FixedIncomeMarketCommentary
January2017
Breakout:BondYieldsMoveHigher
Sincethepresidentialelection,bondyieldshavebeguntobreakoutfromthe
lowinterest‐rateenvironmentthathasfrustratedfixed‐incomeinvestorsfor
years.
Andthemoveshavebeendecisive.Bondpriceshavedroppedandyields
haverisen,withlonger‐maturitybondsfeelingamuchgreaterstingthantheirshorter‐
maturitykin.Thesemovesserveasanexcellentreminderoftherisksassociatedwith
“reachingforyield”inlongbonds.Allseemedfineasyieldsfellandpricesrose,butthe
speedwithwhichthetideturnedhassurprisedthosewhotookonmoreriskthanthey
bargainedfor.
Thoughit’simpossibletocalleitherthetoporthebottomoftheinterestratecycle,Ihave
beenanticipatingaperiodofrisinginterestratesforsometimeandhaveconstructedour
bondportfoliosaccordingly,keepingaveragedurationonthelowside.It’sbeenmybelief
thatwesacrificedlittleinyieldcomparedtothepotentialforcapitallosses,andtherecent
marketactionhasbornethatout.
ThoughIexpectedrisinginterestratestobedrivenbyacombinationofanimproving
economyandFederalReservepolicyadjustments,that’snotexactlyhowit’splayedoutjust
yet.Rather,bondinvestorshaveseeminglyrespondedtotheelectionoutcomeandthe
incomingpresident’sstatedviewthatinfrastructurespendingshouldriseandtaxesshould
fallmorethananythingelse.Theconcernamongsomebondinvestorsisthatthisvision
mayresultinhigherlevelsofinflationandincreaseddeficits—neitherofwhichisbond‐
marketfriendly.Theunknown,ofcourse,isthedegreetowhichwordscanbetranslated
intopolicy,andpolicyintoacceleratedeconomicgrowth.
Marketsentimenthasshiftedfrom“lowerforlonger”toamoreuncertainreadonfuture
interest‐ratepolicy.It’sthereforenotsurprisingthatmanybondinvestorsbegantorethink
theirpositioningandtomoveawayfromperceivedrisks.Thiswasevidentintheoutflows
thatmanybondfundsexperiencedoverthefinalweeksoftheyearfollowingtheelection.
Butnomatterhowwegothere,bondinvestorsshouldwelcomethehigheryieldsthatare
nowavailableinthemarket.YouandIhavebeenwaitingpatiently,andourpatienceis
abouttoberewarded.BecauseIhavekeptmaturitiesshort,manyofthebondsinour
portfoliosarematuringintothishigher‐yieldenvironment,givingustheabilitytoreinvest
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Fixed Income Market Commentary
andlockinhigherrateswithoutpayingapremiumtodosoorextendingoutasfarinto
longer‐maturitybondsaswewouldhavehadtojustamonthortwoago.
Investinginbondswheninterestratesarerisingbenefitsdisciplinedfixed‐income
investors.Wemaynotseeanimmediatereward,butovertime,whenmaturingprincipal
andinterestarereinvestedinadditionalbondsorsharesofbondfunds,wewilleffectively
bebuyinginatlowerpricesandhigheryieldsthat,moreoftenthannot,willgeneratemore
currentincome.
Iampositivethatsomeinvestorswillequaterisinginterestrateswithrisingrisksforthe
bondmarket.However,Iwouldmakeadifferentargument—thatultra‐lowyields(and
ultra‐highprices)representedsomeofthegreatestrisksbondinvestorshaveever
encountered.Asratesrise,thoserisksactuallyabatesomewhat.
Finally,I’dliketomakeadistinctionbetweenriskintheinvestment‐grade‐ratedbond
marketandriskinotherinvestmentassets.November’sbondmarketloss(measuredby
theBloombergBarclaysAggregateBondIndex)of2.4%markeditsworstmonthinmore
thaneightyears.Yetthissetbackisnothingcomparedtosomeoftheworstmonthsforthe
S&P500stockindex,oreventheaverageofalltheindex’slosingmonths.(Overthepast37
years,theS&P500lostanaverage3.3%duringdownmonths.)Thisisnottomakelightof
thedeclineinthebondmarket,butrathertoputitintoperspective.
Bondinvestorshaveenduredlowinterestratesforyears.Nowthatratesarebeginningto
rise,itwouldbefolly,nottomentionpoortiming,tostepawayfromthebondmarket.We
needmerelyavoidtheriskiestpartsofthemarket.I’veoftensaidthatbondinvestorsdon’t
havetoinvestinthewholemarket,andwewon’t.Iwillcontinuetoavoidlargeswathsofit,
suchaslong‐maturitybondsorthosewithless‐than‐stellarcreditquality.Togetherwewill
findtheareathatsuitsyourindividualneedsandconcentratethere.Today’srisingbond
yieldsareexactlywhatyouandIhavebeenwaitingfor.
ChristopherKeith
SeniorVicePresident FixedIncomeManager
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Fixed Income Market Commentary
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