Stocks posted big gains in October, propelled by better-than-expected corporate reports. The Dow Jones Industrial…
We mentioned a couple of quarters ago that volatility was beginning to make its way back into this market. The evidence is now clear. There is no denying that this past quarter was one of the most volatile in recent years. There were many factors that stirred the pot this quarter. Turning the calendar is often an event that has investors taking a fresh look at their portfolio which prompts change.
Inflation has been largely ignored for the past 6 to 9 months, but suddenly investors took notice in January. The Federal Reserve finally admitted that inflation was a problem and hinted to the world that they would raise interest rates in March for the first time since 2018. Bond yields spiked on this news and continued through the end of the quarter. That certainly added fuel to the fire right about the same time that Russia began to encroach on the border of Ukraine. The days leading up to the first shots being fired were clearly the worst for this market as the uncertainty continued to build. However, as the market usually does, it frets on the uncertainty, and then quickly shifts its focus to the next event. As such, we saw a healthy rally at the end of the quarter to erase much of the losses.
Q1 2022 Rally
When the dust settled in the quarter, we saw the bottom of the market out on or around March 14th and then rally hard into the end of the quarter. At its low point, the S&P 500 dropped by -12.4% but finished just -4.9% lower by the end of the quarter. Likewise, the NASDAQ, which dropped by -19.6% at its lows, was able to reduce those losses to just -9.1% by quarter-end. The Dow, which is often looked at as a less volatile index, only dropped -10.2% at its bottom and finished the quarter lower by just -4.6%.
We rarely talk about bonds here, but this quarter is different. Bonds are usually considered a “safe-haven” and have certainly been less volatile than stocks over the years. However, as rates rise bond prices fall, it is simple mathematics as you consider the maturity date, the fixed coupon, and the current interest rate environment, and the yield to maturity on each bond. During the quarter, we saw the 10-year Treasury yield rise from 1.51% to about 2.32% by the end of the quarter. That increase crushed bond prices. As a result, we saw widely held bond funds such as the Vanguard Total Bond Market Index Fund (VBMFX) post a negative -6.3% return for the quarter. If you look at a long-term bond fund such as the Vanguard Long-Term Corporate Bond Index fund (VLTCX), that fund lost -11.0% for the quarter. These are MASSIVE losses – especially when you consider the modest yields they were paying. Just 2.44% for the former and 4.04% for the latter.
Bond Fund vs Individual Bonds
With a bond fund, it is tough to pinpoint how low it may go – especially if rates continue to rise. However, rising rates do not impact the Yield to Maturity on the cost of your individual bond. It only impacts the temporary price of the bond. Therefore, so long as the bond does not default, your expected rate of return will remain intact if you hold it until maturity and collect the income. This also gives you fresh cash to go into the open market and buy a new bond with a lower price and a higher Yield to Maturity. That is quite an advantage.
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