Friday 500: Five Hundred Words on Finance Every Friday

Friday 500: Five Hundred Words on Finance Every Friday

What goes up, must come down                     

The biggest economic change in the past 90 days might not be what you think it is: Over the last three months, the stock market took a backseat to the bond market. What goes up must come down has been a common theme in the bond market over the last 40 years.  When the bond market has shown bearish sentiments, it has turned around and either maintained or fallen.  In October, the latest bearish bond market rally ended with  the 10 year treasury hitting five percent.  Aided by hopes that inflation was under control, and weakening purchases of US debt, the rates started to fall and have consistently fallen. We are now sitting at around four percent.

Let’s dig into the details of what that means for investors. The good news for the U.S. debt is that the cost of debt fell by one percent. The bad news for savers and investors is that we just lost one percent of effective yield on our fixed income investments in the 10 year treasury.  This is also a proxy for how the rest of the debt issuers are paying as well. Corporate bond yields came down significantly over that same time frame.

There is a reason why experts call the bond market the fixed income market and that is because inside each bond that you own there is a fixed payment to begin to payoff their debt back to you.  This is sometimes referred to as the coupon payment or the interest payment.  This income payment is part of the measurement of the overall rate of return you will receive from your bond investment.

The other part is related to the interest rate market today vs. when you purchased the bond.  If you have a bond from 1982 that is still paying 14 percent interest, someone would pay you a significant premium for that bond. Most debt is issued in $1,000 increments so you could receive way more than your $1,000 in the form of appreciation on your bond because interest rates are lower today than when you bought the bond.  Now this works both ways: If you bought a bond in 2020 when the 10 year treasury bottomed out around .47 percent, and tried to sell that bond on the open market today, you would be forced to sell it at a discount.  Why would I pay $1,000for a bond earning .47 percent when I can buy one on the open market for the same $1,000 that yields four percent?

Much of what we do here is focus on the fixed income markets as much as the stock market because we are retirement advisers and income planners.  We need to know and understand the inner workings of the income market for our clients. If you want to know where income is heading, check out the fixed income market, not the stock market!

—Billy Voyles, Founder & President of Fundamental Wealth Designs

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