What to do about the bond sell-off

While the bond sell-off has been disorderly, it shouldn’t be shocking, says Stephen Lingard, senior vice-president and portfolio manager, Franklin Templeton Solutions.

“This is one of the more overvalued asset classes,” he says. “Growth is better than the bond market is indicating. The market was just too complacent. […] I don’t think investors should be surprised [by rising yields] in a non-recessionary environment, with inflation moving back toward targets, and growth being better than people expected.

“That’s not the stuff of negative yields.”

Since November 8, the yield on 10-year U.S. Treasuries is up by almost 50 basis points and rose to an 18-month high of 2.4% Friday. On Monday, $26 billion of two-year notes were sold at 1.085%, the highest level since December 2009.

Lingard recognizes the rise is “a scary move over a short time period, and if we see a continuation, we could start to undermine equities. It is a concern that the bond market sell-off is disorderly.”

Read: Negative rates can turn your world upside down

Tom Elliott, international investment strategist at deVere Group, says in a release that “fears of hyperinflation and a return to [the] 15% bond yields seen in the early 1980s are an overreaction.” He points out that baby boomers are retiring, “thereby reducing household consumption, which is a deflationary force.”

Jimmy Jean, senior economist at Desjardins, says in a report that Donald Trump’s tax cuts and spending promises could result in the U.S. federal debt rising to 105% of GDP by 2026, from about 75% currently.

“If downgrades were to occur, some investors such as pension funds, foreign reserves and financial institutions, which are required to hold high-quality debt securities, may see U.S. bonds as less attractive.”

But he points out some Congressional Republicans “are unlikely to endorse a slippage of public finances,” so it’s too early to draw conclusions.

What investors can do

Lingard is generally underweight duration. “It’s not just the bond side. We’ve also been favouring more of the cyclical industries on the equity side, so we’ve avoided a lot of the rout we saw in bond proxies: REITs, consumer staples, some of the defensive parts of the equity market.”

He admits his underweight “hurt us a little bit over the last year, because we were probably too early. But as you can see, when it happens, it happens quickly.”

Read: Understand duration for better bond returns

What about investors who didn’t prepare?

“We’re trying to determine if this is structural or a head fake,” says Lingard. “This is a great time to evaluate portfolio risk, because we have something showing up that hasn’t been visible in five or six years, and that is rising interest rates.” He suggests evaluating not only your bond mix, but also your interest rate sensitivity in other asset classes.

“If investors have [been] in long-duration assets, that’s been great over the last seven to eight years as yields have fallen. But we may be in a period where that relationship starts to break down.” For diversification, he’d look to value investments and corporate debt. “Make sure you have access to economically sensitive parts of the market.”

Elliott says that rising yields mean “there will be a good entry point over the coming two to three years, but we are probably not there yet.”

Read: Why to leave rate-sensitive sectors now

Avoid interest rate-sensitive trades

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.