Despite record low interest rates and the S&P up over 120% since the 2009 lows investors have continued to pile into bonds. According to Morningstar, an estimated $911B has flowed into taxable bond funds since 2009 while at the same time $240B has left U.S. equity funds. Consequently, chatter about the impending bursting of the bond bubble has reached a crescendo. In addition to the bursting of the bond bubble talk is the fear of the “great rotation” out of fixed income and into equities.
We believe that the fixed income markets are at an inflection point where treasury yields stop going down and risk of rising interest rates becomes a possibility. In other words we don’t think the bubble will burst but rather have a slow leak. The below charts offer a historical perspective of the effects of a modest rise in interest rates on high quality bonds. Each of the six time periods* reflect the performance of fixed income sectors when the 10 year treasury yield rose by more than 1% over the last 30 years.
For many investors, abandoning fixed income is not an option. For these investors the high yield fixed income sector may have mitigated some of the interest rate risk.