The metaphor of a “roller coaster” is often used to describe the capital markets. Ups, downs, quick turns; they all apply to the gyrations we see in the markets. This year is no exception!
Most surprising this year, though, are the gyrations we have seen in the bond markets. A newly-turned “hawkish” Fed has put all parts of the yield curve at risk with targeted increases in the Fed Funds rate and planned selling of bonds from Fed inventory impacting the long end. Moreover, the potential for a weakening economy begs the question of corporate credit strength and the widening of credit spreads.
Nowhere have we seen this more evident than in the recent performance of short corporate bonds (SLQD) versus intermediate term corporate bonds (LQD). As seen from the chart below, the recent performance since May 3 shows increased volatility and varied performance. SLQD (the green line) has been decidedly “flattish”, whereas LQD (the blue line) shows a nice “trough/peak” profile; core bonds (AGG, the gold line) is somewhere in the middle.
These profiles looks something like a classic risk versus return tradeoff; SLQD is less risky and delivers less return, whereas LQD has shown more risk and more return. No one knows if rates will continue higher or revert lower due to potential for impending recession or other causes; no one knows! Consequently, if you have an aggressive risk profile you would opt for the “blue line” in lieu of the “green line”, and vice versa. Or, as I prefer, regardless of your risk profile you would opt for “some” green line exposure to smooth your return profile and provide well-diversified exposure to the bond markets.