Bond market recap: two contrasting years

4 minute read

12 November 2019

By Michel Vernier, CFA, London UK, Head of Fixed Income Strategy

While 2018 disappointed bond investors, 2019 delivered exceptional returns across the major bond markets. While this pattern, as well as ultra-low yields, may raise concerns, it is worth a closer look before drawing conclusions for 2020.

2019 goldilocks scenario

Bond returns in 2019 should not be extrapolated when looking forward to 2020, given that the market, across most currencies and segments, started the year at very low entry levels after the sell-off in December 2018. Investment grade bonds, as well as longer dated US treasuries, delivered 13% performance while high yield bonds and emerging market bonds returned around 10% over 2019. This is in stark contrast to 2018, when most bond segments, even taking into account coupon payments, delivered negative returns.

Short-dated bonds offer certainty

Only short-dated government bonds achieved positive returns in each of the two years. Future returns of short-dated bonds, unsurprisingly, are more predictable. At the start of 2018 short-dated treasury bonds yielded 1.6%, on average, delivering a performance of 1.9% while at the start of 2019 the yield was 2.5%, delivering a performance of 3.2%. This may suggest that short-dated bonds are the superior segment in the bond market.

In the long run, short-dated bonds underperform significantly

However, certainty comes at a cost. While in the short and medium term the yield difference seems a small sacrifice, in the long run bond investors are losing out on two additional features: income and a hedge against recession or low growth.

Since 2004, the return of short-dated bonds averaged 2.5% in USD each year. This compares with a 9% average return for longer dated US treasuries, or an 8% average return for investment grade bonds. In the same period, high yield bonds and emerging market bonds returned over 13% on average each year. So short-dated high grade bonds underperformed by 5.5-10.5% each year depending on the respective market.

Which bond assets perform when yields are rising?

The performance of longer dated bonds has been helped by lower trending rates. So how does this compare when considering periods of increasing rates? A prominent example is the 2012-2013 period when the US Federal Reserve decided to reduce its balance sheet, causing a dramatic surge in bond yields.

EM and HY bonds perform even in rising rate environment

Unsurprisingly, longer dated treasuries lost over 9% within 1.5 years in 2012 and 2013, while returns on short-dated bonds provided a positive return of 0.6%. Investment grade bonds (3.7%), high yield (HY) bonds (18.5%) and emerging market (EM) bonds (8.6%) performed well during that period. The often quoted underperformance of EM and HY assets was only two months, while both segments recovered quickly afterwards. A similar pattern was observed during 2016, when US rates rose on the back of President Donald Trump’s fiscal stimulus plans.

It seems that apart from temporary bursts of volatility, most parts of the bond market typically outperform short-dated bonds significantly over the longer term. And this even occurs in periods of rising yields or when short-dated bonds seemed to offer the only safe haven. Losing out by 5.5-8.5% each year seems a big sacrifice in this context.

US short-dated bonds/cash underperformed in most cases

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