Stocks ended the week on a mixed note, with gains for the S&P 500 ( ^GSPC 0.51% ) and Dow Jones Industrial Average (^ DJI 0.44% ) but a slight setback for the Nasdaq Composite (^IXIC -0.16% ). Even going into a weekend during which any number of uncertain situations around the world could worsen, investors were nonetheless confident enough in the long-term outlook for the stock market to keep equity prices high. shares in much of the market.
Daily percentage change
daily point change
Many investors who have become fearful in light of stock market declines so far in 2022 have frantically searched for perceived lower-risk alternatives. In particular, bonds are often portrayed as safer than stocks, and many investors use balanced portfolio allocations to try to reduce its overall volatility. Unfortunately, bonds have proven vulnerable to a type of risk that many investors never considered. In some cases, that has led to even worse returns so far this year for the bond side of their portfolios than for stocks.
A great week for rising interest rates
The bond market is usually calm and relatively stable, but this week bonds experienced considerable volatility. Consider the weekly moves in some key Treasury yields:
- The 10-year Treasury yield started the week around 2.15%. At Friday’s close, it was close to 2.50%.
- Five-year Treasuries started at about the same 2.15%, but rose even higher, ending at 2.57% and creating a small inversion in the yield curve.
- Two-year Treasuries were yielding less than 2% at the start of the week, but closed around 2.30%.
Those interest rate changes may not sound like much. But the impact on prices was substantial. In just one week, the long term iShares 20+ Year Treasury ETF (TLT -1.39% ) lost about 4%. the middle ground iShares 7-10 Year Treasury ETF (IEF -1.03% ) it fell almost 3% in the same period.
losing his balance
Increase in interest rates they have been a problem for the bond market all year, and that has led to staggering losses for investors in bond funds. The iShares Long-Term Bond ETF is down 13% year-to-date, which is even worse than the Nasdaq’s roughly 10% loss. The iShares Medium-Term Bond ETF’s declines have been less severe at 8%, but are still much worse than the S&P 500’s 5% decline year to date.
However, many investors are surprised that their bonds could lose value. This is due to a misunderstanding of risk in the bond market. It is true that Treasury bonds are almost completely safe in the sense that it is very unlikely that the US government will default on its obligation to pay the bonds when they come due.
However, even though the bonds are essentially guaranteed to pay their face value when they mature, that does not mean that their prices are stable in the market before maturity. When prevailing interest rates rise in the broader bond market, bonds whose interest rates have been pegged at lower levels look less attractive than newer bonds issued at higher rates. That drives prices down on those lower-paying bonds to make up for their less attractive payouts. If you have to sell those bonds before maturity, or if your bond fund does, then you won’t necessarily recoup those losses.
Bonds can play a valuable role in investment portfolios, but you still need to know how they will perform in different market conditions. Right now, the risks of bonds are more apparent than ever.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We are motley! Questioning an investment thesis, even one of your own, helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.