Global equity markets rallied convincingly for the week, with U.S. equities leading the charge. In the U.S., the S&P 500 Index rose to a level of 3,887, representing a 4.67% gain, while the Russell Midcap Index followed suit, rising 5.58%. Meanwhile, the Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, pushed 7.72% higher over the week. Moreover, developed and emerging international markets returned 2.76% and 4.96%, respectively. Finally, the 10-year U.S. Treasury rose to 1.19%, eight basis points higher than the prior week.
Many may recall, or even still hear, rally cries to abandon fixed-income investments, suggesting that the actions taken by the world’s major central banks to artificially maintain historically low interest rates has made the asset class uninvestable. The argument goes that with interest rates so low, investors would be unable to earn an annualized return above the level of inflation. Moreover, with interest rates so low, one can only assume that the only place for them to go is up, and as history has shown, when interest rates or yields increase, the price of a fixed income security conversely decreases.
For context, 10-year sovereign debt issued by the United States, the United Kingdom, France, and Germany yields approximately 1.1%, 0.37%, -0.24%, and -0.47%, respectively. Historically, yield to maturity has been a reasonably good indicator of the level of return an investor is likely to experience over the life of a given bond. This would suggest that those investing in a 10-year note issued in France would lock in a negative 0.47% return per year over the next 10 years, while those investing in a 10 Year U.S. note would average a return of roughly 1.1% per year over the next 10 years.
Relatively speaking, the return offered by U.S. debt is more attractive than that presented by its international counterparts, but still, nothing to write home about for those strictly interested in generating the most substantial return possible. However, not all investors are interested in the potential growth of their investments alone. To the contrary, many retirees, or those rapidly approaching retirement, are looking to maintain a degree of portfolio stability, perhaps with some income potential, while slowly and gradually growing their portfolios over time. For those investors, the fixed income asset class continues to play an essential role in helping to mitigate portfolio volatility and provide income potential. As such, fixed income very much remains an investable asset class in our view.
For those investors interested in dampening portfolio volatility, the charts below, which use data from Morningstar, provide some compelling evidence in favor of using fixed income for that purpose specifically. In the chart below, we compare the performance and volatility of four different strategies for the final week of January 2021, a week when investors witnessed the S&P 500 Index fall by 3.29%. The four strategies included in the chart below are broken down as such: 100% S&P 500 Index (S&P 500), 70% S&P 500/ 30% Barclays US Aggregate Bond Index (AGG), 50% S&P 500/ 50% AGG, 30% S&P 500/ 70% AGG.
What’s immediately clear from an inspection of the two charts above is that the S&P 500 Index saw a much steeper drop off in performance and step up in volatility than did those portfolios that incorporated at least some allocation to fixed income. Further analysis shows that this isn’t merely a recent phenomenon but instead a pattern that tends to repeat itself every time global equity markets face a major shock. In fact, scenario analysis shows that those portfolios containing some allocation to fixed income have done a better job at weathering every substantial equity market shock that has taken place over the last 20 years.
Although we don’t advocate abandoning equities altogether for most investors, we do recognize that investment-grade fixed income serves the underappreciated role of dampening volatility, as well as income-producing potential, in diversified growth and income portfolios. As such, we recommend that those investors who are uncomfortable with the unpredictable gyrations of equity markets revisit their overall portfolio allocations. As such, we continue to encourage investors to stay disciplined and work with experienced financial professionals to help build and manage the asset allocations within their portfolios consistent with their objectives, timeframe, and tolerance for risk.
Best wishes for the week ahead!
Disclosures: Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion and Walsh cannot guarantee the accuracy of said information and cannot be held liable. You cannot invest directly in an index. Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against a loss.
Other Data Sources: Equity Market and Fixed Income returns are from JP Morgan as of 2/5/20. Rates and Economic Calendar Data from Bloomberg as of 2/5/20. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index, U.S. Large Cap defined by the S&P 500. Sector performance is measured using GICS methodology. S&P 500 sector performance represents total return figures sourced from Bloomberg. All figures contained in all data tables was sourced from Morningstar as of 1/29/20.
Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against loss.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than the original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.