The benchmark bond index that we follow, Barclays U.S. Government/Credit Index, lost 2.5%, the worst quarter since 1994. In fact the quarterly result has only been worse 8 times in the past 40+ years (162 quarters).
The Barclays U.S. TIPS Index had its worst quarter ever losing 7.1% (data only goes back to 1997).
Markets do not like surprises – even when the information is not really a surprise. The financial media has dubbed it the Taper Tantrum, which started when Ben Bernanke came out of the Fed’s June meeting and said the Fed would taper its purchases of long-term bonds, if the economy continues to improve. The so-called quantitative easing program was intended to hold down long-term interest rates to encourage investment, lending, and economic growth.
The market was surprised by Bernanke’s comments, and long-term interest rates immediately jumped.
Morningstar recently reported, “Over the past two-plus weeks, many bond investors have headed for the exits, on the heels of Federal Reserve Bank chairman Ben Bernanke disclosing plans to end quantitative easing.” This suggests that market participants were assuming the Fed would continue its bond buying indefinitely.
Two things strike me as very ironic:
- The market was surprised to hear that something always considered a temporary measure, would eventually end… (when unemployment falls to a target of 6.5% and economic growth seems sustainable without the crutch of monetary policy).
- The prospect of improving unemployment and economic growth hammered both stock and bond investors at the end of June, contrary to an expectation that confirmation of economic improvement should be good for stocks.
There is little doubt that markets will continue to be volatile as the Fed proceeds to unwind the unprecedented monetary policy currently in place. Market participants will try to predict what is going to happen (interest rates will rise – that’s easy); when it is going to happen (more difficult); and how to take advantage (approaching impossible).
There has been a general consensus that interest rates must rise since the Fed took short-term rates to zero at the end of 2008. Since January 2009 the bond index has provided an annual return of 4.8%, including the most recent quarter, while money market funds and short-term CDs have provided almost no return. Once again illustrating our long-held beliefs:
- Markets work, and respond to new information.
- Markets cannot be predicted.
- Long-term investors must be willing to endure quarters like this and maintain the discipline of a long-term strategy that is consistent with their risk tolerance.