So much of the global economic outlook depends on the success of the fight against the coronavirus pandemic and one thing that is almost certain is that current ultra-low interest rates will likely continue for quite some time. Each time the news features progress on a vaccine, the U.S. stock market jumps as investors get excited about possibly getting the pandemic under control. However, as the U.S. and other countries struggle to contain the virus, the effect of COVID-19 on the global economy is expected to be deflationary in major developed markets and is likely to keep inflation below targeted levels. In the United States, for instance, the expectation of prolonged low inflation has seen the U.S. Central Bank pledging to keep short-term interest rates near zero through 2022 in order to soften the blow to the economy caused by the coronavirus pandemic as well as to stimulate economic activity.
Low interest rates are beneficial for economies because they suppress borrowing costs and help to stimulate spending for both individuals and corporations. At the same time, low-interest-rate environments can be difficult for investors looking to add fixed-income investments to their portfolio with the objective of achieving higher income. Nevertheless, bonds are worthwhile additions for long-term investors, not only because they provide income, but also because they provide protection during volatile and uncertain times.
The best illustration of the benefit of adding bonds in your portfolio, especially in a volatile 2020 so far, is seen in the performance of the S&P U.S. Treasury Bond Current 10-Year Index (try and say it in one go!-which is a one-security index comprising the most recently issued 10-year U.S. Treasury note) which has produced a total return of 13.66% year-to-date (YTD). Contrastingly, the performance of the S&P 500 index has been virtually flat YTD. During the March sell-off, a diversified portfolio of bonds assisted investors to stabilize their portfolios (S&P 500 lost 20% in the first quarter!). An allocation to “high yield” bonds can also help increase returns for an investor during the economic recovery.
As economies reopen “safely”, economic and corporate fundamentals should continue to improve causing the current economic cycle to transition from recession to recovery. However, concentrating solely on the destination and not the voyage could result in investors missing out on opportunities that arise. Maintaining a diversified mix of bonds that match one’s risk tolerance can help to remain focused on the path of reaching your financial goals over time.
Eugene Stanley is the VP, Fixed Income & Foreign Exchange at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: [email protected]