This infographic is available as a poster.

Demystifying Three Bond Myths During Rising Rates

Today U.S. Treasury yields, a key return measure for bonds, are over 1% higher than pre-pandemic levels.

• January 2020: 1.8%
• May 2022: 2.9*

*As of May 17, 2022

While rising interest rates are often seen to have a negative impact on bonds, the current environment may be beneficial.

In this infographic from New York Life Investments, we debunk three common myths about bonds during rising rate environments to explain why.

Bonds During Rising Interest Rates

To start, here’s a brief introduction on how bond yields are affected by interest rates.

Bond yields are the return investors will earn from a bond over a period of time. Bond investors receive interest for purchasing debt issued by the government or a corporation. For instance, a $1,000 bond with a 3% yield would earn $30 annually.

Rising interest rates directly affect bonds.

When interest rates rise, bond yields typically rise. As investors seek out new bonds that provide higher yields (income), the demand for existing lower-yielding bonds declines. Consequently, the price of these existing bonds typically falls.

Given this backdrop, let’s explore how bonds have historically performed during rising rates, the potential buying opportunities they present, and their long-term performance in a rising rate climate.

Myth #1: “Never Hold Bonds During a Rising Rate Environment”

Answer: False

Even during multiple rising rate periods, bonds have shown positive performance in the last 38 out of 42 years. Let’s take a look at the two most recent rising rate periods:

Time periods measured from the first Federal Reserve rate hike until one month after the last rate hike, which, on average, is when the effective federal funds rate tends to stabilize.
Source: Morningstar (Feb 2022)

As shown above, every type of bond showed positive performance.

High-yield bonds returned the highest over the last two rising rate periods, averaging 7.9%. Not only that, when equities decline, bonds have often cushioned losses, as seen in the Great Financial Crisis and the COVID-19 market crash.

Myth #2: “This Is the Worst Time to Invest In Bonds”

Answer: False

Rather than doom and gloom, the current environment could present a buying opportunity. Consider how municipal (muni) bonds have performed after historically low periods:

Municipal bonds represented by Bloomberg Municipal Bond Index. Data is for the time period 1/1/1994 to 4/30/2022. Meredith Whitney is known as “The Oracle of Wall Street”. In 2010, when Whitney stated that many municipal bonds would default in 2010, it shocked the market.
Source: Morningstar (Apr 2022)

In the 12 months following each trough date, muni bonds rebounded notably.

For example, after falling over 11% during the Global Financial Crisis, munis returned nearly 20% in the 12 months after. Munis also could potentially benefit from other key factors including solid credit fundamentals and the $350 billion federal stimulus to state and local budgets.

Not only that as bond prices dip, a “buy low” opportunity may be present not only in munis, but other areas of the bond market.

Myth #3: “The Long-Term View Looks Dismal”

Answer: False

When taking a long-term perspective, investors could potentially generate more income from their bond holdings in a rising rate environment than they would have otherwise.

Here’s how investors can capitalize on rising rates as bonds mature, given the following assumptions:

1. Every year, a maturing bond is replaced with a new 5-year bond.
2. The yield is 20 basis points (bps) higher on each new bond.

Hypothetical example, for illustrative purposes only. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument.
Source: RBC Global Asset Management (2020)

Over the long term, a rising rate environment more than doubled the bond portfolio’s return compared to the falling rate scenario.

With this in mind, active management and a long-term strategy can potentially benefit investors during today’s rising interest rate environment.

Research shows that active approaches to fixed income have generally outperformed passive strategies by diversifying across the maturity spectrum while proactively balancing risk and return. Active strategies can seek out new opportunities as interest rates shift, addressing a broader scope of the bond market.

The Case for Bonds

With inflation and bond yields on the rise, purchasing newly-issued bonds at higher rates can help offset this impact. While bonds may not seem like the obvious choice for investors amid rising rates, history shows us that they may be worth a closer look.

This infographic is available as a poster.

The Benefits of Value Stocks in Rising Rate Environments

As investors flock to safety, value stocks have outperformed growth stocks year-to-date amid economic turbulence and rising interest rates.

Owing to their strong fundamentals and cash flows, value stocks may be returning into favor.

In this infographic from New York Life Investments, we illustrate why value stocks offer opportunities in rising rate periods.

Recent Performance

In a matter of two years, the Ukraine war, supply chain shocks, and COVID-19 have led inflation to multi-decade highs.

Amid these complex struggles, value stocks have outperformed significantly.

• Russell 1000 Value Index: -1.1%
• Russell 1000 Growth Index: -14.1%
• S&P 500: -8.4%

As of April 14, 2022

With higher inflation predicted for the medium term, value stocks may be staging a comeback.

As investors look to de-risk their portfolios, many are turning to value stocks, thanks in part to their historical outperformance during inflationary and rising rate periods.

Value vs. Growth: Key Characteristics

As a quick refresher, here are the key distinctions between value stocks and growth stocks.

Cyclical sectors such as financials and energy often benefit when prices increase after an economic contraction.

Since companies earn money in different ways, it is often useful to compare price-to-earning (P/E) ratios within a sector. A P/E ratio is a metric for valuing a company, where a company’s stock price is divided by its earnings per share.

An overvalued company in the tech sector may have a P/E ratio of 100, while the S&P sector average is 24. By contrast, an undervalued healthcare company may have a P/E ratio of 14, lower than the S&P sector average of 16.

When a company is undervalued it means that it’s trading below its intrinsic value.

Value vs. Growth: Performance

Looking back, the previous decade saw the worst performance for value in the last 90 years.

On average, growth outperformed value by 7.8% annually since 2010. However, looking at 10-year periods, value has outperformed growth over every decade since the 1940s.

Average annual performance of Fama and French (“HML”) value factor by decade.
Source: Fama & French via Mercer (Mar 2021)

Now, against economic uncertainty and other structural shifts, the growth and value divergence is beginning to change for the first time in over a decade.

What is Driving Value Stocks?

On a broader level, the following forces have driven outperformance in value stocks and growth stocks.

So how do these apply today?

In an inflationary (and rising rate) period, current earnings become more valuable and future earnings become less valuable. Typically, “value stocks” are assessed based on their current earnings while “growth stocks” are valued on their future earnings.

Consequently, inflationary periods have tended to favor value stocks and deflationary periods have tended to favor growth stocks. When prices are climbing, companies with actual earnings are potentially better positioned to increase prices and retain profit margins.

At the same time, it is important for investors to avoid value-traps, which are companies trading below value that are in financial duress. To help mitigate this challenge, active investment managers can help identify the appropriate companies.

Sign of the Times

It’s worth noting that this isn’t about value vs. growth. Instead, different styles have performed better at different times. Of course, it’s important for investors to consider a number of variables for their portfolios:

• Investment Objectives
• Time Horizons
• Volatility
• ESG Objectives

With these in mind, investors can implement the best strategies to help achieve their goals.