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The 10 Year U.S. Treasury Note yield is once again above 4%. It was at that level earlier in 2023 as well, before declining in the spring as the market began to anticipate (prematurely) the end of the Fed’s tightening cycle. In absolute historical terms, 4% is still low, but it’s noteworthy now because the 10 Year hasn’t spent a meaningful amount of time above 4% since the early days of the Global Financial Crisis in 2008. 15 years is a long time for rates to have stayed that low.

Good for Investors

15 years is also a long time to force low-yield bonds into balanced portfolios. Uncomfortable as it was, Peloton kept buying short-intermediate bonds in balanced portfolios for two reasons. First, bonds act as ballast in portfolios: typically less volatile than stocks, bonds provide a hedge against disconcerting market gyrations. More significantly, bonds provide contractual sources of income and a return of invested principal in the future. This matters tremendously for those investors withdrawing money from portfolios, as it allows them to maintain spending levels without succumbing to equity market timing temptations.

At long last, there is now (again) a third advantage to bonds: attractive returns. Treasury bonds typically offer lower yields than high-grade corporate bonds because the former offer no practical risk of default. We see investment grade corporate bond ETF yields in the 5.20% to 5.90% range for one to ten year average maturities. Placing that alongside the 8.0% to 9.0% historical annual returns for stocks, we’re no longer cringing as we force bonds into portfolios.

Risk

While Treasury bonds are more attractive than they have been in many years, we still favor single-year maturity, investment-grade corporate bond ETFs over U.S. government debt: yields are higher and credit risk is largely mitigated through broad diversification. ETFs holding only bonds which mature in a single calendar year also provide certainty of principal return.

We should also remind readers that whether Treasuries, corporate bonds, or bank CDs, fixed income yields are quoted in annualized terms. In other words, a 3 month bank CD which pays 5.0% will actually only have yielded ~1.25% at maturity.

Portfolio Positioning in the Current Environment

With more attractive bond yields, we are now typically allocating bond money closer to the higher end of the strategic allocation range than we would have previously. The long-term risk bonds posed to balanced portfolio returns is no longer a factor. We do still favor short-intermediate maturities (< 10 years) and believe that diversified credit risk is worth the higher yield in corporates over and against Treasuries.

Fundamentally, strategic bond allocations should align with the anticipated need to access money in the short-term or permanent risk tolerance shifts, not due to short-term market volatility. Modest changes like allowing bond allocations to drift higher are suitable and can add value at the margin.

Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal. Diversification may not protect against market risk or loss of principal. The opinions expressed above should be construed as neither investment advice nor a solicitation to buy or sell securities. Actual investor results may vary.

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