Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
As we approach the half-year mark, some big-hitting investors are licking their wounds. For investors in shares it has been a positive six-month period. But for bond investors it has been tougher going.
The big story of the first half of 2021 has been the vaccine roll-out and subsequent opening up of the economy. That’s good news for equities, which like growth; it’s less obviously good news for fixed income investments, which are fearful of the rising inflation and higher interest rates that growth brings in its wake.
Dig beneath the surface, however, and the reality is more nuanced than that simple characterisation. Most stock markets have moved steadily higher since the start of the year. For bond investors, the first half year has itself had two distinct halves.
In the first three months, expectations about growth and inflation led to a sharp rise in bond yields. On the benchmark 10-year US Treasury bond, it rose from 0.9% to 1.75% in a matter of weeks. Because prices move in the opposite direction to yields that meant losses for bond investors (or gains for more sophisticated investors betting that prices would fall).
In the last three months, however, yields have gone the other way, retreating to about 1.5% and pushing bond prices higher. That’s because the Federal Reserve has persuaded investors of its view that any inflation will be short-term, ‘transitory’ to use its preferred word.
Even when the Fed admitted after its most recent rate-setting meeting that inflation was higher than it expected and hinted at earlier interest rate rises than the market expected, it stuck to its line that inflation is not the big problem that some fear.
To make matters even more complicated, bonds with different maturities have behaved differently. The expectations of an earlier than expected hike in interest rates has pushed the yield on short-term bonds (those maturing in the next two years) higher. But that on longer-term bonds (not paying back capital for 30 years or more) has fallen because the market has decided that a firmer Fed is less likely to allow inflation to run out of control.
Confused? You’re not alone. Some of the biggest players in the investment business have been wrong-footed by the swings in the markets in the first half of the year. Hedge funds placing big bets on these relatively small changes in direction have been seriously caught out according to analysis in the FT this morning.
For me, there are a few key lessons to draw from all of this:
1. Different asset classes respond to the same news in different ways. Over the first six months as a whole, bonds have lost value while shares have risen (by 12% on average, using the MSCI World Index as a guide to global share prices). Having a balanced portfolio, with shares, bonds and other assets like commodities can help smooth out these ups and downs.
2. Sometimes markets behave as you would expect (bonds in the first three months of the year) and sometimes they don’t (the more recent performance). We should be humble enough to accept that we can’t always understand what is going on. And make sure that we are not derailed if we occasionally get it wrong.
3. Even if we do get the big calls right, timing changes in direction in the markets is extremely difficult. No-one rang a bell at the end of March to indicate the change of direction for bond yields. It just happened. Often it is only clear well after the event what has triggered a change - by which time, of course, it is too late.
If this makes you nervous, don’t be. The good news is that we can protect ourselves from the unpredictability and uncertainty of the financial markets in a handful of simple ways: by being well-diversified; by avoiding the temptation to try and time the market; by investing regularly through the cycle; and by keeping enough cash to hand so that we can take the market’s ups and downs in our stride.
Looking for help in creating a well-balanced portfolio that matches your risk appetite? Check out our Navigator tool.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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