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Bonds Markets Have Struggled Amid Rising Rates. How Should Investors React?

December 14, 2016

Bond markets have struggled recently (top table), with the Barclays Aggregate Bond index losing 2.4% in November, its worst monthly performance in 12 years.

Bond losses are the flip-side of rising interest rates, which bottomed after the Brexit vote in June. The 10-year Treasury yield finished November at 2.38%, up from a summer low of 1.35%.

Recent declines are a reminder that bond markets can and do go down — a fact that is easy to forget for investors who have lived through 35 years of falling interest rates (adjacent chart).

Bond losses should be viewed through the lens of diversification. A well designed portfolio will include assets that go up and down at different moments in the market cycle. Recent bond declines have been matched by gains in U.S. stocks.

Investors who desire income and downside protection should continue to own bonds, which can perform well when stocks fall (bottom chart). Indeed, recent losses in the bond market are modest compared to the losses that stocks can experience. In addition, higher rates suggest more attractive return potential for new money invested in bonds, and create opportunities for bond fund managers to capitalize on.

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