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Bonds, not stocks, posed the biggest challenge in the last month

By March 29, 2020 2 Comments

There’s not much to say about the stock market that people don’t already know. The last four weeks have been unprecedented, with the Dow Jones falling 38%, its fastest decline from a high, ever. That’s a faster drop than ones experienced during the 2008 Financial Crisis or even the Great Depression! But believe it or not, that’s not what made the last month so challenging for investors. That title belongs to the bond market, which basically imploded during a two-week stretch earlier this month.

This crushed diversified portfolios that rely on the typical stability of bonds to help smooth out volatility from stocks. Here, we’ll show just how bad the last month was, and why bond investors have reason to believe the worst is over. Unfortunately, we’re still not sure if we can say the same for stocks.

The relationship between Treasurys and stocks

Historically, one of the best ways to protect against drastic downturns in stocks is by owning long-dated treasury bonds. In 2008, for example, long-dated treasury bonds, as measured by the ETF, TLT, rose more than 30%. True to form, as the S&P 500 (SPX) started to drop in late February this year, TLT started to rise. In fact, the first 10% of year-to-date losses in SPX was matched by a 15% rise in TLT. But that’s where the historically inverse relationship broke down. Around March 9, as losses in SPX accelerated, TLT plummeted too, falling 17% in a week. You can see this represented in the graph below (TLT top, SPX bottom):

So when investors in stocks needed protection from Treasuries most, it wasn’t there. And that was a major theme of why the last month was so challenging. Bond assets that typically help reduce portfolio volatility actually contributed to it. And while there’s no way to prove it succinctly, we would opine that this breakdown actually created a vicious cycle of even more volatility! As investors saw both their equity and bond allocations decline in value, this promoted greater fear. The result was they started panic selling both asset classes, in a flight to cash, pressuring each asset class further. We argue that this market phenomenon fed on itself for much of the last three weeks and exacerbated volatility across asset classes.

Some good news

Here’s some good news: the bond market has experienced a swift bounce back. TLT, for instance, has risen 20% since bottoming out on March 18. In addition, other areas of the bond market have also seen stabilization. The following graph shows the performance of an aggregate bond ETF (AGG), a municipal bond ETF (MUB), and an investment-grade corporate bond ETF (LQD) over the last month:

AGG, MUB, and LQD fell 7%, 13%, and 20% in two weeks. Those are the fastest price declines in either of these ETFs on record. And all three were around in 2008 during the Great Financial Crisis. Simply put, investors didn’t just lose confidence in stocks over the last month, they lost confidence in everything. It might even be more accurate to say that they totally freaked out. But again, as the graph above shows, the bond market is coming back strong. AGG has recovered all of its 7% loss, while MUB and LQD have risen 12% and 15% each.

A bottom in the bond market

Recent events saw the bond market experience sell-offs that, on a relative basis, were arguably more dramatic than the declines seen in the stock market. Yet the sudden snap-back rally across various bond ETFs suggests the bond market has a bottom in place. This is good news for investors who were likely very surprised to see “safer” aspects of their portfolio also get pummeled over the last few weeks. While nothing is guaranteed and no one knows what will happen next, we’re confident in saying that the worst is over for the bond market.

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