First off, let me explain the title a bit.  Typically, investment professionals view bonds as a way to safeguard against stock market risk.  Those same people usually view bonds as a “boring” investment.  And let’s face it, over the last 30 years or so, they have been pretty boring.  Of course there are years where they do have some volatility, but when you compare it to energy, technology, certain commodities, and various other types of investments, bonds don’t exactly make for exciting conversation at a party.

This year, we have seen a great deal of talk about bonds due to interest rate hikes.  As a quick review, bond values and interest rates have an inverse relationship.  In other words, when interest rates go up, bond values typically go down.

So far this year, bonds have had quite the decline.  What is interesting to me is that we have only had 2 rate hikes from the Fed.  Bonds have sold off more on the expectation of rate hikes than the rate hikes themselves.  While it is anybody’s guess how many more rate hikes the Fed will do, I think that most people will agree that there are more rate hikes to come.

That is where bonds have become interesting.  If the 10-year note has a yield of around 3%, and the yield was around 2% in January, that is a pretty significant increase.  With that, the value of the notes themselves have dropped (once again, it is an inverse relationship).

So, that tells me a couple of things.  The first is that most bond traders have expected (or are expecting) more rate hikes than have already happened.  If that is the case, we may be near a bottom in the bond world.  Now, let’s say we are done (or at least near the end) or the rate hikes. If that is the case, what reason does the bond market have to sell off again?  The answer in my opinion is inflation.  Since that is the hot topic these days, we need to address it. 

Inflation is typically not a good thing for bonds.  The reason is that even though you could get around a 3% yield on your investment if you used the 10-year note, if we have a greater amount of inflation, you could still be losing money if you factor that in.  That is another thing that keeps people away from bonds when inflation is a threat.  That is also a potential reason for the bond selloff of 2022.

With all of that in mind, what could you possibly do for the “conservative” section of your portfolio?  We have been owning a bond ETF, and selling covered calls and buying puts on it while owning it.  Yes, it is more work, but the premium that we’ve taken in this year has helped us tremendously against this selloff.  We haven’t been able to protect against the entirety of this selloff, but the options have helped a lot.  It is not the perfect solution, but there is no strategy out there that is always right all of the time.  We like this as it is a way of customizing risk and having a bit more control than simple holding a bond.

If you have any questions about what we do and would like to have a conversation, please email me.

mtosaw@rcmfs.com