Bond market disrupted by inflation concerns
At one point this month, for example, the S&P 500 had fallen more than 10%, in the range known in market jargon as a correction, and the Nasdaq Composite Index was down more than 20%. , in what Wall Street labels bear on market territory. , although the two have since rallied. Still, the S&P 500 on Friday was down 4.7% for 2022, and the Nasdaq was down more than 9%.
Keeping the rout in perspective
Historically bad bond yields pale in comparison to periodic stock market crashes. For example, in February and March 2020, the early days of the coronavirus pandemic, the S&P 500 fell nearly 33% in just 23 trading days. Nonetheless, the double whammy of poor bond returns combined with weak stock market returns in the same sequence is leaving many diversified stock and bond portfolios in dire straits.
The Vanguard Balanced index fund, a classic mix of 60% stocks and 40% bonds, is down 5.8% for the year. Bonds, which generally serve as a buffer to protect investors from the volatility of their equity holdings, have not performed that function well this year.
The culprit for the sharp decline in bond values is the rise in interest rates which accelerated across all fixed income markets in 2022 as inflation took off. Bond yields (i.e. interest rates) and prices move in opposite directions.
Rising interest rates have been expected for years by bond market experts. It was the suddenness of the recent increases that caused a selloff in the Steady Eddie bond market.
Consider that in August 2020, in the first year of the pandemic, the yield on the benchmark 10-year Treasury fell to 0.5%. The Federal Reserve, which directly controls the short-term federal funds rate — but not bond market rates — had lowered that short-term rate to near zero, as it did in 2008, during the financial crisis.
In both cases, the Fed and the US government, through fiscal stimulus, were making extraordinary efforts to revive the economy: low interest rates encourage borrowing and business activity, just as higher rates discourage them.