not historically terrible. Not only was the Great Depression’s biggest loss nearly double today’s decline, but three other periods also saw significantly larger declines: 1) the 2009 global financial crisis, 2) the 1973-74 oil crisis, and 3) the post-world crisis. Funky WWII. Even a little worse this year was the headache after the “go-go” years of the 60s.
(It is worth noting the absence of a chronological pattern. In order of magnitude, the six selloffs occurred during the 1930s, 2000s, 1970s, 1940s, 1960s, and 2020s. We can perhaps consider the Great Depression a an anomaly that will not be repeated. Since then, however, there is no indication that bear markets have become less frequent or less severe with time.)
Saved by Actions
The relative blessing for this year’s market has been equities. For the most part, balanced portfolios go where their shares take them. (This insight informs strategy for risk-matched funds, which severely underwhelmed their investors in 2022. But that’s a story for another column.) Growth stocks have struggled a lot in recent months, but stocks value remained firm. As shown below, their support has made 2022 look pretty good from an equity-only perspective. (The exercise is conducted as before, looking for the lowest 12-month real returns, but this time it is calculated solely from the performance of US equities.)
At a negative 21.6%, the stock market’s recent drop falls short of catching up to the past six.
Bad news bonds
Unfortunately, the same cannot be said for bonds. Among fixed income securities, there has been no refuge. Interest rates have risen across the yield curve, thus sinking all investment grade debt. Even the lower quality notes struggled. Sometimes, when interest rates go up, junk bonds do well because credit spreads tighten. Not this year. Conversely, credit spreads widened on fears of a recession. The result was total bond market losses.
The next exhibit proves the point. It is calculated in the same way and over the same period as the previous two graphs. That is, it features the worst 12-month trailing results since 1926, including the effects of inflation. In this case, however, the illustration shows medium-term US government notes, rather than balanced portfolios or the domestic stock market.
Two elements of this graph stand out.
First, the bars are much shorter here. True, bond market margins can be volatile. For example, long Treasuries fell 34% in real terms from November 2021 to October 2022. This almost matches the lowest real yield of a balanced fund during the Great Depression! But major fixed-income securities, the kind held within a medium-term government index or major taxable bond funds, are generally fairly stable.
Second, the current bond market rates as worse than last century. Barring further substantial losses, the stock market decline will soon be forgotten, buried in a database for future Internet columnists to unearth. But the downturn in the bond market will be remembered for a long time. The post-inflation loss for medium-term government bonds was even greater than during the second oil crisis which ran from 1979 to 1981, when 10-year Treasury yields peaked at 15.8%. .
An imperfect storm
This is because US bond yields were at their lowest when this bear market began. Except for a brief period in 2013, and again when the coronavirus pandemic hit in spring 2020, Treasury payments have not been below summer 2021 levels for at least the last 150 years. Because bond yields are inversely related to price, Treasuries were more expensive when inflation began to resurface. A more dangerous combination for bond prices can hardly be imagined.
Fund investors—and perhaps even pension fund managers, although the data to conduct such an analysis are lacking—have ended up buying high and selling low. In 2021, taxable bond funds had their highest sales ever, receiving $340 billion in net new assets. This year, by a not-so-amusing coincidence, they suffered the same dollar amount of net refunds. Investors walked in the door when Treasury payments were 1% and walked out when they hit 4%. Buy high, sell low.
In 2010, the financial press ran story after story about the great bond bubble. Those predictions turned out to be, as Mark Twain famously said of the news of his death, premature. While bond yields rose shortly after those articles were published, they quickly leveled off. Ten years later, the yield on medium-term Treasuries had fallen below 2010 levels. The big bond bubble was not such a thing.
However, if the timing of the warnings was off, the sentiment was not. Buying stocks when their prices are unusually high, in the belief that they will rise again, can be a profitable strategy. It was for Japanese stock buyers in the mid-1980s, internet stock enthusiasts in the late 1990s, and Treasury investors a decade ago. But, as recent events have shown, such a strategy is nothing short of dangerous.