In case you are unfamiliar with the bonds market, here’s a quick 101. US savings bonds are debt securities, which are issued by the Department of the Treasury. They help to pay for US government borrowing, and pay dividends in return for investment. When they are popular the price obviously rises, but the yield drops. And when the yield rises, you’ve guess it, the price goes down.
Bonds are generally viewed as a port in the storm, a safe-haven investment that is often overlooked during times of boom and closely eyed during economic depressions. But the reason we are talking about them now is simple – we are about to enter uncertain times, with the Presidential Election likely to take the country in two different directions (dependent on who is elected). And that uncertainty is trickling into the bonds market… so where are they headed?
If we look at the past 10 elections in correlation with something called the Barclays Aggregate Bond Index (an index used to represent investment grade bonds being traded in United States; formerly the Lehman Aggregate Bond Index) we see an interesting pattern forming. During election years we’ve seen a peak in bond returns, with bond total returns over the last four months of an election year tending to be higher than non-election years with the exception of the month of November.
November, the month when the election is actually decided, has always had lower bond returns, likely because investors are flooding to the safe-haven of bonds and in turn this is causing their returns to slide.
But if you look closely at the results these differences in average returns are small, and could easily have been driven by something other than the election – Federal Reserve policy, economic growth, and inflation expectations to name just a few.
So it there any way of predicting the way bonds will react in this coming election and beyond? Sure we could look at the Barclays Aggregate Bond Index and assume that we’ll see a dip in the returns for November, but the layover of the election will extend much further than the 8th November.
Each candidate has very different policies on economic policy, with both hoping to ignite economic growth. That will require different amounts of government borrowing, and will rock the bonds market in different ways. For now, we can expect that if history repeats itself we could see a downturn in the markets in November, but that doesn’t tell us what is coming next and analysts aren’t calling it just yet.
Rich Clifford, our Managing Director adds “[w]hen looking beyond the election, the conversation always returns to a declining GDP (down from 3.3% to 1.2%) and a declining ISM. Both factors combined have historically been leading indicators for bearish equity markets and rising bond prices. But with bonds at or near all-time-highs, further increasing prices will put real pressure on further long term investment.”
In these uncertain times, investors should consider a good rule of thumb; build a safety valve into your trading, allowing only a certain percentage of your portfolio to be exposed to the risks, because otherwise, just like the election, there will be winners and there will be losers.