2 crucial things to know about investing in bonds in the coming year 

13 September 2023

If you witnessed your investment portfolio go through a range of significant fluctuations in the past three years, you are not alone. 

The Covid-19 pandemic caused supply chain issues and economic slowdown, the effects of which are still being felt to this day. Plus, Russia’s invasion of Ukraine in February 2022 sparked even further volatility as the price of energy and other key commodities rose steeply.

All this has contributed to one key factor: inflation. 

UK inflation rose to a peak of 11.1% in October 2022, the Office for National Statistics (ONS) reports. Now, as of August 2023, inflation has decreased to 6.7%, and is forecast to continue reducing over the coming months.

One key contributor to the curbing of UK inflation is the Bank of England (BoE)’s monetary policy decisions that saw the base interest rate rise to 5.25% in August and remain fixed at this rate in September.

These factors have set the scene for rather extreme market fluctuations in the past few years – and bonds, a key asset class for many portfolios, have been rather harshly affected.

So, read on to find out the effect that the above factors have had on bond values, and what could be about to change in the months to come.

1. The recent “bear market” has had a detrimental effect on bond values

As the value of global bonds and equities fell for an extended period of time in 2022, we entered what is known as a “bear market”. 

This describes a drop of more than 20% in overall asset values for an extended period of time; according to Forbes Advisor, the 2022 bear market lasted 10 months and ended in October.  

Positioned in the centre of bear market declines were bonds. Often, bonds are considered a “steady” investment as they provide regular interest payments, and if they’re held to maturity, investors receive the full value of the holding back too.

However, due to the BoE, US Federal Reserve (Fed) and the European Central Bank (ECB) all raising central interest rates in response to recent rising inflation, bond values have suffered. 

The value of bonds and gilts, which are UK government bonds, typically move in the opposite direction to interest rates; when interest rates rise, bond prices fall. This is because bonds offer fixed interest payments that become more attractive to investors if central interest rates fall; this typically drives demand up and pushes bond prices higher.

Indeed, when global interest rates plummeted during the Covid-19 pandemic, Reuters reports that worldwide bond values reached an all-time high. Once interest rates began to be pushed up by central banks, the opposite became true, as the below graph reveals.

Source: Reuters

If your investment portfolio is made up partially of bonds, their decline could have brought your annual returns down. While it could be tempting to panic and sell assets when they dip, doing so means you’ll crystallise those losses without giving the holding time to recover.

Plus, although it has been a difficult 12 months for bond investors, it seems that wind is changing direction, and a “bull market” may be coming our way.

2. There could be a “bond bull market” on the horizon

The counterpart to a bear market, a bull market is defined as a period of incline for the stock market and other invested assets, such as bonds. Typically, a 20% or more increase over an extended period is considered to be indicative of a bull market. 

While interest rates have been rising steeply since the end of 2021, interactive investor (ii) reports that the BoE’s base rate could peak at 5.75% before settling at around 4% over the medium term. Similar circumstances are predicted to occur in America and Europe, too; when inflation falls, interest rates are likely to do the same.

In simple terms, we could be about to move firmly away from bear market conditions and into a more favourable bull market. This may be positive news for many asset classes, but particularly for bonds. 

As you read earlier, bonds tend to perform well when interest rates fall. So, bonds that have decreased in value since the pandemic started could begin to do the opposite.

The last transition between a bear and a bull market is said to have been in 2009, as the stock market began to recover from the 2008 financial crash (our most recent bear market prior to 2022). 

Investopedia calls the period between 2009 and 2020 “the longest bull market in history”, at which point the Covid-19 pandemic influenced a downturn in the markets. Over this time of low interest rates and high investor confidence, the S&P 500 index gained more than 300%.

All this points towards the fact that, if you have felt despondent about the value of the bonds you hold, your patience may be rewarded soon. 

Remember that the value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. 

However, historic examples suggest that bond securities could regain value in 2024.

Working with an investment expert can help you position your portfolio favourably when the market changes

Bonds are likely to form a portion of a wider, diverse portfolio. Each asset class may have been affected slightly differently by the volatility we’ve experienced since the pandemic, and if your confidence as an investor has been knocked by these events, this is highly understandable.

This is where forming a relationship with an investment expert is so crucial. Our financial planners can offer peace of mind, and we can also help you position your portfolio in a potentially favourable position for the months and years to come.

Plus, speaking with a financial planner can enable you to combine your investment goals with your retirement and legacy planning. We’re always thinking ahead, and we can help you do the same.

To learn more, email info@depledgeswm.com or call 0161 8080200.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.